Thwart Employee Wrongdoing with Good Internal Controls

Internal controls and periodic audits are a CU’s best defense against employee wrongdoing.

May 15, 2015

Employee dishonesty is a constant threat to all credit unions regardless of asset size.

According to CUNA Mutual Group, employee dishonesty losses continues to be the top claims category, making up 49% of claims dollars paid under the Bond. Weak or nonexistent internal controls and infrequent surprise audits are the primary culprits for these losses.

Implementing internal controls, combined with periodic audits, are a credit union’s best defense against employee wrongdoing. Although internal controls will not prevent employee dishonesty losses altogether, properly implemented controls combined with frequent surprise audits will lessen the severity of a loss if one occurs.

It’s easier to prevent a loss than to uncover one. Credit unions cannot be complacent simply because they have not incurred an employee dishonesty loss.

It’s best to proactively implement important internal controls rather than wait for an embezzlement to occur.

Here are three key steps to take when establishing a good internal control environment:

1. Set the tone from the top with a written employee fraud policy statement.

An important tool in managing risks associated with employee dishonesty is a written policy specifically addressing employee fraud. The board of directors should develop the fraud policy with the assistance of legal counsel and include a fraud policy statement for employees to sign annually.

A board-approved policy on fraud sets a “tone from the top” that dishonesty on the part of employees will not be tolerated.

2. Establish a system of internal controls, including surprise audits.

Implement two primary types of internal controls:

  1. Preventive controls, designed to help prevent employee wrongdoing. Examples include segregation of duties and dual controls.
  2. Detective controls, designed to detect employee wrongdoing. Examples include periodic surprise cash counts and loan audits.

The loan department is one of the key areas in which to segregate duties. Loan officers should not have the ability to disburse loans they approve.

Dual controls help discourage employee wrongdoing by requiring two employees, acting jointly, to perform certain tasks (e.g., verifying cash shipments and replenishing ATMs) and accessing the vault cash.

Periodic surprise audits, such as cash counts, are an excellent deterrent to employee wrongdoing. Those performing surprise audits should know the tricks dishonest employees may use to evade detection.

The following embezzlement scheme involving theft of cash illustrates one of these tricks:

A vault teller concealed her theft of vault cash and evaded detection during surprise cash counts by making fraudulent entries to the general ledger vault cash account. She would make entries sell cash to other tellers and transfer funds to the ATM general ledger account shortly before the start of the cash count.

This made it appear that the actual amount of vault cash matched the balance in the general ledger. The vault teller reversed the entries after the surprise cash counts were completed.

3. Conduct thorough criminal background checks on job applicants and check their references prior to making job offers.

CUNA Mutual Group Bond policyholders should also use the company’s bondability verification service to screen applicants.

KEN OTSUKA is a senior consultant, risk management, with CUNA Mutual Group. Contact him at 847-612-9653.