Moving fraud awareness from the back room to the boardroom

The ACFE's Report to the Nations on Occupational Fraud and Abuse has led to the classification and analysis of thousands of occupational frauds. But, perhaps, more importantly, it has shown organizational management and the public the dire need for well-planned fraud awareness, deterrence and prevention programs.

Imagine this. It's 1995, and Sam, an internal auditor and Certified Fraud Examiner at a mid-size corporation, is frustrated. His bosses are blissfully ignorant of possible fraud situations. But Sam is even more alarmed that the corporation doesn't have any substantial fraud detection, deterrence and prevention programs. Sam just wants some authoritative information, which he can use to convince management that it's heading down an expensive road.

Back then, organizations knew little about occupational fraud. Fraud examiners had no statistics on its cost, frequency and methodology.

Dr. Joseph T. Wells, CFE, CPA, Chairman of the ACFE and its founder in 1988, wanted to change that. He wanted to give fraud examiners, accountants, auditors, investigators, management and boards of directors a sharp-edged tool that could show the high cost of fraud and the folly of ignoring measures to mitigate it.

Groundbreaking survey

Dr. Wells had seen scores of different types of fraud when he was an FBI agent, and he says they seemed to occur in definite patterns. "Until that time in the 1980s, it was generally thought that there were an unlimited number of ways that fraud could be committed," he says. "When I began the ACFE I wanted to see if that was true; my senses told me it wasn't."

So in the early to mid-'90s, Dr. Wells acted on a long-brewing idea. He devised a survey for U.S. CFEs, which asked them to estimate — based upon their industry knowledge — the percentage of annual revenue lost to fraud and abuse in the average organization. He recruited Sandra Thomas Welch, Ph.D., of the University of Texas at San Antonio, Robert H. Strawser, Ph.D., of Texas A&M University and Sarah A. Reed, Ph.D., then at Texas A&M, to help develop the survey form and eventually analyze the first layer of data.

In the survey, CFEs were asked to provide: specific fraud schemes in their organizations and how they were committed and detected, costs and duration of those schemes, fraudster profiles, demographics about victim organizations and other information. Then the survey asked them to write detailed descriptions of fraud cases they'd worked. No organization had ever asked anti-fraud practitioners these questions.

In 1993, the ACFE mailed surveys to all U.S. CFEs. And waited. Dr. Wells had no idea if members would respond. They did. More than 2,600 dutifully mailed their responses back. The ACFE issued its first Report to the Nation on Occupational Fraud and Abuse ("Nations" in later reports) in 1996, and the fraud examination profession changed forever.

Body of knowledge

John Warren, J.D., CFE, the report's lead manager in its early days, and now the ACFE's vice president and general counsel, said most companies in the '90s didn't want to acknowledge they had a fraud problem. "It was really, really hard for CFEs to get buy-in from management to implement effective controls and detection procedures. CFEs just couldn't demonstrate a threat or its size," says Warren, who's also now a co-editor of the report.

James D. Ratley, CFE, president of the ACFE, and one of the first association executives in 1988, says members "described the problems they were having in their efforts to convince their managers and other senior managers that fraud was a problem worthy of the time and expense necessary to prevent and detect it."

Warren says the ACFE knew then that fraud was a huge problem. "Our members were telling us this. Our own experience was telling us this. But we couldn't find any numbers to validate it.

"The brilliant idea that Dr. Wells had was that we were sitting on top of what might have been the largest collection of fraud knowledge in the world, and we should do something with it," Warren says. "We had all these members who had all this information. If anybody was going to try to aggregate it, it might as well be us."

"Any profession — law, medicine, accounting, engineering, architecture, fraud detection and deterrence — is defined by its common body of knowledge (CBOK)," Dr. Wells says. "Until the first report, there was no CBOK in the anti-fraud field. This was a major step forward."

Fraud Tree and a seminal book

"In the first study, we were attempting to classify frauds by the methods with which they were committed," Dr. Wells says. "We determined that in occupational fraud, there were three principal schemes — corruption, asset misappropriation and financial statement fraud — and 11 distinct sub-schemes. This involved nearly a year of Warren's intensive work because there was no roadmap to follow," he says. "We used the results to devise the Occupational Fraud and Abuse Classification System — the Fraud Tree.

