Rogue CFO I- Introduction

by Sands Anderson PC
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Small, privately owned corporations deal with all types of challenges: competition, government regulations, recessions, rising cost of benefits for employees —the list is long. But one area that seems to be a persistent problem for small businesses is the area of fraud, in particular economic crimes and financial negligence. Increasingly the kinds of fraud and negligence that are being reported in the financial press originates with the most senior level employees, in particular, in the role of Chief Financial Officer. We are picking on CFOs because the problems seem to be originating from the office more than other. But the issues we will discuss in this series can involve any senior executive with substantial financial authority and responsibility and not just the CFO.

In Price Waterhouse Coopers 17th Annual Global Economic Crime Survey (“PWC”) for 2014 (the “PWC Survey”) http://www.pwc.com/gx/en/economic-crime-survey/index.jhtml PWC asked respondents whose organization experienced economic crime to profile the main perpetrator of the most serious fraud they had faced. The picture which emerged was similar to previous years, with 56% reporting that the main perpetrator was someone inside the company.

So who are the insiders who are committing internal fraud? The PWC Survey indicates that the overall profile of the internal perpetrator was — middle-aged males with a college education or higher who have substantial tenure with the enterprise. Almost half of all frauds are committed by employees with 6 or more years of experience, and almost a third (29%) are committed by employees with 3 to 5 years of experience. The good news here, if there is any, if most of your fraud loss is internal, you have a better opportunity to mitigate these risks through improved internal controls, policies, and processes. Mitigating the actions of external criminals or internet hackers may not be so easy.

Fraud comes in a variety of forms. From the PWC Survey three types of fraud have consistently been highlighted by the respondents — asset misappropriation (#1 by a wide margin), bribery and corruption, and accounting fraud. The PWC Survey added cybercrime as a distinct classification in 2011 and it appears to be on a fast growth curve. Examples of common financial frauds are: credit card and check fraud, theft of assets — especially high-value intellectual property, fraudulent billing schemes, check tampering, paying fictitious vendors, transferring cash to a private undisclosed entity, skimming cash before it enters into the accounting system, stealing inventory, creating unauthorized or fraudulent expenditures, embellishing expense accounts. The list is long. The Chief Financial Officer and anyone in the accounting department, by way of their access to the accounting and financial control systems, and their responsibility for supervising those systems have ample opportunity to succumb to these temptations.

Fraud or financial abuse in any business, especially in a small company, can be devastating. The Chief Financial Officer, because of his or her authority, responsibility and control over the finances has the potential to severely damage or wipe out a small business in a very short time.

The response from small company management is often “not us – we’re too small!”   ”There would be no way to hide it.” “Our employees are loyal – they have been with us forever.” According to the Association of Certified Fraud Examiners (“ACFE”) small companies are particularly vulnerable to fraud and theft from insiders. Based on a report from the ACFE (The 2008 Report to the Nation on Occupational Fraud & Abuse), “small businesses—defined as those with less than 100 employees—suffered both a greater percentage of frauds (38%) and a higher median loss ($200,000) than their larger counterparts, that had lower occurrence rates from 18.9% – 23%.

As attorneys, time and again we see insiders, such as the CFO, who are entrusted with the financial management of the company, defraud the company or simply, through poor management and lack of control, make decisions that cause the company substantial loss.

The encouraging part of this is that it’s easily preventable with simple rudimentary precautions. Our series is designed to offer small-to-medium size businesses and their boards of directors, some suggestions on steps they can take to help prevent executive fraud. We offer these simple steps, not as revelations, because they are old news. But we offer them because of how often they are ignored.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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