Part I: Protecting The Value Of Your Company

Fraud can cause significant financial damage to companies of all sizes. Small- and medium-sized businesses are particularly vulnerable to fraudulent activity because they often lack the infrastructure or resources to effectively deter such behavior.

Even the average family-owned business is exposed to fraud risk, as shown in a recent article published by the U.S. Department of Justice. The article describes federal charges filed against the former office manager of a Midwest-based metal fabrication company for allegedly stealing more than $2.6 million from her employer. A trusted employee for more than 20 years, the defendant allegedly forged checks drawn from company accounts over an eight-year period. The fraud scheme was discovered after an anonymous source tipped off the company’s owners.

To avoid falling victim to a similar situation, business owners should take an active approach toward fraud prevention by understanding how fraud is committed, how companies are susceptible to fraud, and how to reduce fraud risk.

Understanding the crime

In the case above, the office manager perpetrated fraud using what is known as a “forged maker scheme.” In such a fraud scheme, a person entrusted with access to his employer’s bank accounts embezzles funds by forging the signature of an individual authorized to sign checks. These forgeries are generally done by free-hand, stamp, computer signature generator, or photocopier.

An employee can abuse the role entrusted to him by accessing the company’s check stock and writing a check payable to himself. This avoids having to create a false identity or involve an accomplice. The perpetrator then simply endorses the check and presents it at the bank for payment. Next, the perpetrator must craft a mechanism which will allow him to conceal the payment that he has made to himself.

Concealment

In a forged maker scheme, a perpetrator can conceal his actions in a number of ways. Typically, information for all checks written is recorded in a disbursement journal. The perpetrator must “explain” the fraudulent check in the disbursement journal by coding it to “void”, or alternatively, he may choose to not record it at all.

Assuming the perpetrator has chosen to not record the check at all, it will still be visible to those who review monthly bank statements. Therefore, the perpetrator will remove the fraudulent check or alter the bank statement before it is seen by anyone who regularly reviews them. The perpetrator of a forged maker scheme is often an individual responsible for reconciling company bank statements to company records because it is unlikely that anyone else in the company will notice the missing check.

Now there will be no record of the check in the disbursement journal and no physical evidence of the check on hand. However, simply omitting the fraudulent check from the disbursement journal creates a problem: the bank balance – now reduced by the amount of the concealed fraudulent check – will not reconcile to the company’s book balance, which would reflect a higher amount. Consequently, the perpetrator may “force” the bank reconciliation by reporting that the bank balance matches the book balance, while in fact, they do not match.

It is important to note that the checks used in forged maker schemes may be those at the end of a company’s check stock. Since these checks are out of sequence, they are reflected last on a bank statement, and therefore are easier to remove from a document through physical alteration.

Preventing the crime

It is critical to design and implement internal controls to help reduce your company’s exposure to fraud risk. Examples of controls that can help reduce the risk of the forged maker scheme and closely-related types of fraud include, but are not limited to:

• Adequate segregation of duties in the cash disbursement process
• Strong financial statement oversight
• Protection of the company’s check stock
• Establishment of a positive pay program in which your bank will pay only pre-established payments
• Protect access to signature stamps, electronic signatures, etc.
• Requiring bank reconciliations to be performed by someone who doesn’t have access to the company’s general ledger and cannot post journal entries
• Performing various procedures to determine the completeness of bank statement activity and the related reconciliation:
• Check the beginning balance against the prior month’s ending balance
• Foot the bank statement activity to reconcile the deposits and withdrawals against those included in the bank statement
• Confirm the ending balance with the bank directly
• Having an outside advisor review original bank statements and compare them to those used to support bank reconciliations prepared internally
• Implementing a hotline or other anonymous method for employees to report suspected wrongdoing

Consulting a forensic accounting expert

When searching for an outside advisor, select an experienced forensic accountant who is trained to help you identify weaknesses that make your company susceptible to fraud. He or she can also help you conduct a fraud self-assessment using a tool similar to the one provided above. Having an outside advisor perform frequent fraud examinations is also an effective way to deter fraudulent behavior.

If you would like assistance detecting fraud and implementing controls that will deter fraud in your company, please contact us.

This document is for informational use only and may be outdated and/or no longer applicable. Nothing in this publication is intended to constitute legal, tax, or investment advice. There is no guarantee that any claims made will come to pass. The information contained herein has been obtained from sources believed to be reliable, but Mariner Capital Advisors does not warrant the accuracy of the information. Consult a financial, tax or legal professional for specific information related to your own situation.