The bad news about fraud in small businesses: The economic downturn has spawned an increase.
The good news: Most of it is predictable and preventable. The most common problem is having one person in charge of finances, from handling invoices to writing checks and reconciling bank statements.
Michael Balskus, the assistant district attorney in Winnebago County, recalls a couple who had hired a new, very personal bookkeeper for their small business. Distracted by a parent’s Alzheimer’s disease, they failed to monitor their accounts until $80,000 was stolen.
“She was their one and only bookkeeper,” he says.
Some fraud can be a little easier with credit cards and the Internet, says David Lasee, the district attorney in Brown County.
“But I still find it’s mostly the same old unsophisticated things – you have one person in a small business who oversees the money and you don’t have anyone to do an audit,” Lasee says. “Then two years down the road you do an audit and find a substantial amount has been taken.”
Marty Mathias, an accountant with the Madison office of SVA Certified Public Accountants, says small business fraud usually just involves bookkeepers writing checks to themselves.
“They are able to hide it because the owner isn’t looking over their shoulder to see who they are writing checks to, and they haven’t imposed segregation of duties,” Mathias says.
The most common way fraud is discovered is through anonymous tips, he adds. Embezzlement is usually in even dollar amounts, so look for checks for $1,000 or $2,500 – people rarely steal with checks for $973.25.
Gambling debts and drugs are the leading catalysts for embezzling, according to accountants and prosecutors, so the funds stolen are usually gone by the time the crime is discovered. Recovery is rare although sometimes families will step in with restitution to avoid prosecution. In some cases the embezzling is for serious problems, such as a spouse who is ill or a person who loses a job and needs to pay the mortgage.
Once a theft is discovered, the responses of employers and prosecutors can vary.
“Some decide not to prosecute,” says Lasee. “It depends on the relationship. Some might have a person who has been working there for 20 years and they fell on hard times and the employer understands. And some employers also understand they are more likely to recover something if he doesn’t prosecute.”
Prosecutors will take an employer’s wishes into account and may decline prosecution, especially if a person has a clean record. Sometimes, however, the victims have little say.
Balskus had a case where the nephew of a jewelry store owner distracted the owner’s son – his own cousin – while the nephew’s accomplice took $60,000 in valuables. The owners wanted to throw the book at the accomplice, but they didn’t want to prosecute their nephew.
“That’s not going to happen,” says Balskus. “We prosecuted them both and also the third person they had transferred the jewelry to.”
Brown County’s Lasee says fairness requires prosecution. Many embezzlement cases aren’t uncovered until $100,000 or more has disappeared.
“You can’t give that person a pass,” Lasee says. “If you jail someone for stealing $1,000 from Walmart, it is only fair to take action against someone who took $100,000 from their employer.”
Mathias says owners’ responses vary widely.
“Some people are out for blood and want to prosecute. That can be a very costly endeavor because you generally have to hire a fraud specialist to come in and help put the case together. You want to be able to go to law enforcement so they don’t have to do the investigation; they don’t have the resources to follow up on all their fraud complaints.”
Insurance may cover all or part of the loss, which could justify hiring a fraud specialist.
“If you have insurance, you want someone in there who knows what they are doing so you can submit a claim in a nice package case and the insurance company sees there is fraud and agrees to a payment,” Mathias says. His advice to owners who discover fraud is to bring in an expert for a couple of hours and get their advice.
More often than not the business owner just wants to forget about it and move on, he adds. Some, perhaps one in 10, keep the fraudster employed, which he regards as a huge mistake.
Mathias says the solution to preventing most fraud is simple – have a second person, an outside bookkeeper or a spouse for example, reconcile the books every single month.
“Make sure the checks are signed appropriately and there is an invoice.” With credit cards, insist on the itemized receipt.
“I have a lot of construction contractors and managers who need to buy supplies,” Mathias says. “They will go to Menards, which has building supplies plus TVs and groceries. It is very easy for them, if the controls aren’t in place, to buy all their groceries, plus a TV, and give the credit card receipt and say it was all for building supplies.”
Mark DeBroux, a CPA at Schenck in Appleton, specializes in medical practices. He says a dentist whose staff consists of himself, a hygienist and a receptionist shouldn’t leave all the finance to the office person. Professionals sometimes tell him they don’t want to be involved; he just tells them it’s their business.
“You need procedures in place and segregation of duties so the person taking cash can’t delete appointments from the system,” DeBroux says. “Set it up in your software.”
Medical practices have the same challenges as other small businesses, except that doctors and dentists often are more hands-off, which creates opportunity for fraud. The revenues are higher too – the median loss from fraud in medicine is $155,000.
Audits only discover a small portion of fraud, about 4 percent. More than 30 percent is found from an operational assessment where an accounting professional walks the money through the business looking for fraud opportunities, he says.
A CLOSER LOOK
Mark DeBroux, a CPA at Schenck in Appleton, writes:
» Employ people who can be trusted. Check references when hiring.
» Pay employees a fair wage.
» As an owner, set a good example.
» Make it hard for someone to steal by balancing reports and making deposits every day.
» Provide receipts to patients who make payment in the office,using pre-numbered receipts.
» Bill all patient accounts monthly.
» Once an account is determined to be uncollectable, write it off and send it to a collection agency.
» Involve more than one staff member in all financial aspects of the practice.
» Use a computer system to generate checks and use a pen with permanent or non-washable ink to sign.
» Install a time clock.
» Require all staff members to take at least five continuous days of vacation, and cross train other staff to complete their tasks while that employee is on vacation.
» Make use of passwords on practice management systems allowing staff to access only the modules they need, and change passwords at least four times a year.
» If you use online banking, be sure to verify who has access and passwords.
A CLOSER LOOK
Scott Shaffer, Grant Thornton Wisconsin Practice Leader for Forensic and Valuation Services, says that businesses should encrypt their computer records, especially if they contain customer information and customer credit cards. Never keep financial records on a company’s Web server – hackers can get into those easily. And set up firewalls to protect your systems.