Fraud can occur anywhere and anytime, moreso in times of crisis. While organizations are busy firefighting unexpected challenges brought on by the pandemic fraudsters are taking advantage of the company's increasing vulnerabilities.
To better understand the increase of fraud incidents, we look back to the 2008 financial crisis when a survey by the Association of Certified Fraud Examiners (ACFE) showed an 80% observable increase in the number of fraud incidents during an economic distress. We note that many of the factors observed during that recession are also applicable today, i.e., declining profits, decreasing market demands, and workforce anxiety, among others.
So why is fraud heightened during these times? One main factor is the increased economic pressure for organizations and their employees to still meet the bottom line despite the challenging situation. Some organizations, in order to meet their targets, could falsify their financials while stressed employees try to rationalize this fraud and even make the organization a target itself.
Another emerging concern brought by the pandemic is the discovery of previously unknown vulnerabilities and, in some cases, uncovering existing fraud. This is because fraudsters, when cornered, oftentimes make reckless mistakes resulting in their fraudulent acts being discovered. Warren Buffett even said in his 2004 annual letter to the investors, “You only find out who is swimming naked when the tide goes out”. This means that when the waves of success subside, a company with weak corporate governance and poor internal controls are revealed.
We can see that the trend is clear. In the 2002 financial crisis, major companies such as Enron and Tyco were prosecuted for fraud. During the 2008 recession, Bernard Madoff, the perpetrator of the largest financial fraud in history, pleaded guilty to a $65 billion Ponzi scheme. Madoff's fraud scheme caused catastrophic damages to thousands of people and organizations.
As we watch revenues dry up due to the economic distress of the COVID-19 pandemic, how many more fraud schemes will come to light?
How can we manage our fraud measures as we enter the "New Reality"?
We need to go back to the Fraud Triangle which consists of three elements - Pressure, Opportunity and Rationalization. Understanding these elements is critical in combating fraud.
First, we examine how the three elements relate to the pandemic:
- Pressure - Management should be aware of the different kinds of pressure created by the pandemic. At an organizational level, this may include pressure to meet financial targets and the demands of various stakeholders. At an individual level, this may include fear of redundancy, pay cuts and financial problems. As a consequence, extreme financial pressure may cause management to manipulate financial statements or employees to steal from the organization to sustain their current lifestyle.
- Opportunity - There is an increased opportunity to commit fraud when there is a weakening of internal controls. In KPMG’s Global Profiles of the Fraudster survey, 61% of the fraudsters said that weak internal controls were a contributing factor in allowing fraud to occur. For example, the shift to different working patterns may lead companies to neglect the usual controls in place. Remote working may tempt employees to commit fraud due to lack of supervision. This kind of situation is further aggravated when companies cut down important non-revenue-generating departments such as compliance and internal audit.
- Rationalization - Employees who are under pressure may see the disruption as an opportunity to commit fraud, believing that they are less likely to get caught as management is busy tackling more important issues. The management, on the other hand, would see committing fraud as acceptable to protect the organization or their position. When employees feel uncertain about their future, it becomes easier for them to rationalize committing fraud.
After considering these elements, organizations should review their own unique situation. Senior management should take a proactive stance when dealing with fraud risks or even the discovery of fraud. While this may magnify the reinstatement of fraud prevention measures, the measures in place should go beyond "fraud risk identification”, "tone at the top" or "leveraging on technology". Organizations should have the mindset that the risk of fraud can occur anytime and, if not properly addressed, may have adverse consequences and even cause organizational failure.
KPMG’s Fraud Risk Management services aim to help organizations prevent, detect and respond to fraud and misconduct risks. Some of the preventive and reactive activities that organizations should consider are root cause investigations, proactive process reviews, diagnostic risk reviews, fraud awareness training and due diligence of new business partners.
The COVID-19 pandemic presents an opportunity for organizations to build a strong Anti-Fraud Program. Although some mature organizations may already have a program in place, there is still a need for management to periodically review its effectiveness. A robust Anti-Fraud Program must be progressive and adaptable to the ever-changing business landscape.
In our experience, the best anti-fraud strategy is to acknowledge that fraud can happen in your organization. The next step is responding to it by implementing effective and reliable anti-fraud measures.
Allan Roger N. Tabuco is a Senior Manager from the Advisory group of KPMG R.G. Manabat & Co. (KPMG RGM&Co.), the Philippine member firm of KPMG International.
This article is for general information purposes only and should not be considered as professional advice to a specific issue or entity.
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