Michael B. Lehner, CPA/ABV, CFE, ASA
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Fight fraud with active detection methods

Fight fraud with active detection methods

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The Association of Certified Fraud Examiners (ACFE) recently released its Report to the Nations: 2018 Global Study on Occupational Fraud and Abuse. This biennial report — based on an analysis of 2,690 occupational fraud cases from 125 countries investigated between January 2016 and October 2017 — provides valuable guidance to help businesses, attorneys, and forensic experts prevent, detect and investigate fraud.

A key takeaway is that active detection methods — such as surprise audits or data monitoring and analysis — are far more effective than passive methods — such as confessions or notification by police — in reducing fraud loss and duration. Unfortunately, many companies fail to use these methods to their full potential.

Active vs. passive detection

The best way to minimize fraud losses and the duration of fraud scams is to implement antifraud controls to actively detect schemes, rather than waiting to receive tips or confessions. The ACFE study found that frauds detected using passive methods tend to last longer and produce larger losses than those detected by such active methods as:

  • IT controls,
  • Data monitoring and analysis,
  • Account reconciliation,
  • Internal audit,
  • Surprise audits,
  • Management review, and
  • Document examination.

These active methods of detection can significantly lower fraud durations and losses. For example, frauds detected by IT controls had a median duration of five months and a median loss of $39,000. By comparison, fraud detected through notification by police had a median duration of 24 months and a median loss of $935,000.

Surprise audits and proactive data monitoring and analysis can be especially effective ways to fight fraud. On average, victim-organizations without these antifraud controls in place reported more than double the fraud losses and their frauds lasted more than twice as long as victim-organizations with these controls in place. Yet only 37% of the organizations in the ACFE study had implemented surprise audits or data monitoring and analysis, however.

Close-up on tips

The ACFE categorized tips — the leading fraud detection method — as “potentially active or passive,” because they may or may not involve proactive efforts designed to identify fraud. Organizations that use hotlines for reporting misconduct detected fraud by tips more often (46% of cases) than those without hotlines (30% of cases).

More than half of tips came from employees, but nearly one-third came from outside parties, such as customers and vendors. To ensure that tips are used as an active detection method, an organization should set up a hotline and promote its use among employees, supply chain partners and others. If possible, users should be able to make anonymous reports.

Lessons learned

Here are other key findings from the ACFE’s 2018 study:

  • Asset misappropriation occurred in 89% of cases. It was the most common but least costly type of occupational fraud, with a median loss of $114,000.
  • Financial statement fraud occurred in 10% of cases. It was the least common but most costly type of occupational fraud, with a median loss of $800,000.
  • Corruption, such as bribery or conflicts of interest, occurred in 38% of cases. It caused a median loss of $250,000.
  • Internal control weaknesses were responsible for nearly half of fraud cases.
  • Small businesses with fewer than 100 employees lost almost twice as much per fraud scheme ($200,000 median loss) than larger businesses ($104,000 median loss). Why? In general, small businesses have fewer resources to implement robust antifraud controls, particularly those that involve separation of duties and independent checks.
  • Over the past 10 years, referrals of frauds to law enforcement for criminal prosecution have declined by 16%. The top reason is fear of bad publicity.

Occupational fraud victims that attempt to recover their losses from the perpetrators are rarely made whole. According to the ACFE survey, 53% of victims recovered nothing, 32% made a partial recovery and only 15% fully recovered their losses. The bigger the loss, the less likely they were to make a full recovery. These statistics underscore the importance of taking steps to detect fraud proactively rather than passively.

How to reduce fraud risks

Occupational fraud poses a significant threat to organizations of every type and size. Before fraud strikes, a forensic accounting expert can evaluate a company’s controls and reinforce potential weaknesses.


Sidebar: Red flags of occupational fraud

According to the latest Report to the Nations by the Association of Certified Fraud Examiners, these are the top behavioral red flags exhibited by fraud perpetrators:

  1. Living beyond one’s means (41% of cases),
  2. Financial difficulties (29% of cases),
  3. Unusually close association with a vendor or customer (20% of cases),
  4. Control issues or unwillingness to share duties (15% of cases),
  5. Divorce or family problems (14% of cases), and
  6. A “wheeler-dealer” attitude (13% of cases).

The perpetrator showed no behavioral signs of fraud in only 15% of the cases. So, training company insiders to identify behavioral red flags can be an effective tool for helping detect occupational fraud. If a client notices an executive or other employee that exhibits suspicious behaviors, contact a forensic accounting expert to investigate further.

Michael Lehner

This publication is distributed with the understanding that the author, publisher and distributor are not rendering legal, accounting or other professional advice or opinions on specific facts or matters, and, accordingly, assume no liability whatsoever in connection with its use. In addition, any discounts are used for illustrative purposes and do not purport to be specific recommendations.