Fraud

Employee or Contractor Fraud
The reliability of your staff cannot be taken as a given. Employee fraud does happen, often when you least expect it. There are a range of measures you can take to protect your business against and effectively manage fraud from hiring, controls, managing actual fraud and firing/dismissing your employee.
Wayne Merry
January 29, 2020

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One of the greatest dangers to your business is the trustworthiness of your staff – both employees and contractors. Double if they handle your money or accounts. Having a significant fraud in your business will be very challenging. In some cases, viable and strong businesses fail due to employee fraud. In this overview post, we will consider how to avoid fraud in the first place, what to do when you first detect it, how to recover from it and how to account for it.

Avoiding employee fraud

Due diligence in hiring

It is critical that when you hire, you do background checks. People outright lying on resumes is far too common. A “false positive”, i.e. hiring someone that you should not have, can really hurt your business. This is true of any role in your business, but it really counts when your hire has a finance role. Check out Manager Tools’s podcast episode for advice on questions to ask referees. If you are hiring for a finance role, does the candidate claim to have a professional accounting membership? If so, get their membership details and confirm it with the professional body.

Internal Controls

Controls can seem like they get in the way of you running your business. Without them; however, you might not have a business. Accounting and finance controls have a principle purpose is to protect you from fraud. Some of the controls you may wish to consider:

  • processes to deal with invoices received, matching to suppliers, purchase orders
  • who can access business monies. It is best if possible to have different people do bookkeeping and handling money. As your business grows, segregate accounting and finance roles further
  • who can issue invoices to your customers and how customers can pay you
  • purchase orders to control significant or regular purchases
  • procurement or credit cards to control smaller purchases or when employees travel
  • managing any cash in your office using a petty cash impress system
  • have a comprehensive data backup in place
  • ensuring finance staff take regular holidays and someone else does their role when they are gone

All of these procedures improve the structural integrity of your business. The larger the scale or complexity of your business, stronger controls need to be.

Detecting fraud

Fraud, especially sophisticated fraud, can be challenging to detect. People that are experienced at fraud may go to great lengths to cover their tracks and to lie. Whenever your segregation of duties policy is breached – even when it really had to be, when someone has not taken holidays for a long time, or someone who should know how to do something seems to struggle, then be on the lookout.

Most employee frauds are uncovered when some change happens that the fraudster did not expect. Perhaps it is an unexpected audit. Perhaps they got sick. It can happen because a hole develops in their web of lies that they build to perpetuate their fraud.

Initial steps in dealing with employee fraud

Act quickly, but hasten slowly!

When you first become aware of fraud:

  • take “no fault” measures that stop any additional fraud from taking place. This could include making computer login accounts inactive or suspending access to cloud services and the like. If the fraud is in your payment processes, it is unlikely to materially affect your business if you halt payments for a day or so – known essential invoices excepted. All of these processes don’t need to be explained in an accusational way. They instead can be explained along the lines of “irregularities have been detected and we need to understand better what they are”
  • don’t immediately confront your employee or contractor. First, gather your facts. If you have put in place controls as highlighted above, then it likely you will be able to access data to assist you in understanding the situation. It is likely through this process that it becomes increasingly clear that it is a fraud, or there was an innocent alternative explanation.

Firing a fraudulent employee

Once you are reasonably satisfied that fraud is taking place, now is the time to act. There is no value in retaining an employee or contractor that has breached trust with you and your business in this way.

Contracts

Employee malfeasance generally trumps any contract provisions regarding termination for cause or notice periods. You have to have acted reasonably in order to rely on this, however. By gathering the facts earlier and making effort to discount alternative explanations, you will be in a much stronger position to demonstrate that you have acted reasonably.

Due process and unfair dismissal/firing

Your obligations to act reasonably also extend to the firing process. No, an SMS is not sufficient! You must provide procedure fairness to your employee. Most jurisdictions provide minimum requirements in order for you to avoid an unfair firing or dismissal claim:

  • Consider a two meeting format. At the first meeting put the accusation to the employee and allow her or him to respond. At the second, proceed to the firing
  • If the employee admits to the fraud at the first meeting, you can move immediately to dismissal/firing. Make sure you make detailed notes of what they confess.
  • The employee should be given opportunity to respond to accusations. This includes allowing them some time to gather their thoughts to consider the information, or seek outside advice
  • When accusations are to be made, or firing/dismissal is to be discussed, ensure that your employee has the opportunity to have a support person present. Make them aware of this option before discussing the accusation or potential firing. If the employee chooses not to take up these options, take detailed notes of this

Recovering from fraud

Lock down access

Ensure that all accounts, logins and access that the employee has are made inactive. If you use company accounts on your cloud service, then you can use that account to revoke access. There will be additional pain if your employee was the master user for any accounting, data or document storage services in your business. You may have to copy this data off that service and create a new one and/or rely on your backups if you allowed your business to be exposed in this way.

Employee fraud is a crime and criminal penalties apply

Report the fraud to the police

Report the fraud. It is not about being vindictive or hoping the perpetrator goes to jail, but it is about both protecting the community and the reputation of your business.

Build a brief of evidence for the police. Consider including the following:

  • Particulars of the fraudulent employee: Name, address, contact details, date of birth, summary of HR records
  • A summary of the fraud: Times, places, and parties involved
  • A summary of the supporting evidence
  • Copies of key documents that support the accusations. If the police need more documents, they will ask for them. If they wish to lay charges, they are likely to want a comprehensive set of records
  • A summary of action that you have taken against the employee. Disclose any civil action you plan to take

Tax treatment

The tax treatment of fraud can vary widely. It depends on the circumstances of the fraud and if any recovery is possible. In general, tax treatment is like a bad debt. Only deduct the debt write-off when the prospect of recovery is remote.

Additional resources

CPA Australia have a useful PDF document about employee fraud, which can be found here.

Summary

The reliability of your staff cannot be taken as a given. Employee fraud does happen, often when you least expect it. You can help protect your business against and effectively manage fraud through:

  • Doing due diligence when hiring
  • Implementing internal controls across your business
  • Being aware when people’s circumstances change that frauds can be revealed
  • Protecting yourself quickly against discovered fraud. Make sure to catch your breath before making accusations
  • Providing procedural fairness when confronting or firing your employee
  • Reporting the fraud to police
  • Claiming fraud losses when possible as tax deductions

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