Article:

Employee Fraud – The Threat From Within

18 October 2021

Author: Adam Smith, Director, Forensic and Valuations Services

“Employees are a company’s greatest asset” – a quote often used by business leaders.

It’s likely to be true as employees generate great ideas and sales leads, they are often the ‘face’ of a company, they are people with an innate knowledge of the business, they contribute to the profitability of the entity and they understand the culture and systems within.

However, there is a flipside.  Some employees can also cause damage far beyond monetary loss for a business because of fraud and often more damage can be inflicted by an employee than by someone outside of the business.

Why is this and how can business owners and leaders combat this threat?

It was noted above that employees have a deep knowledge of the business and understand the systems and controls that are in place. That knowledge is sometimes misused for illegitimate gains by the employee.

Examples of frauds we have seen involving employees:

Accounts payable

An employee in the accounts payable team of a very successful business had sole control over payments made to suppliers.  The employee, for reasons that appear to be based on greed, started making payments to a third party bank account under her control but disguising the payment as one being made to a legitimate supplier to the business. Regular reviews of the payment runs of the business did not uncover the issue as the actual payments were supported by invoices and legitimate supplier statements but no one spotted that payments were being made to a fraudulent bank account.

However, when the unpaid legitimate supplier started to chase payment a few weeks after they should have been paid, the employee ensured they were paid up to date immediately and then disguised the payments to her account under the cover of a different (legitimate) supplier. The fraud was only discovered when a supplier spoke to someone else in the accounts payable team and demanded payment. Whilst it appeared that the supplier had already been paid, further investigation established that funds had been paid to the fraudulent employee’s bank account instead.

IT Purchasing

A purchaser of IT equipment was able to authorise the purchase of portable, attractive and valuable items – iPads, iPhones, laptops and other easily sold on equipment.  The company only needed 10 or so new iPads each month for its new recruits.  However, 100s were ordered over a number of months and the surplus kit was sold on well-known auction sites or via other sales channels with the employee pocketing the sale proceeds.  In the knowledge that there were no formal reviews of the purchase of IT equipment, this pattern continued for a long period before being discovered. 

Accounting manipulation

Another area regularly encountered is where certain staff seek to manipulate accounting information for their own benefit.  This is often seen where businesses have operations that are separate to the head office – satellite offices, for example, or subsidiaries that operate in other locations. The manipulation of management information is usually designed to show financial results that are better than the actual performance.  This may be to secure an employee’s bonus which is based on financial outcomes or to disguise poor results would otherwise result in no bonuses being paid or, ultimately, the closing down of that business unit with redundancies.

Detecting accounting manipulation is difficult particularly as ‘good news’ is often never questioned by those receiving pleasing it.  Where results do go against the known trends of a business and the markets in which it operates they should be queried.  It may be the case that a unit has found innovative ways to deal with fluctuations in the markets and the general economy. However, it may also be the case that the accounting information is being massaged for the benefit of fraudsters.

Consequences

Monetary loss is fairly easy to quantify but one then has to factor in the following issues:

  • Staff morale – it is often the case that those employees uncovered as fraudsters are well liked and trusted by colleagues and resentment can be found amongst staff as well as increased levels of distrust after the discovery of a fraud. This will inevitably impact upon staff morale, productivity and may increase staff turnover. Employees want to work in an open and trusting environment with colleagues they can rely on. If this environment is not sustained, staff will seek employment elsewhere which often means losing the best people and businesses can then find it hard to recruit and train replacements.
  • Increased scrutiny from lenders/stakeholders/regulators who may be nervous following the discovery of a fraud. Often if an entity takes the right steps, such as undertaking a detailed investigation, considering recovery of funds and being open with stakeholders, then such concerns can be assuaged.  Burying the corporate head in the sand is not an option and expert advice will be required.  This will come at a cost but it will help a business to recover and ensure that systems are strengthened to try and prevent reoccurrences.
  • Suppliers, if they become aware of issues, particularly those in the first example above, may require more stringent trading terms such as payment up-front or on delivery.  This will put a strain on cashflows which could result in solvency issues for a business.   

Defences

What defences should be deployed to prevent employee fraud?

Recruitment, recruitment, recruitment! If an entity is able to screen out dishonest people who wish to become employees then this will clearly be a significant step-up in defences.

Procedures such as ensuring we properly identify and perform due-diligence on potential new recruits must be in place.  Such due-diligence would include:

  • Checking references provided by the employee – why not give the referee a call?  Is the referee independent?  In one previous investigation we saw a recruitment agency provide a reference for a potential candidate – it was a good reference which was unsurprising as the agency has a financial interest in that employee being employed.
  • Check qualifications per the curriculum vitae, confirm where possible that former employers did actually employ the person, check social media such as Facebook, Twitter, LinkedIn and other platforms – is this person who we want to employ and does the CV match with these other sources of information?  A lack of a social media footprint may also indicate issues – is the person we are considering really who they say they are?
  • Ensure probationary periods of employment are monitored and that when employment is confirmed that there are no concerns about the employee. All HR systems and controls should operate before, during and after recruitment to assist those hiring new staff.

Another defence is to regularly train staff in fraud awareness. Without having the awareness of a threat, staff will not be able to spot potential warning signs. It follows that there must also be a route for employees to raise concerns via a whistleblowing facility and without any concern for their job security when raising legitimate concerns in good faith.

There should also be appropriate systems and controls in place with ‘trip wires’ that can alert management of issues at an early stage. When systems and controls fail, there should be a ‘lessons learned’ approach and alternative systems and controls put in place effectively and efficiently.

Businesses must be cognisant that employees can pose a significant threat to the entity. Monetary loss is often just the beginning. The consequences can also be unexpected – a recent investigation by BDO was commenced just days before our client was to be sold in a lucrative deal for the owners.  The proceeds received by the owners was reduced because of a fraud within the business undertaken by an employee.

The risk of fraud should be seen as another business risk that has to be managed. As with other risks, fraud cannot be completely eradicated but significant mitigation steps can be taken to effectively manage the risks. For more information, please get in touch with Kaley Crossthwaite.

To assist you in negotiating the changing fraud landscape we bring together further insights, articles and other useful resources to help combat fraud on our Fraud Hub.