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 [email protected].