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. In this month’s blog we discuss why embezzlement occurs, how fraud is detected, red flags that may indicate fraud and tips for prevention.

Why Embezzlement Occurs:

Embezzlement occurs for a number of reasons:

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.

Rationalization – someone feels he or she is not being compensated appropriately or has been passed over unfairly for a promotion.

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.

Arrogance – the more arrogant an executive, manager, or employee, the more likely he or she will commit fraud.

Competence – highly skilled people are better able to commit fraud.

How Fraud Is Detected And Prevented:

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.

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.

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:

The following are red flags that may indicate fraud. (Note, one of these, alone, is generally a sufficient indicator.)

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

Preventing Fraud:

There are two primary things you can do to prevent fraud.

Set up a Hotline

An external hotline may work best as it can be monitored continually.

Establish Internal controls including:

Segregation of duties
Management reviews–e.g., investigating red flags, verifying the legitimacy of vendors
Surprise audits can serve to demonstrate to employees that they commit fraud at great risk of being detected
Employee support programs, e.g., assistance with financial planning, guidance in drug abuse problems
Requiring annual vacations
Regular rotation of job functions
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)
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 our office at (270) 443-3643.