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Battle the Threat from Within

Fact: An organization typically loses 5% of revenue each year to occupational fraud, according to a report from the Association of Certified Fraud Examiners (ACFE),

On a global basis, according to the 2016 ACFE Report to the Nations on Occupational Fraud and Abuse, losses are approaching an estimated $4 trillion a year. Other highlights from the report are:

  • The total loss caused by the 1,410 companies in the study exceeded $6.3 billion with an average loss of $2.7 million.
  • The median loss for all cases was $150,000.
  • Losses of $1 million or more were experienced by 23.2% of cases.

Perhaps even more distressing is that it’s often long-time trusted employees who concoct schemes to defraud the company. A recent case involving falsified vendor invoices — a common occurrence — illustrates the problem of occupational fraud, or the “threat from within.”

Redirecting Funds

In the case, three employees of a Houston company have been charged with eight counts of wire fraud and one count of conspiracy to commit wire fraud. The defendants — two women and one man — are alleged to have electronically submitted falsified vendor requests to divert money from the employer’s bank account to themselves and relatives.

The company is a branch of a Florida-based security company that installs, tests and monitors fire and security systems.

The Houston branch relied on third-party vendors to install the alarm systems. The two female defendants worked in the accounting department and were responsible for paying vendors and logging the transactions.

For five years, from November 2011 until May 2016, the three defendants allegedly diverted more than $1.66 million from the company’s bank account. The indictment alleges that they used a computer in Texas to submit fraudulent vendor requests for payments to their employer’s bank account in another state. They then purportedly used an electronic bank token to release funds from the employer’s account to their own bank accounts as well as bank accounts of relatives (electronic bank tokens are small hardware devices such as smart cards that are used to authorize access to an account).

Categorizing Fraud

This case illustrates just one type of threat from within. Fraud comes in many forms, but generally, there are three main types to watch for:

  1. Misappropriation of assets. This is when an employee steals money or physical assets. For example, a corporate officer might abscond with expensive inventory. In some cases, employees will conduct clandestine operations to circumvent security, facilitating the theft.  Typically, though, misappropriation is simple embezzlement of money. The Supreme Court defined embezzlement as “the fraudulent appropriation of property by a person to whom it has been entrusted or into whose hands it has lawfully come, and it differs from larceny in the fact that the original taking of the property was lawful, or with the consent of the owner, while in larceny the felonious intent must have existed at the time of the taking.” (Moore v. United States, 160 U.S. 268 (1895)) Misappropriation can be as simple as emptying out the petty cash drawer or as complex as transferring funds to an offshore account.
  2. Misrepresentation of financial statements. Here we have what is colloquially known as “cooking the books.” In this fraud, the crook purposely falsifies statements to make the company’s financial position look better (or worse) than it actually is. For instance, the fraudster might falsely boost revenue, lower expenses or put balance sheet figures such as debt-to-equity ratios in a more favorable light. The objective is to deceive other businesses or lenders.
  3. Corruption. This fraud occurs when employees exert influence over business matters to line their own pockets. For example, employees may engage in bribery, extortion or conflicts of interest for their own gain that harm their employer.

Steps to Help Counter Fraud

According to the ACFE, a single fraud continues for an average of about 18 months before it is discovered. Given the type of fraud, that time frame could severely damage your business. To get you started on trying to sidestep the problem, consider the following:

  • Establish a zero-tolerance policy. Let all staff members know that the company will not tolerate fraud. Educate them about the types of fraud and the consequences for violating the policy. When people are expected to be honest, and they know others are watching, they are less likely to succumb to temptation.
  • Observe and detect. Employees on the verge of, or already committing fraud, often show changes in behavior or attitude toward the business. If you are observant, you may catch telltale signs. Someone starts showing up late or performs badly or buys a car or house that is too expensive for the amount of money he or she makes. The better you know the typical behaviors of your employees, the sooner you’ll suspect if something is amiss.
  • Enforce vacations. Workers who never take a sick day or vacation would seem to be ideal. Not so. Not taking time off or sick days could signal that the person is worried about being caught if he or she is out of the office even for a day and particularly for an extended period. Make sure all your employees take some vacation.
  • Institute internal controls. Don’t assume that your company can do business the same way it has for decades. For instance, you can implement internal controls designed to ensure integrity of accounting systems and segregation of duties. Simply put, the employee who receives, logs and disburses payments should not be the same person. Other methods, including detailed documentation requirements, can discourage fraudsters.
  • Set the tone. Fraud protection starts at the top with corporate management and business owners. It can become part of the corporate culture and identifiable to both insiders and outsiders. Top officers can emphasize communication and encourage input from employees. Having an “open-door” policy may help thwart potential problems.
  • Have a visible presence. Make sure that employees are fully aware of fraud deterrents. Your company can reinforce this by informing employees of updates to your monitoring and fraud detection efforts. Follow up with disciplinary action, when warranted.

No company, regardless of size or industry, is immune from fraud. You don’t have to go it alone. You can rely on the expertise of professionals skilled in financial forensics to guide you along the way. In particular, they can help with implementation of internal controls and related anti-fraud procedures. Notably, the services may include accounting audits and forensic analysis that can provide valuable insights.

The full 2016 ACFA report can be found here.

If you believe your company may be the victim of fraud, please contact our experienced fraud examiners today!

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