Fraud is very common in cooperatives.
Does this statement get your attention? It got mine. It was made by a forensic auditor familiar with cooperatives and other small businesses. My initial thought was that the statement may be true, but certainly not for electric cooperatives. However, the research I did opened my eyes.
This year’s Regional Meetings feature a session titled, “The Irony of Oversight: A Cautionary Note for Boards.” The interviews I did of potential panelists made me aware of a number of misconceptions I had about fraud. For instance, I found that 95 percent of the people that commit fraud are just regular folks, not professional fraudsters or sophisticated scammers.
They can be the people we work with, coach with, or go to church with. Another misconception I had was that everyone knows stealing is wrong. Not so. I found that people who commit fraud often say that they did not know what they were doing was wrong.
So, what is fraud? For our purposes, here is a broad definition from USLegal.com: “Fraud is generally defined in the law as an intentional misrepresentation of material existing fact made by one person to another with knowledge of its falsity and for the purpose of inducing the other person to act, and upon which the other person relies with resulting injury or damage.”
A fiduciary duty of the board is to seek to protect the cooperative from fraud through the implementation of a fraud program consisting of policies, controls and reporting. Boards are legally obligated, through the oversight function, to ensure that reasonable fraud detection, prevention, and mitigation measures are in place at the co-op.
Three things I’d like to share from my discussions with panelists include the need for clearly stated fraud policies, the board’s role versus management in preventing fraud, and questions the board may wish to ask the auditor.
A Policy Inventory
The good news is that many cooperatives already have policies in place that cover fraud or could be modified to include fraud protections. For example, a code of ethics or standards of conduct should clearly state what fraud is, that fraud is wrong, and what the consequences will be if it is committed.
Some co-ops ask all employees to review and sign a code of ethics statement annually to keep its purpose front and center. Whistleblower policies typically include a reporting process for employees that discover fraud or other potential wrongdoing and a process whereby reports of fraud will be investigated.
Consider working with your co-op’s attorney to do an inventory of your co-op’s fraud detection, prevention, and mitigation policies. Add or revise policy language where appropriate.
Stay in Your Lane
With clear policies set by the board in line with the co-op’s mission and values, management then takes the responsibility for communicating and implementing the policies with all employees. This may include things such as periodic training, an annual signature confirming understanding of an ethics policy, or setting up a whistleblower hotline.
Management’s job is to implement the necessary internal controls to prevent and detect fraud, which may include things like requiring two signatures on checks, regular review of the co-op’s vendors, and verification of expense reimbursements The board, management and the co-op’s attorney may wish to come to agreement on how fraud incidents will be reported to the board and by whom.
The Board’s Relationship with the Auditor
Regarding the board’s relationship with the auditor, it’s a good idea to foster an environment of healthy skepticism and inquiry. Many of the directors and CEOs I talked with, as well as cooperative auditors and attorneys, recommend the use of executive session to give board members an opportunity to ask questions of the auditor that they may be less likely to ask if management is present. Through my discussions, I picked up some good questions boards could ask, including:
Did the audit process reveal anything out of the ordinary? If so, what?
Are the co-op’s internal controls adequate? If not, where are there weaknesses?
Are there any areas of noncompliance with our existing internal control system?
NRECA Legal Reporting Service features a detailed report on fraud and how co-ops can mitigate their risks. The July 2017 article was written by Steve Dawson, a forensic auditor familiar with cooperatives. Download the article from Legal Reporting Service. Learn more about Dawson Forensic Group of Lubbock, TX.
- Watch a short video interview with Steve Dawson discussing various aspects of fraud.