Some Tips on Preventing Corporate Fraud

According to an ACFE report, organizations lose five percent of revenue to fraud each year, with the average loss per case standing at a whopping $1,783,000. Reportedly, nearly half of the frauds take place in these four departments: Operations 15%, Accounting 12%, Executive/Upper Management 11%, and Sales 11%.

Notably, these frauds occur either due to lack of internal controls or over-riding of internal controls. It has also been observed that 81% of the victim organizations modified anti-fraud controls to avoid future fraud. 75% of these organizations increased their management review and 61% increased their data monitoring analysis.?

Well, this indicates that instead of waiting for a fraud to occur, organizations should be proactive in adopting fraud controls right from the outset. In this post, we talk about the psychology of white-collar criminals, the Fraud Pyramid and some of the most famous corporate frauds that resulted due to lack of internal controls within the organizations.

The Psychology of White-Collar Criminals

Corporate fraud involves more complex details than street crimes, but its general psychology remains similar. According to experts, white-collar criminals typically do not consider risk-reward calculations when making their decisions. Instead, they tend to be motivated by greed for power or wealth; revenge against those they perceive have wronged them; peer pressure; or fitting into unethical workplace cultures.?

What is the Fraud Pyramid? ?

The Fraud Pyramid, also known as the Fraud Triangle, was propounded by Donald R Cressy, a criminologist. According to him, corporate frauds rest on three components; Pressure, Opportunity, and Rationalization. This implies that these three aspects must be present if corporate frauds are to take place.

How to handle the Pressure aspect of the Fraud Pyramid?

Pressure acts as the foundation of the Fraud Pyramid. It’s driven by financial difficulties of the employee and the company; and professional stress faced by executives such as favoritism and lack of appreciation at the workplace. To combat this, organizations can adopt various measures, some of which include: ?

• Establishing realistic performance expectations.
• Ensuring transparency in matters by making disclosures, and following international standards etc.
• Fostering a culture that prioritizes employee well-being, such as Employee Assistance Programs (EAPs).
• Assuring employees of a fair compensation.

How to handle the Opportunity aspect of the Fraud Pyramid?

Opportunity represents the peak of the Fraud Pyramid. It signifies the circumstances that allow fraud to occur, such as weaknesses in internal controls, absence of analysis for anomalies or poor vigilance. To reduce the opportunity for frauds, organizations can adopt various measures, some of which include:

• Implementing strong internal controls such as segregation of duties, regular audits, and monitoring performance (real time and historical).
• Establishing a stringent anti-fraud policy and apprising employees about the same.
• Conducting background checks on employees, especially the ones in strategic operational and financial positions.
• Ensuring regular employee rotations especially in critical positions.

How to handle the Rationalization aspect of the Fraud Pyramid?

Rationalization refers to the excuses that individuals use to justify their fraudulent activities. To reduce the opportunity for frauds, organizations can adopt various measures, some of which include:

• Educating employees on corporate ethics.
• Placing the onus on the leadership to exhibit ethics and morals and set an example for other employees.
• Establishing a whistleblower hotline where employees can voice concerns, report unethical behavior and avail grievance redress. According to experts, the probability of fraud detection in organizations with hotlines is 47%. On the other hand, this statistic falls to 31% in organizations without hotlines.?

A glimpse into some of the most famous corporate frauds

Bernie Madoff Ponzi Scheme (2008)

The Bernie Madoff Ponzi scheme was perpetrated by Bernie Madoff, an ex-chairman at NASDAQ. His investment firm named Bernard L. Madoff Investment Securities LLC lured new investors by assuring them high returns and used the money to pay dividends to the existing investors. Madoff's Ponzi scheme began to unravel in 2008 when many of his clients asked to withdraw funds that they had invested with him.

Due to global financial turmoil and limited available investment funds, he was unable to meet these withdrawal requests within legitimate investments. It was later observed that this Ponzi scheme thrived on the weakness of internal controls and a discrepant regulatory framework within the organization.

Enron Accounting Scandal (2001)

One of the most notorious frauds in the US, the Enron Accounting Scandal revealed how a company’s top management can use the lack of financial transparency to deceive investors. Enron inflated its revenues and showed minimal profits by indulging in highly complex financial transactions. This was centered on showing off-the-book entities to conceal debt and maximize profits.

Later, it was learned that the company’s CEO Jeffrey Skilling and CFO Andrew Fastow, along with other executives, were actively involved in misrepresentation of financials to investors. Ultimately, the company collapsed, and its stocks plummeted, leading to huge losses for employees and investors.

WorldCom Accounting Scandal (2002)

WorldCom, which was at one point a leading name in telecommunications, inflated profits through improper capitalization of expenses. Through fraudulent accounting practices, investors were deceived into believing that ordinary expenses were long term investments.

The company declared bankruptcy in 2002, leading to significant losses for investors and employees. It was later observed that the company suffered from weak internal controls that provided a breeding ground for this scandal to flourish and go undetected.

Choose RSM Saudi Arabia to Prevent Corporate Frauds

At RSM Saudi, we believe in building strong, collaborative client relationships based on a genuine understanding of needs, strategy, and aspirations. We devise robust internal controls, and whistleblower programs to strengthen defenses against corporate fraud. We curate multi-faceted fraud prevention mechanisms in the context of the Fraud Pyramid. If you’re a business keen on preventing corporate fraud, get in touch with our experts today. We’re passionate about assisting you.?

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