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Employee Fraud

The U.S. Marshall’s online auction of clothing seized from Sujata “Sue” Sachdeva continues at Gaston & Sheehan. I didn’t bid on anything, but I stopped by the website, curious to see what sort of things Ms. Sachdeva bought with the $34 million she embezzled from Koss Corporation (link to a Reuters summary of the fraud case; Ms. Sachdeva was convicted and sentenced to 11 years in prison last year). I was surprised to see how many items still had the tags attached, indicating they had never been worn. It would take a while to go through millions of dollars worth of apparel, even if you bought very expensive designer clothes and wore two or three different outfits each day. It must have taken many hours of shopping each week to accumulate so much stuff. In fact, Ms. Sachdeva’s attorney presented her in court as the pathetic victim of a compulsive shopping disorder.

I’m not sure what to think of classifying an urge to acquire stuff as a disabling mental illness. In SHAM – How the Self-Help Movement Made America Hopeless, Steve Salerno argues against excusing crimes based on the criminals’ reasons for committing them. Consideration of mitigating circumstances at the sentencing phase of a trial seems only fair in some cases (for example, a man stealing food to keep his starving children alive), but to lighten the sentence on someone who almost put her employer out of business by embezzling money to buy clothes and limousine rides … I don’t know … it seems that once someone accepts this view, it’s only a short step from holding the employer responsible for harming Ms. Sachdeva by enabling her compulsion.

At least two other Koss employees knew about the thefts, which took place over a period of five years. Both employees reported directly to Ms. Sachdeva. No charges were ever filed against the other employees, so their reasons for keeping quiet are not public information. Were they afraid of losing their jobs? Did Ms. Sachdeva somehow convince them that she was doing nothing wrong?

Can small business owners learn something from this? Having an upper management open door policy comes to mind, so that employees could feel somewhat less uncomfortable about going over their supervisors’ heads. Personal review by the CEO or CFO of all expenditures over a certain amount I another. Koss actually had a review policy for expenditures over $5000. It’s not clear how Sachdeval circumvented this, or why the CPA’s who audited the company didn’t notice it.

The Internal Controls section of Koss’s 2010 annual report states that “approximately 98.1% of the of the unauthorized transactions from fiscal years 2005 through December 2009 was misappropriated by circumventing the Company’s internal controls and other operating procedures for the payment of Company expenditures by using wire transfers or cashier’s checks from the Company’s bank accounts to pay for personal expenditures.”  The remaining 2% of the money apparently was stolen via the petty cash funds.

All purchases of more than $5000 were supposed to be approved by the CEO, Michael Koss, and the auditors should have chosen representative samples of wire transfers and cashier’s checks and matched them to signed CEO approvals. Since this somehow didn’t happen, it made sense for Koss to change whatever it had been doing. The annual report says that Koss remedied the situation in the following way: “This has been remediated by: (1) disallowing the use of any cashier’s checks; (2) enforcing that all wire transfers are initiated within the financial function and electronically approved by the CEO; and (3) performing an enhanced review, reconciliation and reporting of cash activities.”

The fraud was first discovered by Michael Koss when American Express notified Koss of large wire transfers being used to pay personal expenses.

Lawsuits were filed by Koss v Grant Thornton (their auditor);shareholders v Koss Corp, Michael Koss, and Grant Thornton; Koss v American Express. A quick online search indicates that the shareholders’ class action lawsuit against Grant Thornton was dismissed, and the shareholders’ case against Michael Koss and the corporation was settled. I believe the Koss v Grant Thornton is still pending.

One point about this case that especially caught my attention was that the Koss family was said to have been not entirely careful about their own transfers of cash and other assets into and out of the company. Michael Koss held several corporate offices, including CEO and CFO, an arrangement which tends to encourage financially loose behavior.

Commingling business and personal assets is one of the most common mistakes I see in my own clients’ businesses. When I set up a business entity for a client, I tell them that if they can remember only one bullet point from their organizational meeting with me, it should be NEVER COMMINGLE.

The attitude of business owners, especially of a closely held business is, “It’s my money, I can do whatever I like with it.” This is true where there are no other owners, but it has to be done correctly in order to prevent tears in the “corporate veil.”

Where there are other owners, such as partners or investors, the owners have to be far more careful about taking assets out of the entity, or using entity equipment for personal purposes. Most business owners are aware of this, even if they do not always act accordingly. It’s less common to consider the effect it has on employees when they see the owners freely helping themselves to money and other assets belonging to the business entity. Not only does a general attitude of financial carelessness on the part of management encourage employees to have the same outlook, it can also make it more difficult to notice when fraud is taking place. For example, constantly transferring cash between various entity and personal accounts provides a great springboard for dishonest employees to add a few discreet transfers of their own.

I do not know the details of the Sachdeva case, but if the Grant Thornton auditors overlooked $34 million of bogus payments, I’d be willing to bet that the Koss accounting practices were not shiny-clean.

Posted in Accounting, Business, Employee Theft on 11/14/2011 11:32 pm
 

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