Don?t Get ?Frosted?

When it looks like the company bean counter is eating the beans, John Warren said it’s usually hard for the owner to swallow.

Warren, associate general counsel for the Association of Certified Fraud Examiners, said the more access to finances and familiarity with procedures an employee has, the more damage he or she can do. His point was reinforced Dec. 5 by the 69-count indictment of Jack Frost, who from 1993-97 stole more than $1.8 million from the Harvey and Bernice Jones Charitable Trust in Springdale.

At the trial, Bernice Jones testified that she thought of Frost as family.

“Almost always, it’s the person who’s been with the firm for a long time and who everyone knows and trusts,” Warren said. “That’s the person who’s going to hit you for a big fraud loss. It’s going to be the person who knows your kids names. People don’t want to believe that, but that’s the reason these schemes work.”

According to the ACFE’s 2001 National Fraud Survey and “The ACFE Report to the Nation,” median losses caused by executives are 16 times those of lower-level employees. Males, older workers and college-educated employees account for the biggest fraud losses.

Sue Talkington — a CFE, certified public accountant and partner with Beall, Barclay & Co. of Fort Smith — said it’s not the ACFE’s intention to make business owners paranoid. Most bookkeepers, she said, are honest and hard working.

But blind trust leads to opportunity and temptation. And as Barney Fife said on “The Andy Griffith Show,” it’s best to “nip it in the bud.”

Talkington has in recent years handled six company audits in which major embezzlement was discovered. In each case, she said, the perpetrator had “100 percent trust” from the owner.

One business owner in a neighboring state had entrusted a female employee of 22 years with complete control of his company’s books. He called Beall in for an audit when the firm started having cash-flow problems.

“After looking at only six months worth of stuff, we told him the employee was stealing,” Talkington said. “He was upset with us at first, but then he got to thinking that maybe there was something to it. He had us come back and quantify the whole year, and she had stolen $400,000.

“Then he got real mad and had us do five years. During that time, she had taken $1.4 million.”

Talkington said the Federal Bureau of Investigation was called in for the ongoing case because it involved interstate commerce. It would have never gotten this far, she said, if the owner had just paid more attention.

“My client missed the telltale signs,” Talkington said. “[The bookkeeper] had bought a 900-acre farm that he wasn’t paying her enough to afford. She had cattle all over the place and was driving a new car every year.”

Why They Do It

Based in Austin, Texas, the ACFE is an international professional organization with more 25,000 members aimed at fighting fraud and white-collar crime. Its studies show that fraud and abuse annually costs U.S. organizations more than $400 billion. The average organization loses $9 per day per employee to fraud and abuse, or 6 percent of its total revenue.

The highest losses occur in the real estate and financing sectors, and the most costly abuses hit organizations with fewer than 100 people. Warren said a psychological theory called “The Fraud Triangle” explains how a person might expect to get away with stealing large sums of money.

The triangle’s three sides are defined as “financial need,” “opportunity” and “rationalization.” Usually, Warren said, embezzlers don’t start out with the intention of becoming criminals. They’re generally ordinary people who suddenly find themselves needing a lot of money fast, and they want to solve the problem quietly.

“Maybe it’s a drug habit, a gambling addiction, a failing business, unexpected medical bills or who knows what,” Warren said. “But suddenly this pressure is great. Then if there’s opportunity there, such as no one else checks the books, it might become easy for the fraudster to rationalize the crime.”

“‘I’m only borrowing the money. Everyone does it. The owners aren’t paying me enough anyway, and they have it coming. They passed me over for a promotion.’ That line of thinking is what leads to an ordinary person becoming an embezzler.”

Warren said the “potato chip theory of fraud” explains how the situation can escalate. One batch of easy money tastes so good, the embezzler wants another and another. Before long, they’re career criminals.

Ounce of Prevention

Warren said if embezzlers were really smart, they’d take just enough money to pay their debts. Then, he said, the chance might be 20 percent or less that they’d get caught. But most are caught because they keep stealing, and the amounts get larger and more frequent.

