Law Firm Embezzlement: The Butler Didn’t Do It

Keep your law firm from becoming the scene of an embezzlement whodunit.

The culprit must be a decidedly worth-while person - one that wouldn't ordinarily come under suspicion.
S.S. Van Dine, "Twenty Rules for Writing Detective Stories"¹

A personal ATM. That's how prosecutors recently described the bank accounts of a suburban Chicago law firm that lost $550,000 through a legal secretary's embezzlement. According to prosecutors, the secretary took money "for whatever she needed whenever she needed it" by writing unauthorized checks, forging signatures, and writing checks to herself from the estate of one of the firm's clients. The scheme finally came to light when a check bounced.² A legal assistant in Champaign County will also be sentenced soon for writing checks on her firm's trust account.³

It's not just the support staff with their hands in the till. Lawyers embezzle, too, and when they do, the sums are often spectacular. For example, a 26-year partner in a Minneapolis law firm stole $2 million over 16 years, using fraudulent expense reports and invoices, forged checks, and a phony business entity into which funds were funneled. He used much of the money to renovate his home, a historic mansion in St. Paul. The scheme came to light when the firm discovered that he had double-billed a client, and then that he had submitted false expense reports for dinners. ⁴

There had to have been an awful moment at each of these firms when someone discovered that the bounced check or double-billing wasn't a one-time mistake, but instead a tiny part of a massive betrayal of trust. I imagine that person simply couldn't - and didn't want to - believe the horrible truth before his or her eyes. Often, the embezzler is the very last person anyone would suspect of wrongdoing - a trusted employee or partner whom everyone likes and respects. The revelation that a seemingly loyal colleague has been stealing from the firm and/or its clients for many months or years⁵ can cause inestimable damage to the law firm's morale and reputation. And the financial loss can be devastating.

Let's look at the factors that paint a target on law firms' proverbial backs, identify some internal controls that can help prevent theft and fraud, and catalog some symptoms that may indicate that your firm is the victim of employee fraud or embezzlement.

Casing the joint: why law firms are vulnerable

Whenever we needed money, we'd rob the airport.To us, it was better than Citibank.
Henry Hill in Goodfellas

All businesses, not just law firms, are vulnerable to fraud, and the toll it takes may surprise you. The Association of Certified Examiners (ACFE) estimates that the typical business loses five percent of its revenues to fraud each year, translating to an annual fraud loss of $3.5 trillion. In the ACFE's 2012 study, the median loss caused by occupational fraud was $140,000, and more than one-fifth of the cases studied involved losses of over $1 million. Sadly, nearly half of the victims recover nothing.⁶

But law firms have some unique features that make them especially vulnerable to fraud and embezzlement:

• Lawyers tend to focus on the practice of law, leaving the day-to-day operations of the law firm to employees.

• The requirement that lawyers keep clients' money separate from their own means that large sums of money can sit untouched for long periods. Employees may be tempted to "borrow" or outright steal from these accounts, because the theft will not be discovered for a long time, and it may be possible to shift money from account to account to avoid detection.

• Almost half (48 percent) of all lawyers in the United States are sole practitioners, and another 15 percent practice in firms of 2-5 lawyers.⁷ Small firms have small staffs, and may find it difficult to implement internal controls like requiring two signatures on every check or segregating job functions related to finances and accounting.

And when lawyers embezzle, their legal skills can come in handy. For example, they can set up shell corporations into which purloined funds can be paid.

Cheese it!⁸ It's the internal controls!

Where large sums of money are concerned, it is advisable to trust nobody.
Agatha Christie

Trust, but verify.
Ronald Reagan

Effective internal controls are not a foolproof solution, but they are a good start. An exhaustive list of anti-fraud procedures and policies is beyond the scope of this article, but here is a short list:

• Educate lawyers and support staff about the importance of ethical behavior. Make sure management "walks the talk."

• Separate job duties so that no one person has complete control over the management of funds.

• Rotate job duties among employees, if possible. Avoid making one person SAKU - the source of all knowledge in (your financial) universe. Require cross-training on all job functions.

• Implement a mandatory vacation policy.

• Reconcile bank account statements regularly. With electronic banking, this can be done anytime - no need to wait for paper statements.

• Review accounts payable and receivable for irregularities and discrepancies.

• Require dual signatures on checks, and do not pre-sign checks.

• Conduct surprise audits of your financial records.

• Implement a confidential fraud-reporting program.

None of these procedures and policies will help much if lawyers are permitted to override them for "emergencies" or "special situations." Everyone - even the firm's managing partners - must follow the rules, and others at the firm must feel free to speak up if they do not do so.

