41 Types of Fraud and How to Detect and Prevent Them

Know the fraud schemes and red flags to protect your company from harm.

Posted by Dawn Lomer in on March 15th, 2017

Employee fraud is one of the most expensive liabilities of an organization.

One frequently quoted statistic comes from the ACFE, which has reported year after year that companies lose, on average, five per cent of revenues to employee fraud.

 

Types of Fraud and Theft


One of the biggest challenges of detecting, investigating and preventing employee fraud is the fact that there are so many types of fraud and theft that require different methods for discovery.

Every department presents opportunities for employees to steal, although it’s been widely reported that a disproportionate percentage of theft is carried out by employees in senior positions and that employees involved in accounting and finance are the most frequent offenders.

Most types of employee fraud schemes fall into the following categories:

 

So you’ve found the fraudster in your organization. Now what? Download the free cheat sheet: How to Confront Employee Theft.

 

 

Asset Misappropriation


Asset misappropriation is a broad term that describes a vast number of employee fraud schemes.

Simply, it’s the theft of company assets by an employee, also known as insider fraud.

Asset misappropriation schemes include:

 

Check Forgery

An employee forges a signature on a check made out to himself/herself or to someone else.

 

Check Kiting

An employee writes checks on an account that doesn’t have sufficient funds with the expectation that the funds will be in the account before the check clears.

Check kiting schemes are less common nowadays, with faster check clearing times.

 

Check Tampering

An employee alters the payee, amount or other details on a check or creates an unauthorized check.

 

Inventory Theft

An employee steals product from a company, either by physically taking it or diverting it in some other way.

 

Theft of Cash

Most common in retail environments where cash exchanges are common, this type of fraud covers simply:

  • Stealing cash
  • Skimming (not registering a sale and pocketing the cash)
  • Return fraud (an employee colludes with someone else to return goods fraudulently for a refund)
  • Any other scheme that involves the removal of hard currency

 

Theft of Services

An employee misuses company services or company-funded services, for example, an employee at an auto shop gets the mechanics to do his oil changes for free.

 

Expense Reimbursement Fraud

Also called expense fraud, this type of fraud includes:

  • Forging receipts
  • Double claiming for expenses
  • Submitting false reimbursement claims
  • Inflated expense claims

 

Expense Account Fraud

An employee uses a company expense account for personal expenses and submits them as business-related.

This can also include expense reimbursement fraud, above.

 

Procurement Fraud

This type of fraud includes schemes such as over-ordering product then returning some and pocketing the refund, purchase order fraud where the employee sets up a phantom vendor account into which are paid fraudulent invoices, or initiating the purchase of goods for personal use

 

Payment Fraud

This can include vendor fraud schemes as well as creating false customer accounts to generate false payments.

It also includes:

  • Altering payee details on checks and payables
  • Self-authorizing payments
  • Colluding with others to process false claims for benefits or payments

 

Workers’ Compensation Fraud

In these types of fraud, an employee exaggerates injuries or a disability, invents injuries that did not occur or attributes injuries that occurred outside of the work environment to work to receive compensation pay.

Employees also commit workers’ compensation fraud when they lie about their health or work status while receiving compensation.

Head over to our 31 Warning Signs of Workers’ Compensation Fraud article for more information about detecting and preventing workers’ compensation fraud in your organization.

 

Health Insurance Fraud

An employee conspires or colludes with health care providers to defraud an insurance company by submitting false or inflated receipts.

An employee claims a reimbursement for medical or health services not received.

 

Commission Fraud

An employee inflates sales numbers to receive higher commissions, falsifies sales that did not occur or colludes with customers to record and collect commissions on falsified sales.

 

Personal Use of Company Vehicle

This is similar to theft of services, but involves the employee using a company vehicle (and often the company-issued credit card for fuel) for unauthorized personal activities.

 

Preventing & Detecting Asset Misappropriation

To prevent and detect asset misappropriation:

  • Conduct thorough background checks on new employees.
  • Implement checks and balances.
  • Separate the functions of check preparer and check signer.
  • Rotate duties of employees in accounts.
  • Conduct random audits of company accounts.
  • Don’t pay commission until goods are services have been delivered.
  • Keep checks in a locked cabinet and destroy voided checks.
  • Implement an anonymous ethics hotline to encourage employees to report wrongdoing.

 

 

Vendor Fraud


Vendor fraud can be committed by employees acting alone or in collusion with vendors. This type of fraud can also be committed by vendors on their own.

Step 1: Examine your vendor files. To find out what to look for, download the free cheat sheet: 16 Ways to Identify Fictitious Vendors.

