Corporate Fraud

Corporate Fraud Definition

Corporate fraud, or white-collar crime, refers to fraud or illegal activities within a corporation or organization. The main purpose of indulging in such fraud is to earn some extra dollars secretly without reporting it to the government.

Corporate fraud scandals could occur due to various reasons and factors. Such fraud can be committed by any pillar of the organization, like directors, top executives, or others. As a result, it leads to financial, accounting, or data theft of the firm. Therefore, it becomes necessary to expose such corporate fraud cases. Otherwise, it may lead to bankruptcy.

• Corporate fraud, also white-collar crimes, is a crime by employees or directors of a company for indulging in illegal activities to earn extra money. 
• This concept was referenced in the mid-20th century by American sociologist Edwin Hardin Sutherland while addressing the American Sociological Association. 
• The three main types of corporate fraud include corruption, misappropriation of assets and cash, and financial statements fraud.
• The major historical scandals include Enron (2001), WorldCom and Sarbanes-Oxley Act 2002, and the Rajat Gupta case of 2010.

Corporate Fraud Explained

Corporate fraud is a form of deceit (cheating) performed by the organization's board of directors or top executives while engaging in illegal activities. And the primary motive behind this idea is money. It can occur in any business, regardless of size or form.

The intentions of individuals behind corporate fraud can be many. It includes corruption, conflicts of interest, bribery, and others. So, if an employee has a major conflict with the organization, they might leak sensitive data to the rival. Another case is when a firm illegally trades and does not show in the financial statements. They might bribe the employees or hide factual data from the public and the government. Thus, when a whistleblower exposes these activities, there are high chances of bankruptcy.

These firms have to sell everything and repay the victims. However, these executives often run away from the nation to escape corporate fraud penalties. As a result, there are various laws made to monitor such frauds. For instance, in the United States, any person representing any false or fake information has to pay corporate fraud penalties of $50,000 (corporates) and $10,000. The federal government has a list of penal codes given as follows:

U.S Code	Type of fraud
18 U.S.C. 472	Uttering counterfeit obligations or securities
18 U.S.C. 873	Extortion or blackmail
18 U.S.C 1001	Creating or making false, fake statements
18 U.S.C 1031	Major fraud schemes within the U.S.
18 U.S.C 1341	Defraud occurred with the use of mail service
18 U.S.C 1343	Fraud occurs through electronic or wire means.
18 U.S.C 1347	Healthcare fraud
18 U.S.C 1348	Fraud is committed as a result of securities or commodities.
18 U.S.C 1956	Money laundering or associated illegal activities.

Origin

There have been various corporate fraud scandals in the past century. However, the term corporate fraud originated in the mid-20th century. During the 1939 presidential address, sociologist Edwin Hardin Sutherland first used it for the American Sociological Association. Edwin stated how individuals conduct white collar crimes through their high status and occupation. According to data between 1997 and 2022, on average, 13% of large firms were a part of corporate fraud yearly. However, these frauds had already existed in the 18th century.

In 1725, a London-based institution named Charitable Corporation was accused of corporate fraud. Even though they aimed to provide loans at cheaper rates to the poor, in 1725, the new board of directors (BOD) diverted their aim. The board of directors secretly swept money and bought shares in their companies. Also, the employees should have recorded the documents. Thus, in 1731, the keeper John Thomson and others fled from the country. As a result, in 1732, the firm went bankrupt.

Types

Let us look at the types of corporate fraud that prevail in the organizations:

#1 - Corruption

One of the major roots of corporate fraud is individuals' corrupt nature. It includes bribery, interest conflicts, extortion, and illegal gratuities. Executives try to conduct illegal activities in exchange for bribes. In addition, conflicts of interest also stand out. Individuals try to place their interests ahead instead of firm.

