Occupational Fraud and Abuse

Part I: Losses Suffered by Victim Organizations
Neil Gerber
Heinold-Banwart, Ltd.

Direct Hit to the Bottom Line

The Association of Certified Fraud Examiners (ACFE) estimates that five percent of U.S. organizations’ annual revenues are lost due to fraud. Occupational fraud can be defined as “the use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization’s resources or assets.”

Categories of Fraud

All instances of occupational fraud and abuse can be classified into one of three major categories:

  • Asset Misappropriations: “any scheme that involves the theft or misuse of an organization’s assets”
  • Corruption: “any scheme in which a person uses his or her influence in a business transaction to obtain an unauthorized benefit contrary to that person’s duty to his or her employer”
  • Fraudulent Financial Reporting: “falsification of an organization’s financial statements to make it appear more or less profitable.”

It is important to note that any one instance of fraud may fall into more than one category. Of the major categories, asset misappropriations represent the largest number of reported cases, approximately 92 percent, but reported the smallest median loss of $150,000. Fraudulent financial reporting reported the least number of cases, approximately 11 percent, with the largest median loss of $2 million. Corruption, representing approximately 31 percent of reported cases, reported a median loss of $538,000.

How Does It Happen?

Misappropriation of assets is further divided into two subcategories: cash and non-cash. Cash misappropriations, occurring nearly four times more frequently than non-cash misappropriations, are committed against cash receipts, cash on hand and fraudulent disbursements. Although primarily through the theft of inventory or other physical assets, non-cash misappropriations are also committed through the release of proprietary information and theft of securities.

Corruption frauds are generally facilitated through four primary schemes: conflicts of interest, bribery, illegal gratuities and extortion.

Fraudulent financial reporting occurs when financial statements are manipulated through one of five methods: reporting fictitious or overstated revenues, concealing or understating liabilities or expenses, recording revenues or expenses in the wrong period, improperly valuing assets or failing to disclose significant information.

Victims of Occupational Fraud and Abuse

Fraud is not industry-specific, and no particular industry is more susceptible to fraud than another; rather, frauds occur across a wide range of industries. Organization type, on the other hand, did appear to be a relevant factor in fraud abuse cases. Private companies fell victim to fraud more often than any other organization type, representing nearly 37 percent of reported cases. Public companies ranked second, followed by governments and not-for-profit organizations.

Size of the organization also tends to make it more susceptible to fraud. Studies have shown that organizations with fewer than 100 employees suffer a disproportionate share of large fraud losses, likely due to the challenges they face in deterring and detecting fraud. Representing 36 percent of the cases reported, small businesses suffered the highest median loss at $190,000.

Small businesses (those defined as having fewer than 100 employees) are unique in that fraud is perpetrated against them differently than larger organizations. Just as fraud can be classified into more than one major category, it can also involve multiple schemes; therefore, the percentages of the most common fraud schemes committed against these victim organizations in the table below exceeds 100 percent.

Annual revenues are another way to classify organization by size. Studies have shown organizations with annual revenues between $10M and $50M suffered the highest median losses, approximately $275,000, while representing only 14.2 percent of the cases reported.

Perpetrators of Fraud

Perpetrators of occupational fraud and abuse can be committed by any employee of an organization. For purposes of the study, perpetrators were classified into three general categories: owner/ executive, manager and employee. Studies have shown there is a direct correlation between a perpetrator’s annual income and the median loss suffered by the victim organization. Owners/executives represented 19.3 percent of cases reported with $1 million in median losses. Managers, with 41.2 percent of reported cases and employees with 39.5 percent, resulted in median losses of $218,000 and $78,000, respectively.

Studies also revealed specific demographic factors had a bearing on the median losses suffered by organizations. Males were twice as likely to commit fraud than females. Perpetrators with more tenure, those closer to retirement age and those with higher education levels resulted in greater losses.

Criminal histories, on the other hand, had little bearing on the losses suffered by victim organizations. Perpetrators of fraud are rarely career criminals. Of the perpetrators identified in this study, 87.9 percent had never been charged or convicted of a previous fraud-related offense, while 7.7 percent did have prior convictions and 4.4 percent were charged but never convicted.

Case Results

Once fraud has been identified in an organization, more than a third of those cases are never referred to law enforcement for prosecution. Of the cases reported, 73.5 percent plead guilty or no contest, with another 14.8 percent convicted at trial. Less than one half percent of the cases reported to law enforcement resulted in an acquittal of the accused.

Fear of bad publicity was cited as the number one reason for not turning cases over to law enforcement, followed by internal discipline and private settlement. Other reasons included the cost of prosecution, lack of sufficient evidence or the disappearance of the perpetrator.

Fraud Loss Recovery

Studies have shown that once a fraud has been detected, victim organizations will rarely make a full recovery of the losses they suffered. Over 42 percent of the reported cases were unable to recover any of the loss, with another 23 percent recovering between one percent and 25 percent of sustained losses. Full recoveries were reported by 16 percent of the cases; however, the median loss was only $50,000. Median losses suffered by organizations with no recovery were three times as large.

Fraud deterrence is the best weapon that an organization can employ to limit fraud losses and protect their assets. For information on fraud deterrence, see “Occupational Fraud and Abuse, Part 2: Fraud Deterrence and Limiting Losses” in a future article. IBI

Information and statistics in this article were obtained from the “2006 ACFE Report to the Nation on Occupational Fraud and Abuse” as published by the Association of Certified Fraud Examiners.