Spotting and Responding to the Red Flags of Fraud

Corporate fraud happens often enough that in-house counsel need to keep in their arsenal a good understanding of the signs of fraud, as well as what to do when they suspect it is occurring at their company. When you do have an allegation or an issue, how do you know if you have enough information to follow up on it? When do you bring in a forensic accountant? How many resources should you spend on it—including board time?

The Numbers of Fraud

Fraud has been well studied over the past few decades, and the statistics show that the most common occurrence involves a long-term employee with a high level of authority within the company.

In over 80 percent of reported fraud cases in 2010 and 2011, the perpetrator displayed one or more of the behavioral red flags associated with fraudulent conduct, according to the “2012 Report to the Nations on Occupational Fraud and Abuse” from the Association of Certified Fraud Examiners (ACFE).

The typical organization loses 5 percent of its revenues to fraud each year, according to the report. The median loss caused by the occupational fraud cases in the study was $140,000, but in more than one-fifth of these cases, fraud caused losses of at least $1 million. Companies tend to see larger losses when the fraudster is someone with a high level of authority. For example, employees caused a median loss of $60,000, but for managers the loss went up to $180,000, and for executives or owners it was $573,000.

Fraud is most commonly detected by employees (43.3 percent of the time), management (14.6 percent), and internal audits (14.4 percent). By being aware of the behavioral red flags and making key employees aware of them as well, you can increase your company’s resistance to fraud. (Naturally, you also need to have the proper internal controls in place.)

Companies may experience various types of fraud including:

• Asset misappropriations (stealing cash, fraudulent disbursements, or misappropriating of other types of assets such as inventory or confidential customer financial information) is the most common type of fraud and comprises 87 percent of fraud reported in 2011.
• Corruption fraud (bribery or conflicts of interest).
• Financial reporting fraud (intentional misstatement of the financial statements) makes up only about 8 percent of reported fraud, but accounts for the greatest losses at a median of $1 million per case.

The Red Flags of Fraud