Heightened risk of fraud in an economic downturn must be managed
“The economic downturn is changing the nature and scale of fraud and integrity risks that organisations face” says PricewaterhouseCoopers SA National Leader of Forensic Services, Louis Strydom. “And the speed of the downturn is such that opportunities to commit fraud will become increasingly prevalent. More people will feel real pressure to ‘cross the line’ or to look the other way while others do so. Also, the falling economic tide will expose more frauds that have been ongoing while economic conditions were good.”
Strydom highlights that current conditions present the perfect storm for fraudulent activities. “The Fraud Triangle, developed by the criminologist, Dr. Donald Cressey, describes three conditions that are commonly found when fraud occurs - Incentive or Pressure to engage in misconduct; Opportunity to commit fraud; and Rationalisation or Justification by the perpetrators of their actions. The global economic decline is such that each of these three factors is present as never before.”
Strydom says boards and audit committees should be reflecting very carefully on the changing landscape of fraud and other integrity risks. “An organisation should be considering whether it is at risk of regulatory scrutiny for breaches of local statutes. In SA, companies should assess whether their employees are bribing public officials locally or overseas and should determine whether they are falling foul of The Prevention and Combating of Corrupt Activities Act, 2004. In fact, companies themselves are now required to report actual or suspected instances of theft, fraud, extortion and forgery involving an amount of R100 000 or more. Particularly relevant at this time is whether competition law is being breached in the form of price fixing as the penalties here can be very punitive, along with significant reputational harm.”
Equally crucial is that a business needs to understand the true cost of fraud losses occurring in the supply chain and through revenue leakage. Strydom says it continues to surprise that businesses, including the retailers, do not have an accurate fix on just how much fraud, for example in the form of stock shrinkage, is really costing them. Also relevant to the supply chain is that companies must know who their external partners are. “A company could suffer reputational damage from the fraudulent practices of its business partners.”
Strydom says it is not only physical assets which are vulnerable at this time. “Data theft is on the increase and criminal organisations are working in collusion with permanent, short term or temporary staff to infiltrate organisations and circumvent existing control systems.”
More than ever, controls in treasury and banking operations of all businesses need to be robust, not only those of investment banks. There is company and personal pressure on staff in these divisions to trade beyond their levels of authority, to ‘massage’ numbers in order avoid loan covenant breaches, and to present more favourable financial data which enables the company to access increasingly rare credit lines.
With regard to the accuracy of financial information, Strydom says audit committees should consider whether internal controls and processes are sufficiently preventative of accounting fraud and whether such controls and processes would recognise any suspicion regarding the reported numbers. “They should be asking some key questions such as is the ethical tone at the top correct and are remuneration systems driving the right behaviours for senior people? They should also assess whether there is adequate segregation of duties and responsibilities, especially following any cost cutting initiatives. The internal audit function must remain well-resourced despite pressure to cut costs, with the necessary fraud detection experience, and its reporting lines must be appropriate. There should also be adequate and well-publicised whistleblower hotlines and employees must be encouraged to speak up if they have concerns.”
Strydom says that company recruitment policies need to be tightened up as misleading information from potential employees will increase as job competition intensifies. “There will be more false references, fictitious qualifications and hiding of past negative history. Employment screening needs to become more intense.”
Despite the best internal controls, compliance programmes and ‘fire-drills’, Strydom says the risk of fraud can never be completely eliminated. “It is therefore sensible to ensure that the company carries sufficient Directors and Officers insurance to protect senior management in the event of inward litigation and claims.”
Strydom says that there is no single ‘key’ to stopping fraud. “A comprehensive fraud and integrity risk framework is therefore required. Organisations need to develop a strategy that enables the deployment of appropriate measures to manage this increasing risk. This strategy needs to be owned by those charged with governance otherwise it will not succeed, and it needs to involve people from across the organisation.
“Most large organisations have mature legal, compliance and internal audit functions – but these must work together in an integrated way to maximise their effect. Also, these functions tend to be one step removed from where the fraud and misconduct actually occur. Front line operations and finance personnel therefore need to become effective first and second lines of defence.”
Strydom concludes that it is for those charged with governance to take the lead on fraud and integrity issues. “Employees look to the board and senior management to set the tone and unless the leadership commitment is there, change will not happen and the benefits of reducing fraud and other integrity risks will not be realised.”
