DEIRDRE McMURDY,D. M. July 27 1992



DEIRDRE McMURDY,D. M. July 27 1992




They are experienced chartered accountants—with the tracking skills of bloodhounds. They are a new group of so-called forensic accountants scrambling for a share in one of the few growth markets of the 1990s: exposing fraud. Larceny and embezzlement have existed for centuries, but never before have they offered such enormous prizes to successful practitioners. Few reliable statistics exist, but the growing number of chartered accountants who specialize in the area estimate that fraud costs Canadian companies as much as $8 billion a year. Bank robbers, by contrast, got away with a comparatively paltry $4 million in 1991.

The causes that experts blamed for the surge in swindles range from the recession to the psychology, of greed left over from the 1980s. The techniques employed are almost as various—running from such time-dishonored scams as padding expense accounts to hightech counterfeiting of legitimate credit cards. The villains are just as often supposedly loyal employees as shady characters with dubious addresses. And, say specialists in the field, few regular police forces are equipped to expose and prosecute the people who commit fraud. But despite the enormous amounts that swindlers pocket each year, forensic accountants say that their hardest task is often to convince managers to admit the extent of the problem. Declared Robert Lindquist, a partner in the forensic accounting firm Lindquist, Avey, Macdonald, Baskerville Inc. of Toronto: “Opening up about fraud is like talking to your kids about sex: it may be awkward, but it has to be done for the health of everyone.”

Still, many businesses resist acknowledging their vulnerability. “Senior executives are embarrassed by the revelation of fraud in their backyard,” said Robert Chambers, chairman of the international team of forensic accountants at Toronto-based KPMG Peat Marwick Thome. “They would rather ignore it because it reflects on their competence and credibility as managers.” Banks and trust companies, two industries where managers exhibit a particular aversion to public confession, evidently fear that exposure of a fraud will cause customers to lose confidence in the safety of their deposits. Said one veteran security consultant who

spoke on condition of anonymity: “There is absolutely no up side for a trust company in this edgy climate to announce the discovery of some massive fraud at a branch. Employees who commit fraud know that only too well.” The reluctance to confront fraud is strikingly at odds with the evidence of its toll on Canadian business. In one recent survey of Canada’s 900 largest companies, conducted by KPMG Peat Marwick Thome, 63 per cent acknowledged that they had been defrauded during the previous two years—with half of those frauds resulting in losses of more than $25,000 each. According to the same study, employees themselves were responsible for 84 per cent of frauds aimed against corporations. Despite those findings, the study found that only 44 per cent of Canadian chief executives surveyed were aware of the wide range of frauds that can occur in the workplace.

Even among companies that had experienced fraud, only two per cent took steps afterwards to improve their internal controls against future swindles. Indeed, experts contend that more than half of frauds aimed at businesses are never reported. Said Chambers: “Fraud has always been the hidden crime, buried in the income statement. It is rationalized easily because there is no apparent victim or injury—especially in a large organization.” Although there is no fully reliable psychological profile of an employee who embezzles, there are some common attributes. Most have worked at the firm they victimize for several years—long enough to become familiar with its vulnerable areas. Often, in fact, they are

considered hardworking, taking few vacations because they are afraid that their crime will be discovered in their absence. Many are also above average in intelligence and initiative. And those who are lower on the corporate ladder have to be both creative and flexible to conceive and sustain a successful fraud.

In a minority of cases, experts say, employees who defraud a company are motivated by the cerebral thrill of beating the system or getting even for a perceived slight. More commonly, fraud is linked to insecurity and need— financial or emotional. “When people are uncertain about their future or are treated like a disposable commodity,” said Alan Langley, president of the Canadian Region of the National Association of Certified Fraud Examiners, “they want to grab what they can and feather their nests.” He added: “Managers tend to overlook that an environment that has warmth and team spirit is hostile to fraud—especially in a recession.”

In fact, the economic downturn has provided a powerful new reason for some employees to turn to fraud. Families accustomed to two incomes and the easy-credit consumer boom of the 1980s are often reluctant to make sacrifices when jobs are threatened or lost. Said Lindquist: “People are stuck with higher life-

style expectations than ever before. They start to think they have a right to live a certain way, even when it’s no longer realistic.” Added Murray Swift, senior vice-president at the Insurance Crime Prevention Bureau in Toronto, which investigates more than 5,000 suspect insurance claims a year across Canada: “In hard times, we have far more fraudulent claims because people think they can recoup what they have paid out in premiums over the years. They seem to assume insurance companies can afford it.”

At the same time, the recession has provided an expanded opportunity for fraud. Cost-cutting staff reductions at many companies have eliminated some of the cross-checks and levels of supervision that previously existed in the corporate structure—and which made it more difficult for embezzlers to operate undetected. By the same token, where irregularities or indiscretions are uncovered, there is often a dearth of managers to deal with it.

On the other hand, hard times have exposed some swindles that might otherwise have escaped detection. As the lingering recession pushes many businesses to the brink of bankruptcy, there is less financial slack in their

accounts for swindlers to exploit. Forensic accountants examining the books of publishing tycoon Robert Maxwell, for one, say that the flamboyant financier was close to being caught in just such a squeeze when he died after he fell, jumped or was pushed from his yacht in the Atlantic Ocean last year. The sale of corporate divisions can also unearth frauds that have existed for many years under a previous management.

