Managing Risk What’s More Important: Fraud Prevention or Detection?

By David Becker

It’s a trick question. They are both of critical importance, according to SDRMA Spring Education Day speaker David Becker in his Fraud Detection & Prevention presentation to a room full of special district professionals in March.

There are core strategies to enact to set the stage for fraud prevention. Along with a set of practices designed to detect fraud when it occurs, an agency can set itself up with protective measures to reduce fraud risk overall.

First, it’s important to understand why fraud occurs. According to Becker, there are three drivers of fraud that are almost always present when fraud occurs. The fraduster has opportunity, an incentive, and rationalization. Identifying when these components align and taking measures to reduce them, leads to reduced likelihood of fraud.

Let’s take a look at these components and provide some ideas agencies can implement to counteract their occurrence and prevent fraud.

Opportunity can arise when agencies have inherent risk components, such as accepting cash for ticket sales, or complex projects. Agencies can reduce an opportunity to pocket cash by having multiple staff members account for it. For example, one person sells the ticket and accepts the cash, another counts the tickets and cross references the number sold to the amount of cash in the cash box at the end of the event, and a third person is responsible for securing the funds in a safe and verifying the deposit amount matches the verified amount. In the case of complex projects, it is important to have multiple people overseeing the project’s contracts, equipment inventory and management, and an auditor for grants, funds, accounts payable and contracts.

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Incentive to commit fraud can come in various forms. It may come in the form of personal financial challenges, life events that cause financial strain, or other forms that can be difficult to identify. Setting a culture of fraud prevention and detection can set a tone of zero tolerance that dissuades those with incentive from becoming a bad actor. This tone is set from the top, and should be built into processes for expense reporting, financial audits, and be addressed in department meetings and training. Rationalization, or justification, is present in every case of fraud. It is the thought process that enables someone to commit fraud because they convince themselves they “deserve” the item or money they are stealing. Employee retention and satisfaction initiatives designed to enhance a supportive work culture where employees feel appreciated, have support from their supervisor, or feel they are recognized for their contribution can reduce this aspect. While prevention techniques are critical to set up proactively to stop fraud from occurring, it is equally important to have methods to react to instances of fraud. The key is to have policies and processes in place to detect fraud quickly.

Becker pointed out two categories of “red flags” to be aware of: Employee indicators and financial indicators.

Employee indicators should be noted and explored carefully. Take caution to work with the facts in place and not to speculate or make assumptions. Employee indicators may include:

• Behavior changes

• Lifestyle changes

• Refusal to take time off

• Unreasonable responses to reasonable questions

Financial red flags in the agency should be identified through policies and processes that are designed to shine a light on anomalies. Financial indicators may include:

• Budget overage

• Complex or unusual journal entries

• Unexpected cash balances

• Unusual long-term trends (It is important to have a consecutive trend view of at least five years)

Agencies should perform risk assessments to evaluate the quality of the controls in place. While it is important to have policies in place to reduce risk, they are ineffective if they are not adhered to – risk assessments should include an assessment of adherence to policy. When fraud is discovered, it should be investigated thoroughly to uncover facts. Avoid speculation. Include legal counsel, verify the facts with external audits, and notify the Board of the process.

Taking proactive steps to ensure reliable accounting processes are in place and adhered to, along with employee satisfaction initiatives to build a culture of loyalty to the agency and identify steps for action in instances of suspected fraud are all critical components to an agency’s fraud prevention and detection capacity.

David Becker retired as a Partner at James Marta & Company in 2021. With over thirty years of experience in public accounting, he has participated in industry committees, mentored dozens of staff accountants and provided practical insight and guidance to government agencies.