THE SMALL BUSINESS FRAUD PREVENTION MANUAL

THE SMALL BUSINESS FRAUD PREVENTION MANUAL

TABLE OF CONTENTS PART 1: INTERNAL FRAUD THREATS I. INTRODUCTION TO EMPLOYEE FRAUD The Shocking Cost of Employee Theft and Fraud... 1 The Cost of Fraud to Small Businesses... 2 Why Employees Commit Fraud... 6 Donald R. Cressey and the Fraud Triangle... 6 Continuing Conduct... 11 Working Conditions and Fraud... 12 The Hollinger-Clark Study: The Effect of Workplace Conditions... 12 Profile of a Fraudster... 17 Profile of a Fraudster Survey... 17 2010 Report to the Nations... 19 II. HOW EMPLOYEES STEAL CASH FRAUD Introduction... 20 Cash Theft... 20 Types of Cash Theft Schemes... 21 Skimming and Larceny... 21 Unrecorded Sales... 21 Skimming Receivables... 24 Cash Larceny from the Deposit... 28 Deterring and Detecting Skimming and Cash Larceny... 30 Accounting Anomalies that Indicate Skimming... 32 Trend Analysis... 33 Using Customers to Detect Skimming... 34 General Control Objectives for Cash Receipts... 34 Maintaining Physical Security of Cash... 35 Billing Schemes... 36 Shell Company Schemes... 36 Non-Accomplice Vendor Schemes... 40 Personal Purchases with Company Funds... 41 Deterring and Detecting Billing Schemes... 42 Determining Who Is Involved in a Billing Scheme... 46 Determining If a Vendor Is Legitimate... 49 Control Objectives for Preventing Billing Schemes... 51 i

II. HOW EMPLOYEES STEAL CASH FRAUD (CONT.) Payroll Schemes... 52 Falsified Hours and Salary... 53 Ghost Employees... 55 Commission Schemes... 56 Deterring and Detecting Payroll Schemes... 56 Control Objectives for Preventing Payroll Schemes... 59 Expense Reimbursement Schemes... 60 Mischaracterized Expense Reimbursements... 61 Overstated Expense Reimbursements... 62 Fictitious Expense Reimbursements... 63 Multiple Reimbursements... 64 Deterring and Detecting Expense Reimbursement Schemes... 64 Red Flags of Expense Reimbursement Schemes... 64 Check Tampering... 65 Forged Maker Schemes... 66 Forged Endorsement Schemes... 68 Altered Payee Schemes... 69 Authorized Maker Schemes... 70 How Check Tampering Is Concealed... 71 Deterring and Detecting Check Tampering Schemes... 73 Check-Tampering Red Flags... 75 Physical Tampering Prevention... 76 Cash Register Disbursement Schemes... 77 Common Register Disbursement Schemes... 77 Control Weaknesses... 77 Deterring and Detecting Cash Register Disbursement Schemes... 79 Red Flags of Register Disbursement Schemes... 79 III. HOW EMPLOYEES STEAL INVENTORY, EQUIPMENT, AND OTHER ASSETS Misuse of Inventory and Other Assets... 81 The Costs of Inventory Misuse... 81 Types of Non-Cash Theft... 82 Unconcealed Larceny... 82 Falsified Receiving Reports... 83 Fraudulent Shipments... 84 Fraudulent Write-Offs... 84 Concealing Inventory Shrinkage... 84 ii

