ENIOR executives are committing more fraud, a survey by global consulting company KPMG has found. A comparison of the results of surveys from 2007 and 2011 indicates an increase in fraud and fraudulent behaviour by senior managers. The global survey by KPMG shows that CEOs were involved in 26 percent of cases, up from just 11 percent in the previous survey. The survey was based on the findings of fraud investigations conducted by KPMG member firms. One finding, identified as alarming by KPMG, is that companies are continuing to ignore warning signs of fraud. This, and the fact that more than one half of the investigated frauds had run for more than three years before they were detected, suggests that more white-collar fraud may emerge in the future.
The KPMG study follows a 2007 analysis of fraudulent behaviour across Europe, the Middle East and Africa. Since that report proved so popular, KPMG extended the 2011 survey worldwide. KPMG sought to identify patterns among individuals who have committed acts of fraud and compared the value and duration, as well as many other characteristics.
The 2011 survey is based on 348 cases investigated by KPMG across 69 countries, including Slovakia, between 2008 and 2010, covering the start and the main part of the recent financial and economic crisis.
The typical fraudster
The 2011 research found that the typical fraudster is a man aged between 36 and 45 who works in a finance or finance-related role, has been with the company in question for more than 10 years, and holds a senior management position. Often such individuals will be better placed to override controls and may have accumulated a good deal of personal trust. They are most likely to engage in embezzlement or procurement fraud.
Viliam Kačeriak, a manager at KPMG’s forensic services department in Slovakia that covers the central and eastern Europe (CEE) region, noted that in Slovakia the typical fraudster most commonly works in the procurement or sales departments. The finance department often plays the role of policing these areas.
“We most often register frauds leading to misappropriation of assets, embezzlement and other corrupt activities,” said Kačeriak, adding that in other regions misstatement of financial results is more common.
In this respect the CEE region bucks the global trend. Fewer frauds occur within the finance function, while most are committed within sales and procurement.
“In central and eastern Europe many multinational companies have tended to transfer trusted expatriate employees from the parent company into key financial positions at their subsidiaries in the region, to provide not only the necessary experience, but also to police the subsidiary from within the finance function,” Jimmy Helm, KPMG’s head of forensics in CEE, said, as quoted in the KPMG analysis. “They act as whistleblowers, the initiators of investigations. Often they are further transferred from region to region as the company sets up new operations to ensure the ongoing integrity of the finance function.”
According to the KPMG findings, in eastern Europe some 89 percent of people investigated had been employed at the company in question for more than three years, of whom more than half had been employed for longer than six years. Fifty-two percent of the frauds had been running for more than three years before they were detected, said Kačeriak.
The results of the survey also showed that a typical fraudster does not work alone: in 61 percent of cases, the fraudster colluded with either an internal or external third party. The CEE cases followed this trend, with 63 percent involving collusion. This characteristic is further supported by a review of reported cases in Slovakia resulting in convictions, which indicates that there was collusion in more than 50 percent of cases.
Ľubica Martauzová, a manager at KPMG’s forensic services department in Slovakia, said that, interestingly, men have a far greater tendency to act in cooperation with somebody else than women.
Fraudsters’ motivations
Martauzová explained that based on the theory of fraud, three basic preconditions must be fulfilled in order for a fraud to be committed: pressure, opportunity and rationalisation.
The latter is the most crucial component in most frauds, KPMG stated, saying that about 80 percent of the population are in the so-called grey zone, i.e. they would commit a fraud only when the above three preconditions are fulfilled and that at both ends of the population spectrum are small percentages of people who would never commit a fraud or would commit a fraud every time they have the opportunity. Rationalisation means that the person must be able to justify in his or her own mind the fraudulent behaviour, for example labelling theft as “borrowing”, or by intending to pay stolen money back at some point, or using job dissatisfaction to justify the belief that something more is owed to them.
With regards to motive, it is not restricted to the desire for personal financial gain, but can also be prompted by an effort to improve the image of the company in the eyes of a parent company or shareholders. This is often done to conceal losses or poor performance.
