Fraud against businesses is costly and grows more rampant during a recession, national research reports say. Still, though the signs usually are easy to spot, oftentimes the crime isn't caught until significant financial damage has been done, fraud investigators here say.

Small businesses are particularly vulnerable to internal fraud, because typically they have few employees, and day-to-day financial recordkeeping often is entrusted to one person, says Tom Griffiths, a certified fraud examiner and partner in the Spokane accounting firm Griffiths, Dreher & Evans PS.

Spokane County Sheriff's Sgt. Dave Reagan says the sheriff's department receives one or two fraud complaints every month. He adds that awareness can be a key to preventing such crimes.

"It's no different for a business than for private citizens," Reagan says. "You need to be environmentally conscious about your financial information. Know who has access to business records. It pays to do an occasional review of procedures and controls."

When fraud is discovered, prosecuting the perpetrators can be difficult, he says. The cases often don't end up in court because the owners weigh the cost of hiring a CPA to document the theft activity against what they've already lost, and often fire the perpetrator to save the expense of preparing for a prosecution, Reagan says.

"We say, 'Look, we believe you, but we aren't accountants; you have to pay someone to go through the books'" and provide evidence of the crime, he says. "They often balance the cost of that loss with the cost of getting proof."

The national report by the Austin, Texas-based Association of Certified Fraud Examiners says the median loss caused by occupational fraud schemes is about $175,000. It says the most common types of occupational fraud are corruption—which can include bribes, extortion, or conflict of interest—and fraudulent billing. Yet, the most costly cases are financial statement fraud, or the intentional misstatement on or omission of material information from a business's financial reports, so-called "cooking the books"—which resulted in a median loss of $2 million in the cases surveyed.

Another report produced by the association says fraud has increased during the recession. When the association polled its members during February and March of this year, nearly half of those who responded said the instance of employee embezzlement and the dollar amount lost to fraud had risen over the past 12 months due to increased financial pressure on organizations and individuals in the economic crisis.

The Network Inc., a national firm that runs compliance and governance hotlines, says that about 21 percent of the reports it received in the first quarter were fraud related, up nearly 5 percentage points from the first quarter of 2008.

Other cases of internal fraud involve misappropriation of company funds or resources, the association says. External fraud typically involves schemes through which someone steals a business's bank account number and uses it to make unauthorized withdrawals, often in the form of counterfeit checks.

In 2006, Griffiths, Dreher & Evans was seeing enough demand from clients who had run into such problems that it trained much of its staff to perform fraud examinations when requested. The fraud schemes the firm finds range from employees issuing themselves a second paycheck within a pay period to cutting company checks to pay their personal bills.

He says business owners who fall victim to such fraud schemes often feel crushed because the crimes are committed by someone they have trusted implicitly with their money.

"It's crushing, it's embarrassing, it's a violation—it almost doesn't matter what the amount is," Griffiths says. He adds that the aftermath of an impropriety can be a huge headache for a company, often with back taxes due, penalties incurred, and significant financial costs.

Griffiths says the problem of fraud at smaller businesses here became more prevalent after easy-to-use bookkeeping software became widely available in the mid-1990s. More small businesses started doing their bookkeeping in-house, frequently entrusting their day-to-day financial affairs to a single employee and using accounting firms more for annual tax preparation than routine bookkeeping.

Griffiths says the incidence of embezzlement seems to be slightly higher within medical practices here than in other types of businesses. He says nonprofits also seem to be vulnerable, because they often rely on volunteer help, and if someone steps up to fill the role of bookkeeper, the organizers are grateful for their willingness and lack the manpower to double-check what the volunteer is doing.

What one bank does

Washington Trust Bank, of Spokane says it looks at educating their customers on fraud prevention as a necessary part of doing business. The bank posts fraud prevention tips for its customers on its Web site and has a fraud investigation team that researches individual instances and works with law enforcement to help try to catch perpetrators and recover funds, says Troy Wunderlich, operational risk manager and security officer at the bank.

"In the best case scenario, we're able to get their money for them," Wunderlich says. In the case of business fraud, the bank might be asked to provide financial records to the prosecution for a case, he says.

Most of the fraud that the team at Washington Trust deals with involves checking account fraud, Wunderlich says. He says individuals who have their accounts compromised aren't liable for fraudulent transactions, but businesses that accept fraudulent checks could be at risk for losses.

He says the bank recommends that both business and individual customers write down the 800 numbers for their credit card issuers in a safe location so they can call right away if their cards are lost or stolen, and that they take common-sense measures, such as not writing their personal identification numbers on their debit cards. The bank also recommends that businesses adhere to the practice of verifying identification when accepting checks or credit cards for payment.

It's not very difficult to spot improper transactions, Griffiths says. One of the primary things a small-business owner can do is to open a company's bank statements personally and look at them, and at least be familiar with who the payees are, he says.

Just looking at such statements with a critical eye on a regular basis can nip a problem early, Griffiths says. For example, he says, an employee might pay himself or herself twice during a pay period, or pay personal bills using company checks. Other times, an employee might open a credit card in the company's name and use it for personal expenditures.

He says business owners sometimes believe they're protected because they are the only authorized signer of checks on a company's account, but that's a false sense of security because someone who wants to defraud a company frequently will either forge the owner's signature on a check or change the payee after the owner has signed a check.

"People are usually very aware of the money coming in," he says, but neglect to become informed about where accounts payable checks are going.

Business owners don't always think about taking precautionary steps until they've been victimized, Griffiths says. Fraud isn't always internal, either, the sheriff's department's Reagan says. He says the department advises that businesses protect their financial information just as individuals do, and be cautious about how they send out or accept mail from vendors and subcontractors.

"Some businesses are very cavalier about how they treat their outgoing mail," he says. "We occasionally see where someone has wandered into an office and scooped up the mail and walked out."

Reagan adds that it's also important to not leave checkbooks in vehicles, as car prowling and mail theft remain the most common way thieves steal account information.

In the case of internal fraud, misappropriation of funds usually escalates over time, Griffiths says.

"Most frauds grow as time goes on—they get greedier as time goes on," or do more brazen things, Griffiths says. When confronted with suspicions, the perpetrator often goes on the attack to discourage the business owner from looking into the matter further, and Griffiths says perpetrators often have a sense of entitlement. They justify the crime because they feel they're owed a raise they didn't get and this is their way of collecting it, he says.

Griffiths advises that if a business owner has suspicions, it's important to satisfy them. Some of the red flags to look for include a bookkeeper being very messy, not being able to produce requested reports, or providing financial statements on a rudimentary spreadsheet rather than with a financial software report.

"Usually, if the red flags are flying, it's a fraud," he says.

He adds that often, when business owners are suspicious, they take their financial records to their CPA and request an audit. Griffiths says that's not always sufficient, because an auditor needs to know if a client is looking for suspicious transactions.

"They might say, 'I'm concerned, I want an audit,'" but to a CPA an audit is a review of the financial statements, and if everything balances, that alone might not catch improprieties.

In nearly half of the cases included in the Association for Certified Examiners' most recent study, fraud was discovered through a tip from a customer, employee, or vendor, rather than through a routine audit or controls. If a business owner is suspicious about a possible fraud scheme, it's wise to ask a CPA specifically to check for a misappropriation of funds, Griffiths says.