The Scourge of Occupational Fraud

DP: Something near and dear to your heart. There are many types of fraud. Here we're talking about the workplace, so it's occupational fraud. Tell our listeners what that is.
JA: Occupational fraud is basically the use of one's position. Typically one's employment position to access gain or other benefits to which one would not otherwise be entitled.
DP:Okay. That's pretty straightforward. Tell us about the different forms that it can take.
JA: Sure. There are three basic categories: misappropriation of assets, corruption, and then financial statement of fraud. Misappropriation of assets. The first one is the one that we usually think of when we hear about somebody committing fraud against his employer, her employer — things like the hand in the till.
DP:Sticky fingers.
JA: Sticky fingers, but it doesn't necessarily need to be money. It can be inventory. It can even be, and we'll get into this a little bit later, perhaps, but it can be information. It can be ghost employees and things of that nature. So there's a number of different techniques a fraudster might use to misappropriate assets.
DP:How do companies set the stage for these bad actors? What conditions are they creating?
JA: Well, basically what I advise companies is to keep something in mind called the fraud triangle, which is promoted by the Association of Certified Fraud Examiners as an illustrative tool to basically show the conditions that need to be present in order for fraud to take place. So companies should seek the advice of a forensic accountant or an investigations professional, like myself, identify those areas where they're weak. With regard to the three legs of the fraud triangle. The fraud triangle consists of opportunity to commit fraud, pressure to commit fraud, and rationalization over the fraud that it's okay.
DP:I deserve this. I work hard. I should have a bigger paycheck, so I'm going to rationalize that it’s okay to take this money.
JA: Yeah. I should have gotten that promotion. Everybody's doing it.
DP: They won't miss it. The owners are rich. It's no big deal.
JA: On an investigation that I did several years ago, the bad guy, that's a technical term, by the way, the bad guy, finally admitted to what he had done. But then he said, look, had the company not expected that I might take some money here or there, they would have put better controls in place. They wouldn't have given me access to the checkbook without requiring dual signatures. They wouldn't have put me in as an officer on the corporate documents. They wouldn't have enabled me to do this stuff if they didn't expect that was going to be a part of my compensation anyway.
DP:What red flags should business owners look for? What should put their antenna up, to say: “Hey something, something doesn't pass the smell test here.”
JA: There are probably 101, and that's probably an underestimate. Here are some of the things that I would look at. Number one, an employee who does have some access to financial records or to disbursements or to hiring or, any sensitive area like that who essentially just doesn't want to give up control or share information or go on vacation or delegate duties.
DP:Has a fiefdom within the organization.
JA: Exactly. I don't want you to know what I'm doing because I don't want anybody to know what I'm doing. That's one example. Another example is the unexplained financial statement fluctuations. And what I mean by that is business owners should always be cognizant of how their revenues, expenses and income look, and they can then develop a good set of expectations around that. If something happens that doesn't conform to those expectations, one needs to investigate, or one that needs to at least ask if business appears to be steady. But suddenly there's an inability to pay one's bills as they become due. That's a red flag.
DP:Now, conversely, if let's say one day an employee is driving to work in a Honda Accord and then on Monday they come in in a brand new Porsche, is that a red flag?
JA: That's a red flag. Let me tell you about an investigation that I did several years ago that demonstrates your example. A manager of a temporary staffing agency who had control over hiring, firing and the reporting of hours, as well as the personnel payroll file for people who were under her purview. She was able to change addresses, change reported hours, and basically do anything that she wanted in order to create false time entries. Ultimately paid by a third-party corporation, it ended up in her desk drawer, and then in her bank account. This same person who probably made a salary of about $50,000 a year was throwing birthday parties for herself and inviting all of her friends, many of whom also worked for the same agency, to luxury hotels in the downtown area. And then it got even more egregious because then she started deciding to do the same thing, but for her half birthday. By the time it was detected, it was a seasonal thing where it was done for every quarter birthday — no explanation as to why.
DP:Okay. Begging to be caught. Now let's say that some of those red flags are appearing and the business owner has an inkling that something is not right. What should the organization do? Because I mean, let's look at the other side. There's no crime and having a new car. So how do you balance the taking action where you think something is crooked versus condemning an innocent person?
JA: Sure. That's a very, very tough sell.
DP:But let's assume for a second that there is impropriety going on and the owner suspects it. What should he/she do?
JA: First thing I would do, ask the owner has he retained counsel. Fraud is a legal issue and when investigations are not handled properly, an owner can expose himself or herself to further damage through lawsuits for reputational damage and things of that nature. So one should be guided by legal counsel. In cases where there are accounting or a cash issues, retain a forensic accountant on behalf of the business owner.
DP:And that's all well and good after the fact. Now, what can owners do to be proactive, so it never gets to that level?
JA: Sure. The biggest thing that we in the forensic accounting field say is to establish a good tone at the top. The best thing one can do is keep in mind the fraud triangle about which we previously spoke — opportunity, pressure, and rationalization. The business owner should work as hard as he or she can to limit those three things. If you don't have all three or even if you have two, but you don't have one, fraud doesn't happen. So move from theory to actually actionable steps. First thing, increase the perception of detection, communicate with staff about expectations. Perhaps have a code of conduct that employees need to be trained on or at least read and certify once a year. When there are issues within the organization, pursue prosecution; certainly terminate the employee if appropriate. Make employees understand that, yes, this is a great place to work, and I'm empowering you. But at the same time, there will be consequences if you violate trust.Employees also should have a way to report fraud if fraud is suspected. A lot of times, employees will look the other way because they simply don't want to get involved. They don't want to implicate somebody who they suspect is committing a fraud, even if they're pretty sure that it's happening because they know about the personal consequences that that person might suffer and their suspicions are wrong.Many of my clients have, at my recommendation, implemented a fraud hotline that can either be anonymous or not anonymous. There are services out there that actually will independently monitor and report calls. So that sort of provides an additional layer of anonymity. Employers should also train employees on how to detect or how to at least identify some of the red flags. As the saying goes, you need to kind of know what it is in order to know what it is. I'd also consider very strongly looking at one's hiring procedures. This gets into pressures if people have histories of arrests, drug addiction, significant financial pressures as shown by their credit report. Those are red flags or indicators that those people might have undue pressures and they, good people perhaps otherwise, but they may come into the organization, have pressures on the outside, and feel that they have no choice.
DP:Perform thorough due diligence when you're hiring someone.
JA: Oh, absolutely.
DP:Well, Jim, this has been interesting. It's definitely an interesting area —very high stakes for business owners. So I thank you for your expertise and your insight.
JA: Thank you very much.
DP:And thank you for listening to the EisnerAmper podcast series. Visit eisneramper.com for more information on this and a host of other topics and join us for our next EisnerAmper podcast. When we get down to business.