What measures can you take to minimise the risk?
Employee fraud in small-to-medium businesses, unlike many other causes of insolvency and business failure, can be prevented at little or no cost to the business owner. In my experience, two of the more common characteristics of small-to-medium businesses are:
- They are owned and managed by people with longstanding business and/or personal relationships, frequently family members.
- They have limited administrative resources, making it necessary to authorise their employees to transact on their bank accounts, often with minimal supervision and no separation of duties.
Therefore, a high degree of trust is needed between the owners, management and employees, which is a result of their relationships, and a requisite to be practically expedient. As such, the social norms of trust and personal integrity are prominent among the business's core values. While these are just two of many qualities that make small-to-medium business successful, it also makes them susceptible to employee fraud. The risk of employee fraud increases as businesses grow and employ new people outside of the existing familial or professional network, and the owners delegate management of the day-to-day operations.
Asset misappropriation most often involves siphoning money from the owner's bank account. Usually, the offenders are account signatories and/or are authorised to process electronic fund transfers (EFTs). To conceal this fraud, they may also have access to the business's financial records. Having said that, the methods and characteristics of the offenders are certainly not typical. For example, I was liquidator for a company where our investigations uncovered that two senior employees, including the director's daughter, colluded to redirect debtor payments to their personal bank accounts.
The Association of Certified Fraud Examiners' 2018 annual report1 on "occupational fraud", (defined as fraud committed against an organisation by its own officers/directors/employees) shows that from 2,690 cases of occupational fraud from 125 countries in 23 different industries:
- Asset misappropriation schemes are the most common, but least costly, at a median loss of US$114,000.
- Small businesses lost almost twice as much per instance of fraud.
- Nearly half of frauds were attributed to internal control weaknesses.
- Offenders who were employed for over five years stole twice as much as those whose tenure was under five years.
- Most victims recovered nil.
- At least one behavioural red flag of fraud was shown in 85 percent of cases, for example:
- Living beyond their means.
- Financial difficulties.
- Unusually close association with a supplier or customer.
- Unwillingness to share duties.
- Family problems.
- "Wheeler-dealer" attitude.
- Refusal to take vacations.
- Data monitoring/analysis and surprise audits were correlated with the largest reductions in fraud loss and duration.
The association also found that the most common reason for asset misappropriation is a lack of management review.
The Australian Securities and Investments Commission also reports that in 2016-17, 123 cases of fraud were cited as a reason for business failure that led to a formal insolvency appointment (irrespective of business size/structure).
In my experience, the loss the business owner sustained is one primary cause of its insolvency and failure. And the methods used are rarely sophisticated. Instead, they relied on the lack of internal business controls and the trust and good faith shown to them by the owners or management. The upside from this is that the risk can be significantly reduced through internal controls and processes, without incurring significant monitoring costs. For example:
- Being in regular and meaningful conversations with employees to uncover the red flags listed above.
- Conducting random and frequent spot checks of business transactions.
- Two-party authorisation on EFTs.
- Director or owner authority on payments made above a certain amount.
- Using the accounting software's reporting to identify any anomalies, reconciliation issues.
I strongly urge business owners to be vigilant to the real risk of employee fraud and to work with their professional advisors to design and implement appropriate measures to manage that risk. Those measures should be regularly reviewed and updated to respond to changes in the business.
Worrells has four certified fraud examiners, among our network of liquidators, bankruptcy trustees, and forensic accountants. Your local Worrells partner can give you their insights on how business processes can go awry across many industries and business structures.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.