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Fraud Awareness Programs: Employee Training to Combat Fraud
Financial scandals at the turn of the 21st century undermined investor confidence and public trust. In response, Congress passed the Sarbanes-Oxley Act (SOX) in 2002. Yet fraud and corruption persist, and the scale of white-collar crime is staggering. A 2012 report to the nation by the Association of Certified Fraud Examiners said that companies lose 5 percent of their revenue to fraud each year and that the total global cost of fraud exceeds $3.5 trillion annually. As the recent $7 billion fraud at Societe Generale shows, fraud is an international problem. If you or your CFO can imagine how employees could commit malfeasance against your company, chances are it has already happened.
The extent of ethical violations by employees is also staggering. According to the semi-annual National Business Ethics Survey (NBES) conducted by the Ethics Resource Center, only 55 percent of employees surveyed said they reported violations. The main reasons they did not report misconduct included:
• They did not feel that any corrective action would be taken,
• Fear that reports of violations will not be confidential,
• Fear that reporting misconduct will result in retaliation from superiors,
• Fear that reporting misconduct will result in retaliation by colleagues, and
• They didn’t know who to turn to.
The 2007 National Survey of Government Ethics, also conducted by NBES, points to the pervasiveness of the problem in the public sector:
• Nearly sixty percent (57 percent) of public employees report that they have witnessed a violation of ethical standards, policy, or law at their workplace within the past year, and
• Nearly one-third of public servants who observed a violation of the code of conduct did not report it, making it impossible for management to ensure that problems are properly addressed to prevent such incidents in the future.
While you might hope that the ethics situation has improved, recent NBES research (2011) found that retaliation against employees who whistleblowers has increased dramatically, and that the percentage of employees who feel pressured to violate their standards in order to do their jobs, increased by five points compared to 2009. up to 12 percent.
Don’t rely on auditors to detect fraud. Auditors, both internal and external, are notoriously bad at detecting fraud. While the audit function is necessary and important, it is not sufficient to detect or prevent fraud. Most fraud is discovered when an employee complains or provides an anonymous tip. To significantly reduce fraud losses, companies must increase fraud awareness among all employees at all levels. Employees are the company’s eyes and ears for the prevention and early detection of all types of malfeasance. Unfortunately, most employees, like most auditors, don’t know what to look for. This is where the training director plays an important role.
Training is required
The Sarbanes-Oxley Act of 2002 (SOX) and the Federal Sentencing Guidelines have prompted companies to adopt compliance and ethics training programs. Training is not required under SOX, however SOX Section 301 requires clear communication of reporting channels and protocols. In addition, SOX states that audit committees must establish a procedure for confidential, anonymous complaints (Section 301(4)). The necessary communications and procedures naturally involve training.
The two main reasons employees did not report violations in the NBES study cited above were that they did not know who to contact and that they feared their reports would not be kept confidential. If this is the case, it is clear that the procedures required by SOX section 301(4) are not being followed successfully. Additionally, training focused on meeting specific SOX requirements is not sufficient to deter fraud. We need more.
Fraud Awareness Training
Fraud education programs can be designed to meet SOX communication requirements as well as an effective fraud deterrent. Upon completion of the fraud awareness program, participants should be able to:
• Explain what fraud is,
• Understand how fraud hurts them and their companies,
• Describe how the fraud is committed,
• Describe the personality characteristics of fraudsters,
• Identify the three conditions necessary to commit fraud,
• Identify “red flags” of fraud and
• Explain what to do if you suspect fraud.
The following sections provide background information for each of these learning objectives.
Fraud is deception that is intentionally used to obtain an unfair or illegal advantage. A fuller definition is that it is an intentional misrepresentation of a material fact made to obtain an unfair advantage that another relies on to his detriment. In summary, the key elements of fraud are:
• Misrepresentation, big lie.
• The lie was made intentionally or knowingly.
• The lie must be made to gain an advantage or improper advantage.
• The lie must be material, that is, have meaning.
If told the truth, would you do anything differently? If so, the lie was material.
• A lie relies on another.
• Resulting in a loss.
One of the main differences between armed robbery and fraud is that fraud is usually perceived as a victimless crime. Many scams go undetected, so the victim never knows a crime has been committed. Also, unlike armed robbery, fraud is difficult to detect; the crime is deliberately concealed.
