Companies should be prepared for the risks that a downward economy poses. In my opinion, fraud risk for business is exacerbated in weak economic conditions because of the following factors:
1) reduction in employee headcount (creating improper segregation of duties),
2) weaker internal controls and fraud-awareness training,
3) diminished morale across the organizations,
4) salary reductions “rationalize” inappropriate activity by employees,
5) financial pressure to meet short-term performance goals (“whatever it takes” attitude), and
6) diverted attention from risk management issues.
Historically, fraud schemes committed during downturns include:
1) omitted or improper disclosures in financial statements,
2) manipulation of financial categories as revenue recognition (fictitious sales, premature recognition, channel stuffing), inventory and cost of goods, manipulation of reserves or expenses,
3) manipulative trading practices,
4) unreported violations of the Foreign Corrupt Practices Act (FCPA), and
5) asset misappropriation: skimming, check tampering, and expense reimbursement.
The regulatory apparatus should quickly adapt to respond to these criminal activities. The US Congress already has held hearings to address the issue of transparency in business conduct. Congress needs to fill these regulatory holes by passing legislation that would give regulators the power to rein in manipulative or fraudulent trading practices and help the public better assess the risks involved. The collapse of Bernard L. Madoff Investment Securities makes it easier to understand the importance of proper due diligence.
In a slowing economy, companies today will have to be more proactive in protecting themselves against fraud, and engaging in more stringent financial and investigatory due diligence to better evaluate regulatory risks and their impact on future investments. As I discussed bellow, initiatives for more robust fraud-risk assessments to reflect current conditions mitigate these risks.