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Coportate fraud and its evidence

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Fraud has been a considerable concern in every corporate sector, although the financial sector is the most affected and the one undertaking the most measures to prevent it in addition to respecting and complying with regulations by competent bodies.

Pricewaterhouse Coopers (PwC), for example, performed an interesting research in 2020 regarding fraud with 5,000 respondents in 99 different territories and reached some noteworthy conclusions:

1. On average, companies reportedly experienced 6 incidents of fraud.

2. 40% of frauds were internally committed by employees, 40% of frauds were externally committed by third parties and 20% of frauds were committed by a collusion of employees and third parties.

3. The total cost of such frauds reached US$ 42 billion.

4. 47% of companies experienced a fraud in the past 2 years.

5. 13% of companies had frauds of over US$ 50 million.

6. Only 56% of companies conducted an investigation into their worst fraud incident.

These results demonstrate that the risk of fraud cannot be absolutely neglected, both from preventive and active perspectives. Considering the range of respondents in the survey, the values identified form a snowball effect, in other words, these values are significantly higher in their totality considering the number of globally spread companies.

But how do we define fraud? According to Wikipedia, fraud is an illicit or bad faith scheme created to obtain personal gain, specific legal meanings notwithstanding. Therefore, it is impossible not to define fraud as criminal conduct

I am particularly pleased with the insight brought by Thomas P. DiNapoli, State of New York, Office of the State Comptroller. In an article titled “Red Flags for Fraud”, citing the fraud triangle, i.e., the reasons contributing to its occurrence, whether carried out by internal employees, third parties, or in collusion by both parties:

1. Opportunity – generally provided through weaknesses in the internal controls including inadequate or lack of supervision and review, separation of duties, management approval, system controls. No wonder the saying goes “opportunity makes the thief”.

2. Pressure or motivation – can have a variety of meanings, from pressure for results, unattainable deadlines, personal vices, alimony, excess debt, maintenance of a living standard, etc.

3. Rationale – are the fraudster's reasons justifying their behavior. Some examples include: “the risk is worthwhile” or “I’d rather have the company on my back than the IRS”

The great challenge is to accurately identify the signs that a fraud might be taking place. Thus, consistent training in identifying such signs is very important, especially for employees whose objective is to control and curb irregularities.

Also based on the excellent article by DiNapoli, signs are listed below which should be carefully observed by corporate management and by those whose mission is to curb irregularities:

RED FLAGS FOR FARUDS BY EMPLOYEES

1. Employee lifestyle changes: expensive cars, jewelry, homes, clothes, etc.

2. Significant personal debt and credit problems.

3. Behavioral changes: these may be an indication of drugs, alcohol, gambling, or just fear of losing the job.

4. High employee turnover, especially in those areas which are more vulnerable to fraud.

5. Refusal to take vacation or sick leave.

6. Lack of segregation of duties in the vulnerable area.

RED FLAGS FOR MANAGEMENT FRAUD

1. Reluctance to provide information to auditors.

2. Managers engage in frequent disputes with auditors.

3. Management decisions are dominated by an individual or small group.

4. Managers display significant disrespect for regulatory bodies.

5. There is a weak internal control environment.

6. Accounting personnel are lax or inexperienced in their duties.

7. Decentralization without adequate monitoring.

8. Excessive number of checking accounts.

9. Frequent changes in banking accounts.

10. Frequent changes in external auditors.

11. Company assets sold under market value.

12. Significant downsizing in a healthy market.

13. Continuous rollover of loans.

14. Excessive number of year-end transactions.

15. High employee turnover rate.

16. Unexpected overdrafts or declines in cash balances.

17. Refusal by company or division to use serial numbered documents (receipts).

18. Compensation program that is out of proportion.

19. Any financial transaction that doesn’t make sense – either common or business.

20. Service Contracts result in no product.

21. Missing copies, documents, invoices, or receipt.

RED FLAGS FOR CHANGES IN BEHAVIOR

1. Borrowing money from co-workers.

2. Creditors or collectors appearing at the workplace.

3. Gambling beyond the ability to stand the loss.

4. Excessive drinking or other personal habits.

5. Easily annoyed at reasonable questioning.

6. Providing unreasonable responses to questions.

7. Refusing vacations or promotions for fear of detection.

8. Bragging about significant new purchases.

9. Carrying unusually large sums of money.

10. Rewriting records under the guise of neatness in presentation.

RED FLAGSFOR FRAUD IN CASH/ACCOUNTS RECEIVABLE

1. Excessive number of voids, discounts and returns.

2. Unauthorized bank accounts.

3. Sudden activity in a dormant banking accounts.

4. Taxpayer complaints that they are receiving non-payment notices.

5. Discrepancies between bank deposits and posting.

6. Abnormal number of expense items, supplies, or reimbursement to the employee.

7. Presence of employee checks in the petty cash for the employee in charge of petty cash.

8. Excessive or unjustified cash transactions.

9. Large number of write-offs of accounts.

10. Bank accounts that are not reconciled on a timely basis.

RED FLAGS FOR FRAUD IN PAYROLL

1. Inconsistent overtime hours for a cost center.

2. Overtime charged during a slack period.

3. Overtime charged for employees who normally would not have overtime wages.

4. Budget variations for payroll by cost center.

5. Employees with duplicate Social Security numbers, names, and addresses.

6. Employees with few or no payroll deductions.

RED FLAGS FOR FRAUD PURCHASING/INVENTORY

1. Increasing number of complaints about products or service.

2. Increase in purchasing inventory but no increase in sales.

3. Abnormal inventory shrinkage.

4. Lack of physical security over assets/inventory.

5. Charges without shipping documents.

6. Payments to vendors who aren’t on an approved vendor list.

7. High volume of purchases from new vendors.

8. Purchases that bypass the normal procedures.

9. Vendors without physical addresses.

10. Vendor addresses matching employee addresses.

11. Excess inventory and inventory that is slow to turnover.

12. Purchasing agents that pick up vendor payments rather than have it mailed.

13. Payments to the same vendor with different records.

For all of the above, controls, review, and approval by senior management are essential to curb fraud. Hence the relevance of areas such as compliance, internal controls, and comptroller.

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