The cost of fraud

In the lights of recent events in the HBOS Reading case, H4L presents this article on “The cost of fraud” by David Rosen

The Association of Certified Fraud Examiners, (‘The ACFE’), based in Texas, USA, published their bi-annual report early last year, which is a Report to the Nations in occupational fraud and abuse: The 2016 Global Study.

What is occupational fraud?

Occupational fraud is fraud that occurs in and around the workplace. It is the use of one’s occupation ‘…for personal enrichment through the deliberate misuse or application of the organisation’s resources or assets’, as defined by the ACFE.

What is fraud?

There is no precise definition. Fraud is generally considered to be wrongful or criminal deception intended to result in financial or personal gain.

The Fraud Act 2006 does not so much define ‘fraud’, but rather clarifies that if you intend to take or omit to take action with a view to causing a gain or a loss, that will be fraud. This is different from previous criminal offences of fraud under the Theft Act whereby an actual financial gain or loss actually had to result and so the web to catch those committing fraud or attempting to do so, has been widened.

How is fraud measured?

Dr Martin Tunley in his book, ‘Mandating the measurement of fraud’, came up with a more scientific approach to measuring fraud, the explanation of which is beyond the remit of this blog post.

The main difficulty is what to look for, and where to look for it. Most frauds only become known, once committed. They are like icebergs. You may see the tip, but know that the fraud itself stems from the deep dark unfathomable waters, and the true extent is never likely to be known.

The measurement in the 2016 Global Study is notional. Figures are reported by Certified Fraud Examiners based upon cases they have been examining.

That means that figures for the true cost of fraud are likely to be significantly higher than considered, however much the 2,410 cases are analysed.

The total loss is $6.3billion. The average loss per fraud was $150,000.

However, what is generally agreed amongst the fraud theorists, academics, and anti-fraud practitioners, is that the loss of annual revenues to fraud in business is…5%.

Can a business afford to lose 5% of annual revenues to fraud?

The general objective of any business is to maximise profit and minimise cost.

To some, 5% is an affordable loss. It is rather like the ‘sandwich bar principle’. The owner of a bar knows that there will be spillage, breakages, the odd sandwich and drink pilfered here and there by staff and preferred customers alike. That figure is accounted for in higher prices. It is off-loaded onto other customers.

The same occurs in the mobile phone industry and car insurance. The cost and loss of fraud, is factored into raised premiums…shocking. Innocent customers pay for the cost of other’s fraud, criminal acts, and misdemeanours.

What if the figure increases by more than 5% of loss of annual revenues to fraud?

How is a business going to know?

What systems are there in place to measure fraud?

Probably none. Where do you start, other than to measure the loss discovered once the fraud was committed?

Who commits fraud?

The figures are given from particular regions, but the general averages depict a male in his 40s, from middle-management, with a degree, in the accounting department.

Fraud Theories:

Dr Cressey’s fraud triangle is a triangle of factors in which the ingredients produce fraud. The ingredients are pressure, opportunity, and rationalisation.

Dr Steve Allbrecht refers to the motivating factors for committing fraud:

Pressure:

Some of the factors cited include:

Living beyond their means

close association with customers/contractors

A desire to beat the system

Excessive gambling/addictive personalities

high personal debt

an overwhelming desire for personal gain

Opportunity to commit fraud:

Some of the factors identified by Dr Allbrecht include: Too much trust in key employees, lack of lines of authority, lack of frequent policy and procedure audits, no segregation of key duties, lack of independent checks.

Workplace deviance:

A study carried out by Hollinger and Clark, interviewing 12,000 employees over a 20 year period gave some cringing results:

90% of employees engage in workplace deviance which could include shirking/excuses for laziness, pretend sick days, workplace slowdowns, prolonged breaks etc…

1/3rd of employees interviewed accepted that they had stolen from their workplace. It ranged from pens, stationery, to toilet rolls, at the lower end (no pun intended), to embezzlement, and fraud at the high end.

How to combat fraud:

As a starter: A business should seek to reduce the opportunity to commit fraud. They should know their staff. They should know their strengths and weaknesses. The employee with debt and alcohol dependency should be distanced from cash and cheque validation. To protect the employee and the employer. The employer should consider providing counselling and outside help to relieve that pressure. A caring employer is never a bad thing.

Maintenance of morale should, of course, be high on the agenda. Giving employees a reason to take ‘wages in kind’, can be avoided.

A business needs to have checks and balances. There must be systems and policies in place. They must be implemented. There should be regulation within the industry. That regulation should be effective and independent, ready and willing to punish those they regulate. Wrongdoers should be named and shamed.

This is a basic explanation of fraud, measurement, and how to reduce the opportunity, rationalisation, and relief of pressure to commit fraud. The subject is far more complicated to combat fraud. The blog post is created to provoke thought and consideration on the subject.

This blog post is for information purposes and should not be relied upon as legal advice because it does not consider or take into account your own personal circumstances. If in doubt, seek legal advice.

Professor David Rosen is a solicitor-advocate, partner and head of litigation at Darlingtons Solicitors LLP. He is a strategic legal advisor for Help4LiPs, a member of the Society of Legal Scholars amongst other memberships, and honorary professor of law at Brunel University where he regularly lectures on practical legal skills and procedure, and advocacy amongst other subjects.