Column: Embezzlement--Protecting Your Assets

      In order to conduct business with the U.S. Government, contactors are expected to have a strong internal control structure in place. This includes taking proactive steps to ensure that fraud is not occurring within the organization. Even with these expectations, fraud and embezzlement still occur within the contracting community. This was highlighted by the recent guilty plea of the former Controller of NCI Inc., a large publicly-traded government services company, to embezzling $19.3 million.

      If such an embezzlement can happen within a large company such as NCI, what can small contractors do to minimize such a risk within their company? This article will discuss some of the more common embezzlement techniques and strategies to help prevent embezzlement from occurring with your organization.

Behavioral Indicators

      Embezzlement is generally conducted by a single individual who is exploiting a weakness in the company’s internal control structure. It occurs in organizations where there is little segregation of duties and a lack of supervision of the accounting function is prevalent.

      There are certain common behaviors or indicators of individuals who have embezzled in the past. These include:

• Living above one’s means;
• Experiencing financial difficulties;
• Going through a divorce or other family issues;
• Having control issues with the work and work processes, being unwilling to involve others in his/her duties;
• Having complained in the past about inadequate pay;
• Having addiction problems;
• Refusing to take vacations.

      Just because an individual is displaying such behaviors does not mean an embezzlement is occurring or is about to occur. However, the company should be cognizant of the potential.

Common Forms of Embezzlement

      The objective of the embezzler is to somehow redirect cash (or the potential receipt of cash) from the company to the individual for his/her own personal gain. This can occur through several common techniques including:

1. Fraudulent Disbursements. Fictitious employees or fictitious companies controlled by the embezzler are set up, for which payments are then made. This can occur with either company-issued checks or fraudulently-established wire transfers. Setting up a fictitious company is the technique that the NCI Controller used to embezzle the $19.3 million.
2. Lapping. This is a technique where a payment received from a customer is diverted to an account under the individual’s control. Then, to cover-up this “hole” in the customer receivable, the next payment made by the customer is applied against the previous receivable, or a fictitious credit memo is applied. This technique requires the perpetrator to remain on top of the cash receipts and customer account ledgers, almost daily. Individuals performing this type of embezzlement rarely take time off.
3. Fake Refunds. This occurs when an individual either creates a refund situation (i.e. issues a refund to a customer but the refund actually goes to him/her personally) or when he/she overpays a vendor invoice or payroll tax deposit and diverts the refund payment to themselves personally.

Means of Prevention

      Some steps that companies can take to discourage and even prevent embezzlement include:

1. Know your employees both before and after hiring. Many embezzlers are repeat performers. Conducting background checks before hiring can help flush out such situations. Learn their lifestyle and situation outside of the office (i.e. financial, family, other) noting any changes that may be occurring.
2. Separate duties. Be sure that no one individual has the ability to initiate a new transaction (i.e. establish a new vendor or employee), approve the payment and disburse funds.
3. Supervise employees. Knowing that the work of an individual will be reviewed and supervised can be a major deterrent.
4. Follow-up on customer and vendor calls regarding payments applied or received. Receiving calls from customers or vendors regarding payments received, or failure to pay invoices, can be an indicator of embezzlement, especially if it is believed that these items were previously received or paid.
5. Reconcile and review cash accounts monthly. Many embezzlements occur when cash accounts are not reconciled. Insist on cash accounts being reconciled monthly and be reviewed and approved by someone independent of the preparer.
6. Conduct audits. Having unannounced internal audits and a year-end financial statement audit can also be a major deterrent to embezzlement.

Conclusion

      Smaller companies rely on individuals to wear multiple hats within the organization. For financial and accounting personnel, this creates an opportunity for embezzlement to occur, especially if a lack of supervision is evident. Taking preventative steps today can help ensure the company will retain its financial assets into the future.

Michael Smigocki, CPA/ABV, CVA is the Senior Managing Director of Federal Strategies Group, LLC. He can be reached via email at MikeS@FedStrat.com.

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Column: Embezzlement--Protecting Your Assets

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