A Proactive Approach to Fraud Prevention and Deterrence
W. James Lloyd, CPA/ABV, CBA, McWilliams & Company,
PLLC, Knoxville, TN
Casey P. Dannen, CPA, CFE, McWilliams & Company, PLLC,
Knoxville, TN
Due to the substantial media attention being given to several
recent high profile cases, one might think that fraud is more prevalent
today than in the past. It's difficult to open any current business
magazine or newspaper without finding at least one story about
an individual or organization that has fallen victim to some fraud
related scheme. However, the fact is that fraud is nothing new
- people are probably no more dishonest today than they were a
decade or more ago. But due to the significant dollar amounts involved
with some of the recent highly publicized cases, fraud is finally
getting the attention that it deserves. Because of this heightened
public awareness, many organizations are being more proactive in
taking steps that will help prevent or deter the risk of becoming
another fraud statistic.
Fraud is a widespread problem that affects most every organization,
regardless of size, location or industry. It occurs in many forms
and can range from employee theft and unproductive behavior, to
misappropriation of assets and fraudulent financial reporting.
It's been estimated that fraud costs some organizations as much
as six percent of their revenues annually. No one knows for sure
just how much fraud does occur because much of it goes undetected.
However, if the six percent of revenue estimate is reasonably accurate,
then many organizations have a strong financial incentive to be
proactive in reducing their risk of fraud related losses.
Fraud is difficult to detect because it generally involves insiders
who are participating in collusion and concealment activities.
Therefore, creating a culture of honest and ethical behavior throughout
the organization is generally the best way to minimize occurrences
of fraud. By placing strong emphasis on fraud prevention, which
reduces the opportunities for fraud to occur, and fraud deterrence,
which influences employees not to commit fraud due to the likelihood
of being caught and punished, organizations can help create a more
honest and ethical culture. This should lead to fewer instances
of fraud.
Fraud prevention and deterrence starts by creating an organizational culture
of honest and ethical behavior that is based upon a set of core values.
The cornerstone for establishing such a culture is the example set by the
organization's top management team. Because employees generally follow
the example set by their superiors, it is critical that upper-level management
conduct themselves honestly and ethically with regards to all facets of
the organization's activities. Management's actions should set the tone
and clearly demonstrate the kind of behavior that is expected from everyone
within the organization. In addition to setting an example of honest and
ethical behavior, management can further reduce the risk of fraudulent
activity by taking the following steps:
Create a Positive Workplace
Establishing a positive workplace for employees is a key ingredient
to preventing and deterring occurrences of fraud. Employees are
critical to the success of most all organizations. However, employees
with no or little regard for their employer are more likely to
participate in fraudulent activity. Such indifference usually exists
in work environments where employees feel unappreciated, easily
replaceable and without value to the organization. Employees with
such negative feelings can generally be found at all levels within
the organization from shift worker to senior management.
Implementing the following procedures can help create a more positive work
environment, which should reduce the level of employee dissatisfaction
and the risk of fraudulent or other inappropriate conduct:
Establish Open Lines of Communication
Creating open lines of communication between superiors and subordinates
is a critical first step. Open communications will help employees
feel more like an important part of the organization. Employees
should know to whom to turn should a problem arise, and they should
feel confident their concerns will be heard and appropriate action
will be taken.
Provide Positive Feedback
Providing employees with encouraging feedback is another way to
create a positive working environment. Employers are often quick
to criticize employees for underperformance but slow to praise
them when they excel. Not only should employees be recognized when
they do well at assigned tasks, but they should also be acknowledged
when they demonstrate ethical behavior. Doing so helps to reinforce
the organization's core values.
Compensate Employees Fairly
As basic as it may seem, one of the best ways to make employees
feel appreciated is to adequately compensate them. That doesn't
mean that employees must be overpaid or even at the top of the
pay scale in order to prevent them from committing fraud. All that
is required is that employees feel they are being fairly compensated
for their efforts. Employees who consistently feel underpaid are
generally more inclined to participate in fraudulent activity.
They may justify their actions by rationalizing that the employer
owes them. This sense of entitlement heightens the temptation to
engage in fraudulent misconduct.
Develop a Code of Conduct
Organizations wanting to reduce occurrences of fraud must convey
a clear message to employees regarding its commitment to preventing,
detecting, and punishing all fraud related crimes. A written code
of conduct can be an effective means of communicating anti-fraud
policies and expected ethical behavior. Each employee should receive
a written copy of the code of conduct and, after having an opportunity
to review it, should sign a document stating that they understand
and agree to adhere to it. A copy of the signed document should
be kept in the employee's personnel file.
