The Money Pit

By Douglas P. Cushing

Taking simple steps to control paper flow and office procedure can help avoid financial disaster. Two areas where putting safeguards in place and paying attention to the details can make a big difference to your bottom line are discussed below.

I. Embezzlement and Employee Screening

The techniques of employee screening and evaluation are issues that can translate directly into expensive losses. That an employee steals from their employer, even when the employer is a charity as has been reported in the metro area more than once in the last year or two, is not a happy result.

What frequently occurs is that a bookkeeper or payables processor issues checks, as an authorized signer, to their own improper payee. Dummy invoices may be submitted, or legitimate payees may not get full payment and the employee pockets the difference or the payment. What employer actions or inactions allow this?

The most basic mistake is allowing the same person to write checks and reconcile bank statements. A business's size may make this arrangement seem logical, but unless the business has a regular audit or review by an outside accountant, the reconciling individual may be the only "second set of eyes" to review the checks that have been issued. An employer can require verification of invoices paid and also double check with payees randomly, but by basically not letting the proverbial fox guard the chickens, the risks can be substantially reduced. Paid invoices or receipts should be "cancelled," don't let them float and find one of them paid twice — perhaps the second time to the employee's personal account. One California lawyer recently had the worst situation one could imagine. His secretary had pocketed over $250,000 from plaintiff's verdicts over the years, having access to his trust account throughout her employment, and to add insult to injury, when the state Bar notified the office about an investigation, she "resigned" him from the Bar before leaving.

Real people audits are critical. Perhaps random, or regular surprise visits by one's CPA is the answer, as no software program can ensure fully adequate reviews. Too often they will fall victim to the GIGO principle — garbage in garbage out.

Wire transfer payments present a slight variation of the same problem in that the same person authorizing the wires should not be the person verifying the amount of funds and the payee credited. Internet fund transfers may require more complicated technical controls be developed, but the essential element will remain having at least a second set of eyes double checking records of transactions. Other specific acts recommended are to bond all employees handling funds, prohibit any "cash" checks, and monitor deposits against billings.

II. Lost or Stolen Checks

If a check is lost or stolen before the Payee receives it, or the check is lost or stolen after receipt by the Payee but before the Payee is able to present it for payment, the Issuer's goal is to avoid double liability for the goods and services that arises if the lost or stolen check is negotiated by a wrongdoer and paid by the Issuer's bank. The original intended Payee is still demanding payment for its account. The Issuer has two avenues. First, a timely stop payment order will protect the Issuer when the wrongdoer has been delayed in presenting the forged check or where the Issuer's bank has yet to honor it. Second, if the Issuer's bank has honored the check bearing a forged or improper indorsement, and there has been no negligence on the part of the Issuer in contributing to the loss or theft of the check, the Issuer can demand that his bank recredit the Issuer's account.

What if the bank pays over a stop payment order? It is subrogated to its rights against either the drawer or the payee IF the customer could recover, i.e., if the payee had a legitimate claim and the stop payment order was unjustified the bank's payment of the check is covered and the account can be charged.

If the stop payment order was correct, the bank can seek recovery from that payee, but not charge its account holder.

If the lost or stolen check is negotiated by the thief or finder to a person able to assert "Holder in Due Course" status: one who takes for value, in good faith, without notice of defenses, and the document appears authentic, the original issuer of the check would have to pay the Holder in Due Course, even if they had already issued a second check to the original Payee. If the check was made payable only to the order of the Payee ("order paper"), however, no subsequent person in possession of the check other than the Payee could be a Holder in Due Course.

In conclusion, sometimes the "details" of business aren't really exciting, but dotting the i's and crossing the t's can most certainly help to protect your profits.

This article is intended to inform the reader of general legal principles applicable to the subject area. It is not intended to provide legal advice regarding specific problems or circumstances. Readers should consult with competent counsel with regard to specific situations.

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