Destination Success: Too much trust opens door to employee fraud

Fraud can slip into any organization virtually unnoticed. It likes to hang out in the accounting department, but it can occur in any part of the organization. Many think that employee theft is not a big deal. According to an estimate from the United States Department of Commerce, U.S. businesses lose as much as $40 billion a year because of employee-related crimes.

Check fraud is the most common form of business fraud. In 1992, the cost of check fraud was $4.2 billion. Only four years later, that figure grew to $13.6 billion. The most popular check fraud schemes include stealing and forging checks; issuing checks to fictitious entities; altering legitimately issued checks; and duplicating/printing counterfeit checks.

Many companies that have been defrauded by an employee thought they had adequate internal controls. In addition, businesses have been bilked by long-standing employees whom the employer trusted unconditionally. Every business has areas of vulnerability that should be considered.

Cash receipts

A parts clerk for an appliance distributor pocketed much of the cash received from the buyers of service parts. Although the clerk was required to make out sales slips, he destroyed the duplicate copies. His theft went undetected because the sales slips were not pre-numbered. One day, however, the manager observed him tearing up the duplicate copy of the sales slip and the embezzlement was uncovered.

Accounts receivable

An employee embezzled more than $300,000 from his employer by diverting payments from a customer's account. To cover the shortfall in the account, the employee would intercept payments by other customers to their own accounts. The employee continued to transfer funds from one account to another. The shortage was always there, but not in the same account. One day, while the employee was out sick, a transfer was missed and the embezzlement scheme unraveled.

Employee benefit plans

An employee responsible for handling contributions to the company-sponsored savings plan diverted funds from these contributions for his own personal use. His theft was eventually uncovered after an audit of the plan was made, at which time a substantial shortfall was uncovered.

Purchasing

The chief accountant of a food-processing company embezzled more than $500,000 during a three-year period. Using an optical scanner and laser-jet printer, he duplicated the invoice of a supplier. After forging the initials of the purchasing agent, he presented many bogus invoices for nonexistent shipments of glass containers along with a check to be signed by the treasurer of the company.

The signed check was mailed to the address on the bill, where the chief accountant had arranged to pick up the mail. When he received the check, he deposited it in a bank account he had established. Later he withdrew the funds and transferred them to his own personal account.

Petty cash

An employee who was in charge of a petty cash account at a metal products company used the stroke of a pen to embezzle from her employer. After a salesman gave her a voucher made out for $75 to be used for travel or entertainment, she turned it into $175. She then handed the salesman $75 and kept the $100 for herself. Later she increased the amounts by $200. The alteration became more obvious and eventually exposed her scheme.

Payroll

The paymaster of a large food company stole more than $200,000 from its payroll over a 15-year period. His scheme was to mark "vacation" on an employee's time card and generate a paycheck for vacation time for the employee. He would then cash the paycheck by forging the employee's name. The embezzlement scheme was only detected when the paymaster was on an extended vacation.

Inventory

A company vice president in charge of shipping, a plant foreman and a trucking company employee colluded to cause a loss of more than $1 million to a manufacturer of cutlery. They loaded trucks with merchandise and resold the items at flea markets, tag sales and small retail shops. Employees who questioned their activities were fired, and others who were suspicious of wrongdoing kept quiet. Eventually, the controller for the cutlery manufacturer uncovered the scheme, and the employees confessed.

Securities

A trusted bank officer was responsible for the theft of $800,000 through the manipulation of securities. In addition to being an officer of the bank, he was also the treasurer of a charity. The bank officer knew that the bank had purchased certain bonds. He advised the charity to purchase the same amount of these bonds, but the bond numbers he reported to the charity were the bond numbers of the bank's bonds. He then sold the charity's bonds and kept the proceeds.

Each year, before the charity was audited, he transferred the bonds from the bank to the charity. After the audit was complete, he transferred the bonds back to the bank. He repeated the process each year until his demise, after which the loss was uncovered.

Unfortunately, people steal. Although there is no absolute defense against the determination of a skilled embezzler, there are techniques that will reduce the probability of internal theft, particularly a sound system of internal controls.

Make sure there are clear lines of authority and responsibility between employees and departments.

Require countersignatures on checks over a certain amount.

Have a carefully planned accounting system. The accounting department must be able to prepare and analyze reports for management. It must also properly record transactions so that discrepancies can be identified.

Mark all invoices "paid" or perforate them to prevent duplicate payments.

Require all employees to take annual vacations of at least five business days.

Select personnel carefully.

Supervise and enforce internal controls.

A review of the internal controls should be done at least once a year.

The second line of defense against employee theft is the purchase of an employee dishonesty insurance policy, also known as a fidelity bond. Most policies are written on a blanket basis. ERISA also requires that every trustee, officer, employee or administrator handling the funds or other property of an employer-sponsored welfare or pension plan must be covered.

Lastly, if employee theft is discovered, prosecution has to be part of the action an employer takes. It is probably one of the most effective deterrents known. Unfortunately, 93 percent of embezzlers are not prosecuted, mainly because businesses are fearful of casting doubt on their management or corporate structure.

(Richard Ollis is a commercial insurance specialist with Ollis & Company.)