The Phantom Menace: Employee Embezzlement and the Bottom Line

September 1, 2001 · by Kerry Harding

A growing trend of demand-driven honesty? The experts point out potential opportunities and steps to put in place to foil the efforts of employee dishonesty.

Earlier this summer, a top executive from a leading national A/E firm quietly resigned for “personal reasons.” What most firm members did not know, however, was that his indictment by the FBI was imminent for secretly channeling tens of thousands of dollars into dummy accounts while working at his previous firm. In August, an employee of carpeting company giant Mohawk Industries, was arrested for depositing 12 company checks totally $73,693 into her personal account between June 1999 and May 2000. Also, an office manager, in charge of reconciling a prominent East Coast firm’s corporate American Express card accounts, charged thousands of dollars worth of personal items including a $900 sofa from Ikea before finally being caught. Perhaps the most blatant case of employee dishonesty was revealed late this summer by the Washington Post when it reported that, armed with 1.8 million credit cards, Pentagon employees went on a $9 billion shopping spree last year that congressional investigators found was filled with fraud. Military personnel did personal shopping at Wal-Mart and Home Depot, partied at Hooters and charged personal items like DVD players, computers and pet supplies.

Unfortunately, business fraud has become a reality of conducting business, including such minor offenses as writing a personal letter during company time to more major offenses as embezzling large sums of money. Company fraud can manifest itself in several ways.

Employee fraud is committed by an employee and generally involves theft of the company’s assets and falsification of records to conceal it.

Management fraud involves the deliberate falsification of financial statement data, generally committed with the intent to manipulate earnings; and may also include theft of company assets through more complex, less easily detectible means. This sometimes involves company outsiders such as suppliers, clients or consultants, who inflate expenses, submit fraudulent or inflated invoices in exchange for an insider getting a “piece of the pie.” Employee fraud occurs for several reasons:

Opportunity. Blanket control of a firm’s funds create the mindset, “No one will know.” Sometimes it starts out as a loan with an intent to pay it back. Other times, it starts out with a small amount which increases over time. One interior design firm’s principals cannot access any of its financial systems or records— only the firm’s office manager has the necessary passwords and keys. They jokingly refer to her as “a control friek” but assume she is simply a dedicated, overworked employee. She may be, but also, may not be. They have no way of telling.

Business Environment. Some firms cultivate a culture of dishonesty to begin with, encouraging employees to pad hourly billings and expenses, as well as marking up consultant invoices substantially more than industry norms. When employees see top management bending the law or at least making questionable ethical decisions, they are less likely to exhibit honesty in their own actions with the firm.

Situational pressures. In what has been called “the excesses of the 90s” many families developed a lifestyle that was consistently at the limit of, if not beyond their means. With the downsizings and bankruptcies of the past year, half of many two-income families, are now unemployed, straining family finances to the brink of bankruptcy.

Rationalization. Downsizing is a common trigger of employee fraud. As firms tout the savings from operating with fewer employees, some who remain worry about their futures and plot ways to steal from the company. They have two or three times the amount of work with no pay increase. They say to themselves, ‘I work hard here—I deserve it.’

The Association of Certified Fraud Examiners recently completed a survey of approximately 2,500 cases of employee fraud during the past decade. The study found that businesses with less than 100 employees were the most vulnerable to fraud and abuse by employees as well as having an average loss of $120,000 per incident. About 80% of the reported cases represented theft of company assets, most commonly cash, with the balance of the cases comprising such practices as placing business with an outside company in which the employee had a financial interest.

In reality, the instances of fraud are substantially higher because few cases are actually reported to the police. According to Robert Rothwell, a fraud detective for the Columbus, Ohio Police Department, “A lot of people don’t want the notoriety. They want the cases prosecuted and the people put in jail, but they say, ‘Just don’t put my name in the paper.’”

A recently published article quoted John Warren, ACFE’s Associated General Counsel as saying, “A lot of fraud goes undetected. These schemes tend to run for long periods—one, two, three, four or five years, and it’s only getting detected in the fifth year. We expect that’s happening in a lot of organizations. They just don’t know they’re getting ripped off.”

Why are smaller firms more subjected to employee fraud issues? According to Joseph Wells, ACFE’s chairmn, there are two general characteristics that make them especially vulnerable.

