A one-time trusted employee at a Long Island manufacturing company was caught fudging tracking numbers after she booked a quote as a valid sale, then booked it again when the sale actually took place.
She pulled a double whammy," said Yigal Rechtman, principal of forensics and litigation at Grassi & Co. in Jericho, who helped the company uncover the fraudulent activity. "Nobody paid attention to the fact that the first time instead of using the invoice number she gave the quote number," Rechtman said. "People saw the number and assumed there must be a document out there somewhere that reflected this agreement."
The investigation that followed revealed the employee wanted the company to be above the rest of the competition. "This was with no motivation other than ego," said Rechtman, noting other common reasons behind such schemes include individuals looking for a bigger bonus, a promotion or inventory to sell.
In another instance, John Shillingsford, a partner at AVZ in Hauppauge, was on a consultation engagement and uncovered an employee had set up a separate bank account and had customers wire funds directly into it.
"This was a sizable manufacturer with relatively small products so there were small dollar amounts over seven years where she was basically getting money into this account," Shillingsford said.
They want the goods
Fraudulent stories like these are common in manufacturing companies, according to the 2016 Report to the Nations on Occupational Fraud and Abuse by the Association of Certified Fraud Examiners. The report ranks the manufacturing industry third in terms of the frequency of fraud cases among all U.S. companies. The report also listed the median loss of the fraud for manufacturers as $194,000, compared to $120,000 for all U.S. companies.
"What sets manufacturing apart is the movement of the goods - when there is more movement there could be potential for fraud," said Matthew Jahrsdoerfer, an audit principal at Berdon in Jericho. "I think it has a lot to do with products that people can use in their daily lives. It just gives more incentive to potentially commit fraud or theft whether it's technology or electronics, apparel or food and beverage. These are things there is a market for so if someone wanted to resell it or use it for personal use that's an option."
Setting up controls
To help combat fraud, companies should create strong internal controls and oversee their manufacturing process on a regular basis.
"The reason why fraud is so high in the manufacturing environment is the lack of segregation of duties, which certainly does not bode well when talking about good internal controls and certainly provides opportunity," Shillingsford said. "Internal controls need to be reviewed regularly and need to be assessed on where they can be improved. Hopefully this will mitigate or at least minimize fraudulent activity that may occur."
Performance-based incentives with lack of oversight and a pressure to meet budget can also spark fraudulent behavior. "If the goals that are set by higher-up management are not achievable and employees can't achieve them without the proper resources they may feel the pressure to meet those goals at any cost," Shillingsford explained.
Looking for red flags
Learning to recognize red flags can alert companies of possible fraud, experts say.
"When shrinkage fluctuates you want to really look into it," Jahrsdoerfer said. "There is always an element of shrinkage in the manufacturing process but shrinkage is something that should be relatively consistent in the process when making a certain item. A reasonable amount is expected but this is an area where sometimes people write off things to shrinkage when there are really other things involved."
Other things that can signal a problem include declining margins and high volume of slow-moving inventory, where companies have too much inventory, Jahrsdoerfer noted.
"This is when someone purchased inventory that they should not have and somehow they are benefiting from that," Jahrsdoerfer said. The employee "could be getting a kickback, or a vendor is looking to move inventory they can't sell to anyone so they induce a purchasing agent to purchase inventory that the company does not need and maybe the agent benefits from that."
Sudden changes in numbers are also a warning sign, Rechtman said.
"If the company has a spike in sales and a spike in assets, I'm going to question it," Rechtman explained. "I want to know what was done differently this year. It is possible they did something real. Maybe they opened a new office, which, of course, made revenue and assets go up. But if they come up with an answer I don't believe, I will question it."
Changing things up
Being proactive can ward off fraudulent behavior.
"At a bare minimum companies should be rotating employees into different functions so someone else is also doing the job and can see what changes occur," said Craig Savell, co-managing partner at Margolin, Winer & Evens in Garden City.
