Under former Attorney General Eric Holder’s leadership, the US Justice Department drastically increased its fight against fraud, bringing in more than $24 billion in penalties. This substantial sum came mainly from the department’s pursuit of big banks for financial misconduct. Yet it also increased its crackdown on smaller instances of fraud.
Fraud is prevalent in many facets of life, particularly within businesses. This swindling can come in many forms and eats away at a business’s funds. According to the Association of Certified Fraud Examiners (ACFE), on average, businesses lose 5% of revenue each year to fraud. Additionally, 22% of the cases examined by the ACFE involved losses of at least $1 million. Therefore business owners, attorneys, and investigators should know what types of fraud occur, how to look for them, and how to prevent them.
Asset Misappropriation Fraud
To put it plainly, asset misappropriation takes place when someone steals funds from his employer. Asset misappropriation constitutes the most common type of fraud affecting businesses. What follows is a list of the most commonly encountered forms of asset misappropriation, ways to discover them, and methods of prevention.
An authorized maker is a person with the power to create and sign checks for a company. In this scheme, the authorized maker creates a check payable to himself, or one that pays his expenses, later altering the payee name in the accounting records to make the disbursement look like it was made to an authentic vendor.
This scheme can be recognized in two ways: by regularly contacting vendors to ensure that the invoices are being fully paid, and by reviewing the company’s routine expenses and looking for abnormal increases.
Businesses should set up checks and balances in their payment organizations to prevent this form of fraud, for example, by designating someone other than the authorized maker to control the bank statements.
This straightforward type of fraud involves someone obtaining a company check, making themselves the payee, and forging the authorized maker’s signature.
The biggest red flag for a forged check scheme arises when there are checks not indicated within the system. An unusual payee for a check also provides a strong sign of check forgery.
The easiest way to prevent check forgery is to make sure the checks cannot easily fall into the wrong hands. Store company check stock in a secure place where only authorized individuals have access, develop a thorough method for disposing of unused checks, and match vendor and check payee lists against bank statements to discover any anomalies.
Like forged check fraud, an altered check scheme involves an individual intercepting a legitimately signed check and altering the payee on the check or the amount to be paid.
Since altering a check means erasing the information previously printed on it, one can usually tell it has been tampered with; if an authorized person filled out a check incorrectly, she would note it and use a fresh check, not erase and write over the same check. In addition, if checks are being altered, the company will likely hear from the original payee who has not received payment.
As with forged checks, the prevention of altered check fraud includes making the check supply available only to authorized persons, creating a system of checks within the company payment system, and conducting a regular review of bank statements.
Concealed check schemers take advantage of “rubber stamping” that can occur in larger businesses. The perpetrator prepares a check and submits it with legitimate checks, hoping that the authorized signer will sign off without paying close attention.
The most direct way to detect this type of fraud—besides the other methods to detect check fraud described above—involves the authorized signer paying strict attention to the checks she is “rubber stamping” in case someone has slipped a fraudulent check within.
To avoid concealed check fraud, first implement a more complex system of check approval that involves multiple viewers and checkers. This way more people look at each check, and, therefore, can detect fraud more readily.
A billing scheme involves an individual submitting false invoices that the business issues payment on; while the disbursement of funds is legitimate, the payee is fraudulent. The two most common ways this scheme occurs is through the use of a “shell” company—which then issues the false invoices—or by simply double-paying a legitimate vendor.
Detecting the former type of billing scheme can be as easy as looking at the way a legitimate invoice from a vendor has been altered. With a suspected shell company, a simple investigation of the shell and its relation to the organization can unmask the fraud.
Here again, checks and balances aid prevention. Split the duties of ordering, approving vendors, recording invoices, paying vendors, and reviewing bank accounts among different positions to lessen the chances of a billing scheme.
Cash larceny concerns an individual blatantly stealing cash after it has already been entered into records. A common example would be a theft that occurs while a business’s cash deposit is en route to the bank.
Because of the crime’s transparency, cash larceny is often easy to spot. If cash has not been deposited, or the balance of checks-to-cash in a deposit differs from normal, or the business’s sales do not match its deposits—then someone may be taking money before it reaches the bank.