Consequences of fraud
A few statistics can quickly demonstrate that white collar crime is big business. A 2012 ACFE report to the nation noted that companies lose 5 percent of annual revenue to fraud. As noted above, this means global losses of about $3.5 trillion. The average dollar loss from the cases used as the basis for the biennial report was $140,000. However, about one-fifth of the cases resulted in losses of more than $1 million. Cases like Enron get a lot of press, but fraud affects companies of all sizes. In fact, small companies, companies with fewer than 100 employees, tend to be the hardest hit. Also, on average, detected fraud lasted 18 months before being detected.
Assume that net profit is five percent of your company’s profit. If this were true and your company suffered a $100,000 fraud, it would take $2 million in sales to recoup the lost profits. Fraud hurts. This damage is passed on to customers in the form of higher prices and to employees in the form of reduced wages and benefits. Fraud awareness program participants need to understand how fraud can (or has) affected their company and how it affects them.
The steps in committing fraud are misappropriation of assets (a nice way of saying “theft”), concealment, and conversion. Fraud is difficult to detect because of concealment. The fraudster deliberately hides evidence of embezzlement. For example, an employee may steal cash and then conceal the theft by preparing a seemingly routine entry in the accounting system. The balance sheet appears to be fine, but there is no cash and the theft is hidden.
It is generally accepted that three conditions must be present for fraud to be committed: opportunity, duress, and rationality. A reduction in any of these three factors is seen as reducing a person’s ability and motivation to commit fraud and thus helps prevent fraud. The opportunity exists when an individual determines a method of misappropriating another’s assets for personal use and, in most cases, concealing the diversion. Strengthening internal control is generally perceived as the “best” method of reducing opportunity risk, and it is the only one of the three factors under the organization’s direct control.
Pressure is thought to fuel corruption when people face financial problems they perceive as intractable. Rationalization provides a mechanism to justify corrupt actions. Although it is possible to identify people experiencing financial stress, managers have little or no direct control over that stress or people’s rationalizations. Colleagues, on the other hand, may be intimately familiar with the financial stresses their peers face, as well as their thought processes and statements that can lead to rationalizations. This puts them in a better position to identify individuals who may have incentives to commit fraud if they are trained to recognize the symptoms.
Who is committing fraud? Look carefully around you. Mostly people like you and me. In fact, those convicted of fraud are not much like other property criminals; they are more like college students. Compared to other incarcerated property offenders, those convicted of fraud are more educated, more religious, less likely to abuse drugs or alcohol, have fewer criminal records, and have better mental health. In addition, they demonstrate higher self-esteem, self-sufficiency, motivation and achievement and are more optimistic. Often the scammers are trusted employees who have been working for a long time. Training is required
Red flags are signs that fraud may be taking place. A red flag does not prove the existence of fraud, all it does is draw attention to a condition that should be investigated more thoroughly. The sidebar lists common red flags. A fraud education program should teach employees to recognize red flags that may appear in their workplace and teach them what to do if they do identify red flags.
The ultimate goal of learning is the most important. Everyone in the organization should know what to do if they suspect that fraud may have been committed. To overcome the fear of being a whistleblower, employees should:
• Know who to contact
• Feeling that corrective action will be taken,
• Know that reports of violations will be kept confidential,
• Know that reporting misconduct will never result in retaliation from a superior,
• Know that reporting misconduct will never result in retaliation from co-workers or supervisors.
The latter two concerns become non-issues when employees are confident that their reports of violations will be kept confidential. The easiest way to ensure privacy and make sure employees know who to contact is to implement a 24/7 cheater. Employees should know when and how to use the fraud hotline to prevent financial loss.
A fraud readiness program can help make your company fraud-proof. It requires commitment at the top and buy-in across the board. Only when all employees know what fraud is, how it hurts, what to look for and how to report it, the risk of fraud will be significantly reduced. The trust that was placed in them makes the fraud possible. While only 2% of incarcerated property offenders are women, about 30% of fraud offenders are women. All this makes it difficult to identify fraudsters. Fraud awareness program participants must understand that any of their colleagues may be capable of fraud.
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