Effective fraud detection frameworks are essential for organizations to proactively identify, manage, and mitigate potential threats, ensuring financial integrity and fostering trust among stakeholders.
Building the fraud detection process involves a review of historical financial transactions, fraud incidents data, regulatory inspections and observations to uncover potential or existing frauds, internal audit reports highlighting significant processes weaknesses leading to fraud incidents, employees’ behavior or conduct, tone of the management towards ethics and culture, etc.
Fraud detection is an ongoing process that is performed on the occurrence of fraud incidents or to assess the possibilities of the occurrence of fraud in any particular area of the department.
In most cases, the frauds are not detected by preventative or detective measures but rather are identified through external or independent business functions or sources.
The fraud detection process framework helps to identify suspicious transactions or transactions showing fraud indicators in the institution based on the deep analysis of past data and fraud trends.
The fraud detection process is also a forward-looking activity to assess the possibilities of reoccurrence of fraud incidents. The fraud detection process involves the analysis of possible fraud scenarios created by the fraud investigation team based on a deep understanding of past data trends, fraud risks, and fraud incidents. It also involves understanding the future approach of digital fraudsters who invent new processes and techniques to perform digital frauds.
To assess the reoccurrence of fraud in the future in any particular department or function of the institution, the fraud investigators or specialists establish the interconnections between past data patterns and trends to assess and predict possible future fraud incidents.
To detect fraud all the processes and activities of the institution are studied and mapped with internal controls to identify control weaknesses or control gaps in the processes and systems. The weaknesses and control gaps may be exploited by fraudsters or employees.
Effective Fraud Detection Frameworks
Below are some methods of fraud detection, which identify frauds:
Whistleblowing Hotline
Through a whistle-blower program, the institution demonstrates its commitment to good corporate governance and the establishment of a fraud risk management culture that promotes a high degree of ethics and belief in its stated corporate values. The fraud management policy shall highlight the responsibility of the employees to report any identified fraud to the senior management of the company.
Usually, employees feel the reluctance to share the information with the management in the fear of losing their jobs, therefore, the senior management should devise a policy where everyone in the institution or company is encouraged to share the information with the senior management without any fear. The management may establish fraud hotlines, as a means of encouraging employees to report fraud incidents, without any fear.
Such programs may be developed to:
encourage the reporting of fraud incidents
allow for the appropriate investigation of the reported fraud incidents
protect employees who disclosed the fraud to the management
Fraud Database
The management may establish a database built to record the details of fraud incidents, including the details of the progress of investigations. Such databases must be analyzed and monitored on an ongoing basis. This helps management in understanding the reasons and causes of fraud incidents, therefore, management establishes and implements relevant processes and procedures to prevent the occurrence of similar frauds.
Communicate and Training
The management must ensure that appropriate training is provided to the employees for the prevention and detection of fraud incidents. The training programs should be developed based on the complexities of the operations of the institution. Training programs should be very practical and focused on the requirements to identify and prevent fraud in the institution.
Every employee should be encouraged to identify fraud in their respective departments and functions. The employees may be encouraged through awarding the prizes if the fraud incidents are identified and reported.
Internal Tip-off
The institution should establish internal fraud deterrence processes with the element of the internal tip-off, to ensure that the fraud incidents are reported confidentially to the relevant department or authorities such as the fraud investigations department or the fraud management committee.
Tip-off helps in planning the fraud investigation process without getting the culprit informed. Such practices help in the performance of appropriate planning and performance of fraud investigations.
External Tip-off
The institution should establish an external corporate communication function where fraud-related external tip-off considerations are practiced, to ensure that the fraud incidents are reported to the institution by the stakeholders, in a confidential manner. External stakeholders might be the customers, general public, vendors, or regulators of the institution.
Such communication from external stakeholders should be reported to the fraud investigations department or the fraud management committee.
Law Enforcement Investigation
Law enforcement authorities investigate frauds, where applicable legal provisions are breached. Law enforcement authorities perform a variety of tasks such as collecting pieces of evidence and testifying the shreds of evidence in the relevant courts.
Law enforcement authorities may work for the Federal Government or the State. Police departments may also be involved in the fraud investigation process depending on the local applicable laws of the State and Federal Governments.
There may be situations where Law Enforcement Agencies and Police may work together undercover. The nature of the investigation and involvement of Agencies and Police depend on the location of the fraud, the size of the institution, the profile of the fraudsters, and the legal provisions breached.
Internal Audit
The internal audit department of the institution is an independent function that reports to the Board Audit Committee (BAC). The internal audit function is headed by Chief Internal Audit (CIA) who works as the secretary to the BAC.
The internal audit function is vested with the powers to investigate the fraud incidents and they are provided with sufficient authority to obtain and review the relevant shreds of evidence both within and outside the institution. Internal auditors appropriately plan fraud investigations and deploy relevant and experienced resources to investigate the case. The process may involve interviewing fraudsters and other relevant employees.
External Audit
External auditors of the institution are responsible for the performance of the audit of the financial statements of the company. Their scope is limited to the financial statements of the institution.
However, there may be the possibility that the management of the institution prepares the financial statements fraudulently or artificially inflate or deflate the financial amounts.
External auditors are required to obtain sufficient appropriate audit evidence to support the audit opinion on the financial statements of the institution or company.
To cover the risk that financial statements may be prepared fraudulently, the external auditors appropriately plan the external audit. External auditors ensure that appropriate audit procedures are performed on the financial statements, balances, and amounts so that any intentional fraud is identified during the audit activities.
Final Thoughts
Fraud detection is an intricate and ever-evolving process requiring meticulous examination of historical financial transactions, keen observation of employee conduct, and a deep understanding of internal and external dynamics. This process is not just about looking backward to identify previous frauds, but also forward to anticipate potential future scams. While internal measures like preventive controls play a role, surprisingly, many frauds come to light through external sources or independent business functions.
The commitment to fraud detection and prevention is often showcased through whistleblowing hotlines, databases, training initiatives, and both internal and external tip-offs. Moreover, internal and external audits serve as pivotal checkpoints, with auditors systematically planning their investigations to detect discrepancies. In a landscape where fraudsters constantly adapt and employ novel techniques, institutions must remain vigilant, leveraging all available resources and continuously updating their strategies to safeguard their assets and reputation.
