Legal Aspects

Fraud Investigations Employee Fraud

Arun Chauhan and Mark Kenkre

Biographies
Arun Chauhan and Mark Kenkre are Joint Heads of Fraud & Risk Services, and
Directors at Cobbetts LLP, where they head up a very experienced Fraud & Risk
Services Team.

Arun Chauhan
Joint Head of Fraud &
Risk Services at
Cobbetts LLP

Arun and Mark specialize in commercial fraud and asset recovery litigation arising out
of complex corporate fraud disputes, and have acted for clients from a broad range of
sectors, including Financial Services, Public Bodies, Charities and Construction. They
deal with fraud investigations and litigation advice with particular focus in advising on
breach of fiduciary duty and fraudulent misrepresentation claims. Arun and Mark also
handle cases involving inter-company collusion, procurement and internal fraud
(employee fraud) and claims arising out of insolvency of companies, and are experts in
claims arising from fraudulent misrepresentation in corporate transactions, and in
recovery of assets both nationally and internationally.
Both Arun and Mark are experienced and accomplished trainers and presenters, and
have contributed articles dealing with fraud arising from corporate and individual
insolvency for Recovery Magazine through to factoring fraud for Butterworths. Arun
chairs regional Fraud Advisory Panel meetings, and Mark is a Director of the Midlands
Fraud Forum.

Mark Kenkre
Joint Head of Fraud &
Risk Services at
Cobbetts LLP

Keywords Employee fraud, Litigation, Financial loss, Breach of Fiduciary Duties

Paper type Research, Case study

Abstract
Many issues have surfaced during the economic downturn, one of the most
prevalent is the issue of fraud. One of the primary concerns of all companies is
to combat fraud and put in measures to avoid becoming a victim. Among the
victims of fraud, there is evidence of self-help. Counter fraud practices and
procedures are being shared to make it even more difficult for fraudsters to
succeed in their aims.
In this article, the authors discuss the penalties and impact of fraud, providing
case study material, continuing the theme of employee fraud as a case example
of detection, investigation, its process, and how a well thought out fraud
investigation led to recovery for the Claimant. This article concludes by looking
at issues such as a fraud response plan, whistle blowing policies and effective
fraud risk management. All these issues are vitally important to not only provide
a barrier and a deterrent to fraud but, on those rare occasions that it does affect
a business, it provides a greater opportunity for limitation of the impact of fraud.

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Introduction
Fraud costs the UK economy 38 billion according to figures released by the
National Fraud Authority in 2011. This alarming figure can not realistically take
into account all acts of deception causing financial loss. By way of example,
employee fraud may occur from a small fiddle on an expenses claim through to
a multi-million pound scheme such as that of Paul Hopes, an accountant at Toys
R Us.
Paul Hopes managed to embezzle an estimated 3.7 million from his employer
over a period of four years by way of a series of falsified accounts and false
supplier payments. Whilst this degree of fraud grabs the headlines, what about
those which are not commercial to pursue or would cause more internal or
external reputational damage to report than not? How much do all of those
losses add up to?
Employee fraud appears to be on the rise in this poor economic climate.
Understanding why businesses need to focus on prevention is critical in order to
avoid the difficulties caused by unforeseen losses.
Penalties and the impact of fraud
Employee fraud in isolation is high up on the agenda of many businesses.
However fraud in general needs full consideration at management board level.
Fraud on a business can be catastrophic. Publicly or privately owned
businesses carry the risk of losing the confidence of their shareholders,
employees, and most importantly, clients and customers if it becomes apparent
a failure of management has led to fraudulent loss.
Penalties are now being handed down by Government organizations to
businesses guilty of corruption or employee fraud. The Financial Services
Authority have issued fines for failing to protect customers and clients against
the threat of employee fraud. UBS were fined approximately 8 million for
employee fraud. It is clear that there is an intention by the Government to
protect the consumer.
So what does that mean to your business? If you are a director or a CEO of a
business faced with a large sudden loss caused by fraud, could your business
continue to trade? It is clear that the actions of a minority who perpetrate fraud
affecting third parties can cause huge detrimental effects to the officers and
shareholders of their employer business. However, it is not only the financial
consequences, penalties and the impact on a business that an officer of a
company needs to be aware.
The Fraud Act 2006 now ensures that company boards and individual directors
need to be fully aware of their obligations and responsibilities about their
company and that the company has appropriate policies and procedures in
place to deal with fraudulent activity. Whether fraud was intentional or not, the
Fraud Act 2006 will in practice be another means of regulating directors
conduct.

