Employee Fraud: Detecting and Eliminating the Unintentional Perk
Meiners, Cary, Risk Management
All companies want to believe that their employees are honest, hard-working and have only the company's best interests at heart. And most employees do fit that description. There are some, however, who feel that they are entitled to an occasional box of pens or unlimited copies run off from the company machine. These sorts of unintentional perks may go unnoticed by management, but they do add up. And the reality is that few companies recognize the deep bite that employee theft--big or small--can take out of a company's profit margin. That is, until a major incident makes headlines or cuts into their own bottom line.
Take a nationally-known beverage retailer, for example. This Pacific Northwest business found success with premium coffee and expanded rapidly--so rapidly that it perhaps outgrew its internal controls. Managers no doubt kept an eye on employees to make sure they did not pass out free beverages to their friends. But despite these internal controls, in 2001 an employee created a fictitious consulting firm, submitted invoices to the beverage retailer and arranged for the retailer to send payments to a special post office box. In less than a year, this employee embezzled $3.7 million, using the money to buy a collection of automobiles, motorcycles, a yacht, real estate, three grand pianos and a variety of other luxury goods.
That same year, a leading boat manufacturer filed suit against its former CFO, accusing him of embezzling $14 million in company funds over 16 years to finance his own stock purchases, run three businesses and pay personal credit card expenses. In another case, an employee of a subsidiary of a well-known computer company falsely billed the company for more than $500,000.
Fast forward to 2005. A national office supply retailer begins the year by firing four employees who are believed to have fabricated documentation for $3.3 million in invoices to the company in 2003 and 2004--a fraud that was only uncovered when a vendor complained that kickbacks were being demanded and bills were being falsified.
It All Adds Up
Are these isolated incidents? Not according to the Association of Certified Fraud Examiners (ACFE). In their "2004 Report to the Nation on Occupational Fraud and Abuse," the ACFE reported that the typical U.S. company loses 6% of its annual revenues to employee fraud. Nationally, that translates to about $660 billion in corporate losses per year.
The report notes that fraud can happen at any level of a company, from the mailroom employee to the account executive to the senior executive. While fraud is more frequent at lower levels, the damage is usually more substantial when high-level executives are involved. The ACFE found that the median loss when executives are revolved ($900,000) was more than six times the median loss caused by managers ($140,000) and more than 14 times that involving low-level employees ($62,000).
Despite the examples cited at the beginning of this article, losses are not limited to major corporations. Small businesses are often the hardest hit by employee fraud. Almost half of the fraud cases studied by the ACFE involved small businesses, with the median loss pegged at almost $100,000. That is a difficult amount for any company to lose, let alone a small business with limited resources.
The ACFE's report also looked at recovery of losses and found disheartening news. The median recovery in all cases was only about 20% of the loss amount and in almost 40% of the cases, nothing was recovered at all. The report's conclusion: "The most cost-effective way to deal with fraud is to prevent it. Once fraud occurs, it is expensive and time-consuming to try to recover what was stolen, and often those efforts prove futile."
Five Red Flags
Experts say that any company can fall victim to employee fraud. But companies are not helpless. There are five red flags that signal an increased opportunity for fraud. …