Family fraud: A game of broken trust

It’s often an inside job, but there are steps to reduce the risk of family business fraud.

When it comes to fraud, family businesses are definitely in a league of their own.

One of the most appealing features of family businesses as a place to work is trust, but the flipside of that is that it makes family businesses vulnerable to fraud.

Such is the trust that many family members have that they don’t believe any of their clan or close employees would intentionally harm their company. But they would be very wrong. Family fraud is very common.

One of the most notorious recent examples was high-profile retailer Clive Peeters, a family business and public company that was tipped into receivership in 2010 after a trusted senior accountant admitted to defrauding the company of around $20 million. Investing the money in more than 40 properties around Australia, a car, motor bike and jewellery, she later repaid about $16 million. For her efforts, she was sentenced to eight years in jail by a Supreme Court judge.

There have been many fraud cases since, but none of them quite as high profile. Business Spectator has been told of cases where a manager of a family business eatery was filmed fiddling the till, and where a family member was caught syphoning funds from company bank accounts. Most cases never get to court. Both were sorted out on the quiet, and swept under the carpet. Family businesses, the most private of all businesses, are often like that.

Susan Rix, from accounting and advisory firm BDO, says keeping theft out of the public spotlight, especially when it involves a family member, is commonplace.

“If there is some fraud, the owner will turn a blind eye to it on the basis that we’ll deal with this internally, we won’t go to the police and the family member knows that as well, that they won’t be charged,’’ Ms Rix says.  “With most of them, you never get to hear about it.”

Robert Powell from Grant Thornton tells the story of one case where accountants from his firm started probing some discrepancies in the accounts at one family business. He says the internal financial controller called him for a 7am meeting in Chatswood. Realising he was about to be exposed, the financial controller confessed everything.

Mr Powell believes family businesses are particularly vulnerable to fraud because of the trust factor and the fact that their controls aren’t rigorous.

“Typically a family business will retain employees out of loyalty to them,’’ Mr Powell says. “They tend to put less emphasis on skills and ability and more emphasis on loyalty, and sometimes that results in an uncommercial situation.

“If you walk into family businesses, you will generally find one or two employees who have been there for a very long time, who potentially are there for reasons other than them doing a fantastic job. The other point is, fraud experts will tell you the longer a person has been in a position the longer they are more likely to commit a fraud, simply because they are in a position where they can identify where there might be some weaknesses they can take advantage of.”

Mr Powell says that fraud thrives in circumstances where loose business practices, business controls and unprofessional practices are allowed to happen.

“It’s fertile ground for someone looking to commit some sort of fraud,” he notes. “It’s more about trust being put automatically into people rather than having a robust controlled structure around the finance function. It’s more about the controls that are allowed to get loose, which means that if someone is in a position to commit fraud it makes it a lot easier for them to do so.”

Mr Powell says that’s part of a bigger issue with family businesses in that a lot of them need to do work around professionalising their business.

“That’s happening but, for a lot of family businesses, it remains one of their key challenges and fraud is a much bigger risk for them.”

Fotini Kypraios, from law firm Meerkin & Apel, says it comes down to governance.

“If you’ve got good governance, you have transparency and you’ve got accountability. Whereas, if the left hand doesn’t know what the right hand is doing, you’re inviting people to be tempted and to do the wrong thing if they know there is no way they will be caught out,” Ms Kypraios says.

“For me it all comes down to having processes in place to monitor areas of risk and to make sure they can keep on top of things.

“Generally it is good practice in any business to make sure you can keep on top of issues that are risky, whether it’s people taking money from the till or people misrepresenting stock that’s ordered and how it’s paid for.”

She says family businesses are at risk here.

“I think it would raise the factor of risk for them. Any business is vulnerable to someone doing the wrong thing, but where there aren’t processes in place to monitor it people are more likely to take advantage of it or be tempted to do the wrong thing,’’ she says.

Ms Kypraios agrees that culture can be more relaxed in family businesses because there is an inherent element of trust there.

“When it’s a closely held private family company, you more often than not have people relying on each other’s word and supposed good faith and good intentions. And that’s when people come undone, because they relied on the wrong person and someone has taken advantage.”

All businesses are vulnerable to fraud, but the trust factor is the tripwire for family businesses. The only solution is to professionalise the business and create early warning systems.