What is Occupational Fraud?
Merriam-Webster (2022) defines fraud as the “intentional perversion of truth in order to induce another to part with something of value or to surrender legal right.” To put it simply, fraud is a criminal act that is intended to deceive someone for financial or personal gain.
So, what might fraud look like within your organization? Occupational fraud is loosely defined as deceptive acts committed by people who work for your business or those you do business with. Your business can be affected by internal organizational fraud (where an employee, manager, or executive of an organization deceives the organization (ACFE, 2022)) or by external occupational fraud (where the fraud is committed by outside sources – such as vendors or customers). There are three types of occupational fraud: corruption, asset misappropriation, and financial statement fraud.
Most people understand the basic concept of fraud; however, they might be surprised by what it looks like within an organization and the damage it can cause. That’s why in this article we’re going to examine how to detect it, examples of occupational fraud in business, how it affects your organization, and how to protect against it.
The 3 Risk Factors for Fraud
There are three motivations for why people commit fraud, and they are referred to as the fraud triangle.
Motive (also referred to as incentive or pressure) may push someone to commit fraud. This could look like someone experiencing financial difficulties looking for ways to make ends meet. Sometimes, it looks like unrealistic performance expectations or reward structures that could cause them to look for ways to make the business look more profitable or report higher growth (Davis, 2022).
It’s worth noting that executives aren’t exempt from committing fraud. Having more authority means that greater damage can happen to a business; however, their red flags often give them away.
Opportunity is exactly what you might expect. It is a vulnerability that an employee takes advantage of. They find a weakness – such as a lack of management oversight in a small business – and commit their crime.
People who commit fraud need a way to justify their behavior. They might believe things like:
- They deserve the money because they didn’t get a raise.
- It’s ok to take the money because other employees are doing it.
- They’re doing the right thing for the business (this could be an executive).
- That it is, “How the game is played.”
There are variety of ways that someone can commit fraud within an organization. Discover what corruption, asset misappropriation, and financial statement fraud look like below.
- Net Worth Overstatements (e.g., improper disclosures)
- Net Worth Understatements (e.g., timing differences)
- Fraudulent Disbursements (e.g., payroll schemes)
- Conflicts of Interest (e.g., sales schemes)
- Bribery (e.g., bid rigging)
- Economic Extortion
- Illegal Gratuities
Imagine, a nurse taking unrecorded vacation or sick leave, an executive at a large company using a corporate credit card for unauthorized personal purchases, or a warehouse employee stealing inventory. These are all examples of internal occupational fraud.
How Does Fraud Affect Your Organization?
The unfortunate truth about fraud is that it costs billions in damage to companies, governments, and individuals worldwide. Certified Fraud Examiners (CFEs) estimate that organizations lose approximately 5% of revenue to fraud each year – with an average loss of $1,509,000 per case.
Fraud within your organization means significant financial loss which, in turn, could mean potential layoffs, fewer raises, decrease employee benefits, and more. It also means your organization may suffer from an inability to attract and retain employees, customers, and business partners.
Let’s look at some interesting trends:
- Males are more likely to commit fraud (62%) compared to their female counterparts (38%) in the United States.
- Frauds are getting caught faster and are causing smaller losses – thanks to increased awareness.
- More perpetrators are in roles with higher levels of authority.
- Implementation rates for anti-fraud controls have increased.
- Fraudsters are collaborating more.
How to Detect Fraud in an Organization
What is so alarming about occupational fraud is that many cases go undetected. To make matters worse, the pandemic created more potential opportunities for fraud in some organizations. According to the Association of Certified Fraud Examiners, half of the fraud cases they studied in their 2022 report were affected by the pandemic in some way.
Fortunately, there is a method you can implement right now to help increase the detection of occupational fraud in your organization.
Implement a Fraud Hotline
The number one best way to uncover fraud within your organization is through tips. This has been an ongoing trend over the past decade. In 2022, 42% of the cases studied by ACFE were discovered through tips – nearly three times as many cases as the next most common detection method.
More than half of these tips came from employees; however, another third came from external sources. This demonstrates how important anti-fraud education and communication of reporting mechanisms are to your organization. Effective training and processes established by CPEs or Certified Public Accountants (CPA) should be implemented in organizations of all sizes.
Having a tip hotline is a must. Here are some more statistics why you need to have one in place:
- Combine a hotline with training to increase the likelihood of detection by tip by 38%.
- Organizations with hotlines detect frauds in 12 months – instead of 18 months.