According to security consultant Jack Deal, here are some key areas to look for:

Be certain theft, pilferage or embezzlement is occurring or has occurred. The burden of proof is on the business. Courts are very unsympathetic to businesses that cannot prove an employee is guilty. Always consult your lawyer first. Something like a non-consent tape recording could be considered illegal and not admissible as evidence. Setting up a ‘sting’ might be construed as entrapment.

Keep emotions out of it. Anger, resentment and other nasty feelings can distort judgment and cause you to do or say something that is not in your best interests.

Watch your moneyhandlers. They have the greatest potential for embezzlement. Watch those that sign on bank accounts. Be especially aware of the ‘dummy company’ ploy. This is simply a fake company that an employee sets up so they can take payments. Regularly look at payables and bills paid and note any unfamiliar vendors. Each employee handling funds should be periodically removed from their job so that any malfeasance may not be continually concealed; this can be accomplished through required through vacations and short-term job rotation.

Accountants and automation have made the monitoring process easier. A good accountant should be able to show you ways to catch a thief. A ‘mini-audit’ or ‘spot-check’ audit is a good, cost-effective way to monitor theft. This process looks for things like sequentially numbered invoices or verifying revenues to bank deposits.

Do not assume any employee or partner is beyond theft. Personal circumstances change and so does motivation to steal. Even family members working with the firm should be subject to the same checks and controls as other employees. Recognize that even the “nicest” employees may be subject to temptations and failures of character.

Look for spikes in expenses that appear to be excessive. Outside accountants are good here. They can often quickly spot the exceptions to the norms in office supplies, travel, etc.

Theft Loss Prevention Forms are very helpful. A software called Employee Manual Maker includes a form to be signed by each employee which clearly states the causes for dismissal. This makes the employee aware of company policy and eliminates any ambiguity.

The right hire can greatly reduce the potential for theft. It is permissible to do a credit check before hiring for a sensitive position. If all references offer a ‘no comment’ on an employee’s performance, it probably means that the employee has had some problems—which could have involved theft.

Track inventories and supplies. Careful monitoring can point out problem areas. Most theft goes unnoticed with little or no monitoring.

Be creative in your search for theft and embezzlement. People who want to be dishonest can be amazingly creative. Jim Rahmlow of Rochester, New York-based Mengel Metzger Barr & Co., advises firms to implement ten tips to protecting their businesses.

Consider having bank statements sent to the top executive’s home for review before the bookkeepers receive them. Do the amounts and vendors seem reasonable and familiar?

Pay only original invoices, never photocopies. Once you’ve signed the check, stamp it “paid” immediately. Watch for missing or altered documentation.

Watch for out-of-balance accounts, unexplained adjustments to accounts, cash shortfalls and confusing records. If you confront your bookkeeper, listen for unreasonable or convoluted explanations.

Be aware of changes in employee lifestyles. Sudden needs, unexpected financial needs or relationship problems could lure a former faithful employee to “take out a loan” from company funds.

Be especially wary of the possibility of computer-aided fraud. Changing passwords and shredding papers are important ways to guard intellectual property.

Limit access to valuable equipment, charge accounts and checks. Segregate responsibilities so that no one person controls the complete cycle in financial functions.

A perfect attendance record or unwarranted long hours can sometimes indicate a nervous employee who fears being caught. If they never take vacations or a day off, they might be trying to cover a paper trail.
Fully check employee references and resume information. Have criminal background checks done for anyone being considered for financial oversight—including outside hires at the principal level and above.

If you do catch an employee involved in fraud of some kind, don’t overreact or confront them immediately. Quietly collect evidence, then contact a lawyer and local law enforcement officials. After discussing the appropriate language with your HR director and corporate attorney, inform the staff what has happened and reinforce a zero tolerance policy for all future infractions.

Don’t let one bad apple create a culture of paranoia, which can be counterproductive. As a general rule most employees are honest and have a great deal of integrity. Good employees often view management paranoia as mistrust and they are right. Research shows that compensation directly effects theft. If your firm pays significantly below the market standard your employees may view theft as a way to “correct the injustice.”

As Deal writes, “Theft, pilferage and embezzlement are tough issues and certainly one side of business that is not fun. Employees need to be aware of the consequences of theft on the bottom line and encouraged to report such abuses. This is especially easy to get across in a profit-sharing environment—a thief steals from all, not just owners and management.”

Hiring good people, compensating them fairly, implementing the necessary safeguards and taking quick action to prosecute those who violate the trust placed in them will go on long way in minimizing employee fraud and perhaps prevent your own financial ruin.

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