In March 2023, Michael Humphery-Smith was jailed for two and a half years having been found guilty at Canterbury Crown Court of siphoning off £43,000 worth of custom from the family-owned business run by his father, Nicholas.
Nicholas was said to be in “total shock” at being conned by his “best friend, partner and son,” after Michael, whilst acting as a Sales Manager for the firm, diverted payments away from the family’s collectibles and antiques business, Ancestors, by sending out fraudulent invoices under the name of a new business that he had purposefully set-up in opposition.
The issue here arose because of the inherent ‘trust’ that generally runs through most family business structures, something which, unfortunately, can make businesses vulnerable to exploitation or being taken advantage of.
With that in mind, what lessons can we learn from this case, and how can family businesses better protect themselves from the risks of misplaced familial loyalty?
How does fraud occur?
Successful family businesses thrive on mutual understanding and cooperation within their trusted inner circle. However, blind faith can make them susceptible to abuse, as appears to be the situation in the Humphery-Smith case. In order to maintain a healthy balance between trust and oversight, it is crucial for family offices and businesses to exercise caution and remain vigilant.
It doesn’t take an experienced or professional criminal mind to commit fraud, it’s often opportunistic or disenfranchised insiders wishing to take back control or seek compensation for feeling undervalued or overlooked.
Such fraudulent activity can take a number of forms. These include theft, which remains one of the oldest and most common practices, as well as conflicts of interest, where personal interests supersede business priorities.
Some fraudsters go so far as to dip into company funds for their own benefit, while others use elaborate schemes to target high-net-worth individuals investing in art and other luxury goods. T
The key takeaway is that fraud doesn’t happen overnight. There will be warning signs, such as extravagant lifestyles, overly close relationships with vendors and customers, internal pressure, and an unwillingness to share duties or relinquish control.
Steps to prevent fraud
In family businesses, trust is generally considered the foundation for success. This trust is built on the bonds of social, economic, and familial relationships, which creates an atmosphere of long-term commitment, often foregoing short-term personal gain.
However, too little trust can result in coordination and control issues that can undermine the business’s leadership. Conversely, too much trust can lead to lax financial controls and individuals taking advantage of their situation.
In every business, especially those that are family-run, policies and processes are essential to preventing instances of fraud occurring.
Active prevention is by far the best way to safeguard yourself against fraud. Investigating fraud and recovering stolen funds is an uphill task that drains your resources. Even when dealing with a family member, the chances of recovering your losses are slim – on average, companies recover less than 25% of fraud proceeds at significant costs.
There are numerous proactive actions that should form a crucial part of any governance framework to tackle and prevent fraud, and these can include;
- Fraud risk assessment: The key to minimising the threat of fraud is to anticipate that it could occur and plug any weak points in your operating systems which allow for it. It’s wise to conduct thorough stress-tests for all processes to expose potential vulnerabilities, allowing for effective risk management and the fortification of existing control measures against fraud.
- Code of conduct: Fraud can strike any office or business, regardless of close familial connections or long-standing relationships. It is crucial to establish robust codes of conduct and educate employees about them to prevent fraud. Consistent communication about the code of conduct, its contents, and the consequences of any breeches can be highly effective in preventing fraudulent activities.
- Whistleblowing: It is imperative for all organisations to establish a robust whistleblowing system that includes a reliable channel for reporting suspected fraud or misconduct. By establishing an independent and credible whistleblowing framework, employees are more likely to come forward with valuable information.
- IT: It’s vital to ensure that IT systems are appropriate for the size and complexity of the business. Advanced analytics and fraud detection tools can be used to identify the potential or occurrence of cyberattacks and asset theft. The trick is to keep these current. E-commerce has changed how we transact, thus it’s possible that current models will need to be modified to fit the new standard.
- Audits: Enlist experts to conduct audits of financial statements and investment structures, conducting complete fraud assessments utilising cutting-edge technology and analytics techniques. This should ensure compliance and documentation across all business locations, and identify any possible risks.
- Due diligence: Ensure that you take all necessary steps to mitigate the risks associated with making new appointments, both familial and otherwise, by implementing strict hiring policies. it is crucial to always exercise caution when hiring, particularly high-level executives who possess sensitive information and wield significant power. Undertaking rigorous background checks and reference verifications prior to hiring is essential.
Be mindful that the trust which might bind a family business together at the outset is likely to decrease with each subsequent generation that takes up the reigns of ownership, especially where the business evolves, often to a position far away from the founder’s initial vision.
There may be some individuals resistant to such business changes, and who will act uncharacteristically as a result, possibly even reverting to fraudulent activities as a reaction to any perceived wrongdoing. It could be that management changes within the family have seen a person take a role that they didn’t necessarily want, or for which they are underqualified, who then misguidedly resorts to negligent activities to cover for their mistakes or inadequacies.
It’s pertinent to highlight such possible eventualities and respond accordingly. This may mean other family members or even outside parties buying out the shares of such individuals, if this can be done without endangering the business’ financial health. In theory, this could prevent the festering of ill will, and deter instances where individuals feel they have little choice but to break trust in order to further their own interests.
Consequences
As difficult as it may be, families must uphold ethical professional standards and accountability, even when it involves one of their own. However, many businesses choose to save their fraudulent relative from public scandal and legal repercussions, opting instead forprivate mediation to resolve matters. Unfortunately, most perpetrators will be well aware of this tendency.
A well advised Family Business Agreement, with independently facilitated negotiations in the calm before any storm is even on the horizon, can help with scenario-planning, enabling you to set boundaries and expectations, agree in advance how you would navigate those choppy waters and outline the potential consequences of default.
And of course, if you uncover fraudulent activity within your family, the sooner you seek legal advice, the more successful the outcome is likely to be
