By James S. Peet, Ph.D., CFE
The transportation world is afloat in fraud, and that includes the maritime sector. While most in the shipping industry are aware of the grander fraud schemes, such as phantom ships (a result of piracy), scuttling of vessels for insurance purposes, documentary fraud, cargo theft, and fraud related to chartering vessels, one area that affects almost all firms, and is seldom proactively addressed, is occupational fraud – theft of company property by those entrusted to it. A good example of this is the recent case of a Hudd/MDSI billing clerk in Sumner, Washington, who defrauded the company of more than $260,000 over a three-year period.
The billing clerk was able to commit fraud by submitting false check requests to the company’s accounting department, and having the checks sent to her for distribution, or to vendors who thought they had been overpaid and returned the checks to the billing clerk. Her fraud led to the company having to cancel the annual employee bonuses.
Could this fraud have been prevented? With due diligence and proper internal controls, the answer is most likely ‘yes.’
In occupational fraud there exists a concept known as the fraud triangle, where the three legs of motivation, rationalization, and opportunity exist to perpetuate fraudulent activity. In the clerk’s case, the motivation was a drug and gambling problem, a financial need she couldn’t quite share with her co-workers. The rationalization was probably something akin to “they don’t pay me enough” or “I need it more than the company does” or “they won’t really miss it, since they’re a big enough company.” The opportunity came in the form of having the ability to get the accounting department to send checks to her, or to convince vendors to return overpayments to her.
According to the Association of Certified Fraud Examiner’s 2010 Report to the Nation (www.acfe.com), more than 80 percent of occupational fraud was committed by individuals in six departments: accounting, operations, sales, executive/upper management, customer service, and purchasing. Employee fraud, such as the billing clerk’s activities, usually lasts for about 13 months before being uncovered, with the average loss being $80,000.
Any company that hires employees who handle cash, checks, or who has access to such (which is every business entity known), should develop a fraud prevention program to deter and detect fraud. Had a strong program been in place at Hudd/MDSI then the company would not have lost so much money, nor would it have been detected so late.
In personnel matters, due diligence is the process of investigating and evaluating a person to ensure he is who he says he is. It differs from a standard background check in that more resources are used and much more information is gathered to ensure the best possible decision is made. Due diligence looks at past employment, references, education, criminal and civil actions, and current lifestyle, to list just a few of the things reviewed. A basic background check might verify past employment and check for a criminal record, along with a drug test, but that may be all that’s done.
One should also have a process in place, as part of a fraud prevention policy, to allow continued due diligence for current employees in positions of financial authority, such as CEOs, CFOs, accountants, and billing clerks. This could be as minor as annual credit checks and drug testing, or could go so far as to ensure these employees are not exhibiting some classic fraud red flags, such as living beyond their means.
Had Hudd/MDSI bonded the billing clerk with a fidelity bond, the employees would probably not have missed out on their annual bonus and salary increases. A fidelity bond, also known as an Employee Dishonesty Bond is one that provides coverage for dishonest and fraudulent acts of employees that may take place while handling your company’s money or securities. Obtaining a fidelity bond requires conducting due diligence on those employees to be covered. As with the due diligence, employees to be covered should include CEOs, CFO, accountants, and anyone else entrusted with the company’s money or securities. In some cases, it might be best to conduct due diligence prior to seeking a fidelity bond on a current employee, because if the employee is already committing fraud, their prior actions will most likely not be covered by a future fidelity bond.
A fraud hotline should also have been in place, with all employees and vendors aware of its existence and having information on how and why to call. It’s probable that the billing clerk showed many of the classic red flags of fraud, particularly living beyond her means. Had her fellow employees been made aware of these red flags and had a clear way to report the issue anonymously, it’s doubtful that the crime would have lasted three years.
While establishing and maintaining these controls may appear daunting, particularly for smaller shipping firms, consider the alternative. According to the ACFE’s 2010 Report to the Nation, while the median loss for all companies is $231,000, most small companies (those with fewer than 100 employees) hit with fraud usually suffer losses of $155,000. This size loss can be the difference between being successful or going out of business for most small companies. One case I investigated cost the company $250,000 out of a $6 million contract they had– that’s a four percent loss!
James Peet, a Certified Fraud Examiner (CFE), is the principle manager of Peet & Associates, LLC, a fraud examination business located just outside Enumclaw, Washington. He is a graduate of two law enforcement academies and has earned a BA at the University of Miami, an MA from California State University, Hayward and the Global Trade, Transportation, and Logistics Certificate, as well as a Ph.D. from the University of Washington.
