Measuring and Detecting Fraud in Employee Loss Claims

Employee losses – the loss of money, securities, or other property caused by employee dishonesty – are typically categorized as asset misappropriation, bribery and corruption, or financial statement fraud. Claims for employee losses are generally examined by insurance carriers who often seek the assistance of forensic accountants to quantify such claims. During the analysis, should a forensic accountant detect the possibility of fraud, it may prompt further investigation by the carrier.

This column focuses on the two significant, but different, roles forensic accountants play in quantifying employee losses and how – in the normal course of the analysis – they may find instances of fraud that require further investigation.

Fraud is a global problem affecting organizations of all sizes. The Association of Certified Fraud Examiners (ACFE) states in its 2022 Global Study on Occupational Fraud and Abuse, Report to the Nations, that fraud caused total losses exceeding $3.6 billion and that organizations lose an estimated 5% of their revenue each year to fraud.1 Major elements of fraud include a false statement of a material fact which is willfully made with an intent to deceive.

Employee Loss Claims

An employee loss may trigger coverage through a business entity’s various insurance policies. But attempting to measure the potential loss, and whether the loss is related to asset misappropriation, bribery and corruption, or financial statement fraud can be complex. What follows is a quick overview of each employee loss type.

Asset Misappropriation – This is most often a theft of cash, but may also include theft of a company’s securities, inventory, time, or intellectual property. Common examples include the following:

• Removing cash from the register in a retail business
• Forging company checks to the employee or to entities he controls
• Deliberately overstating amounts for reimbursement from the company
• Creating fictitious expense reports
• Diverting corporate receipts to the employee or entities she controls
• Removing or diverting inventory from the business
• Using business time or resources for personal gain
• Selling proprietary computer code to competitors
• Using customer lists or other trade secrets for personal gain

To measure an asset misappropriation employee loss event, the first step is determining what calculations must be done. Generally, the potential loss is assessed as such:

Amount Withdrawn from Company

– Personal Funds Returned

– Legitimate Expenses

= Actual Employee Loss

The documents required to complete this analysis will vary, but the following are typical requests:

• Bank statements/bank reconciliations
• Copies of cancelled checks (original documents are preferable)
• Details of deposits and wire/ACH transfers
• General ledger (for relevant periods)
• Income/profit and loss statements
• Insured’s claim
• Police report (if applicable)

It may be suitable to conduct interviews of relevant company personnel to gain additional information about the claim or the alleged losses.

The second step is to perform the correct analysis. This process may be as simple as looking at a bank account for a forged check; in more complicated situations, it may entail using formulas to determine the amount of money that should have been deposited and comparing those amounts to actual deposits.

The forensic accountant will also examine bank statements for transactions that relate to relevant business activities to analyze which transactions are potentially legitimate versus those of a more personal nature. It is important that the forensic accountant have a thorough understanding of the company’s business to better be able to determine questionable transactions.

Bribery and Corruption – Bribery occurs when a person offers something of value to another person to receive something in exchange. Corruption may be defined as dishonest or fraudulent conduct by those in power, sometimes involving bribery (bribery is a subset of corruption). Bribery and corruption are common to both business and governmental concerns.

Here are some examples:

• Employee accepting money or favors for free or reduced cost services
• Business bribing government or private officials to receive contracts
• Bid rigging – An illegal practice that involves competing parties colluding to choose a winner in an open bidding process
• Kickbacks – Payments made to someone to facilitate a transaction or event
• Bribing management for a compensation or bonus increase
• Bribing public officials for changes to laws or regulations

In measuring a bribery and corruption employee loss event, the first step is determining what calculations must be done. Generally, the potential loss is assessed through analysis of the financial impact to the business. For example, if a bribe was paid by an employee, how was the bribe paid? Was it paid in cash, services, or through the transfer of inventory? The determination of the payment method will determine much of the needed analysis.

