Protecting Yourself from Bad Business Practices

By Eddie Childs

Like so many other small businesses these days, Cynthia’s company has been struggling. Even worse, the numbers haven’t been adding up lately, and a large amount of money seems to be missing. In fact, she has begun to suspect someone might even be stealing from her, but who? Surely it couldn’t be trusty Angela in accounts payable, could it? The woman is so dedicated to her job that she hasn’t taken a vacation in almost two years! It could all just be a mistake, right?

Any business owners finding themselves in Cynthia’s predicament might want to consider consulting a forensic accountant or hiring an attorney who works with one. On an annual basis, occupational fraud and the associated economic damages cost billions of dollars to businesses across the U.S., and these incidents are only increasing. Couple that fact with other common bad business practices—such as sloppy accounting or online-transactions-gone-wrong (just for example)—and the effects can be devastating.

“Small businesses are particularly vulnerable to fraud, economic damages and lost profits,” says Laurie Dyke, managing partner and expert forensic accountant with IAG Forensics, “and it isn’t abnormal for these businesses to become bankrupt by the actions of just one employee.”

By most accounts, Dyke isn’t exaggerating—especially when it comes to occupational fraud. In its yearly “Report to the Nations,” the Association of Certified Fraud Examiners (ACFE) has found that small businesses suffer an average loss of $100,000 per scheme from fraud and other abuses. Significantly, Dyke notes, these are higher than the losses experienced by much larger companies, because larger businesses generally have better internal controls in place.

“Small businesses don’t think it’s ever going to actually happen to them, so many of them are unwilling to spend the money for fraud prevention services,” she says. “When it does happen, they have to call somebody to investigate, and it costs ten times as much in fees, plus whatever they lost.”

Preventing Occupational Fraud
Unfortunately, the risks associated with many companies’ razor-thin bottom lines cannot allow for a single bad hire involving anyone in a position of trust, or who will otherwise have access to bank accounts and other financial information. Falsified resumes, employee crime, negligent hiring lawsuits and ineffective/inept employees mean pre-employment screening is an important control in minimizing your own company’s risks.

“Our clients find that, by background-screening their candidates, their average hiring cost, turnover rate and risk of negligent hiring claims are greatly reduced, while employee productivity and longevity are increased,” says Tammy Cohen, president of Cobb-based InfoMart. “Merely checking references supplied by an applicant isn’t going to give you the information you need to determine whether he or she poses a threat to the safety and security of your company.”

According to Cohen, candidates’ former employers will often only divulge confirmation of employment and dates of service. A professional background screening company will provide many more services including criminal record searches onsite at the courthouse, sexual offender registry checks, licensure verifications and education verifications.

Of course, employee screening can only be so effective a control when it comes to discouraging and preventing occupational fraud. “We see many breach-of-trust cases involving long-time, trusted employees with no prior record; so in those situations, background checks would have made no difference,” says Susan Murphy, a Cobb resident and an attorney with Schulten, Ward & Turner—a law firm that often works with Dyke and IAG Forensics. “Typically, embezzlement by a trusted employee is revealed when they take a vacation or are otherwise out of the office.”

Only then, when someone else steps in to do their job and discovers something unusual, is any attention drawn to this individual who may previously have been considered above suspicion. “This doesn’t mean that every person who appears to be a dedicated employee is really a fraudster if they don’t take a vacation,” says Dyke, “but it’s a very important internal control to make sure that every employee takes at least a week of vacation a year.”

Likewise, Murphy suggests employers would be prudent to install a checks-and-balances system dividing labor and responsibilities, thereby insuring that a single person doesn’t gain total control over a critical area. “For example, an employer probably shouldn’t have the same person who writes the checks also be the one to receive and reconcile the bank statements,” she adds.

Dyke suggests another possible internal control could involve hiring a forensic accountant in a consulting role to do what she calls a “fraud-checkup” beforehand, as opposed to doing so once one has become suspicious that fraud has already occurred. “It’s just like buying insurance. There’s no guarantee that fraud won’t occur, but a few thousand dollars up front can prevent a lot of loss on the back-end,” she says. “Bigger firms do this already—many of them have internal audit departments and they already have an ongoing process.”

Understanding The Fraud Triangle
When a large sum of money goes missing, business owners want to be sure a legitimate mistake has occurred as opposed to outright fraud or embezzlement. According to Dyke, occupational fraud primarily happens because business owners and managers trust too much. “I’m certainly not advocating that you distrust everyone that you come into contact with, but I ascribe to the old philosophy of ‘trust but verify,’” she adds.

A lot of studies have been conducted about what factors are typically in place when employees steal. The ACFE has subsequently identified what it calls a “fraud triangle” that says three major factors are present in almost all fraud schemes, which are crucial in understanding why employees might steal.

One is a critical (or seemingly critical) financial need that has emerged on the part of the employee. “You know, they have a sick spouse or child, or they’ve run up a lot of debt, or they’re going through a divorce or an extramarital affair,” says Dyke, “but there’s some reason they need more money than they have from their regular sources, and frankly in today’s economy, there are a lot of people who are under a severe amount of financial pressure.”

The second key point on the ACFE’s “fraud triangle” is the predisposition and willingness of the employee to rationalize their actions to explain them to themselves or somebody else. “There’s 10 percent of people who won’t steal under any circumstance; they’d lose their house and let their children go hungry before they’d steal,” says Dyke. “And there’s another 10 percent who would steal just because they can. The other 80 percent of people think of themselves as usually being honest, but under the right circumstances, they could steal.”

In all reality, business owners and managers are more or less powerless in controlling the first two factors, which lie entirely in the life experiences and psychologies of their employees—namely, the financial need and the rationalization. However, Dyke says, the third factor of the ACFE’s “fraud triangle” is one that can be controlled, and that’s where the employee is presented with the opportunity to steal.

“The reason we see fraud in a lot of these organizations, small businesses and non-profit organizations in particular, is that the business owner or manager gives trust to employees and gives them access to assets,” she says. “If they can’t sign their name on the checkbook or they don’t have access to the signature stamp, they really can’t steal cash. If they don’t have access to the inventory, then they can’t steal the inventory; but [business owners and managers] trust them too much to do their jobs, which gives them the opportunity to steal.”

Trusting Your Instincts
Interestingly enough, in almost every case Dyke has investigated, she says that numerous red flags existed which may have indicated an ongoing case of fraud long before it was detected. “There’s something than an employer might think is wrong and gives them all these little butterflies in their stomach, but they ignore it,” she says. “Our No. 1 recommendation is ‘don’t trust too much,’ and our No. 2 recommendation is ‘go with your gut.’ Don’t ignore red flags when they’re there.“

This generally happens, of course, because some of the most challenging cases are the ones involving long-time, trusted employees. For the business owner, the stakes are far higher than simple business.

“There’s often a sense of personal betrayal,” says Murphy. “Someone they’ve worked side-by-side with for years, sharing personal moments—birthdays, Christenings and graduations—has been stealing from them. Employees who have been with the company for a long time know the company systems inside and out. They know the weak spots and can exploit them.”

And if your instincts are telling you that you’re a fraud victim? Dyke warns that forcing a confrontation too early and acting rashly can often have disastrous results. “Once you fire an employee, then they’re gone from your premises and you may not have access to them anymore,” she explains. “The best route is to investigate quietly, gather all the evidence — bring in [and attorney and/or a forensic accountant] if you have to—approach the employee when you know what’s going on, and then many times you can get a confession and arrange restitution.”

*Originally Published in Cobb In Focus Magazine

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