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Dealing with Employee Fraud

employee fraudRecently, I was visiting with a potential client who had been the victim of fraud.  Talking with him brought back unpleasant memories of the first time I discovered that one of my client’s employees had committed fraud against the company.  Despite the fact that it happened a long time ago, all of the emotions associated with the violation came flooding back.

Dealing with Employee Fraud

Betrayal

The first, and perhaps strongest, emotion is betrayal.  Anyone who has been a victim of fraud feels violated.  It’s not unlike finding out that your spouse or significant other has had a relationship with another person.  Most likely, the violator’s motive wasn’t personal, but it’s difficult not to take such treachery personally.

Shock

The next emotion I remember feeling was shock.  How could this have happened?  How could we have been so blind?  It’s hard to believe that this person you trusted could steal from you without you knowing it.  You feel duped and, as a result, may question your ability to judge a person’s character.

Anger

Once the hurt feelings and shock have passed, you will be angry. You may seek retribution. Unfortunately, it is often difficult to get your money back and district attorneys are reluctant to prosecute such cases unless there are large sums involved.  Even if they go forward with prosecution or seek compensation, any recovery is often less than the amount stolen.

Despite this fact, it’s important to pursue the matter regardless of the sum. It’s not just about you getting your money back.  It’s also about ensuring that this person doesn’t have the opportunity to violate someone else in the future.  Often, this is not the first time the person has committed fraud.  Even if you recover less than your losses, the paper trail created by the prosecution will be a red flag to anyone who runs a criminal background check on the individual in the future.

Eventually, most people move on past the emotions and learn to trust again.  Most likely, they won’t trust to the same extent, though.  The painful lesson learned is trust, but verify.

One of the positive outcomes of such an experience is tightened internal controls.  Because of this, the company can come out stronger in the end for having survived the theft.

How do you know if employee fraud is happening in your company? Check out our free Internal Analysis whitepaper to create the roadmap for your company’s success!

Dealing with Employee Fraud
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Dealing with Employee Fraud

Check out our article:  7 Warning Signs of Fraud

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7 Warning Signs of Fraud

warning signs of fraudUnfortunately, companies of all sizes can become victims of fraud. In fact, a study on fraud published by accounting firm KPMG International found “a very large increase in cases involving the exploitation of weak internal controls by fraudsters up from 49 percent in 2007 to 74 percent in 2011.” Thus, internal controls are a first line of defense and are important in any size organization. So, implement them to reduce the opportunity for fraud. Whatever the size company, there are some warning signs of fraud that are important to pay attention to.

7 Warning Signs of Fraud

1.  Is the person reconciling the bank statement also a check signer?

These are important duties to segregate. When combined, a person signing a fraudulent check can go on without being detected.

2.  Does your company have several bank accounts?

Multiple bank accounts make inappropriate movements of cash harder to detect. So, make sure you understand the business need for each bank account the company has and use as few accounts as possible.

3.  Do you have a budget to compare with your actual financial results on a monthly basis?

This is an important control in the detection of unauthorized transactions.

4.  Have you noticed a controlling personality or secretive behavior on the part of an employee?

This may be a sign that a person is being deceptive or needs to control people or the environment in order to conceal their activity.

(Have you ever heard of skimming fraud? It’s the most difficult fraud to detect.)

5.  Are there accounts on your financial statements that you do not understand?

Ask! If your question is not welcomed or answered to your satisfaction, then pay attention to this response.

6.  Financials that are not timely or closed on a monthly basis.

Lax or non-existent cut offs leave room for inappropriate entries in months long gone.

7.  Are employees related in your accounting department?

Part of a functioning internal controls system is the need for collusion in order to circumvent controls.

The Fraud Triangle

What is the motivation for an employee to steal?  The fraud triangle shows us 3 following conditions:

  • Pressure (motivation or intent to steal)
  • Rationalization (justification of dishonesty)
  • Opportunity (ability to carry out misappropriation of company assets.)

Well designed internal controls serve to mitigate the opportunity for fraud in your organization.

(Have you every wondered does fraud follow economic cycles?)

How to Reduce Fraud

What can you do to reduce the chance for fraud in your organization? First, remember that internal controls are necessary for all size organizations. Check out the following ideas that you will find helpful as you assess controls in your organization:

Live Ethics in Your Corporate Culture 

A culture of ethics starts at the top and you start by demonstrating it on a daily basis. We cannot emphasize this enough as it sets the bar for acceptable behavior in your organization.

Trust is Not a Control 

Trust is not a control, so design internal controls. Then put them in place for the position. Thus, they should not be for a particular employee, regardless of how trusted that employee is.

