Employee Fraud: Forewarned is Forearmed

A 2004 annual study of occupational fraud by the Association of Certified Fraud Examiners (ACFE) reveals that fraud has a disproportionate impact on smaller businesses. Its results also indicate that asset misappropriation is the most common type of fraud, but fraudulent financial statements are the most costly. This article shows how the study can help attorneys and their clients develop stronger tools for preventing and detecting fraud.

The Association of Certified Fraud Examiners (ACFE) estimates that occupational fraud cost American businesses $660 billion in 2003 — 6% of annual revenues. In its 2004 Report to the Nation on Occupational Fraud and Abuse, the ACFE breaks down and analyzes the various types of employee fraud to give employers a better understanding of how fraud is committed and which schemes produce the largest losses. This information also can help employers and their attorneys develop stronger tools for fraud prevention and detection.

3 Major Categories
The ACFE focuses on three broad categories of employee fraud. Asset misappropriation represents the most common type of employee fraud, constituting more than 90% of the cases in the 2004 study. Asset misappropriation involves theft or misuse of an organization’s assets, such as skimming revenues, inventory theft and payroll fraud.

The least common, but most costly, types of employee fraud fall into the category of fraudulent statements. Examples include overstatements of revenue and understatements of liabilities or expenses, and the median loss rings in at $1 million.

The third type of employee fraud is labeled as corruption. Corruption generally involves the wrongful use of influence in business transactions to procure a benefit for the employee or another party. The use of influence runs contrary to the employee’s duty to its employer or the rights of another. Corruption encompasses kickback schemes and conflicts of interest.

Milking the Cash Cow
The ACFE study confirms that cash is the most frequently targeted asset, showing up in 93% of asset misappropriation cases. Fraud perpetrators help themselves to cash by skimming (stealing cash before the employer records it), cash larceny (stealing cash after the employer records it), or fraudulent disbursements. In a fraudulent disbursement scheme, the perpetrator uses some trick or device — such as false invoices or forged company checks — to induce the employer to disburse funds. Fraudulent disbursements make up 75% of cash frauds and cause the highest median loss — $125,000.

The wide world of fraudulent disbursements
About two-thirds of the cases in the ACFE study involved some type of fraudulent disbursements, falling into five distinct subcategories:

  1. Billing schemes — Causing the employer to issue payment by submitting invoices for fictitious goods or services, inflated invoices, or invoices for personal items,
  2. Payroll schemes — Inducing the employer to issue payment by making false claims for compensation — to ghost employees, for example,
  3. Expense reimbursement schemes — Claiming fictitious or inflated business expenses,
  4. Check tampering — Converting the employer’s funds by forging or altering its business checks, or stealing a check legitimately issued to another payee, and
  5. Register disbursement schemes — Making false entries on a cash register to hide the fraudulent removal of currency.

Knowing what to look for
ACFE observed a distinct difference in occupational fraud experiences based on the size of the employer organization, with organizations of less than 100 employees disproportionately vulnerable to fraud. The most common types of schemes in smaller organizations were billing, check tampering and skimming; in larger organizations, the top three were billing, corruption and noncash misappropriations.

Armed with the knowledge from the ACFE study, organizations can become more adept at recognizing and preventing fraud.