Save content
Have you found this content useful? Use the button above to save it to your profile.
AIA

Fraud: The risk that still defies financial controls

by
15th Aug 2007
Save content
Have you found this content useful? Use the button above to save it to your profile.

red handsThe number and scale of frauds against private business are rising sharply – and costs of clearing up after it far exceed those of action to stop it happening. Though forensic accountants can usually find the culprit and trace the money, funds and reputation can be hard to recover: but many are still missing essential safeguards against ‘insider’ fraud, beginning with adequately screening new recruits and independently monitoring transactions

The number and scale of detected fraud cases continues to rise sharply, according to the KPMG Fraud Barometer released last week. Despite the entry into force in January of a Fraud Act, which clearly defined the offence for the first time, cases in the first half summed to £594m, a doubling in less than three years, according to KPMG. While tax and benefit offices remain the biggest victims, with government picking up the bill for 82% of the fraud exposed so far this year, businesses are victims in a growing proportion of cases.

While the number of these reaching the courts – over 100 in the first half of 2007 – may show that companies are getting better at detecting it, the suggestion is that unreported frauds are also on the increase. The KPMG survey only tallies cases that reach the country courts, involving sums above £100,000. Even some of the biggest, like the £500,000 which banknote printer De La Rue reportedly requested an employee to return last year, have not resulted in prosecutions, although police investigations were continuing at the company’s premises last week.

Tip of the iceberg?
The “step change” KPMG detected in this year’s survey echoes those of BDO Stoy Hayward’s FraudTrack, which suggests a rise in the value of business fraud of 40% (to £1.37bn) in 2006, and 314% since its surveys started in 2003. This survey tracks cases involving £50,000 and upwards, comprising 295 cases in 2006. In an accompanying YouGov survey of FDs conducted last October, 55% reported their suspicion that fewer than 10% of ‘white collar’ fraud cases actually get reported to the police. This survey also suggests, however, that rising standards of corporate behaviour are widening perceptions of what counts as fraud or risks creating conditions for it.

As well as most condemning employees who use company equipment to help a friend’s business or exaggerate their travel expenses, over 90% believe it is unacceptable for a manager to award a contract to a company whose owner is a friend of theirs. Almost 60% say it is wrong for an employee to process payments if they are also involved in the bank reconciliation; and over 65% say regard it as inappropriate for a manager who has awarded a contract to accept a gift even as small as a CD player.

What kinds of fraud?
VAT and excise duty frauds, including the ‘carousel’ retention of the tax element when re-selling items imported VAT-free, account for most of the reported cases and amounts. But other areas showing an increase include misuse of bank cards, ID theft, money laundering, and the traditional staples of false invoices or payments into fictitious accounts, once carried out on paper and now translated into electronic systems and online.

Because of they have – or are assumed to have – first sight of the financial effects, FDs are inevitably in the firing line when irregularities come to light, whether the defrauding is of:

  • Another company: through deception by staff aimed either at pocketing the proceeds directly, or boosting the division’s performance so they gain through bonus pay
  • The tax authorities: through under-reporting of transactions or invention of fictitious counterparties
  • An individual customer: through overcharging by which an employee profits, or theft of personal data held by the company
  • The company itself: by a manager or employee taking payment that they fail to hand over, or diverting business to assist another firm with which they have connections

How to prevent it
While some clients may try it, many of the biggest frauds against companies continue to be traced to insiders. Poverty, debt and other personal difficulties can be a factor in driving employees or managers into stealing from their employer. But most perpetrators are not badly off, and the pursuit of a lavish lifestyle is the motive most often established in cases that come to trial – Conrad Black’s recently exposed thefts from Hollinger being an extreme case, but one that seems to be increasing on a smaller scale.

Those closest to raw flows of materials, products or cash are also most likely to be tempted to dip a finger in, or commissioned by others to do so. BDO’s research suggests that while the financial services sector generates the largest number of employee frauds, their sums of money involved are largest in transportation and warehousing (where they totalled over £250m in 2006), and public administration. It concludes that “comprehensive pre-employment screening is a key tool for fraud prevention.” A typical ‘fraud-proofing’ process involves:

  • Vetting of all staff involved in large contract awards or the transactions that follow, extending to customers and suppliers where appropriate
  • Training managers and employees to understand what constitutes fraud, and how to recognise events which might signal that it’s happening
  • Informing staff of the procedures to follow if suspicious of fraud, including the provision of safe whistleblowing channels
  • Ensuring the accounting system has checks that pick up and probe unusually large or oddly timed transactions, and trigger additional inspection by people from outside the unit affected
  • Tightening these checks in areas identified as vulnerable to fraud, and ensuring a sharing of responsibilities in these areas to prevent one individual amassing authority to conduct and account for transactions
  • Setting up an emergency procedure for suspending transactions, freezing accounts and calling individuals to account if the fraud alarm-bell sounds

Although forensic accountants are keen to offer prevention services, many find their business made more lucrative by companies’ tendency only to come to them when the crime has already occurred. “There’s a saying in the industry that people will pay us £1m to investigate a fraud, but not £5,000 to prevent one,” reflects Raj Bairoliya at London-based specialists Forensic Accounting. “Prevention essentially means paying us to find holes in their system, and that’s often not palatable to them.”

Cultures of dishonesty
The string of high profile turn-of-the-century frauds that culminated in Enron – when “the smartest guys in the room” turned out also to be the most dishonest – highlighted the ways in which hard-driving incentive could inadvertently encourage fraud. When large bonuses ride on hitting a stretch target for quarterly earnings or sales, previously honest employees can be tempted to book sales that haven’t yet been agreed or take financial gambles whose losses they then have to conceal.

