Workplace fraud and theft Red Flags

Published: Nov 21, 2019
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If you find yourself wondering if your business partner is taking more than his or her fair share, you could be right. Situations involving allegations between business partners are referred to as “shareholder disputes,” and the path to a resolution is never clear and easy. There are many ways a fellow shareholder can steal from you and the company, but the most common is theft of company cash.

Shareholders can take more than their fair share by diverting company cash for their own economic benefit. A few ways they can do this are:

Make a wire transfer to a bank account in their name or to another person or entity in which they control or have access to.
Write checks to themselves or to another person or entity in which they control or have access to.
Pay a salary to non-employee family members.
Pay for personal expenses with funds from the business. This can include personal expenses such as car payments, utility bills, credit card payments and others.

Shareholders commonly allot a certain amount of compensation or personal expenses in the form of an owners’ draw from the business, pursuant to the terms of a shareholder agreement. However, problems arise when (1) a shareholder takes draws from the company in excess of his/her fair share based on ownership percentage; and (2) when a shareholder does not take these withdrawals in the form of a draw, but rather expenses them through the company’s profit and loss statements. This reduces net income, which then reduces the pool of profits to be shared based on ownership percentages—with the embezzler still getting 100% of the benefit of the diverted funds. Not only will this affect the cash flow available to each shareholder, but it will also throw the capital accounts and owners’ equity out of balance. This will result in significant problems when and if the company is sold or one of the partners wishes to be bought out.

According to a study in the Association of Certified Fraud Examiner’s (“ACFE”) 2018 Report to the Nations, fraud committed by persons at the owner/executive level accounted for only 19% of occupational frauds, however, the median loss was approximately $850,000. It also notes that 27% of owner/executive frauds involved financial statement fraud, compared to only 6% of non-owners/executives.

Red Flags

Based on the partners’ relationship, one of them may have an inkling that something is amiss. However, there are many red flags to look for:

Based on past performance, profits and cash suddenly and unexpectedly decrease.
A sudden change in a partner’s general demeanor and attitude.
The other shareholder is not forthcoming in producing company documents.
The partner gets defensive when questioned about the company’s financial state.
The shareholder makes large personal purchases (e.g., boat, vacation home).
The business partner has debilitating personal or health issues.

What to Do

If you find yourself in the aforementioned situation, contact a lawyer immediately. It is critical to get on top of this and stop the bleeding, because you may have no idea how bad the situation may truly be. Counsel will advise you on bringing a derivative action against your partner and discuss the process of retaining a forensic accountant. Any conversations between you and the forensic accountant are not protected by attorney-client privilege. Therefore, counsel will retain the forensic accountant on your behalf to keep communications with the forensic accountant privileged. However, privilege will be lost should the forensic accountant be declared an expert witness.

You will also need to gather documents and evidence, starting with the following:

Shareholders/partnership agreements, including amendments
Financial statements and general ledgers
Tax returns and K-1s
Bank statement with copies of canceled checks and credit card statements

It is important not to raise suspicions with your partner before you collect evidence. The timely collection of documentation is key, as you do not want to give the other shareholder time to destroy or alter these documents. The ACFE states that 80% of cases involved the creation of fraudulent evidence and 43% involved deleting or destroying evidence; only 3% of cases did not involve any attempt to conceal the fraud.

Last, but certainly not least, you need to deal with your emotions. In a shareholder dispute, you will go through a roller coaster of emotions, ranging from denial to sadness to anger. You will need to keep your emotions in check during this difficult process. You just found out someone whom you trusted, or even loved whether it be a family member or someone considered family, had betrayed you. The important thing is you are doing something about it, the bleeding has stopped and the healing process can now begin.