The potential for fraud is an unfortunate fact of business life. Employee fraud can be particularly damaging as it is an act of deceit committed by a trusted worker or partner. It is not something many business owners like to think about. But a proactive business owner will have the right internal controls in place to eliminate the opportunity for fraud or make fraud less likely to occur, says Bruce S. Ludlow, CPA at Klatzkin & Company in Hamilton.
Opportunity is just one side of the “fraud triangle” Ludlow will discuss at a breakfast forum presented by the MIDJersey Chamber of Commerce and the MIDJersey Center for Economic Development on how to “Protect Your Business: Fraud Risks and Schemes.” In addition to Ludlow, panelists include Suzanne T. Heller, also a CPA at Klatzkin & Company, and Robert E. Lytle, an attorney at Szaferman, Lakind, Blumstein and Blader in Lawrenceville.
The 45-minute panel discussion, followed by a Q&A session, will be held on Thursday, January 29, from 8 to 10 a.m. at Greenacres Country Club, 2170 Lawrence Road, Lawrenceville. $40 non-members; members $25 in advance, $30 at the door. For information or to register, visit www.midjerseychamber.org/events.
Other topics to be discussed at the breakfast forum are hiring and managing personnel, to be presented by attorney Lytle, and how to manage a fraud situation after it occurs.
Ludlow grew up in Feasterville, Pennsylvania. His father, a banker with a business degree from Temple University, served as a sergeant in the U.S. Army under General George Patton. His mother, also a Temple graduate, taught home economics before having children and becoming a full-time homemaker.
Ludlow graduated from Shippensburg University in 1974 with a B.S. in business administration in accounting (a year in which he was also MVP in the Bucks County Softball Tournament). He is a partner in Klatzkin & Company and has been a CPA for more than 35 years, certified to practice in New Jersey and Pennsylvania. He is a past treasurer and director of the Mercer Chapter of the New Jersey Society of CPAs. His firm does accounting for nonprofit organizations and financial reports and taxes for commercial businesses.
He resides in Langhorne, with his wife, Debbie, and their daughters Michelle, a Ph.D. chemist, and Kristen, a graduate of the University of Pittsburgh and a business analyst (who as a senior at Neshaminy High School drove in the winning run for the school’s state championship softball team).
“Pressure,” Ludlow says is the first side of the fraud triangle. Pressure may be internal, such as the pressure to meet revenue quotas to earn a bonus, or external, such as the pressure to earn money to pay medical bills for a sick child. Such pressures can drive some employees to search for ways to supplement their income.
The second element usually present is “rationalization,” says Ludlow. Statements such as: “I’m worth it, I should be getting it, I’m underpaid” provide the rationale for employees looking to justify their illegal actions.
The third leg of the fraud triangle is “opportunity.” The person who feels pressured to obtain more wealth and has rationalized committing fraud must still find an opportunity to do so with little risk of getting caught. If the business has no internal controls, or worse yet “if the head guy’s doing stuff or fudging things,” the employee who is tempted to commit fraud will find an opportunity, says Ludlow.
What are some potential opportunities for employee fraud and what internal controls can prevent them?
“Somebody in charge of payables could set up a fictitious vendor and have invoices paid to this vendor, and actually then they have access to that account,” says Ludlow. “So somebody’s paying something that looks like a bill, but it’s not a real vendor.” Similarly, “somebody who has payroll responsibility could set up a fictitious person or could have employees who were real but were terminated put back on the payroll and get that direct deposit into an account.”
Internal controls are a key to fraud prevention for the business owner who wants to be proactive rather than reactive, Ludlow says.
“Most things actually come as tips from employees seeing something. You have a kind of chain of command where a person can contact a higher-up person to say, ‘I just saw something here that didn’t seem right’ so they can give a tip. It should be anonymous so there can’t be retribution, but that’s a lot of times how things are done.
“With a bigger company, for internal control the bigger thing is segregation of duties, so that somebody’s not paying checks, collecting checks, and doing the bank reconciliation. Bigger entities can separate those duties. A lot of times a smaller entity can’t because they only have so many people. To hire somebody just to write checks, that’s not going to be feasible. So that’s when the responsibility would fall on the owner, the office manager, or somebody to make sure everything is done correctly.”
How can a small business owner use segregation of duties to prevent fraud? Ludlow says the owner can open the bank statement when it arrives in the mail instead of having it go directly to the person who prepares the bank reconciliation. This way the owner sees it before it can be altered. “With technology, if you have online access you could alter a bank statement so that it looks right,” he says. Most companies receive a statement in the mail, he adds, but for those who view theirs online, the owner “would be the only one to have access and print it out and let the other person do the bank reconciliation.”
While internal controls are important, someone needs to check that they are being implemented, Ludlow says. In a smaller company the chief financial officer would have an overview of all of the company’s financial practices, but in a larger company there might be other managers who check them in steps along the way.
Employee fraud prevention all comes down to checks and balances, Ludlow says. “That takes the opportunity, or at least it will deter some people because they figure the opportunity’s not there because there are checks. A lot of times what happens is a person who might do this for the first time does something small, gets away with it, and they grow in confidence. And if there’s that initial fear that something’s going to be checked or be found, maybe they don’t even try it. So if you don’t have those controls in, they’d be more apt to try it.”