Fraud in Times of Recession
When a financial bubble bursts, fraud increases. True or false?
The indications from past recessions are that there is more likelihood for this statement to have an element of truth than to be completely untrue. Fraud is a constant. A recession does not create fraud – it simply makes it more probable that it will be discovered.
As a business risk, fraud has a number of aspects:
There are, of course, a number of popular misconceptions about fraud, although these may be less so now than 10 or 15 years ago:
With the impact of recession, there are a number of risks that increase for businesses as sales become harder to achieve and profit margins and cash flow are squeezed. Those at the sharp end trying to win orders or sales may have their targets increased and therefore may be inclined to falsify the number and value of orders, especially in periods when bonuses or commissions are calculated. This is followed by credits or cancellations at the commencement of a new period in the hope these can be recovered before the end of the subsequent period. This may lead to a ‘teeming and lading’ effect as orders are not achieved, and more fictitious sales or orders have to be created to maintain bonus and lifestyle. Alternatively, goods may be offered with some form of ‘hidden’ discounts, which may be good news for the customer, but where the combination of lower sales prices and payment of bonuses is a double blow to the selling business.
As profits become squeezed, and reductions in workforce or managerial levels have to be made, fewer individuals are left to carry out the supervision of the business. In this instance, controls over quality and processes may deteriorate, leading to customer complaints and falling orders but, more importantly, reductions in controls allowing the opportunist fraudster to strike. In areas such as control of ordering levels or cheque signing authority there is often the opportunity for abuse, or a reduction in resources that creates opportunity for fraud to take place.
One area where lack of control may allow fraud to take place is in the purchasing or procurement departments. As suppliers, who are facing the same squeeze on profits and cash flow, look to maintain sales levels, inducements may be offered to the purchasing department staff by those suppliers to accept some form of ‘consideration’ to place orders or increased orders with them, which may not be in the best interests of the company. Where there is already a relationship between suppliers and certain members of a purchasing department, this possibility may be even greater. If there has been a reduction in staff levels in that department, there will be less control, and the clear opportunity for this type of fraud to occur.
Not every business will be large enough to have a purchasing department, and where the business is small and control is in the hands of one or two people, the proprietors themselves may unwittingly become party to the fraud perpetrated on their supplier. The new Bribery Bill in the UK, which hopefully will come before Parliament soon, will deal with this type of misdemeanour, something which, to date, has been more difficult to prosecute.
In an investigation in which I was involved some years ago, staff in the purchasing department were suspected of having too close a relationship with a number of suppliers. The subsequent investigation showed controls were weak, and while levels at which managers could place orders or contracts were not exceeded, the system was being abused by contracts being awarded just below the authority level, thereby requiring no higher supervision, but that shortly after the contract had been signed, supplementary contracts were issued, taking the overall price well over the authority level of the individual managers.
While my part of the investigation was limited to control, breaches, as a result of the work of others, a number of managers were dismissed or downgraded. Information on the benefits they had received covered membership of golf clubs, overseas holidays and work on their personal homes.
In a recession, ‘black holes’ will undoubtedly emerge, as has been shown in the case of Bernie Madoff in the US. While markets were buoyant and cash was in plentiful supply for investors, there was never any suggestion that someone who was one of the most respected figures in the financial community was anything other than ‘gold-plated’. When the funds began to dry up, and Madoff’s funds were found to be more virtual than real, the extent of the ‘black hole’ began to emerge, and with it, the realisation that there was very little in the till.
Sadly in a number of cases, the effect of fraud can only lead to one outcome – an insolvent business, where the assets have to be sold off, possibly in a fire sale, if a rescue package such as an administration cannot save the business. It is often after the insolvency of the business that the insolvency practitioner, in his quest to recover assets for the creditors, then discovers either fraud that had been carried out before the business ceased, or the misdemeanours of the directors in the knowledge the end was in sight.
There is no all-encompassing list to explain why people commit fraud, but a number of reasons have emerged.
For an employee with the knowledge his company is not doing well, there is the fear of redundancy, and if the opportunity arises to soften that blow by some fraudulent act, there are some individuals who will go down that route. Of course, not all employees are in a position to carry out some type of fraud, and there are many who given the opportunity would not do so, but no management can believe and rely on the honesty of everyone they employ. In a situation where an employee (or a director) has financial pressures arising from a cash-draining habit such as drug-taking, gambling or maintaining a lifestyle beyond their means, it may be the catalyst for committing fraud.
There has been much recent publicity about the costs of caring for elderly parents. The pressure for families to ensure their parents are well looked-after is increased if funds are low or non-existent. Add to that the difficulties of being a single parent or in a marriage break-up, and the driver to commit fraud is ever-present.
There are a number of areas where individuals may be tempted to commit some form of fraud on the business that employs them. Among these are:
In the current economic cycle, all businesses, but more importantly those which are at the smaller end of the scale and do not have a large number of managerial staff, but rely on a few individuals to carry out a range of operations, must take time to look closely at any areas of risk and take steps to ensure that every effort is made to mitigate the risk of fraud.
Where new employees are being hired, particularly in a time of recession, it is even more important that pre-employment screening is carried out to check qualifications and experience claimed are genuine. It is only too easy now to manufacture a certificate or some document that purports to show experience that has not been achieved. There are a number of commercial companies who will carry this checking out for a reasonable fee, which I consider to be money well spent. In all cases however, the prospective employee’s consent must be gained to carry out the background check, as most universities and colleges will not release this information without proper authority. There are of course Internet sites available, where a limited amount of checking can be made, but I would always recommend where some qualification is given that the awarding institution is contacted. All too often I have seen a curriculum vitae where there is an unexplained gap in the employment history, or some other factor requiring further and more extensive investigation, although it must be borne in mind that this is not always an indication of fraud.
Not every business has the resources to ensure that all duties are segregated. Where this cannot be the case, it is important that risks are assessed and revisited from time to time. However small, I believe every business, whether it is a sole trader with a few employees, a company with a few million pounds of turnover or the very largest quoted company, must have in place both a fraud prevention and fraud response plan.
Every business and every sector is different and has different risks, and these risks must be assessed for the purposes of the fraud prevention plan. A fraud response plan for the senior management of larger organisations, or owners of small businesses, must have some basic elements, but should contain some or all of the following:
After any fraud, the reputation of the business is at risk, and having a documented, even basic plan in place may help reduce any collateral damage that may be suffered. Recessions do not create frauds, but in such times all businesses should continue to take steps to ensure that they do not become the next victim.