COVID-19 fraud outlook

February 2021  |  SPECIAL REPORT: CORPORATE FRAUD & CORRUPTION

Financier Worldwide Magazine

February 2021 Issue

2020 is a year that most people will wish to forget and never repeat. A worldwide pandemic has taken more than a million lives, shut down businesses and transportation systems, moved classrooms to computer screens and otherwise ground everyday life to a screeching halt.

Certainly, there will be many lasting effects of the pandemic that will continue far beyond the end of 2020, and while some of those effects may be hard to predict, one is a certainty: fraud. And it is going to hit hard in 2021, as many more instances of fraud come to light.

According to the ‘Report to the Nations – 2020 Global Study on Occupational Fraud and Abuse’ by the Association of Certified Fraud Examiners (ACFE), the global cost of fraud was estimated at $3.6bn in losses. That total was based on 2019 data, so it does not account for increased fraud related to coronavirus (COVID-19). The ACFE’s ‘Fraud in the Wake of COVID-19: Benchmarking Report’ found that 79 percent of anti-fraud experts surveyed have seen an increase in the overall level of fraud during 2020, and 38 percent reported seeing a significant increase. Nine out of 10 also said they anticipate a further increase in the overall level of fraud over the next 12 months.

Delays in fraud detection also continue to present challenges and indicate persistent problems ahead. Consistent with previous reports, the ACFE also found that the average fraud took 14 months from when it was begun to when it was detected.

To consider the impact of the COVID-19 environment on fraud cost and detection requires understanding what causes people to commit fraud. The ‘Fraud Triangle’ is a decades-old theory developed by Dr Donald R. Cressey, a renowned sociologist and criminologist who undertook a study into why people embezzle. It identifies three causal factors for occupational fraud and finds that when the risks increase within all three factors at the same time, the risk of occupational fraud increases.

The three causal factors of the Fraud Triangle are: opportunity, rationalisation and motivation.

Opportunity concerns a person’s ability to commit fraud, which is affected by, among other things: internal controls, training, knowledge, education, authority and experience. Though internal controls typically come to mind first and are a common and effective means of reducing the opportunity factor’s risks, persons with advanced training, knowledge, education, authority or experience may be better able to devise schemes to circumvent even otherwise strong internal controls and conceal fraudulent acts.

Rationalisation concerns a person’s ability to internally justify their wrongful actions or misconduct. This is often affected not only by a person’s individual values, ethical beliefs and moral compass, but also by the ethical tone within an organisation and the person’s perception about the fairness and equality of rewards and punishments for actions and behaviour, particularly misconduct.

Motivation relates to a need within a person’s life which they perceive cannot be shared, particularly with an employer, boss or co-worker. Such a need can arise from a broad range of factors, from ordinary and common life issues to those that are more nefarious. For fraud, where the misconduct results in financial gain, the motivation is that which drives the need for more money.

There were many occurrences in 2020 related to COVID-19 that impacted each of these areas of the Fraud Triangle simultaneously, therefore increasing the risk of internal fraud. Remembering that the average time from when a fraud begins to when it is detected is 14 months, this detection lag forebodes a potential explosion in the number of internal frauds that began during 2020 becoming known in 2021 and beyond.

Let us explore some of the COVID-19 impacts on the Fraud Triangle during 2020.

As companies were forced to shut down operations, downsizing came along with it. The record filings for unemployment demonstrate the scale on which companies engaged in significant cost-cutting efforts to remain afloat. In doing this, fraud monitoring duties which had previously been segregated were now less so. Additionally, many of those who were laid off were more junior, less experienced personnel, such that more senior and experienced employees assumed their functions. This combination dramatically increases the opportunity risk. There is less segregation of duties, and those less segregated duties are now being performed by those whose knowledge, skills and experience would enable them to better circumvent controls or conceal misconduct.

The motivation factor has also been affected by job losses and cost pressures, and both of those circumstances can impact the rationalisation factor as well. Those who may have lost an income stream due to a layoff or furlough could face increasing personal financial pressures. Similarly, as owners and senior executives in companies tried to keep their businesses afloat, the motivation to use creative accounting techniques or conceal losses may have led to actions that slipped over the bright line. Whether it is an individual facing lost income and hardship or a business leader trying to stay in business, the motivation factor is increased. Add to that substantial sums of money being available through government relief programmes with inadequate oversight, and the conditions are ripe for commission of fraud.

There is evidence to indicate that a significant amount of fraud occurred during 2020 compared to previous years. And with the average fraud taking 14 months from initiation to discovery, it is fair to predict that more instances of fraud initiated in 2020 will come to light during 2021 and beyond. Another factor is the incoming Democratic presidential administration, which could take a more aggressive posture in terms of regulation and enforcement (as well as corporate criminal liability).

Fortunately, there are steps that organisations can take to strengthen their existing anti-fraud practices and mitigate the increase in fraud activity. These include: (i) separate accounting duties, where possible; (ii) review and reinforce internal controls; (iii) conduct robust audit reviews; (iv) increase training for fraud prevention and detection; (v) leverage fraud analytics tools; and (vi) obtain assistance from anti-fraud experts and investigators.

From simple embezzlements to outright corporate and accounting fraud, these effects of COVID-19 will last long after the public health crisis subsides. But organisations that take a proactive approach to addressing the risks of occupational fraud will be better prepared for the road ahead.

 

John Hanson is managing director of forensic investigation & litigation services at BDO. He can be contacted by email: john.hanson@bdo.com.

© Financier Worldwide

BY

John Hanson

BDO

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