Understanding Fraud in Economic Downturns and Recessions

As a business owner navigating COVID-19, you’re focused on protecting your organization as best you can. While many components of the pandemic are beyond our control, focusing on mitigating risk and understanding vulnerabilities can help. One area to think about is the risk of fraud in your business.

During times of economic hardship, the consequences of acting in an unacceptable manner may not outweigh economic motivations. An economic downturn is a slump in economic activity and can include:

• Negative or very low economic growth;
• Falling asset prices;
• Low confidence and reduced investment;
• Rising spare capacity;
• Rising unemployment;
• Increased government borrowing;
• Higher government spending; and
• Lower tax revenue

Although economic downturns are cyclical, a recession involves a prolonged contraction when there are two consecutive quarters of decline in GDP. Recessions can be triggered by a financial crisis, an external trade shock, an adverse supply shock, a pandemic or the bursting of an economic bubble. With the unknown lasting impacts of the COVID-19 virus on the global economy, a continued economic downturn or recession is likely.

During an economic downturn or recession, economic pressures are one of the main reasons why fraud increases. Rising unemployment, increased personal debt, scarcities in supply chains and inflating costs of necessities like food result in increasing pressures on individuals to make ends meet. As sales become harder to make and profit margins and cash flows tightened, personal and business motivations to break the rules expand.

Internal threats to an organization can result from having to downsize its workforce, requiring more work from fewer people, giving rise to disgruntled employees and low morale. Employees may be more motivated to defraud the company, stealing cash, inventory and other assets. During a time of downsizing, middle management may be cut reducing a company’s abilities to deter and detect fraudulent activity.

In business dealings, management and employees may find themselves deviating from the rules for the benefit of the company — taking or giving incentives to make the deal or entering side deals. Financial statement fraud, misappropriations, false asset values, overstatement of revenue are just some of the fraud schemes that could take place. Rationalizations that may allow an otherwise trusted person to commit fraud include, “this company is financially viable, I just have to do this to get us through the recession” or “everyone pays bribes to get sales.”

External threats to an organization include theft, vendors inflating costs or submitting fictitious invoices. Cyber criminals also see the economic downturn as an opening to exploit vulnerabilities. Companies are often forced to cut budgets and lay off workers, which may include cyber security, leaving private data more vulnerable.

In times of economic hardship, some or all aspects of the fraud triangle may be significantly enhanced. The fraud triangle illustrates three conditions that are commonly found when fraud occurs. First, there is a motivation, pressure or incentive to engage in fraudulent activity. Second, the individual is in a position that provides an opportunity to commit the fraud. Finally, the individual can find sufficient reason to rationalize or justify their actions.

Anti-fraud controls and safeguards

• Assess your new internal control environment to ensure changes have not compromised control functions.
• Completing or updating a fraud risk assessment allows a company to analyze each of its business processes for the associated risks of fraudulent behaviour taking account of the business environment of the times.
• A whistleblower hotline is an effective way to identify fraud. Employees may be more inclined to report others to protect their business and job as the recession continues. Ensure your employees, contractors and third parties are aware of your whistleblower hotline.
• Heightened inventory management and controls should be deployed.
• Increased access control to valuable assets and improved loss prevention efforts may be required.
• Enhanced controls to limit opportunities for fraud could include adding surveillance cameras, card controls that identify, limit and track e-access, employing positive payroll controls, reconciling bank accounts, accounts receivable and payable in a timely fashion.
• Ensure owners and management convey a unanimous message that policies and procedures still apply, and that fraud prevention is a priority for all employees.
• Keep watch for changing employee behavior that could be a red flag. These flags could be indications of personal financial difficulties, living beyond one’s means, unusually close association with a vendor or customer, unwillingness to share duties or excessive control, addictions and family problems.

Contact

Learn more about creating fraud controls for your organization. Contact:

Lisa Majeau Gordon, CPA, CA.IFA, CFE, CFI, CFF
National Leader, Forensics and Litigation Support
780.451.4406
[email protected]

Joleen Collier, CPA, MFAcc, CFE, CIA
CIA Senior Consultant, Forensics and Litigation Support
780.733.8689
[email protected]