Keeping Honest People Honest

One Friday afternoon, the president of a large window replacement company on the West Coast discovered something strange. The employee managing HR came to him with a check stub found in the file of a health savings account. The check was a reimbursement for out-of-pocket medical expenses, and had been written by the company’s accountant to the company’s accountant- i.e., from the accountant to herself. Called in to explain, she dismissed it as an innocent mistake, a matter of momentarily forgetting established protocols. But her body language said something else.

The president of the company spent that weekend in the office going through two years worth of records and receipts. What he discovered was a pattern of small thefts. For instance, the accountant had transformed a $30 invoice for installer supplies at The Home Depot into a $230 invoice by having the installers purchase, in addition to the supplies, two $100 gift certificates, which she gave to ... herself. The accountant also had her family’s phone bills paid on the company’s Verizon account, and her family members routinely filled their gas tanks with a company credit card. In one instance, the company had been invoiced and paid for the beverages at her daughter’s wedding shower. Expenditures ranged between $200 and $1,000, and by the time the owner had calculated the total, it was somewhere between $40,000 and $50,000 in a two-year period. 

Smaller Means More Vulnerable

Freedictionary.com defines embezzlement as “the crime of stealing the funds or property of an employer, company or government or misappropriating money or assets held in trust.”
You might imagine that it’s something only large companies have to deal with. But stories like the one above occur for businesses of all kinds. What’s different, though, is that embezzlement is especially damaging to small businesses, which are both the most likely targets of embezzlers and the least capable of sustaining the damage that results.

Two patterns are typical. There’s the embezzler who steals a big chunk of money and disappears. That’s the type dramatized in movies (think Psycho). Far more common, according to Cornell University’s Legal Information Institute, are embezzlers who skim off the top “so that they continually acquire a small amount over a particular time interval. This reduces the likelihood of being caught.”

Small businesses are vulnerable because many have few, or inadequate, controls in place. A recent story in Entrepreneur cites an insurance company survey showing that “80 percent of embezzlements occurred at small businesses.” A recent study by the Association of Certified Fraud Examiners found that small businesses (less than 100 employees) had a 28.8 percent occurrence rate, compared with a 19.8 percent rate at large companies.

If the amount of money is big enough, the theft can hobble a small business financially for years, especially because there is little hope of recovery. For example, in 2010, James P. Koumjian, bookkeeper for window and insulation company Huff N Puff/Renewal by Andersen of Eastern New York, in Schenectady, pleaded guilty print to three counts of third degree grand larceny and “agreed to restitution in the amount of $487,000.” Second generation owner, Eric Minkiewicz, described to the court “massive personal losses and mental anguish as a result of Koumjian’s action.” That embezzlement, by someone Minkiewicz “still referred to as ‘Jim,’” nearly put the company out of business.

Here’s how it often happens. Someone with access to or control of funds (or other assets) devises one or more ways to appropriate them for their own use. The most common methods are check tampering, phony invoices, credit card misuse, altering deposit statements, and pocketing petty cash. The result is a slow drain of money from the business into the pockets of the thief.  

A look at cases of embezzlement from small companies in which charges were filed and media coverage resulted shows that this type of stealing spree is detected after a few years, often because the thief becomes careless or greedy enough to arouse suspicion. Studies find small business embezzlers are more likely to be female (64 percent), working in finance, bookkeeping, or accounting (66 percent), and acting alone (84 percent).

Use These Controls To Prevent It 

Nothing will make your company embezzlement proof, but there are ways to reduce the possibility of its happening to your company. All of them involve heightened levels of vigilance - in other words, simply paying attention. Certain procedures and systems, some specific and some general, will also substantially reduce the possibility.

First, conduct a criminal background check when you’re hiring someone to manage your company’s money. John Tschohl, owner of Service Quality Institute, whose bookkeeper was convicted of stealing $330,000 from his company, never conducted a criminal background check. He must’ve thought he could trust her, since it was a matter of promoting from within: from assistant bookkeeper to bookkeeper. “Had Tschohl conducted a criminal background check of Scholz prior to hiring her, he would have learned that she had previously been convicted of credit card fraud while working for a Bloomington auto glass business,” notes the The Sun (in Apple Valley, MN). That’s the reddest of red flags when it comes to managing money.

Second, conduct a credit check if handling money is part of the job, whether you’re hiring from outside or promoting from within. “If you are planning to hire a new employee for a position that includes handling money, credit card information, or valuable equipment or inventory, it may be a good idea to obtain a credit report on applicants before extending an offer of employment if it is permitted in your area,” says an article at datacheckinc.com, a company which conducts background screening. “Identifying people who have a lot of debt and are irresponsible may help you avoid hiring employees who steal or misappropriate funds belonging to the company or clients.” If that person’s going to be managing your company’s money, shouldn’t they be capable of responsibly managing their own?

Third, set up controls that divide responsibilities for money management tasks among multiple employees. That automatically establishes a level of accountability, since embezzlers tend to work alone. For instance, a story at thebalance.com suggests that “the employee who writes the checks should not be the employee who reconciles bank statements.” Make separate functions out of opening the mail and posting the mail, signing checks and distributing checks, and other money-related tasks, and make sure that one employee is not responsible for both handling and recording cash. Cross-train employees in how to perform these duties and have them rotate. 

Fourth, discourage temptation. Don’t be shy about letting people know that you’re keeping an eye on things. “Make unannounced internal audits and have a yearly audit performed by an outside firm,” suggests Score, a nonprofit “dedicated to helping small businesses get off the ground.” Set aside time to check monthly company credit card statements. Check bank deposit statements at least monthly with an eye to unusual amounts, discrepancies, or suspicious patterns. 

Fifth, maintain a proper professional distance, even with trusted employees. “Small business owners have their guard down around trusted employees,” writes Lynne Terry in a story in The Oregonian describing a couple whose longtime bookkeeper pilfered at least $160,000 and put their plastics manufacturing business into debt for years. “They expect them to be loyal. They don’t put double-checking procedures in place. They’re lax on supervision.” 

Lesson Learned

In the case of that West Coast window replacement contractor, before confronting his bookkeeper he called the local Sheriff’s Department “to notify them that there was evidence of larceny.” He “gave them some evidence and received a business card with the case number written on it.” At an early morning meeting the following Monday with the bookkeeper, he demanded answers. In response to her various denials, he pointed to the piles of evidence on the desk and showed her the business card with the case number on it. Eventually he was able to recover $40,000, which the thief obtained by emptying her 401(k).

That California window replacement contractor almost immediately engaged an outside firm to, from that point forward, reconcile the checkbooks and bank statements at the end of each month. “What I realized,” he says, “is that we as owners are so preoccupied working in the business that we don’t step back far enough to be able to monitor what’s going on.” His suggestion is to “get a second or even a third person to examine the checkbooks and reconcile bank statements. You have to have systems and processes in place to keep honest people honest.”