Evaluate the family
office's management structure and its managers' ability to delegate
responsibilities, provide accurate reports and monitor day-to-day
activities.
Identify specific opportunities to increase expertise and controls through outsourced relationships.
Establish effective protocols for such activities as wire transfers,
maintenance of books and records, and timely financial reporting.
Increase professionalism by segregating staff duties and implementing thorough background checks for job candidates.
Document investment policy for the family office and create consistent
standards for due diligence, investment decision-making, and
performance monitoring and reporting.
The bottom-line benefit of a fraud-prevention audit is that it can help family offices treat their affairs and assets as a serious business in which all participants are held to clear, consistent standards.
Practical Methods For Preventing Fraud
In
addition to conducting a fraud-prevention audit, family offices can
discourage fraudulent activity by taking the following steps:
Vary the routine - Acts of fraud often arise from predictable daily
routines and repetitive patterns. For example, some family offices
regularly dispense cash through physical deliveries made by the same
person, traveling the same routes at the same times of day or week. A
professional service provider such as Wells Fargo should be hired to
deliver large sums of cash. If this isn't feasible, vary the delivery
routine, with different people assigned to the task to increase checks
and balances.
Open the mail - One of the simplest tasks can be
among the most effective: Just open the mail. Family members should
open any mail addressed to them that contains financial documents such
as bank and brokerage statements, capital letters, credit card bills
and invoices. Even if a family member lacks the time to read or check
these documents, opening the mail before it's distributed to the office
staff can discourage fraud because perpetrators thrive on patterns of
neglect.
Segregate duties - Segregating related responsibilities
can be an effective anti-fraud measure. For example, the person who
writes the checks should not be the same person who receives the bank
statements and reconciles the bank accounts. The person who maintains
the general ledger should not reconcile the bank accounts and write
checks. The same person who enters the deposits and reconciles the
accounts should not make bank deposits. Following these rules helps to
eliminate opportunities for covering up theft with false records or
destruction of documents.
Outsource the basics - Another
time-tested practice is to outsource basic accounting and bookkeeping
services, including check-writing. Engaging a professional service firm
to maintain accounts and write checks can deter fraud, especially if
the accounting firm has a fraud-prevention perspective.
Ensure
that financial reports are complete and timely - Whether internal staff
or an outside accountant prepares financial reports, he should follow
consistent formats and schedules. The more time between events and
reports, the more room fraud perpetrators have to maneuver. A complete
set of financial reports should at least include an operating statement
comparing budget versus actual results, and a statement of net worth
including updated and reconciled asset values for alternative
investments and brokerage accounts.
Establish procedures for
check-signing - Dual check-signing authority is not necessary for
paying day-to-day bills in small amounts, but it should be required for
any expenditure over a certain amount, such as $10,000. Large checks
should have two signers-one from an accounting firm and the other a
designated family member or office manager.
Set protocols for wire
transfers - Wire transfers are notorious vehicles for fraud, especially
when money is wired from an internal account to an external bank.
Unlike an internal transfer, there may be limited ability to recover a
fraudulent external wire transfer. Before such a transfer is made, a
protocol should be followed for having the family office's bank call
back a designated individual, other than the person requesting the
transfer, to verify approval. This protocol should be followed
regardless of the wire transfer amount or external bank used.
Conduct consistent background checks - Personal background checks
should be conducted before hiring anyone who will be involved in
financial transactions. This policy should be enforced without fail,
even when a job candidate is a "family friend" or comes highly
recommended by an impeccable source, such as another family office.
Set clear, documented investment policies -Family offices use many
types of structures in vetting, selecting and monitoring investments.
While flexibility has advantages, a few basic guidelines are also
advisable:
Important investment decisions should be made by
designated family members on behalf of the whole family. Fragmented
investments made on behalf of specific members, to the exclusion of
others, often lead to family friction and ultimately a dysfunctional
family office.
Strong family offices hire a dedicated investment
professional as chief investment officer to conduct due diligence and
make recommendations. It is essential to review the track record,
experience and background-including references, criminal record and
credit check-of any CIO candidate. Make sure the CIO is producing
original work and is not acting as a conduit for recommendations from
other entities.
Strong family offices encourage investment
transparency and communications. They have an investment policy
statement that prohibits opaque or highly complex arrangements. They
establish a committee of key members to fully debate and decide on
specific recommendations made by the CIO. They demand full and
consistent due diligence on every investment considered, especially
"pet projects" of individual family members.
Offices can create
checks and balances by outsourcing data aggregation, performance
reporting and analysis, and tax reporting. An experienced accounting
firm also can help to verify the accuracy and consistency of capital
letters received from alternative investments, including capital
contributions and withdrawals.
A Process For Increasing Protection And Peace Of Mind
Fraud
can happen anywhere and to almost anyone, including sophisticated
investors, operating companies and victims of identity theft. The
Internet has enabled fraudulent acts to be committed against U.S.
residents by criminals in Russia, China and other foreign
jurisdictions, while an economic downturn has exposed new types of
fraud, such as mortgage market manipulation.
Family offices are vulnerable to many types of fraud, ranging from elaborate swindles to petty theft. But costly and damaging acts can also fall outside the legal definition of fraud as "deliberate deception." They can be the result of mistakes that aren't detected, reported or corrected.
This is why we advocate a fraud-prevention audit as a process for changing the perspective of family offices and implementing practical methods that have consistently worked. You don't have to change your unique, defining values to treat your office as a serious business and increase its protection and peace of mind.
David Kaufman is a principal in the Rothstein Kass Family Office Group in New York City. He has been accepted as a certified fraud examiner by the Association of Certified Fraud Examiners.