Every couple of years we are hired by an attorney who has been the victim of fraud. As we listen to his story it reminds us once again that crimes of fraud in most small law offices follow an eerily similar, very predictable pattern.
In many cases the perpetrator is female — a trusted Office Manager or bookkeeper who has been with the firm for years and is heavily relied upon. She may work long hours, take no time off and have a tendency to do everything herself (which appears to be dedication, but is instead a way of keeping others from discovering her questionable activities).
The victim is a typical attorney, someone who is stressed, distracted and not paying close attention to the financial side of the practice. He or she doesn’t have good financial systems in place and trusts the Office Manager or bookkeeper to handle everything.
Financial carelessness and a trusting nature are an important part of this picture, but a couple of other ingredients must be in place before the temptation to defraud is irresistible. Cammie Hauser, CPA and Atticus® Practice Advisor, says that three important elements are usually present prior to a fraud occurring. Altogether these three factors are called the “Fraud Triangle,” and are well-known to law enforcement officials because they tend to occur in all professional service businesses, not just law firms. Dentists, doctors, architects and lawyers tend to focus on their work and leave the administration of their finances to others. Our hope is that once these factors are clearly understood, they can be prevented from occurring. Here they are:
- Motivation – this occurs when there is a financial challenge in the life of the potential fraudster. Whether that challenge is due to a divorce, the need to pay off debt or finance a child’s education, it must create significant financial pressure.
- Rationalization/Justification – this occurs when the person tells herself that the attorney, “won’t miss a little of his money – he has too much anyway,” or that the attorney, “doesn’t work hard enough to deserve all this money.” There is clearly an underlying sense of resentment fueling these thoughts, though it may be well disguised.
- Opportunity – this occurs when the attorney does not have good financial oversight, lacks financial savvy, is distracted and/or unquestioningly trusts the team member who handles the money.
How can you prevent fraud from happening in your office? By making sure you don’t let these three elements occur simultaneously in your firm.
This is easier said than done. In this difficult economy, many staff members are losing their homes, struggling with mounting debt and/or giving extra financial support to grown children. There is little you can do to prevent financial pressure – it will occur. Fortunately, most people don’t give in to this kind of pressure, but it can amp up the level of temptation. Keep your eyes and ears open when it comes to the personal life of the person handling your finances. If he or she starts complaining to other team members about financial difficulties, watch them carefully. If you also notice that he or she refuses to let others help with financial tasks, works unusually long hours or doesn’t take vacation time — and you have suspicions, it might be time to bring your CPA in for a surprise audit.
As for the second element of the Fraud Triangle – rationalization and justification – you have very little control over this silent, internal process as well. Comparing our lot in life to that of others is a natural human compulsion. As is rationalizing bad behavior. People who work for you will notice the disparity between your financial status and theirs. Some will occasionally resent you for it, so your best bet is to hire someone who is bonded and insured from the start. We realize that’s not always going to happen, especially in small firms where staff wear multiple hats, so look for character flaws such as pettiness or jealousy of others which may indicate negative tendencies.
Given the relative lack of control over the first two elements of the Fraud Triangle, we believe you should do everything you can to prevent the third factor — opportunity — from arising. You do this by establishing an organized, systematic approach to your finances — before someone takes advantage of you. This is one factor you have total control over and it is your best insurance against being cheated. The checklist below, created by Cammie Hauser, allows you to rank your present cash control system to see if you are taking all precautions to protect yourself. If you answer “yes” to all ten questions you’re in good shape. Any questions to which you answer “no” indicates a hole in your system. Take the test right away and see how vulnerable you are to fraud in your firm.
The Cash Control System
- Are checks endorsed with a “for deposit only” stamp when they are received?
- Is the person reconciling the bank statement (matching the bank balance to your balance) NOT the same person receiving (opening mail) and depositing revenue?
- Are daily deposit totals matched to a computerized accounting total for recording revenue?
- Are authorized signers (or those with the access to make transfers) on the bank accounts limited to partners/owners?
- Are pre-numbered checks issued and any missing numbers investigated?
- Are checks kept in a secure locked area?
- Are monthly expense items budgeted and any variances investigated promptly?
- Are client advanced costs details reviewed by the assigned attorney monthly, if applicable?
- Are new vendors (payments made for products/services) approved and reviewed at least quarterly by partner?
- Is there an independent review of cash receipts/disbursements procedures by an objective party at least annually?