Minimizing Fraud

Trusted ministries are keenly aware of their susceptibility to fraud.
They establish and continually test internal controls to minimize significant fraud.

 

by Dan Busby

 

How would a person who committed a major fraud describe serving hard time? One such individual called it “a taste of hell.”

The memories
of a scandal
fade slowly.

One of the first letters from prison written by John “Jack” Bennett, the key figure in planning and executing the Foundation for New Era Ponzi scheme, communicated this poignant story:

In an open letter describing time served at the Federal Correctional Institution (FCI), Fairton, New Jersey, the prisoner said that on his first day at FCI, he had to go to the clinic for the physical required of all new inmates.

Upon arriving at the clinic, “I opened the door and scanned the waiting room for a vacant chair. There were about 15 inmates waiting—all appearing unfriendly and menacing. High up in the corner of the waiting room was a TV suspended and the morning news was being broadcast. I suddenly realized that it was news on a Philadelphia channel. And, just as suddenly, the news that flashed across the screen was about me. There on the TV was a story of my sentencing the day before.

The report focused on the millions of dollars that were defrauded and that all the funds had not yet been accounted for. Then followed pictures of me—a close-up and a profile.

I immediately bent my head forward making it appear that I was reading a magazine on my lap. But it was already too late. As I lifted my eyes, I could see one, then another, inmate looking at me and at each other and then back to me. Back and forth from the TV to me until it was confirmed in their minds that the man on TV and the man sitting in this room with them were one and the same. I could sense they were conjuring up strategies of how they could benefit from the presence of this perceived wealthy man who had just crossed their paths.”[1]

When we hear the latest report of fraud occurring in a ministry, we often say, “How could this happen?” Conditions that give rise to fraud follow common themes, and the actions that can prevent it rest on both policies and people.

According to the Association of Certified Fraud Examiners (ACFE), the typical organization loses five percent of its annual revenues to fraud. And because frauds frequently last over a year-and-a-half before detection, the typical fraudster steals an average of $150,000 or more.[2]

“The first time an embezzler takes money, it’s a very hard thing. Yet there’s generally a reason. There’s an illness or a debt or a gambling problem. Something in his mind requires him to take money he knows is not his. The second time is a little easier. The third time is easier still. And as the arc goes, it becomes easier and easier and easier. And then, after the embezzlement has been going on for some time, it’s all of a sudden his money. The sense of entitlement has been building. And at the end of the arc of embezzlement, the person simply takes as much as he wants because it’s his money. At this point he feels like he’s entitled to it. The guilt and hesitation he felt at the beginning have long since dissipated.”[3]

Fraud is a persistent
risk that doesn't
discriminate by size or
type of organization.
Fraud is an equal-
opportunity problem.

For religious, charitable, and social service organizations, the top five areas for fraud involve (1) corruption (28.8%), (2) billing (25%), (3) expense reimbursement (25%), (4) check tampering (25%), and (5) skimming (19.2%).[4]

Good internal controls can help discover these frauds. More importantly, they are reasons to help discourage fraud from starting. Few people consciously start out intending to steal. Rather, many fraudsters are ordinary people with a financial need (motivation) that helps them internally justify (rationalize) why it is okay for them to take nonprofit assets (opportunity).

The ACFE report noted that the average fraud was discovered by (1) tip (39.1%), (2) internal audit (16.5%), (3) management review (13.4%), (4) accident (5.6%), and (5) account reconciliation (5.5%).[5]

The first part of being a good steward is safeguarding financial resources. The second is not placing a stumbling block in the path of employees and volunteers by relying on human nature, rather than internal controls, to help prevent fraud.

Secrecy is the
badge of fraud.
Sir John Chadwick

Like a lot of crime, embezzlement typically starts small and grows over time. Ministries often have good controls in place, but many are inconsistent in their application.

Consistency comes from both thorough staff training and a commitment to accountability throughout the ministry—starting at the top. When either is lacking, a motivated thief can seize the opportunity for fraud.

Trust is a double-edged sword. It creates a positive, efficient work environment, but it can lead to complacency. It’s no coincidence embezzlers are often described as “trusted insiders.”

People who work together tend to get to a point where they’re familiar with each other and tend to like each other. There’s a temptation to avoid confrontation and to assume the best motives of the other person.

The sole staff member of a ministry pilfered about $100,000. Even as red flags appeared, some directors assumed others were monitoring for problems, and fear of conflict left important questions unasked.

It is impossible to reduce fraud risk to zero, but fraud can be greatly minimized with a combination of solid financial controls and a supportive culture.

