"John," a roof system installer, was filled with excitement. He had decided to start his own roofing company. He had a loose business plan, a few jobs lined up and best of all, he had persuaded his co-worker "Michelle" to work with him. He would handle completing the jobs, and she would handle managing the office duties. John even offered to pay Michelle's vehicle expenses to compensate for the long commute to his new office. John believed he did not need to train Michelle or oversee her work. After all, she was experienced!
Ten months later, John sat down with me at the Denver District Attorney's office and listened in dismay as I explained he might never see a dime of the more than $40,000 Michelle had embezzled from his new company. By the time John ended up in my office, it was simply too late.
If this happens to you, local law enforcement agencies will not perform an audit for your business; they will not recreate your books; and restitution will be limited if you recover any of your lost funds.
Much of the following information comes directly from the 2016 Association of Certified Fraud Examiners [ACFE] Report to the Nations on Occupational Fraud and Abuse. In the report, ACFE has put statistics and definitions to what I have seen anecdotally in cases I have handled during my time as an economic crimes prosecutor in the Denver District Attorney's office.
Occupational fraud is a significant threat to U.S. businesses. ACFE estimates a typical business loses 5 percent of its revenue to employee fraud each year. In addition, ACFE estimates the median loss from occupational fraud has grown during the past 10 years from $93,000 to $150,000. And if that isn't bad enough, in the employee fraud incidents that involved losses of more than $1 million, a majority of those funds were never recovered.
The 10-10-80 is a good rule of thumb for a business owner to remember. Ten percent of your employees will never steal from your company; 10 percent always will steal from you; and 80 percent may steal from you depending on the circumstances.
According to ACFE's 2016 report, small businesses (those with fewer than 100 employees) are victimized more frequently than their larger counterparts and suffer a larger median loss relative to their size. Why are small businesses the most vulnerable to employee theft? What we see in our office is small businesses differ widely in organizational structure, have limited resources to hire enough employees for comprehensive cross-checks and tend to have unsophisticated anti-fraud controls in place.
To combat occupational fraud, business owners need to have an idea of the many ways in which employees can walk away with their money. ACFE recognizes three primary categories of fraud: corruption, financial statement and asset misappropriation. I will focus on asset misappropriation because it is the most common type of employee fraud business owners encounter.
Simply put, asset misappropriation involves schemes where an employee steals or misuses an organization's resources. Within this broad definition, ACFE recognizes nine categories of fraud:
Of the many ways in which an employee can defraud an employer, according to the 2016 ACFE report, the most common schemes in the construction industry were skimming, billing, expense reimbursements, check tampering, payroll fraud and non-cash misappropriations. For small-business owners, billing schemes are the most common fraud, and check tampering is three times more common in smaller organizations than in larger businesses.
So what is a business owner to do? The problem with employee fraud is it commonly takes a long time to detect, allowing precious revenue to slip out the door until someone in the organization finally realizes what is happening or the loss of funds takes the company down completely. Payroll, check tampering, billing and expense reimbursement schemes usually take the longest time to detect with a median average of 24 months. The other schemes averaged from 12 to 18 months. Loose oversight and the sophisticated methods of concealment employees use can combine to make things worse. The most common concealment methods used by perpetrators are creating false documents, altering documents, altering transactions in the accounting system, creating fraudulent transactions in the accounting system or destroying physical documents.
How can you detect fraud? By far the most common way is through tips from other employees. But for employees to come forward, they must believe there is a person in the organization who will listen to their concerns, investigate their allegations and keep their identities confidential. Other ways in which businesses are detecting fraud are through internal audits, management reviews, through bank account reconciliation or by accident.
The statistics are telling. When a business owner identifies an employee who is stealing from the company, surprisingly, a vast majority of these people previously have never stolen from an employer. In fact, 88 percent are first-time offenders, according to the 2016 ACFE report. Think back to the rule of thumb: 80 percent of employees will steal from their employers depending on what is happening in their work or personal lives. Perhaps they are facing gambling debts they cannot cover. Or maybe someone in their family is ill and needs specific medical attention they cannot afford. Or the employee might feel underappreciated, overworked or underpaid. And sometimes, it's just good old-fashioned greed.
Almost half of offenders are between 36 and 45 years old, and 55 percent are male. Just less than half have a college degree, and, interestingly, 38 percent of offenders will have some sort of nonfraud-related misconduct that's been reported during their tenure, such as bullying other employees or using intimidation tactics within the victim organization.
It is common for victims in the cases I have prosecuted to see at least one red flag from an employee who was stealing from their business. In many cases, there were multiple red flags waving around the employee; however, the business owner simply did not see the warning signs or refused to believe the employee would steal from the business.
The most common red flag noted in the 2016 ACFE report was employees who were living beyond their means. This might be an employee who is buying a new car he or she obviously cannot afford. Other signs are employees who are experiencing financial difficulties, have unusually close associations with vendors or customers, or display excessive control issues over their work products.
For instance, you should pay close attention to a "perfect" employee who is looking to take on more responsibility, never misses a day of work even for a vacation or is eager to handle your personal finances. If you find yourself in love with the fact that you can focus on roofing while the "perfect" employee opens the mail, answers the phone, pays the bills, deposits the money, reconciles the bank accounts and collaborates with the accountants, you are setting yourself up for a major disaster.
Think of employee fraud as a triangle composed of three independent but necessary sides. On one side is motive, usually driven by financial hardship or simple greed. On another side is opportunity, usually driven by lack of controls within the victim organization. The third side is rationalization, which can take many forms. Oftentimes, employees view theft from their employers as a loan they will pay back. It is up to you as a business owner to recognize the triangle in your company and install a thorough, robust set of internal controls, including:
Don't ignore signs
In the roofing industry, the pressure to perform a job well and at a profit is increasingly difficult. In the ideal world, every roofing contractor would employ all the internal controls listed previously, but that's not always possible. At the very least, take time to identify the threats that exist in your organization. Then, put policies and procedures in place that are appropriate to protect against employee fraud based on the size of your organization. If you ignore the vulnerabilities that exist, there is a good chance you will end up sitting in a prosecutor's office just like John.