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Workplace Fraud – Limiting Opportunity

Nov 16, 2016

Business losses from workplace fraud – the misappropriation of cash or other assets by employees – are important business risks that can have significant impact. In addition to the financial loss, there’s also the potential damage to reputation and to relationships with customers, banks and employees.  Appropriate attention can go a very long way toward deterring employee fraud. What comprises appropriate attention depends on specific business factors that reflect owners’ and managers’ assessment of exposure to and capability to recover from potential losses of workplace fraud.  

Accounting professionals advise companies about ‘internal controls’ which includes the processes effected by owners and managers to provide reasonable assurance about safeguarding assets. One of the basic building blocks of internal controls to safeguard assets is ‘segregation of duties.’ Generally speaking, segregation of duties refers to assigning responsibilities to different employees so that no single employee can both perpetrate and conceal a misappropriation of assets. 

In the study and investigation of workplace fraud, the ‘Fraud Triangle’ is a widely recognized model which addresses the question of how a trusted person crosses the line and becomes involved in a fraud.  The three sides of the triangle are motivation, opportunity and rationalization.  Motivation and rationalization are interesting as psychological concepts, but the functional aspect of deterring fraud is to focus on limiting opportunity.  In my experience leading accounting investigations over my 35 years as a CPA (including billion dollar Ponzi schemes, securities fraud, bank embezzlements, and inventory diverting schemes) the vast majority of people who were caught in internal corporate frauds had a track record of honest and trustworthy performance – until opportunity presented itself. One investigation in which I was involved early in my career still stands out as a prime example of how opportunity creates its own evil:  A bank’s CFO began as an assistant controller 20 years earlier.  After a few years, the bank’s chief investment officer retired and the CFO was given those responsibilities as well. No one realized that the CFO’s responsibility for recording transactions and the CIO’s responsibility for authorizing transactions, which should have been kept separate, were now vested in one person: opportunity!  After 20 years of honest service, the CFO started with a small, safe and quick – but unauthorized and unrecorded – securities transaction in which he pocketed a $1,500 gain using $300,000 of the bank’s money.  The CFO quickly learned he could safely execute and conceal his scheme. However, the CFO’ scheme didn’t plan on how to keep things covered up if there were losses instead of gains. Once the losses started, they only got worse after he tried doubling his bets on securities trades in an effort to win back the losses faster. After 4 years and millions in losses, when the scheme was finally discovered, the CFO told the FBI he was glad because keeping things hidden was just too much work. By the way, the CFO was caught only because he was forced to take his annual vacation – a bank internal control procedure – after the bank’s compliance officer realized that the CFO hadn’t taken a vacation in 4 years.

Consider segregation of duties in the connection with these business functions and duties: bank authority for signing checks or approving wire transfers, access to checks, recording accounting transactions, reconciling bank accounts, authorizing changes in payroll, and making bank deposits.  Even in a small business with few administrative employees, there are ways to efficiently separate duties (or add alternative controls) to limit opportunity for fraud.

Two other considerations: 1) insurance and 2) attention.  To the first point, crime insurance, also known as a fidelity bond, can be a useful tool in responding to the risk of workplace fraud.  Insurance coverage may also cover the cost of hiring forensic accountants and lawyers to investigate the fraud. While writing this article, I was called to a client’s office to help them respond to workplace fraud.  The client discovered that its controller had made unauthorized increases in his payroll of $50,000 over the past six months.  The client was worried about what else might he have stolen. However, there was no crime insurance and recovery of the loss and the cost of investigation might be limited to what, if anything, the (former) controller could pay back.  As for the second point: Pay attention. The controller was caught after co-workers reported to the owner that the controller had given conflicting stories about why he wasn’t in the office for the past few days.  The owner was able to find out that the controller had checked into a Las Vegas hotel and bought $30,000 in chips.  After hearing that news, his first thought was to check the payroll records – and there it was.

When owners and managers give appropriate attention to internal controls and segregation of duties, workplace fraud can be deterred because opportunity is limited.  In addition, there are numerous reports that indicate that internal controls are enhanced when employees perceive that owners and managers are actively involved in safeguarding assets.


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Andrew C. Bernstein

Mr. Bernstein is a Managing Director in EisnerAmper's Financial Advisory Services Group, with over 30 years of experience in providing expert testimony and forensic accounting services.

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