Author: Johan Van Der Westhuizen

Fraud is a global issue, impacting stakeholders beyond financial losses and reputational damage — which is where a fraud audit comes into play. It is important now, more than ever, to understand the dangers and ramifications of fraud. Fraud is capable of wreaking havoc on businesses, investors, employees, and entire industries. We’ll seek to understand some of the most notorious and insidious fraud schemes, delve into how these were identified and provide strategies and best practices to prevent fraud affecting your organisation.

What is Fraud?

Conceptually, fraud is any activity that relies on deception in order to achieve a gain. Black’s Law Dictionary states that fraud becomes a crime when it is a “knowing misrepresentation of the truth or concealment of a material fact to induce another to act to his or her detriment”. Interestingly, akin to the layers of an onion, fraud extends through layers including:

• Initiation, where motives and opportunities give rise to the dishonest event or conduct. The recipe for fraud to be committed is referred to as the ‘fraud triangle’. You can read more about the ‘fraud triangle’ here.
• Escalation, where the perpetrator actively conceals their actions to avoid detection. The concealment tactics can include manipulating records, social media or fictitious accounts, and even crafting opaque legal documents, and finally
• Discovery, where the red flags point to issues requiring investigation and ultimately unmasking the fraud. You can read about potiential red flags here.

The importance of detecting and addressing fraud, with tactics such as an internal or fraud audit, in a timely manner to minimise its impact on stakeholders cannot be overemphasised. You can read about the statistics and financial losses relating to fraud, along with fraud red flags, here.

Some Of The Most Infamous Fraud Cases

The history of financial crime is marked by some infamous fraud cases that have shocked the world. These instances highlight the critical role of fraud audits in detecting and preventing deceptive practices.

This section will introduce some of the most notorious fraud schemes, serving as a prelude to deeper discussions on the subject. As we explore these cases, we will uncover the impact they had on their victims and industries.

The Enron Scandal

One of the most infamous cases of corporate fraud in history is Enron. Initially involved in natural gas transmission, Enron later transitioned into trading energy derivative contracts, fostering a culture of intense competition and deceptive accounting practices.

The energy company concealed massive debts from its balance sheet, resulting in catastrophic financial losses. Shareholders lost $74 billion, while thousands of employees and investors lost their retirement accounts. Many employees were left jobless.

The scandal was exposed when a whistleblower, suspicious of the company’s unusually high stock prices, revealed the fraudulent activities.

Lehman Brothers

The exploitation of loopholes in the semantics and application of accounting standards, along with an imagination stretching beyond the realms of the Disney Corporation or Pixar, allowed the financial services firm to sell toxic assets disguised as sales when in fact these were loans.

Unsurprisingly, the loans ultimately required repayment. The scandal was exposed in September 2008 when Lehman Brothers filed for bankruptcy – over US$600 billion.

Bernie Madoff’s Ponzi Scheme

The same year as the Lehman Brothers scandal came to light was this fraud, orchestrated by the American financier, who promised unusually consistent annual returns of around 10%.

In fact, Madoff and his accountants paid investors returns out of their money, or that of incoming investors, rather than profits. Through this scheme, Madoff defrauded investors more than an estimated US$60 billion.

Madoff and his accountants received hefty prison sentences. The scheme came to light following several warnings and reports from a whistleblower.

WorldCom

The WorldCom fiasco, perpetrated by a telecommunications company, is another prime example of corporate fraud. Worldcom inflated its assets by approximately $11 billion and recorded false accounting entries to increase revenues presented to the market.

The impacts were devastating, resulting in thousands of employees losing their jobs, investors suffering substantial financial losses and ultimately one of the largest bankruptcy filings in history.

The CEO was sentenced to 25 years in prison. A corporate whistleblower was the one to thank for bringing this to the attention of the auditors and board of directors.

Case studies in other companies and sectors

The following cases and examples emphasise the importance of transparency and accountability in the corporate world. For all organisations, large and small, the examples serve to demonstrate the significance of fraud awareness, as well as the need for robust internal controls, ethical culture, documented policies and procedures — and regular fraud audits to ensure the accuracy of financial reporting.

Misappropriation By Finance Manager

The finance manager of a large organisation was alleged to have misappropriated over $1 million from the organisation through cheque and expense payment fraud.

An investigation ascertained the amounts had been disguised through misstatement of accounts, liabilities not being recorded and falsifying supplier records. Inadequate segregation of duties and the compromising of bank signatories facilitated the fraud to occur.

