RSM Resources

Companies that are the victims of employee fraudrecover just 20 percent of their loss, on average. And 37 percent of firms recovernothing at all, according to a 2004 report from the Association of CertifiedFraud Examiners (ACFE).

"So, the best cost effective measure is toprevent it from happening," says RSM McGladrey’s Conni Ochs, a certifiedfraud examiner in St. Louis, Mo. "Fraud not only impacts the bottom lineof the organization financially, it can also severely affect other aspects ofthe business such as employee moral, competitive position in the marketplace,shareholder and lender confidence, and overall reputation and publicimage."

When preventive measures — background checks,internal controls, anonymous tip hotlines, and a strong ethical culture — don’tstop insiders from stealing, what should you do when you suspect an employee isstealing?

Risk management professionals recommend taking thefollowing steps, which are designed to protect the interests of the businesswithout creating undue threats to employee privacy:

Hold limited initial discussions. At this stage, when fraud is suspected but not proven,the best course of action is to review all issues with management of the areain question. This discussion should cover the alleged fraud, review itspotential scope and duration, and identify all employees who had both accessand opportunity to cause the loss. All parties in this conversation shouldagree to keep the discussion confidential, since leaks would most likely harmthe effectiveness of a follow-up investigation.

Begin with a narrow investigation. This approach limits initial interviews with only the poolof employees — at all levels — who were identified as having access andopportunity. The interview process should be handled by management outside ofthe affected business unit and kept confidential from the broader workforce. Ifthe initial inquiries point to a larger, more complex internal fraud thanoriginally suspected, risk management professionals suggest that it may be wiseto bring in a third-party CPA or certified fraud examiner to move theinvestigation forward.

Compare written statements with outsideaccounting documents. If the initialreview provides enough evidence to believe a fraud is underway, all identifiedemployees should be asked to produce written accounts of their activities andrecollections for the time period in question. Employees should be asked toproduce and sign these documents one at a time, preferably before a neutralwitness. These statements can then be reviewed against the original oralaccounts, as well as outside documents from the company’s banking or accountingfirms.

"Using outside data helps establish the fraudtrail and build a stronger case," says Ochs. "It allows the fraudexaminer to compare what has been recorded in the company’s accounting recordsto tangible evidence that has been processed or produced in some manner outsidethe company."

Conduct second interviews where priorstatements or documents don’t match. Thisstep allows the employers to isolate inconsistencies, while giving an employeethe opportunity to correct earlier statements or admit guilt. These interviewsshould also be done individually, and in front of neutral witnesses.

"Fraud examiners are always looking for the?smoking gun.’ Often it is found in a simple slip up in the perpetrator’sstory, an inconsistency with outside data, or merely an assertion of somethingproven to be simply implausible," says Ochs.

Take disciplinary action. Most frequently, termination of employment is the mostappropriate step to limit the prospect of future fraud loss. If an employerchooses that step, it should fully document the investigative process and becareful not to threaten future criminal or civil actions against the formeremployee.

The ACFE report noted that 88 percent of companiesthat reported cases of inside fraud had fired employees caught in a scheme.About 70 percent of those cases were later referred to law enforcement forcriminal prosecution.

Ochs cautions companies to consult legal counselat the outset of the investigation. "It is important for companies to takecareful and documented actions that are firmly within their right under theprevailing law when dealing with employee fraud. In addition to actualtermination, options may include placing the person on administrative leave,with or without pay, during the investigation."

As an example, consider the case of a treetrimming business, which fired an employee because he didn’t inform managementabout a co-worker’s theft of company property. However, in his union-mandateddischarge notice, the employee was told he was being fired for stealing. Whenthe case went to arbitration, the worker was reinstated, largely because theemployer failed to correct the reason for discharge.

As an alternative, some companies will place aworker on paid administrative leave during an investigation and recoveryprocess — an option some experts believe may improve the odds of recoveringstolen assets.

"Unfortunately, there are often no assets torecover," says Ochs. "Based on my experience, the stolen money wasgenerally used to support a flamboyant lifestyle, day trading, or a drug orgambling debt. In some cases, the money was used to help another familymember’s failing business, pay medical bills or pay off personal loans. But thecases in which assets with any value — such as houses, cars or boats — werefound were certainly in the minority."

By following these steps, you can do a better jobof protecting your company from the financial and legal issues that can arisein internal fraud investigations.