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Temptation to defraud: elevated levels
of organizational fraud worldwide
signal caution for internal auditors
charged with helping to protect against
deceptive and illegal practices
Internal Auditor, Oct, 2010 by Albert G. Holzinger
DOUGLAS ANDERSON, FORMER CORPORATE auditor for The Dow Chemical Co., has
seen the alarming statistics on elevated fraud levels worldwide and is keenly aware that his
own US $45 billion-a-year enterprise, with about 52,000 employees at 214 manufacturing
sites in 37 countries across the globe, could be a tantalizing target for fraudsters. Yet like
many chief audit executives (CAEs), Anderson--recently appointed Dow's global financial
director--sees no need to adopt a radically different approach to fraud prevention, detection,
or investigation. "I haven't really seen a need to change what we've been doing successfully
for years at Dow," he says. "We need, instead, to emphasize and apply the fundamentals
consistently and vigorously."
[ILLUSTRATION OMITTED]
Experts in the field of fraud say it's prudent for internal audit leaders to be on high alert. "All
the internal auditors I have talked to in large organizations have told me that employee
frauds increased substantially during the recessionary years of 2008 and 2009," says Toby
Bishop, Chicago-based director of the Deloitte Forensic Center for Deloitte Financial
Advisory Services LLP.
"Common sense alone will tell you that when the economy is in recession, fraud perpetrators
are likely to come out of the office woodwork," observes James Ratley, president of the
Association of Certified Fraud Examiners (ACFE), based in Austin, Texas. Newly published
http://findarticles.com/p/articles/mi_m4153/is_5_67/ai_n55819425/?tag=content;col1 29-10-2010

2. Page 2 of 3
data on the current likelihood and potential impact of commercial fraud support these
sobering assessments.
The ACFE's 2010 Report to the Nations on Occupational Fraud and Abuse, for example,
broadly estimates that organizations worldwide are losing an average of 5 percent of gross
revenues to fraudulent activities. Moreover, the Corporate Governance and Compliance
Hotline Benchmarking Report recently published by The Network, a Norcross, Ga.-based
hotline vendor, reveals that the percentage of allegations of fraudulent activity has more than
doubled over the past four years, from 10 percent in the first quarter of 2006 to just over 20
percent of the nearly 120,000 hotline reports made during the first three months of this year.
Of course the extent to which fraud affects individual organizations and their audit shops
varies--some are likely to be impacted more than others. Nonetheless, all internal auditors,
not just CAEs, face the formidable task of thoroughly understanding why and where fraud
risk might be elevated in their organization and incorporating an appropriate response into
the overall audit plan and individual audit engagements.
THE FRAUD TRIANGLE
The classic fraud triangle--with "pressure," "rationalization," and "opportunity" at its
vertices--explains why fraud risk is elevated now, the ACFE's Ratley says. The overall U.S.
economy is growing again, but the nation's unemployment rate is stuck at 9.5 percent. This
means, in effect, that millions of Americans remain out of work and, as elevated home
foreclosure rates indicate, many of the unemployed are in dire financial straits. Moreover,
even many Americans with jobs are underemployed, have lost access to health care and other
key benefits, or have had their total incomes halved or worse because spouses or other
household members have lost their employment. Also, executives of countless struggling
businesses may feel intense pressure to commit financial reporting fraud to preserve access
to currently scarce capital, while some of their managers may conclude the only way they can
hit their financial performance targets--and perhaps keep their jobs--is by overbilling, short
shipping, using inferior parts, or initiating some other fraud scheme.
As for rationalization, desperate times can lead even decent people to undertake illegal acts.
"The vast majority of people who end up stealing from an organization had no intention of
doing so when they went to work or began a contracting relationship there but loyalty
diminishes in tough times, especially after widespread layoffs and contracting cutbacks,
thereby creating a 'high-fraud environment,'" Ratley notes. Indeed, more than 85 percent of
frauds examined by the ACFE in researching its 2010 report were perpetrated by individuals
who had never been previously convicted of, or even charged with, a fraud-related offense.
Layoffs also can have the unintended consequence of creating greater opportunities for
fraudsters to operate unnoticed. "Internal controls are the bedrock of every anti-fraud
program," Ratley says. "All it takes to open the door for a fraudster is one round of layoffs
that diminishes controls in critical areas." Moreover, says Deloitte's Bishop, the workload
may be so crushing at downsized organizations that key personnel may spend little or no
time monitoring controls that supposedly remain intact. "Many organizations seem to have
moved into firefighting mode, where people do only what they consider essential. The risk is
that skimping on fraud prevention and detection activities today may create opportunities
for catastrophic frauds tomorrow," he observes.
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3. Temptation to defraud: elevated levels of organizational fraud worldwide signal caution for internal auditors charged with helping to protect against deceptive and illegal practices - page ...
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"As you would assume, fraud has an elevated status in our risk-based audit plan now,"
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audits of higher risk areas ranging from accounts payable and human resources to
compliance with the U.S. Foreign Corrupt Practices Act (FCPA) and the accuracy of
management's public disclosures. It also means "scoping fraud detection into even the
lower risk audits we do," he says.
Anderson also is a strong believer in auditor education as a fraud-fighting tool. "We
have a largely rotational internal audit team at Dow, so we do not assume that
everyone on staff understands fraud risks," he says. Consequently, Anderson ensured
fraud topics were well addressed during the audit team's annual conference and
provided his staff with access to ongoing online training and tools that explain fraud
risks and how to test them.
