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Recession, Employee Fraud - A Dangerous Combo

Recession, Employee Fraud – A Dangerous Combo

Law360, New York (July 13, 2009) -- Our current economic climate has become a breeding ground for employee theft. A recent study conducted by the Association of Certified Fraud Examiners (ACFE) found that employee fraud has risen in the last 12 months and that financial pressures were the biggest contributing factors to committing fraud.

While we may have potentially seen the worst of the recession, its effects are still being felt — and any schemes employees might have orchestrated when their financial outlook seemed grim may still be in place. That is why now is the ideal time for general counsel to take a hard look at their internal controls and ensure that employees are not reaching into the company's coffers.

The Perfect Storm 

As a followup to cutbacks and layoffs on all levels, management often presses remaining employees into doing more work. Fewer supervisors means a reduction in the level of internal controls, higher levels of stress placed upon those individuals, and blurred lines in the segregation of duties.

At a time when management should be even more diligent in keeping tabs, just the opposite happens — activities, people and responsibilities fall through the cracks.

Fraud examiners nationwide are reporting a steady flow of employee fraud cases similar to the following examples. In some circumstances the theft took place over a number of years; others stole fast and furious, racking up six-figure payments to themselves over a period of only months.

The Fraud Triangle 

Why do people steal? Years ago, renowned criminologist Donald Cressey sought to answer this question using a basic concept which he named the 'Fraud Triangle.' He describes the three key elements in the fraud triangle as opportunity, motivation and rationalization.

According to Cressey, when these elements are present, the risk for fraud dramatically increases. Throw in a downturn in the economy, the prospect of no raise, no bonus and potential layoffs, and the rationale for fraud exponentially increases.

Recently, “Kate,” an accounting department employee of ABC company, was caught having stolen more than $900,000 from the firm. She had used her company credit card to purchase personal items. Since she worked in accounts payable, the credit card statements came to her. And since there was no one directly above her checking her work, each month she transferred company funds from the bank to the credit card — and no one knew.

Kate had ample opportunity to commit fraud — she alone had unfettered access to assets and the ability to conceal her theft. She was motivated by greed and the ease with which she could get her hands on cash that in turn improved her lifestyle. Kate rationalized that she was not getting paid enough for all of the various responsibilities of her job. The more she spent (using the company's money) the more she needed to steal.

On a larger scale, an accounts payable supervisor was responsible for embezzling more than $7.4 million and an FCPA act violation. She had created checks to legitimate vendors and ghost vendors, had someone approve the checks and then inserted her own name as the payee. The scheme was discovered when auditors found an $8 million balance in accounts payable — on the debit side.

The lesson learned in these two cases is clear — better internal controls, especially focusing on those employees who handle the company's day-to-day finances, are a necessity to prevent such theft. In both cases, the companies took a hit on all levels — financially, legally, reputationally and, most importantly, in the confidence level of other employees.

Rarely does a case of employee fraud go to court — it is widely known that less than five percent will make it to that level. Most employers and the guilty employees are willing to put the incident behind them and move on, accepting the losses for what they are.

Proactive Stance Toward Fraud Prevention is Key 

General counsel and their litigation support advisors should be the drivers of a fraud management process that includes four key components — detection, deterrence, response and remediation.

Once a plan is in place against each of these components, a company's risk of fraud occurring is already lessened. If a theft is detected, an investigation should begin, using outside fraud examiners or forensic accountants.

Conducting a fraud risk checkup, just like going to the doctor for an annual exam, is a worthwhile investment of time. Spend a day or two and undergo a risk assessment with an internal or external fraud examiner. If your firm typically has a busy season, schedule the 'stress test' before things get too hectic.

Organizations who take proactive measures to implement an effective fraud management process, including programs and controls designed to deter, detect and respond to incidents of fraud, will greatly reduce the risk of loss due to fraudulent activities. Those organizations who choose to ignore this proactive approach, may find themselves immersed in a 'perfect storm' of fraud.

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