Thursday, December 1, 2005

Is Fraud Mostly Detected by Chance?

International accounting firm PricewaterhouseCoopers issued its Global Economic Crime Survey 2005 (here) that surveys companies worldwide about how they are affected by fraud and other types of white collar crime, and how they go about detecting and combating such misconduct.  The headline-grabber (see Reuters story here) is the assertion by PwC that "[o]ver one third of these frauds were discovered by accident, making 'chance' the most common fraud detection tool."  Can if be that so many frauds are only discovered through luck, or some other random happenstance, so that much of the money spent on internal controls is a waste?  It's interesting to note that an "accidental" discovery of fraud includes an internal tip to management or through a corporate hot-line, which does not strike me as necessarily "chance" but the product of a system that permits the reporting of fraud and effective investigation of tips.  It is the rare fraud that involves self-revelation, and perpetrators are unlikely to create files labeled "Fraudulent Scheme" or "Accounts I've Embezzled."  Those engaged in fraud know they have to avoid the internal audit department, and it is often the subordinate or co-worker who notices the misconduct first.

The report notes that internal controls are the second most likely way in which fraud it detected, so it is probably not the case that internal control mechanisms are a waste of money if they encourage employees to report misconduct and operate to uncover other types of fraud.  With a nod to Prof. Pam Bucy, an organization's corporate ethos can go a long way toward preventing fraud and other types of economic misconduct in the first place.  An environment that stresses ethical conduct and a measure of watchfulness can keep some (perhaps even most) fraud from ever happening, something that simply cannot be measured.  As Brooklyn Dodger general manager Branch Rickey once said, "Luck is the residue of design."  So too may be the "chance" discovery of fraud in corporations. (ph)

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Well put. I also think one has to consider the 'secondary' effects of various internal controls. Is it 'luck' if a co-worker discovers a fraud, and that co-worker is in the position to 'accidently' discover the fraud because of a separation-of-duties control?

If the implementation of a strong set of internal controls 'cuts off' some of the mechanisms of hiding fraudulent activity, then isn't it a result of the control environment if that activity is 'accidently' discovered because the perpetrator is forced into having to use less secure means of hiding his acts *because* of those controls?

To me, this is like a running back being 'accidently' stopped in an unexpected 'seam' by a safety, because he was forced into that seam because all the others are 'jammed up' with opponents trying to prevent him from getting through. While the safety is credited with the tackle, it's every bit the result of the design of the defense that puts the linemen in those other lanes.

Posted by: Chris | Dec 2, 2005 8:46:37 AM

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