It is rare today to pick up a newspaper or listen to a newscast without being confronted with reports of some type of recent fraud. In addition to the impact on the individuals involved, these incidents of unethical and fraudulent behavior can be devastating to businesses. Much of the media attention has centered on known incidents of financial statement fraud, such as occurred with Enron, WorldCom, and other high profile cases; however, businesses are negatively impacted by multiple types of fraud, many of which are never made public.
The Association of Certified Fraud Examiners (ACFE) has been tracking fraud for several years. The organization's 2006 ACFE Report to the Nation on Occupational Fraud and Abuse is the fourth comprehensive fraud study to be released by the organization. In the study, occupational fraud is defined as
The use of one's occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization's resources or assets ... The activity is clandestine; violates the perpetrator's fiduciary duties to the victim organization; is committed for the purpose of direct or indirect financial benefit to the perpetrator; and costs the employing organization assets, revenue or reserves ACFE (2006, pg 6)."
The ACFE conducted the study over a twenty-five month period commencing January 2004 and ending January 2006. Information was gathered from Certified Fraud Examiners (CFE) and was based on 1,134 cases of occupational fraud. When the CFEs were asked to estimate the percentage of annual revenues lost to occupational fraud, the median loss estimate was a sizable five percent.
The ACFE classifies occupational fraud into three major types: asset misappropriation, corruption, and fraudulent financial statements. Asset misappropriation results from the misuse or theft of an entity's assets. This includes theft of cash, billing schemes, expense reimbursement schemes, check tampering, payroll fraud, fraudulent wire transfers, cash register disbursement schemes, theft of securities, theft or misuse of propriety information, and inventory theft. Corruption results from an individual using his or her influence in order to receive an unauthorized benefit. These activities include conflicts of interest, bribery, illegal gratuities, and extortion. Fraudulent financial statements result from one or more falsified entries in the entity's accounting system that causes the entity to look more or less profitable. Asset misappropriation occurred in the vast majority of cases reported in the ACFE's report (91.5 percent for asset misappropriation, 30.8 percent for corruption and 10.6 percent for fraudulent statements (some frauds fell into more that one category)) but the median loss was greatest for fraudulent financial statements. Median reported losses by category were $150,000 for asset misappropriation, $538,000 for corruption and $2,000,000 for fraudulent statements (ACFE, 2006).
The ACFE found that fraud was initially discovered by tips (34.2% of cases), accident (25.4% of cases), internal audits (20.2% of cases), internal controls (19.2% of cases), external audit (12% of cases), and police notification (3.8% of cases). The sum of the above percentages exceeds 100 percent due to the overlapping of detection methods. As these data indicate, tips are a more successful fraud detection mechanism than other internal controls or either external or internal auditors. Tips are most often reported by employees (64.1% of the time, according to the ACFE survey). Other sources of tips include anonymous sources (18.1%), customers (10.7%), and vendors (7.1%).
The prevalence of fraud and the wide array of fraudulent activities occurring in United States businesses show a need to understand how people will react when confronted with situations involving fraudulent behaviors. Since businesses rely on tips to discover many frauds, and a sizable portion of those tips come from employees, it is critical for employees to be aware of what activities are considered fraudulent. …