In 2012 the entire nation watched the story of the Controller of the city of Dixon, Illinois, unfold. Rita Crundwell was finally caught for having embezzled over $53,000,000 over several years. She had purchased lavish homes and a fleet of show-horses and vehicles, and was living the life of the rich and famous. How was a financial crime of that magnitude possible?
Simple. Nobody looked at what was right in front of them. Otherwise, they would have seen the warning signs.
Unfortunately, most fraud is perpetrated by employees. But not all. There are methods to prevent fraud that have been around for centuries which are not always observed. Basic accounting controls require a system of checks and balances. It is not rocket science.
Since the introduction of computerized accounting systems, people have come to believe that a computer system will prevent fraud. Not true, and as a result, much ancient wisdom has been ignored.
Old fashioned accounting controls specify that one person opens the mail and makes a list of the checks received with a total. This could be updated to having the person enter the checks into a cash receipts program, and printing a report with a total. But then, the checks and the list are given to a different person who prepares the bank deposit and logs the deposit amount in the cash journal. Now if these two were in cahoots, you could have a problem. But you could have your Controller, as a third external authority, review the deposit and cash report and sign off before they take the deposit to the bank.
Had Dixon, IL, had good control procedures over their checkbook and payments processing, Rita would not have been able to do what she did. In fact, for the fraud that they missed, the audit firm helped pay back Dixon.
Payments over a certain amount should always be reviewed by and signed off by a second or even third person of authority. And that person should ask, “What is this for?” and review the paperwork on large payments. In other words, pay attention and ask!
Closer to home, I just returned from visiting a company that owns and operates a group of fast food stores. The president of the company told us about some significant check fraud experiences that they had had. Theirs were not cases of internal fraud. Criminals had intercepted and altered the amounts and payees of their company checks, and had manipulated them through a fraudulent/bogus bank account they had set up for this purpose.
The company’s response has been to change their payroll account and order new checks periodically. Also, they now send a list of approved AP and payroll checks to their bank to use in their “positive pay service.”
In case you do not know about positive pay, it is a service offered by most banks whereby they verify checks presented for payment against a list of checks you have issued. Banks usually charge for this service, but it can save you from a bigger hit if fraudsters attack.
If your bank supports positive pay, you can generate and submit a valid list of payments and only those payments will be processed by your bank, virtually eliminating fraudulent check activity.
The list may be a printed report or a data file that is transmitted to the bank. The information is imported into their system to screen the check number, date issued, payee and dollar amount.
A positive pay service can help eliminate or at least dramatically reduce the risk of fraudulent check activity.
If a check is presented that does not match, it is not paid. It is held, pending investigation.
Positive Pay is one way to protect your company from check fraud, but add this to detailed audit trails, historical records tracking each and every transaction, and you have an excellent set of tools for fraud protection and detection.
What about ACH?
ACH, which stands for Automated Clearing House, refers to the electronic funds transfer of payments or charges through the banking network. Payroll direct deposit and accounts payable may both be paid via ACH. In this case there is no check produced so it eliminates the possibility of check fraud. Paying electronically eliminates the risk of a check making it into the wrong hands.
In this method, your payroll or AP software creates a data file of the “checks” you wish to issue, and you then upload that data file through your bank’s electronic banking portal.
The money is transferred on the date you specify and you do not have to print and send out paper checks.
This system has been around a long time and works very well. In addition, pay stubs or AP remittance advice documents may be encrypted and emailed to the employees or to vendors.
One additional option for payroll that is becoming more popular is to use the ACH file to deposit employee net pay into a debit card account.
If the employee does not have a bank account with debit card capability, an account may be able to be set up by the employer using what is called a “Pay Card.” It is just like a prepaid debit/credit card so when the employee’s net pay is added to the balance of the card, it becomes available to withdraw or spend with minimal bank fees. For employees who do not have a bank account, this is a huge improvement over taking paper checks to the currency exchange.
Here are some prevention tips that may help your company avoid fraud.
- Separation of duties in small office (AP, AR, GL).
- Routinely change passwords
- All bank correspondences/financial envelopes should to go to CEO, not bookkeeping
- Lock up your check book
- Always review bank statements/checks paid
- Monitor hours reported to payroll (and review paid time off)
- Consider changing or alternating the credit cards that your company uses and review card statements monthly
- In many cases of fraud, computer audit trails are deleted
- Data backup (to a location where no one can get in and delete files)
- Accounting software must provide secured audit trails of all checks
Small and mid-sized companies may be more susceptible to fraud than large organizations which tend to have annual financial audits. But small business owners can protect themselves by implementing internal controls that can significantly reduce the risk of fraud.