Whitepaper Series
Anthony M. Bracco, CPA/CFF, CFE
Partner and Co-Practice Leader
Litigation, Forensic and Valuation Services Group
Anchin, Block & Anchin LLP
Occupational Fraud:
How to Protect
Your Business
Occupational Fraud:
How to Protect Your Business
Anthony M. Bracco, CPA/CFF, CFE
Partner
Co-Practice Leader - Litigation, Forensic and Valuation Services Group
Anchin, Block & Anchin LLP
In order for businesses to operate effectively, ownership and management must place trust in their employees. Unfortunately,
there will always be some employees who exploit this trust for their own benefit. Occupational fraud costs the typical company 5%
of its annual revenue. So, how do you protect your organization? Understanding the types of frauds to look out for, knowing who
is likely to target your company and why they do it can help to design and implement controls to reduce your risk.
While this article will not address every type of fraud, I will discuss several and the red flags that may indicate these frauds are
occurring as well as what can be done to prevent them.
Types of Fraud
There are three main categories of occupational fraud:
1. Asset misappropriation, which involves an employee stealing company resources, is by far the most common type of fraud.
2. Corruption, which is when an employee misuses their influence in a transaction for their own benefit.
3. Financial statement fraud, which involves misstating or omitting material facts, typically overstating revenues or assets and/
or understating expenses and liabilities. Although this is the least frequently occurring fraud, it can often be very costly.
Financial statement fraud can sometimes be the means by which other frauds are concealed.
Asset misappropriation comes in many forms. This category includes billing schemes, payroll schemes, expense reimbursement
schemes and check tampering.
Billing Schemes
Billing schemes are often carried out using shell companies. A dishonest employee establishes a shell company which then
submits fraudulent invoices. These invoices are often for services rather than for goods, the reason being that it is more difficult
to notice that services were not performed than goods not being actually received. When setting up a shell company, a dishonest
employee will often use a post office box as its address. Beware of vendors that do not have a physical address.
Billing schemes can also be carried out through non-accomplice vendors. This is done by a dishonest employee using a real
company vendor to unwittingly assist in their fraud. One way of doing so is for the employee to pay the same vendor invoice twice.
They then contact the vendor and ask them to return one of the payments back to their attention. The dishonest employee now
has a signed check that they can attempt to negotiate. They will however have to find a way to conceal the duplicate payment
in the general ledger. Beware of unusual or undocumented adjusting entries to accounts payable or unusual debit balances in
accounts payable.
Anchin, Block & Anchin LLP
Accountants and Advisors
1375 Broadway, New York, NY 10018
212.840.3456 • www.anchin.com
Anchin Block & Anchin LLP Copyright © 2014
This contains information which is general in nature and based on sources which are believed to be authoritative. Specific applications would require consideration of all facts and circumstances by qualified
professionals familiar with a taxpayer and therefore we are not liable for the application of any information contained herein. No part of this correspondence may be reproduced or utilized in any form or by any
means without written permission from Anchin, Block & Anchin LLP.
Payroll Schemes
Payroll schemes can include falsifying hours, commission schemes and ghost employees. For a company that bills its customers
based on hours charged by employees, an employee falsifying their hours can result in the company and its officers facing criminal
charges.
Commission schemes involve either overstating sales or the commission rate. Be sure that sales numbers used for commission
calculations are real and place restrictions on who can enter commission rates into the payroll system.
A ghost employee is one who does not exist but has been created by a dishonest employee. I have seen this occur more frequently
in businesses with multiple locations when it is more difficult to keep track of every employee. It is important to place restrictions
on who can add new employees to the payroll system. Terminated employees should be removed as soon as practical. Periodically
requiring employees to sign for their paycheck or pay stub in the case of direct deposit, can help identify ghost employees.
Corruption takes many forms including kickbacks, extortion, bid rigging, illegal gratuities and conflicts of interest.
Kickbacks and Extortion
Kickback schemes involve employees who handle purchasing and have direct contact with vendors. Usually a vendor will approach
the employee in charge of purchasing and promise them payments in exchange for receiving orders for goods or services that will
never be delivered or will be provided at an inflated price. In some cases there is no overbilling. A kickback is paid to an employee
for simply diverting business to a particular vendor. Extortion is the reverse situation where an employee approaches a vendor
for a payment in return for awarding business. Be wary of the employee who has unusually close relationships with your vendors.
