Owner-Manager Fraud: Getting Worse...How to Detect It

April 2, 2012 | Download PDF

Statistics show that private businesses -- often owner-managed -- typically lack internal controls mandated by federal laws and the human and managerial resources to focus on possible employee crimes such as embezzlement, corruption and trade secret theft. But there's a bigger problem at privately-held companies: Owners themselves committing fraud.

Reproduced with permission of the copyright owner © White-Collar Crime Fighter, April 2012.

CONCEALMENT SCHEMES

RISKS, PREVENTION AND DETECTION

CONCEALMENT SCHEMES

Owner-managers cover their tracks in the same way as other bosses: They intentionally inflate revenues, overestimate asset values ... or underestimate liabilities.

Misappropriation of funds is typically concealed in fraudulently overstated assets or expenses or understated liabilities or revenues.

Key: Owner-managers have authority that isn't available to non-owner managers and, in many cases, there is an absence of effective oversight. This enables them to intimidate subordinates into cooking the books or going along with questionable accounting, frequently by the implied threat of job loss.

Added problem: Federal whistleblower protection statutes normally don't apply.

RISKS, PREVENTION AND DETECTION

A key reason privately owned company management fraud goes undetected for long periods of time is that the auditing standards contain a provision allowing auditors to overlook the fraud risk related to owner-managers.

Details: SAS 99, Consideration of Fraud in a Financial Statement Audit, curiously points to the risk of fraud only when non-owner management is dominated by a single person or small group.

The current standard thus gives owner-managers a “pass” — by allowing auditors to ignore the risk of fraud committed by owner-managers.

Essential lesson: Privately-held company boards of directors and audit committees should insist that the entity’s auditors consider the fraud risk factors and red flags contained in SAS 99 specifically with respect to owner-managers in planning and carrying out the audit. Examples:

  • Domination of management by a single person or small group without compensating controls, whether they are an owner-manager or a nonowner-manager.
  • Lack of day-to-day involvement in the business by co-owners.
  • Pressure to overstate earnings or assets or to enter into transactions leading to a material misstatement of the financial statements, such as entering into side agreements.
  • Unusual involvement by the owner-manager in the financial reporting process.
  • Withholding information or restricting access to information by other members of management or the auditors.
  • Making false representations to auditors.

Important: Auditors should be particularly critical in their assessment of the level of oversight exercised by boards of directors or the segregation of duties afforded by a chief financial officer or controller in an owner-managed business. In many cases, the oversight or segregation is not be as effective as it appears.


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