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Most employee fraud occurs in small businesses

By Roy Maurer

Organizations around the world lose an estimated 5% of annual revenues to fraudulent activities, according to a study conducted by the Association of Certified Fraud Examiners (ACFE). Forty-two percent of fraudsters were found to be employees, 38 percent managers and 18 percent owners/executives, according to the 2012 Report to the Nations on Occupational Fraud & Abuse

Accounting was the most common area of employment for fraud perpetrators, representing 22 percent of cases. Operations ranked second at 17 percent. A majority of fraudulent activity in the United States occurs in small businesses.

ACFE encourages business leaders and employees to take proactive steps to minimize the impact of fraud by promoting anti-fraud awareness and training.

Fraud Is Costly

The median loss caused by the occupational fraud cases in the ACFE study was $140,000. More than one-fifth of the frauds involved losses of at least $1 million.

At 87 percent of cases reported by respondents, asset misappropriation was the most common type of fraud found in the study. Those cases were the least costly at a median loss of $120,000. Conversely, while financial statement frauds remained relatively rare at 8 percent of the cases detailed by respondents, they inflicted greater damage, with median losses of $1 million, the ACFE found.

For all geographic regions, corruption and billing schemes comprised more than 50 percent of the frauds reported to the ACFE. Corruption was defined as an employee misusing his or her influence in a business transaction in a way that violates his or her duty to the employer in order to gain a direct or indirect benefit.

Small Businesses Especially Vulnerable

Typically, small organizations lack anti-fraud controls compared to their larger counterparts, which makes them particularly vulnerable to fraud, the study found. Because they have fewer resources, the losses they experience have a greater impact than they would in larger organizations.

The research found that fraud risks faced by small organizations typically differ from those faced by larger organizations. For example, corruption was observed to be the most prevalent fraud committed in larger organizations, occurring in nearly 35 percent of the reported cases in companies with more than 100 employees, compared to 28 percent of small business cases. In contrast, billing schemes were the most common fraud committed in smaller organizations. In addition, check tampering was three times as common and payroll and skimming schemes were noted almost twice as often in smaller organizations than larger ones. 

The ACFE recommended that managers and owners of small businesses should focus their anti-fraud efforts on the most cost-effective control mechanisms, such as hotlines, employee education and setting a proper ethical tone within the organization. “Additionally, assessing the specific fraud schemes that pose the greatest threat to the business can help identify those areas that merit additional investment in targeted anti-fraud controls,” the ACFE said.

The key to fraud detection

Occupational frauds are much more likely to be detected by tip than by any other means, the study found. This finding reinforces the need for promoting awareness to foster an informed workforce, the ACFE said. Respondents in 36 percent of the cases in the study said a lack of internal controls was the most important contributing factor to a fraud.

Tips have been the most common method of fraud detection since the ACFE began tracking fraud data in 2002. Management review and internal audit ranked as the second- and third-most common methods of detection, but tips were almost three times as common as either of those factors as an initial method of detection. Initial detection occurred via tip in 43 percent of the frauds in the study.

External audits are the most commonly implemented control, but should not be relied upon as a primary fraud detection method, according to the report, because they detected just 3 percent of the frauds reported in the study.

Fraud awareness training

Targeted fraud awareness training for employees and managers is a critical component of a well-rounded program for preventing and detecting fraud, the ACFE said. Employee tips are the most common way occupational fraud is detected, but the research showed organizations that have anti-fraud training programs for employees, managers and executives experience lower losses and shorter-term frauds than organizations without such programs in place. At a minimum, staff members should be educated regarding what actions constitute fraud, how fraud harms everyone in the organization and how to report questionable activity, the ACFE said.

Most fraudsters exhibit behavioral traits that can serve as warning signs of their actions. 

The most common behavioral flags associated with perpetrators were living beyond their means (36 percent) and financial difficulties (27 percent).

Managers, employees and auditors should be educated on these common behavioral patterns and encouraged to consider them, particularly when noted in tandem with other anomalies, to help identify patterns that might indicate fraudulent activity. Most occupational fraudsters are first-time offenders with clean employment histories. Approximately 87 percent of occupational fraudsters had never been charged or convicted of a fraud-related offense, and 84 percent had never been punished or terminated by an employer for fraud-related conduct.

The Report to the Nations was based on the results of an online survey of certified fraud examiners from October 2011 to December 2011. The report is based on 1,388 fraud cases from 96 countries.

Roy Maurer is an online editor/manager for the Society for Human Resource Management (SHRM).

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