The conventional wisdom—reinforced by the revelation in the last year of huge scams such as the Madoff and Satyam frauds—is that downturns increase levels of fraud. This year’s annual Global Fraud Survey, commissioned by Kroll and carried out by the Economist Intelligence Unit, presents a much more complex picture. The financial crisis has changed the effects of the risks underlying fraud.

Those risks that grow as companies expand—entry into new markets, for example—have actually declined in importance. In simple terms, less money coming into a company and more oversight of spending despite financial constraints limit the opportunity for crime.

The downturn, however, has heightened other risks. Pay stringency in the face of lower revenues, for example, has provided a motive for fraud, and perhaps even turned employees to crime. How these conflicting trends play out, however, varies markedly by sector. Those closer to the original crisis—financial services and professional services in particular—have seen an increase in their incidence and level of fraud. Those for whom the main economic news has been a pronounced drop in sales, and therefore business activity—such as construction and natural resources—have instead seen noticeable declines. Economy-wide the two trends cancel each other out to a remarkable degree. The incidence of fraud is almost identical to that found in last year’s survey, and the average loss per company has risen only slightly in the new survey, to US$8.8 million from US$8.2 million.

The downturn has increased the motive for fraud, but decreased the opportunity
The economic crisis in isolation has raised some fraud risks. Thirty percent of survey respondents say that the global financial crisis has increased the levels of fraud at their organisations, compared with just 5% who saw a decline. Lower profits heighten some risks. One in six companies are seeing greater vulnerability from reducing internal controls to save money, one in seven from pay restraint, and one in eight from reduced revenues overall.

A constrained business environment, however, reduces other dangers as businesses and individuals adopt more defensive behaviour. Survival-focused companies might retrench rather than expand; employees might stay in existing jobs rather than take a chance on new ones. As a result, three factors which often increase fraud vulnerability are having noticeably less effect this year. The number reporting that high staff turnover is raising such exposure has dropped (from 32% to 26%), as has the number seeing greater risk out of entry into new markets (from 32% to 24%) and from increased inter-firm collaboration (from 28% to 20%). Moreover, if companies take in less money in sales, they also have less money to steal. Companies would rarely cut down on business activity simply to reduce fraud, but at least there is a silver lining.

A Tale of Two Sectors: Changing risks have had vastly different impacts in different industries

The contrasting fortunes of the financial services and construction sectors illustrate how these shifts have had such different effects. The former, the epicentre of the financial crisis, saw combined average losses to fraud over the last three years rise to US$15.2 million, or 18% above the 2008 survey figure. The number of sector companies suffering at least one fraud rose to 87%, slightly above the survey norm, from 79%, comfortably below. Most notably, over one-half of respondents indicated that the crisis had led to an increase in the number of cases of fraud at their companies.

The picture for the construction, engineering and infrastructure industry is markedly different. In this sector, the combined average fraud figure dropped by more than one-half, to US$6.4 million from US$14.2 million, making the sector’s losses, for once, below the average level.
The demands of survival in a downturn are also having an impact on which types of fraud are more prevalent for these companies. At a time when government contracts are of increasing importance, and may even mean the difference between survival and collapse, corruption and bribery have seen a marked increase from the levels reported in 2008. Conversely, with much less money to steal, management conflict of interest is down noticeably and, with fewer projects, even compliance breaches have declined.

These types of changes, albeit on a less dramatic scale, have occurred across the economy. Professional services, for example, another sector close to the financial crisis, has seen a marked increase in fraud. Meanwhile, natural resources companies, which have also suffered in the last twelve months from a decline in revenues, have seen a drop in fraud levels. Whether the downturn brings more fraud depends on the line of work. At the economy-wide level, the contrasting tendencies have almost cancelled each other out.

A variety of data indicate that the net change in the fraud picture is tiny, and may even be zero.

• Most see only a slight change at company level As noted earlier, respondents believed that the financial crisis itself had increased levels of fraud. When asked, however, about the last year—precisely when the downturn has been taking its toll—in more general terms, 31% said that fraud levels had declined, and an additional 34% had experienced no change. Only 21% had noted a rise. More importantly, any shift was muted: 67% saw a slight change, at most, in either direction; only 22% reported a substantial change.
• Overall, the incidence of fraud and related levels of worry in this year’s survey are almost identical to those of last year Suffering some kind of fraud is the overwhelming norm in business, but this has long been the case. The table on page 6 of the report gives the percentage of the firms hit by the various categories of frauds in the last three years according to the current survey as well as the corresponding figures from the 2008 survey. The relative ordering has changed little, and all but two of this year’s numbers are within 2% of those from the previous survey—the kind of differences that could easily appear in two surveys taken at the same time. Similarly, the percentage of respondents who considered their companies highly or moderately vulnerable to these frauds stayed roughly the same as last year, albeit with slightly greater variation.
• The average fraud loss has risen slightly in the last year, but this masks larger, countervailing changes across the economy The average combined loss to fraud per surveyed company for the last three years was US$8.8 million, only 7% higher than the 2008 survey figure of US$8.2 million. This hides greater underlying change. Five of the sectors covered in this report saw increases in their average losses, and five saw declines. Moreover, while in this year’s survey larger companies—those with over US$5 billion in annual sales—reported greater average losses, up to US$25.8 million from US$23.3 million in the 2008 survey, the situation actually improved for smaller business—those with yearly revenues under US$5 billion—dropping to US$4.6 million from US$5.5 million.

The change is likely to last only as long as the downturn
Although in the aggregate, fraud levels are little changed, this reflects a substantial shift in business behaviour, which is increasing certain types of fraud risks and diminishing others. Much of this is driven by the downturn, which has left some sectors far more exposed to fraud than others. Just as the current economic situation is temporary, however, these shifts are likely to reverse with renewed growth. Companies should beware, that when volumes and profits start to rise, the fraud risk kaleidoscope will take another turn.