Pre-Employment Screening

Conduct pre-employment screening including background checks as appropriate.

Utilize Entire Team

If you do not have enough employees in accounting, then utilize others as part of your control system.

Have Different Signers

If your bank account reconciler is a signer, then find a different signer. Segregate the check cutting, signing and reconciling duties from each other.

Unbiased Reviewer

Have the company bank statements go unopened for review by someone in a management position who isn’t cutting or signing checks.

Choose Signers Carefully

Understand what authority signers have with company bank accounts and choose signers carefully. Add extra controls to your corporate bank accounts – an example is precluding any counter withdrawals so that all bank account withdrawals go through the check writing process.

Anonymous Alert System

Set up an anonymous way for your employees to alert you of any concerns/suspicions related to potential fraud within your company. Then take these alerts seriously.

Segregation of Duties & Controls

Segregation of duties and internal controls protect both your employees and the company.

If you want to reduce the fraud or detect fraud in your company, then check out our free Internal Analysis whitepaper. We have designed this whitepaper to assist your leadership decisions and create the roadmap for your company’s success!

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The Fraud Triangle

See Also:
Accounting Fraud Prevention using QuickBooks
Audit Scope
Bankruptcy Chapter 11
How to Hire New Employees

Fraud Triangle Definition

Donald Cressey created the concept of the fraud triangle. The creation of the theory required Cressey to interview about 200 convicted embezzlers around the Midwest which he dubbed “trust violators.” The people that had entered the work place with no intention of stealing peaked his interest. After the interviews Cressey formed the following hypothesis:

Trusted Persons become trust violators when they conceive of themselves as having a financial problem which is non-shareable, are aware this problem can be secretly resolved by violation of the position of financial trust, and are able to apply to their own conduct in that situation verbalizations which enable them to adjust their conceptions of themselves as trusted persons with their conceptions of themselves as trusted persons with their conceptions of themselves as users entrusted funds or property.

Cressey created the fraud triangle and the three fraud triangle components. These consist of all of the following:

The fraud triangle can best explain most all abuse unless the particular person entered the company with the intent of stealing in the first place.

Fraud Triangle Pressure

Pressure is the first leg of the fraud triangle. Define the pressure Cressey describes in his hypothesis as a non-shareable financial problem. These financial problems are usually personal to that person. But, they are too ashamed by the problem that they are unwilling to share with others. This is particularly disturbing when it is later understood that if the violator had talked about it others would have been willing to help.

(Have you ever wondered does fraud follow economic cycles?)

Fraud Triangle Opportunity

The second leg of the fraud triangle is an opportunity that exists within a company for fraud to take place. Opportunities usually occur from a lack of internal controls within a company. For example, the violator here feels that he/she can take advantage of the situation without getting caught. Of course, there has to be a certain level of technical skill to be able to define an opportunity which is why several violators find opportunities within their own job function.

(Discover the 7 warning signs of fraud!)

Fraud Triangle Rationalization

The third and final component of the fraud triangle is that of rationalization. Cressey found that many of the violators never felt that they were actually a criminal. This is because they had rationalized to themselves that the misdeed was ok. In fact, many of the violators Cressey interviewed felt that they were justified. Instead, the act was part of a general irresponsibility for which they were not completely accountable.

If you are dealing with fraud, then check out our free Internal Analysis whitepaper to help you solve the issues and prevent it from happening again.

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Skimming Fraud

See Also:
The Fraud Triangle
Larceny (fraud)
Auditor
Audit Scope
Compliance Audit

Skimming Fraud Definition

Skimming fraud is the theft of cash from a business prior to its entry into the accounting system for that company. Although skimming is one of the smallest frauds that can occur, they are also the most difficult to detect.

Skimming Meaning

Skimming is also known as an “off book” fraud because the cash is stolen before it is entered into the bookkeeping system. In business, skimming is the most difficult to detect because there is not direct audit trail that can be followed to the source. Often, skimming fraud is discovered by accident, or if a company suspects that it is going on. A company will often investigate for skimming fraud if a certain part or the business as a whole is low on cash for no reason. If the problem is ongoing companies will often investigate themselves or hire someone to do so like a Certified Fraud Examiner (CFE).

(How are you’re dealing with a fraudulent employee? Learn more about what it feels like to have fraud committed against you here.)

