The threat of fraud is evolving; are your controls?

When asked, many business owners will flat out deny that fraud or misconduct could be happening in their organization 

By Jacklyn Davies, CPA, CA, DIFA, B.C. lead, MNP LLP

When asked, many business owners will flat out deny that fraud or misconduct could be happening in their organization. Their denial is usually based on the belief that appropriate controls are in place or that every employee is loyal and trustworthy. Sadly there are many examples where controls and loyalty are absent. The result can be a catastrophic loss.

In the 2014 MNP fraud survey, 33% of the businesses surveyed in British Columbia reported having been the victim of fraud. Immediately following the incident, business owners believed their fraud risk was higher. Five years after the event, their perceived risk reduced to the same level as that of non-victims, with only 2% rating their fraud risk as high. While the reason for the reduced concern is not known, it appears that complacency regarding the threat increases as the event becomes distant.

The results also showed that the risk of fraud increased with the number of employees: 49% of businesses with 25 or more employees reported having been a victim of fraud, versus 26% of companies with fewer than 25 employees. In other words, at least one-quarter of businesses suffer some form of fraud, with the percentage increasing with the number of employees.

In order for a business to manage its fraud risk, owners must accept the likelihood that their business can be a victim. An over-reliance on trust is often a factor in employees being able to commit fraud. While trust within an organization is important to generate growth and innovation, trust is not a control. Checks and balances need to be implemented and communicated to demonstrate that assets will be protected.

In the MNP survey, internal controls were credited with identifying 35% of the fraud cases, and tips/whistleblowers were credited with identifying 25%. These statistics support the hypothesis that an ethical environment with appropriate policies and controls better protects the organization.

So how do you promote innovation and growth without accepting too much risk? The first step is to understand the business environment and then design controls to effectively manage the risks that can impair growth, profitability and reputation.

At inception, the business owner is often very hands-on and will have a feel for how everything is working. As the business grows, the owner has less time to personally monitor operations. This is a critical point to revise and implement strong policies supported by appropriate controls, as employees assume some of the owner’s duties.

Design a hiring process that attracts employees with an ethical compass that best matches your expectations. Ensure you know as much about prospective employees as possible. Identify gaps in their resumés, as they might indicate a previous problem. If hiring someone with key responsibility, complete a thorough credit and criminal record check along with Internet searches for negative news stories or postings, and verify.

The development of controls at a point in time is not the end of the story. Businesses change and evolve, and so should controls. This is not limited to internal changes in process. Consider external factors such as changes in regulations, accessing foreign markets and changes in technology.

Computers and Internet connectivity have increased organizations’ exposure to fraud. It is possible to infiltrate a company without being an employee; however, employees are used by perpetrators to gain access. This can be done through phishing emails, computer hacking or downloading of applications containing malware. Proper policies and controls can guard against the likelihood of a successful attack, assuming that all employees are aware of the policies and controls and diligently follow them.

Even if proper policies and controls exist, they will not be effective sitting on a shelf or in an employee’s inbox. Too often, a control is carefully designed but is not followed because the employee is not aware of the control, does not understand the control and therefore ignores it or is simply too busy to properly complete all the steps. Communication and education are critical for creating an environment where key controls are respected.

Once controls are developed and implemented, it is incumbent on management to regularly check that the procedures are being followed. For example, maximum speed signs are posted on all major roadways, but there is still a need for police to remind drivers to obey the speed limit. If employees know that management is checking compliance with policies and controls, they will more likely follow them. Additionally, if employees do not understand the relevance of a task, they are less likely to complete it and more likely to spend time on other activities that result greater perceived value.

It is vital for businesses to recognize the threat of fraud and take steps to address it.

To learn more about the evolving threat of fraud, register today for BIV’s Business Excellence Series: Corporate Fraud breakfast event.

Video: Jacklyn Davies discusses forms of loss, new threats and trust in management: