7 Simple Steps to Corporate Fraud Prevention: A CaseStudy

Evidence of internal theft shines a bright light in therear-view mirror. Posted by Chris Hamilton on September 6th,2012

The shock when a victim discovers that a trusted employee – andeven a friend – has stolen from him or her is absolute. It’s afeeling of betrayal and violation that strikes fear in some, griefin others and anger in most.

In my experience, it is almost always accompanied by a sensethat the victim should have known it was going on. The evidence oftheft sheds a bright light in the rear-view mirror. Patterns andcircumstances take on a clarity that contemporaneous experienceobscured. Sometimes the clarity was there but for a variety ofreasons it was ignored.

A Case Study

The internal fraud was revealed, he felt stupid for allowing itto happen and the lesson cost him several hundred thousands ofdollars in uninsured losses.

A victim uncovered theft when his bookkeeper unexpectedly misseda few days of work and he opened a bank statement. The simple actof thumbing through cancelled checks from one month’s bankstatement prompted a phone call to his attorney who directed him toa forensic accountant. The internal fraud was revealed, he feltstupid for allowing it to happen and the lesson cost him severalhundred thousands of dollars in uninsured losses.

The forensic accountant uncovered evidence of a simple buteffective embezzlement scheme. The bookkeeper had set up vendorsthat were very similar to existing real vendors. For example, ifthe real vendor was ABC Service Company then a fake vendor wasestablished called ABC Service Co. The bookkeeper set up bankaccounts for the fake vendors. That was the hard part. The rest waseasy. The business owner signed hundreds of checks to the fakevendors thinking the checks went to legitimate businessactivity.

Since that worked so well, the bookkeeper began forging checksto pay the vendors, personal expenses, and provide cash gifts tofamily and friends. And, since all that worked without detection bythe business owner, the bookkeeper took an unauthorized increase insalary.

It was bold. It was also easily discovered and should have beeneasily prevented. The bookkeeper was quickly arrested and has spenttime in jail.

Fraud Prevention 101

The following are fraud prevention steps that were ignored andcould have prevented the theft:

1. Know your employee. In this particular casethe business owner recounted that he knew the prior employer of thebookkeeper well. He was aware that the bookkeeper had left theprior employer on less than positive terms but figured it was noneof his business and hired the bookkeeper because of knowledge ofthe industry. A phone call to the prior employer/friend after theembezzlement was discovered revealed that the bookkeeper wasprobably stealing from the current employer to pay off a judgmentobtained by the prior employer to recover embezzled funds.
2. Do a background check. Embezzlers tend to berepeat offenders. This is an obvious follow-up to the prior point.A simple background check is not expensive, is easy to do and, inthis case, would have prevented a bad hiring decision. It wouldhave confirmed the ill-at-ease feeling the employer had at the timeof hiring.
3. Open your own mail. Let the bookkeeper do thebookkeeping. You cannot abdicate other important (and seeminglyunimportant) functions because the clerk is always around and doeshis or her job well. Vendor communications, bank statements, andbills from vendors and suppliers are important sources ofinformation.
4. Separate functions and duties. Many smallbusiness owners are so busy that they tend to overlook common sensewhen assigning work. In this case a bookkeeper was eventually giventhe responsibility for answering the phones, opening all the mail,writing checks, making deposits, preparing invoices, reconcilingthe bank statements, and preparing the financial reporting providedto the business owner and his outside tax preparer. As noted above,simply opening the mail would have prevented some of the problems –or would have caught it a lot earlier.
5. Don’t accept bad answers to good questions.When the forensic accountant arrived on the scene, the businessowner requested a report showing payments to all vendors. Thebookkeeper had previously argued that it was difficult to put sucha report together, would take a long time, and would not becorrect. The accountant produced the report in about 90 seconds.The business owner was shocked – and the point was made. Hisbookkeeper, for a long time, had prevented him from seeing the veryreport that exposed the whole scheme.
6. Force vacations. Nobody else had access to thebookkeepers work for more than two years. Any other eyes on theaccounting records would have exposed everything.
7. Acknowledge your instinct. If the lifestyle ofthe employee exceeds what you know about their legitimatecompensation there is good reason to look harder. If the bookkeepercan’t produce simple reports from “the books” they are keepingthere is a problem. If you feel like you are working for thebookkeeper rather than them working for you, something is wrong. Ifit feels like the business is doing better than ever but thereisn’t any cash find out why.

All of the steps above were recognized by the business owner inthis case: “I knew something wasn’t right. I should have known thiswas happening.” That is never good after the fact.

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