Institutional fraud is on the rise

Oversight Systems, the leading provider of automated continuous monitoring solutions, has released the results of its annual report on corporate fraud. Although the Sarbanes-Oxley (SOX) Act took effect five years ago, three out of four survey respondents feel institutional fraud is more prevalent today than it was in 2002. In addition, an eye-opening 56 percent of respondents said they have personally observed financial misconduct in the past year.

The 2007 fraud report also revealed double-digit percentage increases in incidents of expense and reimbursement schemes (41 percent), and bribery/economic extortion (35 percent) over 2005. In response to these issues, the SEC announced a new audit standard (AS 5) which will incorporate a more principles-based approach

"This survey indicates the checklist approach to compliance is not effectively reducing fraud," said Patrick Taylor, CEO of Oversight Systems. "By revising their guidance, the SEC is driving companies to address fraud based on risk, the greatest of which is management override of controls. Financial professionals will be able to evaluate their vulnerability and focus the full power of their monitoring and auditing capabilities on preventing the fraud that could cripple their business."

The State of Fraud Prevention

In the wake of several corporate misdeeds and accounting scandals, Congress passed the historic SOX corporate reform act in 2002. In spite of increased legislation, close to half of the fraud examiners indicated corporate vigilance and executive interest has already started to fade. With the announcement of AS 5, the SEC is guiding companies towards a risk based approach to financial controls. If implemented correctly, these changes will enhance financial reporting integrity while decreasing overall compliance costs.

Fraud Motivations

Participants were asked to select the three main reasons institutional fraud occurs. Four out of five certified fraud examiners chose the pressure to do whatever it takes to meet goals. Executives seeking personal gain was identified as another major cause of fraud (71 percent), followed by the mentality that they won’t get caught (41 percent) and the delusion that they do not consider their actions fraudulent (40 percent).

"Culture is everything when it comes to fraud and fraud prevention," said Dana Hermanson, Dinos Eminent Scholar Chair of Private Enterprise at Kennesaw State University. "If there is a culture of never missing targets, some people will cheat to make the numbers. Their rationalization is that they are just doing what the top people want them to do. Directors and executives need to clearly communicate that ethics come before making targets. If this message is not consistently communicated, then the organization is headed for trouble."

Stopping Institutional Fraud

Following lengthy and high-profile court cases of several corporate executives during the past five years, fraud examiners favor more stringent punishments. Four out of five of respondents felt corporate fraud would decrease if white-collar criminals were prosecuted and sentenced in the same manner as violent offenders.

When asked which crime deserves a stricter punishment - an executive defrauding shareholders through stock-options fraud or a middle manager defrauding a company through accounts payable manipulation - the majority of examiners (58 percent) said they should be punished equally. All other respondents indicated the executive should receive the harsher penalty. When asked to identify the measure most effective in preventing institutional fraud, 43 percent of the professional examiners cited the need for a strong tone from the top of the organization.

The Oversight research report can be downloaded for free at: www.oversightsystems.com/survey.

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