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This legislation creates three ways in which new fraud offences may be
committed, being by false representation, by failing to disclose information and
by abuse of position. Dishonesty will be a key ingredient at the assessing
whether the fraud has been committed, it should be noted that previous
legislation such as Section 19 of the Theft Act 1968 makes it an offence for a
company officer to publish, with intent to deceive its members or creditors about
its affairs, a written statement or account which to his knowledge is or may be
misleading, false or deceptive.
The pressure on businesses to conform to an ethical approach to winning
business has of course also been enforced by the recent coming into force of
the Bribery Act 2010. This Act places emphasis on businesses to have in place
adequate procedures to deal with the threat of bribery and corruption.
As stated at the outset, this article has focussed on employee fraud by way of a
case study of the company Lifted Limited.

Case study: Lifted Limited

Setting the scene

Lift Installation and Serving Business has the regional market monopoly.

Organic growth business has expanded over 25 years to current position

with turnover of approximately 16 million per annum.

Servicing of lifts accounted for 63% of the turnover. Installation accounted

for 36% of the turnover and a further 1% of turnover was from other small
areas of income.

The Managing Director is a 50% shareholder together with his wife who
owns 50%.

Turnover has grown principally reliant on a paper based manual ordering

and financial accounting system save for typical use of SAGE software.

The Managing Director had great industry knowledge great at winning

new business and knew exactly what a customer wanted and how to meet
their demands. Financial management was not his strong point.

Eight years ago he employed Mr Bernard Stanford as the Financial

Manager of the business who was later promoted to Financial Director. No
written contract of employment was in place.

Over the past six of the eight years up to 2007 the business was increasing
in turnover and was considered to be very successful. The success slowed
through to the middle part of 2008. The most recent year has seen a
significant drop off in turnover and net profits.

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About the business and how it runs its operations

Eight years ago Bernard Stanford was employed so to make the business
more efficient in terms of financial management and control.

Two years after his appointment profits had seen a marked increase.

The Managing Director believed their efforts were the principle cause for
this increase.
He was also convinced by Bernard Stanfords
representations that his systems and management had also made a
significant impact.

As a result, Mr Stanford was given a pay rise and the title of Financial
Director.

Jack Careless believed that he kept a careful eye on all issues relating to
the finances of the business and he was very much in control of his own
business.

Ongoing suggestions how to improve the business and additional control

being provided to Bernard Stanford were agreed by the Managing Director
from time-to-time.

Bernard Stanfords work and role including:

(i)
(ii)
(iii)
(iv)
(v)

Third party contractors

Orders for goods
Invoicing/credit control
Employee remuneration
In essence complete control of finances.

What changed?

The economy when times were good the Managing Director never
questioned the margins of the business. He always thought profits were
increasing and believed that business was improving.

He never questioned the net profit margin. He always measured success

by the bottom line; for instance, profits increasing.

What he did not consider was in having a Financial Director, an impact on

the net profit margins of the business should have occurred. That was
never analysed and an investigative audit would have picked up on that
issue.

Sales on new lifts reduced from 36% down to 25%. Servicing reduced by a
smaller margin from 63% down to 61%.

There was therefore a 13% drop in turnover from 16 million to 13.92

million.

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There did not seem to be a correlation with the drop in their profits which
were down from approximately 4 million to 2.4 million, for instance, a
drop of 40%. The expected reduction in correlation to turnover =
approximately 3.5 million as the net profit margin remained the same.

Lifteds bank requested that an independent review be obtained.

The Managing Director told Bernard Stanford that the bank wanted an
independent review of Lifteds finances. Bernard Stanford did not appear to
object but stated that he needed some time to put paperwork in order to
help whoever was going to undertake this financial review.

Two weeks before the financial review was due Bernard Stanford resigned
citing that he had been head hunted by a company in the fire security and
installation sector and he would be resigning with immediate effect.

He cited that he had no written contract and therefore did not need to
provide any significant length of notice.
(Tip: Ensure contracts of
employment in place for updated for future protection which can also allow
for ongoing checks on employees, for example credit and criminal record
checks.)

The financial review report is delivered which caused significant alarm to

the Managing Director.

What was suspected financial review findings?

It was suspected that Bernard Stanford had been stealing and defrauding
the company.

