© August 1996
Association of Certified Fraud Examiners

Collaring Crime at Work

BY JOSEPH T. WELLS

American has big problems with white-collar crime, and the rest of the world is probably not far behind. Here, certified fraud examiner Joseph Wells details the findings of one of the most comprehensive studies into occupational fraud and abuse ever undertaken in the United States.

Late last year the U.S.-based Association of Certified Fraud Examiners released its Report on Occupational Fraud and Abuse. The two and a half year study asked certified fraud examiners (CFEs) to help estimate the revenue loss to organizations as a result of these offences, and to provide an example of an actual case of fraud or abuse for further analysis.

The 2,608 certified fraud examiners who responded provided the most complete look at this phenomenon so far. The Report reached some milestone conclusions:

• U.S. organizations lose an average of 6% of their revenues to all forms of occupational fraud and abuse
• There are three basic forms of occupational fraud and abuse: asset misappropriation, corruption, and fraudulent statements
• There was a direct correlation between average losses and the perpetrator's age, sex, and position in the organization
• organizations with 100 employees or fewer were the most vulnerable to occupational fraud and abuse
• The most effective single deterrent was a hotline.

The Report defines occupational fraud and abuse as: ‘The use of one's occupation for personal enrichment through the deliberate misuse or application of the employing organization's resources or assets'. This encompasses a wide variety of conduct by managers, employees, executives and principals of organizations, ranging from simple pilferage to sophisticated investment swindles. Common violations include asset misappropriation, corruption, false statements, petty theft and pilferage, false overtime, use of company property for personal benefit, and payroll and sick-time abuses.

The line between fraud and abuse is a fine one. If a cashier fudges her paperwork to cover a theft of $100, we call that ‘occupational fraud'. But if the same cashier earns $100 a day and instead falsely calls in sick, we call that ‘occupational abuse'.

The key is that the activity:

• Is clandestine
• Violates the employee's fiduciary duties to the organization
• Is committed for the purpose of direct or indirect financial benefit to the employee
• Costs the employing organization assets, revenues or reserves.

COUNTING THE COST

Although this study is not the first to consider abuse and fraudulent employee behavior, it is the first to attempt to estimate its cost by polling experts in the field.

In the early 1970s, one researcher found that employees of a US manufacturing plant had developed an informal system whereby a variety of company property was considered to be of ‘uncertain ownership', particularly small, plentiful and inexpensive materials and tools. Pilfering such property was often regarded not as stealing, but as ‘taking things from the plant' and would not arouse feelings of guilt on part of the employees.

A 1983 survey of over 9,000 US employees found that a full one-third had admitted theft on the job, while more than two-thirds admitted abuses at some level.

The Ethics Resource Center's 1994 study, Ethics in American business: policies, programs and perceptions, concluded that the two of the most common transactions observed by employees were lying on reports or falsifying records (41%) and stealing and theft (35%).

Unlike many crimes, fraud's clandestine nature makes it difficult to quantitatively measure. That is because not all fraud and abuse is uncovered; of that uncovered, not all is reported; incomplete information is gathered in some reported cases; information gathered is often not distributed; and civil or criminal action is frequently not taken against the perpetrator.

Certified fraud examiners work mostly for organizations large enough to warrant an in-house expert to detect and resolve occupational fraud and abuses. These CFEs are also aware of the indirect costs of fraud and abuse: the loss of productivity from hiring and firing abusive employees, legal action, unemployment, government intervention, and other hidden costs.

According to the CFEs in the 1995 Report, American organizations lose about 6% of their revenues to all forms of occupational fraud and abuse. However, in interpreting these costs, the following should be considered:

• organizations are already paying for the economic losses from fraud and abuse as a part of their operating costs
• Because abuse is seen be many employees as an informal employment benefit, some sociologists have even suggested chronic pilferage and certain other abuses might actually have a positive effect on morale and therefore increase productivity
• Much abuse is silently condoned in organizations. It is not restricted to the rank and file; indeed, one study reflected that 62% of inventory shrinkage caused by employees was committed by company supervisors.

The Report asked respondents to detail characteristics of the people who carry out occupational fraud. The data shows that about 58% of the reported fraud and abuse cases were committed by non-managerial employees, 30% by managers, and 12% by owners/executives. However, the average losses caused by non-managerial employees ($60,000) were significantly lower than those caused by managers and executives ($250,000). The loss differences are attributable primarily to the amount of financial control exercised in each position: those in the highest positions have the greatest access to company funds and assets.

