Written by Michael L. Rosten and Adam Bowler
Fraud costs companies 5 percent of their annual revenues each year, according to the 2016 Report to the Nations on Occupational Fraud and Abuse published by the Association of Certified Fraud Examiners (ACFE). The median loss of 5 percent was observed across all types and sizes of organizations. This means smaller companies are at a greater disadvantage when fighting fraud; they typically have fewer resources to combat fraud and are less capable of absorbing its massive costs.
Additionally, smaller private companies are more likely to become victims of fraud than larger companies, publicly-traded companies or even non-profits. Unfortunately, the companies at the highest risk of exposure tend to have far fewer fraud prevention and deterrence mechanisms in place, even though the costs of certain prevention methods are low.
A strong internal control system reduces the opportunity to commit fraud, making it harder for dishonest employees to steal assets, engage in corrupt business practices or manipulate your company’s financial statements. The mere appearance that a company has increased detection methods can have positive deterrence effects.
A Worthwhile Investment
Business owners and managers may be reluctant to invest in internal controls for various reasons. They may have limited resources and underestimate the value of a strong internal control system. Or they may mistakenly believe that implementing internal controls will signal distrust toward employees, suppliers and customers.
In excess of 80 percent of frauds are committed by perpetrators that had never previously been charged with fraud. Therefore, pinpointing potential threat sources becomes challenging. With perpetrators difficult to identify, proactive fraud detection/deterrence measures are vital.
The most common internal control measures implemented by U.S. companies in the 2016 Report to the Nations include:
- Corporate codes of conduct,
- Independent external audits of the financial statements,
- An anti-fraud policy, and
- Employee support programs.
Investing in antifraud measures can be money well spent: The ACFE reports that the presence of strong internal controls was correlated with both lower fraud losses and quicker detection. A lack of internal controls was cited as the primary factor in 29 percent of the cases analyzed in the 2016 Report to the Nations. Moreover, some controls can be implemented at very low costs, such as management reviews, job rotation, clear lines of authority, fraud training and mandatory vacations. These simpler options can be effective for smaller private companies with limited budgets.
Fortifying Your Defenses
Fraud has been a hot news topic in recent years, which should be a reminder for companies to reinforce their defenses. The ACFE reports that, compared to 2010, the use of whistleblower hotlines is up 9 percent and fraud training programs for employees increased by 8 percent. With so much at stake, companies large and small should adopt company appropriate internal control systems for detecting and preventing fraud.
In our experience, the constant threads in past fraud investigation assignments were lack of oversight and lack of segregation of duties – both of which are addressed by an effective internal control system. A Certified Fraud Examiner can help evaluate your internal control system — or investigate fraud if you suspect wrongdoing.
Michael Rosten, CPA, CFE directs the forensic and litigation services at Piercy Bowler Taylor & Kern (PBTK) which includes fraud investigations. He can be reached at firstname.lastname@example.org. Adam Bowler is an attorney and Certified Fraud Examiner at PBTK. He can be reached at email@example.com.