The Red Flags of Fraud You May Not Know

By Lowers & Associates,

Fraud Red Flags

It would be really good to know who in your organization is most at risk of perpetrating a fraud. You could then take steps—counseling, reviewing controls, rotating jobs—to protect against that risk.

Theoretically, the Fraud Triangle does a good job of stipulating who might be a fraud risk. It says people are more likely to commit an occupational fraud when they have motivation, opportunity, and a rationale to excuse their crime. The rationale is an individual factor which organizations cannot address in advance, but there can be indicators based on motivation and opportunity.

The 2018 Report to the Nations on Occupational Fraud and Abuse contains some concrete information that is consistent with this theory. In research for the Report, the Association of Certified Fraud Examiners (ACFE) identified 17 behavioral “red flag” traits that might be associated with a perpetrator of fraud. These are primarily indicators of motivation or pressure that may cause a potential fraudster to flip into active fraud.

85% of the fraudsters in the 2,690 cases ACFE reviewed had at least one of the red flags, and 50% had more than one. They are at least somewhat predictive.

The most common red flags have to do with financial difficulties (motivation, pressure). Since 2008 when the first edition of the Report was published, the six top red flags, in order, have consistently included:

  • Living beyond one’s means
  • Financial difficulties
  • Unusually close association with a vendor or customer
  • Control issues, unwilling to share duties
  • Divorce/family issues
  • “Wheeler-dealer” attitude

Much is written about these common behavioral red flags of fraud, but there are other red flags organizations should be aware of when it comes to predicting and preventing fraud. So-called human resources-related red flags and non-fraud-related misconduct can offer valuable insight to those responsible for anti-fraud programs.

Human Resources-Related Red Flags

According to the ACFE’s 2018 report, 39% of fraudsters had experienced some form of HR-related red flags prior to or during the time of their frauds. The most common of these red flags were negative performance evaluations, and fear of job loss.

Non-Fraud-Related Misconduct by Perpetrators

According to the ACFE report, 45% of fraud offenders had committed some form of non-fraud workplace violation, which could potentially indicate a link between occupational fraud and other forms of workplace misconduct. The most common non-fraud violation was bullying or intimidation, which was observed in 21% of all cases.

To anticipate occupational fraud, the organization has to be well acquainted with its members at all levels of authority. Regular or routine evaluations (background checks, interviews, work reviews) would help to identify individuals at risk, and help them avoid failure. A fraud prevented saves the organization from damage to people, brands, and profits.

  Category: Fraud Awareness
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Benchmarking Fraud: How Does Your Organization Compare?

By Lowers & Associates,

benchmarking your controls

The Association of Certified Fraud Examiners 2018 Report to the Nations on Occupational Fraud and Abuse offers a treasure trove of data you can use to assess how your organization’s fraud profile stacks up against other organizations in terms of industry, size, and location.

The Report is based on case data reported from Certified Fraud Examiners (CFEs) from all over the world. It lends itself to benchmarking your organization because it allows you to compare your own experiences against the medians reported from broadly similar organizations. Perhaps most important, you can learn about how other organizations responded to fraud.

Your risk of fraud.

Industry sector makes a big difference in the incidence and cost of fraud. Private, for-profit companies have the highest incidence and the highest median loss, where not for profits have much smaller losses and fewer frauds overall. In between are publicly traded companies and government agencies. An interesting comparison is between private vs. public for-profit businesses, with the private ones suffering higher losses. In general, private businesses face less scrutiny than public ones.

One counter-intuitive finding is that defrauded small organizations (less than 100 employees) suffered losses almost twice as high as large organizations (100 or more employees) in absolute terms. It’s not likely that the difference is attributable to the amount of money available—larger organizations offer fatter targets.

Among all types of fraud risk, corruption is one of only two types of fraud that is significantly more likely in large organizations (the other being non-cash fraud), perhaps because size offers more opportunities for small organized cliques to penetrate weak points, or due to a larger network of connections. Corruption is prevalent in almost every industry type, with the lone exception of professional services.

Your fraud prevention measures.

The presence of anti-fraud controls, such as surprise audits, proactive data monitoring/analysis, codes of conduct, etc. is shown by the ACFE Report to reduce the medial losses associated with fraud. It is perhaps predictable that small organizations in the study were far less likely to have a full range of anti-fraud controls in place. They tend to have only the basics, such as internal audits, management review, and external reviews of financial statements. Right on cue, 42% of frauds in small organizations were caused by lack of internal controls, compared with only 25% for larger organizations which tend to have a far more complete and robust set of controls in place.

One important anti-fraud control is the presence of a tip line. This was present in a little over 20% of small organizations, but fully 80% of large ones. The reason the disparity is important is that tips are the most common way a fraud is detected.

