What is Payroll Fraud? Types, Signs, and Prevention Measures

Payroll fraud can significantly undermine your organization’s financial stability and integrity. This is in addition to the loss of employee trust and operational disruptions that can impact business performance.

Gone undetected, the negative impacts of payroll fraud can escalate, potentially leading to difficulty in recovering losses and increased scrutiny from auditors and regulators.

Continuous and proactive measures can help detect and prevent fraud, but the success of your strategies will largely depend on the quality of your payroll system. The right system should help improve vulnerability detection, data protection, and incident monitoring, ultimately safeguarding your organization from potential fraud.

This guide provides effective actionable steps you can take to implement your payroll in a way that guards your business against fraud.

What is payroll fraud?

Payroll fraud is the embezzlement of an organization’s funds through breaches in the payroll process, resulting in financial losses.

This type of fraud often occurs by exploiting weaknesses in payroll systems and controls, such as manipulating payroll records, making unauthorized changes to workers’ compensation and benefits, and payments to non-existent employees.

The 2024 Report to the Nations by the Association of Certified Fraud Examiners revealed that payroll fraud cases averaged a loss of $383,000 USD. But these losses can go significantly higher than that.

For instance, B.A. Blacktop Ltd. and Eurovia BC Inc. collectively lost roughly $2 million USD in a payroll fraud case. The payroll administrator executed this fraud by issuing unauthorized wage payments to herself and altering employees' banking details to divert their salaries into her account.

Any type of payroll fraud poses a significant threat to your financial stability.

What are the most common types of payroll fraud?

Payroll fraud can originate from both internal and external sources.

Payroll fraud from internal sources

This is when employees or insiders within the organization exploit their access to payroll systems to commit fraud.

Examples of internal payroll fraud schemes include:

• Payroll padding: Increasing an employee’s paycheck through unauthorized means, such as altering pay rates.
• Timesheet fraud: Manipulation of timesheets through tactics like buddy punching and double dipping to receive compensation for hours not worked.
• Ghost employees: Fictitious employees in the payroll register who receive wages in a fraudulent account controlled by the fraudster.
• Unauthorized bonuses: Collusion between a payroll administrator and employees to claim bonuses for which they are not eligible.
• Workers’ compensation fraud: Obtaining workers' compensation insurance benefits under false pretenses, such as exaggerating or faking workplace injuries.
• Commission scheme fraud: Manipulating commissions earned by sales representatives through falsifying sales records.
• Expense reimbursement fraud: Submitting expense claims to receive reimbursement for expenses that were either never incurred, inflated, or unrelated to business activities.
• Worker misclassification: Incorrectly classifying employees to benefit from lower payroll taxes or other financial advantages.

Payroll fraud from external sources

This is fraud committed by external agents who exploit weaknesses in the company’s payroll system.

Common forms of payroll fraud from external sources include:

• Payroll diversion: Cybercriminals posing as employees use phishing or email takeovers to redirect paychecks to unauthorized accounts controlled by the fraudster.
• Data breaches: Fraudsters hack into the payroll system to steal sensitive employee information and manipulate or redirect employee wages.
• Man-in-the-Middle attacks (MITM): Cybercriminals intercept and alter communication between the payroll system and banks to redirect funds to their own accounts.

What are the warning signs of payroll fraud?

Here are some red flags that can help you detect payroll fraud, enabling you to take timely corrective action:

• Unusual pay rates, such as employees with significantly different pay rates or salaries compared to their peers in similar job functions.
• Unusual patterns in claimed overtime hours by employees.
• Unauthorized or frequent changes to employee bank details or personal information.
• Patterns of payments that deviate from normal payroll trends, such as unusually high or low payments.
• Complaints or concerns raised by employees regarding payroll errors, discrepancies, or suspicious activities.
• Unexpected emails regarding payroll that you did not submit.
• High volume of manual adjustments or corrections to employee payroll records.
• Inconsistent or missing key fields in employee records.

5 payroll management practices to prevent payroll fraud

Use these strategies to protect your organization from potential payroll fraud.

1. Establish strong internal controls

Internal controls are your first line of defense in preventing payroll fraud. You need solid procedures and practices tailored to protect the integrity of your payroll and enhance accountability.

Effective internal controls also streamline payroll processes, making them more efficient and less prone to errors. Additionally, they provide mechanisms for the early detection of security issues.

