Fraud Prevention 101: Don’t encourage fraud

From my article Fraud Prevention 101 in the Wisconsin Law Journal.
Some of the more obvious policies and procedures that can influence the level of fraud in companies include the following:

• Incentive programs such as stock options based upon financial statement results or bonuses based upon sales goals can encourage unethical behavior. Managers and executives have been known to record sales prior to their completion, in order that the current period’s results are inflated. This affects later accounting periods, however, and such a fraud may balloon quickly. Incentive programs should be balanced to create high performance, but not encourage cheating.
• No audits may be a recipe for disaster. While audits generally don’t detect fraud because they are not designed to do so, the performance of audits can have a significant deterrent effect on employees. If employees and managers know that this level of oversight is present, they may be less likely to act unethically.
• Relying upon regulations to solve a company’s problems is foolish. Regulations such as Sarbanes-Oxley have caused companies to critically review their processes, and as a result, management has made changes that have created efficiencies. However, the regulations don’t address true fraud prevention. Companies that substitute compliance with regulations for real fraud prevention are doing the wrong thing.
• Absence of formal budgeting and evaluation processes are also a cause for concern. Budgeting helps a company to control its expenses, and also provides a benchmark against which to measure performance. Significant deviations from the budget may indicate problems, including fraudulent behavior. Formally evaluating a company’s results and comparing those results to budgets and forecasts provides additional oversight of employees. Again, employee knowledge that controls exist may help deter fraud.
• Significant growth between reporting periods should be investigated. When a company is consistently outpacing the market or showing continued double- or triple-digit growth, scrutiny is warranted. Even in the case of a top performer, there is only so much growth that can consistently occur. It is important to investigate the growth skeptically to avoid another WorldCom or Enron.