Small businesses at greatest risk

By Bill DeRosa

Globally, organizations lose an estimated 5% of their annual revenues to occupational fraud, according to a survey of Certified Fraud Examiners (CFEs) who investigated cases between January 2012 and December 2013. Applied to the estimated 2013 Gross World Product, this figure translates to a potential total fraud loss of more than $3.5 trillion.

The Association of Certified Fraud Examiners (ACFE) published the results of the survey in its 2014 Report to the Nations on Occupational Fraud and Abuse. The report includes data compiled from 1,483 cases of fraud submitted by CFEs globally.

Key findings from the 80-page report include:

  • Fraud schemes are extremely costly. The median loss caused by the occupational fraud cases in the study was $145,000. Nearly one-fourth (24%) of these cases caused losses of at least $1 million.
  • Schemes can continue for months or even years. The frauds in the study lasted a median of 18 months before being discovered.
  • High-level perpetrators do the most damage. The median loss among frauds committed by business owners/executives was $500,000, much higher than the median loss of $130,000 for frauds committed by managers and $75,000 for frauds committed by other employees.
  • External audits are among the least effective controls. Although such audits are used by a large number of organizations in combatting occupational fraud, they were the primary detection method in just 3% of the fraud cases in the study. (To put it in perspective, 7% were detected by accident.
  • Occupational fraud is a global problem. Although some findings differ slightly from region to region, most of the trends in fraud schemes, perpetrator characteristics, and antifraud controls are similar regardless of where the fraud occurred.

Tips Appreciated

Occupational fraud is far more likely to be detected by a tip than by any other method. More than 40% of all cases in the ACFE study were detected by a tip: with the majority of them coming from employees of the victim organization.

To encourage employees to provide tips when they suspect fraud, ACFE's director of research, Andi McNeal, CFE, CPA, urges employers to implement an anonymous reporting system.

"If a business has the resources to dedicate, the most cost-effective control is a hotline," she says.

There are several providers of hotline services that can help implement an anonymous tip reporting system for businesses of all sizes and industries. But if a formal hotline service is beyond a small company's means, McNeal recommends implementing an alternative reporting mechanism.

"It can be something as simple as setting up a dedicated email account or an online reporting form," she says, "or it could be as rudimentary as a box where people can drop off tips on paper."

Whatever the means, she suggests that workers be allowed to report anonymously.

"A lot of employees prefer to do it that way."

In Employees We Trust

The smallest organizations in the ACFE study suffered disproportionately, with a median loss of $154,000: higher than the overall median loss for fraud cases in the study ($145,000). These organizations typically employ fewer anti-fraud controls than their larger counterparts, which increases their vulnerability.

"A lot of small businesses have a small staff and are operating with a much smaller budget than their larger counterparts," says McNeal, which, she notes, can make it difficult for them to implement robust antifraud controls.

But a lack of resources isn't the only problem.

"With a small staff comes an inherently greater level of trust in employees," says McNeal. "In many small companies, everyone knows everyone else and even their families, and they automatically trust that their coworkers are doing their jobs as they are supposed to be. So there tends to be a lot less scrutiny and a lot less checking on things that might not look right."

Simple Prevention Steps

A relatively easy, low-cost way to discourage occupational fraud is to create a formal antifraud policy and distribute it to employees at the time of hire and periodically thereafter. Such a policy, says McNeal, "sends a clear message that management is focused on fraud and won't tolerate it."

Antifraud training is also an important prevention tool, she says, suggesting that small firms roll it into their existing employee training or education programs.

"It doesn't have to be extensive. It really just needs to cover, 'Here's what fraud is, here's what it looks like, and here's what to do if you suspect it.'"

How Do You Like My New Ferrari?

An important part of employee antifraud training, says McNeal, is teaching workers to recognize the most common behavioral traits observed among fraud perpetrators, something the ACFE Report to the Nations tracks closely. More than 90% of fraud perpetrators in the study cases displayed certain common behavioral indicators. The most common was living beyond one's means.

"In nearly 44% of the cases, the perpetrator was living in a way that was overtly beyond his or her means during the time of the fraud," says McNeal. "It could be anything from taking lavish vacations to driving a new sports car to purchasing a new vacation house."

As an example, McNeal cites the well-publicized case of Rita Crundwell, former Dixon, Illinois, comptroller who embezzled an astounding $53 million over 20 years from the small town's coffers, using the money to, among other things, buy hundreds of purebred show horses for her equine breeding business. Crundwell was sentenced in 2013 to 19-plus years in prison.

"She was a city employee who made a typical public servant's salary and was very open about the fact that she had this side project, but no one thought to ask her where she was getting all the money to fund it," recalls McNeal. "So I think the lesson is to let employees know, as part of their fraud awareness training, that there are certain behaviors to watch for."

Other common red flags include having financial difficulties (33% of cases) and keeping an unusually close association with a vendor or customer.

"We saw that in 22% of cases," says McNeal. "It's one that employees may be able to keep hidden, but on the other hand, they might not."

Who's in Control?

Exhibiting control issues with an unwillingness to share job duties (21.1%) is another common behavioral indicator that an employee may be committing fraud: particularly when it comes to accounting or bookkeeping staff.

These are cases of employees "who really just seem to want to keep all of their duties to themselves," says McNeal. "They don't want people looking over their shoulder. They don't want to have to explain why they do things a certain way, and they certainly aren't going to offer to train others how to help them do their job."

She notes that such behaviors may indicate that an employee is keeping his or her job duties closely guarded in an effort to hide something.

"That's something we see a lot in small businesses, because you've got that inherent level of trust, and in the smallest companies, you have a one-person accounting shop," says McNeal. "So if you have someone in that position, and he or she seems hesitant to open up and provide transparent answers to questions that are being asked, that's definitely a red flag."

Bill DeRosa is editor of CBIA News. Contact him at bill.derosa@cbia.com.