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Law firms are at high risk of embezzlement

One would think morally flexible job seekers would avoid any industry where the business owners socialize with judges and read legal journals for fun. Surprisingly, law firms are favored targets of both experienced and novice embezzlers.

Although all types of businesses are at risk for fraud and embezzlement, law firms have more risk than most. Law firm profitability is dependent on billable hours. Since attorneys can’t bill clients for reviewing their own firm’s financial records, they delegate financial and administrative tasks to non-attorneys. This is an effective business model as long as partners understand the attendant risks. The key risk is not monitoring the work of trusted accountants, bookkeepers and office managers.

After reviewing ten cases involving embezzlement from law firms, the commonalities were striking. The alleged perpetrators were all middle aged women in financial positions such as bookkeeper, office manager, secretary, legal assistant, accountant or director of operations. The alleged thefts occurred over several years; four to seven years in these cases.

The estimated loss typically averaged $100,000 or more annually. One of the largest cases involved a bookkeeper who allegedly stole over $800,000 from a two partner law firm over seven years; she left the partners with $63,000 in credit card debt, and decimated their retirement and college savings accounts.

One would think the methods employed to steal that much money over such a long period of time would be very involved and difficult to unravel. Not so. The schemes employed to embezzle funds in these ten cases were fairly simple, such as transferring money to a personal account and paying personal bills with law firm funds.

It is the means employed to hide the nefarious schemes that can be tricky to unravel. Forensic accountants rarely identify all the pilfered funds in an embezzlement investigation; we typically find 50 to 75 percent. The cost of finding every penny isn’t justified, because it is unlikely the victim will get much restitution. Most embezzlers spend the money as fast as they steal it, which explains why they keep stealing – easy money is addictive. It’s best to put checks and balances in place to prevent it, deter it or detect it quickly.

Five tips for law firms

A key prevention tool is to separate duties so no one person controls a transaction from beginning to end. This isn’t feasible in most law firms because there are too few people involved in the financial processes, and there is usually one person who can override the internal controls.

A better approach is to look for ways to deter embezzlement (so anyone who is tempted to steal recognizes there is a high risk of being caught), and to design systems to catch it quickly if it does occur, so partners don’t have to dip into their retirement accounts to make their mortgage payments.

1. Perform background and criminal history checks on all new hires. Experienced fraudsters target law firms because they know the internal controls are weak and the partners are not likely to risk damaging the firm’s reputation by prosecuting a trusted employee.

2. Conduct a credit check on key employees responsible for finances, at hire and every year or two thereafter. The brightest red flags of embezzlement are financial difficulties and living beyond means. Do you want someone handling your firm’s finances if the person can’t handle his or her own finances?

3. Have a forensic accountant review the firm’s financial records on a periodic basis. This is a strong deterrent to someone who considers the firm’s checking account to be the best way to solve his or her personal financial dilemma.

4. Document the firm’s financial processes, train employees in their use, and designate one or two partners (or a committee) to be responsible for oversight. Build continuity into the oversight process so the attorneys charged with this key responsibility gain knowledge from their ongoing experience.

5. Obtain employee dishonesty insurance coverage. Law firms are more likely to collect on an insurance policy than to get restitution from an embezzler.

Being proactive is more rewarding than being a victim. Honest bookkeepers and accountants know the value of a strong system of internal controls. Checks and balances protect employees as much as they protect a law firm’s partners and reputation. Trust, but verify.

Denise McClure, CPA, CFE is a forensic accountant and the owner of Averti Fraud Solutions, LLC in Boise. She is a frequent author, speaker and trainer on preventing and deterring embezzlement and fraud. Her ideas on fraud risk management have helped organizations improve efficiency, profitability and security. For more information, visit www.AvertiFraudSolutions.com or e-mail Denise@AvertiFraudSolutions.com.

About Denise McClure