by Melissa Klein
Occupational fraud will cost United States companies $600 billion in lost revenue in 2002, according to the latest report by the Association of Certified Fraud Examiners.
And that’s a conservative estimate, since most fraud goes unreported, according to the ACFE, in Austin, Texas.
"Occupational fraud is the single biggest category of fraud as far as we know," said ACFE chairman Joseph T. Wells. "There’s hardly any company that’s not affected by it. It’s a seriously underreported issue."
ACFE defines occupational fraud as: "the use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization’s re-sources or assets."
The 2002 Report to the Nation on Occupational Fraud and Abuse, also known as the Wells report after the group’s founder, is based on data from 663 occupational fraud and abuse cases reported on by certified fraud examiners.
The frauds in the study accounted for over $7 billion in total losses, the largest of which involved a financial statement swindle that caused $5.4 billion in losses. The smallest case was a fraudulent expense reimbursement of $100.
The good news, if there is any, is that the rate of occupational fraud has apparently not risen. When asked to estimate the percentage of revenues that will be lost in 2002 to occupational fraud and abuse, CFEs projected a median cost of 6 percent, the same rate that was estimated in the 1996 report. However, a rise in the Gross Domestic Product from roughly $7 trillion to about $10 trillion accounts for a $200 billion increase, the ACFE reported.
But that doesn’t mean it’s less costly. More than half of the 620 cases in which CFEs were able to provide loss data cost victims at least $100,000, and nearly one in six caused losses of $1 million or more.
The report divides occupational fraud into three major categories: Asset misappropriations, such as skimming revenues, stealing inventory, and payroll fraud; corruption, including accepting kickbacks; and fraudulent statements – falsification of financial statements, such as overstating revenues, and understating liabilities or expenses.
While asset misappropriations were by far the most common, accounting for nearly 86 percent of the cases, fraudulent statements accounted for the largest losses, with a median cost of $4.25 million. The 568 asset misappropriations included in the report had a median cost of $80,000, while corruption schemes accounted for 12.8 percent of all cases, with a median cost of $530,000.
Not surprisingly, cash was the most common target. Roughly 90 percent of the asset misappropriation cases involved the theft of cash.
"The majority of occupational frauds occur in the cash account for pretty obvious reasons," Wells noted. "Even for companies that are not fully audited, CPAs can be a big service to clients by offering to do limited examinations of the cash accounts."
Of the three types of cash schemes, fraudulent disbursements – submitting false invoices or false timecards - were the most frequent and had the highest median loss, costing an average of $100,000 and accounting for more than 70 percent of cases. Skimming – the theft of cash before it is recorded on the books – accounted for roughly 32 percent of cases, with a median cost of $70,000. The least common was cash larceny – cash stolen after it’s recorded on the books – which accounted for 8.9 percent of cases and had a median cost of $25,000.
Data on the frequency and cost of occupational fraud by category was similar to data from 1996. However, the median costs of asset misappropriations rose to $80,000 this year, up from $65,000 in 1996. The median cost of fraudulent statements jumped to $4.25 million in 2002, from $4.0 million six years ago, while the median cost of corruption schemes rose to $530,000 from $440,000 in 1996.
Employees may be companies’ best method of detection, according to the report. In more than a quarter of the 532 cases for which data was provided, a tip from an employee was the method of detection. Tips from all sources (employees, customers, vendors and anonymous complaints) were a factor in 46 percent of cases.
The second most common method of detection was by accident, accounting for 18.8 percent of cases, followed by internal audit, which uncovered 18.6 percent of cases. Internal controls were a factor in 15.4 percent of cases.
The report concluded that the presence of an internal audit department has a deterrent effect on occupational fraud, since employees who know that auditors are present and looking for fraud are less likely to commit fraud because of a greater perceived likelihood that they will be caught. Companies that lacked an internal audit department suffered median losses of $153,000, as opposed to the $87,500 median loss in companies that had an internal audit department.
When asked which of eight measures were most helpful in preventing fraud against organizations (with a rank of "1" for the measure that is most effective), respondents ranked a strong system of internal controls as the most effective. Detailed background checks on new employees were thought to be the next most important measure, followed by regular fraud audits and established fraud policies. Willingness of companies to prosecute, ethics training, anonymous reporting mechanisms and workplace surveillance were ranked least effective, respectively.
While 46.2 percent of fraud cases occurred in firms with insufficient controls, almost as many (39.9 percent) occurred where controls were in place but were ignored. In about 11 percent of the cases, respondents said that the scheme couldn’t have been prevented by standard internal controls.
