Senior Advisor, Fogle Keller & Walker PLLC | Professor of Law, University of Kentucky College of Law
Fraud by a trusted employee can bring a successful business to its knees. The story is all too common – a small business relies on a single bookkeeper to handle its financial transactions and finds, much too late, that that bookkeeper has made off with cash from the checking account. In the aftermath, suppliers to the business are unpaid, firm profits are squandered and the reputation of the business is lost. The Association of Certified Fraud Examiners recent study of occupational fraud concludes that small businesses suffer disproportionate losses due to fraud.
Understanding a few rules can help business owners protect against employee checking account fraud.
There are three prevalent types of checking account fraud:
Perhaps the simplest type of fraud is the theft of a check by an employee who simply writes a check to cash or to himself and forges the signature of an authorized signer. Fortunately, this is the easiest type of fraud to detect through a thorough and regular review of the bank statement. The basic rule is simple – banks may not charge their customers for checks that are not signed by an authorized person.
Like most rules, however, there are exceptions. Under the Uniform Commercial Code, if a bank customer treats its checks carelessly, the business may be responsible for any forgeries resulting from that negligence. In addition, if the business fails to review its statements in a reasonable time, it will be responsible for continuing fraud that such a review might have uncovered. Of course, if the thief is authorized to sign checks, losses from this scheme will fall directly on the business.
In this scenario, an employee steals incoming checks from customers, forges the employer’s endorsement and deposits the checks into a separate account over which the forger has full authority. The thief might then try to cover up the loss in collections through manipulation of the accounts receivable ledger.
Liability for this type of fraud depends on the role of the thief. If the thief is a low level employee, the losses from the theft may fall on the bank, unless the business is guilty of negligence. If, however, the thief is a “responsible person,” the employer will suffer the loss. The UCC defines “responsible employee” broadly, including employees who have authority to sign, prepare, process, or control the disposition of checks the business receives.
The hardest scheme to detect involves an employee who creates a fictitious person or company – a phantom supplier or employee – and submits dummy invoices or payroll lists so that the company issues checks to that fictitious person. The thief then steals the check and deposits into an account in the name of that fictitious person. In most cases, the business will be responsible for the losses from this type of fraud and it will be difficult to shift the losses back to the bank.
Clearly the first line of defense against employee check fraud is to know your employees. Thorough background checks for all employees are a must. Also, watch for changes in your employee’s behavior or lifestyle that might signal potential fraud. Even the most careful personnel practices might leave a business vulnerable to employee fraud, however, so close attention to your financial practices is necessary.
The best way to organize your finances is to split up the functions among several employees. If possible, make different employees responsible for opening incoming mail, preparing checks, depositing receipts and reconciling bank accounts. Stay in close contact with suppliers and customers to make sure that payments of receivables are being applied and that payables are kept current. Occasionally rotate financial functions among employees and assure that every employee with financial responsibility takes at least a week long vacation once a year.
Setting up and monitoring a system for your finances will minimize your potential losses from employee fraud. The professionals of Fogle, Keller & Walker can review your system and suggest ways that it might be improved. Of course, no system is perfect so if you have experienced losses from employee fraud, we can evaluate your potential claims and assist you in recovering your losses.