When internal auditors think of fraudulent acts, we tend to associate them with nefarious characters who intentionally set out to do something bad. However, as I have explored in my books and blogs over the years, frauds or other illegal acts are often committed by otherwise good and decent people whose personal circumstances or “blind spots” somehow caused them to lose their way. These are people who often are under extraordinary financial or personal pressures outside of the workplace. Many times, they rationalize their initial actions and don’t intend for the frauds to morph into something as big as they eventually do. As internal auditors, we should not assume that everyone is doing bad things. However, our level of professional skepticism should remind us that even good people can do bad things.
The first time I stumbled onto a fraud was during my very first internal audit job at a major bank. Working in the bank’s internal audit department of proved to be a great learning experience for me. I learned about the internal audit processes and the financial services industry. I had a chance to do the local branch offices’ audits, which were fascinating. These were surprise audits, and the branch office was not notified that the internal auditors were coming. We all assembled about two blocks away from the branch office, and right at closing time we showed up at the front door. We were looking for any concealments, fraud or non-compliance with bank policies. It included a complete count of all cash in the vault and on the premises. Our audit had to be a surprise, because if they knew we were coming, some thefts could have been concealed.
Each internal auditor had an opportunity to audit one of the tellers. Each teller had his or her own bank, so to speak, in their cash drawer. At that time, the tellers had maybe two thousand dollars in cash that they would use each day, as their bank to work from.
On one occasion, I began my audit with a young female teller, and she did not even try to conceal what she had done with her money. She said, “I have an IOU in here for some money that I’ve been using.” It was my first eye-opening experience with a situation involving fraud. I came to learn that she was a “good person” going through a divorce who did not even comprehend that she had committed a serious fraud. In her mind she was going to pay the money back. She really didn’t feel like she was violating the law, but of course she was guilty of embezzlement.
The wayward bank teller may have been the first fraud I discovered or investigated, but it certainly wasn’t the last. Over the years, I would witness several more frauds perpetrated by individuals who were thought of as decent, good-hearted, and upstanding employees. I have discovered or investigated frauds committed by a junior member of the contracting department (to help pay for a family member’s medical bills), a single-mom treasurer of a not-for-profit association (who was out of work and needed money to help with family bills), and even an elderly church secretary(who was living on a fixed income). Each time, I felt a bit of sympathy for the person who had just destroyed their life. I wished I could have helped prevent the fraud I ended up investigating.
When it comes to fraud, internal auditors need to get there early. The Association of Certified Fraud Examiners’ (ACFE’s) Occupational Fraud 2022: A Report to the Nations estimates the global cost of internal fraud at US $4.7 trillion, or 5 percent of total revenue. And, as we all know, internal fraud is only part of the picture.
Everything is moving faster these days, including fraudsters. Today, a rogue employee with a smart phone, given a weak enough control environment, can transfer significant sums of money out of a company’s accounts in the blink of an eye. According to the ACFE, the median loss per occupational fraud case is $117,000. Little of that money is ever recovered.
To be successful at detecting fraud, it is important that we understand exactly what fraud is. The IIA’s Standards defines fraud as: “Any illegal act characterized by deceit, concealment, or violation of trust. These acts are not dependent upon the threat of violence of physical force. Frauds are perpetrated by parties and organizations to obtain money, property, or services; to avoid payment or loss of services; or to secure personal or business advantage.”
Detection technology is advancing as rapidly as fraud, with real-time transaction monitoring exposing anomalous patterns that otherwise might go undetected. Means for collecting tips (e.g., hotlines) and a robust internal audit function also have been shown to be effective fraud detectors. Detection, however, should never be the first line of defense.
In fraud, as in health care, an ounce of prevention is worth a pound of cure. Donald R. Cressey, the late criminologist, is credited with identifying the three ingredients required for fraud: motive, opportunity, and rationalization. Today these are collectively known as The Fraud Triangle. With appropriate risk assessment and controls, an organization can effectively shrink the “opportunity” side of the triangle.
As internal auditors today, we must be prepared to identify fraud effectively. As The IIA Standards convey, “Internal auditors must have sufficient knowledge to evaluate the risk of fraud and the manner in which it is managed by the organization, but are not expected to have the expertise of a person whose primary responsibility is detecting and investigating fraud.”
Later in my career, I would become a United States federal Inspector General (IG). I had a key responsibility to prevent and detect fraud in my agency. I was fortunate to lead a well-resourced cadre of auditors and criminal investigators. In retrospect, I would give us high marks for our ability to detect and investigate instances of fraud that had already occurred. However, I always felt that the real opportunities where fraud was concerned was to have been more effective in prevention. Leveraging our knowledge of fraud risks and getting in early, before the frauds occurred, would have added so much more value.
Whether as a junior internal auditor in a bank or a federal IG, I came to understand that I was auditing people too. By nature, people are sort of flawed—they can do dumb and sometimes dishonest things. Interviews with persons who committed fraud have shown that most people do not originally set out to commit fraud. Often, they simply took advantage of an opportunity; many times, the first fraudulent act was an accident—perhaps they mistakenly processed the same invoice twice. But when they realized that it wasn’t noticed, the fraudulent acts became deliberate and more frequent. Fraud investigators talk about the 10-80-10 law, which states that 10 percent of people will never commit fraud; 80 percent of people will commit fraud under the right circumstances; and 10 percent actively seek out opportunities for fraud. So, we need to be vigilant for the 10 percent who are out to get us and we should try to protect the 80 percent (who are often good people) from making a mistake that could ruin their lives and cost our organizations millions of dollars.