Fraud is a crime you can’t afford to ignore. Industry victims of fraud report damage to their reputation, morale and productivity, and loss of business opportunities – all in addition to the loss of money and equipment. A typical organization loses 5% of its annual revenue to fraud. Small organizations, which tend to lack systematic control mechanisms, lose even more. $32 million in heavy construction equipment alone is stolen in Canada each year. The vast majority is never recovered.

Statistics show that the most likely fraudster is not an external contractor, but your trusted employee. Read on for a few simple ways to reduce the risk of employee fraud – and what to do if you suspect one of your employees of committing it.  

SCHEMES TO WATCH FOR

Employee fraud accounts for 60-70% of business fraud losses. Common schemes include:

  • Inventory or asset misappropriation;
  • Secret commissions or kickbacks;
  • Accounting or payroll fraud; and
  • False or inflated supplier invoices.  

IDENTIFICATION OF EMPLOYEE FRAUDSTERS

The typical perpetrator of a fraud may surprise you:

  • A long term employee in a position of trust;
  • Who quietly works long hours; and
  • Rarely takes vacation or takes very short vacations.  

Watch out for employees who:

  • Live beyond their apparent means;
  • Show emotional instability or addiction problems;
  • See “beating the system” as an intellectual challenge; or
  • Are dissatisfied with their job or remuneration.  

Frauds occur during periods of organizational turmoil, or whenever else employees spot and exploit weaknesses in internal systems. Effective means of detection include internal audits, internal tips, fraud risk management and management review.  

FRAUD PREVENTION

Prevention requires a two-pronged approach: develop policies and controls to ensure you hire honest people, and keep them honest by regularly evaluating your operational risks and controls.  

KNOW YOUR EMPLOYEE

Diligence in hiring is key: discovery of a chequered past may be a mere phone call or Internet search away.1

  • Require a résumé. Watch for gaps in employment.
  • Obtain Written Consent to Obtain a Credit Bureau Report. A report may alert you to legal judgments against the applicant, and may show whether they have a financial motive to commit fraud.2
  • Check References. At a minimum, obtain and contact references. Past employers may not repeat fraud allegations, but they are unlikely to endorse a fraud suspect.  

INTERNAL POLICIES AND CONTROLS

Establishing strong internal controls increases the likelihood of detection.

  • Division of Duties. Separate the three key functions of authorizing transactions, handling money and maintaining financial records.
  • Mandatory Vacation. Require that employees take vacation at least annually. This will allow other employees to check how they carry out their responsibilities.
  • Original Documents. Insist on having original invoices available when cheques are signed.
  • Reconciliations. Have other employees reconcile bank statements, payments and other accounts at least monthly.
  • Outside Reviews. Hold an annual “spot audit”, without notice.
  • Supplier Controls. Consider implementing a list of approved suppliers. Run a comparison of supplier and employee postal codes and investigate anomalies.
  • Construction Site Controls. Perform “spot” inventories of equipment and materials, and reconcile inventories against invoices. Document deliveries.  

In addition, cultivate a reputation for fairness and recognition of good work. If employees feel that cheating the company would be cheating themselves, they will be less likely to steal and more likely to report others’ misconduct.  

INVESTIGATING FRAUD ALLEGATIONS

Your lawyer can help to direct a successful investigation, avoid employment law problems and prevent defamation allegations.

  • If you have a fidelity insurance policy, work with your insurer from the beginning.
  • Keep your mind open until you have amassed sufficient evidence.
  • Carefully secure the evidence. DO NOT WRITE ON OR MARK DOCUMENTS.
  • Confront the employee in a team of two (one to run the meeting and one witness to make notes). DO NOT THREATEN TO GO TO THE POLICE OR OTHERWISE COERCE THE EMPLOYEE TO CONFESS. Present the evidence and note the employee’s explanation.  

RECOVERY OF FRAUD LOSS

Consider immediate negotiation of a settlement (making sure to address potential concerns of insurers, trustees in bankruptcy and other creditors).  

Retain a lawyer with fraud recovery expertise: creative efforts will be more successful than a standard lawsuit. For example, asset-freezing orders (“Mareva injunctions”) and search orders (“Anton Piller orders”) can be extremely effective in preserving funds or evidence.  

Do not neglect possible claims against auditors who failed to detect the fraud, or third parties who benefited from it.