No matter how carefully you go over a company’s financial statements, it’s nearly impossible to detect fraud as an outsider, but that doesn’t mean there’s nothing you can do to avoid the companies where corporate fraud is more likely. The Anti-Fraud Collaboration, a partnership between the Center for Audit Quality (CAQ), Financial Executives International (FEI), The Institute of Internal Auditors (The IIA), and the National Association of Corporate Directors (NACD), says that fraud usually comes down to three different factors: pressure on employees to succeed, the opportunity for abuse, and ease of rationalization.
More importantly, though are a few concrete things that companies can do to address each of these issues, and the presence of anti-fraud measures can give investors some assurance that the financial data they’re using to make decisions is reliable.
“If all who have a role in the financial reporting supply chain understand their responsibilities, encourage a strong tone at the top and ethical culture through both word and deed, know how to exercise skepticism, and communicate consistently and effectively with all relevant parties across all geographic locations, an environment conducive to financial reporting fraud is less likely to occur,” the AFC writes in a recent paper.
Watch out for cultures that enable corporate fraud
There isn’t a good way to guess in advance who is most likely to commit fraud: a person’s age, tenure, or even position within the company aren’t very reliable indicators. Men are responsible for most instances of fraud, about 87%, and it’s the employing firm that gets defrauded some 90% of the time, but trying to detect corporate fraud by identifying suspect individuals is a losing battle.
Instead the AFC recommends looking at corporate culture. High-pressure situations are sometimes unavoidable, and aren’t necessarily undesirable, but it is important to know who is most affected and who has the most to gain from manipulating results. The opportunity for corporate fraud, on the other hand, is more directly observable: the lack of good internal controls or a lax attitude toward corporate fraud prevention on management’s is a red flag.
It’s interesting that the AFC also found rationalizing corporate fraud often takes the form of altruism. People tell themselves that they are helping the company look better or helping the team hit compensation targets, and something as simple as a clear code of ethics that prohibits such behavior is surprisingly effective at preventing it because it makes the rationalizations more difficult.
The ‘tone at the top’ is an important indicator: AFC
To figure out which companies are most at risk you can look for specific anti-fraud measures, but it’s also important to note the ‘tone at the top’. It’s important for management, the board of directors, and the internal auditors to take their role seriously and to encourage open, clear communication both within the company and with external auditors and shareholders.
See the full report here the-fraud-resistant-organization