Legal Update - February - 2004
Preventing Employee Theft and Fraud

Introduction

Theft of money, software or office supplies. Theft of petty cash or postage. Unauthorized use of telephones or company vehicles. Fraudulent expense reports or injury claims. Falsified overtime. Kickback schemes. These are just a few examples of employee theft and fraud that are costing U.S. businesses an estimated 50 billion dollars annually, according to the U.S. Department of Commerce. If, like many business owners, you believe that it can’t happen to you, consider this data which shows otherwise:

• According to the U.S. Department of Commerce, up to 85% of all theft and fraud in U.S. businesses comes from employees; not outsiders.
• The U.S. Chamber of Commerce reports that an estimated 75% of employees steal at least once. Half of these employees steal again and again.
• The Small Business Administration reports that 60% of small business failures are a result of employee theft.

Effects of Fraud

The costs of employee theft and fraud go beyond the potentially devastating financial impact from the loss of money or property. Employers can face potential civil and even criminal exposure. Workplace crime often affects employee morale and may create bad publicity. Undesirable effects can extend to third parties such as customers, patrons, suppliers, taxpayers and even the community at large.

Why Employees Often Don’t Report Theft and Fraud

Employers are often the last to know of illegal activity. Fellow employees sometimes have known or suspected it for some time but have not mentioned or reported it. Why? Often employees do not want to believe that it is happening, or they assume innocence and then fail to abandon their presumption when grounds for suspicion grow. Other factors include fear of getting involved, fear of retribution, or fear that somehow they will be blamed for the problem. A few employees may think that the misconduct is simply not a big deal.

Preventing Theft and Fraud

Investigating and prosecuting theft and fraud are exponentially more expensive than preventing them. Businesses should therefore focus on prevention. There are twelve action steps you can take to prevent theft and fraud:

1. Develop a Proactive Plan. The plan should include three major elements: deterrence, early detection, and effective handling of misconduct. Put yourself in the shoes of a thief and think through what you could do to steal from or defraud your organization. Then consider how you would cover your tracks so that you would not get caught. From there, work backwards to develop your plan.
2. Create a Culture of Honesty and Ethics. The organization’s leaders, from board members to management, must declare a commitment to ethical performance and lead by example. Expecting employees to behave one way while management behaves another is the surest way to undermine an ethical culture in an organization. Strictly enforce policies across the board.
3. Create a Positive Working Environment. Recognize employees for their good work and congratulate them on their successes. Provide opportunities for employee self-improvement and advancement. Empower employees to have a say in the direction of their careers. Don’t underpay employees.
4. Craft and Publish a Written Policy. A written policy statement against theft and fraud sets the tone for the organization. It lets employees know what kind of behavior is expected of them and advises them of the potential consequences for failure to meet expectations. It conveys to employees that you value ethical behavior. The policy should always include an employee duty to cooperate in the prevention and investigation of theft and fraud. Have employees sign an acknowledgment that they have read, understand, and will observe the policy.
5. Train Managers. Train managers to understand their responsibilities and your zero-tolerance approach to theft and fraud. Instruct them on ways to prevent and discover theft and fraud, highlighting the warning signs of each. Teach managers "red flags" such as vendors who only use P.O. boxes, payments that are out of the ordinary, or changes in an employee’s lifestyle or spending habits. Have managers reconcile reports and spot check to make sure that merchandise has actually been delivered. Educate managers about the importance of employees following computer security procedures and safeguarding passwords.
6. Evaluate Controls. Evaluate your internal financial controls and procedures for matters such as purchasing, accounts payable, cash deposits, petty cash, expenses accounts, and receiving. Make sure that you separate accounting responsibilities so that no one controls all aspects of a financial area. Have different employees place and approve purchases. Insist that employees take their vacations; employees who are up to something often won’t be out of the office for extended periods of time for fear that their schemes may be exposed.
7. Review Building Security. Limit access to your facilities. Change locks from time to time so that former employees who may have copied their keys cannot obtain access. Consider installing video surveillance in areas that are particularly vulnerable to theft. The mere presence of the camera may be enough to deter theft.
8. Effective Screening Procedures. Have effective hiring and screening procedures both for employees and for vendors, including comprehensive pre-employment background checks and reference checks. Consider integrity testing, where appropriate.
9. Hot Line. Establish an anonymous hot line so that employees may report theft and fraud. The Association of Certified Fraud Examiners estimates that hot lines cut employer losses by 50%.
10. Audit. Have a third-party audit your books records periodically. Audits make it more difficult for an embezzler to cover up his or her misconduct. For maximum impact, have the audit be unscheduled and at a different time each year.
11. Insurance. Be sure to have appropriate insurance coverage that covers losses from theft and fraud. Understand the reporting requirements of your policy, and report claims without delay. Consider bonding some of your key financial employees in order to protect your organization.
12. Investigate. Investigate all theft, fraud, and other employee misconduct without compromise. Do not hesitate to obtain professional assistance. There are times when it is advisable to bring in well-trained security personnel, undercover investigators, forensic accountants, or lawyers. Under appropriate circumstances, terminate employees and seek their prosecution.

Funkhouser Vegosen Liebman & Dunn Ltd. publishes updates on legal issues and summaries of legal topics for its clients and friends solely for general informational purposes. They do not constitute legal advice, nor are they intended as a substitute for obtaining legal or other professional advice based upon specific factual circumstances or issues. We welcome comments or questions. If we can be of assistance, please call or write: Jon Vegosen, 312.701.6860, , or your regular FVLD contact.

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