Sales Commission Fraud

A retail organisation was concerned about the high outstanding debtor balances in the accounts receivable at year end. This was during a period with some of the worst weather on record. For this organisation, sales ordinarily were a product of good weather.

Enquiries made to some of the debtors identified a number of suspicious sales transactions which were denied by the debtors. Further investigation revealed a number of significant “credit notes” for the alleged sales.

It became apparent one sales manager had created fraudulent sales in order to generate fraudulent commission payments to themselves.

Inventory And Revenue Fraud

An electronics manufacturer saw the surprise resignation of its finance officer during a review into “credit returns”.

Further investigation established a significant proportion of sales invoiced to suspect suppliers had been falsely created, allowing the misappropriation of inventory from the warehouse by an accomplice working in the warehouse. The inventory had been sold privately with the proceeds being shared between the pair.

Corporate Espionage

An information technology company grew increasingly concerned following an increase in customer turnover. A formal customer exit interview was conducted, which led to a further internal review of current and terminated employees.
It was identified that a manager, who had recently resigned, had obtained access to a confidential database of clients, hardware and software support, and price lists.
The (former) manager saw the opportunity to target the organisation’s customers and offer cheaper prices. Accordingly, they established a separate business and set up in direct competition with their company.

Tips to Prevent and Combat Fraud

Fraud prevention and fraud detection are two separate, but interdependent, processes. Fraud prevention encompasses the systems, procedures, and policies organisations employ to prevent fraud.

Fraud detection on the other hand is monitoring transactions and performance to identify and respond to fraudulent activity after it has occurred. Prevention is better than cure, and you presumably don’t want your business to be the next victim of fraud, front page news article or online case study (*blushes*).

Fraud prevention strategies include:

• Establish and promulgate the tone at the top: Tone at the top refers to the ethical atmosphere that is created by the organisation’s leadership. The Board and management has to lead by example and actions. These actions should include rewarding ethical behaviour while punishing unethical actions. There should be sanctions for engaging in, tolerating, or condoning improper conduct.
• Establish a code of ethics: Organisations should produce a clear statement of management philosophy. It should include concise compliance standards that are consistent with management’s ethics policy relevant to business operations.
• Establishing robust internal controls: This includes strong preventive controls such as segregation of duties, passwords and authentication, restricted access and custody, and ensuring no-one person controls end-to-end processes. This includes assigning appropriate authority and responsibility to functions and processes.
• Education and training: Regular tailored training and education programs can help staff learn to recognise red flags and understand fraud prevention and detection best practices. Employees should know what to do if they detect suspicious activity or potential fraud and how to report it.
• Establish a whistleblower policy: Companies should establish and communicate a whistleblower protection policy to allow employees to come forward and report misconduct in the workplace. This policy should allow employees to report or seek guidance regarding actual or potential criminal conduct by others within the organisation while retaining anonymity or confidentiality, without fear of retaliation.
• Implement a confidential hotline: More frauds are detected by tip-off than any other means. Hotlines have proved to be a very effective reporting mechanism for stakeholders to call and confidentially report suspicious fraudulent activity. This also bolsters the ethical environment promoted by the organisation’s leadership.
• Conduct regular audits and internal reviews: Regular audits and reviews prevent fraud and helps organisations maintain better control over their operations.

Protect Yourself From Fraud With an Audit

A strong ethical culture, regular training and awareness, carefully designed and effectively operating internal control environment and ongoing internal and external audit activity offers the greatest preventative protection for your business against fraud. We should all be striving to “do the right thing” as this starts at the top.
For an obligation-free chat, get in touch with the Bishop Collins Audit team. We can assist you with audit and assurance services, during which our experts will provide advice and guidance on how to protect your business against fraud, or how to deal with any fraudulent activity you suspect.

If you’re interested in learning more about internal and external audit, fraud risk management, and awareness training, get in touch with us for an obligation-free chat or simply call us on (02) 4314 8020.

The threat of fraud in a complex and sophisticated business environment is real. Financial systems become more complex over time to fulfil the quest for information from their owners.

Accordingly, opportunities are inherently created for fraudsters to thrive. For this reason, fraud is constantly evolving: new scams and patterns evolve as new opportunities emerge and fraudsters find ways around detection and prevention measures.

Still, many types of fraud and schemes occur again and again, across different geographies, business types, and industry sectors. In this blog, we’ll cover:

• Internal fraud, including embezzlement and fraudulent payments, and
• External fraud, such as hackers, supplier fraud, and customer fraud.

Let’s delve a little deeper into the most common types of fraudsters and how best to respond to them with internal or external audits to help protect you and your business.

