This article is part one of a three-part series. In this series, we will define occupational fraud, provide statistics of the incidence of fraud, identify red flags, and discuss types of fraud and the steps employers can take to help protect themselves against fraud. This first article in the series discusses facts of fraud and red flags that need to be watched. 

• “Hospital employee stole $800,000 in cash from patients’ TV and phone payments, feds say,” John O’Brien, The Post-Standard, Oct. 20, 2011 

• “Albany–area church treasurer charged in $143K theft,” Newport Television LLC, Jan. 31, 2011

• “Police: Employee steals over $250,000 from East Syracuse business,” Rae Fulkerson, CNYCentral.com, July 19, 2011

Have you seen headlines like these and thought “something like that could never happen to my company?” or “I trust all the employees who work for me. They would never do something like that.” Most business owners share those feelings until they discover one of their most trusted employees has been stealing money from them for years. The fact is, occupational fraud happens every day and can cost companies thousands and even millions of dollars. Unfortunately, it can happen at your business and may be happening now. The news headlines above depict recent cases here in Central New York. Most employers will ask how they can protect their companies from headlines like these. The first step is to understand what occupational fraud is and the red flags to watch. 

Occupational fraud, simply put, is: “the use of one’s occupation for personal enrichment”

This can be through stealing money, misusing corporate assets, misrepresenting financial results, or stealing company property. Occupational fraud takes place every day and can range from an employee taking home supplies to an employee embezzling millions of dollars over an extended period. Occupational fraud cases not only have a negative impact on an organization’s bottom line, but also lead to a significant reduction in employee morale that can often permeate the entire organization. 

The Association of Certified Fraud Examiners’ (ACFE) 2010 Report to the Nations presents an eye-opening summary of the impact that occupational fraud can have on all types of organizations. ACFE’s study was based on 1,843 occupational-fraud cases that occurred throughout the world from January 2008 to December 2009; the overall impact on the victim organizations studied was significant:

• The typical victim organization is estimated to lose 5 percent of its annual revenue to fraud.

• The median loss of fraud cases in the study was $160,000.

• The frauds studied lasted a median of 18 months before being detected.

While these figures apply primarily to larger organizations, keep in mind that ACFE’s study encompassed all types of organizations, ranging from small privately owned companies to large publicly traded companies. As it turns out, smaller organizations played a large role in the study:

• Of the 1,834 cases studied, 40 percent were privately-owned businesses.

• Sixteen percent of the frauds occurred at government agencies.

• Organizations with fewer than 100 employees accounted for more than 30 percent of the cases.

• Small organizations are disproportionately victimized by occupational fraud; these organizations typically lack the anti-fraud controls in place at larger organizations.

The first question to ask when trying to understand fraud is why people commit fraud. The “fraud triangle,” developed by criminologist Donald R. Cressey, presents three conditions that generally must be present for occupational fraud to occur: incentive, opportunity, and rationalization. All three conditions must be present for fraud to occur. 

Incentive

Do you find it odd that your recently hired junior staff has been seen arriving at the office in a late model luxury sports coupe? With access to personal credit on the rise over the past decade, living beyond one’s means can provide the necessary incentive to commit occupational fraud. Incentive refers to what caused the employee, often an individual with no prior criminal history, to ultimately perpetrate the fraud. Today’s difficult economic times, accompanied by personal hardships, such as mounting credit card or medical bills, can be enough to push a historically ethical individual over the edge. Do you have employees who have recently requested hardship withdrawals from their 401(k) plan or consistently take loans from their retirement plan? Those can be indicators of personal economic distress.

Another common incentive is fear of losing your job due to poor job or company performance. While this type of incentive doesn’t involve stealing money directly from the organization, the historically high levels of unemployment throughout the region can add pressure on employees to meet or exceed their employer’s performance expectations. The added pressure can be enough to outweigh the consequences of falsifying documents or manipulating accounting records to falsely overstate their department’s performance benchmarks, such as sales figures. Upper management can also be under similar pressures to meet overall budget goals and outside pressure from owners or shareholders. In tough economic times, many companies could be at risk for violating bank debt covenants. They may provide management with incentive to misstate results. There are countless incentives for why employees decide to commit fraud. 

Opportunity

It takes a considerable amount of time to falsify accounting documentation and records in order to cover up a fraud scheme. Every successful organization is built upon hard-working individuals. However, you may have a problem if you have employees who never take time off, and who constantly work odd hours to complete normal tasks. Many frauds are uncovered when the employee perpetrating the fraud is finally on vacation or unexpectedly off due to an illness. 

Opportunities to commit fraud are greatly influenced by the organization’s “tone at the top.” The tone set by top-level management typically flows down to all levels of the organization. Does management place enough emphasis on anti-fraud controls, such as implementing consistent work schedules, mandating that vacation time be utilized each year, identifying significant risk areas within the organization, and implementing the necessary internal-control processes to help mitigate the risks identified? Employers should ask themselves who has access to funds such as cash registers, deposits or blank checks. Is the employee issuing checks also responsible for setting up vendors in the system? Is the employee who does the daily bank deposit also the one who reconciles the bank accounts at month end? Are duties sufficiently segregated so that one individual can’t both take money from the company and falsify the records to cover it up? As noted in ACFE study, smaller organizations are disproportionally victimized by occupational fraud because their budgets and staffing levels make it more difficult to implement such anti-fraud controls. 

Rationalization

Surprisingly, fraud perpetrators often have little or no prior criminal history. The final condition that generally is present in occupational fraud is an employee’s rationalization to commit the act. Given the recent economic downturn, many businesses struggle to increase employee compensation annually, and many companies have even instituted pay cuts. An employee that hasn’t received a raise or bonus in years may convince himself that the amount stolen merely fills the gap between what he is paid and what he believes is owed him for his services. Some common rationalizations used by fraud perpetrators include: the amounts stolen from the organization will eventually be repaid, no one is being hurt by the fraud, or, the company owes me. Sometimes for individuals in economic distress, committing fraud to pay past-due bills may seem to be the lesser of two evils. 

Understanding the consequences and causes of occupational fraud is just the first step in assessing your organization’s susceptibility to it. You also need to design methods to prevent and detect fraud in a timely manner. The next article in this three-part series will discuss the three types of occupational fraud: 1) transactional fraud, 2) corruption fraud, and 3) financial-reporting fraud, as well as detail how each type of fraud may be committed.          

Linda Gabor, CPA, CFE is partner in charge of audit services at Green & Seifter Certified Public Accountants PLLC. Contact her at lgabor@greenseiftercpas.com. Christopher Alger CPA, CFE is a supervisor at Green & Seifter CPAs. Contact him at calger@greenseiftercpas.com.