Every day somewhere in the world a fraudulent crime is committed. This white collar crime is very prevalent in today's world. The article will explore the three main types of fraud, what they entail and some famous cases.
In criminal law, a fraud is an intentional deception made for personal gain or to damage another individual. According to the Association of Certified Fraud Examiners (ACFE), the typical organization loses five percent of its annual revenue to fraud, with a median loss of $160,000. Frauds committed by owners and executives are more than nine times as costly as employee fraud. Interestingly, the industries most commonly affected by business fraud are banking, manufacturing, and government.
Business fraud goes by several different names, including occupational fraud, internal fraud or employee dishonesty. Whatever the name it goes by, the types of business fraud can be categorized into three main areas: bribery and corruption, asset misappropriation and financial statement fraud. In many fraud schemes more than one type of fraud is present.
Asset misappropriation fraud involves third parties or employees in an organization who fraudulently abuse their position to steal from the company’s coffers. The fraud can be committed by persons within the company who are entrusted to manage the assets and interests of an organization. This may include company directors, employees, or board members.
Asset misappropriation might contain activities like:
- Check forgery
- Theft of money
- Inventory theft
- Payroll fraud
- Theft of services, vouchers or credit notes
- Theft of company data, patents or formulas
- Intellectual property theft
The ultimate result of asset misappropriation is that the business cash flow suffers. There is also a backlash on the organization’s reputation and staff morale. According to statistics from the National Fraud Authority (2010) over 91% of fraud schemes are asset misappropriation related, which means it is the most common business fraud. However, the statistics also show that it is not as expensive comparable to other business fraud. The average asset misappropriation costs a company $150,000.
Crazy Eddie was started in 1971 in Brooklyn, New York, by businessmen Eddie and Sam M. Antar as ERS Electronics. Crazy Eddie's management was engaged in various forms of fraud. The Antars deliberately falsified their books to reduce (or eliminate) their taxable income. They also paid employees off the books, and regularly skimmed thousands of dollars (in cash) earned at the stores. The Antar family skimmed an estimated $3 million to $4 million (US) per year at the height of their fraud.
Bribery and Corruption
From a legal point of view, active bribery can be defined as the promising, offering or giving by any person, directly or indirectly, of any undue advantage [to any public official], for himself or herself or for anyone else, for him or her to act or refrain from acting in the exercise of his or her functions. Bribery and corruption is far more costly than asset misappropriation; the average bribery/corruption scheme is over half a million dollars. The most common bribery and corruption schemes include:
- Bribery - Giving or receiving something of value to influence a transaction
- Illegal Gratuity - Giving or receiving something of value after a transaction is completed, in acknowledgment of some influence over the transaction
- Extortion - Demanding a sum of money (or goods) with a threat of harm (physical or business) if demands are not met
- Conflict of Interest - Employee has an economic or personal interest in a transaction
- Kickback - A vendor gives part of an overbilling to a person who helped facilitate or allow the transaction.
- Corporate Espionage - Theft of trade secrets, theft of intellectual property, or copyright piracy
Gerald Garson was a former New York Supreme Court Justice who was convicted in 2007 of accepting bribes to manipulate the outcome of divorce cases in his court. In the bribery scheme, a "fixer" told people divorcing in Brooklyn that for a price he could steer their case to a sympathetic judge. The fixer received payment, and then he would refer the person who wanted the fixed outcome to a lawyer who was bribing the judge. The fixer and the lawyer would then bribe court employees to override the court's computer system, which was programmed to ensure that cases were assigned to judges randomly. The cases were assigned to Garson and in turn he would rule in favor of the lawyer with whom he was in cahoots with.
Financial Statement Fraud
This type of fraud centers on the manipulation of financial statements in order to create financial opportunities for an individual or entity. This type of fraud is the least prevalent type in the business world; however, it is the most expensive and can cost a company an average of $2 million per transaction. Some examples of financial statement fraud include:
- Revenue overstatement
- Understating expenses
- Overstating assets
- Understating liabilities
- Improper use of reserves
- Mischaracterization as "one-time" expenses
- Misapplication of accounting rules
- Misrepresentation or omission of information
Enron Corporation was an American energy, commodities, and services company based in Houston, Texas. The company was one of the world's leading electricity, natural gas, communications, and paper companies. At the end of 2001, it was revealed that its reported financial condition was sustained substantially by institutionalized, systematic, and creatively planned accounting fraud. The case became known as the Enron scandal. Enron has since become a popular symbol of willful corporate fraud and corruption.
How To Detect Fraud
Asset misappropriation is probably the easiest type of business fraud to detect. This can be done by checking adjustment accounts, inventory shrinkage or unexplained overage, customer credits or write-offs and fixed asset write-offs. However, the other types of frauds, financial statement and bribery and corruption, are not very easily detected. Some schemes are “off-book" which means they are not reflected in the company’s official accounting system. According to the Association of Certified Fraud Examiners (ACFE), the most common way internal fraud is detected is through a tip from someone. That tipster could be an employee, an outside vendor, a customer, or an anonymous person. More than 34% of internal frauds are detected with tips.