Learn what can you do to stay a step ahead of fraudsters without limiting revenue growth. Prevent Financial Fraud in your organization with the help of HLB HAMT

1. PREVENTING FINANCIAL
FRAUD – ENSURE YOUR
ORGANISATION IS
PROTECTED
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2. According to the Federal Trade Commission (FTC), in 2019 a
reported $1.9 billion was lost to financial fraud, and that
represented an increase of over 15% from the previous year.
However, not all financial fraud involves companies losing money
in an immediately quantifiable manner. Often, the fraud centers
around deception that results in a slow drain of funds or drop in
profitability that can span several years. Regardless of the
immediate or long-term effect, it’s important to know how to
pinpoint—and stop—financial fraud before it affects your bottom
line.

3. EVOLUTION AND TYPES OF FINANCIAL
FRAUD
The most common types of financial fraud involve inflating
earnings through various means. The objective is to keep specific
groups of stakeholders happy. This often includes private
investors, the stock market, or people or organisations holding
the company’s debt. There are several ways this kind of fraud is
levied, but some of the most common include:

4. • Extending the period of depreciation to delay when the
depreciation gets factored into the company’s accounts. Many
assets depreciate, steadily, year-to-year. If a valuable asset’s
depreciation is left off the books for an extra year or so,
stakeholders can be fooled into thinking the company’s
financial performance is more valuable than it actually is.

5. • Hiding liabilities by shifting debt from the main company to a
special purpose entity. This kind of fraud involves creating or
maintaining a separate company that the main company can
shovel off its debt to. The entity’s balance sheet reflects the
debt that used to be on the main company’s records.

6. • Recognising revenue early while delaying the recognition of
expenses Some companies will enter their revenue but leave
out the funds they spent to make that money until a later date.
When both are, eventually, included, the books balance true.
But before then, it looks like the company’s revenue to expense
ratio is a lot higher than it actually is.

7. • Incorrect capitalisation of expenses When a company
capitalises something, they categorise it as an asset instead of
an expense. As a result, it shows up on the balance sheet
instead of the income statement, which accounts for expenses.
If an investor or other stakeholder were to ask to see the
income statement, this potentially sizeable expense wouldn’t
be factored in, artificially inflating the company’s performance.

8. • Factoring in non-existent inventory to fraudulently reduce the
cost of goods sold (COGS). The lower your cost of goods sold,
the more efficient your company’s production system looks. To
calculate COGS, the Initial inventory is added to Purchases
made during the period and the period ending inventory is
deducted. So, if a company pretends that they have more
inventory at the end of the period, their COGS is lower, making
them look better to investors.

9. CASES OF FINANCIAL FRAUD

10. The history of financial fraud is long and complex, but here are
some of the more notable examples.
One of the largest and the most high profile frauds was that of
Enron.

11. Enron, which was once a poster boy of Wall Street, was found to
have engaged in serious fraudulent activity which involved
keeping large debts off the balance sheets. While the high stock
prices did arouse suspicions, it was eventually an internal
whistleblower’s revelations that led to the downfall of the
organization. The scandal ended up costing shareholders around
$74 billion and resulted in the creation of the Sarbanes-Oxley
Act of 2002.

12. In 2016, the car manufacturer Volkswagen was embroiled in a
scandal that ended in a settlement estimated to be in excess of
$25 billion. This was not a direct financial fraud, but
nevertheless, one that had serious financial consequences . In
order to avoid failing to meet emission standards set
by authorities in the US and other markets, Volkswagen installed
software in their vehicles that enabled them to fool emissions
testers. Thus, vehicles tended to show far lesser emission levels
than actual and were considered roadworthy. Once the cover-up
was unearthed, it led to a recall of almost 500,000 vehicles and
led to serious financial and reputational losses for the company.

13. Other cases like the Lehmann Brothers scandal that triggered the
economic recession in 2008, the Wells Fargo scandal and Bernie
Madoff’s outrageous Ponzi scheme were also noteworthy, but the
unfortunate situation is that despite all efforts from authorities
across the world, there are still several cases which continue
until this day.
The most high profile case in recent times was that of the
German financial services company Wirecard.

14. The Wirecard scandal has been dubbed the “Enron of Germany.”
The payment provider falsified their books by reporting money
that simply did not exist, executing a fraud that spanned the
globe. They owed creditors nearly $4 billion. While the CEO was
arrested, their COO, who was considered to be a key figure in
this scandal, is still missing at the time of writing this article.

15. THE NEXT BIG BUBBLE—CRYPTOCURRENCY
FRAUD
Cryptocurrencies have reached a total market capitalisation
of $600 billion. This is only a small fraction of fiat currencies
worldwide, which are valued at around $36.8 trillion, but this
doesn’t minimize the potential for cryptos to be exploited by
fraudulent actors. There are several reasons why fraudsters may
soon target cryptocurrencies.

