RENO, Nev. — Discussions involving fraud are becoming more prevalent, but what does “fraud” really mean?
“Fraud” is a term that is frequently used, and sometimes even abused, by many who talk or write about it. As defined by Black’s Law Dictionary, “fraud” is a knowing misrepresentation of the truth or concealment of material facts to induce another to act to his or her detriment.
Fraud in the work place, generally fits nicely into two categories, 1) falsification of financial statements and 2) occupational fraud. This article will be focused exclusively on occupational fraud.
Internal fraud, also called occupational fraud, can be defined as: “the use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the organization’s resources or assets.”
Simply stated, this type of fraud occurs when an employee, manager, or executive commits fraud against his or her employer. Of the 2,410 cases of occupational fraud studies by the Association of Certified Fraud Examiners in 2016, victim organizations suffered losses exceeding $6.3 billion.
Many ask … why does fraud occur? This is the million-dollar question that the Association of Certified Fraud Examiners has analyzed in depth and a model has been constructed.
THE FRAUD TRIANGLE
The accepted model for explaining why people commit fraud is commonly referred to as the fraud triangle. The fraud triangle explains three factors that must be present at the same time in order for an ordinary person to commit fraud, which include: 1) pressure, 2) opportunity and 3) rationalization. Each will be addressed as follows:
- Pressure is what motivates a perpetrator to commit the crime in the first place. Generally, there is a financial problem that the perpetrator is unable to solve through legitimate means.
- Opportunity arises when a person finds a way to abuse his/her position of trust with a low perceived risk of getting caught. One of the key factors here is that the perpetrator must be able to solve his/her problem without others knowing. For example, funds may be misappropriated in order to conceal a drug problem, or to pay off a debt that no one else knew existed.
- Perpetrators rationalize why it is acceptable to “steal.” Oftentimes, perpetrators initially intend to borrow funds to be repaid later. They also rationalize the theft by claiming that they are entitled to the funds because they are underpaid or not appreciated by their employer. They may also feel like they have to steal to take care of family expenses, such as medical expenses for a sick child.
NOTICE THE RED FLAGS
Our firm was involved in the forensic investigation of an embezzlement that occurred at a dental practice. Eventually, after four years and $400,000 embezzled, it was determined that the office manager, who had been employed by the dentist for over 20 years, was embezzling funds.
Interestingly enough, the dentist was highly involved in the financial aspects of the practice. In fact, the dentist actually prepared her own bank reconciliations each month, which is not a common task for business owners, as they oftentimes do not have the financial wherewithal to do so.
Each month the office manager at each dental location was required to provide financial reporting. Although the same accounting system was used at each dental location, the reporting was noticeably different at this particular office.
When asked by the dentist, the office manager was unable to explain the discrepancies. The dentist contacted us and the fraud investigation uncovered the office manager’s scheme. The office manager was opening the mail, retrieving insurance payments which were payable to the dental practice, manipulating the accounting system and depositing the checks into her own personal bank account.
The other staff members knew that the office manager was an avid gambler, drove classy expensive vehicles and lived lavishly, yet her salary as an office manager was $30,000 per year. All of these factors should have been red flags for the dentist; however, they were overlooked.
CREATE INTERNAL CONTROLS
In the 2016 Report to the Nations on Occupational Fraud and Abuse, the Association of Certified Fraud Examiners cited that their studies revealed that 46% of perpetrators were living beyond their means.
As in the dentist example, there were red flags surrounding the office manager’s lifestyle —had those around her been paying attention, the fraud scheme may have been uncovered sooner.
As a business owner, it is imperative to create internal controls to ensure that employees are not provided the opportunity to embezzle, as that is the only part of the fraud triangle that an employer can control.
At a very basic level, the same employee should not be responsible for opening the mail, entering transactions in the internal accounting software and making bank deposits. Keep these duties separate and you may save yourself from having to hire a forensic accountant in the future.
Michelle L. Salazar, CPA/ABV, CVA, CFE, is president of Reno-based Litigation and Valuation Consultants, Inc. Visit www.lvcreno.com to learn more.
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