Lapping Scheme

The Lapping Scheme: An Insider's Guide to Understanding and Preventing Financial Fraud

Financial fraud is a pervasive issue that can have devastating consequences for individuals, businesses, and even entire economies. One common form of financial fraud is the lapping scheme, a deceptive practice that involves the misappropriation of funds within an organization. In this article, we will delve into the intricacies of the lapping scheme, explore real-life examples, and discuss effective measures to prevent and detect this type of fraud.

What is a Lapping Scheme?

A lapping scheme is a fraudulent activity where an employee or group of employees divert incoming payments from customers or clients for personal gain. The scheme typically involves a series of transactions that manipulate the accounting records to conceal the misappropriation of funds. The term “lapping” refers to the process of overlapping payments to cover up the initial diversion.

Let's consider a hypothetical example to illustrate how a lapping scheme works. Imagine a company that receives payments from its customers through checks. The employee responsible for processing these payments decides to pocket the first check received. To avoid detection, the employee applies the subsequent payment received from another customer to the account of the first customer. This process continues, with each subsequent payment being used to cover up the previous diversion. As a result, the company's accounting records appear to be in order, while the employee benefits from the stolen funds.

Real-Life Examples of Lapping Schemes

Lapping schemes have been uncovered in various industries and organizations around the world. One notable case is the infamous “Nick Leeson” incident that led to the collapse of Barings Bank in 1995. Leeson, a trader at Barings Bank, engaged in unauthorized speculative trading and concealed his losses through a lapping scheme. By diverting funds and manipulating the accounting records, Leeson managed to hide his activities until the losses became too significant to conceal, ultimately resulting in the bank's demise.

Another example involves the case of a trusted employee at a non-profit organization who embezzled funds through a lapping scheme. Over the course of several years, the employee manipulated the organization's accounting system to divert donations and grants for personal use. The scheme went undetected until an internal audit uncovered irregularities in the financial records.

Red Flags and Detection

Preventing and detecting lapping schemes requires a combination of robust internal controls, vigilant oversight, and a keen eye for potential red flags. Here are some warning signs that may indicate the presence of a lapping scheme:

• Unexplained discrepancies between accounts receivable and bank deposits
• Customers reporting missing or misapplied payments
• Unusual patterns in payment application or allocation
• Employee exhibiting a lifestyle inconsistent with their salary
• Employee displaying signs of financial distress
• Employee refusing to take vacations or allow others to perform their duties

While these red flags do not necessarily indicate the presence of a lapping scheme, they should prompt further investigation and scrutiny. Implementing the following measures can help organizations detect and prevent lapping schemes:

• Segregation of duties: Assign different individuals to handle payment processing, record-keeping, and reconciliation to create a system of checks and balances.
• Regular audits: Conduct periodic audits of financial records to identify any irregularities or discrepancies.
• Rotation of duties: Encourage employees to take vacations and cross-train others to perform their duties, making it difficult for a single individual to maintain control over the entire process.
• Whistleblower hotline: Establish a confidential reporting mechanism to encourage employees to report suspicious activities without fear of retaliation.
• Employee training: Educate employees about the risks of fraud, the importance of ethical behavior, and the consequences of engaging in fraudulent activities.

Conclusion

The lapping scheme is a deceptive practice that can cause significant financial harm to organizations. By understanding the mechanics of this fraud scheme and implementing effective preventive measures, businesses can safeguard their assets and maintain the trust of their stakeholders. Vigilance, robust internal controls, and a culture of integrity are essential in combating financial fraud. By staying informed and proactive, organizations can minimize the risk of falling victim to a lapping scheme and protect their financial well-being.