Knowledge and Insights

Unfortunately for financial institutions, there are universal business truths that do not go away with time, trends or wishful thinking. Insider abuse is one of those truths, as it is a topic that many banks have dealt with in the past or may deal with in the future. The Federal Bureau of Investigation estimates that insiders steal eight times more money than is stolen through bank robberies and burglaries, and collectively cost businesses $18-20 billion per year. Understanding the risk components of insider abuse is key to financial institutions combating this fraud.

Difficult economic times compound the risk and probability of insider abuse occurring because it creates rationalization in the mind of the perpetrator. The recent economic recession demonstrated this, as both incidents of and methods used to carry out white collar crime increased. According to a Report to the Nations on Occupational Fraud and Abuse, in 2009, the average company lost nearly 5% of revenue to fraud perpetrated by employees, with 85% of fraud committed by individuals with no prior records of abuse.

The first step in trying to combat insider abuse is to understand how and why it can occur. The fraud triangle is a model for explaining the factors that are typically present when someone commits fraud and, when they exist, could lead to fraudulent behavior. The three components include:

• perceived unshareable financial need;
• perceived opportunity; and
• rationalization.

The best weapons an institution can wield to protect itself from and combat potential fraud are the ability to identify when these components exist and the establishment of internal controls to prevent and detect fraud.

Although an institution may not be able to prevent a perceived financial need from occurring to its employees, it is able to implement policies and procedures to reduce or prevent the existence of the other two factors of the fraud triangle. A strong corporate culture focused on ethical behavior is the foundation that not only will set the tone for the institution but also can reduce the rationalization and justification of fraud and opportunities for it to occur. Elements of a strong corporate culture include:

• Code of ethics
• Policy for disclosing conflicts of interest
• Restrictions for gifts and gratuities
• Board of director and management involvement and oversight
• Training and guidance for employees related to organizational policies
• Clearly-defined authorities and responsibilities for key positions
• Strong system of internal controls
• Control and review of internal expense accounts
• Segregation of duties within transactions

It is never too late for an institution to address the potential risk of insider abuse, as it is a business risk that will always exist. Since the potential damage from insider abuse could be very significant, it is well worth the time and effort to evaluate the current corporate culture and determine if improvements can be made.

For assistance with such an evaluation or strengthening and implementing fraud controls at your institution, contact The Mercadien Group at (609) 689-9700 or [email protected].