The red flags (or red herrings) of embezzlement

Motive won't make a case. But once you've got the How, the Why drives it home.
Lord Peter Wimsey in Busman's Honeymoon by Dorothy L. Sayers

Embezzlers often exhibit telltale behaviors, according to the Association of Certified Fraud Examiners. In 81 percent of the cases reported to ACFE, the fraudster had exhibited at least one of these behavioral traits in the period before the fraud was discovered:

• Living beyond means

• Financial difficulties

• Unusually close relationship with vendor or customer

• Control issues; unwillingness to share duties

• Divorce or other family problems

• Wheeler-dealer attitude

• Irritability, suspiciousness, or defensiveness

• Addiction problems

• Past-employment-related problems

• Complaints about inadequate pay

• Refusal to take vacations

• Excessive pressure from within organization

• Past legal problems

• Complaints about lack of authority

• Excessive family or peer pressure for success

• Instability in life circumstances⁹

The problem, of course, is that most of us exhibit one or more of these traits most of the time. I would hope that the constant parade of Zappo's boxes into my office¹⁰ does not lead others to wonder if I am a fraudster living beyond my means, and that a friend's painful divorce does not place her under suspicion of embezzlement. And "control issues" and "refusal to take vacations" are a fact of life for many lawyers.

As Lord Peter says, once you know how the crime was done, the why can help drive it home. Something similar is true about the character traits and motivations listed above. They are not, in themselves, indicative of wrongdoing, but, taken together with other facts, they can help signal that something is amiss.

Be one of the meddling kids

And I would have gotten away with it, too, if it weren't for you meddling kids!
Pretty much any unmasked villain in Scooby-Doo, Where Are You?¹¹

It is all too easy for lawyers to be so absorbed in the challenges of law practice that they fail to spot criminal schemes underway in the bookkeeper's office - or the corner office. Preventing fraud and embezzlement at your law firm requires you to take an active role in the day-to-day management of your law firm and to know your colleagues well enough to spot aberrant behavior. The time you spend doing this is not billable, but it is a sound investment in your firm's continued financial and spiritual well-being.

Karen Erger is vice president and director of practice risk management at Lockton Companies, LLC.

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1. This is part of Rule 11 (no, not that Rule 11), which states that "[a] servant must not be chosen by the author as the culprit. This is begging a noble question. It is a too easy solution" - in other words, the butler cannot do it. S.S. Van Dine (a pseudonym for Willard Huntington Wright)) published this essay in the American Magazine in 1928, and you can read it here: http://gaslight.mtroyal.ab.ca/vandine.htm
2. Clifford Ward, Legal Secretary Pleads Guilty in $550,000 Theft Case, Chicago Tribune, June 22, 2012, http://articles.chicagotribune.com/2012-06-21/news/chi-woodridge-secretary-embezzles-downers-grove-law-firm-20120621_1_legal-secretary-firm-mary-marra
3. Mary Schenk, Buckley woman pleads guilty to federal mail-fraud charges, Paxton Record, June 28, 2012, http://www.paxtonrecord.net/news/courts-police-and-fire/2012-06-28/buckley-woman-pleads-guilty-federal-mail-fraud-charges.html
4. Rochelle Olson, St. Paul Lawyer Michael Margulies Leaves Trail of Missing Money, The Star Tribune, April 15, 2010, http://www.startribune.com/local/stpaul/90898154.html; Ashby Jones, Deep Vennum Blues: Lawyer Pleads Guilty to Stealing from Client, The Wall Street Journal, June 9, 2010, http://blogs.wsj.com/law/2010/06/09/deep-vennum-blues-lawyer-pleads-guilty-to-stealing-from-clients/
5. The Association of Certified Fraud Examiners (ACFE) says the fraud case in its study lasted a median of 18 months, but, as in the examples given above, it can take place over much longer time periods. Association of Certified Fraud Examiners, 2012 Report to the Nations on Occupational Fraud and Abuse, p. 4.
6. Association of Certified Fraud Examiners, 2012 Report to the Nations on Occupational Fraud and Abuse, pp. 4-5. Observers nationwide were astonished by the scope of fraud allegedly committed by the former comptroller of downstate Dixon. Martha Neil, "Illinois Town Whose Comptroller Is Accused of Embezzling $53M Blames Auditors in Civil Suit," ABA Journal, June 13, 2012, http://www.abajournal.com/news/article/illinois_town_whose_comptroller_is_accused_of_embezzling_53m_blames_auditor/
7. American Bar Association, Lawyer Demographics, http://www.americanbar.org/content/dam/aba/migrated/marketresearch/PublicDocuments/lawyer_demographics_2011.authcheckdam.pdf
8. Obviously, not a reference to Cheez-It crackers. But while we're on the topic, does it drive anyone else nuts when food names are misspelled? The intentional ones - Kreme, Cheez, Krab, I'm looking at you - are bad enough, but the unintentional grammar and spelling goofs are just pitiful. A particularly egregious example of accidentally edit-worthy edibles might be the bear-shaped sandwich cookies marketed as "Bearwich's" in the early 1990s. By the way, it is now safe to go back into the cookie aisle - Nabisco now markets a similar product under the name "Teddy Grahams." Note the lack of apostrophe.
9. Association of Certified Fraud Examiners, supra note 6, at pp. 5, 57.
10. In fairness, please note that at least half of the merch goes right back to Zappo's. Ordering shoes in two different sizes allows me to choose the pair that will cause the least pain when applied to my outsize feet. Also, some shoes that look charming in the picture on the website resemble decorated canoes when I receive them in my size.
11. The Hanna-Barbera cartoon classic ran for three halcyon seasons beginning on September 13, 1969, untrammeled by Scrappy-Doo, Scooby-Dum, or any of the other shark-jumping characters that would later besmirch the Scooby-Doo franchise.