A STUDY ON EMPLOYEE FRAUDS

BY CA. ASHISH GARG

M.NO. 543742

March 2017

92nd CERTIFICATE COURSE ON FORENSCIC ACCOUNTING

AND FRAUD PREVENTION

BATHINDA
EMPLOYEE FRAUD
OVERVIEW: EMPLOYEE FRAUD IS WIDESPREAD

Privately held businesses are especially exposed to employee fraud. Often the issue is size; there simply
aren’t enough employees to effectively divide responsibilities and install appropriate checks and balances.
Other times it is the closeness of employees, their tenure and relationship with the owner that encourages
lax controls and oversight.

In every case, the issue is the same:

No employer was ever defrauded by an employee he or she didn’t trust.

Put plainly, and employee has to first have access to something worth stealing. Without that access, there
is no theft.

Employee fraud is a common and recurring issue in the day to day running of the business. Any employer
who says “We don’t have people in our company who would steal” is evidencing the highest form of
arrogance- a belief that he or she has the ability to unerringly see inside the soul of each new hire.
WHAT IS EMPLOYEE FRAUD?

Employee frauds are when fraud is committed against the company or organisation a person is working
for.

All employee fraud stems from three conditions, each or which is present in every case.

Opportunity

Need or Rationalization
Motive

FRAUD

Need (or motive): Between 10% and 15% of employees steal because they want to. Their need is to
prove they are smarter, or can get something for nothing. Another 10% to 15% will never steal. Their
need to feel honest and good about themselves trumps any temptation. The remaining 70% to 80% steal
because they are pressed by outside financial strains, or because they are seeking revenge, or sometimes
just because they can.

Opportunity: This is where my comment about “trust” comes in. There are few cases where an employee
takes something that will be immediately noticed, although it sometimes happens. Most fraud occurs
where it won’t be easily missed, or at least not right away. Systems are for keeping honest employees
honest, by making it riskier for them to do anything else.

Rationalization: This is different from motive. In most cases, an employee under financial pressure
thinks “I’ll put it back as soon as I get financially stable again.” It starts out as a “loan.” Other times it is
an employee’s self-explanation of what is “fair.” “She does less work than me and gets paid more. That’s
not fair.” Or “I should have gotten a bigger raise. That’s not fair.” Sometimes the rationalization is that
revenge is appropriate, but most often it is a justification that the defrauded value was earned.
EMPLOYEES COMMIT THE BIGGEST FRAUD IN INDIAN COMPANIES

Current and former employees are the biggest perpetrators of fraud in Indian companies, followed by
agents and intermediaries, according to a survey by US-based risk consulting firm Kroll Inc.
THE IMPACT OF FRAUDULENT ACTIVITIES

Where a business is a victim of a fraud, there is more at stake than just the direct cost of the fraud. Other
impacts to consider are:

• Staff morale can be affected as they feel a sense of betrayal that a colleague could do such a thing and/or
management allowed the fraud to occur.

• Good employees do not want to work for a business where fraud is widespread, not investigated or not
acted upon.

• The reputation of the business in the eyes of suppliers, customers, competitors, possible employees and
other business partners (for example banks) can be damaged.

• Businesses may become overly internally focused in response to a fraud.

• For individuals that supervised the fraudster, the fraud can impact their reputation and therefore their
career, particularly if the manager is in a financial role, as others will expect that given their expertise,
they should have prevented the fraud.
EXAMPLES OF EMPLOYEE FRAUD

• creating “ghost” employees or not deleting ex-employee records and having the salary of these “ghost”
employees paid into the fraudster’s bank account.

• creating bogus suppliers, with payment being made to the fraudster’s bank account.

• creating bogus purchase orders of a bona fide supplier and substituting the supplier’s bank account
details with fraudster’s bank account details.

• obtaining kickbacks or bribes from suppliers or contractors.

• associates of the staff providing services to the business at inflated prices.

• personal use of business resources

• inflated/bogus reimbursement claims

• manipulation of financial data to receive performance based bonuses.

• faking time sheets

• private purchases through business accounts/business credit cards.

• providing discounted (or free) goods or services to friends and associates.

AREAS TO MONITOR FOR EMPLOYEE

FRAUD

Employee fraud can exist anywhere, but CFOs can stay ahead of the game by monitoring some specific
payment and expense areas.

Employee fraud may not be the number one concern that keeps CFOs awake at night, but it can be a
significant drain on the bottom line and have a number of other negative impacts on an organization.
Here are five areas in which employee fraud commonly occurs:

PURCHASE- CORPORATE PAYROLL

TO-PAY CREDIT CARDS

SALES AND INFORMATION

RECIVABLES SYSTEMS AND
CRITICAL DATA

Purchase-to-Pay
Potential fraud risks include (a) an employee initiating purchase orders (P.O.) for goods and services that
are diverted for personal use and (b) an employee setting up a “phantom” vendor account, through which
fraudulent invoices are processed and payments are made to the employee.

