Red Flags for Fraud Detection

Fraud Detection

Recently, Hildegard Antionette Steenkamp, an Accountant, pleaded guilty on 336 accounts of fraud, to the value of R537 million, over a period of 13 years, which raises the question of how does this happen, and why did nobody detect the fraud for so long?

Companies are always at risk of fraud, which is a criminal activity that has devastating consequences for both businesses and individuals, it is a serious business risk that needs to be identified and mitigated timeously.  The first step in fraud protection is fraud detection, and comes into play when fraud prevention has failed, which involves baselining user transaction behaviour, the use of systematic data,  building and optimizing statistical models, techniques, and or tools to uncover suspicious behaviour or inconsistencies and aggregating the resulting threat intelligence that may indicate deception, theft, fraud, or other forms of financial misconduct. The goal of fraud detection is to minimize losses, protect assets, and maintain the integrity of financial systems and institutions, which requires skilled data analytics and or access to machine-learning platforms.

Once fraudulent activity is discovered, the risk needs to be classified, as the misclassification of fraud can leave systems vulnerable and produce erroneous audits, business, and financial results reports. Fraud detection is continuously evolving and once it is known that a detection method or methods are in place, criminals will adapt their strategies and try others. Fraud has two distinct characteristics that contributes to its detection, namely, once fraud has taken place, it cannot be undone, and fraud is always committed to derive and or gain direct or indirect financial gain from it. It is crucial for businesses and individuals to be aware of the warning signs to identify and prevent fraudulent activities.

Realistically, companies cannot prevent all occurrences and forms of fraud, however, they could apply various detection techniques to cultivate an awareness of warning signs that could point to fraud, known as red flags. Zabihollah Rezaee (2002) describes “Red Flags” as indicators or symptoms of specific occurrences, events and behaviours that are employed to commit or conceal fraud.

Some common red flags for fraud detection

Accounting Irregularities

Financial fraud can often be traced back to accounting irregularities. Companies can identify potentially fraudulent activities by being vigilant and watch out for unusual transactions and discrepancies, for example:

1. Revenue fluctuations: Sudden or unexpected changes in revenue, that cannot be explained could be a sign of fraudulent activities such as inflated sales, improper revenue recognition or false sales.
2. Financial statements Discrepancies: Inconsistent comparative numbers between balance sheets, income statements, and cash flow statements may suggest that the numbers have been manipulated.
3. Frequent Financial Statement adjustments and or restatements: Frequent changes to financial statements may be an indication that the company is attempting to conceal possible fraudulent activities and or maintain a specific financial result.
4. Unusual Transactions, data patterns or trends: Transactions and or different pattern and or trend flows that do not fit with the usual business model or are excessively complex, should be scrutinized for possible fraud.
5. Vendor fraud: Rapidly increasing purchases from one vendor, excessive purchase of goods and or services, no segregation of duties between new vendor approval and authorisation for purchasing, Vendor director have the same ID number, contact number and or address as an employee, Vendor banking details are the same as an employee (run at least quarterly reviews comparing these details), to detect fraud timeously.
6. Embezzling receipts: Misappropriating collections on accounts receivable or diverting receipts in respect of written-off customer accounts to personal bank accounts

Behavioural Indicators

Fraudsters often exhibit certain behaviours that can signal fraudulent activity and companies can detect potential fraud, by observing and be on the lookout for certain behavioural indicators, for example:

1. Living beyond one’s means: Individuals who appear to be living a lavish lifestyle that seems inconsistent with their income, could be involved in possible fraudulent activities.
2. Unusual secrecy or defensiveness: When individuals become defensive or being secretive when questioned about financial matters may be attempting to conceal possible fraudulent activities.
3. Close customer and or Vendor relationships: When there is an unusually close personal relationships between employees and external, third parties, it could be a sign of collusion or conflict of interest.
4. Refusal to go on holiday or delegate tasks: Employees who are reluctant to take time off or delegate their responsibilities could be attempting to maintain control over possible fraudulent activities.

Technological Vulnerabilities

As technology advances, so do the methods used by fraudsters to perpetrate financial fraud, for example:

1. Unauthorized access to systems and data: Unusual or unauthorized access to financial systems and or sensitive data could be an indication of an insider threat or a possible external cyber-attack.
2. Irregular electronic transactions: Unusual data trends or patterns, or discrepancies in electronic transactions could be a sign of fraudulent activities such as embezzlement or identity theft.
3. Inadequate security measures: The lack of proper security measures, encryption, strong passwords, the lack of changing passwords regularly, and two-factor authentication, increases the risk of cyber-attacks and data breaches.
4. Unusual emails with strange attachments or social media activity: Phishing emails or suspicious social media messages could be early warning signs of an impending cyber-attack. Employees need to be trained regularly on how to spot suspicious emails and not to open these emails and or attachments.

Fraud detection is a complex and ever-evolving challenge, and companies, individuals, and financial institutions must remain vigilant to safeguard their financial well-being. By remaining alert and aware of red flags and implementing strong internal controls and security measures as well as practising good governance, companies can reduce the risk of financial fraud and its devastating consequences.