Professional Services Accounting ARTICLE -
How to combat occupational fraud

Target Audience: Legal Professionals, Professional Service Firms, Law Firm Partners, Law Firm Marketing, Law Firm Marketing Directors

In tough economic times, it’s not surprising that occupational fraud can become more common, but it’s a significant problem even in the best of times. Participants in the 2010 Report to the Nations on Occupational Fraud and Abuse, a global fraud survey administered by the Association of Certified Fraud Examiners (ACFE), estimated that the typical business worldwide loses 5% of its annual revenues to fraud, for a potential total fraud loss of over $2.9 trillion. The median loss in U.S. organizations is $105,000 — but this rises to $150,000 in smaller companies (less than 100 employees).

Because of those high numbers, it’s critical that law firms keep an eye out for possible fraudulent schemes in their firms. By understanding how occupational fraud schemes work and recognizing the red flags, you can reduce the odds of being victimized.

Types of occupational fraud

Occupational fraud typically falls into one of the following categories:

Asset misappropriation. In these schemes, the perpetrator steals or misuses the firm’s resources. Common examples include false invoicing, payroll fraud and skimming.

Corruption. This refers to schemes where the perpetrators use their influence in business transactions to obtain a benefit for themselves or someone else, thereby violating their duty to their employers. For example, employees might receive or offer bribes or extort funds from third parties.

Financial statement fraud. This type occurs when a perpetrator arranges for the intentional misstatement or omission of material information in the firm’s financial statements. It usually takes the form of fictitious revenues or concealed expenses or liabilities that make the firm seem more profitable than it really is.

Fraud triangle

Regardless of the type of scheme, occupational fraud generally occurs only when certain conditions are present. Experts call these conditions the “fraud triangle,” and it’s composed of:

• Motive. Typically, perpetrators feel some type of pressure. It could include pressure to meet their firm’s billing goals, fund an extravagant lifestyle or cover costs related to gambling or substance abuse.
• Opportunity. This can result from inadequate internal accounting controls, poor employee oversight or ineffective audits. In law firms, partners typically have the greatest opportunity to perpetrate fraud because they usually operate with more autonomy and may be in positions to override internal controls. Their direct client contact may allow them to detect client suspicions and head them off by diverting funds and replenishing clients’ accounts. For example, litigators can divert settlement funds, and real estate partners might divert sale or mortgage proceeds.

Of course, nonattorney staff may have opportunity, too. Associates or support staff can forge their bosses’ signatures or exploit other flaws in the firm’s internal controls (or lack thereof) to misappropriate funds.

• Rationalization. This condition is necessary because perpetrators must be able to mentally justify their conduct. They might tell themselves that they’re only borrowing the funds, that the firm can afford the losses or that the firm owes them more for their hard work.

It’s worth noting that a perpetrator can be just about anyone. Globally, the ACFE has found that most fraud perpetrators are men and are college-educated, and more than half are between the ages of 31 and 45 — employees who have experience and, in turn, authority and access to firm resources. However, the median loss for schemes increases with the age of the perpetrator. Interestingly, most perpetrators are first-time offenders, and in every region except Asia the greatest number of frauds occurred in the accounting department, where check tampering and billing fraud were the most common schemes.

It can be a mistake to concentrate on only lower-level fraud. Both globally and in the United States, executives and upper management constituted only about one-sixth of the perpetrators, but the median loss they caused was more than three times that of managers and over nine times that of employees.

Preventing fraud in the firm

Law firms of all sizes can take several simple steps to minimize the risk of occupational fraud. Primary among them is to forbid even partners to override internal controls other than in rare and well-defined circumstances.  In addition:

• Segregate accounting duties, especially for executing outgoing checks,
• Review returned checks for double endorsements or handwritten changes,
• Send bank statements to the managing partner’s home,
• Require employees to take vacations of sufficient length that irregularities would become apparent during their absence,
• Perform unscheduled audits of practice areas whose clients are unlikely to closely scrutinize their bills,
• Look for pattern changes, such as steep increases in the number of or amount of payments to a vendor or supplier (who could be fictitious or a related party), and
• Compare addresses of vendors and suppliers with addresses of employees.

Finally, employees, clients, vendors and suppliers are often the first to suspect or witness fraud. Establish an anonymous tip line that they can easily use to report their suspicions or evidence.

In fact, the ACFE reports that tips have historically been the most common means of detection, with the latest study indicating that they caught nearly three times as many frauds as any other form of detection. Train employees to recognize fraud and encourage them to report illegal or suspicious behavior confidentially. And periodically check with vendors and suppliers to ensure they’re being paid. Investigate any past-due notices to determine whether the funds intended to pay them were diverted.

Proceed with caution

Simply having a suspicion about an employee or vendor doesn’t provide enough cause to act. Before stepping out and accusing someone of misdeeds, ask a qualified fraud expert to help you investigate. When and if it’s necessary, the expert can assemble evidence, interview employees and testify in court.

Pay attention to these red flags

According to the ACFE, those who commit occupational fraud exhibit some common behaviors. In the U.S., financial difficulties and/or living beyond one’s means were the most common indicators, appearing in nearly 45% of the cases. Other indicators included:

• Control issues — an unwillingness to share duties;
• Divorce/family problems;
• Wheeler-dealer attitude;
• An unusually close association with a vendor;
• Irritability, suspiciousness or defensiveness;
• Addiction problems; and
• Past employment-related problems.

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