Source:Deloitte Development LLC

Picture this: you’re a senior executive of a company that has weathered the financial crisis and recession and is now poised for growth. The controller calls to tell you that a senior member of the finance team is suspected of a major embezzlement. Not only is this person’s integrity in question, but so is the company’s, as is the reliability of its previous financial statements.

An embezzlement can be cause for major concern for senior management, directors and officers. In this event, it is paramount to act swiftly to determine the scale of the issue and mitigate the company’s potential exposure to financial, legal and reputational damage.

The financial impact, including costs to resolve and remediate the matter, can be significant. Of potentially greater concern is the risk of damaging the company’s reputation—an embezzlement casts doubt upon the reliability of current or previously issued financial statements, the firm’s risk management practices and even management integrity.

“The reverberations of reputational damage from a major case of embezzlement could lead lenders, investors, regulators or key counterparties to lose confidence in the company, putting its very survival at risk,” observes Donna Epps, a partner specializing in Forensic & Dispute Services at Deloitte Financial Advisory Services and the national leader of the Anti-fraud Consulting group.

Mitigating Major Embezzlement Risk

According to the ‘Fraud Triangle’ developed by criminologist Dr. Donald Cressey based on his interviews of 200 white-collar criminals, three elements are usually present for someone to commit fraud:

—Financial pressure from factors such as impending home foreclosure, high medical bills and credit card debt.

—Perceived opportunity to commit the fraud with low likelihood of being caught.

—The perpetrator’s perceived ability to rationalize the fraud or justify the proposed action.

“There are at least 10 things companies can do to help mitigate the risk of embezzlement or help detect it earlier if it occurs,” says Ms. Epps. “Implementing these steps can assist both large and small entities in mitigating the risk of major embezzlements.”

1. Updating Risk Assessments—Companies that may have experienced significant changes in their operations during the economic downturn may not have kept their risk assessment processes current with changing conditions. Updating fraud risk assessments can help to identify and mitigate new and increased embezzlement risks.

2. Validating Segregation of Duties—Make different individuals responsible for custody of assets, the authority to initiate transactions and recording transactions in the entity’s books and records. Studying combined job responsibilities after downsizing can reveal incompatible functions or the compromise of previously effective internal controls.

3. Redesigning Business Processes—Consolidating locations for cash receiving, cash disbursements, payroll and other financial functions can help reduce embezzlement opportunities, as well as making supervision easier and more cost-effective. Using a reputable outsourced service provider for one or more such functions takes this idea a step further.

4. Revisiting Background Checks—“Taking a fresh look at the background checks you currently commission might lead you to decide that they don’t give you as much protection as you thought or want,” observes Josh Johnston, senior manager, Forensic & Dispute Services at Deloitte Financial Advisory Services LLP. “Basic criminal background checks may only check records in the applicant’s current location. If an applicant has relocated one or more times, past crimes may be missed,” he says.

5. Enhancing Whistleblower Systems—Employees can be encouraged to report suspected embezzlement via whistleblower systems. As a result of the adoption of final whistleblower rules by the SEC pursuant to the Dodd-Frank Act, whistleblowers can potentially bypass internal reporting mechanisms and report fraud, including embezzlements, directly to the SEC. Companies should be evaluating and improving their anti-fraud programs and controls to encourage internal reporting.

6. Transaction Monitoring and Data Mining—Technology tools make it possible to monitor even a large volume of transactions. Used continuously or for mining batches of data, they can help identify anomalies that may be caused by embezzlement. “Letting employees know that transactions are being computer-monitored to detect fraud can have a deterrent effect as well,” notes Mr. Johnston.

7. Zero-based Budgeting—Embezzlements that continue for several years can get ‘baked into ’budgeted expenses, making them harder to spot. Zero-based budgets can strengthen financial control and help to prevent and detect embezzlements.

8. Providing Employee Assistance—Employer-provided employee assistance services can be an important safety valve, connecting employees with financial and other counselors before they may be tempted to turn to embezzlement to solve their financial problems.

9. Sustaining Values—Holding employees accountable for living the entity’s values even in difficult times can make it harder for employees to rationalize embezzling. It can also help increase the likelihood of whistleblowing in cases of suspected wrongdoing.

10. Maintaining a Code of Ethics and Providing Ethics Training—A values-based, consistently enforced code of ethics or conduct can be made more effective by listing prohibited actions, and the consequences for violating those prohibitions.