May/June 2019

Finance

Spotting the Hole in Your Hull

Peter Roberts

In past Finance columns I have mentioned the benefit of expanding the role of your bookkeeping staff by asking each month for certain year-to-date financial analyses. But, in smaller law firms, do they (or he or she, if only one person) have the time? Those bookkeeping folks are a busy group as they respond to the daily needs of almost any employee in the firm, and often with short notice. If your firm has an office manager, I expect that person to perform the financial analyses. An alternative may be to ask your firm’s certified public accountant to efficiently perform the financial analyses and possibly eventually to pass this task to your bookkeeper if your firm does not have an office manager.

Expanding skills in another way.

Your bookkeeping staff may already have expanded their “skills” unknown to you in ways repugnant to the firm. By this I mean to concoct a scheme for embezzlement. During my legal career I have learned of the circumstances that often may lead to a level of temptation that is too much to resist. Embezzlers may not think of themselves as criminals. A personal financial need arises with little oversight of the bookkeeping function and, anyway, they intend to pay the firm back. Indeed, often the bookkeeper has been with the firm for over a decade or more and is trusted “like family.” You work hard for the fees you receive. Be alert to this possible “hole in your hull.”

A resource worth knowing about.

How might we obtain a better understanding of the schemes for embezzlement? I am impressed by the resources offered by the Association of Certified Fraud Examiners (ACFE). Choose a free weekend when at home and access the ACFE website at acfe.com. The fraud resources page includes articles by topic, such as “financial transactions and fraud schemes.” Access to some of the resources requires membership in the ACFE, but others do not. Resources include books, podcasts and blog posts. Note, however, I don’t think it’s a good idea to explore the topic of financial fraud using the firm’s computer system.

One  article, “Creative Embezzlement,” by Annette Simmons-Brown, states: “When it comes to their modus operandi, few employee-embezzlers are overburdened with imagination: they write checks payable to themselves, submit phony invoices for reimbursement, inflate their proper wages, transfer monies online from business accounts into their own, use the company credit card for their personal expenses, etc.”

Creativity gone awry.

But how might we learn of a nontraditional embezzler? The ACFE provides an answer. This article goes on: “[Edith] committed her crimes without ever cutting one fraudulent check to herself, making one false charge on the company’s credit card or illegally wiring money to herself from her company’s bank accounts.” Her employer, “PMDI [Precision Mold Design Inc.], permitted its employees to take out personal loans from their 401(k) accounts and repay these loans via regular deductions from their paychecks back to their 401(k), which Large National Bank held and administered.” It continues:

Edith regularly took substantial “loans” from her 401(k) and deployed several steps that allowed her to take PMDI’s money from its operating account at Small Local Bank and would hide the thefts primarily by running the funds through the 401(k) loan program.

Edith’s scheme is a testament to the importance of promoting the perception of detection, separation of duties and rotation of duties within an organization.

Edith was responsible for informing PPC [Payroll Processing Company] of how much money should be withheld from each employee’s paycheck for 401(k) loan repayments. However, she didn’t tell PPC to withhold funds from her own paycheck (and PPC’s payroll records would show that).

She instead created a spreadsheet to track funds directed to repayments of 401(k) loans at Large National Bank. For all employees, except for herself, she tracked on the spreadsheet the amounts withheld from their paychecks for loan repayments as processed by PPC. However, for herself, the spreadsheet falsely showed what should have been withheld by PPC for her loan repayment but wasn’t.

Large National Bank would then use the spreadsheet to authorize automated clearinghouse transfers from PMDI’s general operating account at Small Local Bank and make subsequent deposits into participating employees’ 401(k) accounts.

Thus, Edith arranged for PMDI to unwittingly repay her loans with money that should’ve come from her paycheck but instead came from corporate funds.

Report to the Nations.

Another resource available from the ACFE website is its 2018 Report to the Nations. The report concerns fraud internationally and is separated into broad geographical areas worldwide. Law firms with international offices may wish to avail themselves of this report for both the firm’s sake and the sake of the firm’s international clients.

A challenge for solo and small firms.

Of course, solo and small law firms may not have sufficient staff to rotate duties or adequately separate tasks such as check writing from account reconciliations. If this is the case, I recommend setting aside a time to have a meeting with your certified public accountant and bookkeeper for the purpose of a friendly discussion of the need for total transparency. There is no room for defensiveness or resentment by the staff because, as a business owner, you must have total confidence that all financial transactions are handled in the proper fashion. Indeed, your staff should fiercely support that notion.

Another example.

This scheme involves the W-2 form. The bookkeeper may be able to adjust each employee’s W-2 tax withholding downward by a small amount and up ticking his or her own tax withholding amount by the total of the adjustments so that the grand total is correct. The bookkeeper will realize a lower tax bill or larger tax refund as a result.

When hiring.

The candidate(s) applying for a job may have had prior experience working in a law firm, but that experience does not guarantee a command of the proper procedures for the trust account. References are often of limited value, although you can ask the prior employer if it would hire the employee back. Certainly criminal and financial background checks are mandatory. After a person is hired, have the meeting described above to establish the expectation of total transparency.

Peter Roberts

Peter Roberts is a private practice management consultant for lawyers. He was the former practice management advisor in the Law Office Management Assistance Program of the Washington State Bar Association for 13 years. He is active in the ABA Law Practice Division as co-chair of the Law Firm Finance Committee. pete@practicelawadvisor.com

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