Fraudsters From Within

Internal fraud is any criminal act committed by someone associated with a business. This could be a staff member, a member of management, or a member of governance. Also known as occupational fraud, this could look like an employee making deposits into their account, or paying personal expenses on the corporate account.

This type of internal fraud is also referred to as ‘occupational fraud’. It’s among the most damaging types of fraud businesses face since employees can exploit their position within a company to commit acts of theft and embezzlement. In many cases, this kind of fraud goes undetected for long periods.

To better understand internal fraud, we can categorise it into four distinct types.

Embezzlement

Embezzlement is when someone connected to a business steals funds, typically money or amounts in the corporate bank account.

Importantly, embezzlement is not as straightforward as theft. This is because there is usually a manner in which the fraud is concealed in order to avoid detection.

Fraudulent Payments

Fraudulent payments fraud is when someone connected to a business establishes a payment to themselves or a third party.

Typically, this type of fraud takes three forms:

• Invoice fraud: When an employee sets up fake invoices to pay themselves or a third party from the company’s accounts.
• Wage fraud: When an employee creates ‘ghost employees’ on a company’s payroll, listing them as offering ‘third-party services’ when in reality they’re fake and the employee can access the monies paid.
• Expenses fraud: When an employee manipulates expense documents, forging declarations and signatures to receive reimbursement for fabricated expense requests.

As you might expect, fraudulent payments are difficult to detect since they’re often carefully masterminded and concealed in genuine payment and invoice requests.

Data Violations

Data is one of the most valuable assets of a business, and data fraud is quickly becoming one of the biggest threats to modern companies. Certain major Australian companies may spring to mind when thinking about recent data breaches, some of which were nationwide, affecting millions of people and businesses.

Data theft by staff can potentially be on-sold or used as leverage, for instance, in a bribery scenario. Businesses face the risk of severe reputational damage when their data and assets are improperly used by current or outgoing employees.

In efforts to keep track of data breaches and respond to them swiftly, the Notifiable Data Breach (NDB) scheme was instated in 2018. The scheme dictates that data breaches occurring to Australian companies with an annual turnover of $3 million or more report such breaches to the Australian Information Commissioner (OAIC).

Financial Statement Fraud Schemes

Financial statement fraud schemes involve intentional actions by individuals to cause material misstatements or omissions in an organisation’s financial statements. These schemes are a form of white-collar crime where the perpetrating party manipulates financial records for personal gain or to deceive stakeholders.

The motives behind financial statement fraud can vary, ranging from inflating profits to meet financial targets, concealing poor performance, or attempting to boost stock prices. Perpetrators may employ various techniques, such as inflating revenues, understating expenses, or manipulating accounting entries to present a false financial picture.

This type of fraud can have severe consequences for investors, creditors, and other stakeholders, eroding trust and damaging the financial health of the affected organisation.

Responding to Internal Fraud

When it comes to internal fraud, prevention is better than cure. At Bishop Collins, we offer clients practical tips on how to reduce their risk of internal fraud – check them out below:

Segregation of Duties

It’s rarely a good idea to leave one person in charge of your business’ accounting and finances. Instead, split management between two or more parties to improve accountability and make things more difficult for would-be fraudsters.

We also recommend segregating the initiation, review, approval, recording, and disbursement functions between different roles to not only promote transparency and accountability but also to lessen the likelihood of collusion.

Review and Update Access Controls

Who has access to what systems and platforms within your business? Access privileges should be assigned with care and due diligence and make a note of who controls what. This is also referred to as access on a need-to-know basis.

Regularly Audit Your Accounts

Regular accounts auditing is one of the most effective ways to spot anomalies that could signal fraud is taking place.

External audits are mandatorily required by many businesses, but others elect to undertake these voluntarily. Importantly, an internal audit can also help identify anomalies and irregularities.

At Bishop Collins, we specialise in conducting industry-customised company audits to help you identify pain points and safeguard your company.

Screen Your Employees

Business owners need to vet all prospective employees to reduce the risk of falling victim to internal fraud. That means always following through on references, conducting background checks, reviewing social media, and a comprehensive interview process.

External Fraudsters

External fraud is when a business is the victim of someone outside of its organisation. We commonly hear of hackers sending phishing emails, suppliers who lie about the work they did or services provided, and sadly, customers who attempt to return imitated or stolen products.

We can categorise external fraudsters into three main types.

Hackers

Unless you’ve been living under a rock, you will not need an introduction to hackers and the effect they have on businesses. Hackers target not only large, listed entities but also smaller enterprises and government agencies.