In these situations, fraud tests can detect if the same individual both enters and approves a P.O. or if an
individual enters or approves multiple “split” P.O.’s, just under an authorized limit. Other evidence that
can be discovered includes whether the delivery address for goods or services is the same as an
employee’s, whether the goods being purchased are typically consumer items, or whether the vendor
master file information (address, bank account, etc.) is the same as that of an employee.

Corporate Credit Cards

A common fraud risk is an employee using a corporate credit card for personal gain instead of legitimate
corporate purchases or travel and entertainment expenses.

Fraud tests can detect purchasing cards (P-Cards) being used to acquire goods and services from vendors
with suspect merchant codes (e.g., home supplies, personal entertainment, etc.) and corporate cards being
used by employees on weekends or while the employee is on vacation. Additionally, tests can determine
whether fuel is purchased in unusually large quantities, mileage charges are made in the same period as
rental-car charges, and corporate-card transactions are approved by the card holder.

Payroll
Payroll fraud can consist of (a) “phantom” employees being set up on payroll systems; (b) excessive
overtime payments; and (c) employees remaining on the payroll after death or termination.
Tests can detect if there is more than one employee with the same bank account details or the same
address. In addition, they can find invalid address information for employees, invalid social security
numbers, unusually high overtime amounts, and payroll payments made to employees who were
terminated or deceased according to HR records.

Sales and receivables

Some potential frauds include (a) employee collusion with vendors and (b) sales representatives inflating
sales to achieve higher commissions and bonuses.

Fraud tests can detect customer accounts with exceptional credit terms; customer accounts that have
unusually large or frequent credit memos; customers receiving unusually large discounts; customers
returning goods without corresponding adjustments to sales representatives’ commissions; and sales
shipment addresses that are the same as an employee’s address.

Information systems and critical data

This kind of fraud includes (a) employee theft of critical data and (b) employees providing corporate data
to external individuals.

The right tests can discover databases accessed by individuals without appropriate authorities and
reports generated by individuals without appropriate authorization. Similarly, fraud tests can detect
customer accounts with exceptional credit terms and network logs that indicate unauthorized copying and
movement of data files. Tests can also help discover if email attachments include sensitive data.

STRATEGIES TO MINIMISE THE RISK OF FRAUD

As the old saying goes “prevention is better than a cure” and this is certainly true when considering how
manage the risk of employee fraud. The most important aspect to managing this risk is ensuring that the
business has solid internal controls in place as, for every fraudulent activity, there is always a breakdown
of internal controls.

Minimising the potential for fraud will require designing and implementing internal controls that prevent,
detect and deter most fraudulent behaviour. The successful implementation of such internal controls
begins with the “tone at the top”. Managing the risk of fraud requires the business owners and senior
managers to support and adhere to all policies and procedures implemented to manage this risk. The
success of internal controls also requires that they be visible, built into the day-to-day work of the
business and that employees are held accountable for their actions. In addition, internal controls should be
continually reviewed and, where appropriate, amended.

It is important to realise that employee fraud cannot be eliminated but the risks of it occurring can be
substantially reduced. The strategies to reduce the risk of employee fraud must strike a balance between
the need for such controls and not “micro-managing” employees, therefore businesses will have to accept
some degree of risk of employee fraud.
Through the implementation of some or all of the following strategies, your business can minimise the
risk of becoming a victim of employee fraud.

Strategy Description
Lead by example Every person within the business, regardless of seniority, should adhere to the
policies and procedures and be held accountable for their actions.

Create a positive A positive work environment encourages employees to follow policies and
working procedures, and act in the best interests of the business. Most employees will
environment respond positively to clear organizational structure, clarity of job responsibilities,
fair employment practices, open lines of communication between management
and employees and positive employee recognition, hence reducing the likelihood
employee fraud.
Create a code of The code of conduct should make it clear that there will be zero tolerance of any
conduct fraudulent activity on any level of the business and that any such fraud will be
reported to the police. This code should also clarify what constitutes employee
fraud, as this is often an area of confusion for employees.

Separation of duties No one person should be responsible for a complete transaction from start to
finish. For small businesses, where this is not practical, employees handling
finance should be subject to close supervision.
Implement a Management must also demonstrate that they actively follow up on all issues
whistleblowing raised via the whistleblowing mechanism.
Policy
Monitor employee There are a number of employee behaviours that may indicate a heightened
behaviour probability that an employee is committing fraud.
Investigate every Gain the facts you need to make informed decisions and reduce losses through a
incident thorough and prompt investigation of policy and procedure violations,
allegations of fraud or warning signs of fraud.

Others In addition to the aforementioned, employers should:

• regularly review financial statements
• deposit cash and cheques daily and make sure the person doing the banking is
not the person collecting the money
• secure blank cheques, signature stamps and access to EFT payments
• never sign or authorise payments that are not fully completed
• periodically check suppliers’ details, including bank account details, with the
actual supplier
• only pay on original invoices
• review billing error complaints from customers
• engage an external accountant to audit their books
• periodically compare payroll payees with employee records
 • ensure that all employees take annual leave during the year
• have a cross training program in place to ensure that one employee is never the
only person capable of a particular role
• in instances where they use a personnel agency, check their contract with the
agency to see whether the staff hired through the agency have been subject to a
police check
• question unusual accounting methods or unnecessary complexity in an
accounting transaction or excessively long charts of accounts
• bring in a contract accountant to fill in when their accountant is on leave.

