When we think of fraud, there’s a tendency to conjure up images of a masked bandit making off with bags of money. We mythologize the fraudster as an outsider, an unfamiliar face putting us in danger.
But often, fraud is committed right under our noses by people we trust.
Data Off Site Link from 2018 reports that occupational fraud – fraud committed by employees against their employer – created $7 billion in losses. Usually smaller businesses are hit the hardest. These organizations don’t have the robust framework of internal controls that major corporations do and can’t weather the economic storm caused by misappropriation of funds or embezzlement.
The scariest part? It’s uncommon for corporate fraud victims to recover their losses.
“Nine times out of ten the money’s gone,” said Jesse Morton, a director in disputes, compliance and investigations at global advisory firm Stout.
Internal Fraud at Small Organizations
The Association of Certified Fraud Examiners (ACFE) has produced an annual report on fraud since 1996. The ACFE’s Report to the Nations is hailed as one of the premier datasets on the subject.
The ACFE reported in 2018 that small businesses lost almost twice as much to fraudulent schemes as larger companies. Why?
“You see a lot of fraud at smaller companies, which are operating with limited resources, because there aren’t enough people involved to provide the appropriate levels of oversight,” said Chris Roane, a certified fraud examiner at the Atlanta-based firm Bennett Thrasher. “You get individuals wearing multiple hats. It’s impossible to appropriately segregate duties.”
Morton has worked in fraud for more than 20 years. The cases he’s seen recently involving smaller companies have been almost identical: An employee experiences a “triggering” life event – divorce, drug addition, unexpected expenses – that leads them to steal funds.
In each case, a trusted individual with limited oversight commits the offense.
“Even if you have someone that is the greatest person in the world, people do bad things every day – you have to have a healthy dose of skepticism,” said Morton.
Minnesota-born sociologist Donald Cressey created the “fraud triangle,” a framework used to this day to detect and study workplace fraud. The fraud triangle theory states that opportunity, incentive and rationalization all need to be present for occupational fraud to take place.
An employee needs the opportunity – limited oversight and no segregation of duties – as well as an incentive, which often refers to the need for quick cash in a trying financial time.
But, the third piece of the triangle, rationalization, poses an interesting hypothesis.
“Fraudsters don’t think they’re bad people,” said Patrick Finn, a certified fraud examiner and partner at Lighthouse Management in Minneapolis. “They don’t think they did anything wrong, but instead that the ends justified the means.”
The late Cressey’s theory suggests those who commit fraud aren’t as phased by it as a bystander would be. And that they probably aren’t thinking about consequences.
What Small Businesses Can Do
So how can small businesses protect themselves? There’s no perfect set of controls, but the following procedures can help:
- Segregate duties to limit the likelihood an employee can commit fraud
- Conduct routine and surprise audits
- Create a culture that emphasizes the danger fraud poses
- Conduct background checks and check employee references
- Watch for suspicious behavior like employees with lavish new things or workers not wanting to take vacation
- Reconcile your accounts often
- Reward whistleblowing employees
- Promote communication and openness
Tips are the most common form of fraud detection, according to ACFE.
“Ensuring your employees feel safe to report suspicious activity is paramount,” said Roane.