By Roddy Allan
Illustration: Sara Tyson
 WHEN YOUR FIRM IS HIT BY FRAUD, DON'T MAKE ANY RASH DECISIONS. YOU MAY BE ANGRY, BUT TAKE A MOMENT AND FOLLOW A FEW SMALL STEPS
It's a nightmare no executive ever hopes to experience: it appears a serious fraud has been committed against your organization, and as a senior member of the corporation, you have an especially important role in shaping the steps required to address the problem. The first issue you may have to contend with is your reaction. Typical responses include denial and anger. While understandable, emotions can trigger heat-of-the-moment decisions that rarely benefit a comprehensive reaction to the suspected wrongdoing. In fact, they often do the opposite.
While denial is a common reaction, especially if the allegations concern a trusted and valued employee, it can prevent an investigation from commencing. If you sense your company is heading in this direction, insist, at minimum, on a discreet preliminary review of the facts to determine if they warrant a more involved probe.
Anger can be equally destructive. Assert your influence to dissuade management from making premature accusations or taking rash actions before knowing, and being able to prove, if a fraud actually happened.
Once aware of a potential fraud, a company should assemble a response team — as small as possible to ensure confidentiality.
The team typically should include a senior manager, the chief financial officer or another senior financial executive, the director of human resources, internal and/or external counsel, external forensic accountants and the head of internal security. It is wise to exclude anyone who has a personal stake in the outcome of the investigation, either as a result of his or her active involvement in the fraud or because he or she did not identify it earlier.
Assuming the company's initial concerns have merit, the following five initiatives should form the foundation of an immediate reaction plan. Within each of these broad steps there are a myriad of smaller, but critical, issues that must be addressed if the organization's response to the suspected fraud is to be successful.
Stop the bleeding and secure the evidence — to the extent possible, take steps to prevent further losses, unless there is a compelling reason not to (if there is some advantage to catching the fraudster in the act, maybe it's better to wait). At the same time, secure any potential evidence in a manner that ensures it remains untainted.
A fraud is sometimes discovered only after the dishonest employee has left the company. In such instances, the losses are probably not continuing. More frequently, the employee is still at the company and the losses are ongoing at the time of discovery. This presents a dilemma to the response team. Is it better to act precipitously or to be patient and wait? As is often the case, it depends.
In one case a warehouse manager was discovered handing inventory to an unknown person after hours, and the owners of the business wanted the manager dismissed and reported to the police immediately. However, the warehouse manager had no significant assets, and so a more creative strategy was developed to enhance prospects for recovery. Ultimately, they discovered where the stolen goods were being held and distributed. In the final analysis, the owners gained more from letting the theft continue for a short time than from nipping it in the bud.
At the same time, it is essential to secure the documentary, physical and electronic evidence to prove the nature and quantum of the fraud. This requires an understanding of what constitutes evidence and how evidence can be obtained and preserved.
Determine how much has been lost — and how it has been accounted for.
This work is usually the focus of a forensic team retained to conduct the investigation. It is prudent to organize the work in phases to provide for suitable "breaking points" so that findings can be reviewed periodically and the overall strategy reconsidered.
The complexity of the fraud will determine how much investigation is required. A simple scheme can be easily and quickly put to an end. But it's not unusual to discover that what appears to be a straight-forward fraud is, when unraveled, far more widespread and convoluted.
The scope of the investigation can also be affected by the potential for recovery. If it's apparent that little or nothing is recoverable, then the investigation may be more limited than if there is a chance to recoup some or most of the losses.
If the objective is to proceed with a criminal complaint only, it may not be necessary to investigate every aspect of the fraud. Involving the police sends a strong message to all employees that fraud will result in criminal prosecution.
If the intent is to proceed with civil litigation only, the required burden of proof is less than for a criminal prosecution, although strong evidence of the total loss to the victim and the involvement of the defendant will be required.
Whatever the final scope of work, the investigation must answer the following questions:
• How much has been lost?
• How was the fraud perpetrated?
• How was it concealed?
