Employees embezzle billions of dollars a year dragging down the corporate bottom line. Here's how HR can help stem the losses.
Bill Carey won’t be retiring anytime soon. The president and owner of a small business in Wichita, Kan., got the first clue his retirement would be postponed when his trusted bookkeeper stepped out for the weekend in January 1999.
Checking to see if a bill had been paid, Carey discovered that the bookkeeper—a single mother who was like family to him—had written two company checks totaling $10,000 to pay her MasterCard and Visa bills. To cover her tracks, she had forged Carey’s signature and recorded the checks as payments to company suppliers.
When he confronted her, Carey says, she broke down, begged forgiveness and claimed it was the first time she’d ever done it.
But an FBI investigation revealed otherwise. In the end, she pleaded guilty to embezzling $250,000 over five years. Carey thinks the actual amount is closer to $500,000.
Carey’s retirement nest egg—one he hadspent 33 years accumulating—is now gone. And though his bookkeeper is paying the price—the court ordered her to spend 18 months in jail and to make full restitution—it’s unlikely that Carey will get all his money back. So far he’s recovered only about $1,000, forcing him, at 56, to put his retirement on hold indefinitely.
“It rips your guts out,” he says. “People have told me over the years, ‘Bill, you’ve got to trust, you’ve got to delegate.’ ” But, he says, “When you let your guard down, you lose. When it comes to money, people change.”
Lots of Leaky Pockets
Initially, Carey was embarrassed that he had been duped. But once his story hit the news, he found plenty of company. “People would stop me on the street and tell me their stories,” he recalls. “Almost everyone had it happen to them or knew of it happening in their office.”
Embezzlement, it turns out, knows no bounds. All types of firms have been victimized—small, medium and large businesses, nonprofit and for-profit companies alike.
“I expect fraud to be present in any organization—the only question is how big it is,” says Toby Bishop, president and CEO of the Austin, Texas-based Association of Certified Fraud Examiners (ACFE), whose 24,000 members investigate workplace fraud.
“It’s corporate America’s dirty little secret,” adds Martin Biegelman, a certified fraud examiner (CFE) who has made more than 800 fraud arrests in a 30-year career and currently manages a fraud unit for a Fortune 100 company. “The question is not will I be victimized, it’s when and for how much?”
According to the ACFE’s Report to the Nation 2002, sticky-fingered employees siphon off 6 percent of corporate revenues—which amounts to $6 billion each year, or $4,500 for every full-time worker in the United States.
ACFE attributes 85.7 percent of total losses to employee misappropriation of assets, which has jumped 4.6 percent since 1996. Of that, experts estimate 90 percent is embezzlement. The median loss per incident is $80,000, up $15,000 since 1996.
The costs of embezzlement go beyond money, however. Side effects for victimized companies include diversion of management focus and lowered employee morale. What’s more, for employers that rely on a corporate reputation for fiscal honesty—such as banks, charities and financial institutions—the loss of that reputation can be devastating to the business.
The Fraud Triangle
To reduce embezzlement losses, experts say employers must start by examining the three factors that lead employees to pocket corporate dollars. Those factors form “the fraud triangle,” which is expressed by the following equation: motivation + opportunity + rationalization = embezzlement.
Motivation refers to financial pressure on employees—such as medical bills, college tuition payments, gambling debts, lifestyle changes, etc.—with additional stress if the employee feels he can’t share his predicament with others.
Opportunity means an employee is in a position to embezzle. That can translate to access to cash, goods or other company assets—and controls that are inadequate or non-existent.
Rationalization is the personal justification employees use to convince themselves to commit embezzlement. “It’s just a loan,” they might tell themselves. Other rationalizations include: I’m underpaid compared to others; I’m entitled, the boss is getting paid too much; others are doing it, etc.
The good news is that employers can slash the potential for embezzlement if they eliminate or reduce any one of the three elements.
The bad news is that for one of the factors—motivation—employers are essentially powerless. After all, you can’t control your employees’ spending habits or lifestyle. And employees themselves may not be in the position to control unexpected costs, such as medical bills.