"The Fraud Tree has changed the nature of how occupational fraud has been codified," Dr. Wells says. "It clearly shows that there are only so many ways to skin a cat. And when professionals know and understand those ways, responding to fraud issues takes the mystery from them.

"Once we identified the schemes, the next task was to determine their average cost, the length of time they were ongoing, and whether the schemes were increasing or decreasing in frequency. This could only be done with longitudinal studies," he says.

Dr. Wells then used the information from the first report and the Fraud Tree to write the seminal 1997 book, "Occupational Fraud and Abuse." (Dr. Wells' book, " Corporate Fraud Handbook: Prevention and Detection," now in its fourth edition, is the successor to "Occupational Fraud and Abuse.")

"Dr. Wells produced the original book by not only including the initial information from the first report, but many of the cases that CFEs contributed with their surveys," says John Gill, J.D., CFE, the former ACFE Research Department manager who helped with the 1996 report. He's now vice president of education for the ACFE. "He hired writers who contacted the CFEs, gathered further information and wrote compelling case histories to illustrate schemes from the Fraud Tree for ‘Occupational Fraud and Abuse.' To this day, we like to include case stories in our materials to teach about schemes and anti-fraud principles in an entertaining way."

Years of trends, going global and consistency

The 2016 report is the ninth the ACFE has published. "Twenty years of data is an incredible resource," says Bruce Dorris, J.D., CFE, CVA, vice president and program director at the ACFE. "The ability to look back through time and analyze trends is invaluable. As the report segments more and more information, fraud examiners are able to use that information to better perform their jobs of detecting and preventing fraud."

In 2009, the ACFE began collecting information from CFEs around the world, and the 2010 study became the Report to the Nations. "Being able to use worldwide data in the report for the last several years was a watershed moment in the history of the Global Fraud Survey," Dorris says. "Including fraud examination information from around the world demonstrates just how wide this problem is and how important CFEs are to every country and every region."

Andi McNeal, CFE, CPA, the ACFE's research director, and a co-editor of the report since 2006, says the global emphasis has been incredibly positive. More than 50 percent of responses for the 2016 report were from outside the U.S., she says. (McNeal ironically first heard of the ACFE when she read the 2004 Report to the Nation and contacted headquarters. The ACFE hired her four months later for a research position.)

Dr. Wells has been surprised about the consistency of the data from one report to the next. "Although the amounts and frequency of the frauds change, there are no new ones," he says. "That is heartening from a research standpoint; we nailed the right schemes from the outset."

"We analyze entirely different batches of frauds that occurred in entirely different groups of companies in entirely different parts of the world, " Warren says, "but the results are stunningly consistent: how frauds are detected, the kinds of red flags that show up, the ratios of corruption to asset misappropriations to financial statements."

Practitioners laud practicality

"It has always been my hope that fraud examiners use the report as part of an arsenal to show that the hidden cost of fraud can be enormously expensive and that prevention solutions can be cost-effective and inexpensive," Dr. Wells says. Through the years, his hope has become fact.

"I make it a point to memorize many of the key statistics and findings every year it comes out so that I can include it in my client discussions, presentations, research and projects," says Vince Walden, CFE, CITP, partner, fraud investigation and dispute services, at Ernst & Young LLP. "As a CFE, I think it's important that we all have our fingers on the pulse of anti-fraud and behavioral trends that impact people's pressures, opportunities and rationalizations."

Regent Emeritus Roger Darvall-Stevens, CFE, says he uses the report daily "for awareness within my own organization and clients in different industry sectors to which I consult to mitigate the risks of fraud, bribery and corruption."

Darvall-Stevens, partner/director and national head of fraud and forensic services in Australia for RSM, says a major attraction of the report is its global emphasis and unbiased research. "Many other comparable studies are either not global or risk being perceived of pushing an agenda in their survey findings, such as providing anti-fraud services, without looking at the big and holistic picture or landscape," Darvall-Stevens says.

Regent Tiffany R. Couch, CFE, CPA/CFF, principal at Acuity Forensics, a small business, uses the report to inform clients and auditors. "The data in the report is real, helps drive training and selection of internal controls and raises awareness that fraud risk is something that every organization needs to pay attention to," says Couch. "There's no comparison to any other report. When we're talking about fraud and internal controls, there's truly only one source."

