Fraud and the economy: Correlation or coincidence?

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Executives, consultants, and business analysts are currently asking themselves a critical question: Does a major economic downturn increase a company’s chance of being hit by employee fraud? The answer to that question isn’t immediately clear.

Fraud experts are often quick to theorize that difficult economic conditions naturally create a higher instance of workplace fraud. The problem with this theory, however, is that it can’t really be proven true or false.

A recent poll conducted by one of the world’s largest auditing firms found that almost two-thirds of executives think accounting fraud will increase over the next two years. That increase is attributed to the economic downturn, specifically lower or non-existent raises and bonuses, reduced job security, and lower morale.

But do those things really cause more fraud? It’s clear that they could increase the risk. One of the key components of any financial fraud is the motivation to commit fraud. That motivation could include a real or perceived need, a desire to get revenge on the company, a personal financial problem, and the like. Certainly an ailing economy in which one’s finances are uncertain could be a very real motive for fraud.

Statistics tracked by the National White Collar Crime Center demonstrate that arrests for fraud and embezzlement go up during economic downturns. But it’s not clear whether the higher incidence of arrests is because more frauds are being committed across the board or because of some other factor.

The incidence of fraud in bad economic crimes might not really be higher overall than during times of prosperity. It might just seem to be greater because we’re more focused on negative financial stories. Maybe high-tech fraud monitoring tools are more effective at detecting fraud, even if fraud is occurring at the same rate as it always has.

We might also be in a time when there are simply more stories about fraud than ever before, thanks to regulations like Sarbanes-Oxley, which created a greater focus on fraud.

Developments in technology and the sharing of information might also make it seem like there is more fraud simply because we’re hearing about more stories.

There is also a possibility that companies are just more likely to pursue cases of fraud when money is tight. Difficult economic conditions often cause companies to look more carefully at all areas for cost-cutting. One area that may be more heavily scrutinized is fraud, and cases that might otherwise have been ignored or swept under the rug could be pursued.

Even though two-thirds of executives think there’s a higher risk of fraud during difficult economic times, most of them are not doing anything about it. Only about 20 percent of the executives surveyed said they were doing things like increasing fraud risk assessments and enhancing monitoring. The lack of action on the part of management is curious, especially since it seems so clear that they believe their fraud risks are higher.

The way I see it, there’s a 50-50 chance that the economy has a direct impact on the instance of internal fraud at companies. Maybe a depressed economy causes more fraud. Maybe it doesn’t. But no one will really be able to prove this theory, so why even talk about it? Why is it important to make it clear that fraud doesn’t necessarily thrive during difficult economic times?

One of the ways that fraud is detected and prevented is by educating employees. It does no good to speculate about fraud causes and rates if the theories can’t be proven or refuted. Companies should be diligently monitoring fraud at all times, not just when there are higher perceived risks. When the economy recovers, companies shouldn’t get a false sense of security either.

The best approach is a sensible one. Even if fraud doesn’t actually rise or fall with the economy, there are still some obvious fraud risks that could go along with the economy and should be monitored. For example, companies may be more likely to inflate revenue and fail to report liabilities during tough times. The rationale is simple: Despite the economy, investors and lenders still want to see good numbers.

In general, most companies could use additional fraud prevention policies and procedures. To date, there still hasn’t been wide-scale implementation of controls that directly address fraud risks. Issues about the economy aside, executives would do well to mandate a more direct approach to the issue of fraud with the design of procedures to directly impact fraud risks. Preventing fraud is good business, regardless of the health of the economy.