Red Flags of Fraud

Building on an earlier Trends and Issues paper, "The Psychology of Fraud" (No. 199), this paper identifies warning signals for fraud, and proposes some preventive or pre-emptive action. Four fraud types are examined: * entrepreneurial fraud; * client or employee fraud; * direct interpersonal fraud (face-to- face); and * indirect mass fraud. Examples of each of these are evident in our daily lives and there are often warning signals. Not all of these "warning signals" are necessarily precursors to fraud, but it should be noted that the most productive investment in fraud control is likely to involve strategies which reduce opportunity and enhance guardianship. The setting or context in which fraud may occur can be more or less conducive to offending. This paper aims to enhance our understanding of the situational elements of fraud risk, to permit the design of effective fraud control systems. Adam Graycar Director Introduction Fraud, like all crime, is the product of three factors: a supply of motivated offenders; the presence of a prospective victim or target; and the absence of a capable guardian (Cohen & Felson 1979). This general rule applies whether one is referring to fraud against government benefit programs, fraud against elderly people, or misappropriation of corporate assets by a company director. A previous essay (Duffield & Grabosky 2001) explored the motivational basis of fraud. It concluded that a number of psychological factors may be present in those persons who commit fraud, but that they are also associated with entirely legitimate forms of human endeavour. Moreover, technologies of prediction remain imperfect. This paper will look at what are commonly called "red flags" or indicators of fraud (Krambia-Kapardis 2001, pp. 49-52). These indicators are not inevitably or universally associated with fraud. Rather, their presence suggests a degree of fraud risk. Conversely, their absence is no guarantee that a situation or circumstance is "fraud-proof. But when these indicators are present, the risk of fraud is high, and a degree of caution or extra preventive measures may be appropriate. For analytical convenience, we will follow the same basic outline as we did in our earlier paper "The Psychology of Fraud" (Duffield & Grabosky 2001). First, we restate our typology of fraud, then we discuss our general indicators of fraud risk. We then discuss those red flags which are more specific to particular fraud types. We categorise fraud in terms of the organisational context in which it occurs, and the nature of the relationship between offender and victim: * Fraud committed against an organisation by a principal or senior official of that organisation. Examples of this include offences against shareholders or creditors by errant "high-flying entrepreneurs" (Sykes 1994) or corrupt practices by senior public officials. * Fraud committed against an organisation by a client or employee. This category includes embezzlement, insurance fraud, tax evasion and other fraud against government. * Fraud committed against one individual by another in the context of direct face-to-face interaction. This would include classic "con games" (Maurer 1940) , customer frauds by sales staff, and predatory activities against clients or customers by fraudulent investment advisers, roof repairers and others who prey directly on a consumer. * Fraud committed against a number of individuals through print or electronic media, or by other indirect means. This would include Nigerian advance fee frauds (Smith, Holmes & Kaufmann 1999), share market manipulation, and deceptive advertising or investment solicitations pitched at a relatively large number of prospective victims. General Indicators of Fraud Risk In the broadest terms, the fundamental red flag of fraud is the anomaly - a variation from predictable patterns of behaviour or, simply, something that seems out of place. …