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Employee Fraud Up in a "Down" Economy
 

April, 2009

Are instances of employee fraud likely to rise, as more and more businesses falter or fail, while the United States economy remains in a long and painful recession? While not even the experts can prove that there will be a distinct and measurable corollary between economic downturn and an upswing in employee fraud, there already is anecdotal information coming out of the business world that paints a troubling picture for apprehensive business owners and managers, many of whom are looking at contracting markets, shrinking margins and workforce reductions. Conditions are such that one recent auditing firm's poll revealed that almost two-thirds of executives are of the mind that accounting fraud will increase over the next two years.
 
Largely as a result of the deep and protracted economic downturn we are in the midst of, in many firms there are lower or non-existent raises; bonuses that have been shrunk or done away with entirely; lay-offs, rumors of lay-offs and reduced job security for those remaining on the payroll; and resultant lower morale and heightened stress and unease among many employees. Will these conditions result in higher levels of employee fraud? If so, what may cause a disgruntled employee to "cross the line" and commit fraud, and what can you, as a business owner or manager, do to stem what may be yet another growing, and potentially very serious, threat to your company's "bottom line?"
 
In an effort to determine why people commit fraud - whether under good or bad economic conditions - famed criminologist Dr. Donald R. Cressey developed a now widely accepted theory called the "Fraud Triangle" while researching his doctoral thesis in the 1950's.  According to the Dr. Cressey, there are three factors that, when combined, may lead a person to commit fraud.  The first factor is the pressure from an individual's financial problems.  The second factor is the person's perception the there is an opportunity at work to help resolve the financial problems without getting caught.  The third factor is the person's rationalization of the intended illegal action.  In other words, pressure plus perceived opportunity plus rationalization equals fraud.
 
In 2006 the Association of Certified Fraud Examiners (ACFE) conducted and published its Analysis of Occupational Fraud and Abuse wherein the ACFE estimated that 5% of annual revenues are lost to fraud.  The median length of time elapsed before a fraud is detected in 18 months.  The highest median cost of employee fraud was found in the wholesale trade ($1.0 million), construction ($500,000), and manufacturing ($413,000) industries; the lowest median losses were found in government organizations ($82,000) and retail organizations ($80,000).
 
Types of Fraud
 
Employee fraud can be broken down into three main types:  asset misappropriation, bribery and corruption, and financial statement fraud.  Some fraud schemes involve more than one type of employee fraud. According to the ACFE, asset misappropriation is the most frequent type of employee fraud; statistics indicate that it occurs in over 91% of fraud schemes.  Examples of this type of fraud include check forgery, theft of cash and checks, inventory theft, payroll fraud, and theft of services.
 
Bribery and corruption occurs in about 30% of discovered fraud.  It has been estimated that the average bribery / corruption scheme costs a company about $538,000 and examples of this criminal activity include kickbacks, shell company schemes, influence peddling, contract manipulation, and the substitution of inferior goods. Financial statement fraud occurs in over 10% of all fraud cases.  The average financial statement fraud costs a company about $2.0 million and examples include stock price manipulation and improper favorable loan terms.
 
In its 2006 Analysis, the ACFE collected information on over 1,100 cases of employee fraud that were reported between January 2004 and January 2006.  The ACFE reported that businesses employing less than 100 people were the most vulnerable to fraud and abuse. This was generally due to the failure of management in many companies to proactively detect fraud.  More small business frauds were detected by accident than by any other means. The ACFE found that the most common employee fraud in small businesses involved employees fraudulently writing company checks, skimming revenues, and processing fraudulent invoices. 
 
It was a finding of the ACFE that the position of the perpetrator is typically and predictably linked to the size of the company's loss.  Specifically, frauds committed by executives caused a median loss of $1.0 million, or five times more than the median loss caused by managers, and almost 13 times the median loss caused by an employee.  The ACFE also found that over 30% of the employee frauds were committed by accounting department personnel.  Less than 8% of the perpetrators had convictions prior to committing their acts of fraud.
 