The documents required to complete this analysis will vary, but the following are typically requested:

• Bank statements/bank reconciliations
• Copies of cancelled checks (original documents are preferable)
• Relevant contracts
• Inventory records and inventory write-off documentation
• Details of deposits and wire/ACH transfers
• General ledger (for relevant periods)
• Income/profit and loss statements
• Insured’s claim
• Police report (if applicable)

Again, interviews of relevant company personnel may be appropriate to gain additional information.

The second step, the analysis, may be as simple as looking at a bank account for a payment to an individual or a large cash withdrawal. However, in more complicated situations, using analyses may be necessary to determine overcharges to cost centers or missing inventory.

Financial Statement Fraud – In the simplest terms, this type of fraud is the intentional misstatement of financials to deceive financial statement users. Such frauds may cause negative impacts to shareholder value through reductions in share price for publicly traded companies or through fines and penalties by regulators and governmental agencies. Examples include the following:

• Overstating (or understating) revenues or expenses on the company’s income statements
• Inflating (or deflating) asset values on the company balance sheet
• Hiding obligations or other liabilities
• Disguising related-party transactions or financing relationships

In measuring a financial statement fraud loss event, the first step is determining what analysis must be done. Generally, the potential loss is assessed by analyzing the financial impact on the business. For example, if the chief financial officer (CFO) intentionally overstated company revenues in an attempt to increase the size of executive bonuses, the loss analysis may include the corrected revenues and the calculations of the corrected bonus pool. An intentional misstatement of financial statements may not be a specific loss event, but there still may be costs associated with restating the financial statement by outside forensic accountants and law firms (which may or may not be covered under an insurance policy).

The documents required to complete this analysis will vary, but typically include the following:

• Historical financial statements
• General ledgers
• Payroll and bonus documentation
• Bank statements and reconciliations
• Insured’s claim
• Police report (if applicable)

Interviews with relevant company personnel may produce additional information about the claim or the alleged losses. Interviews are generally conducted in the following order:

• Friendly witnesses (whistleblowers/attorneys) – The first phase serves to establish facts and allegations. The attorneys may assist you with intelligence gathered to date. The whistleblower (if available) may provide greater details, facts, and circumstances related to the initial allegations.
• Neutral witnesses (supervisors/direct reports/tangential) – These interviews may confirm the facts obtained from the friendly witnesses and provide additional details. Such interviews are important to determine the reliability of the initial allegations.
• Adverse witnesses (potential accomplices) – This third set focuses on other potential bad actors. Often, when confronted with accusations and supporting facts, adverse witnesses will confirm bad acts and provide details of the target’s involvement.
• Target witnesses – The final interview (if possible) is with the target(s) of the investigation. The interview is most efficient when performed last so that you can have all available information at your disposal to confront the target and rebut any false statements.

The next step (performing the appropriate financial statement fraud analysis) is rarely simple and may become extraordinarily complicated.

Conclusion

When an insurance company brings in forensic accountants to quantify an employee loss, those experts who have significant experience recognizing fraudulent schemes may detect activity that merits further analysis and investigation. When hired to investigate these matters, forensic accountants must know how to identify the signs and patterns that indicate a fraud has occurred or is ongoing.

In these cases, forensic accountants are called on to gain a unique understanding of how the claimant’s business operates – specifically how income, expenses, profit, and loss on a historical basis is realized. With this information and insight into the circumstances of the insured’s financial situation, a forensic accountant can identify instances of fraud within an employee loss claim.

¹ Association of Certified Fraud Examiners, 2022 Global Study on Occupational Fraud and Abuse, Report to the Nations, page 4.

F. Dean Driskell III, CPA, ABV, CFF, is an executive vice president in J.S. Held’s forensic accounting/economics/corporate finance practice. He can be reached at ddriskell@jsheld.com.

Peter S. Davis, CPA, ABV, CFF, is a senior managing director in J.S. Held’s forensic accounting/economics/corporate finance practice. He can be reached at pdavis@jsheld.com.