Public employees’ retirement systems are entrusted with managing substantial funds to secure the financial future of its members. The sheer magnitude of these funds makes this an area ripe for fraud, and when combined with opportunity, pressure, and rationalization — the three sides of a fraud triangle — it’s easy to see how the consequences can become disastrous. With many organizations currently focused on security risks posed by external threats like firewall breaches, cyberattacks, phishing schemes, and malware, it’s also important to prevent or minimize fraud that can be perpetrated internally, including possible misappropriation of plan assets, data manipulation, and financial reporting fraud.
To understand how to protect plan assets from internal fraud and processes you can use to identify fraud in its earlier stages, it’s important to look at the four main cycles in a public retirement system: contributions, distributions, expenses, and investments.
Ensuring data integrity in retirement contributions reporting
Contributions of fraud in public retirement systems can manifest in various ways, including origination from the employer side. Given the complexity of member data reporting, fraud could be achieved through discrepancies in member information — such as salary or employment status — reported to the system. While these risks primarily stem from employer reporting, retirement system administrators can play a role in preventing and detecting potential fraudulent reporting by establishing checks and balances to validate the accuracy of reported contributions. By implementing rigorous data verification processes, conducting regular employer payroll audits, and leveraging technology to detect anomalies, plan administrators can help ensure the integrity of the system and protect the long-term sustainability of member benefits. Examples of controls to consider include:
- Employer reporting oversight. Require certified payroll reports from employers, with attestation by a responsible officer. Implement random audits of employer-submitted data, focusing on high-risk indicators like significant fluctuations in reported wages.
- Verification of data. Perform automated cross-checks between payroll systems/employer reporting and retirement system databases to identify potential discrepancies in member status or contributions reported.
Strengthening oversight of benefit distributions
The integrity of benefit distributions is paramount to maintaining trust and financial accountability in your retirement system. However, this area is particularly vulnerable to internal fraud without robust controls in place. For example, a retirement system benefits employee could fraudulently initiate benefit payments for a term-vested participant who hasn’t yet elected to begin receiving benefits, effectively diverting funds under false pretenses. Another risk involves misdirecting legitimate benefit payments to personal accounts that don’t belong to the intended retiree or beneficiary. These scenarios underscore the critical need for strong internal controls to safeguard against misuse and ensure that distributions are accurate, authorized, and secure. These controls can help prevent distribution fraud:
- Segregation of duties. Separate responsibilities for initiating, approving, and processing benefit payments can minimize the opportunity for fraudulent behavior.
- Multilevel authorization. Require two independent approvals for initiating or modifying benefit payments as well as for any changes to bank account information. This will ensure legitimacy and reduce the risk of misdirection.
- Verification procedures. Implement mandatory verification steps to confirm the identity of those requesting benefits, such as notarized benefit applications or other verifiable documentation to confirm the retiree has formally requested benefits. Establish procedures to validate the ownership of bank accounts receiving benefit payments (including confirmation of identity prior to implementing any account change requests).
- Regular audit trails. Maintain detailed logs of all distribution-related activities and changes, with regular reviews by internal audit or compliance teams.
Mitigating expense fraud
Fraudulent expenses can take many forms and are often perpetrated through schemes that exploit weaknesses in internal control, oversight, and segregation of duties. Retirement systems are particularly vulnerable due to their complex administrative structures and large asset pools. For example, an accounts payable clerk may engage in fraudulent activity by establishing fictitious entities and submitting invoices for services that were never provided. These illegitimate expenses can be disguised as miscellaneous plan costs, administrative fees, or investment management expenses, enabling the misappropriation of funds without immediate detection. To help prevent the misappropriation of assets through payment of expenses, systems should ensure the following controls are in place:
- Segregation of duties. Keep asset custody separate from transaction authorization and implement strict recordkeeping to reduce the risk of expense fraud.
- Dual approval and access controls. Implement a dual approval process for any cash payments being made out of the trust/plan to ensure transactions are reviewed by more than one person. Ensure that all new vendors added to the system are appropriately vetted and reviewed by more than one individual. Limiting access to cash disbursements and recordkeeping systems also helps to reduce the risk of unauthorized payments.
Minimizing investment misconduct
Investment-related fraud can occur internally through misappropriation of investment funds to unauthorized accounts or falsifying investment records and manipulating the valuation of alternative investments to conceal losses or inflate returns. Fund managers may also make unauthorized investment decisions for personal gain or under pressure to meet unrealistic return targets. Consider the following controls to reduce investment-related fraud.
- Segregation of duties: Ensure that no single individual has control over multiple aspects of financial transactions, including the purchase and sale of investments. For example, separate the responsibilities for authorizing and recording transactions to prevent unauthorized changes or the falsification of investment records reported. Implement controls to ensure any changes to bank wire information for distributions or capital calls are properly verified and approved.
- Appropriate governance and oversight: Ensure investment policies are approved by the board and reviewed annually. In addition to this approach, require independent oversight of investment decisions by another party, such as an investment committee, and document all investment decisions, including due diligence reviews to verify the credentials of investment managers.
- Valuation and performance monitoring: Use data analytics to compare reported returns to benchmarks and peer funds to identify and investigate abnormalities with fund performance. Review valuation methodologies and assumptions for alternative investments on a regular basis.
Trust but verify: Strengthening internal safeguards
In all retirement systems, individuals responsible for managing the plan’s assets hold a position of considerable trust. The key to maintaining this trust is implementing verification processes that ensure controls are not only in place but are consistently followed and monitored. Actions to build and verify trust include:
- Segregation of duties. Ensure no sole individual can perform multiple key steps to modify contributions, initiate distributions, direct the payment of benefits, or pay plan expenses.
- Continuous monitoring. Use data analytics to identify anomalies at the earliest stage possible.
- Regular reconciliations. Perform regular reconciliations between payroll contribution records and plan records to confirm that money is getting where it’s supposed to go.
- Creative and random tests. Apply tests creatively and somewhat randomly to prevent fraudsters from anticipating and circumventing controls.
Securing the future: A call to action for fraud prevention
Safeguarding public employee retirement systems requires more than defending against external threats — it demands vigilant oversight of internal processes and employer reporting. By implementing robust controls, leveraging technology, and fostering a culture of accountability, your plan can significantly reduce fraud risk and ensure the long-term integrity of member benefits. Proactive prevention today protects trust and financial security for your members tomorrow.
