Don't fall victim to cunning ploys

Companies must be vigilant against fraud - keeping a particular eye on employees, warns Sandra O'Connell

PAT McDONAGH is familiar with the ways a business can be defrauded. The boss of Supermac's, the fast food chain he established in 1979 and which now has 85 outlets, famously captured CCTV images of a customer deliberately splashing water on the washroom floor of one of his restaurants in order to slip and sue for personal injuries.

At a time when small firms were crippled by rocketing insurance rates, it made him an overnight hero to owner-managers everywhere.

Now chairman of Chambers' Ireland's Retail Crime Council, McDonagh is more alert than ever to the ways of fraudsters. Unfortunately for employers, more often than not the deceiver is likely to be one of their own staff. "Research suggests that about 10% of any business's staff is on the fiddle, one way or another," said McDonagh. "Unfortunately, it is part and parcel of being in business."

Every firm has to have its own way of detecting and dealing with fraud, he says.

"In our case, it's all about keeping tight control of stocks," he said. "We have a policy of weekly stock checks and we keep a very close eye on cash register overrings that don't add up, to see if a pattern emerges. Our systems are such that, where a discrepancy does occur, we can narrow it down to the very hour it happened."

According to research carried out by the Small Firms Association (SFA), 69% of small businesses have been victims of fraud in the past two years, with an average cost per company of E5,400. Of those cases, 85% were perpetrated by staff. Despite this, it found that nine out of 10 small firms have no fraud prevention measures in place.

"Internal fraud is a significant problem, but very few businesses even recognise that problem exists - and then only when it's too late," said Avine McNally, the assistant director of the SFA.

"Small businesses tend to be reactive rather than proactive in dealing with it, and only one in 10 companies have taken fraud-prevention measures and risk audits in the past year. Yet small companies that do not have the necessary internal controls in place are seen as being 'open season' for fraudsters."

There are various steps a business can take to minimise their risk of exposure.

"Firms should always ensure that authorisation requirements are in place for important business processes that involve cash payments and collections," she said. "This includes, for example, orders to suppliers and invoices to be paid.

Any bank operation must be authorised by an appointed signatory."

An effective system of management control needs to be established to monitor the work of employees in addition to the financial performance of the company.

Managers should learn to recognise and identify warning signals and take appropriate preventive action.

"These signals may include irregularities such as increases in the amount of raw materials used relative to output, increases in inventory, increased breakages or unnecessary increases in the number of suppliers that a firm uses," she said. "Be alert too in cases of missing or altered documentation."

Regardless of the nature of fraud, its final outcome will always be financial loss. According to McNally, there can be significant non-financial effects too.

"Fraud can damage trust between the business and its stakeholders, customers or suppliers, which affects the firm's reputation. This could lead to loss of revenue," she said.

Fraud can have a demoralising effect on employees and create an atmosphere of distrust, which inevitably affects performance and customer service.

"White-collar fraud is prevalent in small business and is hidden by nature. It must be treated as an everyday risk because firms that do not take preventive steps are exposing their business to serious losses," she said.

According to the accountancy firm KPMG Forensic, the amount of illegitimate expenditure in an average organisation could be as high as 5% of the total.

Implementing a thorough fraud reduction programme can reduce that by half, giving firms a potential saving of 2.5% of total costs annually.

One of the most effective ways to reduce the incidence of internal fraud is through more rigorous vetting procedures at the recruitment stage.

"Always follow up on an

applicant's references," said Andrew Brown, a director of KPMG Forensic.

"The problem with a tight labour market is that owners are so delighted to find anybody that they don't do enough background checks.

"This is important because increasingly we are hearing anecdotal evidence of criminal gangs putting people into companies specifically to find out how their systems work."

The rise in contracts-based positions can make employers particularly vulnerable.

"Unfortunately, employers simply do not run the same checks for contract staff as they do for full-time staff," said Brown.

"And yet the risks are

enormous. For instance, most employers would know where their company cheque books are at any given time, but few might know precisely who has access to their electronic payments link to the bank."

Equally, outsourcing certain functions can increase the risk of fraud. "If you are working with somebody on an outsourced basis or you are employing people through recruitment agencies, check the contract so that you are clear about where the risk lies, should fraud occur," he said. "People often think the agency will compensate them if somebody they supply does something criminal, but you might find by reading the small print that they don't."

Purchasing arrangements are a notoriously weak link in a company's defences.

"Be vigilant about ensuring you are getting the best price for everything you buy.

Put in place good tendering procedures so that you always get two or three quotes for each transaction. Moreover, ensure that you split functions so that no one person is responsible for ordering, receiving and paying for goods," said Brown.

Businesses must also have clear fraud prevention and detection policies in place.

"Small firms are particularly vulnerable here. Very often personnel are so taken aback when they discover something untoward going on that it can take them longer to take action, increasing the damage done. Nominate one person to take responsibility for fraud and prepare a policy so that they know precisely how to proceed when it occurs," said Brown.

Good personnel management is important too. In Brown's experience, by far the most common perpetrator of internal fraud is a staff member who is experiencing financial troubles, with the cost of divorce and gambling problems among the main causes.

"In cases where you suspect somebody is in difficulties, step in and ask if there is anything you can do to help. Such actions on the part of management build loyalty and improve morale," said Brown.

"This type of intervention can make all the difference because it helps build staff loyalty.

"Poor staff morale is in itself an important indicator of fraud because, where it exists, people who see an opportunity for fraud can more easily convince themselves that what they are doing is not unreasonable.