What is Ethics?
Audit Committees

Business Fraud

Cost of Fraud in Business Organizations

In my last blog I wrote about the ever-increasing cost to society of criminal fraud that targets investors. Fraud in business organizations also seems to be on the rise despite all efforts to reduce it following well-publicized accounting frauds at Enron and WorldCom. According to research conducted by the Association of Certified Fraud Examiners (ACFE) in 2008, Acfe U.S. organizations lose an estimated 7 percent of annual revenues to fraud. Based on the projected U.S. Gross Domestic Product this percentage indicates a staggering estimate of losses around $994 billion among organizations, despite increased emphasis on anti-fraud controls and recent legislation to combat fraud. Also, the median dollar loss caused by fraud schemes was $175,000. More than one-quarter of the frauds involved losses of at least $1 million.  The Sarbanes-Oxley Act (SOX) that was passed in 2002 established strict requirements for internal controls and an independent audit committee. While the jury is still out with respect to whether SOX is accomplishing its goal of reducing fraud, the ACFE Report to the Nation on Occupational Fraud & Abuse seems to indicate otherwise.

The ACFE defines occupational fraud 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 report is based on data compiled from 959 cases of occupational fraud that were investigated between January 2006 and February 2008. ACFE identified three categories of fraud including corruption, asset misappropriation, and fraudulent financial statements. Examples of corruption include conflicts of interests, bribery, illegal gratuities, and economic extortion.  Asset misappropriation includes, among others, fraudulent disbursements and the misuse/theft of assets. The most common occupational fraud schemes were corruption (27%) and fraudulent billing (24%). Financial statement fraud was the most costly with a median loss of $2 million. Fraudulent financial statements come in many forms including asset/revenue over (under) statements, delaying (accelerating) expense recognition, and the failure to accrue for liabilities.

In a recent, disturbing finding, the Institute of Internal Auditors conducted a poll of nearly 300 chief audit executives in early 2010 that found fraudulent acts by employees and outsiders have risen since the beginning of the recession, and internal auditors predict the trend will continue through the rest of 2010. Among the 31 percent of survey participants from organizations where instances of fraud were detected since 2008, 43 percent report that fraud occurrences increased from 1 percent to 10 percent, 28 percent indicate fraud increased from 11 percent to 20 percent, and 14 percent say fraud increased by more than 20 percent. Theft of company property and resources — including proprietary information — is the fastest-growing fraud reported by respondents, followed by embezzlement, including expense account fraud and third-party or vendor fraud.

So why is it that fraud continues to infect corporate America? I believe it reflects the general decline in ethics. Over the years we have morphed into a pursuit of self-interests society. In my previous blogs I addressed the issues of insider trading and Ponzi schemes. These techniques tend to siphon off resources from others who play by the rules of the game. Unfortunately, I expect the trend to continue and possibly even accelerate during the economic “recovery,” especially since fraudsters generally stay one step ahead of the regulators.