The Good, The Bad and The Bernie Madoff's - Mar 15, 2010

Posted by: Stu Lipkin in Articles

Everyone has some "Bernie Madoff" in them. It is said that for the "right price", many people might compromise their values. Fortunately, the vast majority of us have high moral and ethical standards so fraud is not even a consideration. For those very few who have a feeling of entitlement, how do we protect ourselves from them?
Occupational fraud comes in a variety of types and forms. It can be perpetrated by many individuals within an organization. The term "occupational fraud" may be defined as: "The use of one's occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization's resources or assets." According to a study published by the ACFE (Association of Certified Fraud Examiners) in 2008:

• Occupational fraud schemes tend to be extremely costly. The median loss caused by occupational frauds in this study was $175,000. More than one-quarter of the frauds involved losses of at least $1 million.
• Occupational fraud schemes frequently continue for years before they are detected. The typical fraud in the study lasted two years from the time it began until the time it was caught by the victim organization.
• Lack of adequate internal controls was most commonly cited as the factor that allowed fraud to occur.
• Small businesses are especially vulnerable to occupational fraud. The median loss suffered by organizations with fewer than 100 employees was $200,000. This was higher than the median loss in any other category, including the largest organizations.
• Occupational frauds were most often committed by the accounting department (29%) or upper management (18%).

It should be noted that many cases of fraud go undetected, and those that are identified, may not be reported to the police or the extent of the loss may not be fully discovered.
While it's impossible to detect 100% of fraud because collusion can bypass normal company controls, it is much less expensive to implement sound internal policies and controls than it is to investigate and prosecute. According to the ACFE 2008 report, fraud was discovered in small businesses 42% of the time through tips (employees, customers, suppliers, etc) and 29% by accident. Only 16% of the time was the fraud discovered through the company's internal controls. The study also found that the median duration was 24 months with 52% of the perpetrators being with the company for over 5 years.
So what steps can a small business owner take to minimize the frequency and magnitude of fraud? Here are some key tips:
Develop a formalized mechanism for fraud to be reported. A fraud hotline needs to be implemented and its purpose actively communicated to all employees. There should also be a procedure where specific managers are identified as confidential contacts, enabling employees to report their concerns or suspicions. This procedure needs to be documented in writing and should require that more than one manager investigates the allegation.
Educate employees as to what constitutes fraud and the cost to the company. While this sounds like common sense, it highlights to the employees the need to be observant and their responsibility to report their suspicions. Make it very clear to the employees that ALL fraud detected will be reported to the police for further investigation and where applicable, the company will prosecute the offender.
All employees MUST take their vacation time. In many cases, fraud will be detected by someone else performing the duties of the individual perpetrating the fraud. Therefore, employees who are hesitant and/or resistant to take their vacations should be watched very carefully.
Rotate job responsibilities. Once again, fraud becomes more difficult if the perpetrator does not have constant and sole access to certain data and processes.
Develop stronger internal controls which include proper segregation of duties. Since many small businesses have limited staff, it becomes increasingly difficult to define strong controls. For this reason, the ACFE report stated that only 16% of fraud was discovered through the company's internal controls. Many small business owners delegate too much authority to their bookkeepers and/or controllers. Beware of weaknesses in your systems and implement the following controls:

1. The owner (or someone else within the organization) MUST continue to review key financial reports and records. All disbursements should have vendor invoices attached to the check stub with the manager/supervisor responsible for the expenditure approving it before payment.
2. The person who signs the checks should NOT be the one who performs bank reconciliations. Detailed bank reconciliations should be reviewed and initialed by either the owner or an outside accountant who is familiar with the process.
3. The person responsible for billing needs to get an approval from someone outside of the accounting area in order to process credits to customers.
4. All suppliers added to the system need to have an approval by the manager requesting the product/services, in addition to that of the bookkeeper or controller. If the bookkeeper or controller is the one adding the supplier, the owner needs to approve it.
5. A report of additions and deletions of customers and suppliers should be reviewed and approved regularly by someone outside the accounting area.
6. Accounting systems should have security permissions prohibiting accounting personnel from making certain changes to financial data.

Before hiring new employees, perform background and credit checks. Many companies will perform a background check on key employees. However, 87% of the cases reflected the perpetrator had no previous criminal record. The #1 reason for occupational fraud in small businesses was due to financial pressures of the perpetrator. Therefore, credit checks can be a stronger indicator than the background check.
Be aware of employees living beyond their means or expressing personal financial difficulties. In 77% of the occurrences discovered and reported to the ACFE in their 2008 survey, individuals living beyond their means (41%) and personal financial difficulties (36%) were the key reasons fraud was perpetrated by employees of small businesses.
When it comes to fraud and the controls to deter and detect it, don't bury your head in the sand. Take control and derail fraud before it rears its ugly head. It can happen to you. Can your company afford to lose $150,000 (or more)?
If you don't have expertise in this area, bring in a professional to take a look at your systems and controls. The investment will probably be the best return your business will ever see.

(877) 4-B2BCFO

info@b2bcfo.com

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