Small Business FRAUD PREVENTION Manual

Small Business FRAUD PREVENTION Manual

TABLE OF CONTENTS PREFACE... ix 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 Methods of Fraud in Small Businesses... 3 Why Employees Commit Fraud... 4 Donald R. Cressey and the Fraud Triangle... 4 Continuing Conduct... 10 Working Conditions and Fraud... 11 The Hollinger-Clark Study: The Effect of Workplace Conditions... 11 Who Is the Typical Fraudster?... 16 Who Is the Typical Fraudster? Analysis... 16 2016 Report to the Nations... 17 II. HOW EMPLOYEES STEAL CASH FRAUD Introduction... 19 Cash Theft... 19 Types of Cash Theft Schemes... 20 Skimming and Larceny... 20 Unrecorded Sales... 20 Skimming Receivables... 24 Cash Larceny from the Deposit... 28 Deterring and Detecting Skimming and Cash Larceny... 30 Accounting Anomalies That Indicate Skimming... 31 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... 41 Personal Purchases with Company Funds... 42 Deterring and Detecting Billing Schemes... 43 Determining Who Is Involved in a Billing Scheme... 47 Determining Whether a Vendor Is Legitimate... 50 Control Objectives for Preventing Billing Schemes... 52 Payroll Schemes... 54 Falsified Hours and Salary... 54 i

II. HOW EMPLOYEES STEAL CASH FRAUD (CONT.) Ghost Employees... 57 Commission Schemes... 58 Deterring and Detecting Payroll Schemes... 58 Control Objectives for Preventing Payroll Schemes... 61 Expense Reimbursement Schemes... 62 Mischaracterized Expense Reimbursements... 63 Overstated Expense Reimbursements... 64 Fictitious Expense Reimbursements... 65 Multiple Reimbursements... 66 Deterring and Detecting Expense Reimbursement Schemes... 66 Red Flags of Expense Reimbursement Schemes... 67 Check Tampering... 68 Forged Maker Schemes... 68 Forged Endorsement Schemes... 70 Altered Payee Schemes... 71 Authorized Maker Schemes... 72 How Check Tampering Is Concealed... 73 Detection of Check Tampering Schemes... 75 Prevention of Check Tampering Schemes... 77 Electronic Payment Tampering... 79 Prevention and Detection of Electronic Payment Tampering... 80 Cash Register Disbursement Schemes... 81 Common Register Disbursement Schemes... 82 Control Weaknesses... 82 Detection of Register Disbursement Schemes... 84 Prevention of Register Disbursement Schemes... 85 III. HOW EMPLOYEES STEAL INVENTORY, EQUIPMENT, AND OTHER ASSETS Misuse of Inventory and Other Assets... 87 The Costs of Inventory Misuse... 87 Types of Noncash Theft... 88 Unconcealed Larceny... 88 Falsified Receiving Reports... 89 Fraudulent Shipments... 90 Fraudulent Write-Offs... 90 Concealing Inventory Shrinkage... 90 Altered Inventory Records... 91 Fictitious Sales and Accounts Receivable... 91 Write Off Missing Noncash Assets... 92 Physical Padding... 92 Detecting the Theft of Inventory, Equipment, and Supplies... 92 Review of Perpetual Inventory Records... 92 ii

III. HOW EMPLOYEES STEAL INVENTORY, EQUIPMENT, AND OTHER ASSETS (CONT.) Review of Shipping Documents... 92 Analytical Review... 93 Physical Inventory Counts... 93 Preventing Inventory Fraud... 93 Proper Documentation... 93 Segregation of Duties... 94 Independent Checks... 94 Physical Safeguards... 94 Red Flags of Inventory Theft Schemes... 94 IV. PREVENTING EMPLOYEE THEFT Selecting the Right Employee... 97 Past Employment Verification... 97 Criminal Conviction Checks... 97 Drug Screening... 98 Reference Checks... 98 Education and Certification Verification... 98 Get the Consent of the Candidate... 98 Policies and Procedures That Help Eliminate Employee Dishonesty... 98 Environmental Conditions... 98 Provide Incentives for Honest Employees... 99 Control Conditions... 99 Policies and Procedures That Help Deter Fraud... 100 Perception of Detection... 100 Proactive Programs... 100 Monitoring Systems... 103 Insuring Against Dishonesty... 104 PART 2: EXTERNAL FRAUD THREATS V. CHECK FRAUD Introduction... 107 Counterfeiting Checks... 108 Signs of Counterfeit and Forged Checks... 108 Check Fraud Vulnerabilities... 108 Check Theft... 109 Check Fraud Schemes... 109 Check Fraud Rings... 112 Check Fraud Detection... 113 Check Fraud Prevention... 114 iii

VI. CREDIT CARD SCHEMES Introduction... 117 Credit Card Schemes... 117 Unauthorized Use of a Lost or Stolen Card... 117 Organized Crime Rings... 118 Advance Payments... 118 Stolen Card Numbers... 118 Counterfeit Cards... 119 Telephone and Mail Order Fraud... 119 False Applications... 120 Credit Doctors... 120 True Name Fraud... 120 Non-Receipt Fraud... 120 Key-Enter Counterfeiting... 120 Creditmaster... 121 Skimming... 121 Pretext Calling... 122 Account Takeover... 122 Institutional Identity Theft and Spoof Sites... 122 Merchant Scams... 123 Company Credit Cards... 124 Smart Cards... 124 Hybrid Smart Cards... 125 The Law Concerning Credit Card Fraud... 125 Credit Card Fraud Detection... 126 Credit Card Fraud Prevention... 127 Education Programs... 128 Liaison with Law Enforcement... 128 Credit Card Company Security Initiatives... 128 Evolving Credit Card Security Features... 130 Technological Deterrents... 131 Photographs... 131 Holograms... 131 Signature Panel... 131 Activation of Cards... 131 Advanced Authorization... 132 Unusual Activity Monitoring... 132 Card Scrutiny at Point of Sale... 132 Internet and Telephone Orders... 132 Financial Institution Measures... 133 Protecting Credit Card Payment Data from Intrusion... 134 iv