The Warning Signs of Fraud
 
There are warning signs that might indicate employee fraud and there are steps that organizations can take to help prevent, deter, and detect employee fraud.  Be aware that company downsizing and lay-offs may trigger employee fraud.  Some of the fraud warning signs to be aware of include rising costs with no explanation, customer complaints of missing statements, and suppliers or contractors who insist on dealing with one employee.
 
Sometimes a fraud alert results from management's willingness and ability to recognize and effectively respond to employees whose actions or behavior arouse a degree of suspicion. These employee "red flags" include the following: 
 
Employees who consistently work late
Employees who are reluctant to take a vacation or personal time
Change of lifestyle / living beyond one's apparent means
Employees with too much control over company money and/or other assets 
Employees with external business interests
Employees who remain in the same position rather than move up the career ladder
Employees who are resistant to procedural changes
Employees wearing unusually loose clothing to work
Employees bringing large shopping bags to work, and
Employees using unauthorized exits
 
Take Steps to Mitigate the Risk of Fraud,
and Respond with Speed and Prudence when Fraud is Detected!
 
In addition to being always conscious of, and alert to, these warning signs, there are other proactive measures a company can take to help prevent employee fraud.  First and foremost, each company should establish a fraud policy that is first approved by legal counsel and then included in the Employee Handbook.  The fraud policy should clearly state that the company has zero tolerance for employee theft of any sort.  Furthermore, the fraud policy should contain clearly defined examples of employee fraud, a list of repercussions for fraudulent acts, and the methodologies the company may use to discover fraud and gather supporting evidence.  A comprehensive fraud policy enables a company to investigate the slightest suspicion of employee fraud. Additionally, employee fraud can be prevented through use of fraud awareness programs, by establishing an anti-fraud corporate culture, by developing and using effective internal controls, and by using technology, such as security cameras that, if properly deployed and managed, can help to both thwart and deter criminal activity. 
 
Research has shown that when it comes to employee fraud, time is of the essence.  Although most frauds start small, if not checked, they often lead to larger frauds. Therefore, a company's legal department should establish effective evidence-gathering procedures to help ensure that evidence substantiating fraud cases is both properly and expeditiously obtained, handled, packaged, and secured, in order to avoid evidence tampering.  Remember that the burden of proof is on company management.  Courts are unsympathetic to companies that cannot provide adequate proof of employee fraud.
 
Prosecuting Employees Who Commit Fraud
 
Mr. Paul Henninger, Director of Fraud Solutions at Actimize, cautions that once an investigator has confirmed a case of employee fraud, the business faces challenges in resolving the crime and prosecuting the offenders. In an optimal situation, the investigator quickly compiles comprehensive data on the employee's suspected crime and confronts the employee in the workplace where the crime occurred.   Arguably, the best outcome from this scenario is often a signed confession and termination of employment for the miscreant.
 
Steps Businesses Can Take to Reduce the Risk of Employee Fraud
 
What can be done by businesses to respond to the threat of employee fraud? The ACFE found that confidential hotlines are a very important fraud detection tool.  In fact, 44% of the million-dollar frauds in its study were detected by anonymous tips.  This is more than twice the rate of detection by internal audits and three times the rate of detection by external audits.  Organizations with anonymous fraud hotlines suffered a median loss of $100,000, while organizations without such hotlines had a median loss of twice that amount.  The ACFE also found similar reductions in fraud losses for organizations with internal audit departments that performed random audits and that conducted anti-fraud training for employees and managers.
 
The "10-10-80" Rule
 
There is an old fraud-prevention saying called the "10-10-80" rule that holds that 10% of people will never steal, 10% will steal at any opportunity, and the remaining majority of employees can go either way depending on how they rationalize opportunities.  This 80% majority can be influenced to act in their companies' best interests by the actions taken by their employers.  The following are some steps that companies can take to avoid employee fraud:

 
Make sure all checks, purchase orders, and invoices are numbered consecutively and regularly audit for missing documents.
Use a "for deposit only" stamp on all incoming checks to prevent an employee from cashing them.

Give special scrutiny to bills that include products and/or services delivered elsewhere.