Bid Rigging
Bid rigging can involve any employee with control over the bidding process. During the pre-solicitation phase a corrupt employee
can influence the company to believe that a particular project is necessary, or can tailor the specifications of the contract to
the qualifications of a particular vendor. During the solicitation phase bid pooling can occur. This is when bidders conspire to
determine who will submit the lowest bid to ensure they each receive an equal amount of work. A corrupt employee can also use
inflated price quotes from fictitious suppliers to support a higher bid from a vendor that has bribed them. During the submission
phase, a corrupt employee may be bribed to provide a supplier with the supposedly sealed bids of their competitors prior to the
submission due date.
Illegal Gratuities
Illegal gratuities are particularly difficult to prove. They occur when something of value is given to an employee after making a
decision to award a contract to a specific vendor. The promise of this gratuity may or may not have influenced the decision. Even
if their decision was not influenced by the promise of a gift, an employee who accepts such gifts may be open to accepting bribes.
The acceptance of such gifts should be prohibited by a company’s code of ethics.
Conflicts of Interest
Conflicts of interest involve employees who have an undisclosed economic interest in a transaction they are influencing. This often
occurs when an employee or their relative owns an interest in a vendor whose invoices they are approving, often at above market
prices.
Fraud Prevention and Detection
Prevention may be a misnomer. While you cannot prevent all fraud from occurring, you can take steps to reduce your risk. How do
you reduce the risk of fraud? Understand who does it and why they do it. Ensure that the controls you have in place are adequately
designed and are working. The majority of would be fraudsters will pass up the opportunity if they suspect there is a possibility
of getting caught.
The theory behind why people commit fraud is most often illustrated by the “Fraud Triangle”. Each side represents an element
that must be present for fraud to occur. The first side is pressure. These can be internal or external pressures. Internal pressure
could be overly aggressive management pushing employees to achieve specific financial results which in turn may result in an
employee falsifying financial statements. External pressure can be the result of an employee experiencing financial difficulties
created by living beyond their means or due to addictions including drugs, alcohol or gambling problems. The second side is
rationalization. Examples of rationalization would be an employee feeling they are entitled to steal because they have not been
properly compensated or thinking they are only “borrowing” and will repay the company. Lastly, the third side is opportunity,
which is created by weaknesses in internal controls. While you may not be able to control the pressures someone is feeling or the
rationalization going on in their head, you can greatly reduce their opportunity.
Anchin, Block & Anchin LLP
Accountants and Advisors
1375 Broadway, New York, NY 10018
212.840.3456 • www.anchin.com
OPPORTUNITY
FRAUD
TRIANGLE
RATIONALIZATION
PRESSURE
The individuals who commit fraud are usually in a position of trust. If they were not trusted they would not have access to company
resources. This trust should never reach a point where the work of an individual goes unchecked. So, how do you reduce the
possibility of becoming a victim of the frauds discussed earlier? Look for the warning signs.
In the case of billing schemes, look for:
• Payments to vendors not on your approved vendor list
• Invoices paid without a corresponding purchase order when a purchase order system is being used
• Unusual debit balances in accounts payable or unexplained write-offs of debit balances
In the case of kickbacks and extortion there are several indicators to look for:
• Is the volume of materials purchased significantly exceeding the need?
• Is the same vendor consistently selected by the same individual?
• Are materials costs out of line? You should be comparing these costs to the market. Retain quotes received from vendors so
that they can later be compared to the prices charged by the vendor selected.
• Observe your people. What are the characteristics of someone who would be involved in these types of schemes? They are
generally the big spender, overly generous. This person is not afraid to break the rules to get things done. They have unusually
close relationships with vendors. They are controlling and rarely take vacation time.
Some red flags that may indicate employees are involved in bid rigging would be:
• Overly narrow specifications that result in very few or only one qualified provider.
• Splitting costs into separate contracts to bring each of them below a dollar value at which they would be subject to additional
review.
• Allowing an unusually short time period to submit bids that may give an unfair advantage to bidders who may have been
provided advance notice.
• A low bidder withdraws their bid and ultimately becomes a subcontractor on the same contract.
• Late bids are improperly accepted.
• The same bidder is repeatedly being awarded work.
• Unusually high number of complaints from opposing bidders.
• After the bids have been opened, a bidder requests to make changes to their bid due to an error (which is often intentional).
• An unusual number of post-award contract change orders.
A sign of an employee receiving illegal gratuities may be their taking an expensive vacation or the purchase of a new car that their
salary could not support.
