Fraud Can Impact Companies of All Sizes, Primarily Small Businesses

Under close media scrutiny, the trial of Adelphia Communications Corp. founder, John Rigas, began recently in New York. Rigas and his sons are accused of bilking the cable company out of hundreds of millions of dollars.

The allegations in the Rigas trial are yet another reminder of just how pervasive fraud has become both locally and nationally. Fraud is not merely an accounting problem. It is a social phenomenon. In fact, many business owners and business leaders don’t realize that the high-profile, high-dollar fraud cases at major corporations are relatively small in comparison to the volume of fraud that occurs at smaller businesses.

The Association of Certified Fraud Examiners (ACFE) conducted a study which determined that small businesses are most vulnerable to occupational fraud and abuse. The ACFE further quantified the average fraud scheme in a small business causes $127,500 in losses – approximately 30 percent higher than the average scheme in large companies, which costs $97,000.

The reason? Larger organizations that have adequate internal controls are less vulnerable to occupational fraud. Small businesses, by contrast, often have a single employee responsible for all cash-related functions, receiving and disbursing funds, signing checks and reconciling bank accounts. In such cases, cash frauds are easy to commit. In fact, in most cases of occupational fraud, the victim company either had insufficient controls or allowed its controls to be ignored by employees and/or management.

The ACFE recommends the following minimum procedures for fraud prevention and detection for small businesses:

• Segregate duties for bookkeeping, collecting funds, writing checks and reconciling bank statements among at least two different employees. Also, periodically rotate assignments among staff so that no employee can monopolize a certain area of accounting.

• Have the monthly bank statements delivered unopened to the owner, who should review it for unusual transactions such as declining deposits and unfamiliar payees.

• Consider a periodic analysis of cash accounts and bank statements by an independent accountant.

For stronger overall safeguards against fraud, companies should consider the following initiatives:

• Establish a written code of conduct and obtain signed statements annually from all employees confirming their compliance with the written ethical standards.

• Educate employees about what fraud is, how to spot it and why it is important to report it. Employees need to understand that fraud causes lower profits for the organization. Lower profits lead to lower salaries for employees. In some cases, fraud can lead to bankruptcy for the organization and unemployment for its employees.

• Establish a hotline for anonymous reporting of suspected fraud. A variety of hotline outsourcing companies exists to make this control more economical to small businesses. Other options are available for organizations with more limited resources. The hotline should be made available to vendors and suppliers, as well as employees. Vendors and other outside parties can provide valuable information, particularly related to purchasing and procurement fraud.

• Provide for regular internal audits or similar fraud detection procedures. While large corporations often have such “internal auditing” staff on the payroll, small companies can achieve the same type of control by outsourcing this function to an accounting firm. Internal audits send a signal to employees that the company is serious about controls. They also increase the chance that fraud will be detected. This risk of detection can be a sufficient deterrent to many would-be fraudsters.

• Guard access to electronic accounting records and other computer files.

• Conduct background checks on new employees, vendors and customers.

• Be observant to lifestyle changes among employees. Is there a valid reason why your accounting clerk now drives a Jaguar?

• Follow up on anything that looks unusual or unexpected. Even a temporary variance in a bank statement or in inventory could lead to the discovery of a major fraud.

By following some simple procedures, you can reduce fraud and its harm to your company. In addition to better securing your bottom line, this approach can create a positive and productive environment for employees. It also demonstrates that your organization is a good corporate citizen, which is increasingly important to your customers, vendors, banks and investors.

Mr. Jarek is a Shareholder with Alpern Rosenthal’s Business Valuation/Litigation Support Services Group. He can be reached at kjarek@alpern.com or at 412.281.2501, ext. 467.

Back