How Embezzlement Occurs: Key Stages of the Crime and Common Tactics

Embezzlement is an internal crime that someone commits against their organization. The perpetrator's inside knowledge helps them avoid detection and clean up the evidence. It's a problem that can spiral out of control and cause massive damage to an organization's public face. Identifying the warning signs of embezzlement and acting quickly is essential to preventing the worst-case scenario.

WHat is Embezzlement 

Embezzlement is the theft or misuse of funds entrusted to someone within an organization. Unlike traditional theft, where the perpetrator is an outside entity, embezzlement is restricted to individuals who already have access to money due to their position or responsibilities in the group.

The news mainly covers high-profile embezzlement cases like Bernie Madoff, but the crime can occur at any business level, from part-time employees to CEOs.

How Embezzlement Occurs

Since embezzling is possible at any level in an organization, providing an exact structure to all instances is challenging.

However, there are big-picture aspects that most embezzlement cases adhere to, including:

Locating Funds

The first step in an embezzlement scheme is identifying the funds or assets that can be misappropriated. Embezzlers often target accounts or financial streams where transactions are frequent and complex, making the illicit activity harder to detect. This might include petty cash, payroll, expense accounts, or client trust funds. The perpetrator might exploit a company’s lack of oversight or gaps in internal controls to identify opportunities for embezzlement.

Position of Trust

The perpetrator must be trusted to work alone at times. This lack of supervision gives them the confidence to steal without suspicion. Higher-level management escapes notice because there aren't many eyes on them.

Concealing the Crime

After successfully diverting funds, the embezzler's next challenge is to conceal the crime. Concealment is often achieved through meticulous record-keeping and manipulation of financial documents. Accountants or even other employees can quickly notice and track down missing funds. Embezzlers take steps to create fake financial records, such as falsifying invoices or misreporting expenses.

Common Types of Embezzlement 

In some ways, embezzlement is an exercise in creativity. It's a heist. People use different tricks to get it done, but some common types of embezzlement are:

Payroll

Payroll fraud happens when someone steals funds by abusing loopholes in the organization's payroll systems. Managers may manipulate pay by creating phantom employees, giving themselves bonuses, or altering pay rates to increase their income. Employees can commit payroll fraud by having coworkers clock them in early or falsely claiming overtime pay.

Cash Skimming

Also called siphoning, cash skimming is primarily performed by the people handling inbound payments from vendors or customers. The process will differ based on the business's preferred POS system and inventory tracking but always involves pocketing cash from a sale without logging it into the database.

Charity Embezzlement

Charity fraud is when people trick others into donating to a non-existent or fake version of a charity. However, charity embezzlement happens when internal members of an official charity divert funds to themselves rather than aiding the cause. Both are morally heinous crimes and receive significant public outrage when uncovered.

Lapping

Lapping is similar to cash skimming in that they steal at the point of transaction. However, instead of omitting the sale from the business's database, lapping schemes pocket the funds from one sale while using future sales to cover the discrepancy.

For example, an employee sells a product for $100 and keeps the money. However, they overcharge the next person $200 for the same product. This evens out the total balance in the register and keeps accountants at bay. Of course, this is usually performed in smaller amounts as customers will likely notice drastic overpricing.

Ponzi Scheme

A Ponzi scheme is a type of embezzlement where someone promises big returns to investors but is really just using money from new investors to pay earlier ones. It keeps going until there aren’t enough new investors to keep up, and then it all falls apart, leaving most people with nothing. These schemes are illegal and can ruin lives. It’s important to be cautious of investments that seem too good to be true—they often are.

Financial Red Signs of Embezzlement

Many indicators can point to ongoing embezzlement in an organization. Often, red flags are easily explained away, but it's worth keeping a mental record of when you notice the following signs.

Missing Financial Documents

One of the earliest and most suspicious signs of embezzlement is the disappearance of financial records. If the criminal can't alter the papers, they may steal or destroy them instead. This will make it harder to track the source of embezzlement even if the organization realizes funds are missing.

Unpaid Vendors

Vendor transactions are easy to manipulate as there are often mistakes while working with vendors, and it's an exchange outside the organization. If vendors frequently complain about unpaid invoices, it may be a sign that someone is diverting the funds.

Payment Discrepancies

Frequent payment errors, such as double payments or irregular payment schedule schedules, should raise concerns. For example, a customer may be charged again if someone steals their original payment. Receiving multiple complaints about repetitive payment requests is a big problem.

Another example occurs in commission-based workplaces. Salespersons may inflate the reported sale price to inflate their earnings. These issues demand attention regardless of if you believe these are signs of embezzlement.

