"As originally published in Expert Perspective, a Crowe Chizek and Company LLC publication, Fall 2006. All rights reserved."

Occupational fraud drains billions of dollars from American businesses every year. As authors Michael Vian and Daniel Levin note, however, there are steps business owners can take to reduce the risk.

When Joe Smith opened his business, he named John Jones as his CFO. The two were colleagues, business associates, and close friends, and Smith had no qualms about allowing Jones to handle the financial side of the business while he focused on sales and growth strategies.

Twelve years later, Jones took a few days off for a family emergency. In his absence, a coworker fielded a call from an irate vendor demanding payment. That marked the beginning of an investigation that eventually revealed Jones had stolen $7 million from the business in four years.

Smith and Jones are fictitious names, but the story is all too common. In its "Report to the Nation on Occupational Fraud and Abuse," the Association of Certified Fraud Examiners estimates that United States businesses lose 5 percent of their annual revenue — $652 billion — to fraud. When owners or executives are involved, the median loss is $1 million per incident, compared to a median of $159,000 across all employee levels.

There are myriad ways in which people can commit fraud, but virtually every scheme is clandestine, a violation of the perpetrator's fiduciary duties, financially beneficial to the fraudster, and costly to the victim.

While it isn't possible to thwart all fraud, there are steps business owners and executives can take to make it more difficult.

One is to have clearly defined and rigidly enforced codes of ethics and conflict-of-interest policies. Employees who know what their employers consider ethical and honest find it more difficult to justify their own unethical, dishonest activities. When employers clearly state that stealing pencils is just as serious an ethical breach as stealing money, that it's unethical to falsify expense reports, and that accepting gifts worth more than $50 from suppliers is forbidden, employees have little room for rationalization.

Trust, But Verify


Although trust is imperative in successful businesses, it's also important to verify that the trust is not misplaced. Regular audits — including some that are not announced in advance — can alert management not only to potential fraud but also to any financial reporting deficiencies that should be corrected.

Businesses must also recognize that corporate leadership is not immune from the temptation to commit fraud. Lack of executive oversight, an ineffective audit committee, and a poorly defined financial chain of custody can all contribute to leadership fraud.

Another way to discourage fraud is to put limits on individuals' power. When the person responsible for approving and writing the checks is also responsible for reconciling deposits and bank statements, the compulsion to cheat may become uncontrollable.

Account For Irregularities


Worse, the fraud may go undetected for years if the person isn't held accountable for any irregularities. Experienced investigators and auditors pay attention when a business owner says the company should have made more money, for instance.

Owners who have been in business for any length of time know how much revenue their companies should generate. Allowing for inevitable fluctuations caused by unanticipated factors such as rising fuel prices or increased training, they understand what their margins should be. When there is no obvious reason for those margins to change, it's time to look more carefully at underlying causes.

Other indicators that fraud is perhaps being perpetrated in a business include:

  • Frequent overrides of internal controls;
  • Missing documentation;
  • Unresolved exceptions or reconciliations;
  • Photocopies, rather than original documents;
  • Patterns of cash shortage or overage; and
  • Customer complaints.

These are signs of an increased likelihood of fraud, rather than absolute indicators that fraud has occurred. If they are present, business owners may want to review not only their financial records and processes but also the corporate and personnel policies.

Companies that have frequent, comprehensive fraud prevention and ethics training, strong systems of internal controls, and reasonable financial targets are less likely to be victims of fraud. Participatory management styles, efficient communication at all levels of the firm, and practical recognition and rewards systems all help reduce the likelihood of fraud, as well.

Finally, knowledgeable executives will work with experienced financial advisers to develop and maintain solid fraud-prevention strategies. Criminals continue to evolve, and when business owners don't have the time or expertise to keep up with the new techniques these criminals devise, financial advisers can bridge the gap, helping companies detect and prevent fraud and keeping their businesses safe.

Occupational Fraud By The Numbers


The Association of Certified Fraud Examiners (ACFE) defines occupational fraud as: "The use of one's occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization's resources or assets."

In its "Report to the Nation on Occupational Fraud and Abuse," the ACFE reports that 51 percent of all frauds originate with an accounting employee or a member of the senior management team. And, the report continues, the higher the position, the greater the loss.

Other statistics from the report offer these insights into occupational fraud:

  • Men commit 61 percent of all fraud;
  • The average age of a fraudster is 42;
  • Small businesses, with fewer than 100 employees, suffered median losses of $190,000 per fraud scheme;
  • Nine cases of fraud in the last two years resulted in losses of more than $1 billion each;
  • One-third of fraud cases involve more than one type of fraud;
  • Asset misappropriation (theft or misuse of funds) is involved in 91.5 percent of fraud cases;
  • Corruption (accepting bribes or using personal influence) is involved in 30.8 percent of fraud cases;
  • Fraudulent statements (falsification of revenue or profits) are involved in 10.6 percent of fraud cases;
  • Fraud touches all industries, but is most common (14 percent) in banking and financial institutions; and
  • Most fraud (34 percent) is exposed by tips; another 25 percent comes to light "by accident".

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.