Fraud can be difficult to detect. According to the Association of Certified Fraud Examiners (ACFE), the average time from the commencement of fraudulent activities to detection is 14 months. Massive losses can occur over that time, severely damaging businesses, and their financial stability, causing a host of other problems. An awareness of the warning signs of fraud, and what to do if they are present, is vital in preventing these problems from impacting your business. All businesses, and especially small businesses, are vulnerable and should watch for these warning signs of fraud – they may save your business in the future.
Lifestyle Changes
Warning sign
An employee living beyond their means is the most common warning sign of fraud. An ACFE report states that 42% of identified fraudsters were found to be living beyond their means – the highest prevalence of all red flag behaviours. It has also ranked first in every study since 2008, remaining a prevalent sign and an important one to keep track of.
Unfortunately, it is also one of the most difficult to identify, as it pertains to an employee’s personal life. Evidence includes a sudden change in lifestyle, that doesn’t match an employee’s salary or accompany any other personal life changes. Signs of an employee living outside their means include driving expensive cars, taking lavish vacations, living in extravagant homes, or generally spending above what their salary allows.
Actions to consider
As lifestyle is a personal consideration, employers should not pry or ask inappropriate questions. If you are concerned about a sudden lifestyle change, enquire with their direct manager or keep an eye on their workplace behaviour and work done within their area of responsibility to check for any irregular activity.
Financial difficulties
Warning sign
Another sign with personal connotations, and the second most prevalent among identified fraudsters, is financial difficulties. According to the survey, 26% of identified offenders had financial difficulties. Employees facing an excessive debt burden are more likely to search for opportunities to resolve their debt problems, even if that involves illegal activities. Under this umbrella is excessive gambling as a sign of financial difficulties.
Even employees with no history of suspicious behaviour may take an opportunity to resolve their debt if they believe they will not get caught. Only 4% of convicted fraudsters have prior convictions, making first-time fraud common and often based on an opportunistic employee who is in financial difficulty.
Actions to consider
Again, it is difficult for an employer to evaluate the personal circumstances of an employee without overstepping privacy norms, and not every employee struggling with debt should be considered a threat. However, it is an important factor to keep an eye on and investigate if the employee begins to exhibit other suspicious behaviour.
Close relationships with vendors
Warning sign
The most prevalent work-related red flag of possible fraudulent behaviour relates to work relationships. 19% of convicted fraudsters were found to have a close relationship with a vendor or customer linked to the business that suffered the loss. It is also tough to detect because the employee is required to deal with the fraudster as part of his usual responsibilities and establishing that the relationship is unusually close may not be easy.
Once the relationship is established, an employee and the vendor conspire to find ways to charge the company more than what would be normal in an arm’s length transaction. The vendor receives extra money, and the employee receives compensation for setting up the system, with the company none the wiser. The fraud is difficult to detect as it is processed as a regular charge, allowing the activity to continue without detection for significant periods of time.
Actions to consider
This is one of the toughest red flags to investigate because good working relationships are often forged between reliable suppliers and employees who require their services. The good relations do not necessarily mean that an illicit relationship exists. Nevertheless, being aware of these relationships and conducting checks of the work done within that relationship is critical.
In one instance, a company account, who had noticed that a vendor was spending an usual amount of time with one of the company buyers, decided to review purchase orders for the supplier. This review led to the identification of missing purchases order documentation, photocopied purchase orders, and acceptance of higher than usual prices for goods purchased from that supplier. Following up on the red flag, which many would not have done, led to early detection of the fraud and a reduction in the loss that was suffered.
Resistance to controls
Warning sign
Lack of compliance with existing controls, or resistance to increased controls, can indicate that an employee is possibly committing fraud. Employees usually need to avoid controls in order to perpetrate fraud. If an employee discovers a weakness in controls that allows fraud to go undetected, they will exploit the weakness and resist any efforts to improve the controls.
Small businesses are especially vulnerable to this problem due to limited controls (such as a lack of segregation) and a lack of focus on fraud as a concern. Where there are limited controls, and the business grows too quickly to keep track of all the loopholes in the operation, employees could take advantage. If attempts to implement controls result in complaints from any employees, it may require investigating.
Actions to consider
The first step is a focus on prevention and to ensure that there are effective and thorough controls in place. Any persistent failure to follow controls or any undue resistance to the controls should be seen as a warning sign. The employee’s conduct and actions should be investigated in order to establish if the resistance relates to fraudulent or simply negligent conduct.
