Addressing Fraud: A Plan to Avoid the Emotional Reaction

by | October 2, 2012

Fraud is committed in small businesses every day.  Some industries, such as retail and restaurants, are more susceptible than others but it happens everywhere.   Yet most business owners do not believe it will happen to them.   We know that the key element is to put in place key controls to deter and expose fraudulent behavior.   Steps such as separation of duties, background checks, and monitoring bank accounts are necessary; however, an equally important step is to be prepared to handle a fraud scenario when it rears its ugly head.

Often, business owners discover fraudulent activity inadvertently.  An unusual or small expenditure cannot be reconciled or an outside financial professional notices an anomaly.   The business owner is usually taken completely by surprise and responds with anger, frustration and a sense of betrayal.   The immediate reaction is to pursue legal action – and that may well be appropriate; but more importantly, the company should have a comprehensive plan to minimize, uncover and address employee fraud.   The plan should include:

–  Background checks in hiring. Background and credit checks are important tools for business owners to use in making hiring decisions.  They help to screen out behaviors that may put the company at risk.  Credit checks, however, may only be used if relevant to the job and must comply with the Fair Credit Reporting Act.  Even so, these tools are not good indicators of likely fraudulent behavior as most perpetrators are first time offenders.

–  Key controls and monitoring of business functions.  Ensuring that the financial aspects of the business (or even inventory) have controls and separation of duties, so that one person does not handle intake, processing and outbound transfers.   Similarly, regular review and reconciliation of accounts by third parties will provide oversight and minimize the likelihood of dishonest behavior.

–  Investigate all suspected fraudulent activity.   Anytime fraud is suspected, an investigation should be performed by the company.  The investigator may differ based on the type of activity or the severity of the fraud.   A process should be followed with regard to the investigation.  Your insurance carrier and attorney should be involved either directly or as outside advisors throughout the investigation to assist in legally and confidentially gathering data necessary for the company’s case.   Discussions with employees suspected of fraud must be legally handled and unlawful monitoring or harassment of an employee could create more problems than they address.

–  Consistent policies regarding fraudulent activity.   The company should have a policy regarding how fraudulent activities will be handled.  A “zero tolerance” policy is common but it must consider and comply with any unique contractual relationships the company may have such as executive contracts or union relationships.   Alternatively, disciplinary action or immediate termination may be incorporated into the policy and should be applied consistently to employees under similar circumstances.

–  Consider prosecution – sometimes.  The initial reaction is reasonably to prosecute the offender.  However, criminal prosecution may not be best for the business.  As part of a criminal proceeding, the company may be required to divulge confidential information about its business and financials.  In addition, a criminal record may inhibit the employee from being able to pay back the amounts owed.  Sometimes addressing the fraud in-house with a contractual obligation to repay the amounts stolen provides better results for the business – even if it doesn’t feel like justice is done.

When you find out an employee has stolen from your business, it will feel like a punch in the gut.  The emotional response will be severe.  However, it’s important to take time to put it in perspective and act rationally and legally and in the best interests of the company.