WMU News

Could your company fall victim to fraud?

June 26, 2001

by J. Patrick Forrest

"Most lies succeed because no one goes through the work to figure out how to catch them." --Paul Ekman

Is someone defrauding your business? Don't answer to hastily. According to the Association of Certified Fraud Examiners, fraud accounts for $400 billion in losses to American companies annually-that's $9 per employee, per day. In retail, employees, not shoplifters, account for 70 percent of all theft. One third of all business failures are due to internal fraud, and the most costly losses occur in businesses with fewer than 100 employees.

So what exactly is fraud? As defined by the U.S. Supreme Court in its 1888 ruling on Southern Development Co. vs. Silva, fraud consists of:

  • a material false statement;
  • knowledge that the statement was false;
  • the statement must be relied upon by the victim; and
  • the victim must suffer damages as a result of that reliance.

That broad definition still holds true today. There are three generally accepted classes of internal fraud: misappropriation of assets, which accounts for about 80 percent of all fraud; financial statement fraud; and corruption.

The typical fraudster fits the profile of the employee some managers are least likely to suspect. On average, a fraudster is a college-educated male with no prior criminal record. He may be disgruntled, or he may be perceived as exactly the opposite-hard working, dedicated and worthy of a position of trust. Losses caused by managers are four times greater than those caused by employees.

Employees and managers commit fraud for a variety of reasons, but I believe the ultimate motive is pressure. Professionals may be suffering under financial pressure (such as greed, high debt, bad investments, excessive healthcare expenditures, or costs associated with an alcohol or drug habit), work-related pressure (low salary, job dissatisfaction or fear of job loss), or other pressures such as the need for power or control, excessive pride or ambition or family/peer pressure.

But beyond the pressures employees and managers face, to commit fraud they must also perceive an opportunity. In my research, I've found that a lack of internal control factors allows the opportunity for fraud. As an employer, you can't control many of the pressures, but you can control the opportunity.

To prevent, detect and correct fraud, companies must:

  • create and enforce internal controls;
  • scout out and correct areas of vulnerability;
  • separate authorization and record-keeping procedures;
  • draw clear lines of authority;
  • demand and regularly inspect meticulous documentation;
  • brainstorm regularly as to how fraud could be occurring;
  • rotate duties among several staff members;
  • watch for employee red flags, such as lifestyle changes, high employee turnover or refusal to take vacation or sick leave;
  • take note of management red flags, such as override of controls, unusually large product losses, unauthorized transactions or unexpected overdrafts or declines in cash balances.

If fraud is suspected, a fraud examination by a certified professional can often prove useful. A professional examiner will examine documents, interrogate corroborative and neutral third-party witnesses, and identify co-conspirators.

Considering that the average organization loses about 6 percent of its total annual revenue to fraud and abuse committed by its own employees, the problem is far too serious to ignore.

Dr. J. Patrick Forrest is an associate professor of accountancy at WMU. This column was originally published in the June 6 issue of MiBizSouthwest and is reprinted in WMU News with their permission. The article is part of a monthly MiBiz series featuring professors from the WMU Haworth College of Business.

Media contact: Jessica English, 616 387-8400, jessica.english@wmich.edu

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