Skimming Example

Grant owns a sandwich shop named Real Good Wich. Lately, Grant has noticed that the cash account has been dwindling, and decides to hire Mason a CFE to investigate. Mason arrives on the scene and orders a sandwich. skimming fraudAfter observing the cashier for a while he notices that one of the employees is pocketing the cash when the exact amount for a sandwich is paid. Mason takes note of this and returns to Grant and explains the problem. He explains that when the exact amount is paid the employee can simply pocket the cash. This is because there is no need to open the register for change and no sale needs to be recorded. Mason also provides a quick fix to the problem.

If Grant were to provide a free sandwich to his customers if no receipt were given to them on the sale it would significantly reduce the amount of skimming fraud. Grant takes Mason’s advice and fires the employee, and implements the free sandwich. After a while Grant sees that his cash has increased as well as overall profits.

Check out our free Internal Analysis whitepaper to assist your leadership decisions as you deal with fraud AND prevent it before it happens again.

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Sinking Fund

See Also:
How important is personal credit in negotiating a commercial loan?
Loan Agreement
Payment Terms
Down Payment
Self-Liquidating Loans

Sinking Fund Definition

The sinking fund definition is an accumulation of assets set aside to repay a loan when it becomes due. Use the accumulated amount to pay off the debt early to reduce the amount of liability for a company.

Sinking Fund Meaning

Use sinking funds to retire debt or set aside amounts to pay off the debt as it comes due. This means that a sinking fund’s only purpose is the payment of that obligation and nothing else. The assets set aside however may be set aside with the assumption that they will grow over time within the sinking funds account. At times there are sinking funds provisions within most loan agreements. A sinking funds provision often allows for discounted payment of debt. Often times the provision does not account for the entire amount in the loan which will last until maturity. The most common forms of instruments associated with sinking funds are callable bonds or other other option stocks.

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Securities Exchange Act of 1934

See Also:
Secondary Market
Securities Act of 1933
New York Stock Exchange (NYSE)
Primary Market
Sarbanes Oxley Act of 2002 (SOX)

Securities Exchange Act of 1934

The Securities Exchange Act of 1934 deals with the regulation of secondary market transactions, or outstanding securities in the market (which can be traded on a daily basis). The Securities and Exchange Commission (SEC) regulates this act.

Securities Exchange Act of 1934 Meaning

The Securities Exchange Act of 1934 was established after the stock market crash of 1929 – the following Great Depression. The 1934 Securities Exchange Act is meant to provide meaningful and relevant information to the average investor. This ensures that the investor is not mislead in anyway so that they are able to make well informed decisions. The Securities Exchange Act regulations include the need for quarterly and annual audits by an accounting firm. These accounting firms then attest to the accuracy of the statements.

The Securities Exchange Act of 1934 thus ensures that there is no fraud that exist within the company. It also deals with insider trading. If an investor has information that is non-public in nature then, then under the 1934 Securities Exchange Act, he/she may not act on it until the information has gone public. The idea is to provide a fair and equal market so there are no unusual transactions to set the market adrift.

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Securities and Exchange Commission (SEC)

See Also:
New York Stock Exchange (NYSE)
Generally Accepted Accounting Principles (GAAP)
American Institute of Certified Public Accountants – AICPA
Financial Accounting Standards Board (FASB)
Full Disclosure Principle
Corporate Veil
Investment Banks
Treasury Stock
Accounting Fraud Targeted

Securities and Exchange Commission (SEC) Definition

The Securities and Exchange Commission (SEC) is a U.S. government agency that is responsible for protecting the well being of investors. The SEC performs this function by regulating securities whether it is public company stocks, bonds, or any other security issued into the U.S. market.

Securities and Exchange Commission (SEC) Meaning

The Securities and Exchange Commission was created in 1934 to try and rid the market of unfair or corrupt practices. This meant that all publicly traded companies had to present audited financial statements, and meet all other requirements that the SEC established. The idea is to protect the everyday investor who does not have extensive knowledge of markets or securities. Five commissioners operate the SEC, and the President of the United States appoints them. Furthermore, a requirement is that there can only be three members at the most from a single political party. The President also appoints one of these members to be a chairman; however, no one is able to fire them once the President appoints these commissioners. This allows the commissioners to operate in the best interest of the people without worrying about losing his/her job.

Four Divisions of SEC

The SEC has four main divisions Corporation Finance, Trading and Markets, Investment Management, and Enforcement. Each of these has a separate responsibility towards certain securities and how they are offered into the market. Overall, the Securities and Exchange Commission duties have been performed up to par. However, there have been times in which fraud or insider trading has been routed out meaning that the SEC must amend what it is doing to try and avoid the same problems in the future and protect investors.

If you want to overcome obstacles and prepare how your company is going to react to external factors, then download your free External Analysis whitepaper.

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