Even when it helps bring fraud to light, however, the troubled economy has increasingly bound the hands of the agencies charged with prosecuting embezzlers. Most police forces and courts give first call on their limited resources to violent or drug-related crime. The complexity of many frauds, meanwhile, makes them the most expensive and time-consuming type of criminal activity to investigate or prosecute. In the case of Brian Moloney, an assistant bank manager who defrauded the Canadian Imperial Bank of Commerce of more than $10 million in 1982, it took more than 18 months just to prepare the documentation for the trial that led to his eventual conviction. “Before we get anywhere near court,” said Staff Sgt. Frederick Pratt, a 20-year veteran of the

economic crime directorate of the Royal Canadian Mounted Police in Ottawa, “we have to assemble volumes of information for the other side. It’s expensive and time-consuming.” Indeed, while the RCMP has not yet reached the point where it will not prosecute swindles below a certain dollar value, Pratt said that the force may some day have to take such a step in order to streamline its operations.

The ubiquitous use of computers, many of them connected to the ethereal network of global financial markets, has also benefited fraud artists—and complicated the task of investigators. The technology, say experts, has made it easier to create false accounts, to invent fictitious clients or suppliers and to move funds internationally.

“The facilities are all in place for the smallest fraudster to use,” said Lindquist. “The longer the string of transactions, the harder they are to trace.” Added the RCMP’s Pratt: “The fraud scene is becoming much more international, and it makes our job much harder and much more expensive.” He added: “We not only need to travel, we need permission from the various foreign governments to investigate in their jurisdictions.” (Canada currently has treaties with 10 other countries, including the United States, Fiance and the Bahamas, allowing each partner to gather information related to a case and to pursue criminals in the other’s jurisdiction. The RCMP is also negotiating to add Germany and Brazil, among others, to that list.)

Swindlers who target companies from the outside are also increasingly multinational. The most common—and costly—example is the proliferation of counterfeit credit cards. Ac-

cording to Michael Ballard, vice-president of security for the Montrealbased Canadian Bankers’ Association, Canadian issuers of Visa and MasterCards alone lost $50 million to fraud last year—compared with $30 million in 1990. For 1992, Ballard predicts that they will lose $60 million. Despite the introduction of sophisticated magnetic strips and holograms embedded in credit cards, Ballard said that gangs based in Asian Pacific Rim countries that are equipped with state-of-theart technology are producing fake credit cards that are later brought into North America and

put to use. He noted that the surge in credit card scams means that “issuers are forced to spread around the cost of a growing amount of fraud.”

With investigation and prosecution of swindlers increasingly costly, and losses rising, specialists urge their corporate clients to take preventive action. Said one security adviser: “The problem is that forensic accountants are still corporate coroners. Business has to start using them more like consulting physicians.” Among the low-cost remedies urged by such experts is the transformation of personnel departments into the first line of corporate defence against fraud: references and past employers should be carefully screened and psychological testing of job candidates, which can give indications of their propensity to commit a crime, should be routine. According to studies, 80 per cent of the population is capable of perpetrating a fraud-related crime—but only 20 per cent would actually commit a crime without extenuating circumstances. And experts recommend that companies establish a “whistleblower program” that includes hotlines employees can call anonymously if they suspect a fraud— and that companies act promptly to counter any vulnerabilities revealed by a detected fraud.

Some of those measures may seem severe enough to risk creating an air of suspicion in some workplaces. Still, the growing fraternity of forensic accountants insists that those measures are increasingly necessary. And plainly, with billions of dollars at stake at a time when companies are pinching pennies merely to stay afloat, most managers would likely far prefer to deter a swindler—either inside or outside the gate—than to call in the bloodhounds after an embezzler has struck.



A business that provided insurance for Betty Grable’s legs and Madonna’s breasts does not shrink from crime. So-called fidelity insurance protects employers from the consequences of theft by employees. The policies, which are held by close to one out of every two companies, usually cover all workers except officers and directors of a firm—unless they are performing a function outside their normally defined responsibilities. For a typical company with 35 employees in a low-risk business—pencil manufacturers as opposed to jewel traders—$10,000 of fidelity insurance for the workers on staff would cost about $400.

But in a period when losses to fraud are rising dramatically, fidelity insurers are tightening their requirements.

Before approving a company for fidelity insurance, underwriters subject applicants to a thorough security audit. Insurance company underwriters examine both an applicant’s internal security system and its corporate code of ethics. Among the factors taken into consideration are the frequency and rigor of outside financial audits and internal inventory-taking. The insurers also insist that employers try to divide certain duties among employees to limit the opportunities for collusion: managers who have responsibility for hiring should not handle the payroll, and warehouse foremen should not conduct inventory counts. Said Thomas Kennedy, a senior underwriter with Zurich Canada: “Fidelity insurance gives protection from dishonesty but it’s not intended to replace good

business practices.”

And, increasingly, insurers are demanding that employers keep closer tabs on the activities of their employees—and warn their underwriters at the slightest hint of impropriety. If they fail to do so, many insurers will not honor any eventual claim. According to Kennedy, even unreported small-scale pilfering from petty cash may be a “material fact” in determining the degree of risk that a company bears. “We can’t cancel every policy over some small matter or we would have none left,” said Kennedy. “But we can delete high-risk individuals, put a new check in place or transfer the employee to a less tempting area of the business.” Infidelity, at least to a company's insurer, also carries a price.

D. M.