The
Fraud Files
The
eyes have it: Seeing the signs of fraud
By
Tracy L. Coenen
Oct.
26, 2005
 |
| Tracy
L. Coenen
|
Would
you recognize the clues that your client has been ripped off by one of its employees?
Or would management conduct business as usual, blindly trusting their employees?
Companies
make the mistake of not actively searching for fraud. They tend to trust their
employees and trust the procedures in place to safeguard company assets.
It
may be good business to trust employees and empower them to make real contributions
to the growth of the company. However, it is not wise to turn a blind eye to signs
that a trusted employee may be stealing.
An
unexpected increase in affluence may signal an employee with sticky fingers. Favorite
toys of fraudsters include new Harley Davidson motorcycles, luxury vehicles, and
high-end watches. Those things are easy to spot, although management doesn’t
always think through the implications.
Behavioral
changes can also point toward a guilty conscience. Changes in activities such
as starting or quitting time, without any obvious business reason, could be problematic.
Non-compliance with established policies and procedures can also be problematic.
In terms
of company operations, however, signs of fraud may not be as easy to pinpoint.
(Unless of course if you’ve read this article.) Management and legal counsel
need to increase their fraud knowledge in order to best identify fraud.
The
Starting Point
Any
thorough search for fraud starts with the financial statements. You don’t
have to be a financial sleuth to understand that it is a problem if more cash
is going out the door than is coming in.
It
is particularly problematic to experience severe cash flow problems even during
times when sales and market share are increasing. While it may take increased
cash to fund the additional operations, it does not make sense that a company
would be bleeding cash when sales are good.
On
the flip side, unusual prosperity during a time when competitors are struggling
can signal fraud. If market conditions indicate that profit margins should be
slim, yet your company is breaking sales and profit records, there may be a case
of financial statement manipulation.
Digging
Deeper
Looking
behind the financial statements and into the detailed accounting records can yield
valuable information about the potential for fraud. Bank accounts that remain
unreconciled for long periods of time are immediately suspect.
I
have witnessed many fraudsters who are clever enough to steal, but not bright
enough to know how to cover their tracks in the accounting system. Thus they don’t
reconcile the bank accounts in a feeble attempt to hide the fraud.
Additional
red flags of fraud include improperly recorded transactions. This may include
recording incorrect amounts, posting transactions to the wrong accounting period,
or recording transactions that violate company policy.
Be
on the lookout for adjusting entries at the end of accounting periods. Adjustments
are a normal part of the accounting process, as they update balances.
However,
be suspicious of significant accounting adjustments that have a major impact on
the period’s financial results.
Computer
usage should be monitored for unusual activity, such as access late at night or
remote access at unusual hours. Clever fraudsters have been known to process transactions
late at night, when no other personnel will be aware of the activity.
Special
note should also be made of transactions that don’t have any supporting documentation.
When documentation is available, it is important to note whether you are reviewing
original documents or copies.
Copies
should cause you to investigate further. Even if you are reviewing documents that
appear to be originals, make note of any unusual characteristics, as technology
has enabled almost anyone to create “original” documentation.
Consistent
problems with customer accounts signal either incompetent employees or fraud.
Excessive complaints from customers about their account balances may indicate
that an employee is tampering with customer records. It could also indicate that
someone is stealing customer payments.
Lots
of voids and credits to accounts are also red flags of fraud. Accounting systems
typically have a standard procedure for applying payments to customer accounts.
Be on the lookout for account adjustments that are done via some other procedure.
Management
Issues
Owners,
executives, and legal counsel should be on the lookout for incompetent management.
Problems such as poor planning, poor delegation, inability to meet goals, or ignorance
about the company’s business, are all warning signs that fraud could occur.
Management
override of policies and procedures is a cause for significant concern. Policies
and procedures are implemented to prevent fraud and ensure that the financial
records of the company are accurate. Frequent override of controls makes those
controls completely ineffective.
Override
of controls is also a cause for concern because it offers clues about those participating.
Dishonest employees are often known to balk at policies and procedures. They often
have an attitude that the rules do not apply to them. Be on the lookout for these
attributes.
Finally,
another sign of problems at the management level is management performing clerical
functions. Keep an eye on the executives that perform tasks that are clearly below
their “level,” as this may indicate an attempt to conceal certain activities
or information.
Follow-Up
Steps
What
should counsel do if management identifies several of these signs that fraud is
occurring? Ideally, the company would have an action plan in place to investigate
the situation.
Counsel
and management should discuss the potential fraud and determine the risk of fraud.
How does the alleged fraud fit into this risk? If the risk is determined to be
significant and the fraud indicators are clear, an investigation should commence.
This
investigation should be kept very quiet. Manage-ment and employees do not need
to know that an investigation is underway. It is important to gather as much information
as possible without tipping off the perpetrator.
If
the initial investigation confirms the suspicion of fraud, a full-blown investigation
may be started. Disciplinary action should also be considered. Some companies
immediately suspend or terminate the suspect. Other companies prefer to do nothing,
in an attempt to gather more information from the fraudster.
Legal
counsel should be involved in all stages of the investigation and discipline.
It is important to execute the investigation in a way that benefits the company
if management intends to pursue the perpetrator legally.
Final
Words of Wisdom
The
most common way an internal fraud is detected is through a tip from a customer,
employee, or vendor. Therefore, it is important that business clients take tips
very seriously, and have a policy in place for investigating those tips.
Companies
are often concerned that tips may just be intended to cause trouble for someone.
Whether the tips are legitimate or not, it is important to investigate them in
order to rule fraud in or out. Either way, the company will be better off for
gathering the facts.
Information
without action is worthless. Gather the necessary information, make a plan of
action, and follow through. Whether or not a fraud is found, management and counsel
should utilize the facts of the situation to modify policies and procedures to
better prevent fraud in the future.
Tracy
L. Coenen is a CPA, a certified fraud examiner, and president of Sequence Inc.,
a forensic accounting firm with offices in Milwaukee and Chicago. She has gained
recognition locally and nationally as an expert in fraud and financial investigations.
She can be reached at Tracy@sequence-inc.com.
