Sound Business Advice: 7 tips to proactively managing fraud

For independent business owners, fraud is a very real and growing threat. Private enterprises have always been quite vulnerable to fraud because of the nature of their businesses. Many do not have the organizational wherewithal to detect and/or deal with an event, often opting to accept defeat and move on. 

This does not mean they are helpless victims. As with any large-scale enterprise, there are measures that can be taken to detect the signs of fraud and mitigate damage within your organization. A recent KPMG study “Who is the typical fraudster?” looked at 350 investigations into fraud. What it revealed was a “typical pattern” of characteristics and activities on the part of fraudsters. Understanding these warning signs is an integral part of any risk management strategy. 

According to the study, the majority of fraudulent acts are either attempts to conceal losses or poor performance, or involve the misappropriation of assets (embezzlement or procurement fraud). One interesting thing that comes out of the survey is that the primary reason for most frauds occurring continues to be the exploitation of weaknesses in internal controls (up to 74 percent of all cases had weak internal controls). In other words, there has to be opportunity.

Another factor is a very human one: motivation. Fraudsters are typically driven by greed to fulfill a need such as an addiction or financial crisis. Closely tied with that is psychological rationalization. This element needs to be there in order for people to cross the line into illegal activity. For example, they might convince themselves they are not getting their fair share, or are only “borrowing” funds with the intent to pay them back. 

When fraud is perpetrated, more often than not, it is personal; and because it is personal, private enterprises can be highly susceptible to significant losses. More importantly, the sense of betrayal can run significantly deeper in an environment in which long-standing employees are also considered close friends. 

In our work with private enterprise clients, we see a number of common organizational characteristics that increase the potential for fraud. Firstly, they have not set up internal control systems, either because of lack of expertise, time, or simple blind faith. 

Secondly, employers tend to develop deeper personal relationships with their employees and are more inclined to trust them with significant responsibilities. 

This leads to a third threat. Trusted personnel in private enterprise often work independently, and, in many cases, handle a cross-section of functions. A large organization would never have a single person handling mail, deposits and bank statement reconciliation, for example. It stands to reason that having a single person control both record keeping and assets, increases opportunities for them to take assets and manipulate accounting to cover it up. 

So what can a private enterprise do to mitigate the risk of fraud?  The following are some best practices that can play an important part in your risk management picture:

1. Do not have a single person controlling your assets. This practice can place you in a highly vulnerable position and increases the risk of financial fraud significantly. Ensure that banking functions (e.g. deposits, account reviews, etc.) are handled separately. 

2. Be vigilant about financial activity. Make sure you have access to e-banking and transfer activity information. Insist upon monthly statement reporting and reviews and ensure that numbers reconcile with sub-ledgers. 

3. Do not sign blank checks. This may seem obvious, but we have seen many businesses using this practice as a means to simplify payables. Monitor who those checks are going to. Are they companies you know? 

4. Perform independent reviews of financial activities and scrutinize the numbers. Over time, business owners build up their trust in individuals and stop overseeing these types of activities. 

5. Do background checks on new hires. Fraud is not exclusive to long-term employees. There are individuals who make a career of moving between businesses to perpetrate fraud. 

6. Watch for the “red flags” with your employees. A pattern of confrontational behaviour, arrogance, secrecy, signs of stress, tendency to micromanage, blame shifting and intimidation, amongst others. 

7. Do not let your need to run “lean and mean” lead you to discounting the value of legal advisory services. The right expertise can play an important part in assisting you flag potential threats, implement controls and avoid potential losses.

It is clear that private enterprise is not immune to fraudulent activities. Often these businesses have built a culture based on close personal ties and trust. As such, while the dollars may be smaller, the opportunities for fraud are that much greater, which means the financial consequences can be significantly larger and that much more devastating. 

Should you be interested in further information, please do not hesitate to contact Charles Thresh, managing director, advisory, at KPMG. He can be contacted via phone at 441 294 2616 or 441 333 2616 or through e-mail at [email protected].