Theft and Deceit

Victoria Gaitskell
June 10, 2014
By Victoria Gaitskell

Measures to protect your business from employee fraud

The printing industry is continually plagued by cases of employee fraud. During the five years I managed the Ontario Association of Quick Printers, I was surprised by the number of small business owners who confided that at some point their company had been defrauded out of ruinous sums by staff – often a long-term employee whom they thought they knew well and trusted...

Cases of staff fraud at printing companies reported in just the past 12 months, include:

Michael Britt, 31, charged with 13 counts of forgery occurring over more than five years and resulting in the theft of over $1 million from Gene-Del Printing, the Brentwood, Missouri company co-owned by Britt’s mother and three partners. Britt allegedly wrote at least 166 unauthorized cheques to himself using forged signatures of two of the company’s owners, fabricated fraudulent invoices for the cheques, and made at least $25,000 in unauthorized purchases on a company credit card.

Christina and Brian Russo, a married couple, both in their 50s, charged with stealing more than $657,000 from Harmony Press of Easton, Pennsylvania. Christina Russo allegedly wrote hundreds of unauthorized cheques to her husband and herself using a rubber stamp with the owner’s signature.

Leona Gebhart, the 70-year-old former comptroller of Henderson’s Printing in Altoona, Pennsylvania, charged with stealing at least $151,130 over 11 years by allegedly writing unauthorized company cheques to herself (including duplicate and triplicate paycheques), manipulating petty cash, and falsifying documents, while allowing the company’s Federal tax payments to become delinquent.

With all these past and present horror stories in mind, I spoke to Robert Fowlie and David Malamed, forensic accountants at leading Toronto financial and business advisory firms, and Detective Constable Keith Nakahara of the Halton Regional Police Service Fraud Unit (Commercial Team) to learn what printers can do to protect themselves from devastation by employee fraud.

How employee fraud works
Nakahara’s region of Ontario, including the towns of Oakville and Milton, has one of the highest per capita incomes and one of the highest rates of fraud in Canada. He observes that business fraudsters have no particular motivations or characteristics in common except that they have too much control with too little supervision – a position that creates overwhelming temptation for some people. 

“Don’t automatically assume you can trust somebody based on a family connection or the length of time you’ve known them,” he warns. “In business the most common fraud we see is committed by a person in a position of trust with limited oversight, typically a bookkeeper or accountant who has a certain amount of control over what facts get released, so the fraud may go undetected for years.”

Both Fowlie, a partner at Deloitte LLP, and Malamed, a partner at Grant Thornton LLP, have long strings of credentials after their names certifying them as fraud experts. Besides investigating alleged cases and preparing financial information for use in court, they also work proactively to establish preventative controls.

Both say smaller print shops are more susceptible to fraud than larger companies if their smaller staff count results in less separation of duties. In other words, the person writing the cheques may be the same person reconciling the bank accounts and doing the accounting, so he or she can readily conceal bogus payments to themselves or fictional third parties.

In billing fraud, phony vendors may get paid, or an individual working in procurement for a company starts his own business, buys raw materials at cost, marks up the prices exorbitantly, then sells the materials to the company he works for. In payroll fraud, wages may be paid to a fictitious employee or somebody who was terminated still gets paid via deposits to an account controlled by the fraudster.   

Verify bank and accounting records
Fowlie and Malamed say a good way to detect fraud is for owners to obtain their bank statement directly from the bank and review it monthly (or else delegate the review to an internal third party knowledgeable and reliable) to ensure that each payment and vendor is legitimate. They also recommend comparing your list of vendor and delivery addresses with your employees’ addresses and regularly reviewing the payroll journal that most companies submit to an external third party for processing.

“In a recent trial we uncovered that, even after review and approval of payroll information, a clerk was still able to make changes by adding payments to herself and terminated employees to an account she controlled and make accounting entries to cover up these payments,” warns Fowlie. “Our clients thought they were in control when in fact the process was not operating as they intended.”

Nakahara suggests that the notes in your company’s year-end financial reporting may also identify specific items of concern:  “For example, ledgers that don’t match bank payments and the bookkeeper’s explanation dismissing the discrepancy as a computer glitch may warrant closer investigation.”