Conflicts of interest may be indicated by above market prices being paid to a vendor or new vendors that the company has no prior
history with.
Anchin, Block & Anchin LLP
Accountants and Advisors
1375 Broadway, New York, NY 10018
212.840.3456 • www.anchin.com
What can you do to detect these activities if they are occurring?
• Perform background checks on all employees and vendors.
• Ensure proper segregation of duties.
• Require job rotation and assignment so that no single person handles the same function or handles the same vendors or
customers for an extended period of time.
• Obtain and review financial performance reports by project no less than monthly. These reports should include a comparison
of actual job costs to budgeted costs.
• Compare the volume of materials purchased to the contract and bid documents.
• Review a report of purchases by vendor. Verify that employees are not using a single vendor for all purchases of a particular
item.
• Immediately investigate any complaints from owners regarding the quality of materials.
• Train employees on how to review an invoice. Be sure they know what to look for. Verify that purchases are only from an
approved vendor and that the invoice does not have any unusual items such as materials that do not belong to the particular
job, excessive quantities or unusually high prices.
• Review trended financial data to identify irregularities in costs by vendor or purchasing individual.
• Identify conflicts of interest by comparing vendor and employee addresses, vendor tax ID # to employee social security # and
vendor and employee phone numbers.
• Review cash disbursements for unusual items such as duplicate check numbers or duplicate purchase order numbers, invoice
numbers and amounts to the same vendor. Convert the date of the payment to the specific day of the week. Would it be
unusual in your company for checks to be recorded on a weekend?
• Review cell phone records. Who are your employees calling? Are they speaking with vendors more frequently than expected,
after business hours or on weekends? The same review can be done on employee e-mails.
• Do not over-rely on external audits. They are not designed to detect fraud and consequently are responsible for detecting less
than 4% of all frauds.
• Establish a zero tolerance policy. Prosecute frauds that are discovered. If these matters are swept under the rug, other
employees get the message that they can get away with it as well.
• Maintain adequate employee dishonesty insurance coverage. It is often overlooked and default amounts of coverage never
come close to being adequate. It is the significant event that you want to be sure you are covered for.
• Communication. Anonymous fraud reporting hotlines, as well as fraud awareness and ethics training, are powerful tools in
combating fraud. Studies show that the most common way fraud is detected is through tips. More than 40% of all frauds
were detected through tips with most of those tips coming from the victim organization’s employees.1 It is critical for all
organizations, regardless of size, to provide their employees with fraud awareness and ethics training. Not only does it
empower people to speak up without fear of retaliation, but it also sends a message to would be perpetrators that the owners
and management are serious about preventing fraud and will not tolerate it.
Yet all too often we see staff untrained and unprepared to deal with fraud when they uncover it. In my experience, owners
make the incorrect assumption that their people know what to do when they see fraud. It is not uncommon for a lower level
employee to look the other way when a member of management is involved in unethical behavior. After all, what if they are
wrong? You can reassure employees that there will not be any retaliation against them by establishing an anonymous fraud
reporting hotline. Vendors and customers should also be aware of the hotline. All of these individuals will be the eyes and
ears of the company. The more people you have looking out for fraud the less likely someone is to commit a fraud and the
greater the likelihood that it will be uncovered if a fraud occurs.
Management should continuously evaluate the internal controls that have been implemented. Over time, internal controls erode;
people find shortcuts to get their job done and the business environment changes. It is unlikely that all of the controls implemented
in a company established years ago are still the best controls for the current business environment. Internal controls should be
reviewed regularly to make sure they are the best possible controls and that they are being followed. Implementing even a few of
the suggestions above can not only help you detect whether something improper is happening within your company now, but can
also act as a deterrent by sending a clear message to employees that you take fraud prevention seriously and that you will make
every effort to protect your company to ensure that your business is successful now and well into the future.
1
Association of Certified Fraud Examiners, “Report to the Nations on Occupational Fraud and Abuse- 2012 Global Fraud Study”
Anchin, Block & Anchin LLP
Accountants and Advisors
1375 Broadway, New York, NY 10018
212.840.3456 • www.anchin.com
Anchin Block & Anchin LLP Copyright © 2014
This contains information which is general in nature and based on sources which are believed to be authoritative. Specific applications would require consideration of all facts and circumstances by qualified
professionals familiar with a taxpayer and therefore we are not liable for the application of any information contained herein. No part of this correspondence may be reproduced or utilized in any form or by any
means without written permission from Anchin, Block & Anchin LLP.