Association of Certified Fraud Examiners

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7 Fraud Prevention Tips for Small Businesses

Last week’s post, More Red Flags of Fraud, discussed how management should be trained to always be on the lookout for behavioral changes in employees that may be red flags for fraud. As the column pointed out, 92 percent of the people who committed fraud exhibited certain behavioral traits. Recognizing those can be the key to detecting and preventing fraud.

Being aware of and dealing with fraud is crucial for any size business, but particularly for small businesses for three reasons:

  • They are disproportionately victimized by fraud
  • They are less likely to have fraud protection measures in place
  • There tends to be a greater level of trust in small offices

That’s according to the Association of Certified Fraud Examiners (AFCE). Small businesses, defined as those with fewer than 100 employees, suffered 28.8 percent of all fraud cases, with an average median loss of $154,000.

The average median loss was higher for the largest entities, defined as more than 10,000 employees, at $160,000. But obviously that is a much smaller fraction of overall revenue than for smaller companies.

So you’re a small business and can’t afford the most expensive fraud detection systems. But there are plenty of measures you can enact to cut down potential for fraud in your company. Here are a few suggestions.

  • Select the right employees. Always check references and criminal records. You may want to conduct credit checks to make sure your potential employee is not in dire financial straits, which can set the stage for him to consider committing fraud.
  • Separate accounting duties. Many small businesses delegate all the financial dealings to one person, who opens the mail, writes checks, reconciles the accounts and generates invoices. This makes a business vulnerable. If you don’t have the staff to completely separate duties, then have some of the responsibility rotate around the office if possible.
  • Always prosecute theft and fraud. Make it clear that you have a no-tolerance policy towards any type of theft or fraud and you will prosecute any and all people involved. This is easy to include in an employee manual. “If you steal, you will be prosecuted to the fullest extent of the law.” If the policy is equally applied to all employees, no one, even in a small office, should feel mistrusted.
  • Conduct surprise audits. Ask to see the books and review invoices and accounts payable. Call a few of the businesses to make sure they are legit and that your company is doing business with them. Or call your CPA in for an unannounced mini audit to uncover any problems.
  • Have your controller, bookkeeper or CFO take off two consecutive weeks each year. I recommend this measure to all my clients as a way to prevent and detect fraud. In their absence, do their jobs. Open the mail, review deposits, correspond with vendors.
  • Purchase the ACFE’s Small Business Fraud Prevention Manual. At $59, it’s money well spent. The manual goes into detail on how employees steal. It also gives prevention tips and how to deal with dishonest employees.

And as long as you are buying books, add my book to the list. How Not to Hire a Guy Like Me: Lessons Learned from CEOs’ Mistakes contains a chapter called “Stop Fraud Before It Starts” and includes ways to create an office fraud as well as tips on preventing fraud in all size companies.

You’ve worked hard to create revenue for your business. Don’t let anyone steal any of it from you.

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More Red Flags of Fraud

In a previous post, Red Flags of Fraud, I wrote about 5 red flags you should be on the lookout for in your employees’ behavior to prevent fraud in your company.

These are:

  1. An employee refuses to take vacation and rarely takes personal or sick days
  2. An employee gets annoyed at reasonable questions or offers unreasonable explanations
  3. An employee wants to remain in his or her current position
  4. An employee exhibits behavioral changes, undergoes a sudden change in lifestyle or has financial difficulties
  5. An employee has unusually close relationships with vendors

The 2014 Global Fraud Study done by the Association of Certified Fraud Examiners found of all cases they analyzed, 92 percent of the people who committed fraud exhibited certain behavioral traits, all of which are listed above.

fraudchartThe top two traits the study found are Living Beyond Means (43.8 percent) and Financial Difficulties (33 percent), as listed in #4. I’d like to expand on these two behaviors, as they may be harder to detect than the others above and on the chart you see here.

If an employee begins to talk about financial difficulties, too much credit card debt or high medical bills, that’s the time to pay a bit more attention to him. Pressure from financial problems due to things such as overspending, a divorce or health problems can set the stage for an employee to consider fraud as a way out of his difficulties.

Another behavioral change to note is when an employee who may have previously complained about being overworked, underpaid or passed over for a promotion no longer talks about workplace issues and seems more content although nothing has changed.

If she is committing fraud, she may feel that she is evening the score and taking what she considers is due to her. She now feels happier in the workplace.

Changes in lifestyle can be a bit trickier to determine. An employee may start driving an expensive new car, talk about a new second home or take high-end vacations. She may chat about moving to a new home in an upscale neighborhood or bring in photos of a new boat.

It can be tricky to question someone about these purchases and where the money came from. And they could be explained by claiming to have gotten an unexpected inheritance, or a spouse with a new high-paying job.

Or, as often happens, the money is spent somewhere the employee would not be eager to share at his workplace. Michael Dennehy embezzled over $1.7 million from Bexar Waste in San Antonio by forging company checks for more than six years. He admitted that he spent it on escort services and gambling. As a married father of five, he probably wasn’t sharing those stories in the break room.

Make observing behavioral changes part of your fraud prevention program and share this information with your management team, so they can be vigilant about these behaviors.

Fraud prevention is vital for any business. The median loss caused by fraud in the ACFE study was $145,000, with 22 percent of the cases costing a company more than $1 million.

