Employee Dishonesty: Prevention and Detection

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1 Employee Dishonesty: Prevention and Detection Frontline Risk Management Series Welcome to this session on Employee Dishonesty, a risk management module presented by CUMIS General Insurance s Risk Solutions Group. 1

2 Over the last 15 years, CUMIS Insurance has paid out over $40,000,000 in credit union employee dishonesty losses. Employee dishonesty is a significant exposure for financial institutions. Over the last 15 years, CUMIS Insurance has paid out over $40,000,000 in Canadian credit union employee dishonesty losses. 2

3 All credit unions are vulnerable to internal theft if the proper controls aren t put in place and strictly followed. It doesn t matter how big or small your credit union is; All credit unions are vulnerable to internal theft if the proper controls aren t put in to place and strictly followed. 3

4 This session will introduce you to fraud prevention practices. This session will introduce fraud prevention practices which have been shown to reduce your credit union s exposure to these types of losses. We will focus on some strategies to prevent and detect internal fraud. 4

5 Use within the framework of your credit union s guidelines and practices. The information provided in this module is designed to help your credit union safeguard against employee dishonesty. However, it is important that the information is only used within the framework of your credit union s guidelines, as practices and audit requirements may differ from one credit union to the next. Your credit union management can clarify where this module may differ from the procedures you are expected to follow. 5

6 How employee dishonesty can affect your credit union When an employee steals, it s more than just a financial loss. Let s take a look at how employee dishonesty can potentially affect your credit union. 6

7 How employee dishonesty can affect your credit union REPUTATION Damage to the reputation of the credit union can be significant. This is particularly true for financial institutions which rely on their image as a safe and secure place to hold their members money. 7

8 How employee dishonesty can affect your credit union MORALE REPUTATION Employee dishonesty can also damage internal morale. These events can be taken personally and have an emotional toll, taking away from a positive and healthy working environment. 8

9 How employee dishonesty can affect your credit union MORALE FOCUS REPUTATION Internal theft or fraud can also divert focus away from implementing plans. As an unwelcome distraction, a dishonesty event can pull resources and efforts away from other credit union matters. 9

10 How employee dishonesty can affect your credit union MORALE FOCUS REPUTATION FINANCIAL Finally, there is the obvious financial loss associated with employee dishonesty. The Canadian credit union system has seen individual losses near $10MM, a figure that many credit unions would not be able to absorb. 10

11 Examples of Employee Dishonesty To help with context, let s look at a few high level examples of employee dishonesty losses that have occurred at Canadian credit unions. 11

12 Examples Member services supervisor Custodian of the main treasury Cash Misappropriation Delayed Cash Account Commercial Lender Member Not-Present Misappropriated cash from vault Concealed thefts by manipulating the General Ledger Cash physically removed Loss Example #1 Cash Misappropriation The first loss example deals with the misappropriation of cash caused by a credit union s member services supervisor. This member services supervisor was also the custodian of the main treasury at this specific credit union branch. Throughout an 8 10 year period, the employee methodically misappropriated cash from the credit union s vault and concealed the thefts by manipulating the General Ledger. Cash was physically removed from the main treasury, which resulted in a physical cash shortage. 12

13 Examples Clearing Officer Redirecting items Cash Misappropriation Delayed Cash Account Commercial Lender Member Not-Present Posted to Suspense Account, transferred to Delayed Cash Daily balances accumulate in Delayed Cash Fictitious entries at year-end to conceal the losses Loss Example #2 Delayed Cash Account A clearing officer was found to have been redirecting items drawn against some member accounts, including their own, causing them to be posted to the Suspense account that they would clear at the end of each day by transferring the balance to Delayed Cash. The daily balances would accumulate in his delayed cash account. It appears that, just prior to fiscal year ends, the clearing officer posted fictitious entries. These entries were to temporarily remove the accumulating balance of improperly posted items from Delayed Cash and conceal the losses. 13

14 Examples Thought to be a top performer Cash Misappropriation Delayed Cash Account Commercial Lender Member Not-Present Circumventing lending requirements Financial benefit for family and friends Receiving kickbacks Other ethical issues and releasing confidential information Loss Example #3 Commercial Lender What was thought to be a top performing lending officer had actually gone rogue. Some issues with this employee included: This lender coached members to get around the the credit union s lending requirements. They were also using their relationships with members to obtain financial benefit for family and friends and there were even some suspicious transactions to the employee s family. It was believed that the employee was also receiving kickbacks from members whose loans had gone into default. There were other issues surrounding ethical violations and sharing confidential information 14

