How to Identify Signs of Employee Fraud In Your Business


Best Corporate Fraud Detectives in Mumbai If you are business owner, the threat of employee fraud looms large and ignore it at your own peril. Many corporate frauds are based upon setting up fake employees or fake vendors with an unscrupulous employee pocketing the payments made to them. Who controls your  accounts payable vendor master file? What are the policies and procedures to set up a new vendor? These are questions that you must have answers to.

Employees Could Easily Create Fake Vendors or Fake Employees

Think about separation of duties. No one person should be able to set up a new vendor, approve a payment to that vendor, and conceal it by making fictitious accounting entries.

Many fake vendor schemes utilize a variation of the name of a common, well known vendor. For example, instead of “Common Vendor, Inc.,” an unscrupulous employee may set up a vendor called “Common Vendor” and it likely would not arouse any suspicion. If a fraudster can establish a fake vendor and direct payments to that vendor, they he / she may be able to then pocket the money without anyone noticing in the absence of other internal controls. A simple review of the vendor master file would show two nearly identical vendors which should then be investigated. That’s not to say it’s clearly an indication of fraud, but it may be.

A former Quest Diagnostic manager was able to steal $1.2 million dollars by setting up fake companies, fake invoices, and fraudulent expense reports. He was caught during a review of the accounts payable system when someone became suspicious of some fake vendor names the perpetrator had established. When they investigated the suspicious vendors, they found that the addresses did not match the name. Be wary of vendors that do not have a physical address. If you are really sharp, a quick look at Google Maps may substantiate that the new vendor exists and resides where they claim to.

Other business directory searches may further substantiate whether the business is legitimate or not. Some thieves may go to extraordinary lengths so you may even want to make sure the owner of the company isn’t one of your employees! What are your procedures for establishing new employees? How are checks or pay receipts distributed? Paychecks or pay receipts should not be distributed by the same person that controls the employee master file and/or runs the payroll! If an independent person distributes the checks or pay receipts and has an extra check left over, then the “ghost employee” scam may be caught and stopped. Again for both fake vendors or  fake employees fraud schemes, analysis of your spending to budget and prior year may help prevent or detect this type of fraud.

Misapplying Customer Remittances

Think of this type of scheme as robbing Peter to pay Paul. Or think of it as the employee/company version of the classic investment Ponzi scheme. It basically involves deliberately mis-applying customer receipts in an attempt to disguise missing money. A classic case is to steal customer A’s remittance and then apply Customer B’s remittance to A’s account, apply Customer C’s remittance to customer B, etc. (AKA, check lapping). An employee of CCU Associates embezzled $1.3 million dollars over a 25 year period through a lapping scheme. He was caught and is currently serving a 15 year prison term.

An administrative assistant at a Hospital in the US stole $230,000 from Sodexo through a lapping scheme. The scheme unraveled when the hospital decided to change vendors. As Sodexo was working through the final payments due them, they discovered there were many invoices they showed unpaid which the hospital claimed had been paid. When the checks were traced, the fraud was discovered. Although lapping is a common fraud technique, it is rather clumsy and may be easier to detect than some other frauds. Require all employees to take vacation or make sure you have mandatory and periodic job rotation. This type of fraud requires high maintenance and when the perpetrator is absent, it may quickly unravel and be discovered.

You should also segregate record-keeping and opening of mail containing customer remittances. At a minimum, one employee, with no other recordkeeping responsibilities, should open all the mail and make the bank deposit. In most companies there is no reason that the accounts receivable person needs the live check. If they really must have the check, have the other person make them a copy. You cannot mix recordkeeping and asset custody in one person! If you have enough incoming check volume, consider a bank lockbox. The bank will open your mail, deposit the checks and then send remittance data to your accounts receivable staff to update your records. As an added benefit, a lockbox will generally speed up the availability of your cash.

Encourage and Adopt Internet Banking

Again this is something that I highly encourage businesses to do. Encourage your customers to pay you electronically and also do likewise to your vendors and employees. Electronic remittances are generally available quicker than checks and may be less prone to unscrupulous diversion. Do you send out customer statements? Many times if a customer sees misapplied or missing cash on their account they will sound the alarm. In addition, monthly customer statements may help you increase your cash flow. If you don’t send out customer statements, consider periodically sending out account confirmations. Again, if balances are misstated, your customer may call. Be sure to have the call back number on the confirmation directed to an independent person in your company not likely involved in such a scheme!

Who has the authority to write-off accounts or amounts and issue credits? If that employee also has access to cash or checks they may be able to divert the cash back to themselves. Slowing customer collections may be a sign of check lapping, especially from an account that previously paid well. Periodic review of your accounts receivable accounts may also provide other clues of impropriety. If you see a lot of adjustments and credits, you should investigate. Again, not an absolute sign of impropriety but perhaps a clue. Cash flow not quite what you were expecting? Make sure you don’t have your hard-earned cash diverted by an employee thief.

Know that over longer periods of time, cash and profits should have some correlation. Differences in cash and accrual accounting reported profits are caused by timing differences in recognizing expenses and income. If you don’t have some correlation over time, you may have accounting problems or it could be another sign of fraud.

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Author Bio

Amit Sen, a commercial pilot by training, has over 15 years experience in the space of corporate investigations, handling Copyright & Trademark infringement cases, Pre – employment verification Industrial Espionage investigations, Asset & Net – Worth assessment assignments and vendor / supplier verification cases, among others. Co-founder of Alliance One Detectives – which is the best corporate fraud consulting company in Mumbai. Amit has also successfully completed assignments in a wide range of sectors, including the machine tools industry, pharmaceutical industry, hospitality sector, specialized equipment (Oil & natural gas sector, aviation industry etc.), telecom industry & the IT & ITes sectors. These cases have all involved both offline and online investigations.

Article edited and co-written by Atin Dasgupta who is the co-founder and marketing head of Alliance One. Read more about Atin here.

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