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Preventing, detecting, and as needed, investigating and prosecuting even small frauds is
well worth the effort, Anderson says, "because even they can be material in total, and
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letting them go would send the wrong message to the organization." Throughout this
process, however, he remained ever-mindful of preserving the independence of the Analyst Wire
internal audit activity. "It is management's responsibility to institute, establish, and
monitor controls and uncover fraudsters. Internal auditing's job is to encourage Arab American News, The
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4. Temptation to defraud: elevated levels of organizational fraud worldwide signal caution for internal auditors charged with helping to protect against deceptive and illegal practices - page ...
management to undertake what is necessary and then provide assurance to the audit
Arizona Capitol Times
committee that management is getting it right."
Attorneys for the Rights of the Child
At San Francisco-based Del Monte Foods, Vice President of Internal Audit Richard Newsletter
Schmidt also has sharpened his focus on the risk of fraud. Del Monte, which sold about
US $3.7 billion in food and pet products mainly into the U.S. retail market last year, is Beacon Hill Times, The
financially solid and has avoided large layoffs. However, Schmidt is well aware that
some employees may still be tempted to commit fraud. Family member layoffs or "under Most Popular Business Articles
water" home or retirement savings losses are just some of the financial hardships that Most Popular Business Publications
may lead an employee to fraudulent behavior.
"We are a hundred-year-old company with relatively stable processes and controls, and Content provided in partnership with
our strong financial position and organizational maturity thus far have generally helped
shield Del Monte from fraudsters," Schmidt observes. "We also have benefited greatly
from a strong culture and tone at the top of the organization." Del Monte's culture and
management tone is formalized in a code of conduct and a shared values framework
comprising the elements of ownership, respect, courage, and "winning together."
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Re-evaluating fraud risks is smart, says Deloitte's Bishop. "Arguably the most critical www.techrepublic.com Read our white
action an organization can undertake now is updating its assessment of the likelihood of paper on automated file defragmentation.
various fraud scenarios and their potential impact to make sure it accurately reflects the
current business environment," he says. Bishop advises management to involve not only Help.com has your answer
internal auditors but also fraud specialists and information from industry peers in this www.help.com Go Ahead, Ask a Question
process. "This is not a trivial exercise," he says.
It's also prudent, Bishop says, to revisit the subject of
More risk tolerance. "The tendency of most organizations is to
Articles of Interest jump straight from risk assessment to controls and to
skip over the discussion of risk appetite." However, he
The information says, great benefit can accrue from holding candid
guardians: charged with
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system.
Still, achieving consensus on where perpetrators are most likely to strike and
documenting the organization's pain threshold for such misdeeds is one thing; deterring Analyst Wire
and, when necessary, investigating and prosecuting fraudsters is another. And this is
Arab American News, The
where HCA's anti-fraud program comes into play. This program comprises all of the
conventional fraud-fighting elements such as assessing the tone at the top, Arizona Capitol Times
independently assessing fraud risks, planning and scoping audit engagements
Attorneys for the Rights of the Child
correspondingly, and working with the company's ethics and compliance department to
Newsletter
follow up on fraud allegations. Some of the most innovative elements of this program,
however, concern management training and communications. Beacon Hill Times, The
As part of HCA's ongoing efforts to maintain compliance with Sarbanes-Oxley, for
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example, hospital controllers and chief financial officers periodically attest to the
completeness and accuracy of financial statements within their purview and disclose Most Popular Business Publications
known instances of fraud. Internal auditing conducts extensive balance-sheet training for
participants in this process and collects, analyzes, and follows up as appropriate on Content provided in partnership with
reported fraud incidents. When a fraud pattern emerges, Hatley says, internal auditing
issues an "Audit Risk Alert" to help others in management "catch ongoing fraud or,
better yet, prevent similar fraud from happening again."
Although there is no one-size-fits-all solution to effectively mitigating currently elevated
fraud risks, internal auditors can add value to their organization's fraud-fighting efforts,
whatever they comprise. "Internal auditing is often the only proactive source of fraud
detection that management has," the ACFE's Ratley reminds. "Auditors are out there
looking for indications of fraud during every engagement they conduct; no one else in
the organization plays this vital role."
RELATED ARTICLE: Assessing the Impact
Not all frauds, of course, are equal in terms of the financial, reputational, and other
risks they pose to the organization. The most severe by far are instances of fraudulent
financial reporting and other C-suite misdeeds. The ACFE's 2010 Report to the Nations
on Occupational Fraud and Abuse, for example, found that frauds committed by
business owners and executives are more than three times as costly on average as
frauds committed by managers and more than nine times as costly as average employee
frauds. Another recent report, this one by The Committee of Sponsoring Organizations of
the Tread-way Commission (COSO), offers even more explicit evidence of the
destructive potential of executive-level fraud.
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experienced bankruptcy, delisting from a stock exchange, or material asset sales at
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rates much higher than those experienced by other firms. And no wonder: The median
fraud in the COSO study was US $12.1 million, and more than 30 frauds involved
financial misstatements of US $500 million or more.
For most organizations, however, unspectacular and
More almost always unpublicized asset misappropriation is the
Articles of Interest type of fraud scheme most likely to occur. Such "garden
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Recession-induced downsizing of many organizations'
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top concern and recidivist fraudsters. Last fall, The IIA surveyed
Richard Chambers more than 800 chief audit executives and other
management-level internal auditors in organizations of
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widely varying sizes and industries. Overall, 12 percent
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23 percent reported headcount reductions in 2009, and
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Among larger organizations, the audit staffing picture
was even bleaker. Eighteen percent of respondents from Fortune 500 companies Dow Nasdaq S&P 500 News
reported staff reductions in 2008, 34 percent reported cutbacks in 2009, and 18 percent