Fraud, and how to avoid it

 

Got a staff member noticeably living beyond his or her means? Then check your bank account. In four out of ten cases of fraud, the fraudster was found to be living the good life. 

Fraud is a major business cost in New Zealand and all business owners should be treating it as a risk.

Red flags abound for principals wary of fraudsters within the ranks. Often fraud detection is simply a matter of being aware of what’s going on.

According to the National Business Review, in 2013 one third of New Zealand businesses surveyed reported being a victim of fraud. During the 2011 calendar year, the Serious Fraud Office investigated cases with losses in excess of $2 billion.

However, the overall cost of fraud in all its forms, and where those losses are most occurring, is still not as well understood in New Zealand as it is in many other similar markets.

The good news is, there are some simple steps you can take to prevent, recognise and respond to fraud in your organisation.

There are three main categories of fraud – financial statement fraud, asset misappropriation and corruption.

The first, such as bringing forward fictitious revenue and improper asset valuations, is motivated by business objectives such as evading tax and underpinning a share price.

Asset misappropriation, such as theft, false invoicing and payroll fraud, is motivated by greed, financial hardship, substance addition and the like. It’s the same motivation behind corrupt fraud such as kickbacks, supplier favouritism, insider trading and diversion of sales.

All frauds are the outcome of three factors: rationalisation, opportunity and motivation and pressure, according to Cressey’s Fraud Triangle*. 

Fraudsters will rationalise their actions by thinking the organisation ‘can afford it’, ‘everyone does it’, ‘I’m not paid enough’, ‘just this once’ and the like.

Opportunity is provided by weakness in internal systems, the ability of the fraudster to override controls, their skills as a fraudster and the collusion from others.

Finally, if the fraudster is greedy or has an inflated ego or is in financial dire straits, then that can provide motivation or pressure for illegal activity.

The main reasons for fraud are interesting too. 

According to the Office of the Auditor-General’s 2012 report into public sector fraud, in four out of ten cases – by far the majority – the fraudster simply didn’t think he or she would be caught. In nearly a third of cases, internal control procedures simply weren’t followed. In fact, in eight percent of fraud cases, there were no internal control policies or procedures at all.

In the above cases, only 12 percent of the proceeds of the frauds were recovered. Worse, in nearly 60 percent of cases not a dollar was recovered. Worse still, it costs an average ten percent of the known fraud to investigate it.

So how can you stop the fraudsters? Prevention, of course, is the best place to start.

An ethical corporate culture supported by clearly articulated codes of conduct, fraud policy, training and detection, such as audits and management reviews, are effective measures.

To prevent opportunity, clearly risk assessment, internal and dual controls, pre-employment and supplier vetting are all important. Segregating responsibilities is an effective preventative measure because around three quarters of fraud involves only one person.

Simple online desk research can pay huge dividends. Twenty-nine percent of fraud cases relate to supplier invoices, 14 percent of fraudsters have been previously charged or convicted and 19 percent fired or disciplined for fraud-related offences. Much of it will be online somewhere.

Other ways to prevent opportunity include IT back-ups of controls, regularly reviewing access rights, removing terminated staff from systems, and monitoring of privileged accounts, suppliers and contractors.

Most important, you must enforce strong password controls. A SplashData survey in 2013 identified the top five most commonly used passwords as: 123456, password, 12345678, qwerty and abc123.

 

There are some clear red flags signalling possible fraud. An Association of Certified Fraud Examiners (ACFE) 2014 global survey identified the following as the top four indicators: 

• Staff living beyond their means (43 percent of cases). 

• People with financial difficulties (33 percent). 

• Staff with unusually close association with vendors or customers (22 percent).

• Employees with excessive control (21 percent).

 

It is not possible to prevent all fraud but best-practise procedures for prevention, detection and response to fraud will go a long way to protecting your business.

Fraud control is a management responsibility that must be supported by a strong ethical culture and a focus on internal controls. Most fraudsters are individuals rather than career criminals so look for those red flags. 

Finally, prevention of opportunity is the best insurance against fraud. 

A fraud health check is an excellent starting point for businesses and your financial adviser will be able to help.