The ‘trusted’ employee

Deception in a small-business environment


By Keisha Mindley, CFE
keisha-mindley-80x80   Fraud Basics: Fundamentals for all

JanFeb-suspicious-employee    
 © Diego Cervo/iStock/Thinkstock 
Can you completely guarantee that your employees will do the right thing and uphold the strong ethical values outlined in the employee handbook? Regardless of the size of your organization, the answer is “no.” Small organizations, especially, often lack financial resources to implement proper controls to mitigate financial loss, which therefore makes them more susceptive to the possibility of fraud.

ACFE founder and Chairman Dr. Joseph T. Wells, CFE, CPA, writes in “Small Business, Big Losses” from the December 2004 issue of Journal of Accountancy that “small businesses remain the most vulnerable to occupational fraud because of three factors: They are the least likely to have an audit, a hotline or adequate internal controls.”  

In this column, we’ll explore the susceptibility of small businesses to employee theft.

(The names of individuals and businesses are fictitious.)

ATTENTION SEEKER

Richard grew up in a close-knit family in the peaceful country area of a small island. From an early age, he knew he wanted to be popular and recognized by the public. During his late teens, Richard and his family migrated to the U.S. where he later completed college and held several clerical office jobs, most of which didn’t offer much potential for growth.

However, with several years of experience under his belt, he eventually managed to work in office administration and bookkeeping. He soon was operating several businesses, including a mortgage company and a restaurant. He went back to school to earn a master’s degree in mediation and arbitration.

Richard enjoyed being the center of attention. He joined professional business associations just to socialize and brag about his fabricated accomplishments. He lived beyond his means with lavish parties and expensive cars. He often donated computers and other supplies to local institutions in his home country to receive praise and adulation.

Richard clearly utilized any opportunity to overstate his accomplishments, especially to those outside his home state who were unaware of his true professional career. Outside his home state, he portrayed himself as an ophthalmologist who assisted in the development of Xalatan — a medicine for treatment of glaucoma and ocular hypertension. (But he would tellingly often mispronounce and misspell the drug as “Zalatin.”)

So what was Richard’s true profession? In 2002, Olsu & Associates, a local full-service real estate company, offered Richard a job as a bookkeeper. Initially, he had limited authority and wasn’t allowed to sign checks on behalf of the company. However, after four years, Richard became the operations and financial manager in charge of handling the company’s daily operations including signing checks, making deposits, reconciling monthly accounts and remitting payments to authorities.

So what did Richard do with this privilege? For several years, he repeatedly misused the company’s funds for his personal gain in a variety of ways:
  • Overpayment of wages. After deductions, Richard’s bimonthly salary was about $1,300. However, on several pay periods, he would boost his salary by adding an extra $1,000 to his paycheck for an estimated total loss to the company of around $40,000. 
  • Direct deposits and withdrawals. Occasionally, he made direct deposits to his personal account and also made withdrawals from the company’s corporate account. He was able to cover this up by recording transactions as commissions to appraisers. Total estimated loss was $70,000.  
  • Company credit card. The company gave Richard a credit card for business use only but he also used it for personal expenditures, including a holiday party at a famous hotel with a tab of $27,000. Total estimated loss was $36,000. See the chart below for the grand total estimate of losses. 
So, how did Olsu & Associates find out about Richard’s web of deception? The firm received notification from the Internal Revenue Service that a lien was pending for failure to remit employment withholding taxes — a staggering $187,000, including penalty and interest of more than $40,000.

JanFeb-misuse-of-company

The company president confronted Richard about the notice. Richard reassured the president that the IRS had made a mistake and must have placed the deposits in the wrong account; he said he would resolve the matter. However, several months passed, and the lien wasn’t cleared.

The president then included Richard in a conference call with an IRS agent. Richard gave the same excuse that the money was incorrectly deposited, but the president could see he was lying. The president immediately restricted Richard’s access to company funds. After he conducted further internal investigations, the president terminated Richard’s employment.

Richard fled the U.S. and returned to his home country. Olsu & Associates’ additional investigations led to a warrant for Richard’s arrest. Meanwhile, Richard took a connecting flight in the U.S. The fugitive task force arrested him at the airport. Richard was later sentenced to four to six years in prison on two counts of theft by deception and one count of income tax evasion.

FRAUD ENABLERS

The key contributing factors to fraud include:
  1. Inadequate internal controls. Olsu & Associates was a small company operating with little or no segregation of duties and failed to occasionally rotate employee functions. This isn’t unusual, of course. Smaller companies usually have limited resources, which often precludes hiring additional employees. However, this created Richard’s perfect opportunity for embezzlement. According to the 2012 ACFE Report to the Nations on Occupational Fraud and Abuse, small organizations in the study were victimized by fraud more frequently than larger organizations.  
  2. Living above one’s means. Richard’s desire to live an extravagant lifestyle and impress friends — expensive house and car, lavish parties — beyond his income drove him to make unethical decisions. 
NEW INTERNAL CONTROLS

Since the loss occurred, Olsu & Associates implemented a series of checks and balances to the company’s bill payment and accounting system. The company’s authorization of funds policy now requires that all checks have multiple signatures and upper-level executives have to approve all expenditures above a certain amount.

The following are some preventive measures for small businesses:
  • Manage company bank accounts through secured online banking, in addition to paper statements. Ensure more than one appropriate person — usually from treasury and senior-level management — has access to online banking. This is a useful tool for regularly checking account activity and monitoring transactions instead of waiting for monthly banking statements to perform account reconciliation. 
  • Arrange for an independent consultant CPA or internal audit to conduct surprise audits in such areas as payroll, billing, bank reconciliation, account balances and vendor verification. If employees know that surprise audits are a part of the company’s culture, then, of course, they would be less motivated to commit fraud.  
  • Because fraud cannot be 100 percent controlled, secure insurance coverage for losses from employee embezzlement. A fidelity bond is a popular type of insurance against business losses arising from dishonest acts of employees that aren’t usually covered under general property insurance.  
  • Promote a culture with zero tolerance for fraud by reinforcing throughout the organization the consequences of unethical conduct in the workplace. Also, publicize disciplinary actions the organization has taken against fraudsters.  
  • Monitor lifestyles of employees, especially those responsible for overseeing the company’s financials. Though mere appearances don’t prove guilt, they can reveal a person who’s clearly living beyond his or her means.  
Keisha Mindley, CFE, is a tax accountant with the Northrop Grumman Corporation. 

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