Employee Fraud and Embezzlement

Stu and Betty were in their mid-70s, each with character lines beyond their years. Expressive lines that silently spoke of their long journey filled with experiences of hard work, joy and sorrow. I instantly fell in love with them. Their manufacturing firm, in its 35th year, did some $2.8 million in annual revenue. As I listened intently to their story, they explained that they'd recently suffered their third bout of employee embezzlement-$200,000 this time. They weren't sure they had what it would take to struggle through this time. They were emotionally exhausted and financially weak. Betrayed once again by a person they trusted, even nurtured.

Employee theft is white-collar crime. It's categorized by the FBI as deceit, concealment or violation of trust but not involving the application or threat of physical force or violence. These acts are committed to obtain money, property, or services; to avoid the payment or loss of money or services; or to secure a personal or business advantage.

Studies show that on-the-job theft is widespread and growing.

According to the 2003 National Retail Security Survey (NRSS), no other form of larceny costs American citizens more money than employee theft. U.S. retailers alone lost $15.8 billion in 2003 to employee theft. That's not shoplifting, which is theft by customers and resulted in an estimated loss of $10.7 billion in 2003.

The U.S. Chamber of Commerce estimates that U.S. employers lose $20 billion to $40 billion a year due to employee theft. Shockingly, the U.S. Chamber of Commerce states that 30% of all business failures are caused by employee theft, citing a report by David J. Shaffer and Ronald A. Schmidt.

"Occupational fraud and abuse is a tremendous problem, one that affects practically every organization," says the Association of Certified Fraud Examiners (ACFE). In their 2004 Report to the Nation on Occupational Fraud and Abuse, they published the results of their study of 508 occupational fraud cases. In total, these cases caused $761 million in losses. Here are some of their other findings:

• U.S. organizations lose 6% of their annual revenues to fraud.
• Small businesses suffer disproportionately large losses due to occupational fraud and abuse. Themedian loss for small businesses was $98,000-higher than the median loss experienced by all but the very largest organizations. Unfortunately, small businesses are less likely to be able to survive such losses and should better protect themselves from fraud.
• Frauds committed by owners and executives caused a median loss of $900,000-six times higher than losses caused by managers and 14 times higher than losses caused by employees.
• Most occupational fraudsters are first-time offenders. Only 12% had a previous conviction for a fraud-related offense.
• Criminal background checks can help but will not weed out all fraudsters. Most frauds are committed by otherwise "honest" employees.
• Recover of losses is very low. The median recovery is 20% of the original loss. 40% of victims recover nothing.
• Confidential reporting mechanisms reduce fraud losses. The median loss among organizations that had anonymous reporting mechanisms was $56,500 compared to $120,000 for organizations that did not.
• Among cases detected by a tip, 60% of tips came from employees, 20% from customers, 16% from vendors and 13% from anonymous sources.
• Frauds detected by internal controls tended to be relatively small, with a median loss of $40,000.

Apparently, some experts weren't surprised by the ACFE's finding. "Family-owned businesses are more vulnerable to embezzlement ... because they're more trusting," says Detective Steve Beck in an interview with Family Business Magazine. Beck is a white-collar crime investigator with the West Chester Township Police in Ohio.

Amazingly, Christopher Eiben estimates that less than 10% of employee theft and embezzlement is ever discovered and less than 10% of discoveries are reported to authorities. Mr. Eiben is a certified fraud examiner and author of It Pays to Be Paranoid.

What does this mean for you, the owner of a small or mid-size private company?

You are at risk!

This does not mean you MIGHT be at risk. No. You ARE at risk. You must resist thinking "Oh, they'd never do that to me." The experts say every victim is shocked; betrayed by a person they trusted most. By a person they'd never have suspected in a million years. People who had given years of loyal and valuable service.

So get real! Installing and maintaining fraud prevention measures are part of what I call becoming a "real business." Yours is not a "real business" until you run it like one.

Sources:

"Beating Back Fraud," Business Finance Magazine, February 2006

It Pays to Be Paranoid, Christopher Eiben. Agate Publishing, 2004

"Safeguard Your Company Against Embezzlement," Family Business Magazine, Spring 2005

"Experts See Theft on Rise in Workplace," The Oklahoman (date unknown)

"Fight Fraud by Knowing Perpetrator, Common Scams," Research Recommendations

"Fraud Wears Many Masks," Collections and Credit Risk

"Combating Small Business Fraud," Regier Carr & Monroe, LLC Client Newsletter, December 2003

www.AmericanExpress.com

2004 Report to the Nation on Occupational Fraud and Abuse," Association of Certified Fraud Examiners (ACFE)