RSM Resources

A recent study by the Association of Certified Fraud Examiners(ACFE) underscores what many business owners know all too well:Job-related fraud imposes enormous costs on employers. Small tomidsized businesses — those with fewer than 100 employees — suffer adramatically disproportionate number of fraud-related losses, the studysays.

Why midsized businesses?

Occupationalfraud causes a median loss per incident of $159,000 — but for small tomidsized businesses, the median loss is $190,000, according to theACFE. The most common occupational frauds in these organizationsinvolve employees writing fraudulent company checks, skimming revenueand processing bogus invoices.

Many small to midsized businessessuffer high fraud losses because they fail to proactively detectwrongdoing. Less than 10 percent of those studied have anonymousfraud-reporting systems, the ACFE says. And less than 20 percent haveinternal audit departments, conduct surprise audits or providefraud-detection training for their employees. Not surprisingly, then,small to midsized businesses more often uncover fraud accidentally thanby any other means, according to the study.

Several otherfactors contribute to the disproportionate rate of fraud among small tomidsized businesses, says Andi McNeal, an editor on the ACFE researchteam.

"First, the familiarity and level of trust betweenemployees in [small to midsized] organizations frequently results infewer questions from other employees and managers," McNeal says. "In anatmosphere where employees and management know each other well, theytend to be less alert to the possibility of fraud."

Further,McNeal says, many small to midsized business owners hold the attitudethat "it can’t happen to me" — that fraud is a problem only bigcompanies face. This attitude, combined with a lack of awareness andeducation, often leads to a decreased emphasis on preventing fraud inan organization.

Those factors may not directly cause a greaterrate of fraud in small to midsized companies. But they certainly makesuch organizations more susceptible to being defrauded and allowgreater opportunity for potential wrongdoers, McNeal says. In addition,she says, the inherent lack of segregation of duties in some businessesmeans an individual may have the ability to perpetrate and conceal afraudulent act more easily than in a larger organization that dividesresponsibilities and provides greater oversight.

Who’s committing fraud?

Thesize of losses from fraud closely corresponds to the position of theperpetrator. According to the ACFE study, business owners andexecutives who committed fraud caused a median loss of $1 million. Thatis nearly five times the median loss managers caused and almost 13times as large as the median loss employees generated.

Themajority of occupational fraud incidents in the study involved eitherthe accounting department or upper management. Employees in theaccounting department committed more than 30 percent of the frauds, andupper managers or executive-level employees committed slightly morethan 20 percent.

High-level executives who commit fraud arenot immune from detection and punishment. High-profile corporatescandals in publicly held companies, such as those involving ArthurAndersen and Enron, have emboldened federal, state and localprosecutors, and given law-enforcement officials more far-reachingpowers. Since the adoption of the Sarbanes-Oxley Act of 2002 (SOX), theU.S. Department of Justice Corporate Fraud Task Force has secured morethan 1,000 convictions or guilty pleas, including cases against morethan 200 corporate chief executives, presidents and chief financialofficers.

And judges aren’t going easy on corporate crooks.Witness the lengthy sentences handed down in some highly publicizedcases: Adelphia Communications Corp. founder John Rigas was sentencedto 15 years in prison; Tyco’s chairman and CEO Dennis Kozlowski, 25years; and WorldCom Inc. CEO Bernard Ebbers, 25 years.

Tips for stopping fraud

Detectingoccupational fraud can be very difficult, even though fraud incidentsoften occur over many months. In the ACFE study, fraud incidents lasteda median of 18 months from inception to detection. How can a small tomidsized business uncover fraud?

Confidential hotlines and otherreporting mechanisms are the most effective fraud-detection tools. Tipsare more likely to uncover fraud than other means, such as audits orinternal controls. The importance of tips is especially evident incases involving losses of $1 million or more. Tips exposed 44 percentof the million-dollar frauds in the ACFE study. That’s more than twicethe rate of detection by internal audits and three times the rate ofdetection by external audits.

Certain anti-fraud procedures canmeasurably effect an organization’s bottom line. In the ACFE study,organizations with anonymous fraud hotlines suffered a median loss perfraud incident of $100,000, while organizations without hotlines lost amedian of $200,000. Similar reductions in fraud losses occurred inorganizations that had internal audit departments, regularly performedsurprise audits and conducted anti-fraud training for employees.

Adifferent study, conducted by research firm Lord & Benoit LLC,surveyed the share-price performance of nearly 2,500 companies thatfollow the internal-controls rules contained in SOX. During the courseof the two-year study, companies that employed the best fraud-controlpractices outperformed those with weak internal controls in terms ofearnings. Additionally, the process of evaluating internal controlspromoted earnings growth when the companies acted on any problemsfound, according to the study.

Fraud likely worse than numbers show

"Fraud,by its nature, is hidden, and so the true amount of fraud taking placein U.S. businesses at any one time cannot be calculated," says JohnWarren, ACFE general counsel. "Even attempts to measure the amount offraud that has already been detected will lead to incomplete results."

Manyfraud cases go unreported because the victim organizations do notrecognize that they have been defrauded, choose not to report thecrimes for fear of bad publicity or simply do not want to deal with therepercussions, Warren says.

"The one thing we do know for certain is that occupational fraud imposes tremendous costs on U.S. organizations," he says.