Expenses, consumables and cheques
Another big area of concern is employee expense accounts, says Malamed: “Expense fraud is epidemic among all organizations. It’s the number-one trend I see.”  

Fowlie explains: “In today’s tougher economic climate, some families have gone from two to one income or experience no growth in income against growing expenses. Under new financial pressures, some people feel forced to do things they have not done before. Perhaps this is one reason we’re seeing an up-tick in fraudulent employee expense claims involving false documentation or duplicate claims.”  He warns that Websites even exist where users can print out receipts for fictitious claims.

As a remedy, he says companies must check every detail of expense claims submitted by employees and require each item to be supported not only by legitimate documentation but also within business rationale.

“Another form of fraud happens if I cook and sell steaks in the restaurant where I work, then pocket the customer’s money because the owners don’t know they were sold,” says Malamed. “This type of transaction is also possible in the printing world, where press or pre-press operators could be running their own jobs on the side using the owner’s resources.”  Since consumables like toner, ink, and paper are expensive and highly transactional, he thinks there could also be a secondary market for them.

One preventative measure he suggests owners can take is to project what the company’s sales should be based on consumption of supplies. If either the sales or the supplies in stock fall short, they need to investigate why.

“Don’t get carried away with the business and forget to look at the numbers,” he insists. “The numbers tell the story. Perform your own analysis to see if things add up.”

Typically, in cheque fraud the names of payees or dollar amounts on cheques are changed, or duplicates are issued of the same cheque. “Usually cheques are numbered sequentially, so if number 005 shows up a few times, it’s a red flag,” says Malamed. (Red flags are warning signals that deviate from correct practice and may point to the presence of fraud.)

Fowlie says organized criminals commonly perpetrate a counterfeiting scheme by intercepting a company’s cheque in the mail and taking it to a printer to obtain fake blank copies. Then they write the fake cheques to third parties, who cash them and return some of the proceeds to the organized criminals.

“This is the reason why in Europe payment is typically arranged through wires and direct transfers to avoid cheques being intercepted and compromised and counterfeits being written against the account,” explains Fowlie. “Some of my clients have lost millions of dollars through this type of scheme because they didn’t monitor their accounts closely or were unprotected in terms of the way their account was set up.”

As a preventative measure, banks operate something called Positive Pay programs in which companies pay the bank a fee (something like 20 cents) per cheque and provide the bank with standard information on cheques they issue like cheque numbers, payees’ names, and dollar amounts. If the information written on a particular cheque differs from their records, the bank will hold the cheque and notify the company. “Some companies think the cost of a Positive Pay program is too expensive; however, if you’re lacking in segregation of duties, it may be the least expensive way to handle the problem of cheque fraud,” says Malamed.

Staff and hiring issues
Nakahara says before hiring any employee in a position of financial trust it is important to have the person sign a pre-employment contract that clearly delineates the basis and limitations of the job. He explains that fraud is the crime of obtaining money or some other benefit for the perpetrator or someone else by deliberate deception. Thus, to prosecute fraud, police need evidence both of a theft and of the deceit the fraudster used to commit it.

He says a lot of cases get thrown out of court because the fraudster claims that the business owner knew about and approved the transactions in question. Without corroborating evidence on either side, the case boils down to the fraudster’s word against the owner’s and is likely to get tossed.  Thus the pre-employment contract should specify that:  (1) the person will not gain by any transaction without the knowledge and consent of the owner, and (2) the owner’s approval of any transaction must be stated in writing.

Additionally, before hiring accounting and payroll personnel, Fowlie advises owners to call their former employers. If, for example, his client’s company had checked on the payroll clerk mentioned earlier in this way, they would have learned she was charged by the RCMP for doing the same thing at a previous employer’s company.

But Nakahara says doing systematic police background checks on prospective employees only provide a false sense of security: “The checks only reveal when people are convicted, not charged, and for various reasons conviction rates are low in comparison to the larger number of people who are actually committing fraud. So no amount of front-end due diligence can replace ongoing due diligence in a business operation.”