- Organizations without a hotline had 2x the fraud loss.
Fraud Allegation Training
Not everyone who reports fraud will use a formal reporting mechanism like a hotline. They may reach out to a variety of parties within your organization; however, they are more likely to report to direct supervisors. Therefore, it is important that all staff are given guidance on how to manage fraud allegations.
Reduce Duration & Loss with Specific Active Detection Methods
Tips have a longer detection duration of 12 months with a loss of around $117,000. Other active methods (internal audits and management review) also have a long duration of 12 months and a loss of $108,000. So, if you’re looking to reduce detection time and loss, then you may want to implement different active detection methods.
Utilizing automated transaction/data monitoring, surveillance/monitoring, and account reconciliation can help you detect fraud sooner (<8 months) and reduce losses to $75,000.
Executive Fraudsters & Red Flags
Many executives are first-time offenders – so your typical preventative measures won’t work to detect them. Despite this, their schemes typically raise red flags. Executives often become upset when questioned about financial discrepancies and they be reluctant to cooperate with internal investigations or outside auditors.
Other red flags present themselves in their personal life. You may notice a fraudulent executive begin living lavishly, or a once financially responsible person may suddenly have a lot of debt. You might become aware of them trying to feed an addiction – such as gambling or substance abuse (Anderson & Whitney, 2019).
If you see any of these behaviors, it’s worth looking into.
Fraud Examples in Business
There is no shortage of examples of fraud in business. If you regularly read the news, you’ve likely seen your fair share of occupational fraud in news articles. Here are two examples of occupational fraud and the solutions that could have prevented them from ever happening.
The Importance of Account Reconciliation
Did you hear about the woman in Utah who got two years in prison for her $1.6 million embezzlement case? She committed the crime from 2015 to 2018 and took the money from a meat processing business. The woman completed 107 separate transactions that were disguised as double payments to 14 different vendors (AP, 2022).
Prevention Solution: If there had been a separate person to reconcile the credit card activity, this fraud could have been avoided.
Nonprofits and Fraud
Nonprofits are not exempt from fraud. The fraudulent activity occurred against a nonprofit, quasi-governmental body in Philadelphia for seven years (Department of Justice, 2021). She was a former accounting manager for the organization. She stole 2.6 million that she spent on gambling and luxury vacations (Wright, 2022).
The defendant was arrested and charged for fraudulent activity – including fake vendor invoices for legitimate vendors where the legitimate vendor’s name was changed to defendant’s personal name. She was sentenced to more than four years in federal prison.
Prevention Solution: To avoid this type of activity, automatic monitoring can be done in the background – where addresses and bank accounts of employees from payroll records are compared against vendor records. A notification will alert that there is a match – preventing the need to allow access to this personally identifiable information.
How to Protect Your Organization Against Fraud
So, how do you protect your organization against occupational fraud? The first step is to acknowledge the real threat it has on your organization. Many business leaders do not prioritize fraud – making them susceptible.
Experts at Teal recommend that you approach occupational fraud proactively – by implementing anti-fraud controls before becoming a victim.
The most cost-effective way to reduce loss is always by taking preventative measures. Ensure that your organization:
- Has anti-fraud training.
- Implements strong anti-fraud controls.
- Has an open-door policy for employees.
- Conducts surveys to assess employee morale.
- Has a management team that employees believe acts with integrity.
- Supplies a well-thought-out fraud reporting mechanism (e.g., hotline).
- Performs risk assessments and mitigates vulnerabilities to both internal and external fraud.
- Provides employee support programs to aid those struggling with addiction, mental health, family, or financial problems.
- Employees aware of ongoing fraud detection practices – such as through surprise fraud audits, the use data analytics techniques to proactively search for fraud, etc.
Risk Trends: Fraud in Small Businesses
In 2022, larger organizations (100+ employees) had higher frequency in most documented schemes. However, there were two schemes that occurred more frequently in small businesses – skimming (9% of cases) and check and payment tampering (10% of cases).
While skimming and tampering occurred more in small businesses, the scheme that affected small businesses the most was corruption (24%). In fact, all industries surveyed were shown to be at high-risk.
Industries in the following categories need to have controls in place for corruption in the upcoming years:
- Government & public administration
- Health care
- Food service and hospitality
- Banking and financial services
- Transportation and warehousing
Occupational Fraud Prevention
Now that you understand what occupational fraud is, you can make sound decisions for how to protect your organization against it. Experts agree that prevention is key. Take the necessary steps to defend and detect today.