Fraud is a threat to all types and sizes of organizations, but two tendencies in the data stand out.

  • First, large organizations deploy more controls, and ACFE finds that every type of control tends to depress fraud.
  • Second, large organizations are more likely to experience fraud by corruption, which is an intentional organized attack at the weak points in an organizations’ links between units, internal or external.

The good news is that controls do work. Small organizations that may not have enough control due to cost or scale need to find ways to implement variations of these controls. The potential payoff from fraud averted or detected quickly is too large to not implement the controls.

What can the lessons and benchmarks embedded in the ACFE’s Report to the Nations on Occupational Fraud and Abuse teach you about your own organization’s risks? How can you become better protected?

  Category: Occupational Fraud
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How Organizations Respond to Fraud

By Lowers & Associates,

How Organizations Respond to Fraud

You discover your erstwhile trusted employee has been skimming funds to support a gambling habit. What do you do?

Your first response is possibly unprintable, and understandably so. Your cooler head will prevail, and look at a small series of options for recovery, and maybe a dollop of justice. If there are losses, especially substantial losses, you will look at the circumstances of the fraudster carefully and evaluate the alleged crime for prosecution. You will look into the possibility of recovery and what the sources of recovery might be. The disruptive impact of being the victim of a crime might very well turn your thoughts away from revenge to the more practical goal of remediation.

The case studies analyzed in the 2018 Report to the Nations on Occupational Fraud and Abuse suggest a range of options organizations choose in the wake of a fraud. The Report, a study published every other year by the Association of Certified Fraud Examiners (ACFE), includes actions both through internal mechanisms and through external legal channels.

How are fraudsters punished?

It will come as no surprise that 65% of the fraudsters were simply terminated. 12% of organizations agreed to a settlement with the perpetrator and 11% of organizations say the perpetrator was no longer with the organization.  What you might not expect is that 6% of organizations took no action and another 8% put the perpetrator on probation or suspension. The methodology of the study asks participant organizations about their biggest fraud case in the recent past, so a no action result suggests there are some very complicated circumstances below the surface. At the least, these widely disparate outcomes imply that organizations conduct an investigation of the fraud, and the evidence might point to a prudent course of action other than termination.

The perpetrator’s position in the company impacts their punishment.

The perpetrator’s role in the organization clearly modifies the organization’s response. An owner or executive is much less likely to be terminated (44% compared with 65% overall), and also much more likely to receive no punishment (12% compared with 6% overall). 72% of ordinary employees who committed a fraud were terminated.

Law enforcement is not always involved.

In the legal realm, uncertainty is increased by the fact that the alleged fraudster is innocent until proven guilty. The outcome of a civil action or criminal prosecution is not a given. Still, in 2018, 58% of frauds were referred to law enforcement and 23% resulted in a civil suit—the majority of these legal actions were resolved favorably to the victim.

Legal uncertainty abounds.

Yet the legal uncertainty is reflected in the fact that 12% of fraud cases are settled by agreement even before any legal action is taken (18% of owner/executive cases). In the group of civil cases, 27% are settled by agreement.  And, fully 15% of civil cases result in a judgment for the alleged perpetrator.

The risks deter some organizations from taking legal action. 38% of these organizations cited bad publicity as the main reason, and other risks might also impose costs. Compounding the reasons to avoid legal action is the fact that in 53% of cases the victim recovered nothing, zero dollars. The more victims lose, the smaller the proportion they recover.

It is clear that organizations look at the cost-benefit value in deciding on what course of action to take in response to a fraud. Revenge may feel good, but it doesn’t serve the organizations’ interests.

 

  Category: Occupational Fraud
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Lowers Risk Group Joins Movement to Shine a Spotlight on Fraud

By Lowers & Associates,

Fraud costs organizations worldwide an estimated 5 percent of their annual revenues, according to a study conducted by the Association of Certified Fraud Examiners (ACFE). The ACFE’s 2018 Report to the Nations on Occupational Fraud and Abuse analyzed 2,690 occupational fraud cases that caused a total loss of more than $7.1 billion.

The seriousness of the global fraud problem is why Lowers Risk Group announced that it will again be participating in International Fraud Awareness Week, Nov. 11-17, 2018, as an official supporter to promote anti-fraud awareness and education. The movement, known commonly as Fraud Week, champions the need to proactively fight fraud and help safeguard business and investments from the growing fraud problem.

Lowers Risk Group joins hundreds of organizations who have partnered with the ACFE, the world’s largest anti-fraud organization and premier provider of anti-fraud training and education, for the yearly Fraud Week campaign.

During Fraud Week, Lowers Risk Group will post a series of educational articles on its risk management blog at and will share fraud prevention tips and facts on its LinkedIn page.

