Firms Cannot Afford Fraud
As we have covered in the Insight Daily, occupational fraud has been a key theme across the past two years of the recession. From the widely reported cases at firms like Satyam and Societe Generale to many more under-reported (or unreported) instances, internal audit (IA) has had to battle fraud constantly. And this is only going to get harder across the next two years, which means IA should prepare now. As a first step, Audit Director Roundtable (ADR) clients should roll out this survey to find which areas of the business display the highest risk of fraud.
The Cost of Fraud
According to data from the Association of Certified Fraud Examiners, firms across the globe lost 5% of their annual revenues to fraud in 2008 and 2009. This is the first time the ACFE has carried out a global survey but does show how significant the problem is. Chart 1 shows how significant this is for U.S. firms as, of all the losses incurred due to fraud between 2006 and 2008, over half were above $100,000.
The Risks Now and in the Future
Numerous internal audit clients that we speak with tell us that their senior managers do not understand fraud or take it sufficiently seriously. IA clients give us three major reasons why firms should worry about fraud:
- What the recession has wrought. Layoffs have rightly made all employees worry about their livelihoods. The threat of recession or even just the vague worry that their job isn’t secure has led more employees to make more unethical decisions than they would have done in more stable economic times. In other cases, the fact that a company cannot guarantee long-term stability has meant employees feel less connected the firm and so less responsible for any fraudulent behavior that affects it.
- Corporate restructuring. Large-scale personnel and strategic changes are increasing companies’ risk of fraud. Numerous (but necessary) changes to corporate strategy either modify existing processes or create new ones, thereby weakening the existing control structure and creating new opportunities for fraud.
- The threat of emerging market expansion. All western firms are agreed that if they want to capitalize on the next wave of growth, they need to invest in emerging markets. Unfortunately the data show that employee populations in these markets are more likely to commit fraud than their western counterparts, especially as they are often not sure what constitutes fraudulent behavior. According to a 2009 survey by CEB’s Compliance and Ethics Leadership Council, Asia — which includes the bulk of emerging market countries — has by far the highest proportion of employees who “do not know” whether they are seeing misconduct or not, suggesting that firms are doing a poor job of educating Asian employees about fraud.
So while the recession has meant that more people are likely to commit fraud, the actions firms have taken in response to the recession (layoffs, emerging market expansion, etc.) are only likely to exacerbate the problems.
The Case for More Fraud Risk Assessment and Prevention
IA and compliance teams need to lobby senior management now to start taking fraud more seriously. If your firm hasn’t completed a fraud risk assessment in the past 15 months then one is urgently overdue. This is because the firm will have undergone significant changes in personnel and strategic direction since then. However fraud risk assessments are only half the battle; a well-rounded fraud prevention program should also educate employees about fraud.
Risk assessment. ADR clients should use our fraud risk database to help them detect fraudulent behavior during an audit engagement. Drawing on documents contributed by many of our clients, the database provides an extensive list of scenarios that have resulted in fraud at other firms, as well as ways to detect the behavior and tactics to monitor and identify fraud.
Education. ADR clients can use our fraud awareness training program to educate the whole organization about the risks of fraud, how to spot it and prevent it. Clients should also use our online fraud training curriculum to get their teams are up to speed on world-class fraud detection tactics.