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Loss Prevention Bulletins

Fraud and embezzlement

“It couldn’t happen at our place, everyone who works here is just like family.”

Our first piece of advice is that you don’t become too complacent. The “typical” embezzlement scheme occurs at companies with fewer than 100 employees. The average amount stolen is $120,000 versus just $10,000 for Fortune 500 companies. Small businesses, defined by Ruth Crane of Auditors Inc. as employers with less than three bookkeepers, are 100 times more likely to experience employee fraud than larger companies. The crime is often carried out over a number of years and has forced many small companies into bankruptcy. At the very least, hard-earned profits are drained from the company and cash flow is affected.

Embezzlement is defined in most states as theft/larceny of assets (money or property) by a person in a position of trust or responsibility over those assets. Embezzlement typically occurs in the employment and corporate settings. Security and audit experts often refer to the “10-10-80 rule” when teaching companies about the importance of implementing “best practices” to prevent this crime.

What is the 10-10-80 rule? This is a commonly understood rule cited by many auditors that states:

10 percent of employees will never steal;
10 percent of employees will always steal and;
80 percent of employees will steal given the right opportunity, motivation or justification.

In other words – given the right motivation, they will “borrow money” fully meaning to repay until they realize that they have gotten in so deep, repayment is virtually impossible. Even “honest” employees can be tempted to take money that does not belong to them if they think they can get away with it and not get caught. In a recent case, an employee stole money from their employer to give it to a friend they thought was in financial trouble!

Common embezzlement schemes

The bookkeeper pays him/herself – The bookkeeper simply takes a business check, makes it payable to him/herself and signs it.

Duplicate payments to phony accounts – The bookkeeper pays an invoice with multiple checks over time and creates a phony bank account to deposit the second check. By the way, it is very easy to open a phony account.

Check alteration – The bookkeeper either alters checks paid to you by customers, or creates a phony bank account to deposit checks.

Double billing – The bookkeeper re-bills customer twice for the same work and deposits check in a phony account. It is surprising how often businesses will pay twice for the same invoice.

Duplicate checks – The bookkeeper orders a duplicate set of checks mimicking your account and then proceeds to write duplicate checks to vendors – only the duplicate checks are deposited into the phony account. The business owner may be too busy to notice this deception.

Credit card transactions – An employee makes a credit card sale, then issues a credit for that item back on to their own credit card.

Petty cash expenditures – A business does not closely review the petty cash expenditures, unknowingly creating an opportunity for theft.

Tips to prevent embezzlement

Division of labor – divide tasks among multiple employees to prevent illegal activity. If done correctly, this is probably the most reliable way to prevent embezzlement.

Bank statement sent to the owner’s home – this allows the business owner the opportunity to be the first person to open the bank statement, thereby preempting any manipulation of enclosed documents (checks) and allowing the review of checks for forgeries. Some banks are phasing out the return of the actual checks, although with new technologies, it is possible to review checks through the bank’s Internet site.

Employee background and credit check – looking for credit, debt or criminal problems can give you a window into a bookkeeper’s future behavior.

Purchase fidelity insurance – this coverage may help cover embezzlement losses.

Establish a positive corporate culture and code of conduct – this refers to teaching employees to do the right thing. Business owners should operate in an ethical and above-the-board manner and promote this behavior among their employees. If employees see that the business owner cheats or otherwise cuts corners, they will think that this behavior is acceptable.

Develop and test internal controls – consult with an accountant or CPA to develop proper internal accounting controls and test these controls on a regular basis.

Watch employee’s lifestyle – if the employee appears to be spending more money than you would anticipate based on their salary, this may be an indication that they are up to no good.

Bookkeeper does not take vacations – if a bookkeeper does not take vacations, it may be because they have to open all mail to cover the tracks of their embezzlement.

Taxes – many times embezzlement is related to the stealing of funds set aside to pay various taxes. Often the agencies that regulate the payment of taxes take a long time to address non-payment of taxes. This gives the embezzler the opportunity to steal a significant amount of money before the owner knows that it is gone. Watch tax payments carefully.

Positive pay procedures offered by bank – this is a new feature offered by banks in which they call each day and review all checks that cleared the previous day. By taking advantage of this service, the owner may be able to catch fraud immediately.

Listen to your CPA carefully – typically your CPA can set up a system to prevent embezzlement in your business. Many times business owners fail to follow the recommendations set forth by their CPA and open themselves up to embezzlement.

There are many ways to embezzle money from employers. As soon as you think you have a foolproof system, embezzlers will create another way to steal from you. It is best to work with your CPA to create a system to prevent embezzlement. Other resources to help address this issue include trade associations, Internet resources, business and accounting publications, etc. Another good resource is www.embezzlement.com. This website provides consultation services that will help review the policies and procedures you have in place to address fraud and embezzlement.

This bulletin in pdf format:

LC-138G 09/07 � 2007 Zurich American Insurance Company

If you have any questions or comments, contact your Zurich account executive or the Loss Prevention Department at 800-821-7803.

This Loss Prevention Bulletin is provided for informational purposes only. Please consult with qualified legal counsel to address your particular circumstances and needs. Zurich is not providing legal advice and assumes no liability concerning the information set forth above.

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