By Joseph T. Wells, CFE, CPA, Association of Certified Fraud Examiners
1. Selecting the Right Employee
One of the most basic steps in preventing employee fraud is not to hire employees who have stolen previously. Before hiring anyone, you should conduct a background check to find out as much as you can about the employee's previous experience with employers and law enforcement. Each company must decide whether the time and expense of such background checks is worth the return. It is always a good practice, but, at a minimum, you should check the background of any employee who will have constant access to cash, checks, credit card numbers, or any other items that are easily stolen. Before hiring an employee, you should check as many of the following as possible:
Past Employment Verification
Even though most employers will only verify position and dates of employment, you can usually tell by their tone of voice what they think of the employee. Also, ask the previous employers whether the applicant is eligible for rehire.
Criminal Conviction Checks
Most public records services (such as Nexis or ChoicePoint) have criminal conviction records for almost every large county in the U.S. If not, you may go to the courthouse and search the criminal conviction records in the criminal courts division of the employee's county of residence (or other counties in which he or she previously resided).
Drug Screening
Many companies are now conducting drug screenings for potential hires as well as current employees. People who are frequent drug users can be more prone to theft or fraud.
Reference Checks
Amazingly, very few employers actually call the references a candidate provides. Most operate under the theory that someone wouldn't provide a bad reference. However, many times people will list important-sounding individuals as references with the hope that you won't call. And, people often assume, incorrectly, that a former supervisor or co-worker will provide a good reference.
Education and Certification Verification
It is always a good idea to verify a person's education. Also, if the person claims he has a license or other certification, call the issuing organization to verify it. It is not that unusual for someone to claim a certification or license that has actually been revoked due to a disciplinary action. Most licensing or certification organizations, including the Association of Certified Fraud Examiners, will tell you if any disciplinary action has been taken against a particular member.
Get the Consent of the Candidate
Numerous federal and state laws, such as the Fair Credit Reporting Act, govern the gathering and use of information for pre-employment purposes. Many of these laws require that you obtain written consent from the candidate before gaining some types of information listed above. It is also a good idea to obtain a signed authorization and release from a potential candidate. Consult with your human resources and/or legal department to ascertain the laws applicable to your company and to obtain the proper authorization forms.
2. Policies and Procedures that Help Deter Fraud
Developing anti-fraud programs can be one of the most important things that you can do for your business. Prevention, in the long run, is always cheaper than recovering your losses.
Perception of Detection
Employees who perceive that they will be caught engaging in occupational fraud and abuse are less likely to commit it. Increasing the perception of detection may well be the most effective fraud prevention method. Internal controls, for example, do little good in forestalling theft and fraud if their presence is not known by those tempted to steal. This means letting employees, managers, and executives know that managers are actively seeking out information concerning internal theft.
Proactive Programs
Becoming proactive in your anti-fraud efforts can be one of the most effective steps that you can take to prevent fraud. Some of the programs cost very little, while others require a cost commitment, although most anti-fraud programs will more than pay for themselves.
Employee Education
Every company should have some mechanism whereby to educate managers, executives, and employees about fraud. This can be done as a part of employee orientation, or it can be accomplished through memoranda, training programs, and other intra-company communication methods. The goal is to make others within the company your eyes and ears.
Any education efforts should be positive and non-accusatory. It should be emphasized that illegal conduct in any form eventually costs everyone in the company through lost profits, adverse publicity, decreased morale, and productivity.
Auditing for Fraud
Developing audits that focus on high-risk areas for fraud is something that many organizations have found to be effective in their anti-fraud program. Not only have they identified fraud, but fraud decreased in subsequent audits. Some of the areas that are good areas for fraud audits are:
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Expense reports
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Payroll
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Purchasing
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Sales
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Accounts receivable
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Customer complaints
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Cash
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Suspense accounts
Enforcement of Mandatory Vacations
Many internal frauds require manual intervention, and are therefore discovered when the perpetrator is away on vacation. The enforcement of mandatory vacations will aid in the prevention of some frauds.
Job Rotation
Some frauds are detected during sickness or unexpected absences of the perpetrator, because they require continuous, manual intervention.
EXAMPLE: A manager who embezzled $1.6 million from his company said, "If the company had coupled a two-week vacation with four weeks of rotation to another job function, my embezzlement would have been impossible to cover up." His fraud lasted three years.
Surprise Audits Where Possible
All too many fraud perpetrators know when auditors are coming, and therefore have time to alter, destroy, or misplace records and other evidence. A proactive fraud policy involves using the technique of surprise audits as much as possible. It might have a significant deterrent effect.
Management Oversight
It is most common for employees who steal to use the proceeds for lifestyle improvements. Some examples include more expensive cars, extravagant vacations, expensive clothing, new or remodeled homes, expensive recreational property, and outside investments. Managers should be educated to be observant to these signs.
