Red Flag Checklist

Because fraud is a crime of deceit, it is not always apparent that a crime has been committed.  It is therefore crucial that red flags, or fraud symptoms, are looked for in order to detect fraud. The problem, however, is twofold:

-          many people do not know what these symptoms are or

-          do not recognise the red flags as signs of fraud when they do see them.

We have seen red flag checklists of over 100 pages, which will be overwhelming for most employees. We have therefore narrowed down the list to just six categories of fraud red flags that will assist management and staff in recognising potential frauds within their organisations. These six categories are based on the book ‘Fraud Examination’ by Professor W. Steve Albrecht.

The first 4 red flags are ‘operational’ red flags: 

1.  Internal control weaknesses. By focusing on the internal controls that are absent or overridden, we can identify possible areas and suspects, thereby helping us to detect possible fraud. Look out for the employee that hardly ever goes on leave or a lack of segregation of duties.

2.   Accounting anomalies would involve irregularities in source documents, faulty journal entries, and inaccuracies in ledgers. Keep a look out for missing or altered documents, no supporting documents, and photocopies.

3.   Tips and complaints are categorized as red flags rather than actual fraud evidence as many tips turn out to be false.  It is often difficult to know what motivates a person to complain or provide a tip.  Customers, for example, may complain because they think they’re being taken advantage of.  Employees may phone in tips for reasons of malice, personal problems, or jealousy.  Tips from spouses and friends may be motivated by anger, divorce, or blackmail.  Keep in mind that individuals must always be considered innocent until proven guilty. 

4. Analytical anomalies are procedures or relationships that are out of the ordinary or too unrealistic to be believable.  They include transactions that are odd as to:

o           Time (of day, week, month, year, or season)

o           Frequency (too many, too few)

o           Places (too far, too near, and too far out")

o           Amount (too high, too low, too consistent, too alike, too different)

o           Parties or personalities (related parties, strange and estranged relationships between parties, management performing clerical functions)

And the last two categories of red flags are ‘behavioural’ symptoms.

5.   Extravagant lifestyle. Most people who commit fraud do so under financial pressure (gambling, drugs, spousal pressure or pure greed).  Once perpetrators meet their financial needs, however, they often continue to steal, using the stolen funds to improve their lifestyles.  They buy new cars.  They buy expensive clothing & jewellery, go on expensive holidays, remodel their homes, or move into more expensive houses.  Employees can detect potential fraud by focusing on these unexplained changes in colleague’s lifestyles. 

6.   Unusual behaviours. Research in psychology indicates that when people (especially first-time offenders) commit a crime, they are overwhelmed by fear and guilt, which changes their behavior.  For example, a nice person suddenly becomes belligerent.  Or a patient person is no longer patient with anyone. Some other unusual behaviors would be an employee refusing a promotion (because they are currently stealing much more than their promotion would give them!) or the employee that is ‘too good to be true’ – so conscientious that they are always the first to arrive and the last to leave, they also don’t go on leave or, if they do go on leave, they take their work with them – they don’t want anyone else to do their job as the chances of their embezzlement being detected will increase substantially.

Keep in mind that generally no one particular behavior signals fraud, it is the changes in behavior that usually indicates possible fraud and by focusing on these changes; we can identify possible perpetrators of fraud.

The trick now is for every employee within your organisation to be trained on what fraud is, how it affects each employee, what the red flags are and how to report these fraud symptoms. The fraud fighters within organisations (normally just a handful of people) cannot be everywhere at once and rely on all the other employees to recognise and report the red flags that they have seen. These fraud awareness workshops should be held regularly and for all employees – staff, management and directors.    

Do you know if your employees know what fraud is, would they recognize the symptoms, do they know how to report their suspicions, and would they feel comfortable that if they did blow the whistle they would not be ostracized? The only way to achieve this state within an organization is ongoing awareness and dialogue.  

In conclusion then, red flags indicate danger – they do not automatically indicate the existence of fraud. But all red flags must be followed up because early detection of fraud means money saved. Identifying and acting on red flags can reduce the estimated 5% of annual turnovers that are lost each year to fraud and therefore increase shareholder value. So the question to ask now is “can you afford not to provide your employees with regular fraud awareness workshops?