Anyone who works closely with family offices grows to appreciate what complex business organizations they can be. Since there is no standard template for managing family offices, diverse practices evolve over time based on each family's traditions, values and loyalties.
This type of framework, however, can lead to complacency and, in some cases, fraudulent activity.
Many family offices find it difficult to develop effective fraud-prevention programs due to conflicting values. On one hand, they want to avoid incidents of fraud and the attendant liabilities, losses, negative publicity and family friction. On the other, they want to preserve traditions such as trusting loyal staffers or making business transactions convenient for family members.
This poses a problem in today's environment, where each day's headlines announce new examples of fraud, embezzlement, theft or negligence. Every type of business is vulnerable to these threats and must take precautions. For family offices, the vulnerabilities-and damages-can be substantial.
A fraud-prevention audit is one possible resolution to this conflict. Such audits are conducted by forensic accounting specialists who understand the complexities of family offices. Typically, an experienced team evaluates the family office's personnel, operations, records, accountabilities and controls. It then identifies specific vulnerabilities and makes recommendations for reducing risks.
This process can increase awareness and vigilance whether or not a family office accepts all recommendations or implements changes quickly. At minimum, it will encourage constructive communications between family members and help to modify routines that, though seemingly innocuous, are known to invite fraud.
As a next step, a family office can implement a series of practical methods identified in this article for increasing controls, creating checks and balances, and outsourcing critical services. Most of these methods can be adopted without disrupting family traditions and at a fairly modest cost and organizational impact.
A Perspective Of Prudent Awareness
In criminal law, fraud is usually defined as deliberate deception with the intent to harm a victim. A family office should take a broader view and include acts that may be unintentional, negligent or caused by lack of knowledge.
A prudent perspective can be created, in part, by educating office staff and family members about the three red flags that the "fraud triangle." According to the accounting profession's Statement on Auditing Standards No. 99, (SAS 99), they are:
1. Pressures or incentives motivating the perpetrators to act-such as personal financial problems or personality conflicts.
2. Opportunities for fraud, often created by a lack of oversight and/or controls.
3. A negative attitude, lack of judgment, or absence of morals on the part of perpetrators.
Of course, high-profile fraud can be committed by coordinated groups of people or criminal rings. But in family offices, and especially in cases of deliberate internal fraud, perpetrators usually work alone. Typically, they have earned positions of trust and are given relatively unchecked access to accounts, funds, reports and statements.
They tend to thrive on lack of communication-not having to provide reports or share information with others-and take advantage of bad habits, such as the fact that family members often do not read business mail or require reconciliation of accounts.
Benefits Of A Fraud Prevention Audit
Since 2002, independent auditors have been required by SAS 99 to interview the management teams of their clients to discuss how financial statements might be susceptible to material misstatements due to fraud. But, although SAS 99 has increased anti-fraud vigilance in the aftermath of the WorldCom and Enron scandals, family offices should not rely on regular audits for fraud protection. A dedicated fraud-prevention audit provides an objective third-party assessment of vulnerabilities before they are identified and exploited by perpetrators. In addition, it can help to: