HOW TO RECOGNIZE AND PREVENT FRAUD OR EMBEZZLEMENT
by Alison Jones and Steve Flowers
Many articles have been written about increasing an agency's income by instituting a formal planning process, by target marketing, by streamlining operations, automating or by adopting a total quality management approach. Rarely, however, is there anything written that addresses a problem common to about 65% of all agencies: fraud or embezzlement. No sales center, producer compensation program, automation system, or continuous improvement plan will enhance an agency's financial strength if its profits are steadily being eroded by the deceitful actions of an embezzler.
During these continuing difficult economic times, companies struggle to cut expenses by restructuring. Often, in the drive to reorganize, adequate checks and balances aren't given appropriate attention. This opens the door to possible fraud by employees.
How do 65% of the agencies set themselves up to be targets for theft, and why do the other 35% escape this heart-wrenching and costly experience? How can you detect the warning signs that an embezzler is at work, and what can you do to prevent a potential embezzler from ruining your agency? These are some of the questions that will be addressed in this article.
Consider this: You receive a call from a carrier's Accounting Department at 4:30 p.m. Friday afternoon informing you that a check from your agency for $450,000 has just bounced. How could this have happened? You just reviewed the controller's reports. There was certainly enough money in the trust account to cover the check. The bank must have made a mistake. Or did it?
This scenario is all too common with small businesses today. Once an agency has reached this point, it may not be salvageable. The embezzler has already done the damage. What could you have done to prevent it?
Criminal activities cost agencies money through:
- Employee pilferage and embezzlement
- Bad checks
- Business-to- business fraud
- Theft of business information
Let's examine each of the above and discuss ways to minimize your exposure.
EMPLOYEE PILFERAGE AND EMBEZZLEMENT
Employee pilferage and embezzlement is the most insidious, and unfortunately, the most prevalent of all fraudulent crimes attacking small businesses. Agency principals who abdicate their responsibility for the control of the financial area set themselves up as targets. This does not mean that an agency owner must handle the daily accounting functions, but rather, that he oversees and monitors its activities. This includes bank statement reconciliations, month-end closings, collection of accounts receivables, reconciliation of subsidiary reports to the General Ledger, purchase requisitions, payroll, tax payments, check signings, and investments.
As automation and the ability to manipulate data and produce many different and elaborate types of reports becomes more available, the tendency to accept computerized reports with less scrutiny escalates.
The problem often occurs when the reports you are given are not directly produced by your AMS. Instead, the information is a second-generation assimilation or compilation developed by the agency's Accounting Department. If you allow this practice, you lose control!
To ensure accountability, insist that all assimilation, compilation, or spreadsheet reports be accompanied with AMS generated income and expense statements, balance sheets, producer production reports, accounts receivables, and company production reports.
In the scenario described above, a possible reason for your surprise at being overdrawn might be because you had been looking at spread sheets which contained extracted data from reports off the AMS. Your true financial condition may have been deliberately withheld.
How many signatures do you require on an agency check? If it's less than two, you may be asking for trouble. Additionally, if one of your check signers is the controller, make sure the other does not report to him.
If you are the only check signer, there is no chance for theft, but what happens in your absence? Does your business stop because you can't be found to sign a check? Since this practice is neither practical nor efficient, more than one person needs check-signing authority. For better security, there should be two signatures required for all checks. Selecting the right persons will protect you against fraud in this area.
Because a system of checks and balances within the financial area would preclude anyone that posts, issues, or reconciles checks from signing checks, select others from outside of the Accounting Department as cosigners.
Do you receive a copy of your monthly trust and operating bank statements and reconciliations? If not, why not? It's not necessary for you to actually do the reconciliation but you should receive a copy once it is completed.
Requiring that you see monthly bank reconciliations, ensures that bank statements are reconciled regularly and facilitates the review of questionable payments. When reviewing bank reconciliations, you should be alert to any checks issued out of sequence or to any manual checks that have been issued if all checks are system generated.
Your policy should be that all payroll checks be reviewed and signed by at least one agency principal and that you examine payroll tax records quarterly. In many cases of agency embezzlement, embezzlers disguise their crime by failing to pay payroll taxes. In this way, the agency is not short on cash flow and the embezzler is buying time. It takes some time for the government to catch up with tax delinquents, and by the time they do, the embezzler is often long gone.