Fortunately, HR professionals are uniquely positioned to significantly reduce both opportunity and rationalization by:
Thoroughly screening job applicants and preventing likely embezzlers from being in a position to pocket corporate funds.
Improving workplace culture to ensure that employees value ethical behavior and dont have cause to exact a financial pound of flesh.
Screening Job Applicants
The first order of business for HR is to keep embezzlers out of the workplace through applicant screening. But identifying would-be embezzlers or even past embezzlers is difficult.
That’s because when individuals are apprehended, companies rarely pursue formal disciplinary or legal action. In many cases, employees who are caught with their hands in the till are quietly fired and dumped back into the employment pool, only to emerge as someone else’s problem.
“Often, the business owners just want to get the bad guy out of there and work on their internal controls,” explains David Wells, CFE, manager of Litigation Services Group at Plante and Moran PLLC in Southfield, Mich.
It’s also worth noting that a significant number of embezzlers are first-time offenders, according to experts, which means they have no previous history of misconduct that employers can spot in the application stage.
Therefore, screening out embezzlement-prone applicants can be tricky, even for seasoned HR professionals. But that doesn’t mean HR should give up and hope for the best. Here are some of the techniques experts recommend for spotting potential bad hires before they can get in position to siphon off corporate funds. (For more information on weeding out dishonest applicants, see "Spotting Lies.")
Encourage self selection. Les Rosen, attorney and president of Employment Screening Resources in Novato, Calif., says that by asking the following questions, HR professionals can encourage shady applicants to withdraw voluntarily.
We do background checks on all finalists. Do you have any concerns about that?
We do a criminal check on all finalists. Do you have any concerns about that?
We contact all past employers. What do you think they will say? Will your past employer tell us about any negative job-related issues?
Can you explain where you were during these gaps in your resume?
“Most employers won’t tell you about illegal conduct, but it’s still worth checking with them to confirm the candidate’s start date, end date and title,” says Rosen. Discrepancies between the applicant’s and former employers’ accounts may raise warning flags.
To get even more information, ask applicants’ references for the names of other people who know the candidate’s work.
Conduct background checks. “Recently, a teller in Birmingham stole over $400,000 in travelers’ checks,” says Ralph Summerford, CFE, a partner with Dixon Odom PLLC in Birmingham, Ala. “She had a rap sheet eight pages long, but they still hired her. How could they not have known?”
Mark Williamson, director of personnel services at Washington Hospital in Fremont, Calif., relies on Rosen’s company for background investigations. Last year, of the 220 hires he made, 10 failed the screening.
Still, Rosen cautions that while background checks are useful, they’re never 100 percent reliable. “There is no one database you can go to where an employer can instantly find out the good guy, bad guy,” he says. “You have to get the information the hard way—go down and look it up in counties that appear most relevant.” But some records might be missed because there may be literally thousands of jurisdictions to check.
Use integrity tests. Ken Siegel, CEO of The Impact Group, a Los Angeles-based psychological consultancy to global business, recommends complementing background checks with integrity testing. He says few companies do it because they don’t want to risk insulting or losing potential candidates, even at the lowest levels.
“Big mistake,” he says. “No psychological instrument is 100 percent predicative, but they are about 65 percent, which is a very good indicator. HR should encourage senior-level executives who are highly resistant to psychological profiling to shut up and do it.”
The Culture Connection
While applicant screening is a good method for eliminating the most rotten apples in the barrel, the vast majority of good apples can turn bad, given the right circumstances (i.e., motivation, opportunity and rationalization), say experts.
Roughly 95 percent of the population is capable of embezzlement under certain circumstances, claims William Jennings, CFE, principal of Kroll Inc. in Chicago. And, he says, only 15 percent are the kind of people you might be able to identify in pre-employment screening—meaning they are “amoral,” driven by self-interest and will enrich themselves whenever possible, no matter what. Of the remaining 80 percent, good screening should eliminate those who may have done something fraudulent as well.
So, even if you weed out that 15 percent and some of the 80 percent through effective screening practices, you’re left with a large percentage of workers who can be tempted and, if conditions are right, will pocket the money.