Here Kačeriak pointed out one case of parallel bookkeeping that the KPMG team investigated in the CEE region. An investigation revealed that the local management had falsified their financial records for more than five years. They had parallel bookkeeping, i.e. one with real documents and another one, completely fabricated and reported to the parent company.
Warnings ignored
Martauzová pointed out that the KPMG findings suggest that fraud is a growing problem in society, but, paradoxically, defence mechanisms appear to be getting weaker.
One of the most significant findings of the KPMG survey is the very large increase in cases involving the exploitation of weak internal controls by fraudsters – up from 49 percent in 2007 to 74 percent in 2011. The difficult economic climate may be partially to blame, according to the KPMG survey. Tighter budgets are forcing some companies to cut costs in their control environments. Less robust controls, and fewer resources to monitor controls, allow for greater exploitation by fraudsters.
The survey also found that ‘red flag’ warnings, such as an employee who rarely takes holidays or whose lifestyle appears excessive for their income, are commonly being ignored by companies.
Just 6 percent of fraud cases in the 2011 survey had initial red flags that were followed up, compared with 24 percent in 2007 – a substantial drop. In eastern Europe the position is a little more positive, with some 11 percent of red flags being acted upon. However, 43 percent of red flags were not acted upon in eastern Europe: lower than the global average of 56 percent, and comparable with the 2007 average of 45 percent.
“It is surprising that companies continue to ignore warning signs, particularly in light of the recession,” said Martauzová. “While cost-cutting initiatives associated with the downturn may have played their part in the observed shift, such cuts may prove to be a false economy. While defences are down, the fraudster sees an opportunity to capitalise. The need for companies to be vigilant has never seemed more important.”
In 46 percent of the cases investigated in eastern Europe, there were no red flags. This is consistent with the global average of 44 percent.
“78 percent of the cases polled in eastern Europe show that weak controls were exploited in commission of the fraud,” said Kačeriak. “This, coupled with the finding that more than half of the frauds investigated in eastern Europe ran for more than three years before detection, indicates that controls are either inadequate or have not been revised and updated to deal with new threats. This highlights the need for regular fraud risk assessments as part of an overall operational risk assessment strategy.”
Martauzová also said that the statistics suggesting one in seven causes of fraud or fraudulent behaviour is uncovered completely by chance is alarming.
“Such statistics indicate that a company will never uncover many frauds at all,” said Martauzová.
She believes that this is also because employees or affected parties are often not willing to highlight abnormal behaviour because they have had a negative experience from doing so, for instance finding that the company fails to take any follow-up steps.
Reporting fraud
The global average indicates that only 23 percent of the frauds detected were publicly reported, and 46 percent were communicated internally. In eastern Europe, less than 30 percent of fraud incidents were reported internally and only 11 percent were reported externally - only in India were less cases reported. Full disclosure to the authorities only occurred in 2 percent of the cases in eastern Europe, compared to the global average of 13 percent.
Disciplinary action was the most common response to fraud in eastern Europe. Such action was taken in 33 percent of cases and resignation or voluntary retirement occurred in 24 percent. However, enforcement action was taken in just 17 percent of cases and civil recovery in 2 percent.
“These findings suggest that companies are not taking the opportunity to leverage learning points or to instil a corporate culture of zero tolerance towards fraud,” Helm commented, as quoted in a KPMG press release. “Effective communication of a fraud incident provides the opportunity to send the organisation and its business partners a clear message from management that fraud will not be tolerated. A further consequence of the failure to take strong action against the perpetrator is that the fraudster is able to move on to another unsuspecting company with their reputation intact.”
Here Kačeriak provided an example of a security boss who was ousted from a company because of fraud.
“To our big surprise, we found him working as security boss in another company two weeks later,” said Kačeriak.
According to Martauzová, the importance for companies in Slovakia of having a strong control environment has never been greater.
“By adopting measures to prevent fraud or detect it early, businesses can limit the opportunities they present to a would-be fraudster,” she said. “While fraudsters are using more sophisticated techniques to commit their crimes and cover their tracks, often the underlying fraud remains quite simple. The challenge is to see through the ‘ordinary’ disguise of the fraudster; enhance fraud prevention and detection, and respond more often and more rapidly to red flags.”
