Preventing payment fraud and shadow spending

Payment fraud has tripled from $9.84 billion in 2011 to $32.39 billion in 2020 globally. It is projected to continue increasing, reaching an estimated cost of $40.62 billion in 2027, marking a 25% rise compared to 2020. This surge in fraudulent financial activities can be attributed to a combination of factors, including the widespread adoption of online payment systems, the increasing sophistication of fraud techniques, and the collaborative efforts of criminals facilitated through the dark web. In light of these risks, it is essential for individuals and businesses to proactively implement protective measures and maintain constant vigilance to ensure the security of their financial transactions.

Understanding Payment Fraud and Shadow Spending

Payment fraud can be categorized into external and internal frauds, each with its own set of risks and challenges. Understanding these distinctions is crucial for organizations to develop effective strategies to combat fraud.

• External Fraud: External fraud refers to fraudulent activities orchestrated by individuals who are external to the organization. These individuals may have no direct affiliation with the company but aim to exploit vulnerabilities in the payment system to cause financial, material, or reputational harm. Common examples of external payment fraud include:
  • Impersonation: Fraudsters pose as legitimate customers or vendors to deceive organizations into making unauthorized payments. According to the Federal Trade Commission, USA, over 1.4 million individuals in the United States fell victim to identity theft in 2021.
  • Account Takeover: Criminals gain unauthorized access to customer accounts, allowing them to make fraudulent transactions or transfer funds. Seon reports that 22% of adults in the US were victims of this type of fraud in 2022, with average losses of around $12,000 per case.
  • Data Breaches: Hackers infiltrate the organization's systems or third-party platforms to steal sensitive payment information and use it for fraudulent purposes. A study by Comparitech analyzed the share prices of 34 companies listed on the New York Stock Exchange that experienced major data breaches, revealing an average drop of 3.5 percent after 14 market days.
  • Phishing Attacks: Fraudsters send deceptive emails or messages, often mimicking reputable organizations, to trick employees or customers into revealing their payment details. In 2021, a staggering 323,972 internet users worldwide became victims of phishing attacks, indicating that half of the cybercrime victims fell prey to this method. These attacks resulted in a total loss of $44.2 million, with an average of $136 being stolen per phishing attack.
• Internal Fraud or shadow spending: Internal fraud occurs when an employee of the organization intentionally commits fraudulent acts against their employer. These individuals exploit their insider knowledge and access to perpetrate payment fraud schemes. One prevalent concern within organizations is shadow spending, in which employees circumvent procurement policies and initiate purchases without obtaining prior authorization. This unauthorized approach to making purchases not only undermines the established controls and guidelines for trade payables but also poses a risk of financial mismanagement and potentially fraudulent activities. PwC's findings indicate that a substantial 43% of fraud cases involving losses exceeding $100 million are attributed to insiders. Shadow spending can take various forms, including:
  • Embezzlement: Employees misappropriate company funds for personal gain by manipulating financial records or diverting payments to their accounts. Statistic Brain reports that employee theft imposes a significant financial burden on US businesses, amounting to approximately $50 billion annually.
  • Vendor Fraud: Employees collude with external vendors to create fake invoices or overstate charges, leading to improper payments. Vendor fraud caused a total loss of $10.24 billion in 2022 alone.
  • Insider Trading: Employees use privileged information to manipulate stock prices or engage in illegal trading activities for personal profit. A classic example is the flash crash instigated by Navindar Singh Sarah in 2010, in which insider trading caused a sudden 36-minute stock market crash worth $1 trillion.
• External and Internal Fraud: In some instances, external fraudsters collaborate or manipulate internal employees to carry out payment fraud schemes. This combination of external and internal fraud creates additional complexities for organizations. Examples of such scenarios include:
  • Social Engineering: External fraudsters manipulate or deceive employees into disclosing sensitive information or performing fraudulent transactions on their behalf. In March 2019, the CEO of a UK energy provider got a call from someone who sounded just like his boss. The call was so convincing that the CEO transferred $243,000 to a bank account he believed belonged to a legitimate "Hungarian supplier," but it turned out to be a scammer's account.
  • Compromised Employees: Internal employees willingly or unwittingly collude with external fraudsters to execute payment fraud schemes, leveraging their knowledge and access to circumvent controls. The LIBOR Scandal is an example of this. It involved bankers from multiple major financial institutions who conspired to manipulate the London Interbank Offered Rate (LIBOR), gaining widespread attention.