Examples of vendor fraud are:

 

Billing Schemes

In a billing scheme, an employee generates false payments to himself/herself using the company’s vendor payment system either by creating a fictitious vendor (shell company) or by manipulating the account of an existing vendor.

 

Bribery and Kickbacks

An employee participates in a bribery scheme when he or she accepts (or asks for) payments from a vendor in exchange for an advantage.

 

Check Tampering

A check tampering scheme involves forging, altering or creating unauthorized checks.

An employee steals checks for payment to a vendor and alters the payee or forges the vendor’s signature to deposit them in his or her personal account.

 

Overbilling

A vendor pads invoices to charge the company for more goods than it ships or to charge a higher price than agreed.

This can be done in collusion with an employee, who receives a kickback or by the vendor alone to defraud the company.

 

Price Fixing

This type of fraud occurs when competing vendors collude amongst themselves to set a minimum price or price range.

This makes both vendors’ prices appear competitive and ensures the company pays an inflated price no matter which vendor is chosen.

While employees of the company are not usually involved, they sometimes provide information to the vendors about pricing and budgets to facilitate this fraud.

 

Preventing & Detecting Vendor Fraud

To prevent and detect vendor fraud:

  • Conduct thorough background checks on new employees.
  • Implement checks and balances on payments to vendors.
  • Separate the functions of check preparer and check signer.
  • Rotate duties of employees in procurement.
  • Conduct random audits of vendor files.
  • Conduct due diligence when setting up vendors by verifying:
    • Vendor’s business name
    • Tax Identification Number (TIN)
    • Phone number
    • PO box and street address
    • Bank account
    • Vendor contact person
  • Use data mining to uncover anomalies and patterns.
  • Compare vendor addresses with employee addresses.
  • Implement a dual review process for master vendor file management.
  • Review the vendor master file to check that volume of billing is reasonable and consistent.

 

Employee committing workplace fraud

 

Accounting Fraud


An employee who manipulates a company’s accounts to cover up theft or uses the company’s accounts payable and receivable to steal commits accounting fraud.

Employees involved in these types of fraud are generally those in positions that have access to a company’s accounts with little or no oversight.

Accounting fraud includes:

 

Embezzlement

Also called larceny, this is any fraud conducted by a person who controls the funds being used.

 

Accounts Payable Fraud

Accounts payable fraud is among the most damaging for affected businesses.

It’s also among the easiest frauds to perpetrate, since most of the money leaving a company legitimately goes through the accounts payable function.

To learn more about AP fraud, visit our Essential Guide to Accounts Payable Fraud.

 

Fake Supplier

An employee sets up a fake supplier and bills the company for good or services not provided.

 

Personal Purchases

An employee uses company funds to pay for personal purchases and records the payments as legitimate business expenses in the accounting system.

 

Double-Check Fraud

An employee writes a check to pay an invoice then writes a second check to himself or herself and records the disbursement in the accounting system as a payment to the same supplier.

 

Accounts Receivable Fraud

Accounts receivable fraud takes place through many different types of schemes: lapping, fictitious sales, skimming and more.

Check out The Definitive Guide to Accounts Receivable Fraud for a full look into this type of fraud.

 

Preventing & Detecting Accounting Fraud

To prevent and detect accounting fraud:

  • Implement tight internal controls on accounting functions.
  • Separate the functions of account setup and approval.
  • Conduct random audits of account payable and accounts receivable records.
  • Assign a trusted outside contractor to review and reconcile accounts at regular intervals.
  • Rotate duties of employees in accounts payable and accounts receivable.
  • Make it mandatory for employees to take vacation time.
  • Set up an automated positive pay system to detect fraud.

 

Payroll Fraud


Payroll fraud is theft via a company’s payroll system.

It’s one of the most common types of employee fraud – according to the ACFE it occurs in 27 per cent of businesses and lasts for an average of 36 months.

So it’s a significant risk, especially for small businesses where there are usually fewer controls.

Don’t let payroll fraud derail your business. Download the free cheat sheet: How to Detect Payroll Fraud.

Payroll fraud schemes include:

 

Ghost Employee Schemes

A fake employee or ex-employee is kept on the payroll with pay being diverted to the fraudster.

 

Advance Fraud

An employee requests a payroll advance and doesn’t pay it back.

 

Timesheet Fraud

An employee falsifies timesheets to inflate hours, an employee clocks in and out for another employee in his or her absence or a payroll employee manually inflates hours on an employee’s timesheet.