It was suspected he had been using the business to fund and support a
separate business.

It was suspected he had increased his pay and pension contributions

without authorization.

It was suspected that he had employed at least four employees as Service

Engineers without authorization which initially was suspected to have been
used for the work in his own business.

What did we do the investigation?

Speak to the Managing Director regarding the relationship with Bernard

Stanford.

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Whilst the initial instructions were that the Managing Director was very
much in control of the business clearly he was not.

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Specifics he did not understand, in particular:

(i)
(ii)
(iii)

Day-to-day financial operations, including standing orders;

did not know the identity of suppliers paid on a regular basis;
he did not fully appreciate the employee remuneration system and
how pay was assigned or calculated.

Essentially he had not been very forthcoming due to embarrassment as to

his lack of knowledge.

Further discussions revealed that Bernard Stanford had been promised on

promotion to Financial Director an opportunity to buy shares in Lifted
Limited.

That never occurred. The Managing Director kept quiet about the offer as
they were seeing a great increase in their income and effectively got
greedy.

We held discussions with employees as to working practices and took

statements.

It soon became clear that Bernard Stanford controlled most aspects of the
finances.

He frequently took paperwork home and was often working late when
people were not around.

Costs of investigating can be disproportionate. We are therefore keen to

engage those who understand the business best, for instance, the
management, owners and the employees.

We asked employees to put together 20 sample project files which gave

information to assess.

We used information in the public domain to check on the legitimacy of

addresses of employees allegedly employed by Bernard Stanford.

These employees were Mr Arnold, Mr Kinver, Mr Fawlty, Mr Eaton. Their

combined gross pay per annum was approximately 100,000.00. They had
been employed for a period of three years.

We knew the account details of Bernard Stanford so an application was

made to the Court for a Disclosure Order without notice to Bernard
Stanford.

The Order granted to disclose bank statements and phone records for the
past six years.

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Disclosed information revealed income paid to Bernard Stanford from a WS

& Co Ltd. Company searches revealed company appointments and
shareholders Bernard Stanfords wife and Accountants wife.

There was an Autopay system. This was a standing order payment

system used on a monthly basis to pay frequent suppliers who provided kit,
etc, for the servicing and installation aspects of the business.

These suppliers were assigned a numerical identification code. These

codes were placed on a spreadsheet and this spreadsheet was signed by
Jack Careless on a monthly basis to confirm that payment should be made
to those parties identified.

Summary of findings how we discovered the information

It must be noted that not every suspicious activity or act should be

considered a fraud despite the current climate. There does remain a need
to be open minded.

Not every suspicion is a smoking gun.

We reviewed the sample analysis of contracts. We looked at shared email

addresses/fax and phone numbers. We checked for false addresses of
contractors/suppliers.

A pattern revealed itself. A third party company was discovered to have

been having work subcontracted to them being WS & Co Limited whose
post code was very similar to Bernard Stanford.

Credit notes had been issued to a number of customers under the pretence
they were incorrect and would be re-invoiced. No record of final payment
located.

Investigations revealed that the customers had in fact received a further

invoice but the payments were invited to be paid to WS & Co Limited
trading as Lifted and/or a separate account number belonging to WS &
Co.

His phone records revealed a number of telephone conversations with

customers on days when credit notes were issued to them.

We learned that spurious contractors had been engaged on jobs that on

three occasions did not exist.

On other contracts there were found to be duplicate orders or over ordering

with re-direction of supplies to non-site addresses.

Other procurement issues revealed themselves. Purchase order forms with

sequential numbering were in place but the period between the purchase
order forms was quite lengthy.

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We engaged a handwriting expert to review signatures in relation to

analysis of contracts.

The handwriting expert produced a report complaint with CPR35 linking

signatures to Bernard Shepherd.

Certain suppliers/contractors had been paid through the Autopay system.

The suppliers were repeatedly involved in the 20 sample contracts.

The suppliers address was checked and did not exist. VAT numbers whilst
looking legitimate were not real.

The fake employees had been used for three years. The analysis of job
sheets where work signed-off by customers were forged.

WS & Co Limited was incorporated two years ago and had been in part
competing with Lifted Limited but also received payment of a number of
servicing jobs where work was undertaken by Lifted Limited.

It was in direct competition with Lifted Limited. Under control of Bernard

Stanford who had used confidential information in breach of fiduciary duties
and the specific duty to act in good faith.