EXAMPLE: Discovery of a $97,000 embezzlement that occurred over a two-year period resulted when an observant manager asked the internal auditors to examine the responsibilities of a seven-year veteran of the company. The manager noticed that this female employee had begun wearing designer clothes (and making a big deal about it), and was driving a new BMW. The manager was also aware of the fact that this employee had no outside income that might explain the upgrade in lifestyle.
Minimize Employee Pressures
Pressures, such as financial hardship or family problems, can be especially difficult to detect on the part of the employees. Companies can take steps to assist an employee who might be having difficult times.
Open-Door Policies
If employees and others can speak freely, many managers will understand the pressures and might be able to eliminate them before they become acute.
EXAMPLE: The controller of a small fruit-packing company in California stole $112,000 from the company. When asked why, he said, "Nobody at the company ever talked to me, especially the owners. They were unfair. They talked down to me, and they were rude. They deserve everything they got."
Employee Support Programs
Many progressive companies and agencies have realized the benefit of employee support programs. Some kinds of support programs include alcohol and drug assistance, and counseling for gambling, abortion, marital problems, and financial difficulties.
Management Climate
If the style of management is conducted by objective measures rather than by subjective measures, then employees will not manufacture or imagine the performance criteria employed by management. In addition, it is obvious that management that is perceived to be dishonest will beget dishonest employees.
EXAMPLE: Jim, a loan officer for a mortgage bank, received his primary compensation based on the total volume of loans (measured by dollars) he was able to put on the books each year. Dollar volume was the only criteria for the compensation. In addition, the loan officers were all in competition with each other for the high volume award of the year. The pressure to earn more than his fellow officers became more acute each year.
When the mortgage company was closed down, most of Jim's loans were in default. Because Jim perceived that his job performance was based solely on volume, no attention was paid to the quality of the loans. In fact, it was discovered that on several occasions, Jim coerced the loan processing department to close loans, even though all the requirements had not been completed.
EXAMPLE: A large fast food chain lost $200,000 when one of its buyers got involved with a supplier. The company decided to notify all of its vendors of the company's policy prohibiting the giving of anything of value to influence a purchasing decision. Two vendors called in with complaints about competitors, resulting in the discovery of two other frauds totaling an additional $360,000.
Monitoring Systems
Another key part of an anti-fraud program is having a reporting system for employees and agents of the organization to report criminal conduct. Confidential hotlines are one of the best ways for an organization to monitor compliance.
Reporting Programs
Each employee in the company should know where to report suspicious, unethical, or illegal behavior. A reporting program should emphasize that:
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Fraud, waste, and abuse occur in nearly all companies
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Such conduct costs the company jobs and profits
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The company actively encourages any employee with information to come forward
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The employee can come forward and provide information anonymously and without fear of recrimination for good-faith reporting
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There is an exact method for reporting, i.e., a telephone number, name, or other information
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The report need not be made to one's immediate superiors
Hotlines
Hotlines have proved to be a very effective reporting mechanism. However, most hotline reports do not result in fraud cases. At the federal level, published reports indicate that about 5 percent of hotline calls result in serious allegations. With careful screening of calls and proper handling, spurious complaints can be effectively weeded out. There are three general types of hotlines. The advantages and disadvantages of each are summarized below.
Rewards
Some companies have a policy of rewarding information that leads to the recovery of merchandise, property, or money. Others offer rewards upon the criminal conviction of the person(s) involved. If a reward policy exists, strict criteria should establish reward payments, and such proposed policies should be reviewed and approved by counsel. The amount of reward paid by companies varies from fixed fees to a percentage of the recovery. Studies indicate that rewards should not exceed a few thousand dollars. Crime Stoppers recommends rewards not exceeding $1,000.
3. Insuring Against Dishonesty
Many larger organizations carry insurance policies against fraud. These policies, sometimes called fidelity bonds, indemnify the holder against employees who dishonestly (1) commit fraud for personal benefit, or (2) cause the insured to sustain a loss. Everything from routine theft and embezzlement to commercial bribery and stock fraud is covered. The burden is on the insured, though, to show that an act of fraud caused the losses claimed. Companies can't be reimbursed for unexplained inventory losses or pilfered cash accounts without a suspect.
Most fraud insurance carries subrogation provisions which provide that if the insurance company pays a claim, it will acquire the rights of the insured to sue the wrongdoer. Policyholders are forbidden to interfere with the company's right to sue in any way. No settlement agreements or releases can be made with a dishonest employee unless the insurance company consents.
The insurance company's civil suit may seek to recover the losses under its policy, plus any uninsured losses suffered by the victim in excess of the policy limits. The recovered losses over the policy amount are paid to the policyholder.
The Association of Certified Fraud Examiners is an international, 26,000-member professional organization dedicated to fighting fraud and white-collar crime. With offices in North America and chapters around the globe, the Association is networked to respond to the needs of anti-fraud professionals everywhere. For more information on small business fraud, visit http://www.cfenet.com and http://www.fraudweek.com.
Copyright ©2002 The Association of Certified Fraud Examiners. This article is an excerpt from the Small Business Fraud Prevention Manual.
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