The Cannabis Industry and Cash Fraud Vulnerability
April 12, 2021
By Amy Fitzgerald and Hubert Klein
The cannabis industry is emerging at a rapid pace with huge growth expectations and potential in both the near and long term. As a result, any market expanding at such a rate is vulnerable to those with unsavory intentions to exploit both consumers and manufacturers. The cannabis industry can be especially vulnerable to fraud.
Though cannabis remains illegal at the federal level, this past year has seen a number of states advance legalization, allowing more businesses to sprout across the country. While it is a state-by-state regulated and emerging market, many cannabis businesses still operate on a cash-only system, leaving them highly susceptible to various types of cash fraud. There are several types of cash fraud that all business owners should be aware of, but especially those involved with high volumes of physical cash, such as:
- Larceny – Cash is stolen directly from the organization (i.e., removing cash from a safe or register).
- Skimming – Cash is stolen before the transaction is recorded (i.e., pretending to charge a customer and pocketing cash).
- Fraudulent Disbursements – A fraudulent disbursement is made for personal and/or dishonest purposes (i.e., expensing personal purchases as business expenses).
Collusion, while not a particular type of fraud, is something that cannabis businesses should be aware of when considering the aforementioned. Employees intending to commit and actually committing cash fraud could be colluding with each other, customers or suppliers through means such as discounts, bribes or kickbacks.
According to the Association of Certified Fraud Examiner’s (“ACFE’s”) “2020 Report to the Nations,” the typical fraud case lasts 14 months before detection with a loss of $8,300 per month. Asset misappropriation, which covers cash fraud, was the most common type of fraud, consisting of 86% of cases at a median loss of $100,000 per case. It is noteworthy that if there is more than one perpetrator (collusion) committing the fraud, it is statistically shown that the scheme will generally last longer and result in significantly higher losses—making early detection even more critical.
Given the huge cost fraud can have on a business, it is significantly cheaper for cannabis businesses to preemptively establish controls to prevent any form of cash fraud. Many frauds occur due to a lack of sufficient internal controls. With many new business ventures in the cannabis industry (including small businesses considered less than 100 employees), the most likely scenario that leads to fraud is having a lack of internal controls, which creates the opportunity for larceny, skimming or fraudulent disbursements.
In addition to establishing good internal controls around cash, there are other things an organization can do to minimize cash fraud. The ACFE report states that the most common way a fraud is detected within a business is from a tip from another employee, customer, an anonymous line, or vendor. Therefore, instilling a good corporate culture and establishing the proper internal controls can save a business hundreds of thousands by ensuring that the business environment is friendly and there is an anonymous way to report concerns. Organizations with hotlines resulted in losses nearly 50% less than those without and were proven to more quickly detect fraud.
In addition to an anonymous hotline, there should be a clear separation of duties along with checks and balances within the organization to ensure no possible employee collusion and hold everyone accountable. This can be done by having two people count the registers independently, a multiple-step process concerning payroll, and a good product inventory system. Another way to prevent collusion is to count cash randomly and to enforce vacation time and rotate shifts to help expose any multi-person schemes.
For many in the cannabis businesses, their operations are still too small to have a proper internal accounting team, so it is highly recommended that these businesses hire an external, independent consultant to review existing controls and procedures and help develop a plan to minimize incidents of fraud. In addition, management and/or owners should frequently self-audit their internal control systems and review their accounting records and books in order to ensure that everything is running smoothly and as intended.
A huge proven deterrence in fighting fraud is through anti-fraud training for both management and employees. By having this training in place, along with a code of conduct, businesses can prevent their losses by up to 50%. When it comes to fraud, the tone at the top sets the expectations for an organization. It is recommended that those in the cannabis industry work with an experienced firm to development an anti-fraud training program and ensure that they have a good internal controls system.