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August 24, 2020

Preventing the Perfect Storm: Minimizing the Risk of Fraud in a Turbulent Economy

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With current high levels of economic uncertainty, we found it timely to discuss how struggling economies increase the risk of fraud. To investigate this concept further, we turned to KPMG’s Forensic Focus article, “Fraud risk increases in difficult economies,” by Paul Ross, as well as the Corporate Finance Institution’s article “What is the Fraud Triangle?” and the Association of Government Accountants’ (“AGA”) “The Fraud Triangle.” In this article, we will explain how economic difficulties interact with the three points of the Fraud Triangle: motive, opportunity, and rationalization that together increase the risk of fraud. We will also discuss ways to limit the risk of fraud in the workplace.

The first point on the Fraud Triangle is motive. Motive, also known as pressure or incentive, is what drives an individual to commit fraud for personal or organizational gains. During economic downturns, fraudsters may be motivated by unexpected personal needs such as money for house payments, medical bills, or a spouse’s business. Others may commit fraud in order to make their organization appear stronger. As an example, The Corporate Finance Institution states that “The need to meet or exceed investor and analyst expectations can create pressure to commit fraud.” Once a potential fraudster has the motivation to commit fraud, he or she must find a way to do so without being caught.

The second point on the Fraud Triangle is opportunity. The AGA explains that fraudsters take advantage of any weakness in a system, and that these weaknesses can be quite difficult to spot. Simply having internal controls to prevent fraud is not enough. Organizations must frequently assess their fraud prevention and detection strategies in order to catch oversights and adjust as organizational structure changes. Paul Ross explains that fraudsters are able to take advantage of staff reductions and restructuring during economic downturns because such changes often weaken or eliminate controls. Imagine a small organization has to lay off one of two bookkeepers during an economic downturn. In the past, the two bookkeepers reviewed each other’s work and this staffing level allowed for proper segregation of duties. Now bookkeeping is left in the hands of one person. The organization’s leader trusts the remaining bookkeeper because they have worked together for five years without trouble. Although the leader decides to periodically review work, there is not enough time to check everything. In addition to the new lack of internal controls, the bookkeeper has faced personal financial struggles and risks having his house foreclosed. He now has an opportunity and a motive to commit fraud, but will he justify doing so?

The third point on the Fraud Triangle is rationalization. Rationalization differs from motivation because it is how the fraudster justifies his/her actions. According to the AGA, there are two parts to rationalizing fraud: weighing possible benefits against the likelihood of being caught and justifying the fraud from an ethical standpoint. Let’s return to the previous illustration of the bookkeeper. In addition to having personal financial struggles, he also has a close relative who cannot pay for expensive medical treatment due to a sudden lay off. The bookkeeper decides to fabricate additional expenses and to write out checks to deposit into his relative’s bank account. He reasons that the likelihood of being caught is small because the organization’s leader trusts him and rarely reviews his work. He also chooses to see his fraudulent behavior as ethical because it may be what saves his relative’s life. Now the bookkeeper has a motive, opportunity, and rationale to commit fraud. The economic downturn interacted with the Fraud Triangle to create the perfect opportunity for fraud.

The good news is that every organization can take steps to minimize the risk of fraud. Ross recommends frequently reviewing codes of conduct, management oversight practices, data monitoring, and mechanisms for whistleblowing. He also stresses that companies should “Establish and manage a secure, efficient, and impartial reporting channel for whistleblowing.” With Red Flag Reporting, employees are empowered to securely and anonymously report fraud and other unethical practices. In turn, designated case managers can instantly view reports and analyze them for trends using Red Flag Reporting’s case management software. Implementing and routinely reviewing preventative and detective controls will reduce the risk of fraud, even in a turbulent economy.

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Filed Under: Employee Hotline, Fraud Prevention, Fraud Reporting

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