The easiest way to prevent this kind of fraud involves appointing a trusted and authorized individual to make deposits, while another person of authority checks the original bank deposit against the deposit receipt.
Non-cash misappropriation occurs when an individual takes company materials, goods, or other physical assets and utilizes them for his personal use or sells them. Also known as “shrinkage,” this type of fraud commonly befalls businesses that specialize in selling products and merchandise.
Discovering non-cash misappropriation can be difficult, especially in large organizations with extensive inventory. That said, “shrinkage” is usually found during stock-taking activities, or quite simply, when people notice items missing.
Ways to prevent the theft of physical assets include having access controls to inventory, instituting a tip line for employees to report suspicious activities, reviewing and investigating anomalies in inventory records, and, once again, setting up a system of checks and balances that limit the opportunities for individuals to “shrink” inventory.
While payroll schemes can take many different forms, all involve an individual submitting false documents or manipulating the payroll system to cause the business to pay out incorrect funds.
The most common types of payroll fraud include:
- Overstatement of employee hours,
- Unauthorized increases to a rate of pay,
- Alteration of numbers used in determining bonuses or commission,
- Creation of “ghost” employees, and
- Taking payroll checks of employees who have been terminated.
To reduce the chances of payroll fraud, an organization must keep its employee files up-to-date, physically distribute pay to employees, ensure an approval system is in place for hours worked, and that a system of checks and balances exists within the payroll department.
Skimming, in its most basic form, consists of taking company funds before they are recorded. Unlike cash larceny, which occurs after the funds have been documented, skimming happens prior to asset notation, making this type of fraud harder to detect. A basic example of this fraud would be a bartender taking money for drinks and pocketing the cash rather than “ringing it up.”
The most obvious way to detect skimming is to simply look at gross revenue and wonder, “Where is the money going?” If you have an expected profit estimated on number of customers, but your revenue is falling well below that mark, there may be skimming in the organization. Also, if customers begin to complain that they have been billed for amounts already paid, skimming might be the culprit.
Another common scheme involves fraud on an expense reimbursement. Many businesses, quite rightly, reimburse employees for certain costs incurred while the employee conducts work for the company, as when an employee attends a tradeshow to advertise the company and must spend out-of-pocket money on a hotel and rental car. The employee usually supports these costs with receipts and invoices. However, an employee can exaggerate or submit false receipts/invoices, which the business subsequently pays.
Ascertaining fraudulent expense reimbursement can be tricky. Basically one relies on his “gut feeling.” Do the mileage costs seem too high for the distance the employee traveled? Do the dinner tabs seem over the top? By asking these sorts of questions, one can decide whether or not fraud might be present and embark on a subsequent investigation.
Cash Register Disbursement
Cash register disbursement schemes usually take one of two forms, and sometimes occur as a form of skimming:
- False returns: When an individual processes a false return on a sale already recorded.
- Unrecorded sales: Not entering a sale into a register and pocketing the cash instead.
False returns are more easily found than unrecorded sales. If an employee’s register at the end of his shift is not in balance, or he has done an unusual amount of returns, that employee may be conducting false returns. Unrecorded sales, like skimming, are more difficult to ascertain precisely because they are “off the books.” Instead, other means of detection must be used, such as inspecting the causes behind an abnormally low inventory.
The best way to prevent either form of cash register fraud is to have a supervisor approve all returns. In addition, establishing a regular balancing of registers for each employee will help you prevent and discover any possible fraud before it expands too far.
Considering the frequency and range of fraud within businesses, knowing what to look for is key to any preventive effort. Though many of these schemes often deduct only minor amounts of money from a business’s total assets, these small numbers can add up to serious losses. Knowledge is the first step to prevention; as Benjamin Franklin famously said: “An ounce of prevention is worth a pound of cure.” Having a thorough system of checks and balances within your organization wherever money is dealt with, is one “ounce” of prevention that can save “pounds” of lost assets. Knowing and taking steps to prevent fraud can save businesses big headaches.