Require two signatures on all checks over a certain amount.  Authorized check signers should not have access to accounting records.

Review and strengthen the security of your accounts payable system.  Do not allow one employee to handle both deposits and check writing.  Watch for unusual entries, such as fictitious vendors.
Never sign a blank check and avoid using a signature stamp.

Review both sides of canceled checks to ensure the each check payable to a vendor is endorsed by the vendor and not one of your employees.

Look into all customer complaints that they have not received credit for payment.

Track vendor billing patterns.  For example, there should be twelve entries for those vendors who are billed monthly.

Beware of impatient vendors who want you to rush a payment and vendors who always insist on dealing with the same staff member.

Review all company bank and credit card statements.

Closely scrutinize your company's tax returns before submission.

Conduct random financial audits.  Have a third party conduct an at-least annual audit.

Tag and inventory company equipment.  Record serial numbers and store the numbers in a safe place.  Conduct periodic physical inventories and consistent cycle counting.

Change passwords and provide shredders to help secure intellectual property.

Add theft and fraud insurance to your business insurance.

Consider the use of professional undercover contract personnel to detect employee fraud, when necessary.

Contact the police when you do discover employee fraud so that you consistently reinforce the message that fraud will not be tolerated.

Weight the option of filing a civil suit against any employee who has committed, and been convicted of, fraud.
 
Countering Fraud With Effective Physical Security Measures
 
Appropriate physical security measures, directed towards the most basic protection of people and property in and around the work environment, can also directly impact a dishonest employee's willingness and ability to commit acts of fraud. These measures, among many others, include the following:
 
Properly control and monitor all points of ingress and egress, including perimeter doors and windows.

Keep loading docks under surveillance and secured when not is use.

Secure dumpsters.  It should be noted that the dumpster is one of the most frequent hiding places for stolen items taken from a building.

Keep doors to storage and supply rooms, as well as other critical internal areas, locked to properly restrict access.

Restrict employee parking so that it is not adjacent to the building(s).

 
Install and monitor surveillance cameras. Ideally, there should be means for both local (i.e., on-site) and remote (off-site) secure accessing and monitoring of the camera system's video images.  Digitally record all camera views and securely archive the resultant digital data for 60-90 days.
 
Fraud and Small Businesses
 
Crime, such as employee fraud, can have a particularly devastating effect on small businesses.  According to the National Sheriffs' Association, at least 30% of all small business failures are due to burglary, robbery, shoplifting, and fraud.  There are many steps that all businesses, especially small businesses, can take to reduce their risks of becoming a target for these crimes.  These safeguards include:

Providing adequate interior and exterior lighting.  If you are not sure if the lighting is adequate, have a lighting survey conducted by a certified engineer. 
 
Ensure that all light fixtures are maintained in proper working order.

If a video surveillance system is in use, post clear signage noting the presence of security cameras on the premises.

Using a drop safe to minimize the amount of money in the cash registers.

Ensuring that opaque items, such as advertising banners, do not block the view into the shop or work place.

The Human Element
 
Many anti-fraud measures that should be implemented focus directly on the proper management and motivation of the employees in your workforce. These human resources-oriented measures include the following:

Conduct thorough background investigations on all employees, as well as on temporary employees.  Each investigation should include a criminal record check and employment verification for the past seven years.  Credit checks should be done for all with financial responsibilities and / or access to financial records of any kind. 
 
People with financial difficulties are more prone to commit fraud.

Ensure that any employee handling money is adequately bonded.

Provide security and safety training to all employees. 

Maintain a positive work environment with open lines of communication and employee recognition programs.  Pay employees a fair wage for their efforts and insist that they take the vacation time they are allotted.

As noted earlier, establish and monitor an anonymous employee hotline to report suspected fraud. Offer rewards to employees who report theft.

Solicit suggestions from employees on how to eliminate theft and enhance safety and security in the workplace.
 
And last, but not least, business owners and managers always should be role models of honesty and integrity themselves

For more information on preventing employee fraud and theft
Call 1-800-255-2146
or
 
 
 
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