Guest Blogger – Carolyn F. McNiven (DLA Piper)

Although 56 percent of fraud cases were preceded by red flags, instances where actions were taken in response to those red flags "fell massively" since 2007, according to a global KPMG survey. This is probably the most surprising and eye-opening observation in KPMG’s 2011 study, which also found that most fraud was committed by long-term employees, particularly male executives between the ages of 36 and 45; and individuals who worked in the finance area. The increased failure to respond to red flags highlights the need for companies not only develop system for identifying red flags, but also acting on them.

The other notable development KPMG found was an increase in the number of fraud matters perpetrated by company board members. According to KPMG, fraud by board members increased from 11 percent in 2007 to 18 percent in the 2011 analysis. Overall, it found that, "people most often entrusted with a company’s sensitive information and able to override controls are statistically more likely to become perpetrators." Nevertheless, this increase in crimes perpetuated by board members is significant.

KPMG’s global survey was based upon a review of 368 actual fraud investigations conducted by KPMG member firms in 69 countries, over the period January 2008 and December 2010. It only took into consideration frauds that were material to the company. According to KPMG, the majority of the investigations involved matters that were not publicized.

Some might argue that the nature of the investigations themselves accounted for this result: namely that only larger companies are in a position to engage KPMG to investigate such matters, consequently perpetrators examined by KPMG are necessarily more likely to be corporate executives who are in a position to commit fraud that is material to such companies. While KPMG’s data pool was necessarily limited, I think that it would be a mistake to discount their observations. Among other things, their profile of a fraudster fits the typical demographic of white collar criminal defendants in the United States, at least those prosecuted for federal crimes in the past few years, and is consistent with what I observed during my over 13 year tenure with U.S. DOJ.

Fraud is by and large an opportunistic crime. Insider-fraud thrives in environments of trust and access, as the survey points out. Individuals in the executive suite and higher level employees in the finance area are less likely on average to be closely supervised than clerks in accounts receivable. By analogy think of the security surrounding bank employees: tellers have their cash drawers counted after every shift; bank loan officers, who have access to vastly larger sums of bank funds, are generally not scrutinized in the same way although they too are human and subject to the same impulses to steal and self-deal.

That being said, KPMG’s observation that most perpetrators were long term company employees, is noteworthy. KPMG found in its 2011 survey that a solid majority (60 percent) of perpetrators worked at the company for more than five years; and 33 percent of perpetrators had worked at the company over 10.

So what turns a good employee into one who commits fraud? KPMG found that the primary motivators behind the fraud they investigated were greed and work pressure. KPMG found that attempts "to conceal losses or poor performance (possibly due to pressures to meet budgets and targets, to enhance bonuses, or to safeguard against loss of employment)" were motivating factors in many cases. Of course, greed – satisfied by misappropriating assets – was the other primary motivator that they identified.

Good employees turning bad may well also result from the same economic and cultural shifts we have seen in other areas. People — particularly the middle class — were hard hit in the recession resulting in increased financial pressure, which in turn can create the incentive to steal or "borrow" from one's employer. That incentive combined with a fairly systemic disenchantment with employers — particularly those that downsized significantly –creates an environment where workers may be more likely to take what they can get from an employer, particularly if they believe that they are being undercompensated or the employer has transgressed in some way (for example, by paying its upper level management disproportionately while cutting staff and middle management).

All-in-all, KPMG’s 2011 global survey is eye-opening, and a reminder to all companies that they cannot be complacent. At a minimum, companies should regularly ensure that internal controls are operating effectively to prevent and detect insider fraud; and that red flags are not only seen, but acted upon.

Carolyn F. McNiven is a partner in DLA Piper’s San Francisco office where she is a Partner in the White Collar, Corporate Crime and Investigations practice. She is a former long-time federal prosecutor, and handles white collar criminal defense and related administrative, regulatory and compliance matters for individuals and companies. She has particular expertise in the areas of health care, food and drug, and FCPA compliance counseling, risk assessment and litigation.