22nd May 2018 | Fraud Red Flags | by Dr Alexander Schuchter
“One needs … a certain level of awareness. Too many people don’t have it. I think one has a great duty to … be trained in recognising psychological signs … being found out earlier would have been good for all concerned.”
Statement by a fraudster | personal interview
How such awareness could have prevented the fall of the company – this is a question which remains open. According to the fraudster, the penalties and the stigmatisation of the senior management and supervisory board would at least have been less severe.
How good are you at recognising manipulation mechanisms which are already at work in your office? If the worst came to the worst, could you prove that you had taken adequate measures to prevent the crisis?
In the course of my investigations into fraud, I frequently found that typical anomalies went unrecognised. “He kept giving me strange looks, he was often absent and I’m sure he had a criminal background” – these are not common red flags which indicate fraud. Common sense and intuition are definitely not enough.
What happens when employees fail to notice dark red warning signals? You’ve probably already guessed – reports are either wrong or missing, and cause additional costs. Because at the end of the day, even a false report has to be checked – regardless of whether or not you have established a whistleblower system.
If neither managers nor employees are able to recognise the most common warning signals, white collar crime will thrive.
The greatest danger in fraud lies in the fact that offenders will do anything to prevent their deeds from being discovered. As a result, nailing them down is far harder than pointing the finger at an employee who has merely made an error and failed to report it.
An employee who has made a “successful raid” and evaded discovery will virtually always venture out for another foray. My independent research at St. Gallen University (HSG), which included interviews with offenders, confirms this fact. The alarming result: the longer white collar crimes go undiscovered, the more severe the damage and the consequences.
What are Fraud Red Flags?
Significance of Fraud Red Flags
Fraud Red Flags are warning signals which indicate the possibility of white collar crimes. Isolated appearances of single anomalies should not be cause for great concern. In certain situations, numerous red flags may appear – and yet not necessarily be proof of fraud. But the more red flags you see, the more attentive you should be!
As Fraud Red Flags mount, the point at which a thorough investigation is required will differ on a case-by-case basis, depending on the surrounding circumstances. However, rumours of fraud or gut instincts should always be followed up. Whether or not a through investigation is necessary will depend on whether evidence is found to support the rumour or instinct.
Fraud Red Flags & Fraud Triangle
In order to understand Fraud Red Flags better, the Fraud Triangle model is increasingly gaining popularity. This early warning theory names three factors which increase the risk of fraud:
- motivation and
If there is an opportunity to commit an offence, the motivation to do so is high, and it is easy to justify one’s actions, then risk factors arise.
Originally, the Fraud Triangle was used by internal auditors, compliance officers and public accountants. However, due to changing circumstances, increased liability risks and increased opportunity, the Fraud Triangle is now used in numerous professions. It has advanced to become a valuable part of good Corporate Governance.
Note: Management and supervisory organs, and not the public accountants, are responsible for avoiding and disclosing violations!
Categorisation of Fraud Red Flags
In everyday business practice, various categorisations of anomalies can be helpful. Fraud Red Flags can be identified in the following control areas:
- situation and
Situational risk factors can be triggered by external business factors such as increased competition, as well as by internal circumstances such as conflicts. Besides new situations, one should also pay attention to behaviour, e.g. if an employee suddenly displays a defensive attitude during routine checks.
The offenders I interviewed were all aware that this increased the likelihood of discovery. For this reason, both control areas are strong deterrents. They are highly effective in preventing potential offenders from committing fraud. No matter how hard the fraudster tries, there are certain red flags which are virtually impossible to conceal.
Data Fraud Red Flags
Without doubt, technology is on the forward march – with “Industry 4.0”. Thanks to technology, we are able to handle huge amounts of data. For several years now, we have benefitted from intelligent software which recognises anomalies in data. Such programmes are valuable tools which need to be deployed by trained personnel.
Right from the start, the correct questions need to be asked. Interrelations need to be understood. Results need to be decrypted and interpreted. Caution is required when handling sensitive data.
But we must never forget that fraud is a human trait. It requires action to be taken by the offender, and includes victimology, emotions, intuition and awareness. Modern data analysis cannot fully capture these elements.
There are always “blind spots” in modern data analysis systems. According, new opportunities for fraud arise. Last but not least, it is easy to circumvent technological controls by joining forces with other people. Offenders have often told me how easy it was to manipulate controls and systems.
Examples from business reality: The arguments detailed above underscore the necessity for human fraud expertise in the field of data analysis. Many companies I know have regretted investing too little time and energy in understanding the human factor in fraud.
Top 3 warning signals in data material:
- Figures just below control thresholds
- Double or reversed transactions at unusual times
- Missing documents, disruption of consecutive numbering
Fraud Red Flags in manipulated accounts
In the field of manipulated accounts, reports often talk of irregularities or anomalies. In such cases, the problem lies in the misrepresentation of financial reports, or in the omission of essential information. In virtually all cases, the manipulation impacts the balance sheet and/or the profit and loss statement. In rarer cases, notes and management report are also affected.
Top 3 risk factors in manipulated accounts in relation to the Fraud Triangle:
- Opportunity: antiquated control systems
- Motivation: Fear of losses in the event of a negative result, or fear of not achieving bonus targets
- Rationalisation: Deficient awareness for fraud
Fraud Red Flags in corruption and offences against assets
Corruption covers crimes such as bribery, conflicting interests, extortion or unlawful gratuities. Offences against assets lead to financial losses through theft, embezzlement, misappropriation etc. These white collar crimes consist, for example, in the unauthorised use of assets or financial resources, and reveal certain anomalies.
Top 3 Fraud Red Flags in relation to the Fraud Triangle:
- Opportunity: gaps in access restrictions
- Motivation: outstanding promotion or pay rise
- Rationalisation: negligence with regard to fraud management and thus decreasing the perception of detection
Behavioural Fraud Red Flags
By talking to offenders and also by investigating their environment, I have been able to identify a number of behavioural warning signs. These traits can be observed before or after an offence is committed. Depending on the gender and age of the offender and the type of offence involved, there may be slight differences.
Top 3 behavioural changes:
- Living above one’s means
- Reluctance to divide tasks or responsibilities, excessive accumulation of either overtime or holiday leave
- Huge financial pressure and excessive expectations
As a head investigator, I can also agree with the following point made by the American ACFE study: before an offence is discovered, at least one of the behavioural changes manifests itself clearly. In 60% of all cases, two or more of the warning signals can be observed.
Last but not least
Both you and any employees working in sensitive areas should complete a professional training session with an expert! This is particularly relevant for internal auditors, compliance officers, risk managers and IT specialists. From the point of view of legal responsibility, executives – including management – as well as supervisory bodies are also called upon.
Only by doing so can you gain a differentiated picture of possible risks. This will enable you to recognise fraud and “red herrings”. Do not allow yourself to be misled!
Fraud Red Flags can point to white collar crime. In order to assess risk factors, you first need a clear understanding of common warning signals. A high level of awareness is required – not just checklists! The more able an executive is to interpret anomalies correctly, the lower the risk of liability, tarnished reputation, financial losses and personal consequences.
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