• Who benefited?
With respect to the nature of the loss, a key issue is the financial impact upon the company. A significant unrecognized loss will depress or eliminate earnings, may result in restated financial statements from prior years, damage the balance sheet and, as a result, inhibit the company's ability to borrow funds.
Find out who was involved — and their respective roles.
In the vast majority of cases, employees of the organization are the perpetrators of frauds. It is usually advantageous not to dismiss a suspected employee immediately as this may preserve an opportunity to interview the employee once further evidence has been gathered. On the other hand, an objective investigation must proceed without undue delay so as to be fair to the employee under suspicion. If the employee was not involved in the suspected fraud, the last thing the company needs is a wrongful or constructive dismissal suit.
Many employers will suspend the employee, usually with pay, in an effort to keep the interview option open.
Any letters of resignation that are submitted by the employee are not accepted until the culpability of the employee is clear. Obviously, the advice of an employment lawyer can be very useful in these circumstances.
As collusion is often a characteristic of complex frauds — otherwise they would never have been successful — make sure the investigation considers the full range of people inside and outside a company who may have been involved.
Develop a recovery plan — to locate and get back the lost funds or assets.
A successful asset recovery strategy combines creativity, investigative cunning, knowledge of the various avenues for recovery and good negotiating or, if necessary, litigating skills.
From an investigative perspective, the first challenge is to identify where the money went and who got it. In complex cases this may occasionally involve tracing funds through offshore bank accounts. However, the bread-and-butter case that is normally encountered is considerably less glamorous but still provides a stimulating investigative challenge.
The first clues to the destination of the stolen funds are often found in the victim's own records. Usually, these findings are supplemented by further investigative work, such as interviews, surveillance and other steps. A detailed knowledge of the likes, dislikes, habits and life-style of the fraudster is important as this information will help assess the likelihood whether funds can be recovered. For example, if the fraudster is a chronic gambler, recovery may be difficult.
Do not hesitate to ask for your money back. Although a fraudster will often minimize the value of the fraud or claim — perhaps truthfully — that the money has been spent on high living and is all gone, sometimes an immediate recovery can be accomplished. It is useful to know that the fraudster's assets may be frozen under a Mareva injunction. Access to otherwise unavailable documents under Anton Piller or Norwich Pharmacal orders can also be very helpful.
All of these orders are obtained ex parte, meaning without the knowledge or consent of the fraudster. Again, advice from a lawyer experienced in such matters is critical as there are many issues to consider before taking such steps.
Other sources of recovery that should be considered include:
• recovery under banking agreements for funds lost on account of forged signatures on cheques;
• fidelity bonds;
• recovery from financial institutions for improper acceptance of cheques with false endorsements;
• claims against other involved organizations, such as suppliers;
• claims against organizations that failed to spot the fraud;
• restitution orders to the benefit of the victim, which can sometimes be obtained at the conclusion of criminal proceedings.
Particularly in the case of claims under fidelity bonds and commercial banking agreements, time is of the essence. As soon as the fraud is discovered, the clock is ticking. Any undue delay in the investigation may prejudice the victim's ability to recover, as there are time limitations for reporting and proving these claims.
Implement remedial measures — to help ensure that similar losses don't arise in the future.
This step is most often neglected. management has a tendency, once the fraud has been successfully investigated, to assume that lightning won't strike twice, or that the measures taken on discovery will prevent further problems.
This is an unwise assumption. If the system was exploited once for a fraud, it can happen again. Independent advice on what new control layers or other remedial steps need to be implemented may be helpful. But all the advice in the world won't help unless the new systems are strictly reviewed for compliance on an ongoing basis.
Statistics clearly show that no one is immune from fraud. It's myopic to assume it only happens elsewhere.
While you can't guarantee your company will never be victimized, you can be prepared if the nightmare does occur. It is really a form of crisis management planning, which these days is a strategy no company should be without.
Roddy Allan, CA•IFA, is a principal of Kroll Lindquist Avey in Toronto and the technical editor for the Fraud column. |
