With the UK on the brink of recession, firms are likely to see a heightened risk of fraud in the coming months. For law firms with significant responsibility for clients, including access to client funds, the threat is particularly pronounced. But while attention is typically turned to external fraudsters, firms may overlook the risks from within, as employees struggle with a growing cost-of-living crisis.

Recession driving rising fraud risk

The UK is current in the grips of a significant cost-of-living crisis, with inflation to everything from fuel to food placing a heavy financial burden upon ordinary households.

Unfortunately, these trends show few signs of abating quickly. Latest forecasts from the Bank of England suggest that the UK economy is set to enter recession this year, as it continues to recover from recent economic shocks, including rising inflation, and Russia’s invasion of Ukraine.

For businesses, this outlook is set to exacerbate already challenging conditions. But it also threatens to introduce new challenges, including a heightened incidence of internal fraud, involving actors driven either by need, or greed. According to the Cifas Internal Fraud Database (IFD), published in December 2022, cases of fraud carried out by staff against their employer were up by a quarter compared to the same time in 2021.

In particular, the data revealed an 8% increase in dishonest actions, such as a rise in those stealing cash or manipulating accounts. IFD figures also revealed a 48% increase in people unsuccessfully trying to deceive potential employers, by concealing adverse credit and employment histories to gain access to organisations and businesses.

Threats to law firms

For law firms, the threat of internal fraud can manifest in several ways. This may include:

  • Theft of funds or property belonging to a client – e.g. misuse of powers of attorney
  • Misapplication or dishonest investment of funds belonging to a client
  • Misrepresentation to a client concerning held funds, or concerning the performance of investments managed by the firm
  • Theft of funds belonging to the firm – e.g. misappropriation or interception of cash received in payment of fees
  • Misapplication of funds belonging to the firm – e.g. to purchase goods or services for personal consumption

Firms should also be aware of more general threats to businesses, such as:

  • Inflating individual salaries through alterations to a firm’s payroll
  • Fraudulently overclaiming overtime or expenses, supported with false documents – e.g. cancelling hotel bookings and requesting refunds directed to personal accounts
  • Theft of equipment belonging to the firm, such as unreturned laptops or phones

Aside from the recession, other factors may also exacerbate the likelihood of internal fraud. For instance, employees working on a remote or hybrid basis may feel they are protected from managerial oversight, and emboldened to commit fraud.

Regardless of the nature of the crime, all instances of successfully committed fraud have the potential to negatively impact not only upon a firm’s financial health, but also its image, client relationships, and staff morale. A firm's reputation depends, therefore, on its ability to protect itself from fraudulent activities and ensuring any incidents are handled effectively.

Identifying the warning signs

To help prevent internal fraud, there are a number of warning signs that firms should consider, which may indicate that an employee is engaged in malicious activity.

Unusual behaviour is a crucial red flag. Employees working excessive hours without cause, or showing reluctance to take advantage of their holiday allowance, may fear the consequences of a colleague or manager reviewing their work, and thus uncovering their fraud.

Similarly, employees who demonstrate a sudden shift in lifestyle – such as a driving more expensive car or wearing a new watch – may be a cause for concern. In such cases, firms will have to evaluate the legitimate windfalls in an employee’s life, versus the gains from fraudulently obtained funds. This is likely to be a difficult undertaking.

Other actions will be more obvious, such as employees submitting suspicious or inconsistent transactions, or those found to be accessing information outside of the scope of their usual responsibilities.

There are also a number of measures that firms can implement to reduce their likelihood of falling victim to internal fraud:

  • Conduct robust recruitment checks – including taking up of writing references, enquiring regarding previous disciplinary records with any Solicitors Regulation Authority (SRA) regulatory department, or other recognised bodies
  • Make the transition between office and homeworking more seamless to reduce employees’ isolation, discouraging and limiting opportunity for acts of fraud
  • Ensure people have the appropriate access to data and systems according to their job requirements, including robust approval and verification processes for payments
  • Include fraud risk within internal training programmes, making employees aware that it will not be tolerated, and ensuring managers and staff are educated on the warning signs
  • Implement a confidential whistleblowing policy to ensure swift notification of suspected fraud

Coverage for internal fraud

From an insurance perspective, protection for fraud related losses has been available in the market for many years, in the shape of Fidelity Guarantee Insurance (FGI).

Traditionally, FGI policies have offered protection against losses experienced as a result of theft by employees. In more recent years, the market has expanded the available coverage, and moved to what is now referred to as Commercial Crime Insurance (CCI).

There were two main additions to the cover:

  • Losses sustained by the insured firm as a result of dishonesty by any person not just an employee, where any person includes partners or members of the firm
  • Losses sustained by a client of the firm as a result of dishonesty by an employee

For law firms, however, it is standard market practice for CCI policies to carry an exclusion for any claims resulting from the loss of client monies or funds. This exposure is instead picked up by the firms’ Professional Indemnity Insurance (PII), subject to the terms and conditions of the PII in place.

As with all insurance policies, there will be policy exclusions in place. Two potential exclusions are explained below:

  • Past knowledge of fraud – the CCI policy might exclude claims arising from the act of an employee where a director, officer, trustee, partner, or member acquired knowledge of previous crimes committed by the employee either before or during their employment with the firm
  • Shareholders – the CCI policy might also carry a ‘shareholders’ exclusion, where the insurer will only pay out that part of the loss which is in excess of the value of the shareholding on the day immediately preceding the date of discovery of the crime, if the crime has been perpetrated by that shareholder.

For further information, please contact:

Frances Lodge, Assistant Vice President

T: +44 (0)20 7933 2905

E: frances.lodge@lockton.com