Lifteds accountant who had been brought in as a new auditor some six
years ago on the suggestion of Bernard Stanford, was in fact Bernard
Stanfords brother-in-law.

Bernard Stanfords wife + brother-in-laws wife = Directors of WS & Co

Limited as well as a principal shareholders.

The Disclosure Orders revealed that Bernard Stanford was receiving pay in
excess of that agreed and also pay on behalf of the supposedly four
employees being Mr Fawlty, Mr Arnold, Mr Kinver, and Mr Eaton into a
separate account.

He used the Autopay system to pay himself/wife instead of the four

employees who ultimately did not exist.

It was found that the Autopay system was used to directly increase pay to
himself of an extra 30,000 per annum and an increase pension
contribution of 10,000 per annum

The Autopay fraud in relation to his pay and his pension had been ongoing
for four years. That seemed to coincide with a period where Bernard
Stanford had expressed frustration that an offer of shares had not been
provided to him in the business as previously suggested.

The concluded position was that Bernard Stanford had achieved some
300,000.00 of income from false employees.
He had achieved

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unauthorized pay of 120,000.00 and unauthorized pensions of 40,000.00

over four years.

He had used companys monies, and misdirected payments from the

company of at least 600,000.00 over two years.

He had described the drop off in profitability and performance as an issue

related to the market which Jack and Jill Careless all too readily believed
once the auditors for the business confirmed Bernard Stanfords view point.

All in all Bernard Stanford had caused a loss to the business directly of at
least 1 million but it was unknown how much business he had directed to
WS & Co Limited trading as Lifted. It was estimated that he had caused a
loss to the business of anywhere between 1.0 to 1.5 million.

What happened next?

Proceedings were issued injunction was not possible due to length of time
since discovery of the fraud and limited evidence of dissipation of assets
many other cases where more immediate, injunctions are a powerful tool in
a lawyers armoury to stem the loss and avoid further dissipation of stolen
monies

Here summary judgment obtained for an amount that could be proven,

verified by forensic accountants. Judgment obtained for 900k

Recovery of the money was through tracing into his assets, the principles of
equitable tracing come into play.

Recovery was circa 600,000. When considering the time span of the
fraud, this was a good recovery as we expected more to have been
dissipated.

Conclusion
So what can a business do to prevent fraud?
There are a number of avenues available to a business to deal with prevention
of fraud. Here are a few in summary:
1.

Create a culture of zero tolerance: All acts of dishonesty should be

dealt with firmly and consistently so the build towards a zero culture
tolerance.
Even minor expenses fiddles should be addressed to
encourage ethical conduct.

2.

Know your staff: The Power Checks pre-employment screening 2009

report found that the number of candidates whos CVs contained false or

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embellished information increased to 19% in the last year.

annual criminal record checks should be obtained.

Ongoing

3.

Whistle blowing policies: A voice needs to be encouraged amongst the

staff to report concerns. Anonymity can be preserved for staff and there
should be no disclosure to staff who reports a matter which subsequently
leads to no finding of fraud.

4.

Create a fraud risk management plan which deals with prevention,

detection and response: All businesses are vulnerable to fraud but that
risk varies according to the nature and size of the business and sector in
which it operates. Understanding the risk profile of your business is one
of the first steps in successfully managing fraud.

5.

Investigative auditing: The use of the investigative auditing will highlight

the areas where a business may be at risk to fraud. This will enable the
business to manage the risk including the nature of the risk and who is
responsible for managing it, the likelihood of it occurring and the potential
impact and preventative controls which can be put in place.

6.

Have an effective fraud response plan: A fraud response plan outlines

the policies and procedures that a business will follow in the event of fraud
being discovered or suspected. A good fraud response plan should aim
to outline the entire fraud investigation covering, for instance, who, when
and how, upon the receipt of the initial allegation, through to the final
internal report process.
It must demonstrate the organizations
commitment to a zero tolerance culture and ensure that all staff are fully
aware through their staff handbook or otherwise as to how the business
responds to an issue of fraud.

The Chartered Institute of Management Accountants recently stated the

following:
Fraud detection acts as a deterrent by sending a message to likely fraudsters
that the organization is actively fighting fraud and that procedures are in place to
identify illegal activities the possibility of being caught will often persuade a
potential perpetrator not to commit a fraud.
Whilst a well thought out and processed fraud investigation procedure is useful,
would it not be far better to not have to worry about that situation at all?

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