At a minimum, implement these internal controls:

Segregation of duties

When any one individual has excessive control over payroll, it becomes easier to commit and conceal fraud.

Split your payroll management tasks among different employees and establish clear authority lines.

For example, one employee can handle preparing the payroll, another can manage the approval of pay changes, and a third can oversee the verification of payroll data and transactions.

Regular payroll audits

Conduct regular payroll audits to verify records. Cross-check payroll records with employee files and confirm their presence to ensure all listed full-time employees and independent contractors are legitimate and currently employed.

Pay special attention to:

• New hires
• Changes in bank accounts
• Requests for changes in direct deposit information
• Spikes in overtime
• Employee logins that occur outside of business hours
• Changes in pay rates or inconsistencies in job roles and compensation

The payroll audits should be random, as unpredictability can discourage employee fraud.

Consider periodic external audits as well. They can provide an unbiased review of potential vulnerabilities and reveal ways to improve your payroll processes that internal audits might miss.

Regular bank reconciliations

Conduct regular reconciliation of the company’s bank statements with payroll accounts. It allows for the early detection and investigation of any discrepancies.

Look out for:

• Any timing differences between payroll processing dates and bank statement dates
• Unclaimed or stale-dated checks
• Inconsistencies in the number of pays per cycle and the number of active workers
• Transactions to unfamiliar accounts
• Cases of workers who split direct deposit pays into multiple accounts

Proper authorization procedures

Require managerial approval for all payroll changes, including new hires, terminations, and salary adjustments.

This ensures someone is accountable for each payroll action. It also prevents unauthorized individuals from making alterations or fraudulent modifications.

Whistleblower mechanisms

Set up multiple, secure, and confidential channels that employees and independent contractors can use to report suspected fraud or misconduct without fear of retaliation.

Workers are more likely to report suspicious behavior when they believe their concerns will receive serious attention and that you will maintain their confidentiality.

2. Automate payroll

Investing in a payroll automation system, such as Deel, reduces opportunities for fraudulent manipulation. It also ensures consistent application of your payroll internal control policies and procedures.

This is possible through features like:

• Strict access controls
• Detailed audit trails
• Approval workflows
• Automated compliance with regulatory requirements
• Automated reconciliation of payroll accounts
• Real-time monitoring tools
• Reporting and analytics that uncover unusual patterns in the payroll data

Additionally, effective payroll systems integrate with your time and attendance tracking system. This ensures accurate capture of employees' working hours, automatically using them for payroll calculations and eliminating the risk of fraudulent overtime claims.

3. Offer employee training

Raise awareness among employees about payroll fraud. Educate them on different types of fraud, both internal and external, and how to identify, prevent, and report suspicious activities.

It’s also important to inform them about the organization's steps to mitigate these risks. Explain the importance of following the policies and procedures related to payroll processing and the consequences of non-compliance.

Offering training doesn’t have to be disruptive. With a tool like Deel Engage, you can use social and micro-learning on Slack or Teams to provide on-demand training.

4. Establish clear and comprehensive payroll policies

The guidelines you establish to govern your payroll processes should safeguard your business against scams. This includes:

• Thorough background checks during the hiring of payroll employees to ensure they have no history of fraud or misconduct.
• Regularly verifying employee information to prevent unauthorized changes.
• Clear procedures for payroll processing, including how to handle adjustments, corrections, and approvals.
• Role-based access controls for the payroll system to restrict permissions based on job functions.
• Clear guidelines on ethical behavior related to payroll processing and outlining the consequences of fraud.
• A multi-tiered approval process for expense claims and requiring original receipts before reimbursement.
• Strict password policies, such as changing passwords to the system whenever there’s a change in payroll employees.

5. Enhance security measures

Implement strong security measures to prevent unauthorized access and mitigate cyberattacks on payroll systems.

For instance, keeping your payroll software and security systems up to date with the latest patches and updates can help protect against vulnerabilities. Two-factor authentication is also an effective measure against unauthorized access and cyberattacks.

Additionally, enforce strong password policies that include complexity requirements and regular password changes to further reduce the risk of unauthorized access.

It’s also crucial to maintain detailed audit trails of payroll system access, transactions, and changes. It helps in the detection and investigation of any unauthorized activities.

How to select payroll software for effective prevention of scams

Having a sustainable enterprise payroll solution in your tech stack makes implementing these preventive measures easier.

Look for these features when choosing a payroll solution to ensure it meets your needs.

