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Litigation: Dealing with financial fraud

To deal with fraud, you must understand how to detect and identify it first.

Financial fraud is one of many issues in-house counsel sometimes have to address as part of an organization’s overall legal and compliance team. Handling it efficiently and appropriately can be the difference between major losses and full recovery.

According to the most recent estimates from the Association of Certified Fraud Examiners, a typical organization loses 5 percent of its revenues each year. Applied to organizations across the globe, that corresponds to a potential projected annual loss of over $3.5 trillion. The median loss for so-called occupational fraud–use of one’s occupation for personal enrichment through misuse of the organization’s assets–is approximately $140,000, with more than one-fifth of the cases having over $1 million in loss.

Detection

Detecting a financial fraud can come from a variety of sources, including an internal audit, a whistleblower, surveillance or even by accident. But by far the most common source is a tip from a fellow employee. The means of detection also correlates closely with the likely loss. Frauds detected by internal, proactive measures such as internal audits and a fraud-reporting protocol result in far smaller losses than frauds detected by external, reactive measures. And by far the least efficient means of detection, in terms of the resulting size loss amount, is when it is first discovered by law enforcement.

Types of fraud

The types of occupational fraud are almost limitless, but they can be categorized broadly into three groups: corruption, asset misappropriation and accounting fraud. Corruption involves conflicts of interest, bribes and extortion. Accounting fraud involves, through any number of means, overstating or understating company assets or revenue. Finally, asset misappropriation–the broadest of the groups–can involve simple theft, fraudulent disbursements, billing schemes, check schemes, manipulation of inventory and many other types of fraud. Those types of fraud can translate into a wide variety of state or federal crimes, including embezzlement, theft, identity theft, bribery, counterfeiting crimes, computer fraud, mail and wire fraud and money laundering among others.

Origin and prevention

Fraudsters typically have at least one of three traits and often all three: First, there is financial pressure on them or their family. Second, there is an opportunity, perceived or real, to commit their fraud. And third, they internally rationalize their conduct before they act. A combination of those factors increases the risk of fraud. In terms of workplace demographics, not surprisingly persons with more seniority and more responsibility within an organization have the greater opportunity to commit more and larger frauds. Lower-level employees or those with shorter tenures by comparison have lower loss levels associated with their fraud.

Prevention

The best–and cheapest–litigation tactic when dealing with fraud is to prevent it in the first place. The first step of prevention is an effective compliance program. While that program will be business and industry specific, it should still embrace some common themes such as establishing clear standards for conduct; requiring due diligence in hiring; describing expectations, responses, and disciplinary actions for misconduct; and providing for periodic assessment. Related to a compliance program are fraud-specific policies. As noted, these should be proactive and include items such as analytical reviews, job rotation, and audits – both routine and surprise. In addition, management must provide appropriate oversight. That means not just actual oversight, but also furthering employee education, fostering a culture of compliance, and maintaining a perception that fraud will be detected and not tolerated. Finally, good systems for reporting fraud, such as an anonymous hotline or web-based service, are key to allowing the best guards against fraud – your own employees – do so effectively and without fear of repercussion. While setting up and maintaining these various systems and steps can be challenging, they have the potential to save a business far more money and heartache from fraud in the long run.

Contributing Author

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Ty Howard

A former Assistant U.S. Attorney, Ty E. Howard is a partner in the white collar defense and litigation practice groups at Bradley Arant Boult Cummings...

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