#2 - Misappropriation

Corporations can conduct misappropriation either for cash, inventory, or assets. Here, individuals try to skip the record of cash which leads to theft. Likewise, firms also create fake sales invoices, asset theft, incorrect shipping, and inventory misuse. Other frauds include fraudulent issuance (release) salaries to employees, creating fake employees, fictitious expenses, etc.

#3 -Financial Statements Fraud

From the types mentioned above, financial statement fraud has the least occurrence (9%). It includes fake disclosure of financial items like revenue, assets, losses, liabilities, and others. Although strong regulatory compliances and authorities like GAAP (Generally Accepted Accounting Principles) and SEC (Securities and Exchange Commission) exist, the cases still occur. As a result, it affects the overall financial health of the company.

Examples

Let us look at the examples of corporate fraud for a better understanding:

Example #1

Suppose a technology firm named Isaac Inventions has been operating in the market for two decades. As a result, the share of this stock is always performing better than others. In short, the company has good revenues to represent its corporate image. However, the insider story differs. Four board members indulge in bribery and selling sensitive intellectual property to their own companies. In addition, one top management executive records fake employee data and credits their salary to his account. Later, the government seizes the property and offenders. And the firm is declared bankrupt.

Some of the notable scandals in the past decades include Enron (2001), WorldCom and Sarbanes-Oxley Act 2002, the Rajat Gupta case of 2010, and many others.

Example #2

According to a 2022 report, the US and Canada (36%) have the highest number of corporate fraud cases (675) followed by Sub-Saharan (23%), Asian Pacific (10%), and Western Europe (8%). In addition, corporate fraud statistics showed that there were 50% corruption frauds reported at an occurrence rate of 12%. However, misappropriation cases had a chance of 47% compared to others.

Detection

Let us look at the ways through which industry can detect corporate fraud cases:

#1 - Tip Lines

According to the Association of Certified Fraud Examiners (ACFE), 40% of corporate frauds detected result from tip lines. Usually, tip lines are numbers where anonymous persons can report these frauds through telephone to the authorities. So, in case authorities receive such tips, they can directly investigate with the internal auditor or legal department. As a result, proper action can be taken against the firm for any wrongdoing.

#2 - External And Internal Auditors

Auditors play an important role in detecting any fraudulent activities within the organization. Thus, AU-C section 240, a US Act, requires auditors to follow the standards and guidelines. They must report to the federal government or SEC if they detect any misstatements or errors.

#3 - Fraud Triangle

From the fraud detection frameworks, the fraud triangle works best. It usually has three factors, pressure, opportunity, and rationalization. The former usually exists in a non-shareable problem where individuals need money to pay bills. In contrast, an opportunity incentivizes them to earn extra money, which is otherwise impossible. Employees perform it by violating the company's trust. However, rationalization is a mere excuse for committing fraud. Therefore, authorities can examine the activities of an organization through this framework.

#4 - Accident

Fraudsters often make some mistakes while committing fraud. And it can directly expose corporate fraud. However, passive detection occurs when fraudsters themselves confess their crime. As a result, it makes others aware of their irregularities.

#5 - Fraud Risk Assessment

Firms can conduct an assessment test to understand the efficacy within the organization. They can identify loopholes, bridge the gap between employees, and minimize the risk of errors.

Prevention

Let us look at the different methods to prevent these corporate frauds within the organization:

• Companies can establish a strong communication channel throughout the management. As a result, employees clearly understand the dos and don'ts of the organization.
• Assessing and evaluating the background of the new employees for safety standards can help prevent such frauds.
• Reviewing the inventory control system and asset management can help check for any gaps or records that need to be added.
• Scanning all the financial statements and books of accounts also allows prevention. If there is a fake reimbursement or a hypothetical employee, conduct an urgent check.
• Delegate the activity among all employees. Thus, there will not be any supremacy over a particular employee. As a result, the appearance of fraud will be minimized.
• Establishing a tip line so that employees can anonymously report suspicious activities.
• Monitoring the bank statements and other sensitive information of the company.

Frequently Asked Questions (FAQs)

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