Fraud (is) for Dummies
In light of the recent infamous Ides of March, we decided to highlight an area of accounting and finance that has garnered huge headlines in the last decade: the backstabbing act of fraud. Et tu, Brute? We all know what fraud is, but what distinguishes it from run-of-the-mill negligence is that it’s willful deception or manipulation for financial gain. But while the media loves to revile a creative thinker, what we don’t hear enough about is all the upside. We hope to give balance to all the negative publicity.
Fraud comes in many forms, from the old sawdust in the transmission trick to the more elaborate Ponzi schemes, but they all fit under the umbrella of intentional deceit. It’s a timeless tradition and a global phenomenon. The typical organization loses an estimated 5% of annual revenue to fraud. What’s not as commonly understood is just how lucrative a properly conducted fraud scheme can be and how to actually pull the wool over everyone’s eyes long enough to flee to a non-extradition country. Think of Wesley Snipes, who is currently still serving time for tax fraud, or Andy Fastow, the ex-CFO of Enron who was just released last December after his six-year prison sentence. Iron bars and food rations? Ah, the spoils of victory.
Types of Schemes
For the ambitious, there are a number of fraud schemes to choose from, and the beauty is that as financial transactions become more complex and obscure, the only limiting factor on your road to wealth is your creativity. I mean, honestly, why apply all that talent to your actual job when you can almost guarantee time in one of our country’s finest federal hospitality establishments? But to get there, first you have to ask yourself, “What type of fraudster am I?” This is a fundamentally deep question, the kind that begs an answer from the great thinkers of our time: Freud, Jung, Kierkegaard, Hannah Montana… the list goes on.
The first category of fraud is corruption, which involves conflicts of interests, like sales and purchasing schemes, bribery, kickbacks, illegal gratuities, and last but not least extortion or blackmailing. This is a more obvious fraud avenue to pursue, but with the right moxie you can join some of the greats of American history including Jay Gould, the railroad tycoon and owner of Western Union, indicted vice president Spiro Agnew, and just about every Mobster.
Another type of fraud, financial statement fraud, is a bit trickier to pull off and reserved primarily for the C-suite and MBAs of large public companies. To benefit personally from a financial statement scheme you would have to either own the company outright or own significant shares, and in most instances for a hospice this doesn’t apply. You could try to pull off a financial statement fraud at a hospice, but I’d go for something else first as a warm- up to see if you’re ready for the big leagues. Plus, without the personal gain component, why bother? The most you might achieve is scheming to hit every budget number to the penny. Big potatoes. On the other hand, if your compensation structure relies on the profit margins of the hospice, then this could be your ticket.
The largest category of fraud—asset misappropriation— represents 90% of fraud occurrences. Misappropriation amounts to nothing more than stealing, and can encompass cash schemes like larceny (yanking cash from somewhere on site), skimming off the top from billing or donations, and fraudulent disbursements. There’s also non-cash misappropriation which primarily involves walking off with the assets or inventory at your hospice. I wouldn’t go that route though, because walking off with, say, a walker would just be redundant and someone would probably notice if you pulled up in a tow truck and started hauling off company vehicles. I don’t know though, you could just be that brave.
For now, let’s stick to the category of fraudulent disbursements, since they account for roughly two-thirds of all schemes and are the most likely in a hospice setting, given that there isn’t too much access to cash or valuable assets or inventory. Controlled substances might be one exception to this, but they’re so tightly controlled that it’s too risky and too obvious. Now, most disbursement schemes involve some kind of billing shenanigans, but you also have options of tampering with live checks before they’re mailed, stealing blank checks, submitting fraudulent expense reports or even setting up a fictitious employee in payroll (a.k.a. “ghost employee”). Let’s just say for now that you forego the check tampering or fraudulent expense reports since they’re too prosaic, plus these unravel quickly with even a little oversight or when you go on vacation. For now we’ll assume you’re someone in the accounting department, so we’ll suggest you go with a fraudulent billing scheme. Just set up a shell company that you own and invoice the hospice for fictitious services that you then approve and pay—voila!
Types of Perpetrators
To be a perpetrator of fraud, you need to have these three key areas aligned:
- Motive (or pressure) – You have a felt need for more money.
- Rationalization – You can justify the act to appease your shoulder angel.
- Opportunity – You work in a department and organization that allows you the access you need
Accountants refer to these three factors as the “Fraud Triangle,” and while they’re not de facto requirements, they’re present in almost all cases of fraud. Most organizations focus on limiting the Opportunity element of the triangle through internal controls, but this has only limited effectiveness. Complete fraud prevention should also address Motive and Rationalization by having support available in times of crisis (i.e. an Employee Assistance Program) and perhaps even an ethics chairperson and a whistleblower program.
