Fraudulent activity occurs under the radar, and many times, employers do not recognize the red flags hinting that trusted employees are abusing the system. Today's market, with high gas prices and record foreclosures, may well provide the motivation for financial fraud.
This motivation combined with opportunity and rationalization comprise what is known as the fraud pyramid. And as the business world evolves into a paperless environment, there is less hard evidence for employers to identify fraud.
“Internal controls have to be designed with technology in mind to compensate for the lack of paper evidence,” says Michael A. Coakley, a director in the Audit and Accounting Group at Kreischer Miller.
Employers can reduce incidences of fraud by developing systems that squeeze out fraud opportunities.
Smart Business asked Coakley to describe common fraud schemes and what employers can do to protect themselves.
What are some common ways that employees commit financial fraud in the workplace?
Any time financial assets are exposed, employees can beat the system. A payroll clerk can set up an account for a fake employee or keep a terminated employee active in the system and collect his or her paycheck. An employee responsible for payables may create an invoice from a vendor that doesn’t exist, then cut the check and deposit it into a fictitious bank account. Wire transfers may be arranged, or checks written for amounts that do not require a joint signature. If someone is practiced in committing fraud, financial statements won’t necessarily shed light on the situation until enough time passes that a trend becomes evident at which time it may be too late.
If fraud isn’t always apparent on financials, what are other red flags that should tip off employers?
You should know employees well enough to recognize changes in their lifestyles or habits. For example, if an employee that always drove an older car has traded up for an expensive car, is there a valid explanation for this? If a worker who never goes on vacation is all of a sudden taking elaborate excursions, an employer should raise an eyebrow. On the flip side, beware of employees who never take a sick day or vacation people who are always at their desks. This ‘loyalty’ could indicate that the worker must stay on top of activities so no one else in the organization catches on to a scheme.
What are the first steps toward preventing fraud?
Fraud prevention begins during the hiring process. Employers should perform careful background checks on all candidates and always check references. Many problems with dishonest employees can be avoided by doing the homework.
Though managers can’t control employees’ motivations for committing fraud, they can establish systems to reduce workers’ opportunities to take advantage of the company. Segregation of duties is critical. The person who opens the mail should not also prepare deposit slips, take checks to the bank and post deposits to customers’ accounts. Involve more than one person in these financial processes to reduce the risk of collusion and fraud.
What can smaller organizations do when segregation of duties is difficult to accomplish?
For small companies that are lesser staffed, the owner should be visible and regularly involved in everyday business. The presence of an owner or managers who keep a watchful eye is sometimes enough to prevent many employees from even attempting fraud. Also, be sure to assign passwords to accounts, and do not share these with all administrators. Enlist an independent accountant to audit the books annually and check internal controls to look for ‘leaks’ in the system that could present opportunities for fraud. Employers should communicate to their staffs that systems are in place to prevent and detect fraud - let them know that the financial statements and records are periodically reviewed. Finally, have a mandatory vacation policy. A ‘fill-in’ worker may notice any glitches in the system.
What can happen when fraudulent activity occurs over the long term?
In the worst case scenario, fraud can run a company out of business. More often, fraud can disrupt operations and cash flows and can damage relationships with suppliers and customers. For example, if an employee was not paying a key supplier, and was diverting money into a private account instead, that supplier may stop doing business with the employer. From a big-picture perspective, when fraud occurs in public corporations, investors may lose confidence in the company and stock prices can decrease in value.
Most fraudulent activity can be prevented by performing thorough employee background checks, segregating duties, maintaining owner or manager presence, and simply communicating to employees that their work activities are being reviewed. This common-sense approach to fraud prevention is an employer’s greatest defense.
MICHAEL A. COAKLEY is a director in the Audit and Accounting Group at Kreischer Miller in Horsham, Pa. Reach him at (215) 441-4600 or firstname.lastname@example.org.