CAUTION: Double Dip Ahead


Think you’re prepared to meet the challenge of increased fraud in a down economy? Guess again. Sure, you might be ready to handle most fraud coming from the other side of the glass. Fake checks and IDs. Forged endorsements and treasury duplicates. Even the extreme case of a deceased payee propped up in a chair outside your store. But stop deluding yourself. You can never really be ready for fraud coming from inside your own house.
Intuition tells me that embezzlement (often called occupational fraud and internal fraud) increases with the U.S. Misery Index, and right now that index is trending up.
The Index was created in the 1960s by an advisor to President Johnson named Arthur Okun. For July 2011 the U.S. Misery Index stood at 12.73. That figure — which is calculated by combining our current rates of unemployment (9.1 percent) and inflation (3.63 percent) — is the highest it has been since the early 1980s.
Whether it’s the Misery Index or another measure, my research showed I wasn’t alone in seeing a correlation between a bad economic climate and people behaving badly. So I thought it would be a good idea to become familiar with some statistics on internal fraud — because once you do, you’ll be much better at preventing, detecting, analyzing and dealing with it if and when it happens.
Numbers Don’t Lie
In doing my homework, I came upon two studies that were particularly helpful in understanding internal fraud. The first is The 2010 Marquet Report on Embezzlement. It analyzed the 485 largest embezzlements ($100,000+) in the United States, which just happen to be up 17 percent over the prior year.
Then there’s the ACFE 2010 Report to the Nations on Occupational Fraud and Abuse, which is based upon the results of online surveys taken of 22,927 Certified Fraud Examiners in October 2009.
While their sources may be vastly different, the studies find many common conclusions — and their differences are far fewer than one might imagine. From my perspective, both studies absolutley confirm that those in accounting and finance positions are most likely to commit internal fraud (more than two-thirds of the frauds originate with individuals working in accounting and financial departments). And the higher the position, the greater the dollars involved, with the average dollars for owner frauds outstripping employee frauds 10 to 1.
Worse for you, fraud is most prevalent in the financial services sector (which accounted for nearly 20 percent of losses in the Marquet study). In check cashing and payday lending, that’s virtually everyone in your employ.
Now for a real eye-opener: Women commit more than 60 percent of all embezzlements, although men do it on a bigger dollar scale. Moreover, the percentage of woman committing these crimes is on the rise.
While numbers for occupational fraud vary, it’s generally accepted that it accounts for nearly half a trillion dollars annually, and contributes to nearly half of all business failures. On average it is estimated to eat into revenue by 5 percent.
The average length of occupational frauds is measured in years — not days — and the average age of an embezzler is 40-something (the really big crooks are about 10 years older).
Warning Signs
The Marquet study confirms my Misery Index intuition. Even though Marquet statistics indicate most embezzlers are motivated by living a more lavish lifestyle (60 percent) rather than by financial woes, Marquet points out that “we believe that employee misconduct and internal corporate fraud will continue to be a problem as the U.S. economy struggles and unemployment hovers at levels nearing 10 percent.”
In addition to the warning sign of living a disproportionately lavish lifestyle, Marquet also found that gambling is a big driving force in internal fraud (25+ percent), followed by supporting a personal business (7 percent), personal financial issues, including family and medical (4 percent) and substance abuse (2 percent).
Interestingly, the warning sign statistics in the broader ACFE survey confirmed “lavish lifestyle/living beyond one’s means” as the No. 1 reason (43 percent of cases), but it elevated “experiencing financial difficulties” to No. 2 (36 percent of cases).
To my mind, that means the smaller the amount stolen, the greater the likelihood that some personal hardship was the rationalizing force behind the individual’s decision to commit the crime.
While the Marquet study noted that about 4+ percent of cases involved individuals with prior criminal histories, they believe the percentage is really somewhat higher (5 percent to 10 percent) because of underreporting. Despite broad differences in Marquet and ACFE survey groups, the percentages in this area are quite similar. In the ACFE study, 86 percent reported the perpetrator as never having been arrested or charged, while just 7 percent had a criminal record.
By the way, the average prison sentence for convicted major embezzlers was just under four years. In most states, embezzlement of any material magnitude is a felony.
How Big, How Long?
According to Marquet, California, Florida and New York account for nearly 40 percent of losses due to major embezzlements in the U.S.
The 10 states with the highest number of major embezzlement cases are: California, Michigan, Virginia, New York, Texas, Missouri, Pennsylvania, North Carolina, Florida and Ohio.
The 10 states with the highest losses from major embezzlement cases are: New York, Florida, Texas, California, North Carolina, Louisiana, New Jersey, Illinois, Virginia and Arizona.
The broader ACFE survey estimated the typical organization loses 5 percent of annual revenue to fraud. Its median loss was $160,000, with about 25 percent of defrauded organizations experiencing losses of at least $1 million.
Here’s one survey conclusion to keep your eye on: Small organizations are disproportionately victimized by internal fraud. And if you think you’ve discovered the only incident that occurred, better check again. The frauds reported to ACFE lasted a median of 18 months before being detected (4.5 years on average for Marquet).
According to ACFE, keeping your ears open pays off: internal fraud is much more likely to be detected by tip than by any other means. But being proactive can really help.
ACFE concludes that anti-fraud controls help reduce the cost and duration of internal fraud, and apparently more vulnerable smaller organizations can really benefit from such programs.
In fact, ACFE looked at the effects of 15 common controls on the size of loss and duration of frauds. Businesses that had controls in place had significantly lower losses and much quicker time-to-detection.
First Offenders?
According to the ACFE study, in addition to criminal history, only 8 percent of the perpetrators were administratively punished by former employers, and 10 percent had been actually terminated from their prior positions due to some suspected fraud-related activity.
With these limited risks to the perpetrators, is it any wonder why the numbers and incidents are so large?
Despite the relatively low prior criminal history, Marquet still recommends conducting background investigations to eliminate known bad actors. And understanding how your employees have behaved in past positions is certainly a solid first step.
Ultimately, though, your greatest protection lies in developing a better understanding of how your people are behaving right now.
More often than not, internal fraud goes undetected because, on some level, we really don’t want to see it. The greatest obstacle to ferreting it out is our own willful ignorance. Uncovering the ugly truth demands you regularly (but discreetly) look for the worst in those you’ve always tried to see the best in.

Posted in Fall 2011.