Now, we’re going to have to back up a minute here and clarify an assumption: you aren’t already a shady person with a felony conviction. If so, you’re probably already being watched too closely to be successful. 85% of fraud is committed by first-timers, so make sure you’re in that category. Also, most white-collar crime isn’t committed by the suits and ties at the top—in fact, only 16.9% of frauds occur at the executive-level, while 41% of managers and 42.1% of non-managerial employees represent the remainder of frauds perpetrated. Ideally, you want to be an elderly female with long tenure, as this profile is the least likely perpetrator of a fraud. A middle-aged male with one to five years’ tenure working at either an employee or managerial level in the accounting, operations or sales department is the most common profile of a perpetrator of fraud, though instances occur in all genders, age brackets and departments.
You also want to work at a smaller hospice. Larger organizations will typically have tighter internal controls and more segregation of duties, while smaller organizations don’t have the resources to accomplish this as easily. However, don’t be dismayed if you work for a larger organization, you may still be in luck. Internal controls alone don’t do a very good job at prevention or detection—and neither do external audits. If your organization primarily relies on these two controls for fraud prevention, then I’d echo Mr. Floyd and say, “Grab that cash with both hands and make a stash.”
If your organization is smart enough to have fraud awareness training, a whistleblower hotline with a reward component, surprise audits (internal audits focused on the riskiest areas), and creating a top-down culture of ethics and oversight, then, fuhgeddaboudit. Your days are numbered and you’re more likely to get caught much sooner.
Also, to avoid detection you want to avoid the behavioral red flags that are the most common among those who commit fraud (in order of prevalence):
- Living beyond your means
- Ongoing personal financial difficulties
- Control issues (unwilling to share your duties)
- Close relationship with a customer or vendor
- “Wheeler-dealer” attitude
- Family (domestic) problems going on in personal life
- Defensiveness when probed
- Addiction problems or behaviors
- Refusing to take vacations
- Complaining about pay
Now we have the scheme and the profile… the only thing left is to get caught and enjoy the short time between inception and the warrant for your arrest. This part is inevitable. The median duration of an ongoing fraud before it’s detected is eighteen months, so that’s about how much time you have to arrange for a lifetime of evading authorities and bouncing from country to country á la Bourne Identity, or adjusting to a lifestyle of visiting hours and curfews.
The most likely reason you’ll get caught is actually a tip from a fellow coworker (roughly 38% of cases). You work alongside them for years, and then they rat you out. It seems unfair, but that’s life. That’s also why having a culture of high ethics will get you caught so much sooner than a “take what you can get” culture. You could try to share the wealth by involving your coworkers (i.e. collusion), but this will actually increase the likelihood of being caught because you can’t control everyone’s behavior. Other ways your employer could still catch you include managerial review, reconciliation procedures, internal audits and routine document examination such as reviewing a sample of check images that clear the bank each month and tying them to their source invoices.
In the case of your shell company, these aforementioned procedures may not be enough to catch you. Assuming the invoices appear reasonably legitimate, they might go for some time without detection. However, a comparison of the address of the invoice to the employee address list, or a lookup on the Secretary of State website to see who owns the corporation are just two ways your employer could find you out. These aren’t routine procedures performed by most accounting departments though; so again, it depends on the resources of your organization.
You’ll also have to keep your transactions under a certain threshold—wherever invoices receive additional scrutiny at your hospice—but doing a histogram analysis to look at groups of invoices just under a certain threshold or a Benford analysis of the AP check register could potentially detect this behavior pattern. Plus, in most instances of fraud, the perpetrator becomes increasingly greedy and bold, increasing both the frequency and the amounts that they take from the till. You will probably not be able to avoid this behavior as pride and hubris will eventually get the best of you. If a coworker doesn’t find out and tattle, someone pouring over the general ledger and check registers will. It’s just a matter of time.
This is just a primer on fraud—the tip of the proverbial iceberg. Now we hope you’re ready to roll up your sleeves and get to work on your own personal lottery ticket. But first, check and make sure you look good in orange, like good hard manual labor, and don’t mind having a roommate. Unfortunately, that’s all the time I have to delve into this topic, as I have to go check in with my parole officer.
~ Aaron Blackmore, CPA
All statistics presented were taken from the 2010 Report to the Nation on Occupational Fraud and Abuse, published in 2010 by the Association of Certified Fraud Examiners, Inc. and available online at www.acfe.com.