Small businesses: Where fraud can and does occur

While the headlines have been filled with news of financial scandals at giant corporations like Enron, Worldcom and Tyco, CPAs across the country know that fraud is much more likely to occur in a small business.

"Recent events have served as a wakeup call to both CPAs and small businesses," says Dennis M. Echelbarger, former chair of the Michigan Association of CPAs and president of Echelbarger, Himebaugh, Tamm & Co., based in Grand Rapids, Mich. "Companies see what's been going on in the marketplace and realize that without some kind of controls in place, it could happen to them."

"Fraud is no longer viewed as a big company problem," agrees Thomas H. Beard, a partner at Godfrey Hammel, Daneels & Company PC in the Detroit area. "We try to instill in our small business clients that an ounce of prevention is worth a pound of cure."

Most small businesses, however, particularly in today's economy, have to be educated before they are willing to spend the resources necessary to implement effective fraud prevention controls.

"I can't think of even one situation where we were brought in on a purely preventive basis," says Cal Klausner, president of Klausner Dubinsky & Associates, serving the Washington, D.C. metropolitan area.

"No one thinks it can happen to them, even though I have clients to whom it has happened more than once before we are called in to conduct a comprehensive review," agrees Allen DeLeon, a founder of DeLeon & Stang in Gaithersburg.

Another reason small businesses tend to wait may be due to the profession's long-standing expectation gap.

"Small business owners still believe that any service a CPA firm provides, even doing tax returns, automatically looks for fraud. While looking at a company's fraud risk factors are part of an audit, analyzing a company's anti-fraud internal programs and controls is actually a separate engagement," Klausner says.

"At the same time I tell clients we are early adopters of SAS 99, I also explain that even with the renewed scrutiny for fraud, the implementation of anti-fraud controls and policies is outside the scope of the audit," says Doug Hansen, a partner at Tanner & Co, a Salt Lake City firm which audits more than 40 public companies. SAS 99 is the new audit standard that gives auditors significantly more guidance for detecting material fraud.

Also serving as a catalyst to the implementation of fraud controls is an increasing awareness on the part of directors of their own liability.

"We have a number of non-profit clients," explains Klausner, "and in many cases board members are receiving no compensation but, nevertheless, accepting substantial fiduciary responsibility. They have considerable incentive to make certain proper fraud prevention controls are in place."

Many CPA firms have formalized a procedure for the implementation of fraud controls, and have made it an important part of their outreach efforts to both existing and prospective clients. Echelbarger, Himebaugh, for example, offers a 29-step checklist titled, "Recognizing Warning Signs and Preventing Problem Situations."

Like many firms, McLean Koehler Sparks and Hammond, which has four offices in the Baltimore-Washington area, divides its fraud prevention program into three phases.

"In the initial exploratory phase we interview senior management and study the company's existing system of internal control," says Robert Garvey, a principal at McLean and director of its financial investigation practice. "We then prepare a detailed report outlining the client's exposure to fraud, as well as to other kinds of employee abuse. Something like an employee using a company photocopier to run off thousands of copies for personal use may not technically be classified as fraud, but it still can result in significant financial harm. The third implementation phase puts the policies and procedures in place that will specifically address the vulnerabilities that have been identified."

Firms that specialize in fraud prevention point to certain areas for improvement common to most small businesses. "Smaller companies typically don't have enough personnel for the sufficient segregation of duties, and that is the number one cause of fraud," says Garvey. "When the same person who signs the checks is also responsible for approving purchase orders and adding new personnel to the payroll system, the opportunity for abuse is huge."

"Under these circumstances, it's very easy for a dummy person to receive a regular paycheck or a dummy vendor to be paid for inventory that doesn't exist," says Wayne A. Pahssen, partner at the Michigan firm Fuller, Somero & Pahssen PLC.

"Sometimes the best prevention measure can be as simple as having the company's checking account statements sent to the home of the owner or president, or requiring a double signature on all checks," adds Klausner.

"Ideally, the owner should look at every check and be personally familiar with its recipient," agrees Echelbarger. "If that's impractical, they should at least make a spot check, and make it apparent to their accounting department that they've done so. Sometimes just the knowledge that the owner is providing some personal oversight is enough to prevent fraud from occurring. Our message to management is to implement controls that will 'keep honest people honest.'" "We try to encourage our small business clients to sign every check, review all supporting documents and every cancelled check, and monitor daily deposits," says Pahssen. "But most owners are too busy to do all that, so with the heightened awareness of the potential for fraud, more and more of our clients are asking us to come on site and periodically make these reviews for them."

To help companies implement anti-fraud measures, SAS 99 includes an exhibit that describes how to create a code of conduct, develop a company culture that has zero tolerance for fraud, and design systems that reduce the risk of fraud.

"Small companies need to realize their vulnerability," says Michael Daigneault, director of advisory services for DeLeon & Stang and a professor of business ethics at Georgetown University. "We CPAs need to educate them and let them know we are their first resource against fraud."

For more information on helping small business clients prevent and detect fraud, go to AICPA's new online Antifraud and Corporate Responsibility Resource Center at www.aicpa.org/antifraud.

This content has not yet been Rated.

To Rate content, please Login.