Fraud Detection and Prevention

 

Fraud may be committed by senior executives, managers, and employees, and each of these three groups is about equally likely to do so. The higher up on the scale, the longer it takes to detect the fraud.

Why embezzlement occurs:

  1. Opportunity–a person who has been with the company a long time may not be supervised closely; and therefore, may have more opportunities to commit fraud.
  2. Rationalization–someone feels he or she is not being compensated appropriately, or has been passed over unfairly for a promotion.
  3. Pressure–financial pressure or the pressure to lead a life style that can’t be supported by current income. Personnel nearing retirement may have financial pressure if they are concerned about having enough assets to provide for their retirement.
  4. Arrogance–the more arrogant an executive, manager, or employee, the more likely he or she will commit fraud.
  5. Competence–highly skilled people are better able to commit fraud.

How fraud is detected and prevented:

  1. Most fraud is detected by tips from other employees, sometimes via a hotline. Employees may be more likely than management to be aware of unusual behavior that that may indicate another employee is involved in fraudulent activity.
  2. Management attitudes and systems can demonstrate that management is alert to the possibility of fraud. For example management may reconcile bank statements and question employees about non-reconciled items. Employees who are aware that management is alert to possible fraudulent activity are less likely to commit fraud.
  3. Customers may report possible fraudulent activities. For example, not receiving a receipt for a payment may create suspicion of fraudulent activity. Customers can be invited to participate in the hotline mentioned above.

Red flags that may indicate fraud (but no one red flag is generally a sufficient indicator):

  1. Living beyond means
  2. Unusually close to a customer or vendor
  3. Financial problems
  4. Sudden changes in personality or appearance
  5. Refusing promotions or opportunities to learn new skills
  6. Not taking time off even when obviously ill
  7. A pattern of arriving very early and leaving very late every day
  8. Overly protective of work space
  9. Limited segregation of duties
  10. Personnel involved in many outside ventures
  11. Alterations of documents
  12. Documents go missing
  13. Employee involved in nearly every function in the office
  14. Employee or manager has created very complex and confusing processes and refuses to change or simplify them

Prevention

  1. Hotline–an external hotline may work best as it can be monitored continually
  2. Internal controls
    1. Segregation of duties
    2. Management reviews–e.g., investigating red flags, verifying the legitimacy of vendors
    3. Surprise audits can serve to demonstrate to employees that they commit fraud at great risk of being detected
    4. Employee support programs, e.g., assistance with financial planning, guidance in drug abuse problems
    5. Requiring annual vacations
    6. Regular rotation of job functions
    7. Develop a code of conduct and require all personnel to sign it annually. It will set forth the ethical behavior required of all personnel and describe fraudulent activity. It can be helpful in a court of law when trying to recover fraud losses. (most fraud losses are never recovered, due to some extent to the difficulty in getting government officials to agree to prosecute)
  3. Be aware of publicized frauds in other companies and try to determine how the circumstances in your company can lead to a similar occurrence

This blog provides a limited introduction to fraud detection and prevention. For more detailed information or to ask questions about any of the content above, please contact us.

 

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