9 Common Ways Employees Embezzle and Commit Internal Fraud
Safeguarding a business against internal fraud and embezzlement requires a multi-faceted approach. Implementing robust internal controls, conducting regular audits, fostering a culture of ethical behavior, and providing adequate training on fraud prevention can all contribute to mitigating the risk of such occurrences. By staying vigilant and proactive, companies can protect their assets, reputation, and long-term success from the threat of internal fraud.
Video Transcript
Employee Embezzlement and Fraud: Understanding the Risks
What should business owners be aware of when it comes to employee embezzlement and fraud? How do you prevent theft from within your company? How do you, as a business owner, guard against one of the big secret legal risks that affect businesses today?
Complex Financial Landscape and the Role of Financial Software
Businesses today are quite complex, and it is not paper accounting anymore. It is some sort of financial software. There are typically different electronic accounts at various banks or financial institutions. There is a lot going on, and business owners need to stay focused on the big things in growing the business. As a result, they often hire people to handle the financial matters, the smaller matters. One of the big secrets that I have not seen much attention to is how often internal fraud and embezzlement happen in businesses. I know this because it has happened to my clients, and I have been called in as an attorney to help business owners in dealing with internal embezzlement. Here is why you may not have heard about it: businesses don’t want to be known as being vulnerable to this. They don’t want other employees to know that they were taken advantage of. They don’t want customers, vendors, and others to know that they were susceptible to internal fraud, that they might have been naïve or negligent in some way, or not have had proper procedures in place. So, usually, the business owners keep very confidential if there was any sort of fraud or embezzlement or misappropriation that occurred.
Addressing Internal Embezzlement: Seeking Professional Help
When a business owner faces internal embezzlement, typically, they call in the professionals: an attorney, an accountant, and perhaps others to figure out what has actually happened here, like track down all the information and then what are the options for dealing with it. That remains confidential. So what can you, as a business owner, do about this? How do you avoid this sort of internal fraud? Well, the best way is to be aware of the types of fraud that occur and the best practices to mitigate those risks in those areas.
1. Billing Schemes: Identifying and Preventing Fraudulent Payments
One example is billing schemes. A billing scheme is when an employee sets up fictitious vendors, and then they make payments to those vendors. This would be on the company’s payroll. For example, an employee might set up a vendor for some office supplies, but this vendor isn’t real. The employee may set up a fake LLC. Maybe it is even a real LLC and just starts making payments to those LLCs and keeps it a really small amount. So other people don’t worry about it. It is just not enough money to really care, but the employee is essentially pocketing every payment that goes to that fake vendor. So that is billing schemes.
2. Payroll Schemes: Guarding Against Manipulation of Employee Compensation
The next category of employee fraud or embezzlement is payroll schemes. This is when an employee creates a ghost employee or a fake employee on the payroll or inflates their hours on the payroll or manipulates the rate of pay that they should have. I, one time, had an employee deal with this. This employee was responsible for everybody’s payroll, and we had salaried people and we had hourly people, and the hourly people would report their hours to this employee. The employee would hold them accountable and look out for the best interests of the business. And I approved all salaries in advance, so those all stayed the same.
Well, guess what? One time, in the payroll system, he gave himself a raise, a five-figure raise. This was on top of an already six-figure salary. I probably would never have realized it, except a few months later when I was looking at giving this employee a raise, it was brought to my attention that there was a raise a few months earlier. So unfortunately, this is a common area of employee fraud, and the best way to guard against this is to have a second set of eyes reviewing everything. Now, although that second person could be in on the scam, it is far less likely that two people will participate in a scam than one. Just statistically, it is less likely. So that certainly can help. Sometimes you have a person that you especially trust looking over things, that might be a family member or somebody you have worked with for a long time, and that rapport and trust have been built.
3. Expense Reimbursement Schemes: Detecting and Preventing Overstated Claims
The third common way that employees may try to embezzle in your business is through expense reimbursement schemes. This is where they either inflate their expenses for travel or meals or supplies or they make up fake expenses or submit false receipts or false paperwork.
4. Combatting Check Tampering and Unauthorized Withdrawals
The fourth common way that employees try to steal from your company is check tampering. This is when the employee writes checks from the company for their own personal gain. They might forge signatures. One best practice is to require two signatures on every check from your company. So that at least reduces the odds of one person being able to act alone to participate in a fraud.
5. Skimming: Preventing Unauthorized Diversion of Company Revenue
The next common way that employees cheat their company out of money is skimming. Skimming is when the money comes in each day, like in a cash register, and some of it is pulled out and pocketed by the employee. Sometimes this is done with cash. Sometimes it is in a more elaborate scheme, but ultimately, skimming is where the money that is supposed to go to the business gets set aside and pocketed by the employee.