 

Paycheck Theft

One employee steals another employee’s check and cashes it.

 

Preventing & Detecting Payroll Fraud

To prevent and detect payroll fraud:

  • Reconcile balance sheets and payroll accounts each quarter.
  • Require managers or supervisors to approve timesheets and overtime claims.
  • Institute mandatory vacations for payroll employees.
  • Restrict payroll department employees’ ability to modify pay rates and hours.
  • Perform data analytics on payroll records to look for matching addresses, names, bank accounts, etc.
  • Check payroll records to ensure terminated employees have been removed from the payroll.
  • Separate tasks of preparing payroll checks and reconciling payroll account.

 

 

Data Theft


Data or theft or theft of trade secrets in one type of employee fraud that can be devastating to a company that relies on its intellectual property for its product or service.

This type of theft can also compromise marketing and sales efforts and/or put the company in a precarious position with authorities when personally identifiable information is stolen.

Don’t gamble with your company’s sensitive information. Download the free Data Theft Prevention Checklist.

Data theft can include:

 

Trade Secret Theft

Theft of proprietary information to sell to a competitor.

 

Theft of Customer or Contact Lists

A departing employee copies or downloads lists of the company’s contacts to either sell or use.

 

Theft of Personally Identifiable Information (PID)

An employee steals or shares credit card numbers, client lists or other valuable PID to sell to other parties.

 

Preventing & Detecting Data Theft

To prevent and detect data theft:

  • Restrict access to company proprietary information to only those who need it in the course of their jobs.
  • Set up IT controls to alert management of large data downloads or transfers or downloads and transfers that occur at odd times.
  • Purchase software that alerts management of suspicious activity on a company network, such as an employee trying to access sensitive information.
  • Dispose of confidential information properly, by shredding documents and completely removing data from electronic devices before redeploying or disposing of them.
  • Use strong passwords for all computers and devices that can access sensitive information.
  • Implement a clean-desk policy that prohibits employees from keeping sensitive information on their desks while they are not present.

 

Bribery and Corruption


High profile employee frauds, such as bribery and kickbacks, can damage much more than a company’s finances.

The reputational hit from a corruption accusation can deter business, affect employee morale and affect an organization’s stock price.

These frauds can include:

 

Bribes

An employee pays or provides a benefit to an official to secure an advantage for the company or for the employee.

 

Kickbacks

An employee receives payments or benefits from third parties in return for business advantages or for unauthorized discounts.

 

Shell Company Fraud Schemes

An employee or company officer may use a shell company to launder money, pay bribes, divert assets or evade taxes.

 

Product Substitution

A contractor, acting on its own or in collusion with an employee in the purchasing company, substitutes inferior or counterfeit materials for the materials specified in the contract.

 

Preventing & Detecting Bribery and Corruption

To prevent and detect bribery and corruption:

  • Have a strong code of ethics and ensure everyone in the company, from the top down, knows what it says and puts it into practice.
  • Ensure those at the top levels of the company set an example that makes it clear that bribery and corruption are not tolerated.
  • Discipline employees who breach the company’s code of ethics.
  • Conduct due diligence on all third parties your company does business with.
  • Look for product substitution red flags such as:
    • High numbers of tests or failures
    • Unusually high numbers of repairs or replacements
    • Lack of warranty information in packaging
    • Unbranded packaging
    • Products that don’t look like the product ordered
  • Conduct a risk assessment to look for areas to watch more closely
  • Train all employees on bribery and corruption prevention
  • Reward employees for ethical behavior

 

 

Employee Fraud Detection Tips


Watch for the following red flags:

  • Employees with a lavish lifestyle that doesn’t match their salary
  • Employees who don’t take vacation
  • Employees who routinely stay late and work on weekends
  • Frequent tips or complaints about an employee
  • Inventory shortages
  • An employee who reluctant to share his or her job function
  • Large number of write-offs in account receivable
  • Employees who seem to feel the rules don’t apply to them

The best way to detect employee fraud is through tips, which is why implementing a whistleblower hotline can be the best deterrent.

According to the ACFE 2016 Report to the Nations, the most common detection method is tips, with 39.1 per cent of frauds being detected this way.

Employees who know that there’s a hotline and a company culture that encourages its use have more than just the bosses to be worried about.

Every employee becomes the eyes and ears of the company.

Dawn Lomer
Dawn Lomer

Managing Editor

Dawn Lomer is the managing editor at i-Sight Software and a Certified Fraud Examiner (CFE). She writes about topics related to workplace investigations, ethics and compliance, data security and e-discovery, and hosts i-Sight webinars.

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