WHAT TO DO WHEN FRAUD IS DETECTED?

Even with these checks in place, employee fraud can still occur (however the risk of it occurring is
reduced).If a fraud is detected, the immediate reaction from the business owner/management can often be
emotional. An emotive response can compound your problems and give the fraudster the opportunity to
take action against the employer in other ways (such as unfair dismissal).Taking a measured approach is
the best way to deal with such a situation.

Step one: Stop the fraud continuing

The first thing to do when a fraud it committed is to stop it continuing. This involves:

• blocking or reducing access to electronic and other information or resources being used to commit the
fraud, including blocking remote access.

• if the employee has been using a computer, ensuring that the computer is isolated and no one else
touches it. Forensic IT should be brought in to recover anything that
has been deleted from the hard disk. In addition, email lists are often helpful in preparing evidence. The
courts may not accept this evidence if there have been other
users of the equipment. Backups can be useful during this process.

• identifying other computers/equipment the employee may have used, and isolate these computers as
well (even if it is another employee’s computer).

Step two: Collect the facts

The second step to take after a fraud is detected is to make sure you collect as many facts as possible
before you approach the employee. The employee may actually admit to committing the fraud once they
learn you know what has been going on. Ensure that you speak to the fraudster’s work colleagues. Often
where a senior executive is involved in a fraud, their personal assistant has known about it but was
unwilling to get involved. Employees need to know that they can safely discuss what they know.
Step three: Discuss the issue with the employee

The third step to take after a fraud is detected is to discuss the issue with the employee. However, you
should be very careful and approach such conversations with a clear head. You may wish to seek legal
advice before having the conversation or have your lawyer present to make sure it is done the right way.
The business may choose to let the employee resign rather than be terminated. However, it should be
made clear to the employee that, whether the employee resigns or is terminated, the business will still
report the fraud to the police and the business may still seek to recover the business’s property from the
employee through civil action.

Step four: Report the fraud

The fourth step to take after a fraud is detected is for the business to report the fraud to their local
authorities. If the matter is left unreported, the fraudster may commit a fraud on another business and your
inaction may further damage your reputation with employees, potential employees, suppliers, customers
and your bank.

CASE STUDIES

Case 1: At 6:30 one evening the owner of an engineering firm needs to check on a paid invoice amount.
He goes to the envelope containing cancelled checks on the receptionist’s desk which he saw come in the
mail that morning. In it, he finds a check made out to his receptionist for several thousand dollars. He
recognizes his personal signature on the check.

What happened?
How did the owner’s signature get on the check? The engineering firm created one check each day to the
city regulatory authority for multiple permits and filings.
The expenditure was not assigned to individual projects, and whomever was going downtown to the
office asked the receptionist to draw a check from accounting for all the permits needed that day.
The receptionist analyzed and discovered the procedure then requisitioned checks for a “typical” amount
on days when no permits were actually needed. She wrote the agency’s name in as payee using an
erasable pen. She then changed the payee to himself, deposited the check and intercepted the cancelled
checks so that she could change them back. This scheme was complicated and easily discoverable, yet it
still netted the employee over $15,000 in just a few months.

Case 2: The owner of an industrial services company receives a call from a collection agency regarding
the past due balance on a credit card that the company does not have.

What happened?
This is a case of poor mail control. A new receptionist opened a credit card offer. She filled it out with
herself as the authorized company representative. When it arrived, she immediately charged it to the limit.
She destroyed the first few statements. When the collection calls started coming in, she told the collectors
that “she” wasn’t in the office.
As the pressure increased, she quit without notice and moved out of the state.
CONCLUSION

Organisations are facing a number of challenges in the current economic scenario. They constantly
deal with pressure of uncertain markets, escalating input costs, high labour turnover and advent of
technology. Additionally, companies have to meet rising consumer demand across product categories
with price innovation. Such challenges place further pressure on companies and their business
partners. Such pressures may provide opportunity and incentives for fraudsters to commit frauds.
That past decade has witnessed a steep rise in the organisations which have increased the risk of
fraud exposure. With any change in the environment of the businesses, the need to adapt to these
changes is a prerequisite to attain sustainable growth. The change in the current environment is the
increased fraud exposure for organisations. The response to this change is to equip our businesses
against fraud risks and exposure through a systematic programme of fraud risk assessment,
monitoring, incident response and remediation.

REFERENCES
a.) Surveys by Kroll Inc.
http://www.livemint.com/Companies/ND57pGjioH4Ui57opUVvXO/Employees-biggest-
perpetrators-of-fraud-in-Indian-firms-Kro.html
b.) Employee Frauds www.cpaaustralia.com.au
c.) Books published by ICAI