Ryan Hubbs, CFE, senior manager, fraud investigation and dispute services, at Ernst & Young LLP, says if executive management didn't have the report they would have a much more difficult time assessing how their anti-fraud programs and compliance-related controls operate in relation to other organizations.

"The report helps senior management and stakeholders address such questions as: Do we know where we are susceptible to fraud? Are we properly managing and addressing our fraud risks? And are we doing more, or less, in preventing and detecting fraud compared to our peers?

"The aggregated fraud-related information and benchmarking value of the report helps to validate current anti-fraud programs or at the very least, provide areas where the organization may want to focus additional resources," Hubbs says.

"One of the primary benefits of the report is that it provides the breakdown of the frequency and dollar impact of the various fraud schemes by category," says Jared Crafton, CFE, senior manager at Ernst & Young LLP.  "I find it particularly interesting to see how the report measures the positive impact of proactive data analytics in reducing both the dollar amount and duration of the fraud schemes reported."

The media continue to cite the report in print, on the air and on the web. Its statistics have appeared on every major news network and in U.S. and international newspapers. Some of the outlets include: The Wall Street Journal, The New York Times, The Washington Post, USA Today, Miami Herald, Chicago Tribune, Huffington Post, The Houston Chronicle, Bloomberg Businessweek, The Economic Times, The Globe and Mail, Forbes, CFO Magazine, Journal of Accountancy, CNBC and hundreds more.

Important research resource for academics

Warren said he and McNeal knew that the ACFE was sitting on years of valuable fraud data they couldn't fit into the compact report but that other analysts could use to delve deeper into root causes and implications.

"So a few years ago we agreed to turn over much of our data to the Institute for Fraud Prevention [IFP] at West Virginia University for academic research," Warren says. "We now have professional researchers looking at this data in more detail than we've ever done. The extra knowledge is filtering out to the profession." Warren emphasizes that the ACFE has anonymized the report data provided to the IFP and removes any potentially identifying information before providing it to the IFP.  "We go through a very thorough, multi-layer process to ensure the confidentiality of our respondents."

"Because the IFP now has access to the data collected for the report the research teams have examined three topics in detail: situational — sometimes called ‘accidental' — fraudsters versus repeat offenders — sometimes called ‘predators' — financial reporting fraud in public versus private companies and collusive frauds versus single individuals seemingly acting alone," says Richard A. Riley Jr., Ph.D., CFE, CPA, director of research for the IFP. Riley is also the Louis F. Tanner Distinguished Professor of Public Accounting at West Virginia University. "Without the report data we'd be unable to examine these topics."

Sridhar Ramamoorti, Ph.D., CFE, CFSA, CGAP, associate professor of accountancy at Kennesaw State University, says the report has a huge positive impact on the academic world. "It has changed the world for researchers studying different aspects of fraud," he says.

Ramamoorti is a co-author with Riley, Dana R. Hermanson, Ph.D., and Scot Justice, CPA, of "Unique Characteristics of Predator Frauds." The IFP supported the research completed with report information.

Hermanson, an accounting professor and Dinos Eminent Scholar Chair at Kennesaw State University, also is using data from report findings in two other projects sponsored by the IFP: One examines public company versus private company financial statement fraud, and the second explores differences between collusive frauds and single-perpetrator frauds. "These projects wouldn't be possible without access to the report database," he says. "I'm not aware of any other longitudinal, rich source of data on occupational fraud like the report studies

"A notable advantage of the report studies is that they include both public companies and a variety of other types of organizations," Hermanson says. "A lot of the research done in accounting focuses only on public companies due to data availability. The report studies have opened up additional avenues for research now that the IFP and the ACFE have given researchers access to the database."

Theresa DiPonio Hilliard, Ph.D., an associate professor of accounting at Fort Lewis College, says the report was her inspiration for her research on gender distinctions of occupational fraud.

"I was examining the 2012 report and observed that Canada was the only geographical region where there were more frauds committed by females than males," Hilliard says. "Further, Canada experienced the most costly crimes committed by managers rather than owners/executives as was evidenced in other geographical regions.

"Globally and certainly domestically in the U.S., there are more women in management positions than owner/executives," she says  "I theorized that this trend from the survey evidence may indicate a turning point in white-collar crime where occupational mobility has now provided professional paths for women to commit crimes at the same rate as men."