"Another thing that often pops out in fraud is lack of vacation," Savell said. "An owner may think they have a terrific employee because the guy doesn't ever want to take vacation. However, the reason that they may not want to take vacation is the second they are away they can't cover up what they have been doing."
Owners should make it a prerequisite that people take vacation, Savell advised.
"You'd be shocked at how many times that is the thing that uncovers fraud because the two or three weeks that the person is not in the building you see a change in habits," he explained. "For example, you don't get orders from a particular vendor or something else changes."
When dealing with vendors, companies should have a very comprehensive process of approving a vendor before that vendor can be added to the list, Savell added.
"If it were my warehouse manager - no matter how long he or she has been with the company - they should not have the authority or sole discretion to add a vendor. A new vendor should be vetted by another person."
Additionally, business owners should always check that their vendors are a real company and should assign two separate people in the warehouse - one to validate what was ordered and another to validate what has been received, Savell said.
Redirecting where bank statements are sent is another preventive measure, Shillingsford said.
"It is not uncommon for bank statements to go to the bookkeeper/controller," he noted. "A very simple internal control procedure would be to have bank statements go directly to the owner's home or directly to a P.O. box, which is maintained by the owner of that company. It is a very simple thing to do."
To ensure employees are mindful of accurate record-keeping, Shillingsford recommends owners/senior management include surprise audits of their operation during the year. "We will sometimes come in unannounced to look at certain areas," he said.
Jahrsdoerfer has seen physical security reduce fraud for his clients, as in one occasion where a large apparel warehouse saw its margins weren't making sense.
"They weren't making the money they thought they should be making," Jahrsdoerfer said. "A couple of hundred people worked there and what the company decided to do was put in physical security, including cameras and locks on doors, and distribute key cards for people to get in and out. Then the issues stopped happening. While they never actually figured out who was doing it the big thing there was the physical protections definitely deterred whatever issues were going on."
Setting a good example
Owners who set a positive example for their employees and provide a fraud tip line experience less fraud, Rechtman noted.
"The tone at the top is the No. 1 tangible thing you can do," Rechtman said. "Ask yourself if you are sending the right message - not with what you say, but with your behavior. If the tone is, 'I want full accountability. I want excellent performance. I will not tolerate slack on my team.' If the owner sends that tone it will be mimicked by the employees."
On the other hand, if an owner shows up late for work, takes an extended lunch and leaves early, employees will do one of two things,
Rechtman noted. "Employees will start stealing from the company - be it time or some way of getting into the assets. Other top managers will also want to get into the action and may try and fudge the books and go to the owner and say we want more money, better bonuses and so forth."
Tip lines work
With the ACFE reporting that tips from individuals accounted for 40 percent of discovery of fraud in 2016, Rechtman said every company should have a fraud tip line.
"This is the No. 1 way to discover fraud, and companies should open an anonymous tip line," he said. "Even if it's just setting up an 800 number that goes directly to your lawyer."
Best practices with regard to fraud prevention include hiring issues, Shillingsford said.
"That criminal background check, general background check and credit check should be done on people being considered for a position in the company, especially where finances will be involved," Shillingsford said. "It doesn't take much to do a background check. There are companies out there that will do it for you and for the minimal cost, somewhere probably between $75 and $150, you can save yourself the agony of losing a couple of hundred-thousand dollars of defalcation costs."
In most cases, fraud lasts for an average of 18 months before detection and is carried out by an employee often considered a "member of the family," according to ACFE.
"We come in after the fact," Rechtman said. "By the time we come in a lot of people get fired, which is a mistake. You don't want to do that. You want to whistle Dixie all the way to the bank and back."
If fraud is suspected, companies should call their accountant right away and not give a hint of any kind of problems, Rechtman stressed.
"Do not give the perpetrator time to destroy evidence," he said.
"It is amazing how vast fraud is and how often it happens," Savell said. "A lot of businesses take the attitude that 'I have good people - these people have been with me forever.' Avoid this false sense of security because every person who experienced fraud will tell you, 'We didn't think it could happen here.'"