Investors, analysts and
corporate directors rely on external audits to keep companies honest. But a new
study says audits are woefully ineffective at uncovering fraud. In fact, more
than twice as many frauds are uncovered by accident.
This is a finding in the
"Report to the Nations on Occupational Fraud and Abuse" study
released Tuesday by the Association of Certified Fraud Examiners, which bills
itself as the world's largest anti-fraud organization.
"You can't put the onus
on somebody else to keep your place clean," said ACFE faculty member Evy
Poumpouras, a former U.S. Secret Service agent. She said internal controls can
be much more effective in uncovering fraud—and preventing it in the first
place.
The study examined 1,483 cases
of fraud as reported by the Certified Fraud Examiners who investigated them.
"The analysis of these
cases provides valuable lessons about how fraud is committed, how it is
detected and how organizations can reduce their vulnerability to this
risk," wrote ACFE President James Ratley in the report's introduction. Read More on Twitter Page
The report estimates the
typical organization loses five percent of its revenue each year to fraud. That
would work out to a global impact of $3.7 trillion, the report says. But as
staggering as the figure might seem, Poumpouras says she is not surprised.
"There are so many more
cases that we don't know of," she said.
Nearly half of the fraud cases
studied were in the United States, where anti-fraud controls tend to be the
strictest. But the biggest losses were in Eastern Europe and Western and
Central Asia. The median loss in those regions was $383,000, compared to
$100,000 in the U.S.
Employees and middle managers
committed the lion's share of fraud, with owners and senior executives
accounting for just 19 percent of the cases. But perhaps unsurprisingly, the
study noted that the higher-ranking the fraudster was, the greater the losses.
Regardless, financial fraud is
particularly difficult to uncover, Poumpouras said, because the perpetrators
have less of an emotional connection to what they are doing than they do for
other types of crime.
"Usually you are not
touching money. You're fudging documents. It feels less real," said
Poumpouras, who has been involved in many financial fraud investigations.
"Getting people to
confess to financial crime is more difficult than getting them to confess to
murder," she said, which may help explain why audits can be so
ineffective.
The study says auditors
detected just 3 percent of the fraud cases reported last year, compared to 7
percent uncovered by accident.
"While independent audits
serve a vital role in organizational governance," the report says,
"our data indicates that they should not be relied upon as organizations'
primary anti-fraud mechanism."
Instead, the study recommends
what it calls "proactive detection measures" including internal
hotlines that allow employees to report fraud anonymously and keep their
co-workers honest.
"Most employees don't
want to rat on someone," Poumpouras said. "They want to do it
anonymously."
The study appears to bear that
out.
"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 study says. More than 42
percent of the cases in the report came to light as the result of a tip. More Articles from Corliss Group
Yet only about half the
organizations surveyed had a system for collecting tips, and fewer than 11
percent offered rewards to whistleblowers.
The study found small
businesses were particularly vulnerable to fraud, yet they are least likely to
protect themselves, often because don't perceive themselves to be at risk—or
because they think fraud protection is too costly.
But the report says some of
the most effective measures are not costly at all.
They include an anti-fraud
policy that employees are required to acknowledge from time to time—"It
lets them know what management is expecting," Poumpouras said.
Surprise audits and spot
checks by management—rather than by an external auditor who might not know all
the potential ways inside a company to hide fraud—can also be effective.
And training all employees to
spot fraud not only creates more cops on the beat, it also puts everyone on
notice.
"The more police officers
you see on the street, the less likely people are to commit a crime,"
Poumpouras said.
BY SCOTT COHN
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