Investors, corporate executives and analysts depend on external audits to maintain honesty in business organizations. However, a fresh study shows audits are very poor at exposing fraud. In contrast, the study states more than 200% of frauds are uncovered by chance.
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Corliss Tech Review Group Study: External audits not an effective tool for against fraud
1. Corliss Tech Review Group Study:
External audits not an effective
tool for against fraud
Investors, corporate executives and analysts depend on
external audits to maintain honesty in business organizations.
However, a fresh study shows audits are very poor at exposing
fraud. In contrast, the study states more than 200% of frauds
are uncovered by chance.
That is one of the findings released recently in the “Report to the Nations
on Occupational Fraud and Abuse” study by the Association of Certified
Fraud Examiners, which is considered the world’s biggest anti-fraud
organization.
“You should never put the obligation on someone else to keep your
surroundings neat,” said ACFE faculty member Evy Poumpouras, formerly
an agent in the U.S. Secret Service. She stated that internal controls are
deemed more significantly effective in exposing fraud as well as preventing
it beforehand.
The report was based on examinations of 1,483 fraud cases as reported by
the Certified Fraud Examiners who had investigated the cases.
“The evaluation of these fraud cases offers important lessons on how fraud
is perpetrated, how it is spotted and how organizations can minimize the
potential to such danger,” ACFE President James Ratley stated in the
introduction to the report.
From the study’s estimates, the typical organization loses 5% of its revenues
yearly to fraud. Which could mean a worldwide phenomenon to the tune of
$3.7 trillion, the report claims. But as appalling as the number might
appear, Poumpouras says it is not surprising.
“Numerous other cases remain uncovered,” she said.
Almost 50% of the fraud cases investigated was committed in the United
States, where the most stringent anti-fraud controls are often applied. Yet,
2. the greatest damages were uncovered in Eastern Europe and Central and
Western. The median loss in those areas amounted to $383,000, compared
to that of the US at only $100,000.
Workers and junior managers perpetrated the biggest percentage of fraud,
with business owners and senior officers sharing only 19% of the offenses.
But rather as expected, the study highlighted the fact that the higher up on
the ladder the fraudster sat, the bigger the losses.
Nevertheless, financial fraud is for the most part hard to detect,
Poumpouras stated, since the offenders have less of a psychological
attachment to the crime they are committing than they do for other forms
of illegal acts.
“Often, the person does not touch or see the money but rather thumbing
reports or files. It does not feel as real,” said Poumpouras, who has been
engaged in many investigations covering financial fraud.
“Forcing people to admit to committing financial crime is much harder
than forcing them to admit to homicide,” she said, which could explain why
external audits can be next to useless.
The study reports auditors uncovered only 3% of the fraud offenses
reported in the previous year, compared to 7% identified by accident.
“While separate audits provide an essential aid in organizational
management,” the report says, “our findings show that they should not be
totally depended upon as the organizations’ main anti-fraud strategy.”
Rather, the study suggests what it refers to as “proactive detection
procedures”, including in-house hotlines that provide workers a way to
become anonymous informants of fraud and maintain honesty in the ranks.
“Most workers do not wish squeal on a friend or anyone they work with,”
Poumpouras said. “They want to do it from behind.”
The study seems to support this fact.
“Organizations that use these hotlines had a better chance of catching fraud
through a tip, which our statistics prove is the best way to uncover fraud,”
3. the study says. More than 42% of the cases in the study were brought out in
the open due to a tip.
Yet, a mere 50% of all the organizations involved in the survey had a
mechanism for soliciting tips, and less than 11% provided incentives to
whistleblowers.
The study also discovered that small enterprises were especially susceptible
to fraud, yet they are most unlikely to institute measures to protect
themselves, commonly since they do not believe themselves to be in danger
— or because they consider fraud protection as being very expensive.
However, the report says anyone call avail of some of the most efficient
measures with the least cost involved.
These measures include an anti-fraud strategy that workers are obligated to
acknowledge from time to time — “It tells them what is expected of them by
management,” Poumpouras stated.
Spot checks or unannounced audits by management — not by an external
auditor who might not be aware of all the possible ways inside an
organization to hide fraud — can be an effective measure as well.
At the same time, developing the ability to detect fraud among all
employees not only provides more eyes on the scene, it also puts ever
person know he or she is being watched.
“With more people becoming more alert as to possible violations, the less
likely fraudsters will find the opportunity to strike at will,” Poumpouras
said.