Come back next time when I’ll discuss why small businesses are disproportionately affected by fraud and what small business owners can do to protect themselves.

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Employee Tips Key to Fraud Prevention

The simple slogan, “If You See Something, Say Something ™” was first used by The New York Metropolitan Transportation Authority to raise public awareness about terrorism, and later licensed by the Department of Homeland Security (DHS) for a national campaign.

You may have seen some of their public service announcements that urge people to report suspicious activities to local law enforcement or in the case of an emergency, call 911.

I urge companies to institute a similar campaign to help them fight fraud. According to the Association of Certified Fraud Examiners (ACFE), the most common way internal fraud is detected is receiving a tip from someone. While many of these are received from employees, some come from customers, an anonymous person or even outside vendors who notice something not quite right. Just over half of internal frauds are detected with tips, according to the ACFE’s 2012 Report to the Nation on Occupational Fraud and Abuse.

if-you-see-something1In my career as the Turnaround Authority, I’ve uncovered fraud in all types of ways — through audits, following up on suspicions I had, or in one memorable case, installing fake cameras (until the company could afford real ones) to stem the problem of inventory walking out the door. But employee tips have also helped me uncover millions of dollars of fraud.

When I am working with an out-of-town company, I assure the employees that no one will lose their jobs for sharing information with me. Later I will drop into casual conversation the name of hotel where I’m staying. Then I ask them for restaurant recommendations around that hotel. I do this so they know where they can find me outside of the office if they wish to share sensitive information.

Once, in the middle of the night someone pushed a bunch of USB drives under my floor. The drives detailed where the company’s money had gone. I’ve also had file folders with documents with valuable inside information pushed under my door. Some people in hotels just wake up to a USA Today and a bill. I never know what surprises I may get!

Companies should have fraud awareness training for managers and employees. The ACFE recommends these programs include what actions constitute fraud, how fraud hurts everyone in the company and how to report any suspicious activity.

Frequent communication is critical to letting employees understand that the company is dedicated to fraud prevention. This can be done at meetings, in newsletters and on the company website. It is also important to let them know, as I always make a point of doing, that employees will not lose their jobs if they report something suspicious. They must feel protected from retaliation.

Many companies successfully use hotlines where employees can make anonymous calls. They can also set up an online reporting system.

Early detection is crucial to cutting the cost of fraud. The ACFE reports that the average fraud scheme lasts about 18 months before discovery and that U.S. businesses lose more than 6 percent or revenues each year due to fraud.

In my next column, I’ll talk about the behavioral red flags that are often associated with fraudulent conduct. What should you be looking out for?

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“Nice People” Commit Fraud

“Bernie would never do that. He’s my friend,” said one potential investor who lost everything.

“He seemed like a nice person and not concerned about answering my questions at all,” said the reporter.

These were a few comments made about Bernie Madoff in the movie “Chasing Madoff” that I saw recently. It’s a documentary about whistle blower Harry Markopolos, who spent 10 years trying to get action taken on what he had quickly recognized was a massive fraud when his company asked him to come up with a competitive product and he ran the numbers.

Those comments struck me because that is often the case when I’ve uncovered fraud at my clients’ companies. Management and co-workers say, “Why, he is the nicest person in the office.”

He was such a nice guy, some people commented about Bernie Madoff. He would never steal money.

He was such a nice guy, some people commented about Bernie Madoff. He would never steal money.

I’ve seen everyone from owners’ best friends to grandmothers to the kindly old lady in the church office commit fraud. It’s been my experience that most of these people have no prior offenses, which was backed up by a report generated by the Association of Certified Fraud Examiners (ACFE) a few years ago. Here were a few other key findings from that report.

• More than half of the offenders were between 31-45 and slightly more likely to be male. The older the offender is, the bigger the loss.

• More than 80 percent of offenders work in one of six departments: accounting, sales, operations, sales, executive/upper management, customer service or purchasing. No big surprise there — these are the people that have access to money, can write off on purchases or have expense accounts.

• Only seven percent had been previously convicted of a fraud offense. I believe that low percentage is partly because most fraud offenders are let go from previous companies and never prosecuted. This is just one of the reasons I always advise my clients to prosecute those who commit fraud.

In the ACFE’s 2012 Report to The Nations on Occupational Fraud and Abuse, it was reported that the median loss suffered from fraud cases was $140,000. But more than 20 percent of the cases involved losses of more than $1 million.

Small business owners especially need to be concerned as they are more likely to be hit, primarily because they have fewer internal controls.

Want to take a guess how long the fraud goes on before it was detected? A median of 18 months.

Most people don’t go to work for a company with the idea of stealing from it. Most of them see an opportunity and then seize it. And that person is often the nicest person in the office.

I write a lot about fraud and how to prevent it in this blog and also in my new book, “How Not to Hire a Guy Like Me.” I tell the story of sweet Aunt Tess, a payroll clerk that everyone at the office loved. And she was so dedicated she had never missed a payroll in 25 years, even dragging herself to the office hours after an appendectomy. Bless her heart!

Well, old Aunt Tess was there, fresh surgical bandages and all, because she had a whole army of fictitious employees that allowed her to steal up to $100,000 a years.

Fraud does, and can happen to anyone. If you don’t have fraud controls in place in your office, make it a number one priority to do so. Maybe the nicest person in the office can stay that way.