I had an excellent article published in my FraudFiles column in the Wisconsin Law Journal yesterday. The premise of the article is that almost all frauds started small. Even the gigantic frauds of Enron and WorldCom had to start somewhere. That somewhere was small (relatively speaking, anyway), and the key to preventing fraud and minimizing corporate fraud losses lies in catching the small frauds early.

About Enron:

It’s hard to believe that Enron ever did anything small, but it is true. In fact, the downfall of Enron can be traced back to some fairly minor manipulations in the grand scheme of things. One of the early frauds was a manipulation to boost quarterly earnings that otherwise would have fallen just a little short of Wall Street’s expectations.

This type of manipulation at Enron grew over the years. Add a little extra income here, shave a little off expenses there, and manipulate the accounting rules to boost earnings over there. The small fraud grew, and grew and grew. And the more management appeared to turn a blind eye to fraud (and maybe even encouraged fraud), the bigger it got.

How small frauds can start and progress:

It was small, and therefore easy to rationalize in the mind. Maybe the thief decided it was just “borrowing” or rationalized that the money represented excess funds that no one would miss. Either way, a small sum of money was pretty easy to justify.

Many frauds start with an error, which makes the process of justification even easier. That first fraud wasn’t her or his fault anyway! Someone in a position of trust sees that an error wasn’t caught by the company’s system of checks and balances. Maybe a bank account didn’t balance, but no one said anything about it. Or an accounting entry was made to an incorrect account, but no one ever noticed.

These types of oversights can tempt an employee to take advantage of the weaknesses in the system. The employee typically commits that first fraud, and then looks for opportunities to further manipulate the system where the monitoring is lax.

On stopping the smaller frauds:

It’s hard to catch fraud when it’s small because the fraud is scattered throughout the company. From the expense report abuse by an executive, to a purchasing manager who accepts a personal gift, to the employee who padded her hours, these things can be very small in the grand scheme of things. The mere fact that they’re small makes them hard to detect.

In addition to being hard to detect, small frauds often get a pass from management because they don’t seem worthy of the effort. Even though it may not seem cost-effective to seek out the small frauds, if you look at it in terms of preventing larger frauds, it’s worth it. Halting a small fraud completely prevents that situation from getting out of control. That activity can never turn into a big fraud. That seems worth the effort.

Stopping the small frauds also reinforces a zero tolerance policy. When employees see that fraud and abuse is stopped and consequences are given, that goes a long way toward preventing future frauds. An employee who may otherwise have been tempted to test the system or exploit a weakness may consider the consequences given to other employees who committed fraud.

Read the whole article for more comments on stopping these small frauds.