Impacts of Financial Fraud on Companies

External fraud and shadow spending can have significant ramifications for companies, extending beyond the immediate financial losses incurred. The consequences of fraud can affect various aspects of a company's operations and reputation. Here are the key impacts of financial fraud on companies:

Financial Loss and Costs: Financial losses are the first direct outcomes of financial fraud. Enron, once hailed as "America's Most Innovative Company," experienced one of the largest corporate fraud cases in the 21st century. Despite reaching a stock high of $90 in August 2000, a year later, a warning from Enron finance executive Sherron Watkins about a brewing accounting scandal prompted investigations that revealed overstated profits of nearly $600 million. The company declared bankruptcy within two months, leading to a criminal investigation and causing significant job losses and financial harm to ex-employees pension plans.

Companies may also incur expenses related to potential restitution, program reviews, audits, and retrofitting or redesigning of processes and systems.

Reputational Damage: Martha Stewart's insider trading scandal in the early 2000s led to a loss of reputation for her brand. The New York Times Syndicate column "AskMartha" became known as "Living," while "AskMartha Weddings" was simply renamed "Weddings". After her trial, The Martha Stewart Living television program suffered a 50% decrease in viewership as sponsors and networks withdrew their support, resulting in a net loss of $2.7 million in profit for 2003 compared to a profit of $7.2 million in 2002.

Legal and Regulatory Consequences: Companies involved in financial fraud face legal and regulatory consequences, including investigations, penalties, fines, and potential lawsuits. In 2020, Wells Fargo, facing a historic account fraud scandal spanning several years, agreed to pay a substantial $3 billion penalty to the Department of Justice (DOJ) and the Securities and Exchange Commission (SEC).

Operational Disruption: Fraud incidents can disrupt normal business operations, causing inefficiencies, delays, and distractions. Fraud may necessitate takeovers, which can cause significant operational challenges. Operational disruptions can also impact employee morale and productivity, potentially leading to higher turnover rates. Satyam Computer Services, an Indian IT services company, faced a major financial shadow spend scandal in 2009. The company's founder and chairman, Ramalinga Raju, admitted to inflating the company's assets and profits for several years. The revelation shook investor confidence, and the company's operations were severely impacted. Satyam eventually had to be sold to another company to ensure its survival, which resulted in considerable layoffs and employee turnover.

Competitive Disadvantage: Companies may fall out of the competitive business landscape following financial fraud. For example, as a result of PwC’s alleged involvement in the Satyam Computer Services scandal, the company was banned from auditing listed companies in India for two years.

Compromised Business Relationships: Fraudulent activities can damage relationships with customers, suppliers, and partners. Suppliers and partners may hesitate to engage with a company associated with financial fraud, affecting supply chains and collaborative efforts. HealthSouth, a major provider of healthcare services in the United States, was involved in a massive accounting fraud scheme in the early 2000s. As news of the fraud broke, several insurance companies and healthcare providers ended their partnerships with HealthSouth, leading to a significant loss of business and tarnishing the company's reputation.

Preventive measures

Financial fraud can have devastating consequences for individuals, businesses, and the overall economy. Implementing preventive measures is crucial to mitigate the risk of fraud and safeguard financial systems. Here are key preventive measures that can be implemented:

1. Establish Strong Internal Controls:

• Implement robust internal control systems to ensure checks and balances across financial processes.
• Segregate duties and responsibilities to prevent a single individual from having complete control over financial transactions.
• Regularly review and update internal control procedures to address emerging fraud risks.

2. Conduct Regular Risk Assessments:

• Perform comprehensive risk assessments to identify vulnerabilities and potential fraud risks within the organization.
• Evaluate internal processes, systems, and controls to identify weak points that could be exploited by fraudsters.
• Prioritize risks and allocate resources accordingly to strengthen controls in high-risk areas.

3. Enhance Employee Awareness and Training:

• Provide comprehensive training to employees on fraud prevention, detection, and reporting.
• Promote a culture of ethics and integrity, emphasizing the consequences of fraud.
• Educate employees on common fraud schemes and red flags to watch out for in day-to-day operations.

