Forensic accountants are balance-sheet detectives

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Stories of Enron and Bernie Madoff’s financial frauds and scheming grab headlines, but small businesses across the country are quietly being ripped off to the tune of millions every year.

From the not so sophisticated plot to pad expenses to the more clever scheme of setting up fake vendors to divert funds, nearly half of all occupational fraud is committed by trusted employees.

And, the really alarming fact is that most of that fraud, which is estimated to cost businesses $2.9 trillion a year, is caught by accident, said Bob Johnson, Colorado Springs CPA who specializes in forensic accounting and fraud investigations.

Small businesses are the most vulnerable to fraud losing about 5 percent of their annual revenue to fraudsters and schemers, according to a 2010 report by the Association of Certified Fraud Examiners which looked at nearly 2,000 cases of occupational fraud.

“It’s true all the time, the smaller the company, the more they say, ‘I trust this person’ and dog gone it, when we have those trusted employees, we really want to look at them,” Johnson said. “That is the sad part about fraud.”

A typical fraud scheme may go on for as long as 18 months before detection and that is when the financial detectives, also known as forensic accountants, come in to sort things out and prepare a case for court.

“They bring us in and see if we can identify the fraud, what was impacted and find out how it was perpetrated,” said Rand Gambrell, who leads a team of 25 forensic accountants for BKD CPAs & Advisors. “If an employee commits fraud, we help pursue them or help (the firm) package things up if they want to turn it over to law enforcement.”

It doesn’t’ have to get that far, he said.

Fraud triangle

There are three key ingredients in occupational fraud: pressure, opportunity and rationalization.

“With the economic downturn, the financial pressures have gone up,” Gambrell said. “Maybe there has been a freeze on raises for several years.”

A lot of companies have downsized and left internal controls weakened, Gambrell said.

“They just don’t have the same number of people,” he said.

That leaves the accounts payable side at risk and presents opportunity. About 80 percent of all fraud is committed by employees who work in accounting, operations, sales, upper management and customer service.

The first thing Gambrell looks at when cash or supplies go missing is who has access.

He saw a cunning scheme where an employee with access to the company’s vendor list set up a fake printing vendor. The phony company ordered printing supplies from a third company and sold them at a 50 percent marked-up price. There was a paper trail of invoices and supplies to show for the expenditure, so suspicions were not raised, Gambrell said.

“Some of the schemes we have seen are increasingly hard to identify by traditional monitoring tools,” he said.

The median loss of each fraud case is roughly $160,000 and nearly a quarter of the frauds involved losses of least $1 million, according to the 2010 ACFE report.

Fraud prevention is cheaper

Employees who never take vacation, who take control of everything, even working on the weekends, ought to be scrutinized, Johnson said.

“Another red flag is someone living beyond their means — an employee making $30,000 a year driving a $90,000 car,” he said.

Forty percent of all employee fraudsters caught were living beyond their means and 36 percent had financial difficulties. And most of them had never been charged or convicted for fraud-related offenses.

Prevention is as simple as a hotline, Gambrell said. It sets an ethical tone that fraud ought to be reported. Occupational fraud is much more likely to be detected by a tip than any other way.

“If you have a company with 100 employees, then you have 100 sets of eyes watching the company,” Gambrell said. “If someone is seeing something — that they have a gut feeling about — give them an avenue to report it.”

Employee education goes along with the hotline, Johnson said. And, there ought to be consequences. An employee should know that if he or she commits a crime, the company will take them to court, he said.

“We have to create an environment that is encouraging and not an environment that fosters fraud,” said Johnson, who is president of the Colorado Springs chapter of Association of Certified Fraud Examiners. It’s his group’s mission to arm businesses with information that keeps them from being a victim of fraud. ACFE will host a fraud prevention seminar in Colorado Springs in March.

Small businesses must pay attention to their own financial details, Gambrell said. Some of the fraud schemes are ingenious. But, some are obvious, like a business manager at a doctor’s office who wrote checks to herself and just included the check in a stack to be signed by the boss.

“What was amazing, she almost put the practice out of business,” Gambrell said. “I use this as an example. We can help a business get all their internal checks in place — but, they have to take it seriously and pay attention.”