VII. COMPUTER FRAUD Potential Impact of Computer Crime... 137 Securing Computers... 138 Electronic Security... 138 Internet Fraud... 142 Combating Internet Fraud... 143 Computer Hacking... 144 Methods Used to Gain Unauthorized Access... 145 VIII. SHOPLIFTING Introduction... 151 Types of Shoplifters... 151 Amateur Shoplifters... 151 Professional Shoplifters... 152 Shoplifting Methods... 153 Sleight-of-Hand... 153 Devices... 153 Distraction... 154 Employees as Shoplifters... 154 Training Methods of Shoplifters... 155 Shoplifting Detection... 155 Physical Characteristics... 155 Behavioral Characteristics... 156 Shoplifting Prevention... 157 Prevention Techniques... 157 What to Do with the Shoplifter... 160 Confronting and Detaining Shoplifters... 161 Investigation of a Suspect... 162 Criminal and Civil Actions... 164 IX. HOW VENDORS CAN CHEAT SMALL BUSINESSES Bribery: Kickbacks and Gratuities... 165 Methods of Making Illegal Payments... 166 Bribery Scheme Types... 168 Economic Extortion... 174 Illegal Gratuities... 174 Detection of Bribery Schemes... 175 Red Flags Associated with Employees... 176 Red Flags Associated with Vendors... 177 Red Flags Associated with the Corrupt Recipient... 177 Red Flags Associated with the Corrupt Payer... 178 Other Red Flags... 178 Keeping Suppliers Honest... 179 v

IX. HOW VENDORS CAN CHEAT SMALL BUSINESSES (CONT.) Conduct Background Checks... 179 Check References... 179 Check Billings and Invoices... 179 Question Suppliers... 180 Vendor On-Site Audit... 180 Vendor Questionnaire... 181 X. CON SCHEMES AND OTHER SCAMS Telemarketing Frauds... 185 Telemarketing Terminology... 185 Telemarketing Suppliers... 186 Telemarketing Scams Targeting Businesses... 187 Telemarketing Scams Enforcement and Prosecution... 195 Advance-Fee Swindles... 196 Types of Advance-Fee Swindles... 197 Advance-Fee Swindles Detection and Prevention... 198 Ponzi and Pyramid Schemes... 199 Accounts Receivable Schemes... 200 Ponzi Versus Pyramid... 200 Varieties of Pyramid Schemes... 201 Detecting and Preventing Pyramid and Ponzi Schemes... 205 Investment Swindles... 205 Methods of Investment Swindlers... 206 Types of Investment Swindles... 207 Prevention of Investment Swindles... 210 Identity Theft... 211 Business Identity Theft... 211 Profile of the Fraudster... 212 Common Ways of Obtaining Information... 212 Federal Identity Theft Statutes... 216 Identity Theft Guidance for Small Businesses... 217 Workers Compensation Fraud... 219 Red Flags of Workers Compensation Fraud... 220 Preventing Workers Compensation Fraud... 220 Tax Scams... 221 Employment Tax Evasion... 221 Tax Return Preparer Fraud... 221 Unreliable Third-Party Payers... 221 Improper Home-Based Business... 222 Other Common Scams... 222 Phony Invoices... 222 Cramming... 223 vi

X. CON SCHEMES AND OTHER SCAMS (CONT.) Phone Scams... 224 Slamming... 224 Nigerian 419 Fraud Schemes... 225 XI. WHAT TO DO IF YOU ARE A VICTIM OF FRAUD Dealing with Dishonest Employees... 231 Initiation: Detection and Identification... 231 Investigation and Development... 232 Documentation... 232 Detention... 232 Interview... 233 Disposition... 234 Avoiding Liability when Conducting Investigations... 235 Defamation... 235 Invasion of Privacy... 237 False Imprisonment... 238 Wrongful Termination... 239 Rights and Duties of Employees... 239 Employees Duty to Cooperate... 239 Employees Rights During the Investigation... 240 Workplace Searches... 242 Effect of Violation of Employee s Rights... 245 State Constitutions and Statutes... 245 Surveillance... 245 Polygraph Examinations... 249 Prosecuting Employees and Other Fraud Perpetrators... 250 Why Prosecute a Fraud Perpetrator?... 251 Aiding the Company s Civil Remedies and Litigation... 252 Malicious Prosecution... 253 Civil Actions Against Perpetrators... 254 Discovery... 254 Civil Trials... 254 Advantages and Disadvantages of Civil Litigation... 255 Will a Judgment Be Collectible?... 256 Ensuring Recovery of Property or Damages... 256 Enforcement of Money Judgments... 257 Discharging a Suspected Wrongdoer... 258 Just Cause... 259 Negligent Discharge... 259 Breach of Implied Contract... 259 vii

XI. WHAT TO DO IF YOU ARE A VICTIM OF FRAUD (CONT.) Breach of the Duty of Good Faith and Fair Dealing... 259 Discharge in Violation of Public Policy... 260 XII. REFERENCES... 261 viii