The average loss per case caused by males was $185,000, nearly four times that caused by females ($48,000).

Perpetrators younger than 25 years caused average losses of about $12,000, while those caused by employees aged 60 and older were some 28 times greater, or about $346,000. Older employees tend to occupy higher-ranking positions and therefore generally have greater access to company assets.

The Report also found a linear relationship between education and average losses due to fraud and abuse. Again, those with more education generally occupy higher positions in their organizations and therefore have more access to company funds and assets.

The study also gathered information on the size of the defrauded organization by number of employees. The average loss for organizations with 100 employees or fewer was $120,000, nearly the same as that for organizations with more than 10,000 employees ($129,000). On a per capita basis, however, small organizations suffered the largest losses.

The Report classifies the numerous methodologies used by employees to commit occupational fraud and abuse. The methods can be divided into three broad categories: asset misappropriation, corruption, and fraudulent statements.

Asset misappropriation. This was by far the most common form of occupational fraud, constituting more than four out of five reported offences. Assets are misappropriated either directly or indirectly for the employee's benefit. Although any tangible asses can be misappropriated, certain assets are more susceptible than others.

Transactions involving the organization's cash and checking accounts were far more common than all other asset misappropriations combined. Other susceptible assets include inventory, supplies, equipment, and information.

Corruption. Black's Law Dictionary defines corruption as: ‘The act of an official or fiduciary person who unlawfully and wrongfully uses his station or character to procure some benefit for himself or for another person, contrary to duty and the rights of others'.

Corruption, in the sense of occupational fraud, usually involves an executive, manager, or employee or the organization in collusion with an outsider. There are four principal types of corruption: bribery, illegal gratuities, conflicts of interest, and economic extortion. Corruption accounted for about 10% of occupational fraud cases.

Fraudulent Statements. This is the third broad category. These statements, in order to meet the definition of occupational fraud, must bring direct or indirect financial benefit to the employee. Although all fraud involves ‘fraudulent statements', this category is limited to two sub-categories: fraudulent financial statements and all others. Fraudulent statements accounted for about 5% of all occupational fraud cases.

CONCLUSIONS

The 1995 Report drew a number of important conclusions, some of which are equally applicable outside the United States. These are set out below.

There is a direct correlation between the employee's age, sex, and position and the average loss due to fraud and abuse.
The data showed that the most predictive variable concerning the amount lost was the perpetrator's position in the organization. As a general rule, men and older employees occupy higher positions and therefore have greater access to assets.

Small organizations are the most vulnerable to occupational fraud and abuse.

Organizations with 100 employees or fewer suffered the largest average losses per capita. Generally this is because sophisticated internal controls, designed to deter occupational fraud, are less prevalent in smaller organizations.

A lack of understanding of the nature of occupational fraud and abuse adds to its cost.
Certified fraud examiners frequently comment that executives often are reluctant to believe fraud and abuse occurs within their organizations. Because of their clandestine nature, many of these offences go undetected until significant losses are incurred.

Relatively few occupational fraud and abuse offences are discovered through routine audits.
Most fraud is uncovered as a result of tips and complaints from other employees. To deter and detect fraud and abuse, many experts believe an employee hotline is the single most cost-effective measure.

Some organizations install their own hotlines, while others use a subscription service such as EthicsLine, maintained by the Association of Certified Fraud Examiners.

The expansion of computers in organizations will probably increase losses from occupational fraud and abuse.
The use of computers in business has drastically changed the speed with which financial transactions can be accomplished. In addition, computers often do not create the documents necessary to detect fraud and abuse easily. Many experts see increasing reliance on computers as a likely cause of additional offences. However, computers are also being employed to detect fraud and abuse.

The rate of occupational fraud and abuse will probably rise.
Occupational fraud and abuse is caused by many complex sociological factors. Individual and corporate morality are difficult to quantify. Among other things, increasing demands on the criminal justice system by violent criminals may make fraud and abuse prosecutions more difficult.

Additional proactive vigilance and education, however, as well as consumer action, could stem future increases in occupational fraud and abuse.

Joseph T. Wells, CFE, CPA is founder and chairman of the 15,000-member Association of Certified Fraud Examiners, based in Texas, USA. He was previously a staff auditor for Cooper & Lybrand, and a Special Agent of the Federal Bureau of Investigation.