I've Got a Tip for You (Gwen Moritz Editor's Note)

Every other year since 2000, the Association of Certified Fraud Examiners has issued a big, thick study that it calls, ominously, “Report to the Nations on Occupational Fraud.” The eighth Report to the Nations was released this month, and it came to the same conclusion as earlier ones: A typical organization loses 5 percent of revenue each year to fraud.

The ACFE applied that to the Gross World Product and estimates that global fraud translated to a loss of nearly $3.7 trillion in 2013. If we apply it to the largest private companies that are ranked in this issue of Arkansas Business, more than $1.5 billion could have been lost to fraud by just those 75 Arkansas companies last year. The smallest of them, revenuewise, is looking at a loss of more than $4 million a year, the largest at more than $100 million.

For a lot of companies — maybe yours — losing 5 percent of revenue to fraud can mean the difference between a profit and a loss. Consider this: The median loss caused by the frauds studied by the ACFE for its new report was $145,000, but almost a quarter of them involved losses of at least $1 million.

The Association of Certified Fraud Examiners separates occupational fraud into three categories: asset misappropriation, corruption and financial statement fraud. The first category is what we think of as old-fashioned embezzlement, and it is the most common, occurring in 85 percent of the cases that the ACFE studies for the 2014 report. But embezzlement, which can take a number of different forms, is the least costly of the three categories, causing a median loss of $130,000 per incident. (Still, $130,000 is entirely too much for most businesses to allow to walk out the door. And, as it happens, the smallest organizations tend to suffer disproportionately large losses due to occupational fraud.)

Only 9 percent of the cases studied involve financial statement fraud, but those were the big-ticket frauds, with a median loss of $1 million. Corruption schemes fall in the middle: 37 percent of cases, median loss of $200,000.

Of course, 85 percent plus 37 percent plus 9 percent add up to more than 100 percent. That’s because, according to the ACFE, about 30 percent of occupational fraud cases involve more than one of the three categories. Someone stealing assets — cash or inventory — might well try to hide it through financial statement fraud if he or she is in a position to do so.

And position in the organization matters. The higher the perpetrator’s level of authority, the less likely he is to commit fraud but the larger the loss is likely to be. Owners and executives accounted for only 19 percent of the cases studied, but they caused a median loss of $500,000. Middle managers committed 36 percent of the frauds with a median loss of $130,000, while employees committed 42 percent of frauds but caused a median loss of only $75,000.

Guess what else matters: the way people behave. “Red flags” were present in more than 90 percent of the cases detected, and the most common (almost 44 percent of the time) was living beyond one’s (legitimate) means. Personal financial problems, which some folks decide to solve at the expense of their employer, is the second most common red flag, but organizations also need to be aware of unusually close relationships with a vendor or customer, a “wheeler-dealer” attitude and resistance to sharing duties.

I would have guessed that expense reimbursement fraud would be the most common type of asset misappropriation scheme, but I would have been wrong. It’s common — almost 14 percent of cases in that category of occupational fraud — and costly, averaging about $30,000 per case studied. But expense reimbursement fraud is less common and less costly than billing fraud (22.3 percent of cases and averaging $100,000) and theft of non-cash assets (21 percent and $95,000).

Oh, but your organization is different. You have an internal and external auditors. You reconcile accounts regularly. You even use surveillance. The ACFE has some bad news for you: All of those methods of detection put together are less likely to root out a particular incident of occupational fraud than the old-fashioned method of simply being tipped off, often (but not nearly always) by another employee.

“Organizations with hotlines were much more likely to catch fraud by a tip, which our data shows is the most effective way to detect fraud,” the ACFE concluded. “These organizations also experienced frauds that were 41% less costly, and they detected frauds 50% more quickly.”

Take a tip from the ACFE: Make sure your employees, customers and vendors know that they can and should report suspicious activity.

The full Report to the Nations is available online at ACFE.com.

Email Gwen Moritz, editor of Arkansas Business, at GMoritz@ABPG.com.