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Monday, December 15, 2014

5% of Total Revenue: The Cost of Fraud

Posted by Armanino Nonprofit Team

Whether it’s misappropriation of funds, corruption, kickbacks or filing misleading financial statements, fraud is costing businesses 5% of total revenue, new figures suggest. That’s $3.7 trillion, with a median loss of $142,000 per incident. And businesses recover some of the losses in only half the cases. In virtually none of the cases is restitution complete.

The picture is even worse for nonprofits, where disclosure of fraud can raise questions about management controls and sap the enthusiasm of donors.

Yet just 19% of private companies are taking the single most effective step to deter fraud, Armanino Partner Jeff Stegner and Natalie McFarlin, Manager in Armanino’s forensic and valuation services practice, said in a recent webinar. That tool?  A simple employee hotline for reporting tips.

“Red Flag” systems allow employees to call a toll-free hotline or log into a website 24/7. Tipsters can remain anonymous. Tips are routed through independent third parties who then turn over the details to the appropriate company officials for investigation and action.

The Sarbanes-Oxley Act requires such hotlines for public companies, but private companies and nonprofits have been slower to adapt the simple measures. Statistics offered by the Association of Certified Fraud Examiners show 43% of fraud cases come to light because of an employee tip. That’s by far the most effective counter-measure available. Fraud cut off by hotline tips are also 41% less costly and are detected 50% more quickly than those uncovered by other techniques from surprise internal audits to management controls.

Fellow employees are best positioned to spot some of the behaviors that should cause concern:
  • Employees who like to work early or late, when they are alone in the office
  • Employees who never take time off and resist training anyone else in their duties
  • Employees who live above their means
  • Employees who are unusually close to vendors or customers

There are certain patterns that characterize most fraud:

  • Pressure on the employee, from family emergencies to simply a need to keep up with the Joneses
  • Opportunity, usually a combination of misplaced trust and substandard controls
  • Rationalization, a belief that the actions are justified for some reason—from a feeling their efforts are undervalued to a belief they funds can be repaid before anyone notices

There are a lot of steps nonprofit management can take to reduce the risk. But none is as inexpensive or as effective as the employee hotline. It sends a clear message management cares and is setting an expectation of ethical behavior. And it works.

To learn more about fraud prevention and Armanino’s new fraud hotline, visit Armanino’s events page, click on “archived” tab, and select the webinar recording titled Fraud – What Every Nonprofit Needs to Guard Against.

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