All about fraud

"Fraud" is a term frequently used (and abused) by many who talk or write about it. What exactly does it mean? Fraud can be defined as the effort to relieve a victim of assets for personal enrichment of the perpetrator through the use of intentional deceit, concealment, false representation, forgery, and theft.

It is a crime where one hand pats the victim on the back while the other hand reaches into the back pocket emptying the wallet. The victim can be an individual, business, governmental agency, charitable organization, or any entity with assets worthy of a criminal mind's attention.

From experience, business-related fraud fits into two primary categories: false financial statement presentation and representation, or occupational fraud whereby the perpetrator uses his/her occupation for personal enrichment.

The first category is most often perpetrated by a business owner or key executive in order to dupe a bank, financial institution, or investor into loaning or investing liquid assets into a business entity.

This type of fraud consists of manipulating financial statements to present overstated assets and or revenues or understated liabilities and or costs. Just because a CPA's letterhead appears on a financial statement does not mean that it is free of fraud. Even the audited financial statements can not be relied upon to expose fraud. The underlying documents from which the financial statements are prepared are those of the fraudster.

The second type of fraud is more widespread and is likely to impact many of the readers of this article. This type of fraud most often manifests itself in employee theft through intentional deceit, forgery, and theft. It is most often executed by trusted employees who have access to accounting information and records, including cash receipts and cash disbursement documents. By virtue of the trust this person enjoys, the usual controls and segregation of duties are suspended or ignored. In many cases small businesses do not have enough employees to segregate duties sufficiently.

Fraud schemes by employees usually are of a long-term duration, spanning months or even years and can be difficult to detect by an untrained person. In addition, once found, fraud cases are difficult to prosecute and often result in relatively low sentences for the criminals.

As a former FBI agent, I was constantly amazed how the typical bank robber, realizing only a few hundred dollars for his efforts, would be sentenced to many years in prison in comparison to the white collar criminal who would net hundreds of thousands to millions of dollars and receive only minor stints of a few months in a minimum security, country club facility.

I recall one criminal case involving over $15 million in ill gotten gains. The perpetrators, after a lengthy trial and felony counts in the double digits, served only six months of jail time. Fraud can ruin and bankrupt small businesses. It can take these businesses years to recoup the losses, if at all.

Experience dealing with these schemes has shown the primary reasons for fraud include gambling addictions, drugs, personal financial difficulties or mismanagement, a self-induced rationale that they are entitled or "owed" the money because they are underpaid or simply worth it, and the intention that it is simply a "loan" that will be paid back. Gambling is the No. 1 cause we see locally. In a Report to the Nation on Occupational Fraud & Abuse covering periods through 2006, the Association of Certified Fraud Examiners cited that their studies revealed 87.7 percent of asset misappropriations involved the theft of cash. Although this is to be expected, the safeguarding of other readily disposable assets should be considered. The theft of inventory items that can be resold can lead to sizable losses for a small business.

A safe assumption is that all businesses have some form of fraud within their confines. It can be as small as the theft of office supplies to larger thefts of inventory and assets, including cash. In the report cited above, it was estimated that a typical organization loses 5 percent of its annual revenues to fraud. This may seem miniscule; however, consider that the forecasted U.S. Gross Domestic Product as of June 2008 is $14.334 trillion. This equates to roughly $717 billion lost to fraud.

L. Wallace Behrenz, a former FBI agent, works as a director of Meridian Business Advisors in Reno, where he oversees the practice areas of business valuation and forensic (investigative) accounting. Contact him at wbehrenz@mbareno.com.