4. Implement Fraud Detection Technologies:

• Utilize advanced data analytics and artificial intelligence tools to detect patterns and anomalies indicative of fraudulent activities.
• Implement robust monitoring systems to track financial transactions, identify suspicious patterns, and trigger alerts for further investigation.

5. Conduct Regular Audits:

• Perform regular internal and external audits to assess the effectiveness of internal controls and identify potential weaknesses.
• Independent audits help uncover irregularities and ensure compliance with legal and regulatory requirements.

6. Encourage Whistleblowing and Reporting:

• Establish confidential reporting channels to encourage employees and stakeholders to report suspected fraudulent activities.
• Protect whistleblowers from retaliation and ensure anonymity to foster a culture of reporting.

7. Stay Updated on Industry Best Practices:

• Keep abreast of emerging fraud trends, technologies, and regulatory changes to adapt preventive measures accordingly.
• Collaborate with industry peers and participate in forums and conferences to share knowledge and experiences in fraud prevention.

8. Utilize cutting-edge technology solutions

• Use automated data management systems, including automated data entry and processing, to avoid inadvertent errors and deliberate alterations to financial data.
• Integrate advanced data monitoring tools that can continuously analyze financial data in real time, flagging suspicious transactions or patterns for further investigation.
• Deploy artificial intelligence-based fraud detection systems that can learn from historical data and adapt to new fraud patterns, improving detection accuracy over time.

By implementing these preventive measures, businesses can significantly reduce the risk of financial fraud and protect their assets, reputation, and stakeholders' interests.

The Use of Technology in Fraud Prevention

In the realm of fraud detection, technology plays a pivotal role in bolstering defenses through the digitization and automation of financial processes. By digitizing all financial documents and transactions, organizations can create a centralized and easily accessible repository of data, enabling efficient monitoring and analysis. Through automation, checks, and approval protocols can be implemented, ensuring that every financial transaction undergoes a rigorous verification process. For instance, the procure-to-pay process can incorporate three-way matching, cross-referencing purchase orders, receipts, and invoices to identify any discrepancies or irregularities.

Moreover, automation brings significant improvements in accuracy and data validation. By automating data entry and reconciliation, the risk of human error is minimized, enhancing the integrity of financial data. Validation protocols can be established to verify the authenticity and completeness of financial information before it is processed, reducing the chances of fraudulent activities going unnoticed.

Data digitization solutions like Nanonets are powerful tools in the prevention of payment fraud and shadow spending. Solutions like Nanonets may be integrated with fraud detection systems empowers organizations with effective measures to combat fraudulent activities. By leveraging Optical Character Recognition (OCR), Nanonets extract text from images of documents like bank statements and ID cards, enabling thorough analysis for fraud detection. Its image classification models identify fake documents by detecting patterns and feature unique to genuine ones, such as manipulated bank statements or forged ID cards. Nanonets also ensure data validation by cross-referencing entered information with trusted sources to identify inconsistencies and potential fraud.

The solution's signature verification capabilities authenticate signatures on critical documents, detecting forgery attempts. Moreover, Nanonets excels in document segmentation, extracting specific information like account numbers and addresses for comparison with the original document to identify tampering or fraud. Integrating Nanonets with fraud detection systems enhances accuracy, speed, and automation, empowering organizations to proactively combat payment fraud and mitigate the impacts of shadow spending.

Takeaway

Payment fraud and shadow spending pose significant risks to individuals, businesses, and the global economy. The rise of sophisticated fraudulent techniques and the increasing adoption of online payments have created a challenging landscape.

However, by implementing preventive measures and leveraging advanced technologies like Nanonets, organizations can enhance their ability to detect and prevent payment fraud. The integration of machine learning and AI-powered solutions enables the efficient extraction and analysis of data from various documents, empowering organizations to identify fraudulent patterns, detect fake documents, validate data, verify signatures, and ensure document integrity.

By staying vigilant, adopting robust fraud detection systems, and leveraging cutting-edge technologies, businesses can protect themselves against payment fraud and shadow spending, safeguard their financial transactions, and maintain the trust of their customers and partners. Ultimately, a proactive and comprehensive approach to combating payment fraud is essential to preserve the integrity of financial systems and promote a secure and trustworthy digital economy.