15 Examples Members flagged suspicious transactions Cash Misappropriation Delayed Cash Account Commercial Lender Member Not-Present No slips, no member signatures, altered slips, slips with bill payments and withdrawals Aligned with teller s personal transactions Teller committing member-notpresent fraud Loss Example #4 Member Not Present Fraud The credit union was first notified of suspicious transactions by two members who were trying to verify unknown transactions on their personal accounts. The suspicious account transactions performed by the teller in question included no slips, no member signatures, slips that appeared altered, slips with bill payments and withdrawals, and transactions that aligned with personal transactions of this teller. With these findings, it was discovered that the teller had been committing member not present fraudulent transactions. 15

16 Pay special attention to Suspense Accounts Delayed Cash General Ledger In recent years, the largest employee dishonesty losses have occurred from the manipulation of suspense accounts, delayed cash and the general ledger. Particularly taking advantage of accounts used to temporarily store or record items and assets. This was portrayed in our loss example #2 with the clearing officer. Multiple credit unions have incurred individual losses in excess of $1,000,000 from long serving employees targeting these accounts. 16

17 Pay special attention to Suspense Accounts Delayed Cash General Ledger Segregation of Duties Segregation of duties is absolutely vital in stopping this type of fraud. Without this control measure, it leaves these areas vulnerable to manipulation. We will talk more about segregation of duties shortly. 17

18 Prevention Role of employees Employee screening Internal control systems Segregation of duties Trust but Verify So how can we stop these schemes and thefts? Let s take a look at what you and your credit union can do to prevent employee dishonesty. 18

19 Prevention Role of employees Employee screening Internal control systems Segregation of duties Trust but Verify Strictly follow internal controls Dual custody Don t share passwords / stamps Question if you are asked to do transactions outside of establish procedures Report ethical breaches As an Employee, you can follow sound practices to help insulate yourself from any suspicions and reduce the impact of employee fraud. The role of all employees is to: Strictly follow the internal controls in place. This includes maintaining dual custody where required and not sharing passwords and teller stamps. Question if you are asked to do transactions which are outside of established procedures. Do not be pressured to do it if you believe it is wrong. Report any concerns you have concerning ethical breaches. Talk to whom you feel most comfortable with this may be your manager, the Human Resources Department, the board of directors, or through an anonymous reporting program. 19

20 Prevention Role of employees Employee screening Internal control systems Segregation of duties Trust but Verify Will reduce the risk of fraud, misconduct and poor performance. Employee selection based on sound character and strong ethical foundation Completed for all new employees Employment history Criminal record Financial position An employee screening process is important in preventing internal fraud. As an employee of a Canadian credit union, you would have likely gone through a screening process knowing as Bonding or the Fidelity Bond Application Process. Screening will reduce the risk of fraud, employee misconduct and poor performance through a proactive candidate selection. Employee selection should always be based on sound character and strong ethical foundation. Background screening needs to be completed for all new employees and should include verification of employment history, a criminal record search, and an assessment of the applicants financial position. 20

21 Prevention Role of employees Employee screening Internal control systems Segregation of duties Trust but Verify Effective controls will limit opportunity Ensure key processes are independently monitored Safeguards in place based on the inherent risk in the activity, not for the person performing it Effective internal controls will limit the opportunity for employee dishonesty by ensuring that key processes are independently monitored regardless of the level of trust placed in individual employees. A good control environment ensures that safeguards are put in place based on the risk and exposure inherent in the process, rather than the person performing it. For example, expense or lending transactions need to be monitored based on the potential for loss, even if the employee involved is absolutely trusted. 21

22 Prevention Role of employees Employee screening Internal control systems Segregation of duties It is often the most trusted employees that are able to cause the largest dishonesty losses. Trust but Verify It is often the most trusted employees that are able to cause the largest dishonesty losses, precisely because the internal controls placed too much reliance upon the apparent character of the employee; they were trusted without any verification. The controls weren t put in place for the actual risk of that function, regardless of who performed it. 22

23 Prevention Role of employees Employee screening Internal control systems Segregation of duties Trust but Verify Lack of proper separation of responsibilities has been an issue for credit unions Ensure that dual custody or segregation of duties is followed in actual practice The most important single factor that has led to large employee dishonesty losses within the credit union system is a lack of proper separation of responsibilities. It is critical to ensure that dual custody or segregation of employee duties is being followed in actual practice, and that employees are not sharing codes, keys or passwords for convenience. 23

