BY GARY ZEUNE
Entities with fewer than 100 employees lose an average of $147,000 in 2012 while entities with more than 10,000 lost an average of $140,000.[i] Small business owners make the classic mistake of thinking that trust is an internal control. Trust is a feeling, not a control.
Usually, three things are present when someone commits fraud or embezzles:
Dr. Donald Cressy interviewed 200 embezzlers and coined the “triangle of fraud” (see diagram).
The formula sounds simple, but the picture is more complex. The following guidelines may help.
THE NEED FACTOR
Need takes two forms—direct and indirect. Direct need involves stealing to satisfy a usually severe need for cash.
Direct need is often driven by an addiction or compulsion—drugs, alcohol, gambling, or an extramarital affair. Indirect need, on the other hand, is a business owner’s or executive’s need to keep the company afloat. Indirect need results, for example, in cooking the books to obtain or re-ew aloan, or get donors to give.
Of course, it can also result in a host of other fraudulent acts, such as bank fraud, check fraud, invoice scams, etc.
THE OPPORTUNITY FACTOR
Opportunity is defined as a perception that there is a low probability of being caught. Your CPA calls this “poor internal controls.”
THE RATIONALIZATION FACTOR
Rationalization is the fraudster’s mental process of making his or her illegal action fit within a personal code of conduct or ethics. In other words, the dishonest employee must be able to “talk himself into the action.”
Rationalization often results in “situational fraud.” It’s thought that about 5% to 10% of employees would never—ever—do anything wrong. Another 5% to 10% are always scheming (hopefully you don’t have many of these folks working for you or as clients). The real problem is the 80% to 90% of employees who will commit “situational fraud”— fraud that results from being in a position to steal and easily rationalize the illegal deed.
Question: Who are the only employees who can steal from you? Employees you trust. Just because you trust someone doesn’t mean you don’t let your guard down. Remember, only dishonest employees will protest new controls. Here are some warning signs and conditions where trusted employees may be tempted to commit situational fraud:
- A period when employees are being downsized
- Employees who are bored may steal for excitement
- Employees make an honest mistake, no one notices the missing money and are going to “pay it back”
- Thrill-seekers who like bending the rules
- Employees who are under personal stress—with financial problems, divorce, serious illness (especially of a spouse or a child)
- Employees with addictions—to drugs, alcohol, extramarital affairs, gambling, etc.
- Employees who always have to be number one and/or can’t stand not being the center of attention
CREATE A SELF-CORRECTING SYSTEM
Modern CFOs know a lot about human behavior. For example, they know that behavior never remains static. World-class CFOs understand that any time they change a reward, the compensation system, or the control system, people will change their behavior to maximize the benefits of the change for themselves.
Example: Many years ago automobile traffic engineers set out to reduce the accident rates at intersections. They set up cameras and videotaped the traffic patterns. At that time, the green light would turn red and the red light would turn green at the same time. But that one last car tried to get through while cars with the green light had permission to go. So the engineers changed the sequence to add a 2- or 3-second delay (i.e., both lights stay red for that brief moment), giving that one last car time to go through the intersection. And, of course, adding the amber light soon became the standard for creating this delay.[GZ1]
The accident rate declined significantly for two or three months. Then what happened? Drivers coming to an intersection with a yellow light or new red light realized they had several extra seconds to make it through the intersection. Instead of one car going through on the red, now it’s three or four. The drivers adjusted their behavior to benefit themselves.
How does this apply to employee theft? When you change the compensation system, employees will change their behavior. You may solve one problem but create an even worse problem.
So what’s the solution? A sports metaphor may explain. Hockey players don’t skate to where the puck is, they skate to where the puck is going to be. So to become effective at managing change without promoting crime, you must anticipate how employees— and executives—might react dishonestly to any changes, and correct for them.
Sometimes vulnerability to employee theft can be reduced with a little creativity.
- The owner of a small company with little segregation of duties can have the bank statement sent to his or her home, not to the company. If the owner does online banking simply print out the bank transactions. Either wayhe owner reviews the statement and then inquires about several items in each statement. This creates the perception that a theft would probably be detected.
- Employees in a large company’s purchasing department may set up phony vendor accounts with their own addresses. To deter this kind of theft, regularly match the employee address file with the vendor address file.
- Send a letter to banks where the company does business, asking to keep you informed whenever they open accounts using names similar to that of your company. If someone is stealing customer checks from AT&T, they might open an account under A&TT or ATT. The teller would likely accept the check for deposit, assuming the company’s customer simply wrote AT&T incorrectly.
Uncontrolled theft and embezzlement cause a serious drain on company resources. Business owners and CFOs must be aggressive about protecting the company’s assets. The key to this is “self-policing” or “self-correcting” systems to control internal theft. If you don’t know trhee ways someone can steal without getting caught, you don’t understand your control system. Also, how do your compensation and performance-measurement systems drive employee behavior and structure these systems so that they keep the triangle of fraud in check.
GARY ZEUNE is CEO of The Pros & The Cons, the only speakers bureau in the US for white-collar criminals.
SPEAK TO GARY at B2Me.me/CC2