Regarding reconciliations: How many agencies insist that their company statements and account receivable reports be reconciled on a monthly basis? This reconciliation must be done not only to pay producers but also to track with the General Ledger. If subsidiary reports are not in sync with the General Ledger, you may not know exactly where you stand financially. Not only could you be ripe for fraud or embezzlement, but you may think you have more income than you really do. You might be spending money or paying bonuses with money that's not really there.
Agency purchases and expense accounts are areas where fraud by employees is often found. You can protect yourself against employee theft by instituting some very basic procedures.
As a first step, implement a supply-and-purchase requisition system. Regularly account for supplies. Have one person in charge of ordering supplies, and designate a manager to approve all supply requisitions. With this kind of control system and by requiring two signatures on all checks, you can substantially reduce the potential for pilferage.
Studies show that when business principals are honest, there are fewer problems of dishonesty among employees. Openly endorse the importance of honesty as a basic guiding precept of your agency. Your mission statement is a good place to reinforce this principle.
Set standards regarding expense accounts, long-distance telephone calls, completion of insurance applications, postage, and copier use. In order for the honesty principle to be taken seriously by all, all management personnel must set an example. If employees see managers cheating on their expense accounts or falsifying insurance applications, it gives the impression that some forms of stealing are acceptable. Ultimately, other questionable employee behavior will result.
BUSINESS-TO-BUSINESS FRAUD
Unfortunately, some businesses exist solely to victimize other businesses. Crimes in this area take the form of double or duplicate billing, office supply scams, and unfair competition.
Duplicate billing is typically aimed at large businesses, but insurance agencies are no exception. Suppliers with whom you have been doing business for years may suddenly encounter a cash-flow crunch and decide to use you as a way of becoming solvent.
These scams generally begin with a small test double billing. Your bookkeeper, of course, knows that you have been doing business with the supplier for years and pays the bill without question. Sometimes, the schemes are made more complex.
For example, a supplier may ship you 1,000 widgets and bill you for 1,500. If you have a sharp bookkeeper who catches the error, he or she will almost always assume it was an honest error, rather than an intentional act. In order for you to avoid crimes such as this, your policies should make that your receiving staff performs an exact count of all items shipped by vendors. Upon receipt of the invoice, pay only for what you have received. Call the supplier immediately and offer him the opportunity to come out and verify the shortage.
To eliminate any opportunities for theft through business-to-business fraud, ask local supply vendors to present proposals for volume discounts and price comparisons at least every two years to help keep everybody honest. Ask for references from your vendors and suppliers and keep accurate records of all transactions and competitive bids. Develop a manual that outlines your purchasing procedures and contains a statement that describes the agency-vendor relationship.
BAD CHECKS
Agencies that have a preponderance of bad checks from clients, most often also have poor collection processes. If you are willing to keep clients who are bad payers, ones that pay late, or pay with bad checks, you do not have control over your assets.
Writing NSF checks is a crime. If you want to improve your cash flow and prevent the loss of income due to this crime, institute a standardized collection procedure and oversee the process. Once a system is in place that does not bind coverage without payment; invoices renewal policies prior to effective date and cancels policies for non-payment of premium, your cash flow will improve and the number of bad checks you receive will be almost nil.
THEFT OF BUSINESS INFORMATION
The theft of business information, which could include your client list, happens when you do not have proper controls in place to manage your sales and service staff.
Have all employees sign an employee agreement that stipulates against piracy and specifies the ramifications of same. All employee agreements should also contain a covenant not to compete.
Frequently after an acquisition, employees from the acquired agency are disgruntled about the new entity and their perceived loss of status. There is the potential for theft of business information. Consider all employees' feelings and take actions to establish an allegiance to the new structure. Make sure that these actions are part of the acquisition planning process.
CHARACTERISTICS OF A FRAUDULENT PERSON
The characteristics of someone who would commit fraud or embezzlement vary. There does not appear to be a consensus among experts on the personality, background, job status, or economic position of a person who would steal. Often, it is the trusted, long-time employee or the pillar of the community that will commit a dishonest act. Frequently, the person who defrauds an employer is a first-time offender and rarely has a criminal record. Therefore, there are no police records that would warn of a possible crime.
Although there may not be an agreement among sociologists as to what kind of person would commit a dishonest act, there are some situations, opportunities, and personal traits that may lend themselves toward a fraudulent occurrence. We have listed them in a questionnaire as a way in which you can use to deter fraud. Any question in the "Fraudulent Risk Questionnaire" that can be answered "yes" indicates that there may be potential for a fraudulent act to occur.