III. HOW EMPLOYEES STEAL INVENTORY, EQUIPMENT, AND OTHER ASSETS (CONT.) Altered Inventory Records... 85 Fictitious Sales and Accounts Receivable... 85 Write Off Missing Non-Cash Assets... 86 Physical Padding... 86 Deterring and Detecting the Theft of Inventory, Equipment, and Supplies... 86 Red Flags of Inventory Theft Schemes... 87 Control Objectives Inventory Schemes... 88 Preventing Inventory Fraud... 88 IV. PREVENTING EMPLOYEE THEFT Selecting the Right Employee... 90 Past Employment Verification... 90 Criminal Conviction Checks... 90 Drug Screening... 90 Reference Checks... 91 Education and Certification Verification... 91 Get the Consent of the Candidate... 91 Policies and Procedures that Help Eliminate Employee Dishonesty... 91 Environmental Conditions... 91 Provide Incentives for Honest Employees... 91 Control Conditions... 92 Policies and Procedures that Help Deter Fraud... 92 Perception of Detection... 92 Proactive Programs... 93 example... 94 example... 94 Monitoring Systems... 95 Insuring Against Dishonesty... 97 PART 2: EXTERNAL FRAUD THREATS V. CHECK FRAUD Introduction... 99 Types of Checks... 99 Personal Check... 100 Two-Party Check... 100 iii

V. CHECK FRAUD (CONT.) Payroll Check... 100 Government Check... 100 Blank Check... 100 Counter Check... 100 Traveler s Check... 101 Money Order... 101 Types of Check Frauds... 101 Check Fraud Vulnerabilities... 102 Check Theft... 102 Other Check Fraud Schemes... 103 Check Fraud Rings... 105 Check Fraud Detection... 106 FBI Profile of Check Fraud Activity... 106 Detection Techniques... 107 Check Fraud Prevention and Investigation... 108 Check Fraud Investigations... 108 Check Fraud Prevention Tools... 111 Bank Check Fraud Prevention Techniques... 113 VI. CREDIT CARD SCHEMES Introduction... 115 Credit Card Schemes... 115 Unauthorized Use of a Lost or Stolen Card... 115 Organized Crime Rings... 115 Advance Payments... 116 Shave and Paste... 116 De-Emboss/Re-Emboss... 116 Counterfeit Cards... 116 Telephone/Mail Order Fraud... 117 False Applications... 117 Credit Doctors... 118 True Name Fraud... 118 Non-Receipt Fraud... 118 Skimming... 118 Merchant Scams... 118 Magnetic Stripe Diagram... 119 Company Credit Cards... 119 iv

VI. CREDIT CARD SCHEMES (CONT.) Credit Card Fraud Detection... 120 Credit Card Fraud Prevention... 121 Education Programs... 121 Liaison with Law Enforcement... 121 Credit Card Company Security Initiatives... 121 Physical Security Features... 122 Signature Panel... 124 Activation of Cards... 124 Advanced Authorization... 125 CyberSource Advanced Fraud Screen... 125 Computer Edits... 125 Card Scrutiny at Point of Sale... 125 Internet/Telephone Orders... 125 Financial Institution Measures... 126 Smart Cards... 127 Credit Card Fraud Prevention with Online Shopping... 127 Electronic Bill Payment and Person-to-Person Payments... 127 Protecting Data from Intrusion... 128 Payment Card Industry Data Security Standard (PCI DSS)... 129 Potential Impact of Computer Crime... 131 Securing Computers... 133 Internet Commerce... 136 Internet Fraud... 137 Internet Fraud Schemes... 137 Phishing... 138 Combating Internet Fraud... 142 VIII. SHOPLIFTING Introduction... 144 Types of Shoplifters... 144 Amateur Shoplifters... 144 Professional Shoplifters... 145 Other Types of Shoplifters... 146 Shoplifting Methods... 147 Sleight-of-Hand... 147 Devices... 148 Distraction... 148 v

