Misconceptions about Fraud in the Family Business

A family owned business likes to think that it is immune from fraud and that their trusted employees including family members would never steal from the business. Sadly, family businesses are not exempt from fraud and to think that your company is safe from this type of activity can put your business at significant risk for embezzlement and other acts of asset theft. The most common misconceptions related to family business fraud are:

Fraud Just Does Not Happen in Family Business
All businesses are vulnerable to fraud. Trust can never be your internal control. Your company will be vulnerable to fraud if you ignore potential threats and fail to take the required steps to protect your business.

All Our Employees are Trustworthy And Would Never Steal
Unfortunately, forensic accounting research studies have shown that long term employees are the most likely to commit fraudulent acts including family members. The devoted employee that never wants to take a vacation may be doing so in order to prevent discovery of his or her fraudulent activity.

We Have Internal Controls And Are Company is Safe
Internal controls are important but if not properly designed and tested for effectiveness and updated periodically for the changing family business environment they could become useless to detect and prevent fraud. They also need to be supported by management/owners of the family business.

Now that we have outlined several misconceptions about the family business fraud environment let us consider some proactive steps to reduce exposure to fraud in the family business.

Develop a Proper Segregation of Duties
No employee other than the owner or management should have control over an entire financial transaction from beginning to end. When one person has total control over a financial process there are no checks and balances and fraud can be committed.

  1. Make Vacation Mandatory
    All employees including management should be required to take an annual vacation. When another person steps in take over the job of a vacationing employee suspicious activity may be uncovered and fraud detected.
  2. Review Financial Records Regularly
    Staying on top of the financial condition of a family business will help to identify unusual activity . Review of financial statements and bank records will help you uncover red flags of fraudulent transactions.
  3. Conduct Unannounced Internal Audits
    In order to make sure your internal controls are working as designed, conduct unannounced internal audits and test your procedures. Additionally, adapt internal control design as needed to protect key areas of the family business including technology, finances, and intellectual property.

Remember while trust is an important component in any family business it cannot be blind to business risks from within and outside the business. Trust but remember to verify.