Fraud Files: Does a Tough Economy Lead to More Fraud?
There is always a spirited debate about how much fraud is really going on. Fraud is a hidden crime, and so we only know about the frauds we actually discover. There are plenty of frauds that go undiscovered for years and fraud investigation professionals are left to speculate about how much secret fraud exists.
Forensic accountants and fraud investigators estimated that 7% of the average company's revenue is lost to fraud, in the 2008 edition of the Report to the Nation on Occupational Fraud and Abuse published by the Association of Certified Fraud Examiners. This would equal nearly $1 trillion per year in the United States alone.
I'm a dissenter. I think the real figure for fraud is about half of that. Fraud controls at many companies are bad, but I doubt that they are quite this bad.
Investment Frauds Increasing
There are also the frauds that are unrelated to employment, which include investment fraud and Ponzi schemes. These are the types of scams that Bernie Madoff helped make famous recently. We are hearing about more and more investment frauds around the country, including a $162 million fraud by a Florida money manager.
Even forensic accountants are getting into the business of committing fraud, with Lewis Freeman (referred to as Miami's "go-to" forensic accountant) being charged with embezzling $2.6 million from his clients.
The actual figure for the various types of fraud losses is neither here nor there. The fact is that individuals and companies lose a lot of money to fraud, through the direct theft, as well as the cost of investigating, prosecuting, and preventing future frauds. With a lagging economy, investors and business executives are left asking whether their fraud costs are even higher now.
Is The Economy A Factor?
It is reasonable to wonder whether a difficult economy causes more people to turn to fraud to pay their bills, feed their families or support an addiction. Indeed, a real or perceived financial need is a fraud risk factor for employee theft, as outlined in my book Essentials of Corporate Fraud. Many factors can make an employee more or less likely to commit fraud. Some of the most common personal red flags of fraud include:
Lifestyle issues -- Living beyond ones means, having excessive debt, or child support or alimony issues all require cash to resolve.
Personal problems -- An addiction, criminal background, chronic legal problems or infidelity can also require a steady inflow of money.
A quick look at news headlines related to fraud indicates that new frauds are being uncovered daily. Locally, it seems that each night on the news, a new business or organization has reported a large theft by an employee. Every time we turn around, we hear of a new Ponzi scheme bilking investors out of millions of dollars. Is fraud on the rise because of the economy, or is something else at play?
Likelier To Be Uncovered
Anecdotally, I'd have to say that fraud is not on the rise. Yes, we're hearing more about fraud, but that doesn't necessarily mean employees are stealing more often from their employers or money managers are swindling more investors. I don't believe the economy is causing more fraud, but I do believe that tighter finances are making it more likely that existing frauds will be uncovered.
Look at the frauds being reported in the news. These are not new fraud schemes. Most often, they are schemes that have been ongoing for at least several years. That in itself disproves the theory that the fraud is related to a flagging economy. These frauds started while the economy was flying high.
We are hearing more about fraud because companies have much less cash to play around with. They are looking to cut corners, and they are worried about inefficiencies. As belts are tightened, it is more likely that a fraud scheme will be uncovered. Business owners and executives are simply taking a better look at their finances. (Which is something that headphone maker Koss Corp. executives might have considered doing, rather than relying on American Express to bring a $31 million alleged fraud to their attention.)
Withdrawals Expose Ponzis
In the case of investment frauds and Ponzi schemes, these too are more likely to be uncovered during difficult economic times. Ponzi schemes require continual infusions of cash to stay afloat. With the economy tightening, investors are more likely to want to pull money out of these investments (rather than put money in), and this almost guarantees the collapse of a fraudulent investment scheme.
Fraud is a serious issue no matter what the economy is doing, but the economy does not necessarily cause more fraud. The difficult financial situations of many individuals and businesses have simply shined a brighter light on fraudulent activities. Fraudsters can run and they can hide, but now more than ever, they're likely to be discovered.
Tracy L. Coenen, CPA, MBA, CFE, CFF is a fraud examiner and forensic accountant who investigates corporate fraud and consumers scams, and is the author of Essentials of Corporate Fraud and Expert Fraud Investigation: A Step-by-Step Guide.
