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June 8 — Conducting thorough pre-hire background checks on everyone, including senior management, watching out for behavioral “red flags” among employees, and many other aspects that are within the purview of human resources are essential to combatting insider fraud in the business world, investigators say.
A study of 2,410 “occupational fraud” cases in more than 100 countries published earlier this year by the Association of Certified Fraud Examiners found a median loss of $150,000 “per fraud scheme,” with some larger organizations suffering from “dozens or even hundreds of ongoing frauds,” John Warren, the association's vice president and general counsel, said in a June 7 webinar. While the cases examined in the report “caused in excess of $6.3 billion in actual losses,” he added, that is only “a tiny sliver of a percentage” of all losses from fraud, which may total “in the hundreds of billions, if not trillions, of dollars.”
The webinar was sponsored by the ACFE, New York City-based background check company SterlingBackcheck and its subsidiaries Bishops Services and TalentWise.
Warren defined occupational fraud as any scheme committed by individuals against the organizations for which they work—in other words, insider fraud. He outlined three broad categories. The biggest is “asset misappropriation,” which he said accounts for 85 percent of insider fraud and may involve theft of cash, equipment or information, including billing schemes, payroll fraud, expense reimbursement falsification, check tampering, register disbursements, skimming and cash larceny.
The other two categories Warren cited are corruption—cases in which a perpetrator has an outside interest that's not disclosed to the organization, with misdeeds including bribery and extortion, and a median loss of $200,000—and financial statement fraud, which makes up only 10 percent of the total number of schemes but results in a median loss of $975,000 and lots of negative publicity.
While company owners and executives were responsible for less than one in five of the fraud schemes in the ACFE study (18.9 percent), the median loss they caused was $703,000, several times higher than the $173,000 median loss caused by crooked managers, who were responsible for 35.8 percent of the cases. Rank-and-file employees accounted for 40.9 percent of cases, but the median loss was only $65,000.
The reason why dishonest executives cause more damage is that they can evade controls meant to deter fraud, Warren said. This shows that it's “really important to do due diligence” at the upper levels, he said.
And yet, “we still see reluctance by HR to have senior level positions go through background checks,” Chelsea Franks, vice president of investigations at Bishops Services, said.
Other significant demographic data on fraud schemes included:
By department, executives and upper management ran 10.9 percent of the schemes and caused a median loss of $850,000, followed by employees in finance (just 4.5 percent of schemes, but a median loss of $234,000) accounting (16.6 percent and $197,000), purchasing (7.7 percent and $150,000), operations (14.9 percent and $105,000) and sales (12.4 percent and $100,000). HR itself accounted for just 1.2 percent of fraud schemes, with a median loss of $44,000.
“Occupational fraud cases tend to go on for months or years,” Warren said; thus, early detection is key.
One area in which HR can help is in watching out for behavioral red flags. These don't in themselves prove an employee is committing fraud, Warren stressed, but combined with other signs, such as poor job performance, they might be a signal. Some of the top six warning signs “are seen in 80 percent of cases, and this is consistent every time we do this study, even though it's an entirely different set of frauds every two years,” Warren said. “These are things HR can identify more readily” than those in other departments. They are:
In related “non-fraud-related misconduct” seen in fraud cases, bullying or intimidation goes on 18 percent of the time, since, Warren said, perpetrators have a need to cover up their misconduct, and they can't have people looking at their work too closely.
Additionally, “HR-related red flags” that have to do with the perpetrator's job status are seen in 37 percent of cases; for example, 12.2 percent fear they will lose their jobs and 10.1 percent have received poor performance evaluations.
Franks said organizations must do an “adequate and appropriate level of screening.” For some positions, this may include searches for things that don't necessarily come to mind immediately, such as a job candidate's involvement in civil litigation, or home foreclosures.
Criminal background checks won't necessarily catch everyone who engaged in insider fraud before, since, said Jacob Parks, ACFE associate general counsel, organizations are referring fewer cases to law enforcement these days—59.3 percent in 2012, compared with 65.2 percent in 2012—and of course, not all law enforcement referrals result in convictions.
“Employment screening is more likely to raise a red flag,” Parks said, including findings in 17 percent of fraud cases that the perpetrator was previously terminated or otherwise punished. However, he cautioned, “a previous employer may not be willing to cooperate with you and tell you why the person was terminated.”
International checks may be necessary in some cases, said Smith, since “perpetrators can move between countries, so a local screen may not be enough.”
Some surprisingly simple steps can ferret out fraud before it does too much damage, the webinar participants stressed. Many companies rely on external audits to detect fraud, Parks said, but this can be a mistake because the survey found organizations that discovered fraud in this way suffered median losses of $150,000, not much reduced from the median $175,000 loss if they didn't have this control in place. Much more effective is a fraud hotline, which cut losses in half from $200,000 to $100,000. Hotlines can be especially effective if made available to customers and vendors as well as employees, and if anonymous tips are permitted (though some European jurisdictions do not allow this).
Other effective methods of preventing fraud include job rotation and/or mandatory vacations, which keep fraud perpetrators from covering their tracks, and cut losses from $170,000 to $89,000; and fraud training and employee support programs, which cut losses by almost half, according to figures from the ACFE survey cited by the webinar presenters.
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Highlights of the ACFE report can be seen at http://www.acfe.com/rttn2016/about/executive-summary.aspx.
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