Fraud is a serious issue that could bring down a company, no matter its size. According to research by the Association of Certified Financial Examiners (ACFE), businesses lose an estimated 5 percent of their annual revenue as a result of fraud committed by employees, managers, owners and executives.
"Fraud detection and prevention should be an ongoing initiative," said Cynthia Hetherington, founder and president of the Hetherington Group, a consulting firm focusing on intelligence, security and investigations. "[Businesses should] develop and review policies and controls to fight fraud and safeguard their livelihood from this continually growing problem."
Because fraud is such a monumental problem – so much so that it could even lead to the critical failure of an otherwise successful business – it's important to combat it vigorously. Research published in Harvard Business Review suggests that those in the best position to do so are employees.
To encourage employees to come forward when they are aware of fraudulent activities, companies should consider offering job protections and even rewards to whistleblowers. Unfortunately, it appears that firms engaged in fraud often offer incentives for employees to ignore fraud instead; and these methods work.
"Misreporting firms that granted more stock options to rank-and-file employees were less likely to be exposed by a whistleblower," HBR researchers wrote. "Approximately 10 percent of the firms in our sample were subject to a whistleblowing allegation. Firms that avoided a whistleblower granted 78 percent more stock options than these firms did not."
Part of avoiding this vicious cycle in the first place is to build a culture of anti-fraud right from the start. Owners and managers should put together a list of anti-fraud policies in good faith that will govern the organization for years to come and, in the case the company goes public, be subject to shareholder review before being revised or rescinded.
For other tactics to help businesses protect themselves from fraud, Hetherington offered the following tips for all companies:
- Offer internal and external audits.
- Create management reviews and independent audit committees.
- Offer fraud training for management and employees.
- Have mandatory vacation and job rotation.
- Create a hotline/tip line and rewards for whistleblowers.
Small businesses, however, must be extra vigilant about fraud, Hetherington said.
"Small businesses in particular are extremely susceptible to employee fraud, as they often lack the anti-fraud controls or policies found in larger organizations," said Hetherington.
Hetherington offered the following tips to small businesses looking to prevent fraud right from the hiring process:
1. Conduct a background check on employees.
Small companies seldom bother with a background check on new employees, potentially inviting hackers, predators and even convicted felons into the organization. Conduct a thorough background check that goes back over the past seven years on all employees before hiring to see if there is a criminal history. [Looking for the best background check services? Check out our best picks.]
2. Run a credit report.
With a signed release, check new employees' credit reports for any fiscal irresponsibility – especially if they'll be working in any kind of financial role. During an economic crisis, it's OK to have some financial stresses, but you wouldn't want your comptroller to be filing for bankruptcy.
3. Do a social media audit
Once the employee is being considered for hire, review their social networks for any items damaging to reputation, especially any past animosity against their former employer.
4. Implement policies to protect your reputation.
Institute an employee policy that outlines expected employee behavior anytime they are representing the company, including any mention on their social networks.
Additional reporting by Dave Mielach. Some source interviews were conducted for an earlier version of this article.