Identifying and Preventing Corporate Fraud

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Internal fraud is a huge risk to companies. Experts estimate that on average it costs companies 3% to 5% of revenue each year. When profit margins are thin, internal fraud can literally put some companies out of business. Executives are prone to underestimating the amount of fraud that exists within their companies. They want to believe that their internal controls are better, their employees are more honest, and their ability to stop fraud is more effective than that of executives at other companies.

The truth is, they are often unaware of all the frauds committed within their company’s walls. Indeed, fraud is often hard to find and may be hidden among the seemingly more trustworthy employees, those who are necessary for keeping the business running. They are the ones putting companies at risk; they have access to assets and information and the opportunity to steal and cover up fraud. Continue reading

Techniques to Reduce Employee Theft

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It might be hard to believe, but each and every day companies are losing money because they not only give employees opportunities to steal, they encourage it.

How? By not providing adequate oversight. A clerk, for example, sees that an error in an account wasn’t caught by anyone. A purchasing manager notices that no one is watching over his vendor relationships, and won’t know it if he establishes a fake account. Employees are not stupid. They know when they are being monitored and when their work is being checked. They know when they are working in an environment ripe for fraud.

But you have honest employees, you say? You’re probably right. If we thought job applicants were criminals, we wouldn’t hire them. But situations occur where the temptation to steal simply becomes too much. Imagine owing money to a hospital or having an expensive (and necessary) car repair that you can’t afford. What if your child needs clothing or food? There may come a day in your life when your morals are challenged because you have a financial need and an opportunity at the workplace that seems too good to pass up.

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Personal Red Flags of Fraud

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As victims of occupational fraud reflect on crimes committed against their companies, they wonder if there were any signs that a fraud was occurring. They wonder how a trusted employee could steal from the company. Sadly, frauds are committed by people in positions of trust. What is it about those people that leads them to commit fraud?

Corporate thieves have many things in common with one another. There are many tell-tale characteristics about people and their lifestyles that signal the potential for fraud. These range from personal financial circumstances to attitudes on the job. A few of these traits alone do not indicate the potential for fraud, but the probability rises as we identify more of the characteristics.

Work Habits

Employees who steal from their employers often appear very dedicated. They work long hours and seem willing to take on extra responsibilities. For a normal person, these would be desired traits. An employee who helps accomplish more is seen as an asset to the company. For someone with the potential for fraud, however, these characteristics are worrisome.

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Detecting Overrides of Internal Controls

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Where can employees, outside consultants, and board members look for evidence of override of internal controls? This isn’t a simple list of numbers or documents that must be checked off. Instead, looking for improper override of controls requires looking for red flags that point to something being amiss.

  • Complete an analytical review, looking for unusual changes between periods in terms of dollars and percentages.
  • Look for large, round numbers that enhance the financial position, especially if these numbers just happen to occur at the end of an accounting period
  • Examine reversing entries at the beginning of an accounting period, looking for evidence that these entries relate to an improper entry at the end of the previous period
  • Determine whether transactions have been completed on an arms’ length basis, and with legitimate business partners
  • Look for evidence of undisclosed relationships or agreements
  • Listen carefully to employees who may be reporting wrongdoing or hinting that there is a problem

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Overriding Internal Controls (With Permission?)

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It’s clear that there is a time and place for management to occasionally override a control. Everything in business is not routine, and there are times when special situations require special treatment. It would be silly to prohibit management from ever overriding the policies and procedures that are in place. There has to be guidance in place to direct employees when they may consider overriding controls.

However, it’s important to recognize that the override of controls should be the exception rather than the rule. Employees should be able to circumvent the system only on an infrequent basis, and these instances must be actively monitored to determine if the override process is being abused.

For example, there may be a policy specifying levels of approval before a payment can be issued. What if the person who normally approves the payment is on emergency sick leave and a payment needs to be made? There must be a process for getting an alternate employee to approve the payment. This transaction should then be flagged for later follow-up to determine that the payment was still proper. In this case, there is a need for overriding the normal control, but this is something that should happen infrequently.

