Internal fraud risks

27 October 2016

Along with any organisation in any sector, charities are not immune from internal fraud. Whilst the vast majority of people are honest, employee (including volunteers) fraud can range from claiming a few extra miles on expense claims or setting up fictitious suppliers to make payments to an employee’s bank account. Most people who commit fraud at work are not career criminals and often are trusted staff with no criminal history and as such this type of fraud can be opportunistic i.e. it can be a completely unplanned attack purely for personal financial gain. However, employee fraud can also be linked to a serious and organised criminal network.

Research exists which suggests that economic uncertainty, job insecurity and/or their targets being more difficult to achieve, resentment over pay freezes or bonus not being paid has created the conditions to encourage this type of fraudulent behaviour and enable staff to justify it to themselves.

The Key Elements of Fraud

All types of fraud demonstrate four essential elements: opportunity, pressure, rationalisation and malice/technical challenge which combined can lead to fraudulent behaviour. In the case of employee fraud, each element can be used to explain the factors that cause an individual to commit fraud against their employer.

The first and most crucial element is opportunity as it is the element in which organisations have the most control and/or influence over. Many organisations unknowingly create opportunities for dishonest employees to commit fraud by exercising weak controls such as poor supervision and lack of segregation of duties. The opportunity is increased in the absence of any deterrence.

The second element is pressure. Whilst few employees would take the opportunity to commit fraud, adding an element of pressure could sway an honest worker. Pressure may come from the individual’s personal life due to financial problems or addictions such as gambling or drugs. There could be a personal desire for luxury items or the employee feels he/she has to keep up with their peer group/social circle in terms of having the latest gadgets or new cars. Pressure could also come from the work environment in terms of achieving targets. In most cases the pressure results from a significant financial need or problem. The pressures now faced are the risk of being made redundant.

The third element is rationalisation or justification. Again this is another crucial element as this is how the employee justifies his/her actions to themselves. Usually the fraudulent act will be rationalised on the grounds of a personal grievance or set of circumstances. Examples include: ‘I’m only borrowing the money, I’ll pay it back’, ‘they owe it to me, I deserve more money’ and ‘everybody’s doing it so why can’t I?’

The fourth element relates to the employee’s capability to figure out and circumvent internal controls and have the self-assuredness to believe he/she will not get caught.

Some employees may find the circumvention of internal controls as a technical challenge. In both cases the employee may have the ability to handle the stress, perhaps not even experience the stress, that most people feel when they do something wrong. If caught, lying to cover his/her tracks is not a concern.

Examples of employee fraud can include false payment requests, over-billing of debtors, creation of over payment and pocketing any petty cash. It also includes creating fictitious suppliers, altering legitimate purchase orders, the submission of inflated/false timesheets or expenses or the selling of stolen data to third parties. In addition there is also the risk of failing to declare conflicts of interest and or gifts and hospitality and the submission of false or exaggerated claims of work-based injuries. 

An act of fraud committed by an employee presents both a financial and reputational risk to a charity. In addition there is also an internal impact, not only from a financial perspective in terms of the associated costs with conducting an internal investigation but the disruption of the daily routine. Frauds by employees can have a negative impact with respect to morale and trust which in turn could cause a culture of mistrust and suspicion within the department concerned, in addition to concerns by donors.

Effective measures and five key principles

While some people would never contemplate perpetrating a fraud, others might be tempted if they thought they could avoid detection, particularly at a time when some might consider that the risk of detection is reducing. The removal of the opportunity is generally the simplest action to minimise the risk of fraud as it is the element in which the organisation has the greatest influence. Whilst trust is an essential ingredient, it must not be your control measure. Opportunities to commit fraud may be reduced by:

  • acknowledging the problem: accepting that fraud does and may occur is key to developing a strategy that is believed and operates in practice. Making sure it is on the agenda at board/trustee meetings is the first step. Identify a lead senior person to act as the fraud champion in your charity;
  • establishing an anti-fraud culture - setting the right ethical tone that promotes honesty, openness and integrity is vital in preventing fraud and corruption. There should be clear and confidential reporting lines in place should employees wish to raise concerns; 
  • policies and procedures: policies and procedures should be reviewed, regularly updated to ensure the risk of fraud is mitigated and should be communicated clearly to all members of staff;  
  • knowing your employee (volunteers): a robust pre-employment vetting procedure should be in place which applies to both internal and external candidates. In addition the organisation should ensure that there are suitable arrangements in place with regard to checking agency staff; and
  • training: bespoke training sessions should be provided to enable staff to recognise the indicators of fraud, to raise awareness of the counter fraud measures in place, the whistle blowing policy and how to report fraud.