Fraud is moving online. In 2021, when most people were stuck inside because of the pandemic, the Federal Trade Commission (FTC) reported a 70% increase in consumer fraud reports compared to 2020. Consumers lost a total of $5.8 billion to mostly impostor scams and online shopping scams.

But fraudsters don’t just target consumers; they frequently target businesses too. In fact, fraudsters have been known to target their own employers. The Association of Certified Fraud Examiners’ (ACFE’s) 2022 Global Fraud Survey reported that the average business loses about 5% of its revenue to occupational fraud every year. The median cost of each fraud case was $117,000 with some heavy outliers that made the average cost $1,783,000 per fraud case.

The industries most at risk of internal fraud are real estate and wholesale trade, while the industries most at risk of external fraud include e-commerce and insurance. But fraud doesn’t restrict itself to a particular industry. Every company is at risk. In this article, we will cover:

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• What is fraud risk management?
• 5 Fraud Risk Management Principles
  1. Fraud Risk Governance
  2. Fraud Risk Assessment
  3. Fraud Prevention
  4. Risk Detection Mechanisms
  5. Monitoring & Reporting Risk
• Key Takeaways for Effective Risk Management
• Fraud Management FAQs

What is fraud risk management?

Fraud risk management is the process of identifying, understanding, and dealing with fraud risks in an organization. It involves creating a program to detect, stop, and/or prevent both internal and external fraud for an organization. 

Proper fraud risk management reduces the risk of theft, payment fraud, data breaches, account takeover (ATO), corruption, conspiracy, embezzlement, money laundering, extortion, bribery, and all other forms of online and offline fraud. Fraud risk management also frequently closes security loopholes through which various threats, such as application security risks, can reach your business.

5 Fraud Risk Management Principles

The five established principles below provide structure in the fight against fraud, making it much harder for anyone—both inside and outside your organization—to commit an act of fraud against your business.

1. Fraud Risk Governance

Fraud risk governance is the structure of rules, practices, and processes for fraud risk management in a company. A strong and transparent fraud risk governance policy discourages fraudsters because it emphasizes C-level commitment to reducing and controlling fraud risk. Some of the elements of fraud risk governance include:

• Increasing fraud awareness among employees.
• Ensuring the quality of each rule, practice, and fraud risk process.
• Continuous fraud risk monitoring.
• Research on market fraud prevention and mitigation technology.
• Descriptions of the fraud investigation process.

As with all good governance, any element of a fraud risk governance policy should be properly documented, delegated, and easily accessible. Ideally, there should be one person spearheading fraud risk governance.

2. Fraud Risk Assessment

Risk assessment is the process of identifying risks and categorizing them by their likelihood and impact. It allows you to create an easy-to-understand risk quadrant that will help determine with the right type of solution for each type of risk. Here are some helpful fraud risk assessment strategies:

• Understand Your Top Risks: Which fraud risks are the most harmful to your company? You can uncover your top risks with several techniques, such as workshops, interviews, brainstorming sessions, questionnaires, and comparisons with other organizations in your industry.
• Review Your Existing Controls: Do you already have fraud risk management controls in place? How well do they work? Did they uncover any fraud? Can you cheat the controls? All fraud controls should be reviewed frequently.
• Identify Risks and Vulnerabilities: Once you know your top risks, you need to uncover the other risks that may not seem immediately harmful but would deal significant damage. For example, all online companies must prioritize preventing online fraud in addition to common forms of offline fraud.
• Integrate Your Fraud Risk Strategy Across All Departments: Everyone across all departments in your organization should be on the same page when it comes to fraud. This means your leadership team must encourage open communication, transparency, and feedback, while leading by example.

3. Fraud Prevention

Once you’ve written down a fraud risk governance policy and identified and assessed the fraud risks in your organization, you need to implement policies, controls, software, and procedures that will prevent, or at least reduce the chance of, fraud. For fraud prevention, you need to reduce all three aspects of the fraud triangle:

1. Motivation: What are the financial incentives that might encourage people to commit fraud against your business? 
2. Rationalization: How can someone justify committing fraud against your company?
3. Opportunity: How easy is it for someone to commit fraud and walk away unnoticed?

4. Risk Detection Mechanisms

It’s impossible for you to fully prevent fraud—too many factors are outside of your control. That’s why you need fraud risk detection mechanisms to recognize and stop fraud fast, to minimize damage to your business. You need reporting mechanisms that monitor anomalies, such as exception reporting, data mining, trend analyses, etc.

Additionally, you need a streamlined way for your employees to flag fraud. In ACFE’s 2022 Global Fraud Survey, 42% of fraud cases were detected by tips—that’s three times more than the next most common fraud detection method.

5. Monitoring & Reporting Risk

Detecting internal fraud can put an innocent employee in a difficult position. There are many reasons why they may not want to report it: fear of losing their job, uncertainty about whether something is actually fraud, and not knowing how to report it, among other reasons. The best way to avoid whistleblowing silence is through fraud education and a culture of transparency and openness. An anonymous hotline can also be effective.

You should perform frequent internal and external audits to ensure that your fraud policies and controls are working. Even policies that seem to work at first can stop working as fraudsters find new ways around them, and as your organization grows and changes.

Key Takeaways for Effective Fraud Risk Management

Companies of all shapes and sizes are at risk of fraud. Proper fraud risk management reduces your organization’s risk of fraud and tightens security loopholes through which threats can reach your business and customers. Effective fraud risk management means:

• Creating a fraud risk governance policy.
• Frequently assessing your organization’s fraud risks.
• Implementing procedures and solutions to prevent fraud risk.
• Implementing procedures to stop fraud before it does any damage.
• Creating a culture where employees feel safe to report fraud.

Fraud Risk Management FAQs

What type of risk is fraud?

Fraud risk is the chance that an internal (employee) or external fraudster will commit actions that will result in financial, material, or reputational losses for your organization.

What is the foundation of fraud risk management?

The fraud triangle (motivation, rationalization, and opportunity) is at the foundation of fraud risk management, because it evaluates the reasons why someone might be encouraged to commit fraud. Reducing each aspect of the fraud triangle will reduce your risk of fraud.

What is the best way to do a fraud risk assessment?

Every fraud risk assessment should start with a fraud risk quadrant that categorizes fraud risks by their impact and their likelihood of occurring. This allows an organization to create the right fraud risk prevention rules for each type of fraud risk.

What strategy can I adopt to mitigate fraud risk?

Automated fraud prevention software such as DataDome will greatly reduce your organization’s risk of external fraud. The likelihood of internal fraud can be reduced with an anonymous hotline, as well as a culture of transparency and openness.