Payroll fraud can take many forms, but one of the most common involves “phantom employees.” Whether it’s a former employee who was never removed from the system, a fictitious worker created by a fraudster or someone added through collusion, the result is the same: Company funds are diverted to someone who isn’t entitled to them. Our payroll service providers offer these proactive ideas to help you identify suspicious activity, reduce risk and safeguard company assets.
Phantom Employees, Explained
While it may be easier to hide payroll scams at organizations with multiple locations and offsite payroll departments, small businesses can be victims, too. All it takes is a dishonest employee who has access to the payroll system. These scams require three simple steps:
- Put the phantom on the payroll. This can be as simple as adding a fictitious name to the payroll system or using the name of an employee who’s left the company. If the criminal doesn’t have access to the system, they might have to forge documents to create a fictitious account.
- Create wage records. If the phantom employee is paid a regular salary, it may not be necessary to fabricate time sheets, logins and other records. Routine payments at regular intervals work to the criminal’s advantage. However, the perpetrator may have to falsify records for hourly phantom employees.
- Collect the cash. Converting paychecks or direct deposits to cash may require more subterfuge than direct cash payments. For example, an employee may set up a falsified bank account for direct deposits. Check cashing is riskier and may lead to apprehension. But once the crook pockets the cash, the fraud trail goes cold.
Payroll Warning Signs
Potential red flags that signal a phantom employee could be haunting the company’s payroll system include:
- Missing or falsified employee files.
- Employees with overly vague (or no) job titles or descriptions.
- Multiple employees with the same mailing address or bank accounts for payroll deposits.
- Employees who don’t sign up for health care or retirement benefits or who fail to take paid time off.
- Employees who list a post office box as their mailing address.
Under normal conditions, a sudden unexplained spike in employee turnover also could forewarn of phantom employees. However, employee departures can result from many legitimate factors, such as changing labor market conditions, organizational restructuring or workforce preferences. Before initiating a fraud investigation, companies with elevated turnover should first evaluate potential human resources and operational causes.
Protecting Payroll from Phantom Employee Fraud
Strong internal controls like managerial reviews are a company’s first line of defense against phantom employees. Different supervisors might be assigned to approve payments to employees on a random basis, making it more difficult to hide a phantom employee. Supervisors should also be trained on how to scan payroll records for red flags like suspicious names and multiple employees with the same mailing address.
The payroll system also needs to be equipped with checks and balances. For instance, the head of a department should be required to verify any employees who are added or removed from the payroll system. Moreover, payroll records can be coordinated with personnel reviews. If an employee doesn’t show up for a review, further investigation is warranted.
Monitoring Evolving Risks
Phantom employee schemes remain a threat as remote and hybrid work arrangements, digital payroll systems and increasingly sophisticated fraud tactics can make payroll irregularities harder to detect. Look to our Michigan-based payroll service providers and national accounting pros to help you strengthen internal controls, monitor payroll risks and implement safeguards to protect your business from payroll fraud.
