Prevent Fraud in Your Business
Small employers suffer the most the when it comes to business fraud. Those with fewer than 1,000 employees lose an average of $150,000 per fraud case, while larger companies lose $71,000, according to the Association of Certified Fraud Examiners. Ken Springer, a former special agent in the FBI, has investigated hundreds of fraud cases in small companies over the past 25 years. Springer, 56, is founder and president of Corporate Resolutions, a New York investigations and consulting firm that examines, among other things, misappropriation of assets, intellectual property theft, and employee backgrounds for businesses here and overseas. He spoke with Bloomberg Businessweek's Lauren Hatch about the types of fraud that are flourishing in small businesses and what management can do to prevent financial loss. Edited excerpts of their conversation follow.
Lauren Hatch: What is the most prevalent type of fraud affecting small businesses today?
Ken Springer: I think the biggest fraud we see is check tampering, at least, that's probably the biggest way people get hurt.
It's because no one's watching the cookie jar. In the 19 years I've had this company, we've done a lot of fraud investigations at small to midsize businesses. We've seen they don't want to spend the money to put controls in place that bigger companies have. For instance, some smaller companies don't want to pay the money to have an annual audit, but when you have an audit, there are checks and balances so that people can't commit fraud as easily. Some smaller companies also don't want to spend money to do background checks on their staff. If people did background checks on their employees, a lot of problem employees would go elsewhere.
What are the other major frauds small businesses should be looking out for?
One is inventory fraud. Many times you have merchandise being loaded onto trucks for delivery, but no one's actually watching them. We just worked for a technology company that was missing computer goods. If you think about it, you can easily hide a little laptop computer in a box. When no one's looking, you put a laptop in your car, or you put it in the outside dumpster and come back for it when it's dark at night.
Another is commercial bribery. For example, someone comes in to see the same employee all the time. After a while, they develop a relationship, and your employee may give them free merchandise to get a split of the profit.
Often frauds are internal. Sometimes it is with an outside customer, but most times it is an internal employee. And many times, it is a long-standing, loyal employee. It's someone who's grown with the company. We dealt with a recent embezzlement at a company that had started with three people and a bookkeeper. While the company grew and grew, this same bookkeeper kept rising to the top—and ended up stealing a couple of million dollars over time. How does this happen? Well, as they grew they gave him more responsibility. He was in charge of the bookkeeping and was taking money, but because he reconciled all the checks, they never found out.
What should business owners do to prevent fraud?
There are a few things. You need to do some type of background screening. If you have a smaller business, you're not going to spend $3,000 or $5,000 checking out someone who's going to work out on the loading dock or someone who's right out of college. But you do need to verify what they are telling you—at a minimum, you need to do a criminal check.
You should also check credit. Unfortunately, in this day in age a lot of people have financial problems. That's fine; you just want to know about it. If you're hiring a bookkeeper who filed for bankruptcy, you want to know that. If you're hiring someone who's been arrested for drugs, you want to know that. Or it could be that someone's been arrested for theft or sexual harassment. Check if they were sued or if they sued former employers. Because what makes you think they aren't going to sue you?
You should also verify what's on the résumé. If someone says they went to Dartmouth or Ocean Community College, you still want to verify it. Because if they lied on the application, they're going to lie about everything else they do.
We just had a job where the CFO stole money. After we proved that he stole it, we looked at his application. On it, he lied about where he went to school and that he was a CPA. Even the references he gave were lies—one person was dead, one person didn't exist, the other person said, "Are you kidding me? I wouldn't trust him with anything." Had the company checked him out, they would have saved a $5 million fraud.
Beyond these steps, what else can deter internal fraud?
Sometimes the biggest thing is just to tell potential employees that as a condition of employment you're going to do background checks. This way, if he's a con man, or a felon, or whatever, he's going to go elsewhere. It's like having a burglar alarm system in your house; many times, people will just go to the next house on the street.
And keep in mind, sometimes your most loyal employees can take advantage of you. Even if someone's your best employee, you need to have checks and balances so they don't control everything—because that one person could put you out of business.
The biggest way to deter fraud or catch fraud is having some type of hotline. We operate our own ethics hotlines, but a lot of companies also do it. They call them whistle-blower hotlines, and they are a very cost-effective way for employees and others to report anonymously to management or to the investors of a company if there's a problem. And it's not always fraud or unethical behavior. It could be unsafe work conditions, it could be violence or drugs. Most employees are loyal; if they see something, they need to have a way to report it. And they want to do it anonymously.