Fowlie says due diligence should include remaining alert to changes in staff’s behaviour and financial well-being, such as someone suddenly living outside their means. Additionally, he says people involved in fraud often do not take vacations to prevent their fraud from being detected; so refusal to take vacations is often a red flag.

If you suspect fraud
Fowlie encourages businesses to review their insurance policy with their broker or insurer to make sure it includes coverage not only for fraud, but also for fees for a forensic accountant to conduct an investigation on their behalf, if necessary.

If you suspect someone of fraud, he says it is not prudent to confront the individual straight away. Rather, you should first conduct an investigation and strategize about what is to be done. “I have seen companies accuse and fire longtime employees, only to discover the problem was not fraud but careless accounting,” he cautions.

If an investigation substantiates fraud, Nakahara advises owners to be aware that perpetrators usually plan an escape, so that even if they are removed from their job, they can still continue to defraud the company. So the most appropriate course of action is not only to remove the person from the job completely, but also to notify your bank and other financial institutions that the person no longer has the authority to transact business for your company.

Nakahara also recommends you let the fraudster know you have gone to the police, which might make them stop robbing you of more money or prompt them into a legally useful verbal response – something police call a “spontaneous utterance” – such as an admission of guilt or an offer to pay you back the stolen money, which you should carefully make note of.
As the victim, you can also file a complaint with the police, usually in the district where you work or reside. In fact, to pay out on a crime insurance policy, most insurance companies require police to lay criminal charges to validate that the fraud has occurred with reasonable probable cause. A subsequent criminal conviction on the charges in court gives the perpetrator a police record which may prevent the person from repeating the offence at other companies.

Sometimes, if a business is not covered by insurance for fraud, or insurance does not cover the entire loss, the owner may also elect to pursue a civil lawsuit against the perpetrator to try to recover stolen money. In this event, Fowlie says forensic accounts are often enlisted to investigate the fraudster’s assets to determine how much recovery might be possible.

Fraud risk assessment
Fowlie points to statistics from the global Association of Certified Fraud Examiners (ACFE) showing that some businesses are defrauded as often as every two to three years. And because prevention costs are generally lower than the cost of a fraud investigation, he urges businesses to become proactive about prevention.

Malamed concurs:  “Prevention is my key focus. Every dollar you spend on prevention saves $10 or $20 on reaction – not including dollar loss. If there’s one message I want to scream from the top of buildings, it’s ‘Put preventative techniques in place!’”

One thing a business can do is hire a forensic accountant to conduct a fraud risk assessment of its operations, which reviews all of the company’s activities to determine the types of fraud it is exposed to and develops preventative internal controls.

As with legal fees, you pay for the consultant’s professional expertise, so the cost of a fraud risk assessment can be high. But Fowlie explains:  “Like lawyers, most forensic accountants will first meet with you for an hour to understand your business and prepare a quote on how much time and money will be required to assess the entire organization. Some will also help figure out a budget that will work for you, since it is possible to perform the assessment in stages, one division or function at a time. You can start with the most vulnerable area the first year, then assess the rest over time.”

Awareness training and whistleblower programs
Malamed suggests two more important anti-fraud services available from companies like his, which are affordable to small- and medium-sized companies:  fraud awareness training and whistleblower programs. Fraud awareness training educates employees, owners, and stakeholders on how to identify red flags. A whistleblower program enables employees to anonymously point out instances where potential fraud exists.

“For example, in one investigation, I asked the employee I was interviewing:  ‘Didn’t you find it unusual when the manager asked you to make journal entries on Friday nights and Saturday mornings instead of during regular business hours?’” recalls Malamed. “With awareness training, the employee would have realized this timing was a red flag, and a whistleblower program would have given him a way around his feelings of discomfort about questioning a manager’s orders directly.”

Malamed says research by ACFE shows that over 40 percent of fraud is identified by tips. Giving employees a way to report it without worrying about backlash increases the odds of detection. ACFE statistics also show most fraud take about 18 months to identify and result in an average loss of $140,000 over this time. But for companies with controls in place like awareness training and whistleblower programs, detection time goes down from 18 months to nine months and average loss from $140,000 to $77,000.

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