A typical business loses 5 percent of annual revenue to employee fraud each year, according to the Association of Certified Fraud Examiners (ACFE). The median loss from a single case of fraud runs about $150,000. Many HR managers and business owners consider themselves good judges of character when it comes hiring employees, telling themselves, “There’s no way MY employees are stealing from us!”
But the sad truth is otherwise good employees can commit fraud. More than 80 percent of fraudsters had never previously been punished or terminated by an employer for conduct. Also, most fraudsters work for their employers for years before committing fraud. Statistically speaking, the more tenure an employee has, the greater the probability they will steal from you.
A classic 1997 study on employee fraud and abuse found three elements are often present for good employees to “go bad”: pressure, opportunity and rationalization. Pressure to meet financial obligations, coupled with an opportunity to commit and conceal the crime can be high motivators. And then there’s rationalization.
“All of us have a sense of our own worth,” explains Joseph T. Wells, CPA, CFE, who is founder and chairman of the Association of Certified Fraud Examiners (ACFE), which is located in Austin, Texas. “If we believe we are not being fairly treated or adequately compensated, statistically we are at a much higher risk of trying to balance the scales.”
Financial Statement Fraud
The ACFE points to financial statement fraud as the most devastating type of organizational fraud, resulting in a median loss of nearly $1 million. The Houston Chronicle reports financial statement fraud most often includes schemes to manipulate revenue figures. This typically involves posting sales before they are made or prior to payment.
“Examples include recording product shipments to company-owned facilities as sales, re-invoicing past due accounts to improve the age of receivables, pre-billing for future sales and duplicate billings,” explains Chris Bradford, a certified information-technology professional and fraud examiner. “Upper management is usually at the center of financial statement fraud because financial statements are created at the management level.”
Further down the chain of management, false invoicing has become a major issue in large and small businesses alike. Business research and consulting firm Deloitte explains false invoicing as either 1) creating an invoice for supposedly legitimate products or services that have never been delivered or carried out, or 2) re-submitting a legitimate vendor’s invoice for payment but using a bank account under the employee’s control.
A former Quest Diagnostics manager was reimbursed for over $1.2 million in false expenses through a false invoicing scheme. According to HR Morning, the employee set up fake companies, created fake invoices and turned in fake expense reports for payments he’d supposedly made to companies on Quest’s behalf. The FBI eventually caught on, and Smith was sentenced to five years in prison.
Currently, a former MillerCoors marketing executive is being prosecuted for a 10-year scheme to embezzle $8.6 million from the company in an elaborate false invoicing scheme. Crain’s Chicago Business reports the employee defrauded the company by submitting at least 200 false invoices and billing MillerCoors for fictitious promotional events, and inflating prices for other events held to market and promote the company’s products. He faces up to 20 years in prison.
Payroll theft is another very common type of employee fraud. Forbes reports payroll theft happens in 27 percent of all businesses – and nearly twice as often in small organizations with less than 100 employees than in large ones. This type of fraud often occurs in the form of timecard falsification (even more critically important to catch now with the new overtime laws in effect) and paying “ghost employees” who don’t exist.
Before assuming you’d catch on to this type of behavior early on, understand this: “The average instance of payroll fraud lasts about 36 months,” states Forbes. “That’s three years of paying ghost employees or overpaying existing ones.”
Fraud Protection Tips
So what’s an organization to do? Steve Bankler of Steve Bankler, CPA, Ltd., in San Antonio, Texas, offers these fraud protection tips:
- Install checks and balances. The business owner should review bank statements regularly as well as sign the checks. It’s also a good idea to work with an outside accountant to review financials.
- Pay attention to the warning signs. In the vast majority (92 percent) of employee fraud cases, at least one common behavioral red flag was identified. Do you have an employee who seems to be living above their means? A bookkeeper or manager who refuses to take time off or delegate work? These could be valuable clues.
- Put your employees at ease. ACFE has found employee tips are the best way to detect fraud. Plus, the more anonymous the tipster can remain, the more likely they are to report something. Be sure to create a work culture where employees feel safe to report suspicions without fear of retaliation.
Has your organization fallen victim to employee fraud? How did you find out? Help your colleagues learn what to look for by commenting here.
Stay tuned next month for Part 2 of our coverage on employee fraud as we discuss workers compensation and unemployment insurance fraud: two issues draining employers of valuable time and money.
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