A challenging economy, new regulations, and a tougher anti-corruption enforcement environment have converged to push the reporting of corporate fraud to record levels.
According to the latest quarterly Corporate Fraud Index released by the Network and BDO Consulting, fraud-related reports—including incidents of corruption, misuse of assets, conflicts of interest, and Foreign Corrupt Practices Act violations by employees—rose last quarter to 20.8 percent of all compliance reporting activity, its highest peak since the index was created in 2005. The data is based on analysis of more than 1,000 organizations worldwide. The total number of reported fraud-related incidents also jumped, from 5,963 incident reports in the second quarter of 2010 to 7,054 fraud incidents reported in the same period in 2011, an increase of 18 percent.
Glenn Pomerantz, a partner with BDO Consulting, links the record level of fraud reporting to the growing willingness by employees to report issues more readily. “There is more awareness in regard to fraud in the market today and less tolerance,” Pomerantz says. “That's the real driving force for the index going up, not necessarily that there is more fraud today than a year ago, or a quarter ago.”
Luis Ramos, chief executive officer of the Network, says he believes it's a combination of both factors. “We think there is more fraud occurring as a result of tough economic times and people making desperate choices, but we think that a lot of the additional reporting that is going on is not tied necessarily to more fraud, but to this greater willingness to talk about it,” he says.
The poor economy is also a factor, Pomerantz says, as is the time it takes to uncover fraud. “We may in some part be dealing with frauds that were identified over the last quarter that started a year or two ago, when the economy in a lot of people's opinions was at its worst,” he says.
The increase in fraud reporting may actually be good news for companies, Ramos says. “The quicker you identify it and the faster you're able to deal with it, the less likely you are to have a greater cost associated with that,” he says.
One still unanswered question is how the Securities and Exchange Commission's new rewards program for whistleblower tips may change fraud reporting. Pomerantz says he'd be “pleasantly surprised” if more people don't start bypassing internal reporting mechanisms in favor of going straight to the SEC, because of the potential amount of the incentives—“but I hope I'm wrong,” he adds.
Ramos has a different view. Most whistleblowers are more interested in fixing an internal problem than they are in receiving any reporting award, he says. That means companies need to make sure that employees don't think their claims will be ignored.
The top factors in getting employees to come forward with fraud reports is to make sure employees know that the whistleblower program exists and that managers are acting on the information that is provided to them and are further communicating that information, so employees know they're being heard, Ramos adds.
Hotline Benchmarks
The Network and BDO additionally issued a separate “Corporate Governance and Compliance Hotline Benchmarking Report,” an annual statistical study of compliance hotline-related activity from the past five years. This report provides an analysis of 564,438 hotline reports made during the review period. In 2010, 122,318 reports were collected from 1,178 organizations representing more than 15 million employees.
“There is more awareness in regard to fraud in the market today and less tolerance. That's the real driving force for the Index going up, not necessarily that there is more fraud today than a year ago, or a quarter ago.”
—Glenn Pomerantz,
Partner,
BDO Consulting
According to the findings, companies are doing a better job of acting on hotline reports. In 2010, companies conducted investigations in 68 percent of all incidents reported, and three out of five of those cases resulted in corrective action.
For slightly more than 10 percent of all reports, no outcome could be determined with the information available. In those instances, Pomerantz says companies should still use the data from such inconclusive whistleblower reports to improve their controls going forward. “If you have a bevy of whistleblower reports in a particular area but don't have enough evidence that fraud took place, it still makes sense to beef up detective controls in that area,” he says.
Employees are using more avenues to report fraud as well. In 2010, 8.3 percent of all incidents were reported online, up from 5.6 percent in 2008. In most of those cases employees fear retribution, Ramos says. “The telephone is still the primary way that issues are reported in large part because it truly is anonymous,” he says.
Employees request to stay anonymous in about half of all reports, a figure that has remained steady from 2009 to 2010. The anonymity rate is even higher (70 percent) in cases where the incident was previously reported to management.
Transportation, communication and utilities, retail trade, and the services industries continue to experience the highest overall incident rates. Ramos attributes that to those sectors' high turnover rates and widespread use of decentralized management structures.
At many companies the human resources department is taking a more active role in fraud reporting. Yogesh Bahl, a partner in the forensic services practice at Deloitte Financial Advisory Services, says he is seeing that more and more often, “which hasn't been the case historically.”
FRAUD REPORTING TRENDS
The following chart from The Network and BDO Consulting compares fraud reporting levels during the second quarters of 2005 through 2010.
For the second quarter of 2011, the Fraud Reporting Percentage (FRP) was reported at 20.8 percent – the highest quarterly rate since the inception of the Index in 2005. The FRP statistic measures fraud reporting in comparison to all compliance reporting activity from more than 1,000 organizations worldwide. FRP also rose 2.5 percent since last quarter.
”This is the highest quarterly rate we've ever witnessed,” said Luis Ramos, chief executive officer of The Network. “However, a high fraud reporting rate may have a silver lining. Organizations are experiencing more incidents, but they are capturing more, too. Therefore, they have a greater chance to reduce ongoing loss.”
Source: TNW, BDO 2011 Quarterly Fraud Index.
“We're seeing HR get involved not just on the reactionary side, but also on the preventative side,” Bahl says. At global companies in particular, HR is not only helping to get the message out, but also revamping training around fraud and corruption to create a “consistent and cohesive message around the world,” he says.
“From a compliance standpoint, the company needs to make sure they have some streamlined processes around responding to allegations that are reported by internal whistleblowers,” Bahl says.
Additional questions companies should be asking themselves: Who should be involved in the investigation? At what point do we need to get internal audit involved? Do we need to enlist the help of an external investigative firm? “I'm seeing more and more companies actually create these protocols so that there is less guesswork if and when a call comes in,” Bahl says.
Companies should also have a mechanism to centralize the data that comes through the open-door policy to more easily identify trends. “You may realize the same type of issue has been reported multiple times in the same location or same region, and then you may realize you have a broader set of problems to resolve instead of a one-off or isolated incident,” Ramos says.
Training also contributes to the increase in employee awareness of reporting mechanisms. And more companies are supplementing online training with live training. “That's the way to change the culture, to have more interaction more frequently and to link it with tone-from-the top,” Bahl says.
Ramos agrees. “Companies benefit from creating an ethical culture,” he says. “They demonstrate to their employees that how they do business is as important as the business they do.”
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