“Given opportunities, all of us are vulnerable to being persuaded that [embezzlement] is the solution to our problems,” Bishop explains. “These folks are good people gone bad. They don’t have horns or fangs … they sit down the hallway in accounting or in HR.” (For more information on embezzlement within the HR function, see the sidebar “HR Gets Bitten”)
The key then is to create a culture where existing good employees don’t have a reason to turn bad. Experts say there’s a direct correlation between an organization’s culture and the chances people will embezzle—or will look away while others do it.
For example, ACFE has found that the primary method for detecting fraud is through anonymous employee tips, and it estimates that fraud can be cut in half if employers set up effective hotlines for reporting abuses.
W. Michael Hoffman, executive director of the Center for Business Ethics at Bentley College in Waltham, Mass., advocates going beyond providing a hotline for potential whistleblowers. “You need to have a way inside the company where a person can call and talk to an HR specialist or ethics person directly to get help with ethical dilemmas.”
But employees won’t take advantage of such reporting mechanisms if the corporate culture does not value honesty and ethical business dealings, suggests a 2000 survey by accounting firm KPMG LLP. In that survey, 76 percent of workers reported observing illegal or unethical conduct at their jobs during the previous year. Shockingly, 17 percent said they had observed senior management engaging in theft or embezzlement.
Even worse, Siegel cites a recent survey of Fortune 100 companies in which 500 CEOs were asked how honest they were. While 95 percent said they were people of integrity, 94 percent of their subordinates said their bosses had asked them to lie.
Little wonder, then, that when asked why they didn’t report illegal or unethical conduct, 73 percent of employees cited “cynicism/low morale/indifference”; 53 percent feared retaliation for coming forward; and 61 percent believed senior management would fail to administer discipline if alerted to the conduct.
That belief that senior managers will not discipline offenders is not unfounded. For example, 400 CEOs surveyed this year say they have reported fraudulent activity only 20 percent of the time, according to Fraud, the Unmanaged Risk by accounting firm Ernst and Young.
In some cases, employers actually keep embezzlers on the payroll, says Bill Ritter Jr., district attorney for the City of Denver. “In many situations the [embezzling] employee has a close relationship with the owners,” says Ritter. Because of the relationship, the embezzler may view his actions as “borrowing” money instead of stealing, or he may be jealous of his friend’s success. When it’s a close relationship, the victim may not “report it because even after what’s been done to them, they still feel loyalty to the embezzler—friendship, kinship,” he adds.
While such personal loyalty may be admirable in some settings, it hardly sends a positive message to employees about company integrity. And that, in turn, could help other workers rationalize their decisions to embezzle. (For an example of how a perceived lack of corporate integrity can prompt embezzlement, see "The Fraud Triangle at Work.")
Other organizations either fail to address embezzlement head on or try to cover it up, again sending a message that dealing with ethical problems is not important.
For example, a quarter of the time, employers oust an embezzler but do nothing to prevent similar behavior from other employees, estimates Summerford.
In other situations, the company is intent only on sweeping the issue under the rug. “The company weighs the negative publicity, legal fees and opportunity costs, and decides it’s better to eat the loss and move ahead,” says Kristina Maritczak, an attorney at Miller Canfield in Detroit. “But it sends a bad message to your workforce. People have to know about it; some will have suspicions. They’ll be watching to see how you handle it.”
Since actions speak louder than words, executives who fail to handle such situations effectively may undermine employee confidence in their integrity. Given the not-so-distant spate of corporate scandals, executives probably can’t afford any further risks to their credibility.
Holding People Accountable
If you’re in an environment grounded in integrity, where employees feel empowered, with sound controls and a good feedback loop to report illegal conduct, the opportunity for fraud and embezzlement is low, says David Childers, president and CEO of Ethicspoint Inc., a Vancouver, Wash.-based firm that provides web-based fraud reporting systems.
How can management build integrity into the culture? “Set forth the core values of the organization and find appropriate ways to communicate them,” says Hoffman. “You have to get buy-in that the values are worthwhile.”
Having management set the tone by demanding and engaging in ethical business behavior is key. One way to set that tone is to start with an ethics/fraud policy that each employee sees, reads, signs and is asked to reaffirm periodically.
