The recession has led to an increase in fraud perpetrated on businesses. For example, identity theft has become more common, with employees taking images of customer credit cards or hacking into their employer’s system to steal personal information.
“There’s also increased pressure for publicly traded companies to meet earnings expectations,” says Donna Beck Smith, CPA/CFF, CrFA, who leads the financial advisory services practice at Brown Smith Wallace LLC. “Earnings manipulation, via overly aggressive interpretation of accounting rules and manipulation of inventory costs, comes into play, which can lead to fraudulent reporting.”
With companies reducing their work forces, it’s important to put tight controls and surveillance systems in place to minimize opportunities for fraud.
“There’s an opportunity for weaker internal controls because there are not enough people for an effective system of segregation of duties,” says Don Mitchell, CPA/CFF, CFE, co-leader, audit at Brown Smith Wallace LLC.
Smart Business spoke with Mitchell and Smith about the components of the fraud triangle, the warning signs of fraud, what to do if you suspect it and how to prevent it.
What are the components of the fraud triangle?
One is motive — there’s some type of financial pressure, whether from banks or personal financial problems. The second is opportunity — when you have a reduction in force, there is more opportunity to commit fraud because there are fewer checks and balances and less segregation of duties. Finally, there is rationalization — you make the situation look better by thinking you’re just doing it for a short time or you’re going through a difficult period or you’re entitled.
What are the warning signs that fraud is occurring?
You have to watch cash and have good controls over wire transfers and who can set up vendors. Watch for eroding profit margins that you can’t explain, inventory shrinkage or unusual changes in revenue. You might just think it’s because of the down economy, but there could be underlying fraud issues. There’s a much higher need for analysis in this environment.
Another red flag is employees who have a change in demeanor or appearance. If they’re not taking any time off, coming in early or staying late, they may be doing something on the side and can’t afford to be away. Companies are cutting back on overtime, so there shouldn’t be a lot of late night or early morning work.
Background checks are also important during hiring. Many times, people continue to perpetuate the fraud, moving across the country and industries. They just pick up and do their work until just before they get caught, leave, and by the time the fraud is revealed, they’re continuing it someplace else.
What should you do if you suspect fraud?
You should contact a certified fraud examiner (CFE) or certified forensic accountant (CrFA) to assist in determining whether fraud has occurred and the extent to which it has. Is it limited to one employee, or is it a broader base with a large network?
Companies will also typically have insurance coverage for employee dishonesty. You need to give notice to the insurance company, and the CFE or CrFA will assist in filing that claim. After that, it’s up to you to file charges and pursue prosecution. You want to recover what you can — if you can’t recover from the fraudster, you can try to recover on insurance coverages and let the insurance company go after the perpetrator.
How can you educate employees about fraud?
It’s critical that the proper tone is set at the top. If you wink at small indiscretions, employees are going to see that and follow suit. Set up mandatory fraud awareness training for employees so they understand the risks, red flags and repercussions of fraud. Whistleblower policies have also become more common to help protect those who report fraud.
How can a business leader prevent fraud from occurring?
There are many action steps you can take, but the following are critical:
- Separate duties and have a strong set of checks and balances. No one person should have access to a process, such as the cash flow stream, from beginning to end.
- Cross-train employees so you can enforce mandatory vacations. You may boast that Sally or John never took a day of vacation, but if he or she has easy access to cash, that could be an indication of a fraud scheme.
- Secure your check stock and endorsement stamps.
- Set up an ethics hot line for employees to anonymously report fraud. Public companies are required to do this.
- Enforce conflict-of-interest statements requiring that employees not have side businesses or steer work toward companies they have relationships with.
- Have adequate software and IT security.
- Establish an audit committee.
- Conduct a fraud risk assessment to determine which areas of your company are at risk for fraud.
Fraud is a big expense that contributes to the increased cost of goods and services. If you can keep that under control, you can improve your business’s profitability. People also feel better when they know they’re working for organizations with high moral and ethical standards.
Donna Beck Smith, CPA/CFF, CrFA, leads the financial advisory services practice at Brown Smith Wallace LLC. Don Mitchell, CPA/CFF, CFE, is co-leader, audit at Brown Smith Wallace LLC. Reach Smith at (314) 983-1259 or [email protected]. Reach Mitchell at (314) 983-1248 or [email protected].
