The previous article “Who is watching YOUR Controller” foretold the current situation at Koss.   For those of you not in Milwaukee, or who are not shareholders of Koss, here is a synopsis of the situation as it stands currently.  It is alleged that Sujata “Sue” Sachdeva ,  the now former Vice President of Finance of Koss Corporation, allegedly embezzled some $4.5 million in funds from Koss Corporation, a maker of stereo headphones located in the Greater Milwaukee area over a period of years.  The money is alleged to have been used for a lavish spending spree including millions of dollars worth of clothing, much of it unworn, stored at her home, at her office at Koss and at a 1,000 sq. ft. storage facility in the Historic Third Ward.  Just recently the allegations were extended to cover some $20 million of suspicious transactions since 2006.   My article discussed the effects on a company of not having adequate supervision  and controls on a company’s cash and accounting systems.  The alleged internal fraud which is currently being uncovered at Koss reveals how large and small companies need someone to review the financials on an ongoing basis.  

How could this have happened?  Koss is a public company, with audited financial statements, a board of directors, etc.!  The problem is one of basics, that ALL companies need to both understand and prevent.  My earlier article stated “B2B® partners often find that many business owners unintentionally place their employees in a position to steal from the company by giving them almost total control over the company's finances and having absolute trust in them.”  Sachdeva, almost immediate upon her hiring was placed in a position of absolute trust.  In 1992, just a year after the son of the founder had taken over the company, she was appointed Vice President of Finance.  At 29 years of age, Sachdeva was essentially CFO, as the CEO held all three titles – CEO, COO and CFO.   A year later, her husband received a fellowship in pediatrics at a hospital in Houston.  Michael Koss, the CEO, allowed her to telecommute from Houston to her position at Koss using the phone, fax and computer.  This continue for over 10 years and still was the case for an average of two days a week as recently as reported in 2007 in CFO magazine.  This level of absolute trust, with all of the electronic means to move funds at her fingertips, placed her in a position where a fraud, as alleged, could both be committed and concealed.  High Visibility magazine noted in 1996 that she was the ONLY CFO they knew of in the country to telecommute.

Small businesses do the same thing.  Business owners are focused on growing the business sales and allow bookkeepers, people they trust, to write checks, balance check books, receive funds and code expenses.  Clerks who work for the bookkeeper, like the clerks who worked with Sachdeva, perform the work expected of them in the unspoken understanding that their boss knows what they are doing.  In the book “The Danger Zone” Jerry Mills notes that most such schemes are not elaborate.  Usually the money embezzled is expensed to Cost of Goods sold.   The Journel-Sentinel article regarding Koss dated 12/29/2009 also noted that this is the case.  And with the multiple titles, reduction of staffing at Koss, and the variation of costs due to rapid model changes and the economic environment, tracking changes to costs and noting abnormalities would be difficult for the CEO/CFO/COO to analyze without the help of an experience financial executive to analyze performance.  He apparently relied upon the same person who is alleged to have committed the fraud.  Think about how many hats the owners of small, non-public, companies wear…they are putting themselves in the same risky position that Koss may have been in.

“But I know my employees” we often hear business owners comment.  The problem with this statement is being able to discern spending that is unusual.  Your Controller, when he buys a car that seems expensive for his pay, may comment that his wife works and so he can afford it.  Sachdeva’s alleged spending might not have seemed out of place due to both her pay and her husband’s income as a doctor.  It is apparent from news articles that Koss had not been into her office recently, as it was one of the storage locations for thousands of dollars of clothes. 

What about internal controls?  What about the auditors?  Koss had periodically downsized staff over the years – on June 30^th 2009 it employed only 73 people with sales of $38 million annually - so clerks may have been performing multiple roles.  The outside auditors had not opined on internal controls nor had been engaged to do so, since Koss’s size exempted it from Sarbanes-Oxley requirements.  Koss could have still have required an internal controls audit, but due to staffing they may not have met the segregation of duties standard required under Sarbanes-Oxley.  A negative opinion would have been worse for their stock value than not having an opinion that was not required.  Did they do their own review of their controls – apparently yes, but if the person alleged to have been committing a fraud was also in charge of the review, how effective could the review have been?

How would a company avoid the tragedy of fraud?  Most business owners aren’t trained to catch fraud committed by employees or are too busy to focus on the issue.  Michael Koss’ degree is in anthropology, not business or finance and he wore the hats of all three C-Level titles.  As a business owner, be alert to signs of possible problems such as employees who appear to be living beyond their means, like thousands of dollars of dresses stored in their office, or who never take a vacation (because they can work from anywhere) or who guard access to the accounting system. Business owners should also review all cancelled checks and look at the endorsement on the back. It's also a good idea to review the bank statement each month paying particular attention to transfers – like the large transfers that caused American Express to finally call Michael Koss.  The list of ways to prevent employee theft – and more importantly to prevent employees from being tempted to embezzle - is long. The best solution is to engage an experienced senior financial executive to look through the records on a monthly basis and review transactions.  By letting the staff know a process is in place, temptation and opportunity to steal would be significantly reduced. No process can guarantee complete elimination of employee fraud; however there are steps that you, the business owner, can take to minimize the chance of fraud in your company. So tell me, who is watching YOUR Controller? A B2BCFO can bring you great peace of mind!