Small Business Fraud: A Real-World Case Study


The statistics regarding fraud perpetrated against small businesses are staggering - not only from the point of view of how many cases take place every year, but the significant amount of funds that are misappropriated annually. No business, large or small, can easily sustain financial losses but these can be especially devastating for local family owned, privately held companies without the deep pockets necessary to help overcome a hit of any magnitude.

Given that fraud is something every business owner wants to avoid - or at least minimize - knowing the warning signs is essential.

How does fraud begin?

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The “fraud triangle” provides a succinct image that anticipates and predicts fraudulent  behavior. The three sides of the triangle represent (1) pressure - a compelling reason that pushes a desperate person to commit fraud; (2) opportunity - the perpetrator is in a situation that makes it comparatively easy to behave in a fraudulent manner; and (3) rationalization -  this third piece of the triangle enables the perpetrator to convince himself/herself that he/she is entitled to behave illegally because they ‘deserve’ the money, or they have really ‘earned’ the money, reassuring themselves that their behavior is actually respectable.

Case Study 

With the fraud triangle as a foundation, we can drill down into a situation that took place recently in a family business as we see how the three characteristics each played a key role in a fraud case.

A middle market family-owned distribution company had just celebrated 26 years of proudly doing business in the community.  Their balance sheet and profits were strong, and the family members were actively engaged in the company.  In addition to family members they had 10 trusted office employees and they had processes and procedures in place to ensure smooth warehousing operations. An outside accountant performed quarterly account reconciliations to give them confidence that their financial matters were also in order.

The office manager of 19 years, Bianca, was also the bookkeeper. This is a scenario that is common in most small to mid-size companies where there is little distribution of labor and few checks and balances in place in the back office. In this case, security was not an issue and concern over internal controls did not matter because it was a closely knit, dependable and intimate staff.

That is until BIanca’s husband was injured and had to stop working.  As her personal financial problems mounted, and her home was facing foreclosure, Bianca grew desperate.  Based on the first two aspects of the fraud triangle - she had extreme pressure and abundant opportunity. As bookkeeper and office manager her autonomy was complete; there was no oversight on her activities and no ACH authorization call-back instituted to monitor outbound payments.  Over the course of three years, Biana misappropriated $740,000, rationalizing that she needed to do this to keep her family together. Besides, she thought to herself,  the company could afford to help her, and after 19 years with the family, she deserved some support. That attitude of entitlement is part of the rationalization side of the triangle.

Bianca was not caught in the act until the company’s outside accountant questioned debit balances in accounts payable and suspicious ACH payments that didn’t match up with any invoices.  Bianca was initiating ACH payments that looked like overpayments to vendors, butshe was sending the extra money to her own accounts. In addition she was also putting money directly into her account from company accounts.

Lessons Learned

Owners of small businesses that are staffed by loyal employees who boast years with the company often overlook the temptations that may arise when circumstances change. An employee with a sick child, a disabled husband, an addiction or even overwhelming college tuition debt, can decide that, given the opportunity, fraudulent behavior is their best, or only, option.  The embezzlement may start small, as a test to see if the system will work.  Once there is some success, the employee may become bolder, continuously justifying the behavior and giving in to the financial pressure, and the new habit of misappropriation becomes a way of life. Frequently it is the most trusted and long term employees who are the offenders because they are the ones with the greatest opportunity!

Remember the fraud triangle and do not take anything for granted. No matter how small your staff is, be sure to have some distribution of roles and responsibilities to ensure that one employee never has all the authority in the company’s financial processes.  Insist on vacations for all employees so that everyone’s job is periodically handled by someone else.  Review all checks that are written every month and be sure there are reasonable and recognizable invoices to account for every check, each representing a well-known vendor. Watch for extra paychecks. This is especially important today where no tangible checks exist and all deposits are made directly into the employee’s’ account.  Look over the payroll summary and assure yourself there are no phantom employees on the list or that one employee is not regularly drawing extra checks.  Lastly keep your eyes and ears open. If an employee seems to be going through a hard time or consistently appears nervous and out of sorts, pay attention - these could be warning signs of a person under duress.

Even small business owners can put systems in place to help deter or at least quickly uncover fraud in their organizations!

This column will provide business advice and new  perspectives on business news, emerging trends and traditional topics impacting individuals, family businesses and professional service providers across the tri-state area.

The opinions expressed herein are the writer's alone, and do not reflect the opinions of or anyone who works for is not responsible for the accuracy of any of the information supplied by the writer.

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