Three ways to protect a small business from fraud

By Elaine Pofeldt

It’s a rare day lately when there isn’t a report of a corporate fraud or financial scandal in the news, but it’s not just big companies that face threats from within. Small businesses can be just as vulnerable to this type of wrongdoing and the “reputational risk” that surrounds it, said Kenneth S. Springer, co-author of Digging for Disclosure: Tactics for Protecting Your Firm’s Assets from Swindlers, Scammers and Imposters and president of the global financial investigations firm Corporate Resolutions, based in Manhattan.

In fact, small firms can suffer more than their giant counterparts. A 2012 study by the American Association of Certified Fraud Examiners (AACFE) found that businesses with fewer than 100 employees that were affected by fraud suffered a median loss of $147,000, compared with $100,000 for companies with 1,000 to 9,999 employees. Many small-company owners are looking for ways to protect themselves without spending a fortune to do so. Here are some tips on best practices.


Don’t take employees at their word.

HireRight, a provider of employment screening solutions, found in a recent survey that only 46% of small businesses verified job applicants’ employment histories. And, according to Mr. Springer, many small firms don’t apply strong checks and balances to keep employees honest once they’ve been hired.
This lack of scrutiny can lead to problems later. Mr. Springer, a certified fraud examiner, was involved in an investigation at one New York firm that started out small but eventually grew into five related companies with a combined $3 billion in revenue. As the company put more formal systems in place, management discovered that a longtime bookkeeper, who was on the payroll of all of the companies, wasn’t as trustworthy as they thought, he said. “When they were small, they left her to handle everything,” he said. “She was stealing them blind.”
The upshot? Formal background checks can help you to weed out potentially troublesome employees, said Mr. Springer. Also make sure that the people handling your finances are accountable to someone other than themselves, he cautioned. (Billing schemes are the most common type of fraud affecting small businesses, according to the AACFE.)

Check out private investors carefully.

Don’t let your eagerness to raise funding cause you to rush into deals with backers whose past histories might cause you problems once they join your team. “Know who your investors are,” advised Mr. Springer.
A Google search won’t cut it, he said. It’s important to check for legal suits, including those filed outside of your state, he advised. One way to do this is through the Pacer system, which is accessible online, he said. Also talk with a potential investor’s references and independently look for your own, he suggested.
It’s not just the threat of potential fraud that you want to watch out for. An association with an investor with a checkered past could damage your firm’s reputation. “You don’t want to take money from a drug dealer or money launderer,” he said.


Create a hotline.

The AACFE recommends employing an ombudsman or setting up a whistleblower hotline, so employees who suspect fraud have an anonymous way to report it before it snowballs. “There are so many overlooked or ignored warning signs,” said Mr. Springer.
A hotline or email address operated by an outside provider can allay employees’ fears that management will retaliate if they use it, noted Mr. Springer, who is among many providers of such services. “There are a lot of hotlines out there,” he said. If your budget is tight, setting up your own system internally can work, as well.