24 Prevention Role of employees Employee screening Internal control systems Segregation of duties Trust but Verify No concentrated control More than one person involved in the process No one individual should control all key aspects of a transaction or event In an ideal setting, the approval duties, the accounting and reconciling duties, and the asset control duties should all be separated amongst different employees; There should be no concentrated control. There should also always be more than one person involved in the process and no individual should control all key aspects of a transaction or event. 24

25 Prevention Role of employees Employee screening Internal control systems Segregation of duties Trust but Verify In general, the principal duties to be segregated are: Custody of assets Authorization or approval of related transactions affecting those assets Recording or reporting of related transactions Reconciliation making sure transactions reconcile with balances Let s break segregation of duties down a little further to see how this principle should be applied to a credit union. In general the principal duties to be segregated are 25

26 Prevention Role of employees Employee screening Internal control systems Segregation of duties Trust but Verify In general, the principal duties to be segregated are: Custody of assets Authorization or approval of related transactions affecting those assets Recording or reporting of related transactions Reconciliation making sure transactions reconcile with balances Custody of assets 26

27 Prevention Role of employees Employee screening Internal control systems Segregation of duties Trust but Verify In general, the principal duties to be segregated are: Custody of assets Authorization or approval of related transactions affecting those assets Recording or reporting of related transactions Reconciliation making sure transactions reconcile with balances Authorization or approval of related transactions affecting those assets 27

28 Prevention Role of employees Employee screening Internal control systems Segregation of duties Trust but Verify In general, the principal duties to be segregated are: Custody of assets Authorization or approval of related transactions affecting those assets Recording or reporting of related transactions Reconciliation making sure transactions reconcile with balances Authorization or approval of related transactions affecting those assets 28

29 Prevention Role of employees Employee screening Internal control systems Segregation of duties Trust but Verify In general, the principal duties to be segregated are: Custody of assets Authorization or approval of related transactions affecting those assets Recording or reporting of related transactions Reconciliation making sure transactions reconcile with balances Reconciliation making sure transactions reconcile with balances 29

30 Prevention Role of employees Employee screening Internal control systems Segregation of duties Trust but Verify Controls designed to prevent both errors and fraud Use the concept of Trust But Verify Segregation of duties controls should be designed to help prevent employees from committing errors and to also prevent employees from engaging in any fraudulent activity. Use the concept of "trust but verify". Trust employees, but verify the work and have the controls in place to protect them and to protect your credit union. 30

31 Detection Mandatory Vacation Report Monitoring Surprise Cash Counts Loan File Reviews Audits High Risk Accounts Complaint Handling Anonymous Reporting It s not only important for the credit union to have controls in place to prevent employee dishonesty, but there also needs to be mechanisms in place to detect it. 31

32 Detection Mandatory Vacation Report Monitoring Surprise Cash Counts Loan File Reviews Audits High Risk Accounts Complaint Handling Anonymous Reporting A mandatory vacation policy should be enforced for all employees Opportunity to discover suspicious / fraudulent transactions that can t be covered by perpetrator if they aren t working at the credit union It is essential that the credit union enforces a mandatory vacation policy for all employees. It is recommend that employees are required to a take a consecutive 2 week vacation. At the very least, credit unions need to enforce 1 week of consecutive vacation. If an employee is committing internal fraud, mandatory vacation potentially removes the opportunity for this employee to cover their tracks. The intent of these vacation policies is to allow for the potential discovery of suspicious and fraudulent transactions. It is important the credit union not only has this written into policy, but that it is actively enforced at all levels. 32

33 Detection Mandatory Vacation Report Monitoring Surprise Cash Counts Loan File Reviews Audits High Risk Accounts Complaint Handling Anonymous Reporting Diligent review of exception reports Identify transactions that fall outside the scope of what has been identified normal or standard Investigate to help clarity There should always be diligent reviews of exception reports. Exception reports identify transactions and events that fall outside the scope of what has been identified as normal or standard. Exception reports should be completed and reviewed in a timely manner. Investigate why these transactions have been flagged and make sure to investigate questionable transactions to help you build clarity. 33

34 Detection Mandatory Vacation Report Monitoring Surprise Cash Counts Loan File Reviews Audits High Risk Accounts Complaint Handling Anonymous Reporting Always should be a surprise no advance notice Done at least quarterly and on different days / times Count various treasuries together Report findings of all cash counts to head office It is important that cash counts remain a surprise and staff are not made aware of such cash counts in advance. Giving staff notice of cash counts provides them with an opportunity to cover their tracks, rendering the cash counting process ineffective. Even the most trusted and long serving employees should not be made aware of an incoming cash count. A best practice suggestion would be to try and surprise cash count at least on a quarterly basis and to count various treasuries together. Also vary the days and times that cash counts are completed don t get into a routine or pattern. This prevents employees from being able to move cash in order to have a treasury falsely reconcile. It would also be a good idea to report the findings of all cash counts to head office for record keeping. 34

