Existing practices in financial anomaly detection typically use rules-based systems to find breaches of control. An example of such a rule is a transaction amount limit.

Using rules-based systems is the backbone of today’s auditing methods.  However, often this approach fails to find material financial misstatements and fraud. Clever fraudsters understand these rules and get around them. Rules only capture what is explicitly coded into them.

Rules are designed and implemented for each known circumstance that requires control or management. This means rules based systems will not catch unanticipated scenarios. Even with the example of the transaction amount limit, the commonly known way to ‘work around’ simple limit rules is transaction splitting. Often the rules themselves create the opportunity or scenario for the exploit. The data from the Association of Certified Fraud Examiners shows that the higher the education level of the perpetrators, the higher the loss the organization suffers and in most scenarios the perpetrators have at least a University level education.

Tip-off most likely way to catch a fraudster today

The most likely means of which a fraudster gets caught today is through a tip-off, roughly 40%, and industry associations tell organizations to add “fraud hot lines” to gather these tips. Conversely, automated controls and IT systems based on rules only catch a small percentage of scenarios — approximately 3%.

The rate of fraud is increasing and the time to detect fraud is also increasing. In almost every measurable way rules based systems which use data sampling are losing this battle. To compound the problem, Lexis Nexis estimates that the cost to correct $1 of fraud is $2.40.

It’s time for a change because clever people will figure out a way around rules.