Cash: The Favorite Target of Fraudsters

By Thomas A. Buckhoff

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Case Studies

As a sales representative for a medical supplies vendor, “Mark Price” sold medical supplies directly to doctors at local hospitals. Mark had a falling-out with his employer and was fired. Mark continued to work with the hospitals as if he were still a representative of the vendor and hand-delivered false invoices printed on stationery he had kept after his termination. One hospital refused to pay the false invoices because receipt of the invoiced items could not be verified. Another hospital, which did not have an organized system for keeping track of incoming supplies, paid the false invoices by giving checks directly to Mark, rather than mailing them. Using an endorsement stamp from his former employer, Mark stamped, dual-endorsed, and deposited the checks into his personal bank account. Mark stole about $200,000 in less than a year before his scheme was discovered.

As a hospital employee, “Linda Jones” was responsible for receiving, recording, and depositing incoming payments from insurance providers and patients. For three years, Linda exploited these incompatible responsibilities and diverted cash to herself. Stolen checks were either swapped for cash internally or were dual-endorsed and deposited directly into Linda’s personal bank account. She concealed her fraud by recording the stolen funds as a “charity write-off.” Linda’s fraud was discovered when some clients questioned why some payments never appeared on their statements and the dramatic increases in the charity write-off account could not be explained. After a lengthy investigation, Linda was convicted and sentenced to prison.

Effective Fraud Prevention

Organizations should develop and implement formal programs for safeguarding cash. Because fraud losses are estimated to be about 6% of gross revenues, the savings from such programs can far outweigh the costs.

Segregation of duties. When one person controls multiple phases of a transaction, the risk of fraud increases dramatically. Frauds involving such collusion are rare: 70% of all frauds are committed by one person acting alone.

To determine whether employee responsibilities are incompatible, divide business transactions into four phases: authorization, execution, custody, and recording. The authorization phase requires one employee to direct another employee to initiate and execute a transaction. The execution phase requires an employee with authority to initiate a transaction; for example, when a doctor places an order for supplies from an approved vendor. Custody is the actual possession of the asset. Recording requires adjusting a company’s accounts to reflect the effects of the transaction. Employees whose responsibilities encompass two or more phases of a transaction can divert cash into their own pockets. When opportunities to commit fraud exist, someone has likely already exploited them. The role of fraud investigators is to determine the extent of the losses.

Controls over cash disbursements. The most effective way to prevent theft of cash disbursements is to segregate the duties of preparing checks (an authorization duty) and signing checks (a custody duty). Before preparing checks, the employee should verify that the items listed on the vendor invoice were both ordered and received. Copies of purchase orders and receiving documents should be made and forwarded to the person responsible for preparing checks. The check signer should carefully review the check, along with the supporting documentation; mark supporting documentation as paid, with the date and check number; and control the delivery of the check (i.e., do not return a signed check to the person who prepared it). Finally, a third person should review all cancelled checks and perform monthly bank reconciliations.

Adhering to basic controls over cash disbursements can easily prevent fraud schemes such as the example of Mark Price. Organizations without organized systems for keeping track of payments and receipts are breeding grounds for fraudulent activity.

Controls over cash receipts. The most effective way to prevent theft of cash receipts is to segregate the duties of cash handling and recording. For example, two people together should open mail containing incoming cash. One person prepares a detailed remittance list, which then is used to adjust appropriate account balances. The other person handles the cash, prepares the deposit slip, and deposits cash receipts into the bank as soon as possible. Finally, a third person should reconcile bank statements, deposit slips, and remittance lists.

The case of Linda Jones, described above, demonstrates how an individual with a custody duty can steal incoming cash and then conceal it through a recording duty (the false entry in the accounting system). A segregation of these duties makes it difficult for a dishonest employee to steal the organization’s cash.

Background checks. About 30% of employees intend to steal from their employers from the first day they are hired. Typically, such employees have questionable backgrounds. A background check should include independently checking criminal records, driver’s license records, civil and federal court records, references, credit reports, employment history, and education records. Those with questionable backgrounds are high-fraud-risk employees. If hired, they should not be placed in positions where they would have access to cash.

Fraud hotlines. Most frauds are known to others within the organization and are discovered by receiving an inside tip or complaint. A fraud hotline can effectively uncover and prevent fraudulent activity. Fraud losses tend to snowball over time: Organizations with fraud hotlines can cut their fraud losses in half. Few people will commit fraud if they think they will be caught. Well-publicized fraud hotlines strengthen the perception of detection and let employees know the organization does not tolerate fraud.