35 Detection Mandatory Vacation Report Monitoring Surprise Cash Counts Loan File Reviews Audits High Risk Accounts Complaint Handling Anonymous Reporting Ensure employees are subject to regular performance reviews Reviews can uncover irregularities Loan file reviews on employees whose activity is outside of normal ranges Ensure that all employees are subject to regular performance reviews, particularly those involved with lending activity, since this type of review will can uncover irregularities in their documentation. These loan file reviews can help you manage both performance and fraud prevention. Consider performing loan file reviews on employees whose activity is outside normal ranges. While this may just be an indication of strong performance, it could also identify questionable or suspicious behavior that is leading to these irregularities. For example, you may want to complete a file review on a loans officer with loan volumes twice as high as expected. 35

36 Detection Mandatory Vacation Report Monitoring Surprise Cash Counts Loan File Reviews Audits High Risk Accounts Complaint Handling Anonymous Reporting Robust audit procedures with direct reporting to the Board If a credit union is heavily dependent on external auditors, have a verification process. Don t do auditors job for them, but make sure you use the concept of Trust But Verify Ideally, the credit union should have a robust set of internal and external audit procedures with direct reporting to the Board. In situations with a heavy dependence on external auditors, management should review a process to formally verify monthly and annual account details independently.. This is not a suggestion to do the auditors job for them, as this wouldn t be practical. But ensure staff have a set of basic checks and balances that can help verify the authenticity of your accounts. Proceed with the principle of trust, but verify, let the auditors do their job, but don t solely rely on them. We mention this as we have seen credit unions have suffer significant losses due to the negligence of external auditors missing the signs of employee dishonesty. 36

37 Detection Mandatory Vacation Report Monitoring Surprise Cash Counts Loan File Reviews Audits High Risk Accounts Complaint Handling Anonymous Reporting Scrutinize high exposure areas such as: Control environment Employee accounts Suspense accounts Loans Overdrafts Inactive accounts Treasury balances Adjusting entries Write-offs An effective audit program will scrutinize high exposure areas such as: overall control environment; employee accounts; suspense and in transit accounts; loans and overdrafts; inactive accounts; treasury balances; adjusting entries; and write offs We have seen all of these areas targeted by employees looking to exploit their credit union. 37

38 Detection Mandatory Vacation Report Monitoring Surprise Cash Counts Loan File Reviews Audits High Risk Accounts Complaint Handling Anonymous Reporting Have a formal complaint handling process for your membership Take all complaints seriously Investigate all complaints and do so in a timely manner Credit unions have uncovered employee dishonesty schemes after investigating complaints from members. Make sure your credit union has a formal complaint handling process for your membership. If a member reports suspicious transactions or has issues with activity that has been completed on their account, take it seriously even if it seems frivolous or routine at first. Your credit unions should investigate all member complaints and do so in a timely manner. Not only is this a useful fraud prevention technique, but it s also just good customer service. 38

39 Detection Mandatory Vacation Report Monitoring Surprise Cash Counts Loan File Reviews Audits High Risk Accounts Complaint Handling Anonymous Reporting Anonymous tip reporting is a leading detection method for employee dishonesty Watch our Integrity in Action Program webinar for more information on: Why employees steal Red flags A free and anonymous tip line available to you Anonymous tip reporting. We d like to direct your our Integrity in Action Program Webinar that is available to you. Please feel free to watch this short pre recorded webinar that addresses: Why employees may steal from their employee; this is a review of what is known as the fraud triangle Red flags that can potentially identify and employee who is committing internal fraud And information on Integrity in action program. This is a free and anonymous tip line service that is provided by CUMIS insurance and available to employees of Canadian credit unions. 39

40 Thank you for Participating! These Fraud Prevention Practices are provided as a source of general information to assist your credit union in developing its own practices and procedures. However, these suggested practices do not address all possible types of fraud, nor will insurance coverage protect your credit union against all types of fraud loss. While the information contained herein was obtained from sources believed to be reliable, we cannot represent that it is accurate or complete and should not be considered legal or compliance advice. We are not legal advisors and we recommend credit unions seek independent advice from a professional advisor on all legal and compliance related matters. Thank you participating in this risk management module presented by CUMIS General Insurance s Risk Solutions Group. Remember, as a frontline staff member, you can significantly contribute to the fight against employee dishonesty and internal fraud! 40