Shrinking Profits

Persistent declines in profits without a clear explanation may indicate embezzlement. This is an obvious sign if a business hasn't added new expenses or introduced other factors impacting inbound cash flow. Often, managers or administrators with a good sense of standard operations can intuit whether the losses are natural.

Living Outside Their Means

In 2021, Florida accountant Ralph Puglisi embezzled $13 million to buy a yacht, an island, and fund a wedding. These purchases were clearly outside his financial capabilities and prompted an investigation into Puglisi's situation. He ended up facing a 20-year jail sentence and was forced to liquidate the majority of his assets.

Signs of Employee Embezzlement

The previous section focused on recognizing signs of embezzlement from the records. However, floor-level embezzlement has several psychological or behavioral indicators. Noticing sudden changes in an employee's working habits or personality may be the key to unveiling the crime.

Increased Working Hours

Employees may attempt to hide their wrongdoings by appearing more productive. After all, it feels strange to accuse someone of busting their tail for the company.

However, longer working hours give the criminal more time to cover their tracks and others less time to find evidence of the embezzlement. This can also manifest in increased motivation toward specific tasks or a desire to work alone more frequently.

Financial Hardship

Embezzlement is a crime most closely associated with greed, but desperation is sometimes the more powerful emotion. Employees experiencing financial difficulty or struggling with addiction may loosen their ethics and make poor choices.

Is Embezzlement a Felony?

Embezzlement is typically classified as a felony, especially when the amount of money or property involved is significant. However, the classification can vary depending on the jurisdiction and the value of the stolen assets. In some cases, if the amount is relatively small, the crime may be treated as a misdemeanor. Generally, the more severe the embezzlement, the more likely it is to be considered a felony, carrying harsher penalties and long-term consequences.

Punishment and Charges for Embezzlement

Embezzlement is a criminal offense, but its classification depends on the severity of the scheme. Generally, the more the person steals, the worse the punishment. For example, if less than $1000 is stolen, the crime is considered a misdemeanor, and possible jail time is significantly reduced.

Sanctions are also affected by who was stolen from, the official title of the embezzler, and what state the event occurred in. Anyone who embezzles from a government body will likely face harsher consequences than stealing from a private business. If the perpetrator is a government employee or contractor, they'll face a $250,000 fine and up to 10 years in prison.

Bank employees are held to a higher standard when handling money. Bank employees caught engaging in embezzlement face a fine of up to $1 million or up to 30 years in prison.

Embezzlement vs. Money Laundering

Both embezzlement and money laundering involve misreporting money, but they serve distinct purposes. Embezzlement is theft from an organization by trusted individuals. The goal is to increase the criminal's earnings.

Money laundering, however, is performed after the criminal already has money. The aim is to conceal the origins of illegally obtained income by mixing it with earnings of legitimate channels. Popular depictions of money laundering in the media use nail salons or laundromats to clean the funds.

Reporting and Prevention of Embezzlement

Establishing anonymous reporting mechanisms encourages employees to come forward with suspicions of embezzlement. Employees are often reluctant to blame a close coworker, so it's the organization's responsibility to create a comfortable and safe environment to accommodate them.

Prevention and Protection

Preventing embezzlement requires a multi-faceted approach (Multi-Factor Authentication or Two-Factor Authentication (2FA)) since you never know where it originated. Aside from creating clear reporting channels, organizations should follow the following principles:

• Hire Carefully: Positions in charge of money must involve strict screening procedures. Talk to former employers and ask about their character. Run a background check to determine whether they have outstanding motivations to embezzle.
• Separation of Duties in Payroll (SoD): Never trust one person to handle everything. Different people should look over their coworker's work. This deters theft and reduces the risk of recording errors.
• Check Insurance Plans: Business crime insurance covers embezzlement losses. However, consult your agent for more details, as these plans are usually separate from commercial property insurance.

Be On the Lookout For the Signs

Embezzlement is a complex financial crime that demands vigilance and awareness from both administrators and employees. Keeping the warning signs and common strategies in mind will help organizations protect themselves against damage.

Organizations must prioritize safe reporting mechanisms as a clue towards finding embezzlement can occur from anywhere in the hierarchy. While a culture of integrity and transparency is a powerful deterrent, nothing's a guarantee. It's best to have safeguards in place in the form of services like IDStrong's financial fraud detection.

We constantly monitor financial endpoints like credit card numbers and bank accounts to watch for shady activity or data exposure. This allows your business to focus on growth without keeping one eye open for internal crimes.