Fraud Prevention 101

Simple Steps to Save Hundreds of Thousands of Dollars

By implementing just a few simple steps and procedures, business owners can catch or prevent financial fraud that can have devastating financial and personal consequences. In this article, Chris Hamilton outlines six simple steps business owners can put into practice today.

“I Can’t Believe It Happened to Me—I Should Have Known”

The shock of realization when a victim recognizes that a trusted employee—and even a friend—has stolen from them ranges from sad to tragic. It is a very personal feeling of betrayal and violation. It strikes fear in some, grief in others, and anger in most. In my experience, it is almost always accompanied by a sense that “I should have known this was going on.” The evidence of theft sheds a very bright light on the rearview mirror. Patterns and circumstances take on a clarity that contemporaneous experience either hid or obscured. Sometimes the clarity was there, but for a variety of reasons, it was ignored.

The following is just such a case: The victim, a business owner, immediately recognized the theft and simultaneously felt incredibly stupid for “allowing it to happen.” The lesson cost him several hundred thousands of dollars in uninsured losses. The recognition happened when his bookkeeper unexpectedly missed a few days of work, and the business owner ventured into the mail and opened a bank statement. The simple act of thumbing through canceled checks from one month’s bank statement prompted a phone call to his attorney who directed him to a forensic accountant.

What developed was evidence of a simple and devastatingly effective embezzlement scheme. The bookkeeper had set up vendors that were very similar to existing real vendors. For example, if the real vendor was ABC Service Company, then a fake vendor was established called ABC Service Co. The bookkeeper went to the bank and set up bank accounts for the fake vendors. That was the hard part. The rest was easy. The business owner signed hundreds of checks to the fake vendors thinking the checks went to legitimate business activity.

Since that worked so well, the bookkeeper began forging checks, made payable to pay the vendors, for personal expenses and to provide cash gifts to family and friends. And, since all that worked without any notice by the business owner, the bookkeeper got an unauthorized increase in salary. It was bold. It was also easily discovered and should have been easily prevented.

The bookkeeper was pretty quickly arrested and has spent some serious time in jail. The following are Fraud Prevention 101 steps that were ignored and could have prevented the fraud:

• Know your employee. In this particular case, the business owner recounted that he knew the prior employer of the bookkeeper really well. He was aware that the bookkeeper had left the prior employer on less-than-positive terms but figured it was none of his business and hired the bookkeeper because of the bookkeeper’s knowledge of the industry. A phone call to the prior employer/friend after the embezzlement was discovered revealed that the bookkeeper was probably stealing from the current employer to pay off a judgment obtained by the prior employer to recover embezzled funds.
• Embezzlers tend to be repeat offenders. This is an obvious follow-up to the prior point. A simple background check is not expensive, easy to do, and in this case would have prevented a really bad hiring decision. It would have confirmed the ill-at-ease feeling of the employer at the time of hiring.
• Open your own mail. Let the bookkeeper do the bookkeeping. You cannot abdicate other important (and seemingly unimportant) functions because the clerk is always around and does their job well. Vendor communications, bank statements, and bills from vendors and suppliers are important sources of information.
• Separate functions and duties. Many small business owners are so busy that they tend to overlook common sense when assigning work. In this case, a bookkeeper was eventually given the responsibility for answering the phones, opening all the mail, writing checks, making deposits, preparing invoices, reconciling the bank statements, and preparing the financial reporting provided to the business owner and his outside tax preparer. As noted above, simply opening the mail would have prevented some of the problems or would have brought the fraud to light a lot earlier.
• Don’t accept bad answers to good questions. When the forensic accountant arrived on-scene, the business owner requested a report showing payments to all vendors. In the past, the business owner’s similar requests to the bookkeeper were met with a long list of reasons that it was difficult to put such a report together, would take a long time, and would not be precisely correct. The accountant produced the report in about 90 seconds. The business owner was shocked, and the point was made. His bookkeeper for a long time had prevented him from seeing the very report that exposed the whole scheme. He had been given every reason in the book why the report couldn’t be produced.
• Force vacations. Nobody else had access to the bookkeeper’s work for over two years. Another set of eyes on the accounting records would have exposed everything.

Chris Hamilton is a Certified Public Accountant, Certified Fraud Examiner, Certified Valuation Analyst, and a diplomate with the American Board of Forensic Accounting. Mr. Hamilton is a California State University, Northridge graduate and is a member of the American Institute of Certified Public Accountants, California Society of Certified Public Accountants, Litigation Services Committee of the California Society of CPAs, Association of Certified Fraud Examiners, National Association of Certified Valuators and Analysts, San Fernando Valley Bar Association, The American College of Forensic Examiners, and Ventura County Bar Association. In addition, Mr. Hamilton has published articles on a variety of topics in several publications including The Forensic Examiner, Los Angeles Lawyer, The Value Examiner, Valuation Strategies, and the Journal of Forensic Accounting. Mr. Hamilton can be reached at chamilton@arxisfinancial.com or at (805) 306-7890.