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Internal Fraud in the M&D Industry

05/25/2022 Tim Furbush

Internal fraud drains approximately $4.5 trillion dollars annually from global businesses, according to the Association of Certified Fraud Examiners (ACFE). According to ACFE’s latest Report to the Nations, the median internal fraud loss in manufacturing and production companies is $198,000.

Although companies can experience pilferage from customers, vendors and other sources, employees account for the highest losses, when taking into account offenses such as fraudulent insurance claims, unauthorized time off and theft of proprietary information such as technology and trade secrets. Crimes can be as simple as stealing company supplies or as complex as sophisticated financial statement fraud.

More specifically, fraud by managers and key executives generates the highest dollar losses because these employees have access to assets and financial records. This provides the opportunity to falsify financial, credential, work-related or test-related documents for personal gain.

What can your company do to prevent theft? The ACFE report found these measures to be effective:

  1. Improve internal controls. A strong system of internal controls is your company’s first line of defense against fraud. For example, don’t allow the same employee to keep books, collect funds, write checks and reconcile bank accounts. Likewise, it is important to segregate duties in the area of payroll. A second set of eyes can go a long way.
  2. Conduct background checks. Before new employees start working for your company, it’s important to review their criminal and credit history, prior employment and education. You also may want to consider verifying references and checking out social media accounts. A comprehensive background check is especially relevant if the worker will routinely handle cash or have access to your company’s financial records and other sensitive company or employee data.
  3. Arrange for fraud audits. Your company’s outside accountants or an internal audit department should conduct regular independent internal control studies of cash accounts, bank statements and other items to detect criminal activity. Surprise audits are an effective, yet underutilized, tool in the fight against fraud. As inventory fraud can occur in manufacturing and distribution entities, it is important to include appropriate reviews of this area as well, including regular counts of quantities on hand.
  4. Be willing to prosecute perpetrators. Some organizations take no legal action, because management is afraid of bad publicity, has reached a private settlement, wants closure or considers internal punishment sufficient. Failure to prosecute allows fraudsters to move on to other companies and repeat the same crimes.
  5. Provide ethics training for employees. Educate staff members about the possible sources of fraud and consequences, such as the loss of jobs, raises and profits.
  6. Institute anonymous fraud reporting mechanisms. Fraud is commonly discovered through tips from employees, vendors, customers or other sources reported through phone, email or online hotlines. These people are frequently in a position to see violations of company policies or excessive personal spending by colleagues.
  7. Install workplace surveillance devices. Today, there are many inexpensive surveillance devices available in the marketplace. For example, you might install a video camera to monitor a loading dock where theft is suspected. Or you might install a lock on the door to the parts room that requires employees to scan their badges to gain access — this gives management a record of who’s been in the storage room and when.
  8. Look for behavioral red flags. Examples may include the perpetrator living beyond his or her means, having financial or personal difficulties, expressing an unwillingness to share duties or take vacations, and engaging in an unusually close association with vendors or customers.

Who is Involved?

Here are some important statistics to consider about the perpetrators of fraud schemes:

  • Male employees account for 70% of fraud cases, while women are responsible for the other 30% of cases globally.
  • The median loss for all industries was higher when committed by men ($150,000) as compared with women ($85,000).
  • Losses tend to rise as the perpetrators’ tenure with the organization increases.
  • Small businesses are the most vulnerable because of a lack of basic internal control measures.

Adopt a Zero-Tolerance Policy

With a few basic procedures in place, internal business theft can be significantly reduced — or even eliminated — so your manufacturing business can flourish. The keys are to have adequate checks and balances in place, to stay on top of the latest fraud schemes, and to be consistent and swift in investigating and prosecuting suspicious activity.

For questions and guidance related to fraud prevention in the manufacturing and distribution industry, contact Tim Furbush at tfurbush@vlcpa.com or 800.887.0437.

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