Corporate Fraud – More Common Than You Think
It seems like our news is flooded with stories of fraud being committed almost daily. From ransomware and insurance fraud to identity theft and scams, we encounter fraud at every turn. Trying to avoid the negative news is nearly impossible as it seeps into our personal and professional lives.
Recently, we’ve seen social media platforms facing legal issues related to fraud. Facebook, Inc., now rebranded as Meta Platforms, Inc., encountered a multitude of fraudulent claims in 2021 starting with a former product manager, Frances Haugen, copying thousands of internal documents showing Facebook put profits over the safety of its users. This led to a shareholder lawsuit claiming Facebook and its senior executives misrepresented the company’s decisions to investors and made false statements that artificially inflated the market price of the company’s securities.
Even the Vatican has not remained unscathed. In July 2021, it indicted 10 individuals, along with four companies, for embezzlement, money laundering, fraud and abuse of office when a failed real estate deal to turn a London Harrods department store warehouse into luxury apartments became the catalyst for what many are calling a “landmark fraud case.”
The pervasiveness of fraud in our daily lives tends to make us numb and ambivalent towards the concept. We often believe, in an effort of preservation, that fraud cannot and will not happen to our smaller businesses. But what is our risk? It seems, according to the news, that corporate fraud only occurs in a small number of very large businesses. Is this fact or is corporate fraud something more nuanced and insidious that is affecting all of us?
To understand the pervasiveness of corporate fraud and its risks to businesses, we must first understand its nature. Corporate fraud is defined as any illegal conduct taken by a company or an individual acting in their role as a company employee, which is intended to benefit the perpetrating individual or company. Corporate fraud schemes go beyond the scope of an employee’s stated position and are marked by their complexity and economic impact on the business, other employees and outside parties. With such a broad definition, corporate fraud can cover a wide variety of acts such as falsified bookkeeping, misrepresentation of services, the loss of assets by the business and falsification of its reported results and financial position. Driven by such factors as personal greed, funding needs, corporate goals, pride, revenge, opportunity or personal factors such as power, thrill or control, corporate fraud can occur in any business regardless of its size.
It is difficult to determine the amount of fraud that is being perpetrated in any given year. Even people who have spent their lives studying and analyzing corporate wrongdoing have trouble estimating just how much fraud goes on in business and how little is detected. A new study published in the Review of Accounting Studies in January 2023 by Alexander Dyck, professor of finance at the University of Toronto, suggests that only about a third of frauds in public companies come to light, and that fraud is disturbingly common. Dyck and his co-authors estimate that about 40 percent of companies are committing accounting violations and that 10 percent are committing what is considered “securities fraud.”
While the study took an expansive take on the term “fraud,” including alleged frauds and frauds that were honest mistakes and differences of opinion about accounting treatment, it is clear that the problem is much bigger than imagined. According to Dyck, given the most recent cases, the amount of fraud perpetrated at any given time stays pretty steady despite the irregularity of the big corporate frauds reported in the news. More importantly, for those reading this article, given how much fraud there is at audited public companies, Dyck said, misconduct is likely even more pervasive in privately held businesses, which are only loosely regulated. In addition, numerous research suggests that small to mid-sized entities tend to suffer proportionally more than larger companies.
Due to its nature and complexity, it is also extremely hard to detect and prevent. In larger corporations, it can involve several individuals, such as in the case of the Enron Corporation. One of the most infamous examples of corporate fraud occurring in 2001-2002, the fall of the Enron Corporation involved a complex combination of deceptive accounting and business practices perpetrated by several members of management, and those responsible pressured auditors to hide their deception. It is difficult to perceive that so many individuals participated in the fraud but, in many cases, the perpetrators are often experts at lying to themselves and defiant about the rules. According to Allison Herren Lee, a former commissioner and interim chair at the Securities and Exchange Commission, who has worked both as an enforcement officer and inside a mismanaged business, people involved often feel they are just testing boundaries rather than violating the law. Even Sam Bankman-Fried, founder and CEO of crypto currency exchange FTX, who is accused of siphoning billions of dollars from his businesses, has insisted he didn’t steal funds and could have saved FTX if lawyers hadn’t forced him to relinquish his spot as CEO.
However, the perpetrator is only a part of the problem. The company may have poor security procedures, inadequate employee training in spotting fraud, lack of due diligence, poor internal controls or implementation of internal control policies, all of which can contribute to corporate fraud. It is important to understand that all companies, regardless of their size, are vulnerable to fraud. Often, small to mid-sized entities may also work on a system of trust due to fewer employees. This can easily be abused if there are few checks and balances in place to prevent fraud. Assessing the risk to your business according to the size, nature and complexity of your business activities is key to creating policies to foster a culture of accountability and reducing risks. Utilizing professionals that specialize in fraud detection and prevention can also be a tool in the company’s arsenal.
With the integration of our world and the advances of modern technology, it seems that corporate fraud has grown at an exponential rate. It has shaken our trust in corporations and those that manage them. It is clear that every company is at risk for corporate fraud and perhaps, even especially, small to mid-sized entities. It is important to begin the process of developing policies that will help not only detect fraud but prevent its occurrence before we become part of that daily news headline.
Contributing author: Lori A. Beirman is a Supervisor at Dannible & McKee, LLP, who has over 22 years of experience in audit, reviews and compilations in a variety of industries such as construction, manufacturing and professional service firms. She specializes in data analytics and fraud. For more information on this topic, you may contact Lori at email@example.com or (315) 472-9127.