Recent examples include an Australian personal loan and financial service provider, affected by a data breach that impacted 14 million customers in Australia and New Zealand. The data breach was initiated after the credentials of an employee were stolen.

Similarly, a large telecommunications company and health insurance company fell victim to hackers through ineffective credential management of users and multi-factor authentication.

In both of these cases, the hackers sought a ransom from the companies that fell victim to the theft of customer data. For this reason, keeping up with strict and active cybersecurity efforts is paramount.

Supplier Fraud

Another type of fraudster from outside the business can be in the form of a supplier (vendor) to the business. This applies to new and existing suppliers of the business.

Vendor fraud is a type of malpractice used by fraudsters to scam a company’s accounts payable department into paying a vendor, or sometimes multiple vendors, for amounts not rightfully earned.

Sometimes, the fraudulent activity is orchestrated by a vendor acting alone. Other times, sadly, it is carried out with the assistance of an employee.

Supplier fraud takes many forms, some of the most common including:

• Fictitious supplier: In this arrangement, an employee submits a payment request from a non-existent supplier or an actual supplier that never delivered any goods or services.
• Duplicate invoice payments: This happens when an employee duplicates invoices from a legitimate vendor, with the plan of diverting payments to an account under their control.
• Over-billing: An over-billing fraud scheme occurs when a vendor inflates the price or quantity of items on an invoice by adding items they never delivered or higher prices of delivered goods.
• Bid-rigging: Bid rigging is a fraud scheme that involves a supplier offering compensation (or financial benefit) to an employee with a strong influence to secure a contract and supplier payment.
• Price-fixing: Price-fixing happens when two or more vendors conspire to fix the cost of a contract at a price higher than normal. The business is left with no choice but to work with an inflated cost.

Customer Fraud

One of the most common types of fraudsters, and one you may have seen in day-to-day life, are customer fraudsters. When a customer returns an item to a business to get a refund or credit, this is referred to as return fraud.

Return fraud encompasses a variety of fraudulent return practices, such as wardrobing or renting, counterfeit returns, price tag flipping, and returning stolen goods.

• When a buyer buys something with the idea of using it just once and then returning it for a refund, this is known as wardrobing or renting.
• Exchanging price tags is considered as returning counterfeit goods while returning fake products falls under the returning counterfeit commodities category.
• Returning items that have been stolen from a retailer is referred to as returning stolen goods.

These frauds have a significant financial cost to businesses, particularly those in the retail sector. While customer fraud can often be easier to catch or detect than other types of fraud, it’s still a sticky situation when dealing with Australian Consumer Law and the old adage of ‘the customer is always right’!

Responding to External Fraud

Concerning external fraud, the emphasis lies on proactive prevention rather than reactive solutions – the same as internal fraud. Luckily, we have several actionable insights to minimise your susceptibility to external fraudulent activities.

Supplier Management

Implement a supplier management platform or protocol. Supplier management is the process of supporting and empowering vendors through establishing and nurturing long-term relationships.

This includes finding and choosing the right vendor for the company’s needs, controlling the costs and supplier risks, and paying for the services and goods consumed.

Delegate Duties

We said it before, and we’ll say it again – it’s rarely a good idea to leave one person in charge of your business’ internal controls. Segregate the initiation, review, approval, recording, and disbursement functions between different roles.

Importantly, implementing supplier matching protocols reduces the likelihood of fraud. This is achieved by matching supplier invoices to other documents such as purchase orders, payment receipts, inspection slips, delivery dockets, and so on. This is also referred to as ‘the three-way match’.

Screen Employees and Conduct Employee Training

It’s important to run background checks to identify relationships between employers and suppliers. Similarly, businesses should ensure employees are aware of policies, procedures, and protocols.

Ensuring documentation is produced and reviewed and not entering into transactions with incomplete or inconsistent information. This applies to both working with suppliers and serving clients and customers.

Protect Your Business Against Fraud

Fraud arising from dishonest behaviour not only undermines profits, operating efficiencies and reliability, but it can also severely damage an organisation’s reputation. Fraud may be on the increase, but with the right management and approach, you can reduce the likelihood of your business falling prey to fraudsters.

An external or internal audit certainly helps deter fraudsters. Used in conjunction with a carefully designed and effectively operating internal control environment offers greater protection for a business against fraud.

For an obligation-free chat, get in touch with the Bishop Collins team. We can assist you with audit and assurance services, during which our experts will provide advice and guidance on how to protect your business against fraud, or how to deal with any fraudulent activity you suspect.

Remember, prevention is key – don’t wait to safeguard your company until it’s too late!