Martha Stewart has been the topic of conversation as of late.   No, it’s not because she is promoting a new cookbook or television special or advertising her latest line of linens. It’s because she has been charged with securities fraud.   Other companies such as Enron and WorldCom have also had the media’s attention in the recent past due to similar charges, but hey, those are the big guys.   Your business is just small potatoes…right?

Wrong!   Your business is big to you; it’s your world!

While media popular white-collar crimes such as securities fraud and antitrust violations may not be applicable to your small business, there is a monster hiding under your bed, another form of white-collar crime. It’s called occupational fraud, and your world is susceptible to it.  

Who commits this type of fraud?   Look outside your office door and you will find the answer.   Individuals or groups of individuals in connection with their jobs commit occupational fraud.   This type of fraud includes violations by employees who embezzle money from their employers or steal assets such as inventory and supplies.

There are many types of methods used by employees to steal.   The more popular include skimming of sales and check tampering, stealing from cash registers and padding expense accounts with fictitious charges, falsifying hours on timecards and shell company schemes.   The personal use of company assets such as vehicles and computers is also a type of occupational fraud. It is estimated that that organizations lose approximately 6% of their revenues because of fraud and abuse and about 1/3 of employees have admitted to taking something from their employers.

Small organizations can suffer large losses due to occupational fraud for several reasons.   Smaller businesses have fewer divisions of responsibilities.   In other words, less people perform more functions.   In addition, there is a large degree of trust in a small office; everybody knows each other by name and face, they become friendly with each other in and out of work, they know their families, etc.   Most would tend to think that their coworkers and in some cases, friends, would not commit or be capable of committing a crime.   In this type of atmosphere, people’s defenses are naturally relaxed.   One disastrous situation for a business is a one-person accounting staff.   The same person, usually highly trusted, is responsible for writing checks (possibly signing them as well), reconciling bank accounts and posting activity to the books.   There is an enormous opportunity to steal and cover up one’s tracks in this situation.

When it comes to occupational fraud, opportunity is the key to success for potential criminals.   The prevention of fraud requires rules and controls to minimize the probability of an offense and to maximize the possibility of detecting one.   If the potential of being caught is high, it is more likely that the perpetrators will not commit the crime.   The existence of a thorough system of internal controls is essential and a good control environment sets the moral tone of an organization.   There are several actions that can be taken to establish a suitable control environment for an organization.

The organization should institute a code of ethics (the “rules”), which must be read and signed by all new employees so the “rules” as well as the consequences of breaking the “rules” are well known.   In addition, all job applicants should be carefully screened to increase the probability of hiring moral and ethical employees.   Interviews and background checks are a must!   New employees should be provided with well-defined job descriptions and realistic performance goals.   They should be placed in positions suitable to their skills where they can thrive without resorting to unethical conduct.   Disciplinary measures are also very important and must be applied on a consistent basis.   The sanctions for violations must be well defined and sufficient enough to deter violations.

Once the control environment has been established, the company must set it’s own objectives and goals, typically done in a mission statement.   Look for input from all levels of management and don’t set your goals so high that they cannot be achieved.   In addition, the potential risks and violations of the organization must be analyzed and a strategy to manage those risks must be developed.   Policies and procedures should also be developed and updated periodically to enforce management’s directives.   It is also necessary to assess and evaluate the quality of the control environment to be assured it is effective.

Writing up a suitable fraud policy for your business will consume some time and money, but employee fraud can be much more expensive, especially to the small business owner.   If the proper controls are in place, the opportunities for a dishonest employee will be reduced greatly.   Don’t be tomorrow’s headline in your local paper.   Fraudulent activities occurring in your business are not what are considered “good press”.   Negative publicity can have a devastating impact on your profits.

David J. Grindle, CPA

Manager – Konowitz, Kahn & Company, P.C.

Member of the Connecticut Society of Certified Public Accountants

Associate Member of the Association of Certified Fraud Examiners – Connecticut Chapter