Fraud in General

What is fraud?

Fraud is theft by deception. It is a covert act. Theft without deception is just theft. Fraud has been defined as the means that people will go to in order to deceive and obtain an unauthorized advantage over another. The main factor in a fraud is the deception involved in committing or hiding the act.

Is a fraud always hidden?

The difference between fraud and thef is that fraud is hidden, at least at the time it is committed. Some frauds are designed to remain hidden forever and some are hidden at the time they are committed, but will not remain hidden for very long. In these cases, the fraudsters intends to disappear before the fraud is exposed.

How much fraud is committed?

There is no way of accurately determining the amount of fraud actually committed. Frauds are either:

(1) reported (and hopefully the perpetrators are caught and convicted);
(2) discovered or suspected, but not reported; or
(3) remain undiscovered.

The number of frauds that have been reported has been estimated at about 20% of those committed. But there is no way of confirming this figure.

What are the different types of frauds?

Frauds can be organized into two main groups.

Occupational fraud is committed by an employee against an employer. These frauds are either asset misappropriation, collusion or financial statement frauds. They also can be further classified by the assets they attack; cash, inventory or other assets or by the part of the business system they attack; debtors, sales, inventory control, etc.

Third party fraud is committed by a person against unrelated businesses or person and can have many classifications. They can target finance companies, frauds against land owners, frauds against businesses or the general public.

What parts of a business are open to occupational fraud?

All areas of the business can be the target of occupational fraud. The most obvious areas are those where money or inventory is handled by employees, or where payments are made. But any asset is vulnerable and a business may suffer from occupational fraud even when no assets is misappropriated.

AREAS OF OCCUPATIONAL FRAUD

This is a brief description of some occupational frauds and is not meant to be exhaustive.

Money (Cash or Cheques)

Money is a common target of frauds. Cash is easy to steal, may be difficult to trace and does not need conversion to be come useful. Cheques need to be converted into cash to be useful, but this is possible with a little work. (Skimming Frauds)

Money does not need to be stolen from the business. The fraudster can manipulate the payments system and have the business make payments to him under false invoices. (Billing Schemes)

Money can be misappropriated through the payroll system, using real or ghost employees under various remuneration or expense reimbursement schemes. (Payroll Frauds)

Inventory

Inventory is usually the single largest investment made by retail or manufacturing business. Inventory comes in all sizes and may be misappropriated as easily as cash. If the item itself is not useful to the perpetrator, it can be sold. (Inventory Frauds)

Other Physical Assets

The amount of loss from the misappropriation of other physical assets is greater than the loss from the theft of cash or inventory, although they are less common. Any asset is vulnerable to fraud. (Asset Misappropriation Frauds)

Intellectual Property

Theft of property is not limited to physical assets. Intangible assets, intellectual property, trade marks, formulas etc. are also vulnerable and the damage to a business can be as severe as the loss of money or physical assets. These frauds will generally involve a third party, or an employee that is about to go into competition with their current employer.

Financial Statement Fraud

Financial statement fraud is the manipulation of the business's financial statements to obtain some benefit from either within or without the business.

Kickbacks, Bribery and other Collusion

Kickbacks and bribery may involve a third party and may not cause an obvious loss to the business in the short term as they generally do not involve the loss of assets. These frauds involve a party that provides a benefit to the employee for their influence, some information or favors. They usually involve a payment to entice someone to do something, provide influence or give favorable consideration for contracts (Bribery). Payments may be made to someone for giving something; orders to corrupt suppliers, sales at lower costs to customers, etc. (Kickbacks)

While these frauds do not have an immediate loss to a business, they will eventually cause a loss through paying non-competitive prices or receiving substandard quality; or selling goods at lower prices. Eventually the corrupt third party will have to recover the amount of the payment from the victim business, or the fraud would not be worth conducting.

AREAS OF THIRD PARTY FRAUD

This is a brief description of some third party fraud and is not meant to be exhaustive.

Investment Frauds

Investment frauds are generally targeted at the general public, or a community within the general public. The most common investment frauds involve people investing money into a fraudulent investment scheme. (Ponzi Schemes)

Pyramid Schemes are different as, apart from a thin veneer of a proper investment, they are simply a scheme to get people to pay to get onto the lower lever of the pyramid.

Financial Institution Frauds

Leasing frauds are usually committed by business owners who lease the same item of equipment multiple times, and usually from numerous finance companies.

Debt factoring frauds are usually committed by business owners against finance companies and involve the issuance of false invoices for factoring.

Property Frauds

Land sale frauds have a wide range of styles, but either involve (i) selling land to victims under false information or valuations: or (ii) obtaining advance fees for selling the property, and not providing that service.

Vendor finance frauds are generally perpetrated against commercial property owners and involve a sale by the fraudster using finance provided by the vendor and a deposit financed by a third party financier. The fraud involves drawing down monies from the financier who has a first mortgage on the property.

DETECTION AND PREVENTION

What can be done to reduce fraud?

1. Most occupational frauds attack areas of the business recording system where controls or documentation of transactions is not extensive, or where one person has too much control over the business system and can commit and hide fraud. Better control over the business system can reduce the opportunity for fraud.

2. Many businesses try to group functions into as few people as possible. It creates an opportunity for employees to gain sufficient access and control over multiple parts of the system to hide frauds. Separating duties through a number of people eliminates that absolute control over the system, but does add costs and inefficiencies.

3. Internal control systems and facilities for other employees to report fraud have proven to be effective in reducing and detecting frauds.

4. Common sense and a little suspicion are the best protection against investment frauds.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Acknowledgment
The material in this Fact Sheet was sourced from various publications including those listed in the Reading List on the Fraud Awareness page on this website.

Back to Fact Sheets

Last Updated: 25.3.2008