According to the Association of Certified Fraud Examiners’ (ACFE’s) latest “Report to the Nations,” organizations lose about 5% of revenue to occupational fraud each year. The average loss in the ACFE study, based on nearly 2,000 cases of occupational fraud, is $1.67 million.

Although nonprofit losses in the ACFE study are half those of other types of organizations, the median nonprofit loss of $76,000 could prove devastating to small nonprofits. That’s why you need to learn why organizations are vulnerable and how to recognize warning signs.

Identify risks

Understanding the characteristics of fraud victims can help you identify the circumstances under which occupational fraud is most likely to occur — and properly allocate resources to combat the risk and contain any losses. Nonprofits are especially vulnerable to fraud due to factors including fewer internal controls, limited resources for antifraud measures, insufficient staff to segregate duties and a generally greater sense of trust in employees.

The ACFE report assesses antifraud controls (or lack thereof) at victim organizations. As noted in the COSO/ACFE Fraud Risk Management Guide, a well-designed and implemented antifraud control system is “one of the foundational principles of a holistic fraud risk management program.” The presence of 18 controls, evaluated in the ACFE study, is associated with both faster detection of fraud and smaller losses.

Surprise audits, financial statement audits, fraud reporting hotlines (see sidebar, “Tips lead list of detection methods”) and proactive data analysis are associated with at least a 50% reduction in fraud loss and duration. Yet surprise audits and proactive data analysis are among the least commonly implemented antifraud controls in the study. Moreover, organizations with fewer than 100 employees are much less likely to have any of the antifraud controls that their larger counterparts have in place.

Behavioral red flags

The report identifies eight key warning signs of occupational fraud. Seventy-five percent of fraudsters demonstrate at least one of the most common behavioral clues (and 52% show multiple signs):

• Living beyond their means (39% of perpetrators),
• Financial difficulties (27%),
• Unusually close associations with vendors or customers (20%),
• Control issues/unwillingness to share duties (13%),
• Irritability, suspiciousness or defensiveness (12%),
• A “wheeler-dealer” attitude, defined as an aggressive pursuit of goals, often for personal benefit at the expense of others (12%),
• Bullying or intimidation (11%), and
• Divorce/family problems (10%).

“Living beyond their means” has been the most common behavioral red flag exhibited by fraud perpetrators since the ACFE began tracking data in 2008.

Interestingly, the presence of behavioral red flags is correlated with the amount of financial losses. Fraudsters who displayed at least one red flag caused median losses that were 20% greater than those who didn’t — $150,000 versus $125,000.

Also, certain red flags are associated with higher median losses. For example, cases involving perpetrators who’ve experienced excessive employer pressure to perform caused a median loss of $617,000. The median loss in cases involving fraudsters with past legal problems was $500,000. And cases involving perpetrators who displayed a wheeler-dealer attitude led to a median loss of $350,000.

HR-related signs

The report defines HR-related red flags as job-related circumstances that might influence a perpetrator’s decision to commit fraud. Examples include such issues as the fear of job loss or the actual loss of a job. Fraud might be a way to try to avoid a poor performance evaluation, a demotion, or a denial of a raise or promotion. Also, fraud might arise if an employee fears a cut in benefits or pay.

Almost half of the fraudsters in the study exhibit one or more of these red flags. The most common are poor performance evaluations, fear of job loss, and denial of a raise or promotion.

Take action

The ACFE report emphasizes that proactive fraud detection efforts are associated with faster detection. This suggests you can dramatically reduce the consequences of fraud in your organization by implementing internal controls that actively detect fraud, such as account reconciliation and thorough management review. We can help.

Tips lead list of detection methods

Consistent with previous reports from the Association of Certified Fraud Examiners (ACFE) on occupational fraud (see main article), tips are the most common detection method. Forty-three percent of the cases in the ACFE’s study were discovered through a tip — more than three times as many as through other methods.

More than half of the tips were submitted through a formal reporting mechanism, such as a hotline. However, the implementation rate of hotlines at small organizations is significantly lower than that of larger companies. Although phone hotlines are among the most common mechanisms used by tipsters, the percentage of tips received over the phone has, not surprisingly, declined in recent years. Since 2018, email (37%) and online reporting forms (40%) have surpassed phone hotlines (30%) as the most common formal reporting mechanisms. Text messages, included as an option in the ACFE survey for the first time, account for 3%.

Ensure your nonprofit offers cost-efficient online and electronic form reporting options. Also,  publicize these tools to encourage staffers and other stakeholders to use them if they suspect fraud.

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