Portrait of an Employee Fraudster

Fraud Schemes Depend on Opportunity, Incentive, Rationalization

It may come as a surprise to some that the typical fraudster in the workplace is not the bad-attitude ne’er-do-well that slinks off into the corner when faced with new responsibilities and additional tasks. Rather, the high-performing extrovert that never takes a vacation is more likely to perpetrate a fraud against his employer.

They’re generally male, according to Mark Lowers, president of the Purcellville, Va.-based international risk management firm, Lowers & Associates. “They’re typically tenured, people that have been with an organization for quite some time and are generally high performers. People like them. They do well, they’re risk takers but they get the job done,” Lowers said during a presentation at the 2013 Risk and Insurance Management Society’s annual conference.

More often than not, they are people within the organization that are respected by senior management; in fact, 25 percent of perpetrators are senior managers. They are in the position to be able to do something, Lowers said. And generally, motivated by greed or debt, they act alone.

While 85 percent of occupational fraudsters are males between the ages of 30 and 45, some of the most creative perpetrators are women.

Trillions of dollars are lost to organizations worldwide through employee fraud schemes each year. As much as 5 percent of a typical organization’s revenue is lost to fraud annually, according to the Association of Certified Fraud Examiners. Spread out across the gross world product, it amounts to more than $3.5 trillion (based on figures from 2011).

And the cost of employee fraud is not limited to the direct loss of funds or inventory. The overall cost to an organization typically runs about six times the amount of the original fraud, according to Lowers. For instance, “let’s say the fraud was $100,000 … multiply that times six. That’s generally what it’s going to cost the organization,” Lowers said.

The loss may rise due to far-reaching damage that may not be immediately visible, such as: impairment of employee morale; weakening of the company’s brand; the undermining of external business relationships; or, for certain business sectors, trouble with regulators.

The magnitude of employee fraud within organizations is also increasing, according to Frank Scheckton, president of the fidelity and crime division at Cincinnati, Ohio-based Great American Insurance Co.

“If you asked me 10 years ago what was a large loss at Great American I would probably tell you a million dollars. But if you asked me today what was a large loss I would say in excess of $10 million,” said Scheckton, who joined Lowers in the RIMS presentation on occupational fraud.

Opportunity is one of the three components that must be present for a successful fraud to occur, according to Lowers. The other two are an incentive to commit the act and the attitude and/or rationalization to carry it out.

“Take one of those away and you reduce the chance of it happening by 50 percent. Take two away and it can’t happen,” Lowers said.

“There are things you can’t control. You can’t control your employees’ spending habits, drug habits, gambling habits,” he said. But if you take away the opportunity for an employee to get their “hands on an asset without getting caught, then you’ve reduced that probability by 50 percent.”

An environment in which there is a lack of overlapping controls, an absence of management reviews, and inadequate internal and external audits is one that is ripe for the possibility of fraud to occur.

The stripped down, thinly staffed organizations that characterize today’s workplaces “have actually created an atmosphere where there is opportunity for fraud to occur,” Lowers said.

For instance, where in the past there might have been several people who handled contracts, accounts payable and purchasing, now there is only one. And if the person who balances the financial accounts is the same one who writes the checks, that’s a recipe for trouble.

Strong management overview is not as prevalent as it once was, Lowers said. In addition, companies may also cut back on the frequency and depth of internal and external audits in an effort to reduce costs.

Insurance companies that specialize in fidelity and crime will be interested in the internal controls an organization has in place when assessing the entity for coverage, Scheckton said.

“People steal because they can,” Scheckton said. Therefore the insurer needs to know what a company is doing to prevent the fraud from taking place – and how it reacts if a fraud does occur.

In addition to internal controls, a company like Great American will be interested whether the organization maintains a segregation of duties in areas such as accounting and inventory management. Internal audits are also important, Scheckton said, especially surprise audits.

Employee screening – including drug testing, background checks and psychological testing – is one of the biggest controls Great American likes to see, Scheckton said.

He cited a case where psychological testing was effective in weeding out a potentially troublesome employee. The company involved was Loomis. “They did a pre-employment test on an individual who failed that test and they turned him down for the job. His name was Timothy McVey, the Oklahoma City bomber,” Scheckton said.

An insurer will want to see that a company’s authorized vendors have been thoroughly vetted. Scheckton said vendor fraud is one of the major causes of large losses that his company is noticing in firms now.

Most occupational frauds are discovered through anonymous tips, and fraud reporting mechanisms such as hotlines are encouraged as effective ways of uncovering and discouraging fraud.

An insurer also will want to know how the company responded if and when a fraud occurred. “Firing the employee is not the answer,” Scheckton said. “We will want to see what the corrective measures are.”

The Association of Certified Fraud Examiners (ACFE) recommends that hotlines should be able to receive tips from internal sources as well as from those outside the organization. The person calling should be assured that their comments are anonymous and confidential, and will be listened to. It is also helpful if they are monitored by a third party organization.

“This is vitally important in an organization, that if you’re trying to prevent fraud that you do have a strong hotline, tip line, and that it is responded to appropriately,” Lowers said .

“Most often the first call that comes into a tip line … is a test,” he said. “You’re not going to get great information. The caller is really testing to see if they are going to pay any attention to this. … It’s not until the second or third call that you’re really going to get any information.”

Organizations that have anti-fraud training programs in place generally experience lower losses and less lengthy frauds, according to the ACFE. The association recommends that employees, management and executives alike be trained to recognize fraudulent actions and educated on how to report questionable activity.

• Employee expense report fraud is the most common type of occupational fraud but vendor fraud is one of the main causes of large losses.
• The activity is always clandestine, never overt.
• The activity relieves the company of an asset, such as cash or inventory.
• The activity is done for direct personal gain.
• The three basic types of occupational fraud are: misappropriation of assets; corruption; and fraudulent financial statements.