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The key to stopping fraud in a private club


The topic of fraud always elicits some interesting reactions when in a business conversation. This is in large part due to the fact that fraud is rarely addressed directly. It tends to lie in some shadowy corner of the clubhouse, not to be discussed out of concern someone might be offended.

Even the accounting profession struggled to come to terms with using the term and discussing fraud proactively. For many years, the auditing standards talked only of "errors and irregularities" and it was not until the 99th audit standard was issued that the term fraud was placed front and center in an audit standard. To reiterate, it took the audit profession almost 100 standards before it felt comfortable enough to tackle the subject head on and demand that auditors did more to consider the impact of fraud in financial statement audits. Meanwhile, studies on the topic consistently point out that external audits detect only 3 percent of fraud. This is not to minimize the value of external audits as they serve an important purpose and can even have a strong preventive effect on potential fraud. However, their usefulness as a means of uncovering fraud is limited.

The Association of Certified Fraud Examiners is an organization, as the name suggests, that is dedicated to studying the effects of fraud. The Association's 2012 Report to the Nations makes for some interesting and rather scary reading. It begins by challenging typical understandings about the definition of fraud. Most think of fraud as something that happens on Wall Street or in publicly traded companies where the pressure to meet the expectations of earnings analysts and desire to boost the stock price causes executives to play games with the numbers.

Would that really happen in clubs? It is not like numbers are scrutinized with laser like precision by club boards and committees, right? It is not like department heads are held to intensive budgetary reporting metrics, right? While the occasional tale of something happening at another club heard, it is a one-off that does not typically happen at a club, right?

If an employee of a club asks whether or not something is fraud, consider whether a manager could answer and whether there is a clear definition of fraud within the club.

The 2012 report notes that, "although the legal definition of fraud is very specific, for most people — anti-fraud professionals, regulators, the media and the general public alike — the common usage is much broader and generally covers any attempt to deceive another party to gain a benefit. Health care fraud, identity theft, padded expense reports, mortgage fraud, theft of inventory by employees, manipulated financial statements, insider trading, Ponzi schemes — the range of possible fraud schemes is large, but at their core, all of these acts involve a violation of trust. It is this violation, perhaps even more than the resulting financial loss, that makes such crimes so harmful."

Applying the results of the fraud report (organizations lose 5 percent of their revenue to fraud on average) to a club with revenues of $10 million would suggest that $500,000 is being lost to fraud each and every year. While that might sound unlikely and shocking as images emerge of a million dollars of cash being wheeled out the back door, consider the many types of fraud that would be less obvious and reflect on how many could happen within the guard gates of private club. For example, fraud can incorporate not only cash crimes but also those that stem from corruption (e.g., conflicts of interest, bribery, illegal gratuities and economic extortion) or from financial statement overstatements or understatements. Furthermore, in addition to the use of cash, a variety of other assets can used and abused. For a more complete list, readers are encouraged to download The Association's 2012 Report to the Nations presentation available on their website.

If the $500,000 figure is dismissed as outrageous, then consider the median loss of $140,000 listed in the report. Consider how much lower membership dues could be if $140,000 of fraudulent waste were eliminated from a club and its vendors.

Among the myriad of internal control tactics clubs employ, they should incorporate two of the most effective fraud prevention and detection programs: speaking with employees and allowing them to speak with management. Some form of whistleblower mechanism should be in place, but it will only be fully effective if there is explicit communication with employees about fraud that helps to explain what constitutes fraud and what their roles and, more importantly, responsibilities are when it comes to fraud.

Consider this conclusion by the Association of Certified Fraud Examiners:

"Targeted fraud awareness training for employees and managers is a critical component of a well-rounded program for preventing and detecting fraud. Not only are employee tips the most common way occupational fraud is detected, but our research shows organizations that have anti-fraud training programs for employees, managers and executives experience lower losses and shorter frauds than organizations without such programs in place. At a minimum, staff members should be educated regarding what actions constitute fraud, how fraud harms everyone in the organization and how to report questionable activity."

If the club does not have a methodology in place to create a conversation around fraud and fraud prevention, then what chance does it have?