6. Theft and Safeguarding Company Property
Next is theft. Straight-out theft. Employees will steal anything from photocopies, paper, office supplies, electronic equipment, toner cartridges, flash drives, hard drives, and computer equipment. I have seen all sorts of theft because often these things are not carefully tracked and within the team of employees, there has to be a degree of trust that people aren’t going to take things for their purposes. So often what companies will do is they will have a list of all computers that they have with serial numbers on them and who has been assigned to them. Likewise, any other important equipment, and then there might be cameras or something else monitoring copy machine rooms or inventory rooms where inventory is kept so that if somebody is stealing something and there is a question about it later because typically you don’t know at the time, but if there is a question about it later, at least there may be some footage or some sort of video or record of the theft that occurred.
7. Fraudulent Financial Reporting: Maintaining Accurate Financial Records
The next common way employees take from business owners is through fraudulent financial reporting. This was where the employees manipulate financial records to hide what they have done or to make the company seem more profitable than it actually was or to make it look like it met certain financial targets that it didn’t. I had an employee who managed the expenses of the company. We were in cash basis accounting, so whatever cash we had, it looked like that was profit. But what he would do is he would slowly pay the vendors. So instead of paying two weeks after the bill comes, he would pay 90 days after the bill comes. So what that effectively did is it allowed us to keep a lot more money at least for 90 days. So instead of that 90 days’ worth of expenses having been paid out to the vendors to whom it belonged to, it was at least temporarily sitting in our accounts, and this was a rolling 90 days so we always had more. We had 90 days more money in our accounts. It made us look like we were doing much better. And so a person in management can basically say, “Hey, look at all the money we have. Wow, we are doing great. A lot more money than we had before I came. This is incredible.”
8. Kickback Schemes: Detecting and Preventing Vendor-Related Fraud
The eighth way that employees can steal from your company is through kickback schemes. The employee might agree to buy a certain amount of inventory from a legitimate vendor of yours. Let’s say $40,000 worth of inventory. But the employee has a deal with the vendor that in exchange, he gets $2,000 worth of gift cards. Well, those gift cards, he justifies it by saying, “Oh, it is not money.” But essentially, it is; I mean, you can sell gift cards and get money. And those gift cards should have gone to the business, if anyone, not the employee personally. Kickbacks are largely illegal, and in fact, they are always illegal because they are a breach of fiduciary duty. It is always illegal for an employee to do it. It is illegal for a company to participate in kickbacks because they are tortiously interfering with the fiduciary duty of an employee to the company. There are specific industries where kickbacks are flat-out and directly banned. They can actually be criminal, but kickback schemes, whether it be gift cards or baseball games or other dinners out or whatever those perks may be, the employees may be benefiting from the vendors because the employees have the authority to control which vendors are used and which transactions the company is engaged in. So it is important to have policies against this as well as put the vendors on notice that they will have liability if they participate in any kickback schemes. Often companies will require vendors to agree that they will not engage in any kickback schemes or benefits to the employees as a condition of doing business with the company.
9. Data Theft: Protecting Valuable Company Information
The final common way of employee theft is employees stealing data. Employees can sell that to competitors. The employees can sell data for fraudulent purposes, but data has significant value in a company, and often that data can just be copied and you don’t know it is missing. So having control over what data each type of employee has access to can be very valuable, especially as you grow. For example, marketing employees don’t need access to the financial records of the company. Similarly, the accounting department doesn’t need the customer database or the prospect database. All this data should be on a need-to-use basis and that can be partitioned as companies grow and they add more employees. It is very important to limit what data employees have access to based on what they need. This is a summary of common ways that employees can steal from you as a business owner and steal from your company. I am presenting this knowing there is some risk that employees might watch this and learn from this, but this stuff is already out there, and I am doing it on this channel for you as business owners so you can make sure in your company.
Conclusion
At a minimum, you have thought about the risk and decided to accept it, or even better, you have implemented some sort of procedure to minimize the risk that employees can steal from you or devalue your business. This happens all the time. Some reports indicate 90% or a hundred percent of companies suffer from the consequences of employee theft. Of course, it is not often detected, and it is usually only the huge situations where companies finally realize, “Hey, we are missing hundreds of thousands of dollars. What has happened here?” Often by that time, it can be too late.
I am Aaron Hall. I am an attorney for business owners and entrepreneurs. I do this educational channel to help you spot issues to discuss with your attorney and identify ways to avoid problems. But keep in mind that it is an educational channel. This is not a replacement for using an attorney who understands the law in your state, and your jurisdiction, and can take the time to understand your particular goals, concerns, and exceptions that might apply to you.
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