In an economic downturn, small firms find themselves hit by more incidents of in-house larceny. Here’s why – and what to do about it.

First, the statistics. The Association of Certified Fraud Examiners looked at 959 cases of in-house fraud and embezzlement, and came up with the following conclusions:

• The median loss in this study was $175,000.
• The typical period between the time of the first act of fraud and the time someone was caught was two years. In other words, most of the instances of theft went undetected for long periods.
• Most of the thefts were committed by first-time offenders – people who appeared squeaky-clean prior to getting caught. Only 7% of fraud perpetrators in the study had prior convictions, and only 12% had been previously terminated by an employer for fraud-related conduct.
• Most of the perpetrators were caught as a result of tips from employees or others, rather than by audits (more on that below).
• Most of the victims were small businesses – who thought their size was an advantage for keeping track of cash and the people who handle it.

To make matters worse, in-house fraud and embezzlement tend to worsen as the economy worsens, for at least two reasons:
1. Cash-strapped employees get desperate and are more likely to scheme against their employers.
2. Layoffs tend to leave holes in the usual controls designed to prevent fraud.

What to do about it
The ACFE study examined what might have been done to prevent fraud in the 959 cases:

• Look for it in the obvious places. Fact is, fraud and embezzlement usually take place exactly where you’d expect: your accounting department that handles the money. There are variations of fraud and embezzlement – some in billing, some in accounts payable and so on. But no matter the variation, the problem usually exists in the accounting department.
• Use checks and balances as much as possible. As mentioned above, many instances of fraud were uncovered as a result of tips: one employee’s noting misdeeds by another. (In a minority of cases, the tips came from customers, vendors and others.) One suggestion: Use cross-training and job rotation, so that one employee isn’t solely responsible for one area all the time.
• Use surprise internal audits. Big, planned audits or those conducted by outsiders are effective and have their place, but the surprise internal audit remains the most effective deterrent and means of detection.

You can download the full 68-page report in PDF at www.acfe.com/documents/2008-rttn.pdf