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Why Do Good Ethical People Sometimes Make Bad Ethical Decisions? Part 1: The Statistics of Bad Deeds

Posted by Natalie Law Posted on Aug 25 2016

What would you do if someone told you they could help you save money in the amount of 5% of your total revenue? That’s quite a chunk of change that could increase overall profits and overall business performance. Did you know that organizations lose approximately 5% of their total revenue to fraud each year with median losses of $145,000 that took a median duration of 18 months to detect? Now that’s a huge chunk of change. These findings came from the Report to the Nations on Occupational Fraud and Abuse produced by the Association of Certified Fraud Examiners. In the report, 82% of the fraudsters were first-time offenders and had never been previously punished or terminated from an employer relating to fraud. This report also shows that it is more likely that an employee will commit fraud within year 1 to 5 of being employed by the organization, but the median losses are the highest after 10 years of being employed. Only 14% of victim organizations made a full recovery of losses. 58% of victim organizations, at the time of survey for the report, had not recovered any of their fraud losses. These losses can be seen as a huge glaring decrease to the bottom line.

No organization or business is immune to fraud.  Unfortunately, small businesses and organizations lose a disproportionately larger amount compared to large businesses and organizations. Why is this? Why are small businesses at such risk for fraud losses that can be extremely detrimental to its overall well-being? There are three main reasons for the disproportionate losses: (1) cost (2) time and (3) lack of resources.

It does cost money, as well as time, to set up controls and monitor them. But frauds have indirect costs as well, alongside the actual amount stolen. For example the loss of productivity, damage of personal or business reputation, investigative costs, and possibly the loss of all your hard work down the drain.

There are three main categories of occupational fraud: (1) asset misappropriations (theft of cash, inventory, supplies, etc) (2) corruption (“I’ll give you money under the table if you give me that contract) and (3) financial statement fraud (“we’ve got to keep the investors happy”). According to the report mentioned above, 85% of the fraud cases examined were for asset misappropriations with median losses of $130,000, corruption were 37% of the cases with median losses of $200,000, and financial statement fraud made up only 9% of the fraud cases but had median losses of $1,000,000.

So why do employees or owners/executives commit fraud? Why do individuals who don’t have criminal records or a past history of fraud begin that fateful journey? Dr. Donald Cressey conducted extensive research and interviews to answer these very questions. His findings turned into what is known as the Fraud Triangle. The Fraud Triangle consists of three parts: (1) perceived non-shareable financial need (2) rationalization and (3) perceived opportunity. It is widely accepted that all three of these parts must be present for fraud to take place.

Non-shareable financial needs can consist of living beyond one’s means, addictions, unexpected bills, etc. You and other employees should be aware of others in the organization who might exhibit these red flags of a potential pressure to commit fraud. Other red flags include breaking other rules in the organization, unwillingness to share duties, refusal to take vacations, working earlier or later than other employees, disgruntled about work, family problems, excessive pressure from the organization, etc. It’s important to note that these pressures don’t necessarily mean there is fraud, but just something that should make your “this needs attention” antenna go up.

Rationalization is what gives the fraudster justification for his or her actions. So how do individuals convince themselves that committing fraud is okay? Dr. Cressey found that these fraudsters saw their actions as justified, noncriminal, or part of non-controllable situation. Examples of common statements from fraudsters are: “I was going to pay it back” and “I deserved it after all my hard work. My employer doesn’t appreciate me.” Remember, anyone can commit fraud. Many times, fraudsters are honest people who give in to temptation based on a severe pressure because he or she sees an opportunity to conceal the theft. Unfortunately, it is human nature that once the fraud starts, he or she continues with more frequent, larger thefts. Protect your organization from fraud and protect your employees from the temptation to commit fraud. Human beings can be greedy creatures when the right buttons are pushed.

The final part of the Fraud Triangle is the part that you have the most control over; perceived opportunity. Employees will not commit fraud, with a few exceptions, if they believe they will get caught. The perception of detection is your greatest ally with your fight against these fraudsters. Individuals are less likely to commit fraud if they believe they will get caught. According to the Report to the Nations on Occupational Fraud and Abuse, 35% of organizations who were victims of fraud used proactive monitoring and internal controls. The frauds of these organizations were 60% less costly and 50% shorter in duration.

With the potential of losing 5% of your revenue to fraud, what can you do to prevent and detect fraud in your organization? First step is to accept that your organization is not immune to fraud and that anyone in the organization can commit fraud. The next step is to conduct an assessment of risks in your organization. Ask yourself, what are the weak areas in our organization? Where could someone commit fraud? Once those risks are established, create and implement controls which will significantly reduce those risks. It is proven that properly implemented anti-fraud controls reduces fraud losses and detects fraud sooner. Examples of anti-fraud controls include management review of documents and processes, segregation of duties, employee training and awareness, audits, employee monitoring, whistleblower hotlines, etc.

Getting management and employees on board is a key element in the success of your organization’s fight against fraud. In the report mentioned above, tips are consistently the most common method of fraud detection. Employees, customers, and vendors are your friends. Over 40% of the cases in the report were detected by a tip and half of those tips came from fellow employees. Tips are more than twice the rate of any other method of fraud detection. Get other employees on your team. Let them know you need their help to combat fraud in the organization. Remember, the perception of detection is the greatest deterrent to not committing fraud. When something doesn’t look or feel right, question it.

In the next two parts of this series, we will discuss the boiling frog analogy of why good ethical people sometimes make bad ethical decisions and how you can save your organization with a positive ethical culture.

 

 

*Information taken from Report to the Nations on Occupational Fraud and Abuse produced by the Association of Certified Fraud Examiners and also “How to Prevent Small Business Fraud” also produced by the ACFE.

The writers of this blog (whoever they may be) would like to take this opportunity to disclaim any responsibility for it.  While we (the writers) take every precaution to make sure the information conveyed is accurate, we are as human as the next person and thus, subject to flaws.  Also, the views expressed are not necessarily the views of Layton Layton & Tobler LLP or any other person in the firm except for maybe the writer.

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