1. Opt for an all-in-one payroll platform

Dealing with multiple systems and vendors increases the risk of payroll fraud. This is due to potential inconsistencies in controls, data discrepancies, and difficulties in monitoring and auditing.

Choose an all-in-one payroll solution that streamlines processes and consolidates HR data for all the countries where your organization operates.

A solution like Deel offers seamless payroll management along with an integrated HR platform. This combined solution covers other HR tasks, including:

• Onboarding
• Employee benefits administration
• Expense management and payouts
• Employee management

2. Ensure comprehensive data protection capabilities

Only work with a tool that has strong payroll data protection capabilities. This includes features like data encryption both at rest and in transit, as well as strict access controls based on the principle of need-to-know.

Don't simply rely on the payroll service provider’s promises. Verify that they possess industry-standard data protection certifications.

Complete certification means that the payroll system has been officially validated by relevant authorities for meeting established security, operational, and regulatory standards.

Be sure to look out for certifications like the following, all of which Deel Global Payroll holds:

• ISO/IEC 27001: Ensures that the payroll system has robust security controls in place to protect sensitive payroll data from unauthorized access and breaches.
• SOC 2 / SOC 3: Confirms that the payroll system has undergone independent evaluation against the Trust Service Criteria for security, availability, processing integrity, confidentiality, and privacy.
• GDPR Compliance: Indicates that the payroll system has implemented measures to protect the personal data of EU employees in accordance with GDPR requirements.
• HIPAA Compliance: Ensures that health-related information within the payroll system is securely protected for US workers.
• CCPA Compliance: For systems handling data of California residents, this certification verifies that the payroll system respects privacy rights and upholds high standards of data protection.

3. Check for infrastructure that is incident-proof

When evaluating a payroll system, look for built-in features that effectively prevent, detect, and respond to security incidents and fraud attempts. Ensure the system has the following:

• Secure cloud infrastructure
• Regular penetration testing
• Comprehensive vulnerability and patch management processes

For instance, Deel Global Payroll runs on AWS EKS-based cloud infrastructure. It benefits from 24/7 SIEM SOC monitoring and includes CSPM (Cloud Security Posture Management) and DSPM (Data Security Posture Management) capabilities.

This setup provides comprehensive protection against security threats and data breaches. It continuously monitors and analyzes system activities, secures cloud configurations, and manages data protection.

This results in real-time detection and response to potential incidents, maintaining the integrity and security of the payroll system.

4. Evaluate its reporting features

Payroll reports are effective in uncovering deviations from normal data patterns, such as unusual spikes in overtime or bonus payments.

By comparing current payroll data with historical data or benchmarks, you can identify discrepancies and anomalies, prompting timely investigation and corrective action.

However, it’s important to check how comprehensive the reporting feature is. With a multi-country payroll, for instance, you’ll need a global payroll system like Deel that can consolidate different currencies and integrate data across multiple jurisdictions.

This capability ensures you can accurately identify irregularities despite the complex global setting.

5. Assess its integration capabilities

Check that the payroll system has built-in integration options or enables custom integrations through an API, as Deel Global Payroll does.

The ability to integrate your payroll solution with tools, such as accounting, time tracking, and expense management tools enables seamless and accurate data transfer across these systems. It reduces the need for manual processes that create opportunities for tampering and fraud.

Effective integration strengthens payroll fraud prevention by ensuring all related information synchronizes and that monitoring occurs in real time.

Protect your business and employees with Deel Global Payroll

Payroll fraud can originate from within the organization or from external agents. In either case, payroll automation, strong internal controls, and firm policies are your core defenses.

Additionally, it is crucial to implement strong security measures to protect payroll transactions and employee records. Prioritizing employee training to recognize and report suspicious activities is also important. Together, these actions form your defense against fraudulent activities.

Deel Global Payroll simplifies the management of these defenses and minimizes payroll fraud risk through features such as:

• AWS-hosted infrastructure, complete with AWS EKS
• Full certification for data security
• Employee privacy training
• Automated data breach alerts
• Single sign-on (SSO) options with two-factor or multi-factor authentication
• Penetration tests and advanced vulnerability and patch management
• Strong password policy with secure one-way salted hashing
• Role-based access control
• Data encryption at rest and in transit
• 24/7 monitoring of access attempts
• Integrated HR platform to handle all aspects of human resources management

You can experience firsthand how Deel improves and secures your payroll processes by booking a demo.