At companies like Sequa Corp., a manufacturer of products in aerospace, propulsion, metal coatings and specialty chemicals in Hackensack, N.J., personal responsibility is emphasized. For example, HR employees sign confidentiality statements agreeing that if they misuse information, they can be terminated.
In addition, Sequa includes integrity as a key competency in its 360-degree feedback program. “If someone needs improvement in the area of integrity, we sit with them and develop an action plan,” says Jesse Battino, vice president of HR and member of the Board of Directors of the Ethics Officers Association. “The message you want to convey is ‘Even though you may want to do something, don’t risk it because it’s not acceptable here.’ ”
Sequa also conducts an ethics training program that runs about three hours for exempt personnel and two hours for clerical. “We give them role-playing situations, [ethical] scenarios and use breakout groups and team discussions,” says Battino. “The easy answers to ethical questions are in the black and white. It’s the gray areas where the majority of problems occur—and we try to address those.”
But Sequa’s training may be the exception, rather than the rule. Bradley J. Preber, CFE, director of litigation and valuation services at Meyners & Company LLC in Albuquerque, N.M., says that even though policies were in place in the more than 100 investigations he’s conducted, training was rare. “I’ve found no training in the victim organization other than an e-mail reminder that unethical behavior is bad.”
Despite your best efforts to eliminate rationalization and to encourage ethical behavior, some employees are still likely to succumb to the temptation of collecting easy money. So, be wary.
In many cases, there are telltale signs that an employee is ready to cross over from good to bad. Those signs might include sudden debts or family pressures, illness, changes in behavior and demeanor.
“If you hear something about an employee—and HR usually is connected to the rumor mill—don’t ignore it,” advises Maritczak. “If you know the employee has a gambling problem, perhaps you should be more concerned about monitoring her a little more closely.”
In a recent case involving an HR executive, Maritczak says the hints were everywhere. “She was a gambler in financially dire straits; HR knew she was a high roller, but trusted her and let it slide.” (For tips on preventing embezzlement within the HR department, see "Minimizing Moral Hazards in HR.")
A Last Check
Given the staggering potential for losses, it pays to understand the fraud triangle and to take steps to reduce the factors that contribute to embezzlement.
It also pays to invest in a risk assessment early in the game. But few organizations are doing it.
“It’s like going to a doctor for a physical,” says Preber. “I know the risks of avoiding it, but I can’t find the time. Or, I’d rather not know if something is wrong. Costs to small businesses for an initial risk assessment can be as low as $5,000, a really detailed one about $25,000.
“These expenditures,” says Preber, “will pay for themselves.”
Just ask Bill Carey back in Wichita. A risk assessment might have suggested an easy fiscal control that could have saved his retirement money. Carey’s bookkeeper had sole responsibility for writing checks and sole access to the account statements. Had Carey arranged for the bank to send his account statement to his home instead of the office, he probably would have discovered the irregularities in a heartbeat.
You’d better believe he’s doing it now.
Robert J. Grossman, a contributing editor of HR Magazine , is a lawyer and a professor of management studies at Marist College in Poughkeepsie, N.Y.
As one HR director in Oakland County, Mich., recently discovered, HR is not immune to embezzlement. Reviewing his budget report, he found that the annual allocation for the company newsletter had been fully depleted in only one quarter.
Digging deeper, he realized he was paying phony invoices submitted by the HR employee in charge.
“She was in dire straits financially and took about $80,000 in one quarter,” says Kristina Maritczak, an attorney at Miller Canfield in Detroit and a former prosecutor who’s handled hundreds of these cases. “It was a lot of money for this size company.”
Types of Embezzlement
Most embezzlement schemes fall into one of five categories:
Billing, where the fraudster submits invoices for fictitious goods or services, inflated invoices or invoices for personal purchases.
Payroll, where the fraudster makes false claims for compensation by creating ghost employees or awarding unauthorized salary increases or bonuses.
Expense reimbursement, where an employee makes a claim for reimbursement of fictitious or inflated business expenses.
Check tampering, where the fraudster forges or alters an employer’s checks, or steals a check the employer has issued to someone else.
Cash register disbursement, where the employee makes false entries to conceal the fraudulent removal of currency.
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