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Management Override of Internal Controls

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Some companies think they are protected against employee fraud because they have strong internal controls. Often, that’s the case. Good controls mean the rules are followed and the money is properly accounted for.

Sometimes, however, good controls are meaningless. What about the controls over the controls? All the rules and designated procedures in the world are meaningless if management has the ability to override them at will. When these overrides go unchecked, the company is often no better off than if they didn’t have any controls in place.

Indeed, the risk that management will override controls established to prevent fraud and ensure accurate financial statements is great. It is a constant risk as executives are in a position to manipulate numbers and direct employees to aid the manipulation. They can easily fabricate transactions or modify numbers to craft the financial statements to report whatever their hearts desire.

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Five Common Fraud Myths

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19079420I’ve been investigating fraud for over two decades. When I first started, financial fraud wasn’t a big topic. In fact, most people had never heard of forensic accounting. Then in 2001 and 2002 everyone became more aware of the issue of fraud when the big frauds of Enron, WorldCom, and Tyco became public. It is now commonplace to hear about corporate frauds involving embezzlement, financial statement manipulation, or kickbacks.

Despite this knowledge, there are still many misconceptions about employee fraud. If owners and executives mistakenly believe their company is not at risk, they are probably not actively preventing fraud. Management must know the truth about fraud and its perpetrators in order to actively protect the company.

Here are five myths about fraud that I still run into in my forensic accounting practice. They’re often unspoken, and many would never admit that they believe them. However, I know from experience that they run rampant.

1. Our company doesn’t have an internal fraud problem.

While companies would like to believe they have good employees and adequate internal controls to prevent fraud, the fact of the matter is that studies suggest 75% of companies will fall victim to a fraud scheme. While some of these may not be large frauds, they will cause losses nonetheless. Continue reading

Preventing Fraud in a Law Practice: Active Partner Involvement

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There are two inexpensive and simple steps that can be taken to provide more oversight for the disbursement function at a law office. First, a partner needs to be actively involved in the process of issuing checks and payments. It’s not enough to simply glance at checks to vendors and immediately sign them.

Before any check is signed or sent out, it should be compared to an invoice, credit card statement, or other documentation that will help verify the legitimacy of the payment. This reduces the risk that an employee pays a personal credit card with company funds or otherwise improperly issues a payment from the firm’s checking account.

The second step to increase oversight at a law firm is involving at least one other person in some of the functions. If the office manager is disbursing funds, another employee should do the bank reconciliation. This provides a natural checks-and-balances situation, in which the second employee is verifying the work of the office manager. Continue reading

Highlighting Corporate Fraud Investigations

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The unthinkable has happened. We have good employees. Our people are honest. They don’t steal from us. They’re like family. We trust them. So it goes when a company discovers a fraud from within.

Then what happens?

After the initial shock wears off, it’s time to start investigating the situation. The company must know who did it, how the fraud was committed, and what controls can be put in place to stop fraud from happening again. This is all accomplished with an effective fraud investigation.

Investigative Policy

Companies should have in place a standard set of guidelines for managers to follow when fraud is suspected. Most supervisors and managers have not dealt with on-the-job fraud, so they need guidance when evaluating fraud allegations. Fraud investigation guidelines may also help guard the company against employees’ claims of selective treatment. Continue reading

The Wide-Reaching Impact of Financial Statement Fraud

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Of all the fraud schemes perpetrated in our world today, financial statement fraud seems to get the least air time. That makes no sense, as financial statement fraud happens to be one of the most costly types of fraud.

The problem is that involved parties, both inside and outside the company, rely on the information provided in the financial statements. They assess the financial results and make predictions and decisions about the future of the company based on those results.

Financial statements are the measuring stick that numerous parties use to assess the financial health of a company. Falsified financial statements can mean only one thing – those assessments are faulty.

Financial statement fraud causes a median loss of $2 million per fraud scheme, according to the most recent occupational fraud study done by the Association of Certified Fraud Examiners. That amount dwarfs asset misappropriation schemes, which only cause median losses of $150,000 per scheme. Continue reading