United States

Occupational fraud and private clubs: Part II


In the September 2013 issue of eClub News, Part I of this series introduced the latest benchmark fraud study from the Association of Certified Fraud Examiners (ACFE), 2012 Report to the Nations on Occupational Fraud and Abuse, to the private club industry in relation to the cost of occupational fraud.

Attention is turned this month to how occupational fraud is typically committed. It stands to reason that, if clubs understand how fraud is committed, they will be better able to prevent and detect it.

The report from the ACFE divides fraud into three broad categories:

  1. Asset misappropriation schemes
  2. Corruption schemes
  3. Financial statement fraud schemes

Asset misappropriation schemes

Asset misappropriation schemes are those where an employee steals or misuses the club’s resources. As in prior years, these types of schemes were the most frequently represented in the findings—comprising more than 86 percent of cases and averaging a median loss of $120,000. It is important to note that the definition of this type of fraud does not involve cash, as focusing only on the risk of cash theft is often one of the mistakes made in developing a fraud prevention or detection approach.

As many private clubs are essentially noncash environments, they are able to focus easily on more likely to occur schemes. For example, asset misappropriation can be something as straightforward as inflated expense reports or inflated time cards. Meanwhile, the fact that payroll is the largest expense in a private club is one management should note and pay attention to for preventing payroll fraud. And, while payroll fraud is often thought of in terms of adding ghost employees to the payroll records or inflating hours, management must pay heed to the inclusion of misuse of club resources as occupational fraud. Employees do not have to inflate hours to commit payroll fraud; they can just as easily commit fraud by reporting their normal hours without working their full schedule—perhaps leaving the club during their shift and not clocking out, or spending time on social media to check personal status updates on Facebook. While most employees will recognize that stealing $100 of cash or inventory is fraud, stealing $100 of time is not always as obvious to many.

Corruption schemes

Corruption schemes are those in which an employee abuses a position of trust or influence in a club business transaction. These schemes involve an employee violating a fiduciary duty to the club in order to gain personally from a transaction. Bribery or conflicts of interest would be considered corruption schemes that occasionally surface in the private club industry. While many private clubs have adopted conflict of interest policies, too few have taken the time to speak repeatedly to their employees about the topic. Corruption schemes account for approximately one-third of the cases discussed in the ACFE findings, with a median loss of $250,000. Few clubs can afford a loss of a quarter of a million dollars due to corruption; thus, it is arguably worth the time and effort to reinforce the need to avoid conflicts of interest and disclose them as soon as they are aware. For examples, clubs should consider whether the golf course superintendent should be allowed to buy contract labor from his brother’s landscaping company. Preventing this very transaction would have stopped the one club from being defrauded when the contract labor firm overbilled it repeatedly by inflating the number of personnel supplied on invoices.

Financial statement fraud schemes

Financial statement fraud, while involved in less than 8 percent of cases reported, resulted in the greatest median loss, at $1 million. These schemes are those when an employee intentionally causes a misstatement or omission of material information in financial statements, and they are relatively rare in the club industry. Since many of the financial reporting pressures found in the corporate world are absent in the realm of nonprofit clubs (e.g., the need to meet earnings targets for the markets or investors), the incentive to commit financial statement fraud is arguably diminished. However, the pressures to meet budgetary expectations can be huge as boards of directors and members demand greater accountability at their clubs and department heads see larger portions of their compensation tied to meeting budgetary expectations.

Perhaps the department head that holds back an invoice in one month in order to make budget should be made aware that they are committing financial statement fraud—as should members of management who purposely understate their allowance for doubtful accounts so that the club complies with a debt covenant. While these instances may not be material in quantitative terms, they arguably meet the definition of financial statement fraud and signal an acceptance to bend rules when the situation calls for it. Fraud prevention experts refer to this thought process as the fraud conscience.

A club’s fraud conscience can be seen through its behavior, culture and policies. If not a zero tolerance environment, then what level of fraud is the club effectively signaling it is willing to accept from its employees?

Next month, Part III of this series will focus on how fraud schemes are being detected. While tips from employee are the most frequent method of detection and hotlines have been shown to have an impact on fraud prevention and detection, readers might be surprised to learn that these controls are not actually the most powerful when measured in terms of reducing loss in fraud situations.