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January 31, 2023

Recessions Drive an Increase in Fraud – How your Company Can Proactively Prevent Fraud

From financial executives issuing warnings to massive layoffs in the tech sector, virtually everywhere you look in the news lately, signs suggest the United States economy may be headed for a recession. Whether that actually occurs remains to be seen, but as many news articles suggest, it’s wise to prepare business and personal finances should that unfortunate scenario become a reality.  

Following the 2008 recession, the Association of Certified Fraud Examiners released a report examining the impact an economic downturn has on fraud concluding that reports of occupational fraud increased during the recession and attributed this increase to tremendous financial pressure, breakdowns in internal controls and an overall decrease in employee morale. We explore these themes below. 

Employees Under Growing Financial Pressure 

During times of recession, the financial pressure employees face may increase exponentially. Employees may have a spouse, extended family member or close friend who lost their source of income and need additional funds to survive. As the fraud triangle tells us, the greater a perceived financial need an employee has, the more likely they are to commit fraud. During times like these, employees may also be more likely to rationalize fraud as a means of survival during the recession.  

While financial pressure is often viewed as an external force outside the company’s control, there are steps a company can take to alleviate the employees’ perceived threat. Examples include clear and open communication which may reassure the employee that they are valued and not at risk of termination. Management can develop creative means to meet employees’ needs during difficult times, such as counseling, financial guidance and other employee assistance programs.  

Layoffs Leave Holes in Internal Controls 

Layoffs can often be an unfortunate and unavoidable reality during a recession. Often, layoffs affect layers of middle management who are charged with enforcing the company’s internal controls, which are measures set in place to reduce the risk of occupational fraud.  

Internal controls are only effective if the people entrusted to enact and enforce them are performing their roles diligently. Removing or replacing these key employees can lead to lapses in internal controls which put the company at a heightened risk for occupational fraud.   

Again, with reference to the fraud triangle, weakened internal controls create additional opportunities for fraud. The “opportunity” corner of the fraud triangle is often the area over which management has the greatest control. It’s increasingly important during a recession to maintain, or even increase, focus on implementing and enforcing a strong internal control environment to curb the opportunity for fraud. 

Morale is Down, Fear is Up 

When an employee feels optimistic about the direction of the company and their role within it, they’re much less likely to defraud the company. They want to be a part of the company’s success and can see themselves in their role for many years into the future. 

During economic tumult, employee morale tends to decrease dramatically and employees may view the company as a sinking ship. They may fear that their days at the company are numbered and it’s easy to see how an employee might rationalize looting the sinking ship on its way down.  

It is imperative that management seek ways to reassure its employees that recessions are temporary and have been weathered before. Find ways to keep employee morale up and reassure employees that when you weather the storm, you will come out stronger on the other side. 

Increased Scrutiny on Cash Flows Uncover Fraud  

While the previous sections focus on reasons fraud may increase during a recession, there’s also a distinct possibility that fraud has been occurring all along and has simply flown under the radar, concealed by high revenues and strong margins.  

When a recession hits, companies tend to scrutinize their financial performance more than in times of economic growth, where the company is focused on growing the top-line revenue.  

A recession may bring a cash crunch, leading the company to perform detailed reviews of its operational performance, uncovering fraud that had occurred in the past or is ongoing. Further, employees who are concerned for their jobs and the overall health of the company may also become increasingly likely to “blow the whistle” on fraud that they may have otherwise let slip.  

It’s incredibly important to establish channels to allow whistleblowers to anonymously report fraud, not only in times of recession but always. Tips or hotline reports are consistently and overwhelmingly reported as the most common way fraud is uncovered. 

Forensic Accountants are Here to Help 

We’re committed to helping our clients succeed, including curbing the risk that fraud poses to any organization. Whether by assisting, performing or refreshing fraud risk assessments or investigating known or suspected fraud, Anders Forensic, Valuation and Litigation advisors are here to help. Contact Anders below to get in touch with our forensic advisors.

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