After the IFP awarded her a data grant, she says she "designed several ordinal logistic regression models to test the types of crimes most frequented by female offenders and the rates at which these crimes were committed compared to male offenders. I also examined material and immaterial crimes. … The demographic information pertaining to the perpetrators and victim organizations is very valuable."

Riley, Ramamoorti, Hermanson and Hilliard also have used the report in their classrooms for years. "The report data as presented in charts and graphs are exceptional tools for initiating the classroom discussion around the major topics covered by the report: costs of fraud, detection, victim organizations, perpetrators and case results," Riley says. "The report materials capture student attention and allow me to frame the issue for classroom discussion."

Many more online features

McNeal says that many don't realize that anybody can access even more report information and features at ACFE.com/RTTN. "These include not only downloadable copies of all the reports since 1996 but also detailed PowerPoint slides of all graphics for presentations plus infographics," she says. "On the report website you can select in interactive graphs the fraud risks in your industry compared to risks in other industries and print a customized chart.

"You also can see how the implementation rates of any combination of 18 anti-fraud controls varies based on the size of the victim organization, the type of the victim organization or the region in which the fraud occurred," McNeal says.

CFEs make the report successful and accessible to all

"The first CFEs who were asked to participate in the survey were very reluctant to share information about fraud in their organization," Ratley says. "They were unsure how we were going to use the information. However, once they saw the end result, many who first refused to participate were eager to be included."

Ratley says he was initially surprised at the interest in the report from those who weren't involved in the detection and prevention of fraud. "However, the report has helped attract the attention of the public — and organizational management — to the need for well-planned fraud prevention and detection programs. It helped move the problem of fraudulent activity from the back room to the boardroom," Ratley says.

Although the report was designed for anti-fraud professionals, Dr. Wells says, "there is much that can and is gleaned by management, employees and even the consumer. There's something in the Report to the Nations for everyone."

Click here for some salient points in the 2016 ACFE Report to the Nations.

Dick Carozza, CFE, is the editor-in-chief of Fraud Magazine. His email address is: dcarozza@ACFE.com.

Some salient points in the 2016 ACFE Report to the Nations

• The CFEs who participated in the survey estimated that the typical organization loses 5 percent of revenues in a given year as a result of fraud.
• The total loss caused by the cases in our study exceeded $6.3 billion, with an average loss per case of $2.7 million.
• The median loss for all cases in our study was $150,000, with 23.2 percent of cases causing losses of $1 million or more.
• Asset misappropriation was by far the most common form of occupational fraud, occurring in more than 83 percent of cases, but causing the smallest median loss of $125,000. Financial statement fraud was on the other end of the spectrum, occurring in less than 10 percent of cases but causing a median loss of $975,000. Corruption cases fell in the middle, with 35.4 percent of cases and a median loss of $200,000.
• Among the various forms of asset misappropriation, billing schemes and check tampering schemes posed the greatest risk, based on their relative frequency and median loss.
• The longer a fraud lasted, the greater the financial damage it caused. While the median duration of the frauds in our study was 18 months, the losses rose as the duration increased. At the extreme end, those schemes that lasted more than 5 years caused a median loss of $850,000.
• In 94.5 percent of the cases in our study, the perpetrator took some efforts to conceal the fraud. The most common concealment methods were creating and altering physical documents.
• The most common detection method in our study was tips (39.1 percent of cases), but organizations that had reporting hotlines were much more likely to detect fraud through tips than organizations without hotlines (47.3 percent compared to 28.2 percent, respectively).
• When fraud was uncovered through active detection methods, such as surveillance and monitoring or account reconciliation, the median loss and median duration of the schemes were lower than when the schemes were detected through passive methods, such as notification by police or by accidental discovery.
• In cases detected by tip at organizations with formal fraud reporting mechanisms, telephone hotlines were the most commonly used method (39.5 percent). However, tips submitted via email (34.1 percent) and web-based or online form (23.5 percent) combined to make reporting more common through the Internet than by telephone.
• As in previous studies, external audits of the financial statements were the most commonly implemented anti-fraud control; nearly 82 percent of the organizations in our study underwent independent audits. Similarly, 81.1 percent of organizations had a code of conduct in place at the time the fraud occurred.

(See ACFE.com/RTTN.)