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Common Fraud Red Flags

When you hear the news that someone was just arrested for committing fraud at his work, it is usually accompanied by fellow employees or managers saying one of two things: “I never thought they were capable of stealing” or “I should have seen it coming.” Why do employers say that they “should have known” and how exactly is it that they should have known? It turns out there are some common characteristics of people who perpetrate a fraud. And if you, as a business owner, are aware and vigilant about your business, you might never have to say that you “should have known.”

First you need to understand how a fraud can occur. There needs to be several factors present in order for someone to defraud your company:

  • Opportunity – The individual has to have the ability to abscond with assets or manipulate financial statements and go undetected. Generally this happens by inadequate, or a breakdown in, internal controls.
  • Rationalization – Most people cannot rationalize taking money from their employer but one who perpetrates a fraud is able to rationalize why it is ok (i.e. they do not pay me enough, my son is ill, etc.).
  • Pressure – There is some need as to why the individual needs the money. For example, a need may include addiction, illness, or a need for extra cash due to living beyond his or her means.
  • Capability – The individual has to be capable of actually perpetrating a fraud. Perpetrating a fraud is not easy and someone who successfully does so has to be clever enough to pull it off.

Simply because the above elements are present does not guarantee a fraud; however, when you do hear of a fraud, it is more likely than not that some or all of the elements were present in those situations.

Adequately functioning internal controls (both preventative and detective) are the best way to prevent fraud. At the same time, an owner or manager can be mindful of telltale signs. There are certain individual attributes that we see over and over again in fraud investigations.

Below are four common red flags as they relate to individuals who have perpetrated a fraud. If someone in your organization exhibits these red flags, you might want to consider possible remedies to mitigate those risks. This list is not intended to be looked at as all-encompassing or predictive of fraud, but these are the four most common red flags that we see when doing fraud investigations:

Employee with longevity and increasing level of trust

Employees that have been with the company for a long time typically understand how the company works and the procedures or controls, as well as how to circumvent those controls. As well, owners tend to trust employees with longevity and relax controls as a result. To mitigate this risk, companies should update, review and evaluate their controls regularly and require that all employees, regardless of tenure, follow procedures.

Employee that does not take vacations

Employers often look favorably at employees who do not take vacations, seeing them as “hard workers.” However, in fraud situations, the individual perpetrating the fraud is generally not taking time off to avoid being discovered. Watching for irregular work patterns too can be telling (i.e. someone never misses a Thursday which is pay day). Requiring employees to take vacations, specifically taking a single-extended period of time off, can help mitigate this risk.

Single Employee in Charge of Several Processes

For smaller businesses, it is challenging to have good segregation of duties due to fewer employees and as a result, smaller companies must be creative about segregating duties. Having an owner, CEO or a non-accounting department individual open the mail and log in payments or invoices received is an effective, easy to implement control that can go a long way.

Lifestyle exceeding their they rate of pay

One of the most obvious, and yet often overlooked red flags of fraud is someone living beyond his means. When a staff accountant pulls up to the office one day in a brand new Porsche, people tend to justify it in that his spouse/family must have a lot of money. As an employer, being sensitive to disconnect between an employee’s lifestyle and rate of pay (and potentially coupled with other “red flags”) can sometimes determine if additional consideration is necessary.

Be aware and diligent so that you are not the owner or manager that one day is saying, “I should have seen it coming.”