Establish a Reporting Structure
The code of conduct should include simple fraud reporting procedures.
Employees must be able to reference this document and understand
how to report suspected fraud or other misconduct. A good example
is to establish a fraud hotline. Such a hotline can be used anonymously
to report employees who appear to be involved in fraudulent or
unethical behavior without fear of retaliation. The Association
of Certified Fraud Examiner's 2002 Report to the Nation on Occupational
Fraud reported that using a fraud hotline could reduce instances
of fraud by approximately 50 percent.
Consistently Punish Violations
The code of conduct should address the consequences of participating
in fraudulent activity. It should clearly explain that each instance
of suspected fraud will be thoroughly investigated, and violators
will be consistently disciplined. Organizations must be firm in
their commitment to punish all violations of fraud, no matter how
small. By investigating all suspected instances of fraud and consistently
disciplining violators, an organization sends a clear message to
its employees that this type of behavior will not be tolerated.
Don't Forget About It
Once the code of conduct is in place and signed, don't forget
about it. In order to be effective, the code of conduct must be
reinforced with all employees on a regular basis. A good time to
do this is during each employee's annual performance evaluation.
Follow Sensible Personnel Procedures
An organization's risk of fraud can also be curtailed by adhering
to the following sensible personnel procedures:
Use Good Hiring and Promotion Guidelines
By developing and closely following procedures for hiring and
promoting employees, organizations can reduce the possibility of
placing the wrong person into a position capable of misappropriating
assets. One key element that should be included is the careful
screening of all applicants prior to hiring them. Every aspect
of the potential employee's background information including education,
prior employment and references should be verified. In some instances,
individuals most likely to engage in fraudulent activity are those
who misrepresent their past. Accordingly, an independent third
party background check is usually justified for management or other
similar positions of trust and authority.
A similar process should also be established for promoting employees.
Before advancing someone to a position with greater responsibility,
get input from his or her direct supervisor(s) and co-workers if
possible. Carefully review the person's personnel file, including
past performance evaluations, and consider instances of behavior
that were outside the organization's code of conduct. If the new
position is one of trust that includes the ability to misappropriate
assets, a new or updated background check is probably going to
be justified.
Require Employees To Use Vacation Time
Absent unusual circumstances, all employees entitled to receive
vacation time should be required to take it. Most frauds require
ongoing future activity by one or more persons to cover up the
scheme. Accordingly, an employee committing or participating in
fraudulent activity would have a difficult time covering their
trail while on vacation. Requiring employees, especially those
in positions of trust, to take vacation will make it easier to
detect any fraudulent transactions that may exist. A required vacation
policy also serves as a deterrent to those employees thinking about
perpetrating a fraud.
Conduct Exit Interviews
Employees who are leaving generally feel more comfortable discussing
what they perceive to be problem areas within an organization.
Therefore, exit interviews can be an excellent way to learn about
possible fraud or other misconduct. To enhance the opportunity
for open and frank discussions with the departing employee, a person
other than his or her direct supervisor should conduct the exit
interview.
Utilize Sound Internal Controls
Without question, the best way to reduce fraud risk is by having
honest and ethical employees who adhere to the organization's code
of conduct. However, not all employees will be of the same character;
and, sometimes, even otherwise honest employees will be tempted
to commit or participate in a fraudulent transaction. That's why
a good internal control system is a critical element to preventing
and deterring fraud.
The process of developing a good internal control system is no
small task, but the benefits are generally well worth the time
and effort. A good way to start is by preparing an analysis designed
to identify areas posing a higher risk of fraudulent activity.
After preparing the fraud risk analysis, appropriate procedures
and controls can be implemented to mitigate the identified risks.
An effective internal control system should include a well-developed
control environment, an effective and secure information system,
and appropriate control and monitoring activities.
Summary
Although it's unfortunate, fraud is a tremendous problem that
impacts virtually every organization. A well-designed prevention
and deterrence program can be an effective means for reducing occurrences
of fraud and other inappropriate behavior. For individuals interested
in learning more about fraud prevention and deterrence, there is
a wealth of information available. Two excellent places to start
is the AICPA's Anti-Fraud & Corporate Responsibility Resource
Center - www.aicpa.org/antifraud and the Association of Certified
Fraud Examiners website - www.cfenet.com.
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