MORE WAYS TO PREVENT FRAUD
In addition to the practices that were previously recommended in this article, there are other ways to protect yourself and reduce the possibility for fraud and embezzlement. They include:
- Adopt standardized hiring procedures that include uniform personnel testing and thorough reference checks. About half of all embezzlements occur because adequate reference checks were not completed because of a rush to hire staff. Employee theft prevention begins with the hiring process!
- Adhere to established agency procedures and processes with special emphasis on financial activities including audits, invoicing, collections, and check issuance.
- Require frequent and thorough accountability from persons in positions of trust. Create the expectation that all financial decisions will be checked for accuracy and correctness.
- Develop an agency handbook that outlines expectations about acceptable behavior.
- Encourage all employees to take their annual vacations and cross-train other employees to fill in when they are absent.
- Work on eliminating a crisis and pressure loaded atmosphere. This can be done by planning for peak work periods and having additional staff available in the Accounting Department.
- Conduct random audits and review the reports submitted by your staff on a regular basis.
- Develop strong leadership and cohesive work groups. This reduces the feelings among employees that the agency is too big and nobody cares any more. Strong leadership also creates an awareness of personal problems that may foster fraud.
- Establish equitable and uniform personnel policies: conduct regular performance reviews, establish s fair salary structure and prepare position descriptions which describe job responsibilities, and standards of performance which define performance expectations.
- Build a training program for all levels of employees that incorporates a practical approach to cross-training all positions within the agency.
HOW THE FORMULA GROUP CAN HELP
As agency management consultants, we frequently work with agencies who have encountered some form of fraud or embezzlement. The magnitude of these crimes varies from agency to agency, but an alarming number have almost ruined the business. Similar to other types of white-collar crime, it is difficult to determine the extent of the problem. Due to embarrassment or a concern that their agencies will "look bad" to companies and clients, agency principals frequently brush the matter under the rug and bear the loss. Also, most agency principals are aware that even if they pursue and prosecute the culprit, they will recover little or none of the money that was stolen. If they have coverage for employee theft, they will recover whatever they can and attempt to go about "business as usual."
The Formula Group can help deter a fraudulent act from ever occurring or from ever occurring again. We can conduct a security audit of your agency's operations and work with you to design, develop, and install security procedures for all departments within the agency. We can assist in the development and implementation of the recommendations and procedures reviewed in this article and guide the agency toward an environment where fraudulent activity cannot thrive.
Methods for preventing fraud or embezzlement are essential to the profitable operation of your agency because in reality, once a fraud or embezzlement has occurred, business will never again be "business as usual."
FRAUD RISK QUESTIONNAIRE
- Do any key employees have unusually high personal debts or financial losses?
- Do any key employees appear to have incomes which are inadequate to cover expenditures?
- Do any key employees appear to be living beyond their means?
- Are any key employees involved in any excessive gambling?
- Do any key employees feel any extraordinary social or family pressures?
- Do any key employees use alcohol or drugs excessively?
- Do any key employees feel that they are being treated unfairly?
- Are any key employees unduly frustrated with their jobs?
- Is success more important than ethics in this company?
- Are any key employees exhibiting overwhelming desires for personal gain?
- Do any key employees have associations with known unscrupulous suppliers or vendors?
- Is the agency experiencing turnover of key employees?
- Have any key employees failed to take vacations of more than one or two days?
- Does the agency have inconsistent personnel policies?
- Is the agency's management unethical?
- Does the agency continually operate in a crisis mode?
- Does management fail to pay attention to details?
- Is there too much trust placed in key employees rather than in standard controls?
- Is there a lack of good interpersonal relationships between key management personnel?
- Does the agency have unrealistic productivity requirements?
- Is the agency highly computerized? (If so, are there effective controls over hardware, software, personnel?)
- Does the agency fail to enforce standard operating procedures?
- Does the Accounting Department appear to be improperly staffed or does it appear disorganized?
- Does the agency keep sloppy files and records?
- Does the agency have a number of large year-end or unusual transactions?
- Do any of the key employees appear to be of poor moral character or have criminal backgrounds?
- Do any key employees continuously rationalize or excuse behavior which is inconsistent with agency policy or procedure?
- Do any key employees appear to be individuals who enjoy power, excitement and status associated with transactions involving large sums of money?
- Do any key employees appear to have a desire to "beat the system"?
- Do any key employees have poor work histories, references and/or credit ratings?
If you answered yes to any of these questions, you may have a problem. Investigate!