merging businesses are much more
vulnerable proportionally to employee theft, and are much less
able to absorb these losses than large corporations. Upon completing
its 2006 analysis of occupational fraud and abuse, the Association of Certified
Fraud Examiners (ACFE) in Austin, Texas reported that businesses
employing less than 100 persons "were the most vulnerable
to fraud and abuse" by employees. Emerging companies were
the victims of fraud more often than large corporations, and the
resulting losses were much larger commensurate with their resources.
This report identifies three major categories of occupational fraud: asset misappropriation, corruption, and fraudulent statements. Asset misappropriations comprise the largest number of cases (91.5%), but display the lowest median loss ($150,000). Corruption represents 30.8% of cases with a median loss of $538,000. And fraudulent statements comprise only 10.6% of all cases, but represent the largest median loss ($2.0 million).
This survey collected information on 1,134 cases of employee fraud laid open between January 2004 and January 2006.
Among the victims of employee fraud, smaller businesses (less than 100 employees) had a
median loss of $190,000 per occurrence — disproportionately larger than the median loss of $159,000 for all occurrences. "The most common occupational frauds in small businesses involve employees fraudulently writing company checks, skimming revenues , and processing fraudulent invoices."
For all businesses, nearly "one-quarter of the cases caused at least $1.0 million in losses and nine case caused losses of $1.0 billion or more." It is estimated that 5.0% of annual revenues are lost to fraud. "Applied to the estimated 2006 United States Gross Domestic Product, this 5% figure would translate to approximately $652 billion in fraud losses." The median length of time before these crimes are detected is 18 months after the initiation of the fraud.
The most costly employee-fraud problems (median) are to be
found in the "the wholesale trade ($1 million), construction ($500,000), and manufacturing ($413,000)" industries; the lowest median losses were found in "government organizations ($82,000) and retail organizations ($80,000)."
The importance of confidential hotlines and other reporting mechanisms is emphasized as a fraud detection tool. "Occupational frauds are more likely to be detected by a tip than by other means such as internal audits, external audits or internal controls. The importance of encouraging tips is evident in cases involving losses of $1 million or more. Forty-four percent of the million-dollar frauds in this study were detected by tips. This is more than twice the rate of detection by internal audits and three times the rate of detection by external audits."
Encouragingly, an organization's exposure to fraud is reduced measurably with certain anti-fraud controls. "In the cases we reviewed, organizations that had anonymous fraud hotlines suffered a median loss of $100,000, whereas organizations without hotlines had a median loss of $200,000. We founds similar reductions in fraud losses for organizations that had internal audit departments, that regularly performed surprise audits, and that conduct anti-fraud training for their employees and managers."
The higher fraud losses suffered by smaller businesses is generally due to a poor job of proactively detecting fraud. "Less than 10% of small businesses had anonymous fraud reporting systems, and less than 20% had internal audit departments, conducted surprise audits, or conducted fraud training for their employees and managers. This helps explain why more small business frauds were detected by accident than by any other means."
Interestingly, the position of the perpetrator is closley linked with the size of loss due to fraud. "Frauds committed by owners or executives caused a median loss of $1 million. This is nearly five times more than the median loss caused by managers, and almost 13 times as large as the median loss caused by employees." ... "Just over 30% of occupational frauds were committed by employees in the accounting department, and slightly more than 20% were committed by upper management or executive-level employees. The next-most-commonly cited department was sales, which accounted for 14% of the cases in our study."
Background checks of prospective employees are undertaken by nearly two-thirds of the organizations studied. "However, less than 8% of the perpetrators had convictions prior to committing their frauds. Although background checks on new employees can be a valuable anti-fraud tool, our data suggests that other measures such as fraud training, surprise audits and anonymous reporting mechanisms can have a more significant impact in detecting fraud."
In 42.1% of cases, the victim was not able to recover any of its lossesFull recovery was realized in only 16.4% of cases. More soberingly, the "median loss in schemes where full recovery was obtained was only $50,000. By contrast, the median loss in schemes where there was no recovery was over three times as large, at $170,000."
Previous studies have observed that there are two general characteristics of emerging
businesses that make them especially vulnerable to employee fraud:
First, because of the closer relationship between
the owner/managers and their employees, "you generally have
a higher degree of trust" that facilitates the fraud of the
dishonest employee. The survey disclosed about 200 incidents in
emerging companies where a "trusted" bookkeeper had simply
stolen money from the firm, the scheme often continuing for many
years. The report describes one case in which a bookkeeper stole
$150,000 by salting checks drawn to himself in the piles of legitimate
checks presented for the owner/manager's signature. Invariably
laid before the owner/ manager at the busiest periods, reliance
was placed on this trusted employee and the checks were not scrutinized
carefully.
And second, the financial controls in the emerging
business are generally casual and unsophisticated. The refined
security and audit procedures found in the large corporation do
reduce the level of fraud significantly.
However, the emerging business can employ some low-cost
weapons to combat employee fraud. The most critical measure is
to undertake meticulous background checks on all new employees.
Resumes should be checked thoroughly to ascertain that the applicant
did graduate from the schools claimed. Any unaccounted-for time
in the person's past must be acceptably explained. To guard against
bogus employment references, a prospective employer should never
rely on the resume as the source for the telephone number of an
applicant's previous employer.
The owner/manager of the emerging business must exercise
some simple precautions to thwart employee fraud. Each employee
handling money should be removed periodically from their job so
that any malfeasance may not be continually concealed; this can
be accomplished through required vacations and short-term job
rotation. (The classic embezzlement is the handiwork of the trusted
employee working long hours and never taking a vacation — most
thefts would surface if the employee had to take their hands off
the job.) It is essential that other employment and business relationships
of all key employees be known fully. Even family members working
within the business should be subject to the same checks and controls
as other employees. And an independent audit at least annually
is an expense the smaller business cannot afford not to incur.
The emerging business often cannot survive the losses
of significant employee theft. The owner/manager of the emerging
business wants to be trusting, but must have his/her eyes fully
open and not be gullible. Recognizing that even the "nicest"
employees may be subject to temptations and failures of character,
prudence demands that procedures and practices be established
to preclude the possibility of any employee fraud. The survival
of your business depends upon it!
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