VIII. SHOPLIFTING (CONT.) Employees as Shoplifters... 149 Training Methods of Shoplifters... 149 Shoplifting Detection... 149 Physical Characteristics... 150 Behavioral Characteristics... 150 Shoplifting Prevention... 151 Prevention Techniques... 151 What to Do with the Shoplifter... 154 Confronting and Detaining Shoplifters... 155 Investigation of a Suspect... 156 Criminal and Civil Actions... 157 IX. HOW VENDORS CAN CHEAT YOU Bribery: Kickbacks and Gratuities... 158 Bribery and Corruption Survey... 159 Methods of Making Illegal Payments... 159 Bribery Scheme Types... 161 Bid-Rigging Schemes... 164 Economic Extortion... 167 Illegal Gratuities... 168 Detection of Bribery Schemes... 168 Red Flags Associated with Employees... 169 Red Flags Associated with Vendors... 170 Red Flags Associated with the Corrupt Recipient... 170 Red Flags Associated with the Corrupt Payer... 171 Other Red Flags... 171 Keeping Your Suppliers Honest... 172 Conduct Background Checks... 172 Check References... 172 Check Billings and Invoices... 173 Question Suppliers... 173 Vendor On-Site Audit... 173 Vendor Questionnaire... 174 Vendor Questionnaire... 175 vi

X. CON SCHEMES AND OTHER SCAMS Telemarketing Frauds... 177 Telemarketing Terminology... 178 Telemarketing Techniques... 178 Telemarketing Scams Targeting Businesses... 180 Telemarketing Scams Enforcement and Prosecution... 187 Telemarketing Statutes... 189 Advanced Fee Swindles... 190 Types of Advanced Fee Swindles... 190 Advance Fee Swindles Detection & Prevention... 192 Ponzi and Pyramid Schemes... 193 Accounts Receivable Schemes... 193 Ponzi vs. Pyramid... 194 Varieties of Pyramid Schemes... 194 Types of Pyramid Schemes... 195 Detecting & Preventing Pyramid and Ponzi Schemes... 198 Investment Swindles... 199 Methods of Investment Swindlers... 199 Types of Investment Swindles... 200 Prevention of Investment Swindles... 204 Identity Theft... 204 2010 Identity Fraud Survey Report... 204 The Profile... 206 Common Ways of Obtaining Information... 206 Tracking Down the Thief... 209 Confronting the Fraudster... 209 Federal Statutes... 209 State Laws... 212 Identity Theft Guidance for Small Businesses... 214 Workers Compensation Fraud... 216 Red Flags of Workers Compensation Fraud... 217 Preventing Workers Compensation Fraud... 217 Tax Scams... 218 Employment Tax Evasion... 218 Tax Return Preparer Fraud... 218 Unreliable Third-Party Payers... 218 Improper Home-Based Business... 218 Other Common Scams... 219 vii

X. CON SCHEMES AND OTHER SCAMS (CONT.) Loans and Grants... 219 Phone Scams... 220 Phony Invoices... 220 Cramming... 221 Slamming... 222 Nigerian 419... 223 XI. WHAT TO DO IF YOU ARE A VICTIM OF FRAUD Dealing With Dishonest Employees... 227 Initiation: Detection and Identification... 227 Investigation/Development... 228 Documentation... 228 Detention... 229 Interview... 229 Disposition... 230 Avoiding Liability when Conducting Investigations... 231 Defamation... 231 Invasion of Privacy... 233 False Imprisonment... 235 Wrongful Termination... 236 Rights and Duties of Employees... 236 Employees Duty to Cooperate... 236 Employees Rights During the Investigation... 237 Workplace Searches... 239 Effect of Violation of Employee s Rights... 242 State Constitutions and Statutes... 242 Surveillance... 242 Polygraph Examinations... 247 Prosecuting Employees and Other Fraud Perpetrators... 247 Why Prosecute a Fraud Perpetrator?... 248 Aiding the Company s Civil Remedies and Litigation... 250 Malicious Prosecution... 250 Civil Actions Against Perpetrators... 251 Discovery... 252 Civil Trials... 252 Advantages and Disadvantages of Civil Litigation... 253 Will a Judgment be Collectible?... 253 viii

XI. WHAT TO DO IF YOU ARE A VICTIM OF FRAUD (CONT.) Assuring Recovery of Property or Damages... 253 Enforcement of Money Judgments... 254 Discharging a Suspected Wrongdoer... 256 XII. REFERENCES... 258 ix