As very few insider fraudsters manage to work entirely on their own, fraud prevention depends heavily on keeping staff sufficiently motivated to report and act on anomalies, instead of turning a blind eye or even being co-opted to assist their continuation. When small acts of dishonesty are not detected and defused, fraudsters get bolder, and others may start to connive in what they do. Managements that break rules or compromise on values – especially those they have enshrined in mission statements - soon find their workforces being similarly lawless; and those that fail to clamp down on small employee infringements can find them not only multiplying in number but also mounting in scale.

How to deal with it
If checks were not in place, or someone has managed to evade them, the forensics still have a good chance of finding the culprit and tracking down the missing money, if called in quickly. Their science has progressed in line with the sophistication of criminal methods, and now includes:

  • Data analysis: Some frauds have only come to light when a prospective acquirer mines the data made available during due diligence, and detects an abnormal pattern that the seller had failed to detect or divulge.

  • Electronic records: Although ostensibly more transient, digital communication records can be more durable than the paper trail they replace. Even if an employee under suspicion has deleted their emails, they may still be recoverable from the server or back-up tapes, and such traces are now often central to successful prosecutions.

  • Forensic interviewing: Even if electronic traces or expenditure traits point to a particular individual as having spent beyond their authorisation or earned beyond their salary, conclusive evidence often only emerges under questioning. The manager or employee who evades questions about a particular transaction may have something to hide, but so may the one who comes up with eloquent pre-emptive explanations. Interviewers trained to detect and dig into anomalies in people’s verbal accounts, without tipping them off too early, are again best deployed at the point of recruitment – but if not, can be essential to tracking a fraud to its ultimate source, especially where architects who may be outside the company have worked through accomplices within it.

Prevention over cure
Despite the improving technology of fraud-scene investigation, the forensic experts often arrive too late. Trails tend rapidly to go cold. Even if the perpetrators have not disappeared, their ill-gotten gains have often been spent or salted away undetectably. One reason most frauds go unreported is that many victims, already reeling from the hole in their accounts, are reluctant to incur more in legal fees to prosecute alleged culprits who may no longer have the money to pay back, and who with a good defence lawyer may be able to delay the process for years. The Serious Fraud Office, which generally tackles cases involving £1m and above, admitted in last month’s annual report that these now take five years on average to get to court. And even if the police agree to pursue a criminal prosecution, recovery of the proceeds can require a separate civil action.

Investigators are helped by fraudsters’ tendency not to retire on their initial winnings, instead being encouraged by initial success. “Most are very careful the first time. But once they see they’ve got away with it once, they begin to make less effort,” says Forensic Accounting’s Bairoliya. But the problem won’t go away. KPMG forensic accounting director Hinesh Patel suggests that record levels of personal debt may be one factor driving more people to attempt fraud, even with the increased detection effort. Although one of the hardest risks to contemplate – because it means considering even your closest and most trusted colleagues as potential crooks – fraud is becoming one of the most urgent to tackle. And as HMRC gets better at rooting out the scams directed at Alistair Darling’s Treasury, those aimed at the corporate treasury are set to get bolder still.

Tags:

Replies (2)

Please login or register to join the discussion.

avatar
By AnonymousUser
17th Aug 2007 15:33

annual accounts
the advent of abbreviated accounts perhaps the best opportunity for fraudsters that there has ever been. good businessmen and private shareholders/directors have hells own job in having a sound idea in what is going on in their company/investment especially if manager/s are involved. what happened to the expected rent from a property that does not have to be shown in the abbreviated accounts. helped set up some exprt for a company - how much is attributable to my part time efforts - etc., etc. etc. in these and other areas.

abbreviated accounts set up the underworld to unappreciated huge levels - tip of the iceberg - nooooooooooo - the tip of mount everest!

Thanks (0)
David Winch
By David Winch
15th Aug 2007 14:01

Trust

In my experience it often happens that the fraudster takes advantage of the trust placed in him (or her) by colleagues. So I see examples of the most basic internal controls being easily circumvented because, for example, the fraudster asked colleagues to sign blank cheques for him.

In one recent prosecution a post office cashier had been required to get a colleague to countersign each day to confirm the physical presence of cash in a drawer. These records had been dutifully signed off for years by a variety of colleagues (and the signatures checked by internal and external auditors) and all through this time (it later transpired) the cash was actually short by a 5 figure sum.

In many cases it is actually not that easy to prove, beyond reasonable doubt and using only evidence which may properly be produced in court, that the suspected fraudster is actually guilty of taking everything that has gone missing. Frequently a defendant will make a 'deal' with prosecutors whereby the defendant pleads guilty to a lesser offence - and gets a 'discount' for a guilty plea (effectively a double bonus).

Often fraud only comes to light when an employee leaves or is unexpectedly off work due to sickness, for example. Beware of the 'devoted and conscientious' employee who arrives first in the office, leaves last, insists on dealing with queries from inside and outside the organisation, and is seldom on holiday. Get them to swap jobs with someone in a different department for a month to broaden their experience - then wait to see what turns up whilst they are away from their usual desk!

Fraud has two other important impacts. It is seriously damaging to the morale amongst staff and the ambience of the office - particularly where initially everyone is under suspicion!

Secondly, a proper investigation can be both time consuming and disruptive for the employer.

Certainly "prevention is better than cure".

David
www.AccountingEvidence.com

Thanks (0)