Payroll Fraud: The Different Types, Detecting It and Preventing It

The most common payroll fraud schemes and preventative measures include:

Ghost Employee Schemes

A fake, terminated or non-existent employee or vendor is issued checks the thief cashes for personal gain. This is more common in companies where supervisors manage large groups of people, and are not reviewing compensation in detail as a smaller organization might. Another red flag is multiple direct deposits to the same banking account or the issuance of checks to multiple employees at the same address.

Timesheet Fraud

This is relatively common in businesses that pay their workers an hourly rate. An employee inflates his or her hours, or punches the clock for an absent employee.

Rate Adjustment

This type of fraud is where an employee increases their rate of pay, pays themselves overtime, or intentionally gives himself or herself a bonus or commission not actually earned. Nearly always, someone working within the payroll function is committing this type of fraud.

Lack of Deductions

This method involves Federal withholding tax, state and local withholding tax (if applicable), Social Security, and benefits deductions that are required deductions from the employee’s check, but are not deducted. Instead, the employee effectively allows the employer to pay for the tax or benefit.

Un-repaid Payroll Advances

This is a passive fraud, and sometime is unintentional. An employee requests a payroll advance, but does not pay it back. This is easiest to execute when the accounting staff records the advance as an expense rather than charging it as a balance sheet item, or never monitors for repayment, eventually forgetting they ever issued an advance.

Check Cloning

Check cloning aka check counterfeiting is the process where information contained on a valid legal and authorized check is used to duplicate or replicate a similar check in appearance that is not authorized. This form of fraud generally involves obtaining check paper stock from a third party, and using technology to print unauthorized items that resemble legitimate items.

Using today’s technologies, criminals can simply use information such as bank routing numbers, account numbers and authorized signatures on the actual check to duplicate these fraudulent checks. In some cases, this info can be used electronically, significantly increasing the risk of fraud.

Presenting the Same Check Twice

With the ability to deposit checks remotely through bank-provided software and taking a picture of the check, an unscrupulous employee may then go to a currency exchange, for example, or some other place of business such as a bar and cash that same check.

The best measure is a simple review of the payroll reports before payroll has been approved and processed to verify payee names, rates of pay, hours and deductions are all correct. Additional controls include:

• Separate payroll set-up, approval, and processing functions.
• Require employees to take mandatory vacation time.
• Cross train and rotate job duties of employees in payroll and human resources.
  Implement a direct-deposit system for payroll and bonuses.
• Require managers to approve timesheets and overtime requests.
• Conduct periodic audits of your payroll reports to ensure employees are getting the correct pay.
• Review Social Security numbers to make sure there are not any duplicate or missing numbers that may point to a ghost employee scheme.
• Remove terminated employees from payroll immediately.
• Restrict access to blank check stock and signature stamps to authorized personnel only, and keep these items locked away as much as possible.
• Most banks have a Positive Pay service that helps detect cloned and unauthorized checks and prevent those checks from being cashed (or being cashed a second time). If your bank offers such a service, sign up for it.
• Convince or require (in states where direct deposit can be mandated) employees to be paid via direct deposit.
• Establish a zero-tolerance policy for fraud and prosecute violators to set an example.
• Use biometric clocks such as fingerprint readers to deter “buddy punching”.
• If using a mobile app to capture in/out punches, establish a “fence” that prohibits punches from anywhere other than the designated coordinates of the workplace.
• If using a web-based system for capturing in/out punches, lock out unauthorized IP addresses.

Payroll fraud is a costly and potentially devastating crime because very often payroll is a company’s most significant expense. To reduce the likelihood of insider theft, employers should stay up to date on who in the organization is writing checks, being paid and how much pay is authorized. It is critical to keep a close eye on money in and money out to disrupt fraud and prosecute the perpetrator.

To help reduce your risk of payroll fraud, simply contact us today!