In a recent case in Hartford Superior Court, a bookkeeper pled guilty to embezzling more than $100,000 from her employer, a local insurance agency, over an extended period of time. Her motivation? She needed the money to pay her mortgage.
In hard economic times, small-business owners need to be extra vigilant against theft by their employees, and even their partners. Embezzlement is frequently hard to detect because it often comes in the form of a slow bleed — relatively small amounts, no more than a couple thousand dollars a month. And it can last for years, until the perpetrator is finally caught, if ever.
The current recession is causing many people the kind of financial desperation that often leads to embezzlement. But true need is hardly the only thing that prompts people to steal from their workplace. Sometimes, unresolved grievances between business partners or employer and employee are allowed to fester, and one party rationalizes that he or she is “entitled” to take extra compensation. And some people are sociopaths who simply take what they can get.
In the Hartford case noted above, the employee diverted customer checks payable to the business, a common form of embezzlement, and also wrote herself extra paychecks. Here are some of the other methods that the authors have encountered:
• Unrecorded cash. The most straightforward form of small-business embezzlement is simply to keep cash payments without recording them as receipts.
• The hidden bank account. An unscrupulous business partner creates a bank account in the name of the LLC — unknown to the other partners — and deposits select customer checks into it, only to use the funds for personal use.
• Phony vendor payments. The bookkeeper writes a check to herself in an odd amount, but records it in the company’s financial records as a payment to a vendor. Or she writes a check to a vendor but endorses it herself and deposits it into her personal bank account via ATM.
Some simple controls can help business owners to reduce their risk. Three keys to protecting your company.
Preventative controls should be applied to every financial process in the company. To deter fraud, consider:
• Requiring approvals on transactions
• Ensuring regular reviews of cash receipts, payment postings and bank deposits
• Counting cash drawers mid-shift
• Requiring second signatures on checks
• Performing unannounced reconciliations
Detection measures to identify fraudulent behavior as early as possible could include:
• Independent receipt of bank statements
• Independent reconciliations of deposit activity
• Random reviews for compliance with policies and procedures
• Spot audits
• Rotation of employee duties
• Comparing employee information to vendor information for address matches
Employee dishonesty insurance typically enables companies to recover funds stolen by an employee. Even with expertly designed preventive controls and detection measures in place, employee theft and embezzlement remain a risk. Business owners should estimate the minimum amount of insurance coverage needed to ensure the financial health of their company, keeping in mind that $100,000 is usually the recommended minimum for any size entity.
The lesson for employers when it comes to employee fraud and embezzlement is to avoid complacency. Maintain constant vigilance and never simply trust that employees are ethical. Remember too that not only employees, but co-owners as well sometimes engage in this kind of conduct. Small-business owners should remember the famous quote of Ronald Reagan, “Trust, but verify.” Then put it into practice.
William J. O’Sullivan is a principal in Baker O’Sullivan & Bliss PC in Wethersfield and Stephen Pedneault, a CPA, certified fraud examiner, certified in financial forensics, and forensic certified public accountant, is the principal and founder of Forensic Accounting Services LLC in Glastonbury.
