How To Deal With Payroll Fraud And Security

How to promptly detect payroll fraud and protect your business.

Defined by the Association of Certified Fraud Examiners as “any scheme in which an employee causes his or her employer to issue a payment by making false compensation claims,” payroll fraud is challenging for all businesses. When left unattended, it can bring an entire organization down.

In some recent notorious cases, the former payroll director of a hospital in Atlanta, Georgia, altered information regarding vacation pay and severance pay to pocket more than $500,000. In a different case, a former company owner in New York City used over $1.7 million due in payroll taxes to fund his lifestyle.
 

This shows that payroll fraud comes in different shapes and forms and is also perpetrated at various levels within the organization. A report by the ACFE showed that over half of all occupational frauds happened in these four departments: operations (15%), accounting (14%), executive/upper management (12%), and sales, 11%. The same report also disclosed that, while owners and executives were only responsible for 20% of the frauds committed, they were guilty, by far, of the largest financial losses.

If controlling payroll fraud in businesses that conduct their operations in person is difficult, the complexity increases when dealing with international workers who render their services online and even more when these cross-border hires are contractors. Furthermore, this fraud can happen in both directions, and it has caused substantial losses for companies and freelancers alike.

Here are some of the most common types of payroll fraud, as well as ways to identify them so that you can safeguard the integrity of your organization and its finances.

Fake Workers and Contractors

There are many cases where managers will create “ghost employees or ghost contractors". According to the ACFE, “a ghost employee is someone recorded on the payroll system, but who does not work for the business.” In Florida, a ghost worker scheme defrauded an airport operator for over $900,000.

This can happen with contractors, too. For example, we have seen cases where managers who are assigned a budget to work with freelancers created a separate profile as a contractor, and they assigned the task to themselves, pretending that they were hiring a freelancer.

While some people took the fraud committed very seriously, going as far as creating detailed contractor accounts with descriptions, emails, and reference files, there are ways to mitigate this risk. One of them–and perhaps the most important–is to conduct peer-to-peer audits every reporting period. This needs to be done at least quarterly. Also, when working with contractors, it is recommended to only work with those service providers that can give an itemized report, which must include: the services rendered, the dates in which the service was performed, and how much each service was.

Poor Compliance: Circumventing Rules and Regulations

Companies that hire cross-border freelancers often can unknowingly violate local rules and regulations, which can be considered fraud by some countries’ authorities.

An example of this is India, where the freelancing boom has attracted teenagers, who, eager to make money, have learned skills such as website design, graphic design, and SEO writing–all talents in high demand in the freelancing marketplace. However, if a company hires a freelancer that is, let’s say, 14 years old, the contract would not be legally binding. Even if it is an e-contract, an agreement would lose validity if it was signed by someone under 18 without explicit consent from a parent or guardian. If, despite the illegality of the agreement, you decide to proceed and hire a freelancer, you will likely face problems when paying them. This will also generate banking issues for the contractor in the region, and could land the local team and the country’s company office in trouble.

Prepayment and Ghosting

Especially in sectors such as content creation, social media management, and others–where freelancing has boomed in recent years–there can be the problem of prepayment and ghosting. This can affect both, contractors who prepay a freelancer for their services and then get ghosted, or freelancers who, over-trusting their client, choose to work for them even if they haven’t been paid yet. Then, the service provider gets ghosted, and does not receive payment in return. In worse cases, freelancers have also been the victim of fake offers and payments.

Here, the solution is to work with platforms that offer the escrow mechanics service. Essentially, escrow provides the role of a neutral place for funds to be held, and the funds get released once a milestone is reached or the project is completed. Relevant milestones and the payment structure are agreed upon between freelancer and contractor prior to commencing work. This way, the risk for both parties is eliminated. The hiring company knows that its money is safe, and the freelancer knows that they will get paid as agreed.

Worker Misclassification

Worker misclassification is one of the most common ways in which payroll fraud is committed, and employers often commit it.

For example, in what is called “fake freelancing,” companies enter into an employment contract with an employee directly–a full-time employment agreement–but use a freelancing platform to pay them out and classify the worker as an independent contractor, even though the contractor has no other clients and commits all of their working hours to the hiring company. This is fraud. Worker misclassification is very harmful because by treating workers as contractors, employees avoid certain legal obligations and financial responsibilities, such as payroll taxes, minimum wage laws, overtime pay, and other benefits. This leaves employees unprotected.

How to Deal with Payroll Fraud?

There are many things a company can do to prevent payroll fraud. One of them is establishing internal controls. There are many ways in which this can happen. For example, an ACFE study mentioned that having a code of conduct reduced losses by 51%. Other factors that contributed to reducing losses are having an internal audit department (50%), management certification of financial statements (50%), having a hotline (49%), fraud training for employees (38%), and having employee support programs, with 33 percent.

And while all of these internal initiatives are of great help, working with a trusted payroll and compliance services partner can reduce losses even further and even mitigate the risk of fraud entirely. This is particularly important when hiring international contractors and benefits freelancers and hiring companies. These partners eliminate the risk of unknowingly being involved with fraud because they understand all the relevant rules and regulations in the country where you plan on doing business. At the same time, strategic partners provide all the technological infrastructure in place so that payments, receipts, contracts, and assignments are managed through the same platform, ensuring the legal validity of the agreements in place and eliminating the risk that one of the parties will breach the contract or commit any type of payroll fraud.

Author Bio

Pavel Shynkarenko is Founder of Solar Staff. Pavel is an entrepreneur with over 20 years of experience in financial, HR and legal technologies.