The frauds were distributed fairly evenly across four sectors: government agencies, publicly traded companies, privately held companies and not-for-profit organizations. The largest median losses ($150,000) occurred in public companies, while the smallest took place in non-profits ($40,000) and governmental agencies ($48,000).
The smallest organizations (100 employees or less) suffered higher median losses per scheme than the largest organizations (10,000 employees or more). Firms with less than 100 employees had a median loss of $127,500 per scheme, compared to $97,000 per scheme for companies with more than 10,000 employees.
"We found that, by far, the most costly fraud occurs in the smallest organizations," Wells noted. "Auditors need to be especially mindful that asset misappropriation is very common in business. The smaller the business, the more material that asset misappropriation is."
"Eight times out of 10, auditors will run into a fraud where employee has stolen money," Wells added. "It may be a great deal of money, or it may not be. But in all situations, when the auditor doesn’t uncover a fraud, even if it’s not material, the client is disappointed in the performance of the auditor."
According to the study, two factors contribute to the large losses suffered by small companies. First, organizations with small staffs often lack basic accounting controls. It’s not uncommon for a small organization to have a single employee who writes and signs checks, reconciles the bank statement and keeps the company’s books, making fraud easy to commit and conceal.
The second factor is the level of trust between co-workers within small organizations, according to the ACFE. In an atmosphere where employees and management know each other well on a personal basis - as is often the case in small businesses - they can be less alert to the possibility of dishonesty, ACFE said.
For small firms, "The single most effective prevention of fraud is oversight – an independent check by someone else over the activity of an employee," said Wells. "The great majority of frauds, except for financial statement frauds, can be prevented through simple internal control mechanisms, the most important being the separation of duties."
So, how long does the typical fraud scheme go undetected? Based on 583 responses, the median length of time from inception to detection was 18 months. Nearly two out of every three schemes ran for more than a year before they were detected, and 13.5 percent of the frauds ran for five years or longer before they were caught. Only 3 percent of schemes were caught within the first month.
According to the ACFE, one of the strongest indicators of the size of the loss in an occupational fraud scheme is the perpetrator’s position. Schemes committed by managers and executives, on average, cause median losses of $250,000, about 3.5 times higher than losses from frauds committed by rank and file employees. The trend isn’t surprising, the ACFE noted, since higher-level employees have a greater degree of control over company assets.
Collusion has a major impact on the size of fraud. In cases where employees and managers conspired, the median loss was $500,000, over eight times the median loss caused by schemes where employees acted alone.
While most of the frauds were committed by a single perpetrator (68 percent), the median loss in schemes with multiple perpetrators was $450,000 – almost seven times higher than the losses caused by perpetrators who acted alone.
The report also found that most people who commit fraud are first-time offenders. Only about 7 percent of the perpetrators were known to have been convicted for a previous crime, while another 3 percent were known to have been previously charged for a fraud-related offense.
Gender also plays a role. While the number of schemes committed by both sexes was roughly the same, losses from schemes committed by men were more than three times as high as the losses caused by women. According to the ACFE, this is reflective of the fact that losses are strongly related to the perpetrator’s position, and the majority of managerial and executive positions are still held by men.
The report also showed a correlation between age and median loss. As perpetrators got older, their schemes got more costly. Median losses for the oldest employees (those older than 60) were $500,000, 27 times higher than losses caused by employees under 25 years of age. Like gender, the ACFE said age is a secondary factor, with the primary factor being that older employees tend to hold more senior positions with greater access to assets.
Two-thirds of the frauds were committed by people over age 35, and nearly half of all schemes were committed by individuals between the ages of 36 and 50. Only 6 percent of the frauds in this study were committed by individuals below the age of 25.
In contrast to anecdotal evidence that suggests that organizations rarely attempt to prosecute dishonest employees, 75 percent of the 650 CFEs who responded to questions on criminal referrals said that the victim organization referred its case to law enforcement.
In over 75 percent of 490 cases that were referred, the perpetrator was convicted, either through a plea bargain (64 percent) or at trial (14 percent). Among cases that went to trial, the state scored 64 convictions versus five acquittals for the defendants. In only about 12 percent of the cases, the state declined to prosecute.
Of 93 civil cases that went to jury verdict, judgment was rendered in favor of the victim 53 times (57 percent), no judgments were rendered in favor of the perpetrator, and roughly one-third of the cases were settled.
In cases where victims declined to take legal action, the offender, fear of bad publicity, the fact that a private settlement had been reached and the victim’s desire for closure were all cited as reasons in over 25 percent of the cases.
