FEI Financial Reporting Blog: Quick Fraud Tips for Board Members

NOTE: While I am on vacation, I invited some guest posts from popular bloggers. Following is a guest post from Sheila Keefe, a CPA and Certified Fraud Examiner (CFE) whose website is http://www.sheilakeefe.com/, blog is http://www.grcmaven.com/. Following is the guest post from Sheila.

The responsibilities of board members seem to be growing by the day, leaving many board members wondering how to prioritize the many ‘best practices’ out there to make the most effective use of their time. Luckily, there are a handful of fraud prevention and detection tools that have been proven to reduce fraud losses that can be done in just a few days a year. The following are five of the most cost-effective fraud prevention and detection tips out there:

1. Whistleblower Hotlines:
Forty percent of frauds are discovered through anonymous tips, with 67% of tips received through a hotline for organizations that offer them, making whistleblower hotlines the most effective fraud detection technique available. (Source: The Association of Certified Fraud Examiners 2010 Report to the Nations on Fraud and Abuse, www.ACFE.com) There are many highly qualified, national providers of whistleblower hotlines that provide companies with their own 800-number and handle complaints and tips, with 24/7/365 coverage. These companies have experienced operators who will conduct a 15-20 minute intake interview and deliver an incident report to be distributed to key personnel within your organization. A provision for anonymity to any individual who willingly comes forward to report a suspicion of fraud is key to encouraging such reporting and should be a component of the organization’s policy.

Additionally, the Association of Certified Fraud Examiners 2010 Report to the Nations on Fraud and Abuse (www.ACFE.com) indicates that just 66% of tips come from employees, so it’s important to extend the pool of available informants to include vendors and customers. Many companies, like Cisco Systems, include contact information for the company’s whistleblower hotline on the company’s website, customer receipts and vendor code-of-conduct agreements.

2. Surprise Audits:
The threat of detection is a powerful tool. What’s great about surprise audits is that unlike regular audits that can often involve large samples size, surprise audits serve their purpose using very small sample sizes. The Association of Certified Fraud Examiners 2010 Report to the Nations on Fraud and Abuse (www.ACFE.com) indicates that surprise audits are used only 28% of the time, yet reduce fraud losses by over 50%.

3. Employee Support Programs:
According to Cressey’s fraud triangle, there are three elements that must be present for an ordinary person to commit fraud: opportunity, rationalization and financial pressure. Interviews with fraud perpetrators indicate that many fraud perpetrators knew of ways to steal well before they actually started stealing, noting that they did not steal until they experienced financial pressure. This information paired with the fact that over 85% of perpetrators are first offenders (Source: ACFE 2010 Report to the Nation on Fraud and Abuse) indicates that some fraud perpetrators are really just good people caught in a bad financial situation who have chosen stealing money as their last, best option for relieving financial pressure. So by offering employees psychiatric and credit counseling at a time when it’s most needed, before they steal, companies can help redirect employees efforts to more productive solutions to their problems than stealing.

4. Code of Ethics and Ethics Training:
Having a Code of Ethics and performing routine ethics training have both been shown to reduce median fraud losses by over $100,000 per incident. (Source: ACFE 2010 Report to the Nations on Fraud and Abuse, www.ACFE.com) Having a Code of Ethics and providing training is so important because employees must be aware of the company’s Code of Ethics in order to investigate and discipline fraudulent acts. Many fraud perpetrators have successfully avoided punishment because they were able to assert that they did know any better. Further, ethics training can be embraced as an opportunity to improve morale when employees can be shown that reducing fraud will improve job security for all by eliminating a drain on revenues that averages 5%, a margin few organizations can comfortably absorb in this economy.

5. Segregation of Duties:
Trust is not a control, and certain duties must be segregated so that the same employee cannot both steal and conceal. In evaluating which duties must be segregated, be sure to pay special attention to tasks that allow the same person to control any two of the following elements of a transaction: authorization, custody or recordkeeping.

For example, a clerk who posts customer payments should not also be able to issue credit memos. Here’s another example, the clerk who opens purchase orders should not be able to alter master vendor files or receive goods. In working with smaller accounting departments, it is possible to include non-finance personnel to perform one side of an incompatible control pair. The use of ‘exception reports’ is also helpful in providing oversight when segregating duties is not feasible. Exception reports are any report that would allow management to identify a red flag or anomaly. For example, a supervisor could periodically review a report of credit memos issued or changes to master vendor files. With segregation of duties, it is possible to improve controls by merely shuffling duties, rather than adding staff.

In conclusion, some of the best fraud prevention and detection tools are the easiest to implement. So, for board directors concerned about reducing fraud, the use of the most cost-effective methods, including whistleblower hotlines, surprise audits, employee support programs, code of ethics/ethics training and segregation of duties, will go a long way toward satisfying the ever-expanding scope of director responsibilities.

[Editor's note: in addition to resources availalble at http://www.acfe.com/, check out the Committee of Sponsoring Organizations of the Treadway Commission (COSO)'s website at http://www.coso.org/. FEI, along with the AAA, AICPA, IIA, and IMA are the five sponsoring organizations of COSO.)

If you are interested in being considered as a guest blogger for the FEI blog while I am on vacation in August, please contact me at eorenstein@financialexecutives.org.

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