16. NO SOVEREIGN BACKING

17. The value of a currency is driven by the financial health of the
body that issues it. For example, the US dollar has more value
than the Jamaican dollar, primarily because the US economy is
more stable and powerful. The value of each currency is relative,
and a country’s gross domestic product (GDP), exports, imports,
and other factors all affect how much their money is worth in
comparison to those of other nations.

18. While Bitcoin does have the likes of Elon Musk endorsing it, there
is no sovereign backing for the currency. Therefore, the only
thing anchoring their value is the speculation of investors.
Without verifiable financial fundamentals, fraudulent actors could
swing the value of cryptos without being checked by a regulatory
body.

19. VOLATILITY

20. Bitcoin, which comprises 66% of the total cryptocurrency market
cap, went from being valued at $1 to $32 per coin in just three
months. Fast-forward to the time of writing, and a single bitcoin
is worth over $40,000. However, this is more than 10 times what
it was in December 2018 when it dropped to around $3,400.

21. The meteoric rise and falls experienced by cryptocurrencies have
created an atmosphere where large fluctuations are the norm
rather than the exception. Sudden dips or drops in value hardly
raise an eyebrow, leaving open the possibility for widespread
valuation fraud.

22. LACK OF CLARITY

23. There’s a cloud of confusion around how cryptocurrencies work,
as well as their vulnerabilities. As a result, many seasoned
finance professionals and institutions have warned investors to
steer clear of cryptos.

24. Cryptocurrency infrastructure depends on people using
computers to solve mathematical problems, called hashes, on a
register called the blockchain. While blockchain infrastructure
itself does a good job of rebuffing hackers, the anonymity
cryptos provide, as well as the lack of financial oversight,
provides fertile ground for fraud.

25. HOW CAN ORGANISATIONS ENSURE THAT
FINANCIAL FRAUDS ARE BETTER
PREVENTED?
The good news is that financial fraud can be prevented. There
are several steps companies can take to prevent fraud from
impacting their organisation, its partners, and customers.

26. STUDY THE GOVERNANCE MECHANISMS

27. The governance infrastructure of a company can form the
foundation of a fraud-prevention strategy. This would
necessitate strong governance mechanisms at the board level,
including the board’s constitution. A thorough examination and
evaluation of the constitution is best performed by external
experts with the various tasks involved given to separate
committees.

28. It’s also important to delegate authorities effectively, making
sure the right people are in charge of examining the most fraud-
sensitive areas of the organisation. One way to make these
authorities’ jobs easier is to implement whistle-blower policies
that provide protection for those that speak up when they see
something wrong.

29. To prevent fraud before it takes root, it’s important to perform
due diligence on customers and suppliers. In addition, at times,
employees also have to be investigated to mitigate the risks
posed by internal vulnerabilities. This can be done by limiting the
tenure of people in key positions, as well as re-examining the
rights of people who have access to sensitive systems.

30. AUDIT ENVIRONMENT
A healthy audit environment sets the stage for a more thorough
and transparent audit procedure. This requires clear and
independent external and internal audit charters. In addition,
there needs to be open communication between external and
internal auditors, including those on audit committees. At times,
the roles of audit committee members should be re-evaluated to
ensure the integrity of the process.

31. STAKEHOLDER RELATIONSHIPS
Certain stakeholders are naturally more compelled to attempt fraud
than others. Here are some questions to ask to make sure your
company is remaining vigilant:
• Are there instances of exceptionally favourable or unfavourable
financial terms with banks?
• Are there suppliers who appear to be getting exceptionally large
shares of the business or are paid far higher than market rates?
• Are there customers who appear to be getting significantly more
favourable prices and terms than others?
These kinds of questions can help identify those who may be more
likely to levy fraud against your company. Digging into the answers can
help you stay a step ahead.

32. BUSINESS MODEL AND SECTOR
PERFORMANCE
While there are always outliers, in most cases, a company’s
performance should be similar to others within its sector. This is
typically true because they often have similar target customers
and deal with the same, or parallel, micro- and macro-economic
factors. Therefore, it’s prudent to raise questions such as:
• Is the business model clear and sustainable?
• Is the auditor able to visualise what this company would look
like financially in the next 5 or 10 years?
• Is the company reporting earnings significantly more than its
peers? If so, is there a clear competitive advantage that it has
that justifies this earning?

33. CONTACT US
HLB HAMT
Level 18, City Tower-2,​
Sheikh Zayed Road​
PO Box 32665​
Dubai – United Arab Emirates.Tel: +971 4 327 7775
E-mail: dubai@hlbhamt.com
www.hlbhamt.com/