How Family Offices Can Minimize Fraud Risk

A 2014 study indicates that smaller organizations are more often victims and suffer disproportionately large losses.

Just as small businesses are more prone to employee fraud and theft because they tend to lack policies and procedures for preventing fraud, family offices also tend to lack adequate anti-fraud controls, which can put them at higher risk.

Many think a small office with fewer employees makes it easier to monitor and control fraud. However, the fewer employees, the more difficult internal controls become. Smaller organizations are more often victims of occupational fraud and tend to suffer disproportionately large losses, according to a 2014 global study by the Association of Certified Fraud Examiners (ACFE).

The culprit could be a rogue employee or even a previously trustworthy employee who has had a life-changing event with financial implications, such as the death or disability of a spouse or a divorce. Although the family may have complete trust in its internal team, it should still take some steps to minimize risk.

Implement internal controls

Internal controls are a series of systems and procedures designed to serve as the first line of defense in safeguarding a company’s assets. A family office is no different. While not a 100 percent guarantee, internal controls, if properly structured, can go a long way towards helping to protect a family office against theft and fraud. The 2014 ACFE study found that organizations with anti-fraud controls in place experienced significantly lower fraud losses than organizations without those controls.

As a family office’s objectives and structure change, management should continually evaluate controls to assess their effectiveness. Breakdowns in controls can occur, including human error, deliberate circumvention, management override and even collusion.

Minimize opportunities for fraud

The fraud triangle model illustrates the three conditions that are present for occupational fraud to occur: opportunity, rationalization and motivation (financial pressure). Of these, opportunity is the one area that employers can proactively minimize, and it’s one of the most effective ways to reduce fraud risk.

If a family office has inadequate internal controls and poor segregation of duties, there will be more opportunities for employee fraud. A lack of separation of duties can lead to losses.

Your family office clients should ask the following questions about their offices:

• Are controls in place for proper handling of incoming checks and cash?
• Are bank reconciliations and vendor lists regularly reviewed by someone other than authorized persons originating them?
• Does an employee with signature authority have access to check stock?
• Does an employee who originates checks have authority to add vendors?
• Is check stock regularly counted by someone not involved in disbursements

Consider external solutions

Separating duties is challenging if there are only a few people in an office. So what can a small family office do?

Many high-net-worth families hire employees to take care of the day-to-day details. However, in a small office, the family members may have to get more involved in implementing and assessing controls.

Alternatively, a family could hire an independent accounting firm with expertise in family office management. For example, a qualified firm could prepare or review bank reconciliations, count check stock, oversee the disbursement process or even handle the entire administration and management of the family’s affairs. Further, the firm can perform an audit of the financial statements of the family’s main investment entities to validate proper accounting methods and controls. While a financial statement audit isn’t designed to detect fraud, testing of controls and transactions can lead to the discovery of wrongdoing.

An in-depth internal control analysis can help identify areas of weakness and concern. The analysis should focus on the accounting policies and procedures in place, including disbursements and receipts of
the office’s funds. The analysis can identify potential problem areas and provide recommendations that, if properly implemented, can help a family office maintain:

• Efficient operations and effective use of the office’s resources;
• Accurate financial internal and external reports; and
• Compliance with applicable laws and regulations.

Finally, periodic surprise internal control reviews can help keep employees on their toes and verify that implemented controls are still being followed.