Small business owners are often aware of external fraud threats, such as shoplifting, bogus vendor invoices, phishing scams and cyberattacks. But some scams are committed by people inside your company. Fraud schemes perpetrated by employees can be especially difficult to detect — and costly. Here's a recent example that highlights common embezzlement methods and tips to protect your company from similar schemes.
The U.S. Justice Department in New York, the FBI and other law enforcement agencies issued a joint press release in early 2024, announcing charges against five defendants for allegedly embezzling roughly $7 million from an IT company. The defendants purportedly used corporate expenses for their personal pleasure, benefited from no-show jobs, and committed other legal violations and frauds between May 2010 and February 2019.
One defendant was a senior account manager who facilitated work involving a particular client, the subsidiary of a global financial institution. He was responsible for oversight of the contract's performance, including approving payment on invoices submitted for work done on the client's behalf. The manager used his influence to persuade the subsidiary to hire his family members, friends and subordinates. Many of these individuals — including a schoolteacher, a homemaker, a police sergeant and a construction industry manager — lacked apparent qualifications to perform deskside IT work.
The account manager allegedly conspired with these workers to commit various crimes. Specifically, the workers falsely reported they'd provided services under the contract and had incurred business expenses. This was reflected in fraudulent invoices and artificially inflated management fees. Examples of purported business expenses incurred by several co-conspirators, and ultimately paid for by the client, are restaurant meals, hotel stays, transportation fees, a cruise and entertainment at gentlemen's clubs. These were personal expenses that can't be reimbursed, not legitimate business expenses.
Furthermore, to circumvent the client's expense policies, the account manager charged some of his personal expenses to credit cards in the names of co-conspirators. For example, he used the credit cards to pay for private car services for personal travel to restaurants, cigar bars and gentlemen's clubs; for his children to visit family; and for friends to attend parties at his residence.
Additionally, three defendants have been charged with tax fraud. Because the falsified expenses were personal in nature, they should have been reported as income to the IRS. Failure to report these amounts as income allegedly resulted in an underpayment of taxes for the years in question.
Embezzlement comes in many forms, so pinpointing potential internal control weaknesses can be difficult. However, bookkeeping procedures are a good starting point. Separation of duties and management review are essential antifraud controls.
For example, assign separate employees to handle accounts payable and accounts receivable. In addition, at least two employees should handle the main payroll duties — one to write the checks and the other to distribute them. If one person is assigned both tasks, it may create an opportunity for embezzlement.
Business owners also should approve all checks over a specified amount after reviewing an original invoice, not a copy. Monthly bank reconciliations and external financial statement audits further reduce the risk of embezzlement and help detect fraud.
If anomalies are found, you can hire a forensic accountant to investigate the matter. These professionals understand how to examine accounting records and interview employees to preserve evidence. If an investigation reveals illegal activities, your forensic accountant will work with your legal advisor on the appropriate course of action. This may include terminating the perpetrator, contacting the authorities to prevent the wrongdoer from stealing from another employer, and seeking civil and criminal legal remedies. For example, you might sue the embezzler or file an insurance claim to recover the losses.
No matter how much you trust your employees, no business is immune to embezzlement. Strong internal controls are critical to preventing and detecting these schemes. Contact your CPA to help reinforce your company's policies and procedures and investigate any suspicious behaviors.
Embezzlement happens when an employee working in a position of trust or responsibility steals cash or other assets from his or her employer. For example, it may be committed by a corporate officer who has discretionary control over the employer's bank accounts. It also may involve sophisticated methods for siphoning away money from the business.
The following four factors must exist for an embezzlement charge to be punishable by law:
Some embezzlers take all or most of the assets at once. More often, however, criminals steal small amounts over time, frequently becoming bolder after each successful attempt. The methods used for embezzlement may range from fraudulent billing and counterfeit payroll checks to Ponzi schemes.
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