Mark Lowers, President and CEO of Lowers Risk Group, remarks, “The ACFE has done an incredible job bringing awareness to the issue of fraud detection and prevention, and we are proud to be a supporter of this important effort.”

ACFE CEO and President Bruce Dorris, J.D., CFE, CPA, said that the support of organizations around the world helps make Fraud Week an effective tool in raising anti-fraud awareness.

“The latest statistics tell us that fraud isn’t going away, and companies that don’t have protective measures in place stand to lose the most,” Dorris said. “That’s why it is reassuring to me to see so many businesses, agencies, universities and other organizations involved in the Fraud Week movement. The first step in combating fraud is raising awareness worldwide that it is a serious problem that requires a proactive approach toward preventing it.”

“Since our first Fraud Week almost 20 years ago, the movement continues to grow,” Dorris said. “I heartily thank all of the supporters of Fraud Week for making it what it is today.”

For more information about increasing awareness and reducing the risk of fraud during International Fraud Awareness Week, visit FraudWeek.com.

The 2018 Report to the Nations is available for download online at the ACFE’s website: ACFE.com/RTTN.  The Report is in PDF format.

About the Lowers Risk Group

Lowers Risk Group provides comprehensive enterprise risk management solutions to organizations operating in high-risk, highly-regulated environments and organizations that value risk mitigation. Our human capital and specialized industry enterprise risk management solutions protect people, brands, and profits from avoidable loss and harm. For more information, visit lowersriskgroup.com.

About the Association of Certified Fraud Examiners
Based in Austin, Texas, the ACFE is the world’s largest anti-fraud organization and premier provider of anti-fraud training and education. Together with nearly 85,000 members, the ACFE is reducing business fraud worldwide and inspiring public confidence in the integrity and objectivity within the profession. For more information, visit ACFE.com.

 

 

  Category: Occupational Fraud
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The Element of Surprise: How to Cut Fraud Detection Time in Half

By Lowers & Associates,

unannounced audits

When it comes to occupational fraud, the total loss an organization suffers is correlated with the length of time from when the fraud begins to the time it is detected. This is true for all types and circumstances of fraud even though some types lead to greater total losses, e.g., petty larceny vs. financial statement fraud. The Association of Certified Fraud Examiners’ (ACFE) 2018 Report to the Nations finds that frauds that are not detected in 60 months are 20 times as costly as those detected within the first six months.

Therefore, there is substantial value for any policy or procedure that reduces detection time. Overall the most common form of detection is from tips, especially when a safe and easily accessed hotline is provided. Other common forms of active detection are internal controls and routine internal and external audits.

Surprise Audits are Surprisingly Effective

Where external audits reduce fraud losses by less than a third, unannounced audits were found to reduce median loss and duration by 51%. When unannounced audits were in effect, median losses dropped from $152k per fraud case to $75k. What’s more, the use of unannounced audits was shown to cut the average detection time in half for fraud cases in the ACFE 2018 study. However, while superior in terms of effectiveness, unannounced audits are much less commonly used than external audits. Only 37% of the companies surveyed in the 2018 ACFE report, ‘Report to the Nations,’ used unannounced audits to detect fraud.

An unannounced audit would typically be performed by an external third party, but it doesn’t have to be. The key thing is that it must truly be unanticipated by employees or contractors who have access to assets to prevent them from taking steps to conceal fraudulent activity. An unannounced audit might employ a different and unusual approach compared to routine internal audits as an added precaution to thwart the fraudsters’ defensive tactics. Intuitively, an unannounced audit can disrupt fraud more effectively than an audit that is expected.

Perhaps the most important benefit of an unannounced audit is its capacity to detect frauds earlier, thereby reducing total losses. Obviously, these audits have to be performed often enough to disrupt fraudulent activity, but their value justifies the expense of more frequent application.

A secondary, less often recognized benefit of an audit being unannounced is that it provides a test of the routine controls in place to detect fraud. It is exactly where internal controls are weak that some of the most expensive frauds can occur.  The longer-term benefit of being unannounced includes strengthening the routine controls that operate every day.

Unannounced audits can be used in many circumstances. Auditing cash on hand is one of the most important applications, which can cover activities ranging from skimming petty cash to concealing large cash thefts from CIT carriers. Numerous accounting functions like accounts payable and payroll, as well as routines like inventory are vulnerable to frauds that can be detected by unannounced audits.

Like any other audit, unannounced audits have to be planned. The planning will involve identifying the risk points in the system being evaluated and understanding the design of existing internal controls. These factors will be used to create an audit approach leading to reporting and policy revisions as needed.

Sometimes an unannounced audit is the best way to reveal the truth about operations. The clear light of observation is the last thing a fraudster wants to see.

  Category: Fraud Prevention
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