“If a person were to spot a glitch in the system and take advantage of it just one time,” Warren said, “the odds are that they’d never get caught.”

There is hope for business owners. Establishing a system of checks, whether the owner has accounting savvy or not, gives at least the perception of security and acts as a deterrent to would-be embezzlers.

Mark Lundy, a partner with Lundy & Allard Co. PLLC of Rogers, said his firm helps clients use mathematical theory to conduct routine audits. In addition to following the Statement of Auditing Standards, Lundy says his firm incorporates a healthy does of Benford’s Law.

Made public in 1938 by G.E. Labs researcher and physicist Frank Benford, the theory uses a variety of logarithms and data to prove that in naturally occurring numbers — those not manipulated by human bias — tendencies in frequency exist. For example, in standard cash disbursements or street addresses the number “one” occurs as a first digit 30 percent more often than any other number. Or, the numbers “one,” “two” and “three” occur 60.2 percent more often as a first digit than other numbers.

The theory was profiled in the May 1999 issue of the Journal of Accountancy.

“We can take an Excel spreadsheet, run your cash disbursements or receivables and plot the digits that occur against Benford’s law,” Lundy said. “If they don’t fit the curve, it could be an indication of fraud. Let’s say you have a policy in place where a $500 check requires two signatures, and to circumvent the system an employee is signing several checks for $450, $499 and $475.

“That will cause a spike in the No. 4 and would give us an indication that something might be going on. This model is really simple enough that we can help any business use it.”

Lundy said he’s not sure that embezzlement is rampant in Northwest Arkansas. He recently attended a continuing education course with 50 other CPAs. When asked if they had ever detected fraud, only one attendee raised his hand.

Talkington said owners mitigate their risk by staying involved with their firm’s finances. Having attended conferences where famous embezzlers such as Susan McDougal and former Arkansas Attorney General Steve Clark explained to CFEs how they stole money, Talkington said most scams are simple in design.

“It’s cheaper to prevent embezzlement than to correct it,” Talkington said. “The thing to remember is if you have employees, this can happen to you.”

Fighting Fraud

Here are 10 tips for business owners interested in protecting their company from fraud and embezzlement:

• 1 –?Have bank statements sent directly to your home and really look at them. They should reach the company owner unopened. Don’t assume that just because it’s a copy of a bank statement that it’s accurate.

• 2 –?Review the general ledger on a monthly basis. Compare actual payables to your authorized vendor list sorting by vendor, amount or date. A common scam is to run the same invoice through the system twice. Two payments for the same amount on the same day should be a red flag.

• 3 –?Review the payroll frequently. Make sure no employee is getting two checks, and that check amounts are for the salaries employees are supposed to be paid. Monitor a lot of needless overtime.

• 4 –?Track monthly revenues to watch for skimming. If revenue for a given year is, for instance, 10 percent lower than the last year — and you know you’re buying more inventory than ever — that money must be going somewhere else.

• 5 –?Scrutinize all accounting adjustments. Changes to the cash count or excessive write-offs and bad debt can be a sign of a shell game or skimming.

• 6 –?Do surprise checks. Have someone open the mail and run a check independent of receivables. Run a tape of all of the checks received that day. Date it, and jot it down. Then turn over the mail to the person who makes the deposit and have another person go back and make a third comparison later. Have two people assigned to open the mail whenever possible.

• 7 –?Make photo copies of incoming checks and stamp them “for deposit only” as soon as they are received.

• 8 –?Check the references of potential employees. Tight labor markets have made everyone desperate for workers, but you want to know who you’re hiring.

• 9 –?Use Excel or Lotus software to run reports that would identify a ghost employee with the same post office box or name as another employee. The Association of Certified Fraud Examiners has additional software that can be of assistance.

• 10 –?Read up on the latest fraud prevention techniques at www.cfenet.com.

Source: Beall, Barclay & Co. of Fort Smith