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| Who Can You Trust?: Sentinels or Swindlers? |
Inside Jobs
11/01/2005
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Family offices, cloaked as they are in secrecy and sometimes peculiar
eccentricities, can hide flawed financial controls that allow some of the most
startling betrayals, including fraud, embezzlement and forgery. In more than 20
years of advising families on matters related to their wealth, I have observed
that most cases of fraud are committed by someone who does not go into the job
with the intention of stealing. But the temptation is there; the thief is
opportunistic, and his crime develops over time.
While the wealth management
industry does not compile statistics on how many families have been robbed or
otherwise duped by a trusted employee, advisor or administrator, we certainly
hear of it happening. A few fundamental attributes of very affluent families
cause these problems. There is no audit or public reporting oversight, such as
SEC regulation, over most family wealth, although some family offices oversee as
much money as the largest companies in the world. Families generally crave
secrecy in their affairs. Family offices are high-trust environments where an
employee’s value is measured by his or her access to the inner circle and to
highly confidential information.
Violations of this trust are largely
preventable if at least one person in the family keeps an active hand in
day-to-day management. However, many hire a family office management team
precisely because their family members prefer doing other things. Individuals
busy with family businesses and other ventures are often so preoccupied that
they value convenience and time savings over prudent and necessary financial
controls. They might be only too happy to have a trusted executive assistant pay
their bills. Soon they ask the same person to reconcile the checking account. In
time, they delegate signing authority. Before long, they start leaving signed
blank checks when they travel. Unfortunately, delegating this level of
responsibility for your financial affairs will result in disaster sooner or
later.
Growing Pains
Malfeasance by a trusted employee almost always begins
small. The employee might be suffering financial problems and borrows a few
dollars from petty cash with the full intention of paying it back before anyone
notices it missing. The next month, that same employee might pay a personal
phone bill or credit card bill with a family check and the process is quietly
well on its way. Such minor pilfering can gradually turn into truly staggering
theft.
A natural progression might include the employee paying the same bill
twice. One check is sent to the rightful service provider, the other is neatly
endorsed and deposited into the employee’s account. Would you really notice if
your pool service bill for July was paid twice? As a next step, the employee
might create a bogus company that invoices the family for services that are
never in fact rendered. The invoice might claim the company performed a service
that is difficult to actually detect, such as deep-root fertilizing. All of
these payments, naturally, go directly to the employee’s fraudulent
account.
Another common scheme involves vendor kickbacks. A family office
manager who has authority over hiring service providers, say a landscaper or
housekeeper, will intimate to a hopeful provider that to win the business, they
must provide the employee a finder’s fee or commission. The employee then
influences the competing bids as well as your own view in order to manipulate
the outcome and pocket the kickback that was extracted from you, by the vendor,
in the form of an artificially inflated bid.
Research by the Association of
Certified Fraud Examiners’ Report to the Nation on Occupational Fraud and Abuse
confirms that the lack of sophisticated internal controls found in small offices
leads to ever-larger problems. The report found that organizations with fewer
that 100 employees suffer the largest median losses per capita.
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