Refusal to take vacations
Warning sign
Although it may sound like a positive attribute to an employer, an employee’s refusal to take vacations can be a sign that they are afraid their absence will lead to the detection of illicit conduct. The tendency to avoid taking leave was found in 7% of reported fraud cases– a smaller percentage than other red flags – but an easy red flag to identify and investigate. Considering that detection takes 14 months on average, an employee going several months without taking any vacation time should be a concern.
This red flag usually occurs when the employee is the only person involved or is vital in the functioning of fraudulent activities. Vacations will be delayed, or not taken altogether, in an attempt to keep an eye on the scheme and ensure the process continues to run smoothly. Extensive periods without vacation time, and no valid reason to do so (such as increased work responsibilities), is a definite red flag and cause for concern.
Actions to consider
The simplest solution to this problem is to have a policy that requires employees to take their vacation time. If they cannot provide a valid reason for not taking their vacation time, or seem very reluctant to do so, their absence is a good opportunity to monitor any changes in their department or investigate potential irregularities.
Increased use of cash
Warning sign
Cash is a highly targeted asset in fraudulent activities. It can be easily manipulated, transferred, and covered up – or at least more easily manipulated than electronic transactions. The less of a trail there is, the less likely a problem will be discovered.
If an employee insists on paying vendors or other employees in cash, or if there is an unusual or unexplained increase in the use of cash, it may require a closer look. It could be an employee’s method of covering illegal activity without being discovered. For example, if an employee insists on paying for business expenses with cash (even if they claim it is at the request of a vendor), it could be an opportunity for that employee to manipulate cash assets without oversight.
Actions to consider
Ensure company policy states all business expenses, where possible, should come off company cards or accounts so there is a central record of all payments made. Recognise that cash is notoriously high-risk and reconcile cash assets at the end of each day. If an employee increases their use of cash for payments, investigate the issue and their reasoning.
Employees not using proper channels or lacking explanation for their choices
Warning sign
Following proper protocol is vital in business operations, and in fraud prevention. This applies to all areas of the business, but particularly areas where vendors are involved. Procurement fraud is one of the most common types of fraud and business deals with other service providers are especially vulnerable. An employee not following the proper protocol in procurement procedures is a major red flag and requires thorough investigation to ensure no relationship exists between the vendor and employee or that there are no suspicious activities between the two parties.
Similarly, if an employee makes a deal or decision without a clear justification, it may be a sign of irregular activity. Vague explanations for decisions could be a sign that the employee is attempting to cover up illegal activity and should be investigated.
Action to consider
Ensure that company protocol across all departments is clear and explained to employees when they are hired. Any changes to the protocol should be explained and understood by all parties to prevent issues in the future. Make motivations for important decisions – such as the hiring of vendors – a part of this protocol so any vague or incoherent explanations for decisions can be quickly identified and dealt with. And, ultimately, follow up on obvious and regular breaches of company policy and protocol.
Increasing company purchases
Warning sign
In a large business with many moving parts, incremental changes to inventory may be difficult to uncover, but this is often a red flag of fraud that too can go undetected for long periods of time. Business inventory is vulnerable to opportunistic fraudsters as it can be easily concealed. It may begin small – with an employee taking something as simple as a ream of paper home – but undetected, the theft can get out of hand quickly, leading to massive company losses.
Fraud is often discovered when the employee attempts to cover up the theft by increasing company expenditures on inventory or requesting more purchases where no explanation is present. If you note increased expenditure, without concomitant increases in inventory and sales, the reasons should be further investigated.
Actions to consider
Standard inventory control procedures should be implemented in every business to prevent irregularities. Implement a procedure for the use of company property and ensure all employees understand the process. While micromanaging is not an ideal practice, making employees aware of the monitoring of inventory and company property can deter employees from theft or misuse in the future.
Although many business owners may not consider fraud prevention and detection a priority, no company is completely immune to fraud. Whether a minor instance or a major one, preventing fraudulent activity can be essential to the success of your business. Keeping abreast of the warning signs of fraud and investigating any red flags detected goes a long way to preventing losses and deterring employees from fraudulent activity.
Every company can be a victim of fraud. Before these warning signs even occur, a solid fraud prevention and detection plan should be step one for every company. If you are unsure of where to begin, speak to The Fraud Triangle about prevention plan options and employee awareness training.