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Set tone from top to reduce exposure to fraud

Entrepreneurs often go wrong when it comes to fraud by looking out instead of in.

"It's easier to think of the external people we do business with as potentially hurting our business than it is our own employees," said Mike Savage, leader of Ernst & Young's fraud investigation and dispute services practice group.

But the truth is that internal fraud – whether it's expense-account related, accepting kickbacks from suppliers or simply pocketing cash from the register – is a harsh reality for many business owners, large and small. In fact, a 2009 KPMG report found that 69 per cent of fraud cases were internal jobs, 20 per cent were external and 11 per cent involved both insiders and outsiders.

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With an estimated $67-billion in funds lost annually in Canada, no business can afford to ignore the possibility of fraud, said Rock Lefebvre, vice-president of research and standards at the Certified General Accountants Association of Canada.

It's critical for entrepreneurs to consider the potential for fraud as their businesses evolve, Mr. Savage said. "As an organization grows, it's exposed to more and more people. At some point, your organization is going to be exposed to a fraudster and you want to mitigate that risk."

The good news is that there are a number of steps entrepreneurs can take to reduce exposure, aside from simply hiring a good accountant.

The first thing, said Mr. Lefebvre, is to lead by example. "You must create an environment where fraud is discouraged, a moral tone that dictates that everything is done and aligns with ethical standards," he said.

"You set the tone from the top," Mr. Savage explained. "It's very hard to expect your staff not to cheat you when you're instructing them to cheat customers or the tax man."

But it's not always going to be so extreme, he added. In most cases it doesn't even involve illegal behaviour. "Some actions, while not illegal, may still be activities that the employer considers undesirable."

Take accepting expensive gifts from potential suppliers as an example of questionable conduct. Business owners certainly are not breaking any laws by doing so. But they can't turn around and ask staff not to do the same thing.

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Next is to establish internal controls around accounting and procurement, no matter how small the business. For businesses with limited resources, a risk assessment is in order. "Focus on the assets that lend themselves to being stolen and put your procedures around those," Mr. Savage said.

An example of an effective financial control is segregation of duties, or assigning tasks so that one employee performs a particular duty and another completes it. For example, "have one person write cheques and another record that entry in the cash book – one would be a check on the other," Mr. Savage said.

The reality for many small businesses is that there simply are not enough staff for such labour division. "They should try to segregate duties in this manner as much as possible," Mr. Savage said. "And as their business grows, they should think about new hires and allocate responsibilities accordingly."

Mr. Lefebvre recommended instituting surprise audits to deter fraudsters. "Have your accountant do them more than once a year in a pattern your employees aren't familiar with. Typically employees know when an auditor is coming in so someone creating irregularities has time to alter and destroy records. Surprise audits take that level of comfort away."

He also suggested job rotation in businesses where it makes sense to shift staff around. "By moving people you're changing their comfort zone and heightening the potential of detection," he said. It also means your staff will be comfortable in a variety of jobs within your business.

Similarly, he points to mandatory vacations. "If someone is away from their desk for two weeks, there's a paper trail that might surface in their absence," he said. "And they wouldn't be there to cover it up."

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He suggested a policy that makes it mandatory for staff wishing to work outside scheduled hours to seek approval from their supervisor – likely the owner in a small business situation. If it comes to the attention of the owner that a staff member has worked overtime without permission or works through a scheduled vacation, "the employer has a right – and responsibility – to approach the employee," to ask exactly what that person is doing, Mr. Lefebvre said.

Being a caring employer can also go a long way, Mr. Savage pointed out. "It's easier to rationalize stealing from your boss if he's not been pleasant to work for."

Having internal controls in place is the single best way to limit fraud, but it can't end there. "If management doesn't enforce punishment, people don't take it seriously," Mr. Lefebvre said.

He recommended that consequences be documented. "Be very clear about what warrants a reprimand to probation to what kind of behaviour could get you fired."

James Hunter, president of KPMG's forensic practice, adds: "You want to trust your employees and you want them to believe they're trusted but you have to be clear that there are certain controls in place and that's part of normal business. It's a bit like a father or mother setting rules. Yes, I love you, children, but you're going to play this game by my rules."

The consequences of being a victim of fraud can be steep, and not just financially. "If it can be proven that an employee did something unethical in hopes of benefiting an organization, that organization can be held responsible," Mr. Lefebvre said. "Ignorance is not a defence. The owner has a responsibility to know how their business is done."

A whiff of fraud can leave a bad impression on associates, no matter how innocent the business owner is. "Clients might get to hear of it and they might lose trust and faith in the business," Mr. Savage said.

The bottom line, experts agree, is that entrepreneurs can't afford to delegate management of financials and their corresponding controls entirely to someone else. "Often entrepreneurs aren't really interested in accounting and some assume the luxury that things will go well," Mr. Hunter said. "But if you assume that, chances are they will not. Very often fraud can be the final nail in the coffin for a small company that might otherwise have been successful."

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