Start the fraud minimization process with the following three steps:

  1. Identify the areas most susceptible for major fraud occurrences. For the ministry you serve, what are the three areas which are most susceptible to fraud? If you can’t readily answer that question, the risk of fraud is probably not very high on your radar screen. For ministries with sound overall internal controls, the largest risks will likely be with electronic transactions—receiving gifts, fees, and sales. For a ministry with weak internal controls, the largest risks may relate to check approvals, bank reconciliations, and more.
  2. Design and apply fraud prevention steps specifically to address the susceptibility of major fraud. Once the most significant risk areas are identified, fraud prevention steps must be especially designed to minimize fraud in each of these areas.
  3. Review and revisit. Periodically review the top areas of fraud susceptibility. These areas may change over time. For example, a ministry may only have a major construction project once every 20 years, but that one project could be an opportunity for major fraud while the project is in process. Revisit the fraud prevention steps to see if they need to be updated. And, review the application of the fraud prevention steps. Policies are not enough to reduce the risk of major fraud—the consistent application of the polices is the key.

After focusing on major fraud risks, be sure the following measures are in place:

Fraud and falsehood
only dread examination.
Truth invites it.
Samuel Johnson
  • Segregation of duties. No one person should be responsible for all accounting functions.
  • Double approval of expenses. At least for expenses over a predetermined level, two expenditure authorizations should be required. For small ministries, this will often require the involvement of a board member.
  • Multiple reviews. Bank and credit card statements and expense reports should be reviewed by more than one person.
  • Diligent background checks. For any staff or volunteer position that interacts with financial transactions, background checks can reveal previous criminal records.
  • Recurring fraud-risk assessments. Periodically select certain financial processes and test them to be sure policies and procedures are being followed. Even the mere presence of such reviews can act as a deterrent.
  • Increase samples of transactions reviewed. Consider increasing the volume of transactions sampled in a standard external audit—yes, this will increase the audit costs. With or without an external audit, staff should periodically and randomly sample transactions to ensure compliance with financial procedures.
What design
would I be forming
if I were the enemy?
Frederick the Great

Many ministries that suffer fraud get clean audits every year. Executives and boards have a false sense of security about their financial audits. While some fraud testing is done by external auditors, a financial audit is not designed to discover fraud. Because a routine audit tests a sample of transactions, when it does uncover fraud, it’s almost by accident.

Look at the big picture. Where are the major flows of money coming into the ministry? Are significant sums being received digitally? How easy would it be for someone to redirect the routing of digital deposits just for a few hours a week or each month? Are large amounts received remotely from the ministry’s primary office? Are the remote location controls as strong as the controls in the home office?

Based on the flow of funds, take aggressive steps to monitor major inflows and outflows. These areas should be your prime targets for review.

Where are significant expenditures made of a non-routine fashion? Construction projects are a haven for fraud. Here, payments are being made to vendors that usually do not receive funds—ministry staff are not as familiar with these vendors, and a payment to a fraudulent vendor is easier to occur.

In Luke 16:10–14, Jesus declared:

If you’re honest in small things,
you’ll be honest in big things;
If you’re a crook in small things,
you’ll be a crook in big things.
If you’re not honest in small jobs,
who will put you in charge of the store?
No worker can serve two bosses:
He’ll either hate the first and love the second
Or adore the first and despise the second.
You can’t serve both God and the Bank.

When the Pharisees, a money-obsessed bunch, heard him say these things, they rolled their eyes, dismissing him as hopelessly out of touch.

Jesus was not out of touch. He spoke the truth and struck a sensitive nerve with the Pharisees.

Significant fraud and repeated incidents of fraud can completely cripple a ministry’s trust level.

 

  Questions   for reflection

 

  1. Are your board and staff committed to fraud prevention?
  2. For the ministry you serve, what are the three areas most susceptible to fraud?
  3. What steps should the ministry take to strengthen controls in these three areas?

 

 

[1] An open letter from John Bennett after his imprisonment at the Federal Correctional Institution, Fairton, New Jersey, December, 2002.

[2] Association of Certified Fraud Examiners (ACFE), “Report to the Nations on Occupational Fraud and Abuse: 2016 Global Fraud Study,” 9, http://www.acfe.com/rttn/docs/2014-report-to-nations.pdf.

[3] Doug White, Abusing Donor Intent: The Robertson Family’s Epic Lawsuit Against Princeton University (St. Paul, Minn.: Paragon House, 2014), 177. ?Author interview with Seth Lapidou, August 21, 2012.

[4] ACFE, 2016 Global Fraud Study, 36.

[5] ACFE, 2016 Global Fraud Study, 21.

 

From TRUST: The Firm Foundation for Kingdom Fruitfulness, ECFAPress, 2015, www.ECFA.org/KnowledgeCenter.


This text is provided with the understanding that ECFA is not rendering legal, accounting, or other professional advice or service. Professional advice on specific issues should be sought from an accountant, lawyer, or other professional.

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