Fraud Deterrence in Small Business

This past week, I watched the ABC original movie “Madoff,” which recounts the life of Bernie Madoff, the former NASDAQ Chairman notorious for engineering the world’s largest Ponzi scheme.  The amount of money that Madoff investors lost is staggering, but most shocking to me is the length of time over which Madoff’s practices continued relatively unquestioned.  Despite numerous complaints filed by a financial analyst with both the SEC’s Boston and New York offices, asserting that Madoff’s claimed returns were “legally and mathematically impossible,” Madoff’s “business” survived multiple SEC investigations.  

Of course, fraudulent business practices aren’t happening only on Wall Street.  In its 2014 Report to the Nations on Occupational Fraud and Abuse, the Association of Certified Fraud Examiners found that the typical organization loses five percent of its revenues each year to fraud, with a median loss of $145,000.  The report noted that small businesses are disproportionately bearing the brunt of all fraud losses: Organizations with less than 100 employees experienced a 28 percent greater median fraud loss than organizations with more than 100 employees.  And where there are two or more people involved, the median losses increase to $300,000.  For small businesses, these are big numbers.

Detailing the ways in which these frauds are committed could be the topic of an entire series of blog posts, but the resounding answer to the question, “How do I prevent fraud within my organization?” is “Implement internal controls, especially segregation of duties.”  In other words, the person who opens the mail should not also be the accounts receivable clerk, who should not also be the person responsible for depositing funds.

That’s all well and good if your organization has sufficient personnel to separate out each critical function: Authorization, recording, custody, and reconciliation.  But as a small business, that simply isn’t the case.  You’re operating on a lean staffing model and placing an incredible amount of trust in your employees (much like the trust Madoff’s investors placed in him).  So as a business owner, what can you do to increase the likelihood of identifying potential fraudulent activity?  Each of the following requires some effort on your part, but each can be very effective:

• Review your bank and credit card statement(s) on a periodic basis

            o  Look for any unusual charges, either in amounts or payees.  Look at the 

                 cancelled checks – has anyone forged your signature?  Compare transactions 

                 to your check register, and confirm that all deposits have been made.

• Put your blank checks and credit cards under lock and key and restrict access  

             o   Check forgery is common, in part because banks frequently fail to

                 compare signatures to your signature card, but can be easy to catch.

                 Credit cards can be easily used by unauthorized parties.

• Check your own mail

             o This ensures you have the first look at any incoming payments, 

                 overdraft notices, past due notices, confidential documents, etc.

•  Encourage your employees to take vacation time

            o Frauds are often uncovered when an employee critical to the

                fraud is on vacation and another employee is forced to assume

                his or her responsibilities. 

Remember also: The element of surprise can be an incredibly effective fraud deterrent. That is, even if you don’t check the mail every day, but your employees know you will on occasion, that alone can make a potential fraudster think twice.  And most importantly, as unfortunate as this may be to admit, fraud is often times committed by those whom we trust the most: Many fraudsters are the most trusted person in the organization.  Never abandon your professional skepticism, and consider the actions you can take to deter fraudulent activity within your business.