Internal fraud: A silent epidemic

Internal fraud may be invisible, but its impact is anything but. This silent epidemic infiltrates organizations of all sizes and sectors, causing financial damage, eroding trust, and undermining authority. When employees prioritize personal gains over company interests, the consequences are often severe and far-reaching.

Internal fraud accounts for an estimated 5% of annual revenue loss across businesses, equating to a staggering $50 billion annually in the US alone. While 5% may sound small, the cumulative impact can be devastating, prompting the urgent need for effective detection and prevention strategies.

Let’s take a further look into workplace deception and its hidden consequences.

Understanding Internal Fraud: The Fraud Triangle

Definition and Explanation

Internal fraud, also known as occupational or insider fraud, refers to the intentional and unauthorized abuse of an organization's resources, assets, or information by employees or insiders for personal gain. This type of fraud can manifest in various forms, including embezzlement, asset misappropriation, ghost employees, and vendor fraud. The consequences of internal fraud are severe, often leading to significant financial losses, damage to the organization's reputation, and erosion of trust among employees, clients, and stakeholders. Understanding the different forms of internal fraud is crucial for organizations to develop effective strategies to combat this silent epidemic.

There are, generally speaking, three types of internal fraud:

• Asset misappropriation: When someone takes or misuses an organization's assets, like cash, supplies, or information. It can happen in different ways, from grabbing office supplies to fancy embezzlement schemes. Often, it involves an employee taking advantage of their trusted position.
  
  
• Financial statement fraud: When people purposely misrepresent or change financial accounts. The aim is to make a business look financially stronger than it actually is, often to attract investors, pump up stock prices, meet goals, or get loans. This can be done by faking revenue, hiding expenses, downplaying debts, exaggerating assets, or using tricky transactions to confuse people. It’s different from other types of occupational fraud, like stealing assets or being corrupt, because it usually involves senior-level management.
  
  
• Corruption: When individuals within an organization are dishonest or unethical, such as accepting bribes, showing favoritism, or acting in a way that benefits themselves but harms the organization. Corruption can happen anywhere in a company, but it’s usually connected to people in power. They might bend the rules, fake records, or misuse company resources for personal gain and the consequences are significant - financial losses, reputational damage, legal implications, and a loss of trust from stakeholders.

According to the 2022 Association of Certified Fraud Examiners (ACFE) report, asset misappropriation is the most common type of internal fraud, accounting for 86% of cases with the median loss being $100,000 USD. Financial statement fraud, while less common at 9% of cases, results in the highest financial losses at a median of nearly $600,000 USD. Meanwhile, corruption falls in between, in terms of frequency and losses.

The Fraud Triangle

The Fraud Triangle, developed by criminologist Dr. Donald Cressey, offers a framework for understanding why employees commit fraud. It consists of three elements:

• Non-shareable financial need: Personal pressures that can’t be resolved legitimately.
• Perceived opportunity: The belief that fraud can be committed without getting caught.
• Rationalization: Justifying fraudulent actions as acceptable.

When these three elements converge, the likelihood of an individual engaging in fraudulent activities increases significantly. Unshareable financial need refers to personal financial pressures that the individual feels cannot be shared or resolved through legitimate means.

Perceived opportunity is the belief that the individual can commit fraud without getting caught, often due to weak internal controls. Rationalization involves the individual justifying their fraudulent behavior, and convincing themselves that their actions are acceptable. By understanding the Fraud Triangle, organizations can better identify potential risks and implement measures to prevent fraud.

Motivations and Warning Signs

Employees may engage in fraud due to financial pressures, personal ambition, or even a sense of entitlement. Common warning signs include unusual or unexplained changes in behavior, inconsistencies in financial records, unauthorized access to sensitive data, and unexplained transactions. For instance, an employee who suddenly starts living beyond their means or exhibits secretive behavior may be a red flag. Organizations should be vigilant and foster an environment where employees feel comfortable reporting suspicious activities. By being aware of these warning signs, companies can take timely action to mitigate the risk of internal fraud.

Identifying High-Risk Activities

High-risk areas for internal fraud include cash management, accounts payable, inventory control, and procurement. By closely monitoring these areas, organisations can mitigate risks and protect assets. Implement measures like regular audits, robust tracking systems, and clear expense policies to reduce vulnerabilities.

High-risk areas include cash handling and management, accounts payable and receivable, inventory management, travel and expense reimbursement, payroll and benefits administration, and procurement and purchasing. These areas are susceptible to different types of fraud, such as theft, embezzlement, invoice fraud, and vendor fraud. By identifying and closely monitoring these high-risk activities, organizations can better protect their resources and reduce the likelihood of fraudulent activities.

Areas of High-Risk

Organizations should pay particular attention to the following high-risk areas:

• Cash handling and management: This area is vulnerable to theft, embezzlement, and other forms of fraud. Implementing strict cash handling procedures and regular audits can help mitigate these risks.
• Accounts payable and receivable: Susceptible to invoice fraud, payment fraud, and other financial frauds. Ensuring proper segregation of duties and regular reconciliation can prevent unauthorized transactions.
• Inventory management: Vulnerable to theft, misappropriation, and other asset fraud. Regular inventory checks and robust tracking systems can help safeguard assets.

• Travel and expense reimbursement: Susceptible to fraudulent expense claims and misuse of company credit cards. Implementing clear policies and thorough review processes can prevent misuse.
• Payroll and benefits administration: Vulnerable to ghost employees and payroll fraud. Regular audits and verification processes can ensure the accuracy of payroll records.
• Procurement and purchasing: Susceptible to vendor fraud and bid-rigging. Establishing transparent procurement processes and conducting vendor due diligence can reduce the risk of fraud.

By understanding these high-risk areas and implementing robust controls, organizations can take proactive measures to prevent internal fraud and protect their resources, assets, and information.

The importance of internal controls to prevent internal fraud

Let’s share an intriguing fact from the ACFE report: the main issue in almost half of the cases studied was the noticeable absence of proper internal controls. The remaining cases were equally interesting as they showcased managers overriding existing controls.

To effectively prevent internal fraud, it’s crucial to have strong internal controls in place. Regulatory bodies like the Prudential Regulation Authority and the Financial Conduct Authority emphasize the importance of these controls to establish authority and compliance. These controls include regular monitoring, strong oversight, and separating duties to protect all aspects of the organization. By establishing a transparent and accountable framework, businesses can address vulnerabilities and improve their risk management strategy, creating a more secure and trustworthy environment.

Detecting fraud through audits: Leveraging technology for prevention

Regular audits are a critical weapon in the battle against employee fraud. They have the power to uncover inconsistencies and suspicious activities that may otherwise go unnoticed. With comprehensive reports built-in to Protege GX for events, mustering, attendance, and users, which can be scheduled and downloaded, tracking any irregular activities becomes effortless. 

Open technology platforms, such as Protege, are imperative in combating internal fraud by integrating robust access control, cameras, and wireless sensors. These platforms act as effective deterrents, leveraging features like anti-passback to track movements accurately, automatic re-arm for secure areas, and dual authentication to require two users to badge at a door for it to unlock. By implementing these proactive measures, organizations can mitigate risks and ensure the security of their operations. 

Prioritizing Fraud Prevention for a Secure Workplace

The threat of internal fraud is real and pressing. As such, companies must prioritize fraud prevention measures to safeguard their businesses and assets. Don’t let internal fraud derail your success. Strengthen your defenses with effective internal controls, regular audits, and the latest technology solutions. Protect your business today.