Employee crime: the cost and some control measures.

Employee crime has gained much attention in the media in the last few years. Is it occurring more or is it just being reported more? The answer seems to be both. United States business owners and managers have long recognized that employee crime is a huge problem. Unfortunately, its dimensions

According to Neil Snyder, a University of Virginia business professor and co-author of Reducing Employee Theft (Quorum Books), losses just from employee theft have reached an estimated $120 billion a year.(1) And this does not include other employee-related crimes such as fraudulent reporting of financial statements.

Kenneth Weiss, a security consultant based in Massachusetts, believes about 30% of American workers plan to steal from their employers, another 30% are normally good employees but may give in to temptation occasionally, and the remaining 40% are basically honest.(2) These figures seem to generally agree with some other estimates.

According to a National Retail Federation study released last year, employee theft made up approximately 38% of all "shrinkage." roughly the same percentage as shoplifting.(3)

FDIC investigators report that one-third of all bank failures in the late 1980's were primarily caused by internal fraud.(4)

Justice Department statistics show that federal convictions were obtained for 10.733 while-collar criminals in 1985, an 18% increase from 1980.(5)

With all of this reported dishonesty, it seems employers would be ready to raise the white flag and surrender. However, because of the recent recession, businesses are focusing on employee crime more than ever. A company generally can expect to lose 1% to 2% of its annual sales to crime, most of which is committed by insiders.(6) For a company the size of IBM, this amount can exceed $500 million a year. Richard Hollinger, a University of Florida sociologist, says this "can mean the difference between viability and failure" for many companies.(7)

With such high dollar losses at stake, it is not surprising that companies are beginning to take employee crime so seriously. Employers are beginning to realize that what have been called costs of security are actually investments in their businesses.

Types of Employee Crime

Employees have always committed crimes at the workplace. However, as technology has advanced, so too have opportunities for employees to steal. Employees still commit the more "blue-collar" type offenses, but technology has enabled them to defraud companies in previously unheard of ways. Some typical employee crimes follow.

Blue-Collar Crimes

When people talk of employee theft, they typically are referring to the so-called blue-collar crimes. These include stealing office supplies, parts and inventory for personal use or resale, making long-distance personal telephone calls on company lines, and falsifying time cards. Although these activities have been historically simple, even they are becoming more sophisticated. For example, service department employees of several companies have been caught submitting false warranty claims and reselling the merchandise and parts that manufacturers thought were being destroyed.(8) With this increased sophistication, it is becoming more difficult to distinguish the blue-collar criminals from the white-collar criminals.

White-Collar Crimes

White-collar crimes by employees are by far the most costly to the employer and are often the most difficult to detect and prevent. Some of these crimes include using the company's computer for personal business (sometimes running entire operations on the company's time and with a free computer),(9) embezzlement, and falsifying financial statements.

With the advent of the computer and other technology, employees are finding more innovative ways to steal. Employees are using modern laser printers and copiers to forge documents and are employing computers to switch funds electronically from company accounts to personal accounts.(10)

Of course, employees still commit the all-time favorite crime of voiding sales and pocketing the cash.(11) Another crime that is particularly difficult to detect is accepting kickbacks from unscrupulous vendors.(12)

This is only the tip of the iceberg. Private investigator Ed Pankau, who is helping the government sort out the Savings and Loan crisis (which itself included enough crime to fill this essay), believes that the next big scandals will be in banks, insurance companies and pension funds.(13)

Ramifications of Employee Crime: Who Pays for it?

It is often said that when people commit crimes, we are all affected. This is particularly true of employee crime because it is so widespread. The consequences to various stakeholders are discussed below:

Employees

Employees who are caught stealing from employers are probably the most adversely affected by the prosecution and punishment of all parties (and deservedly so). With recent changes in the Federal Sentencing Guidelines, employees convicted of federal crimes are subject to mandatory prison sentences and fines(14) In the past, companies often tended to simply fire a guilty employee to avoid public embarrassment. However, as cost consciousness increases, companies are beginning to pursue these criminals with greater enthusiasm and frequency. It is not unusual for a company to press for convictions even in minor cases as a deterrent to future crime.(15)

Employees who get involved in crime face a higher incidence of divorce, suicide, depression, and innumerable other problems. Further, they are often required to make restitution payments which could last a lifetime.(16)

Perhaps the most enduring consequence is the near-impossible task of finding comparable future employment. Companies generally do not hire convicted felons for positions of responsibility.

Even guilty employees who are never caught will face some of these same costs. It is very stressful to lead a life of deception. These employees are also more susceptible to divorce, ulcers, hair-loss, and other stress-related afflictions. Loss of pride and self-respect are common as well.

Employers

Employers who are victims of employee crime suffer many negative ramifications. Of course, there is the obvious monetary loss, which averages 1% to 2% of sales.(17) Employers also face public humiliation when employee theft is revealed. This can damage a company's reputation with stockholders and investors who view this as a weakness. Because of this, businesses have historically not aggressively pursued employee criminals due to fear of adverse publicity.

A growing number of companies have been so adversely affected by employee crime that failure resulted. As mentioned earlier, internal fraud was primarily responsible for one-third of all bank closures in the late 1980's, and the highly-publicized Savings and Loan debacle was largely caused by the fraudulent business practices of managers.(18)

Companies might also be adversely affected by the aforementioned new Federal Sentencing Guidelines. A little known aspect is that an employer can be held responsible for crimes of its employees.(19) For example, under the Foreign Corrupt Practices Act, the company is responsible for establishing and maintaining a system of internal control such as to prevent such employee crime. The company can be held liable if such a system is deficient. Companies found liable under this provision could face fines in the millions of dollars.

Other Affected Stakeholders

Ultimately, consumers pay for employee crime. It has been said that every American family will pay the equivalent of a new automobile over the next five to ten years as a result of the Savings and Loan scandal.(20) Of course, all costs of employee theft, such as retail operations, are passed along to the public at-large.

Insurance companies are also affected by employee crime. Many companies are covered against any fraud their employees might commit. However, insurance companies are becoming more discerning in paying claims. Again, these insurance costs are passed along to consumers.

Stockholders and investors are adversely affected whenever employees steal from companies. When employees steal it hurts a business' profit, which has an unfavorable effect on stock values and dividend payments. Adverse publicity resulting from employee fraud can negatively affect a company, also damaging its stock value.

Motivation: Why Do They Do It?

Mr. X spent ten months in a federal prison in Morgantown, West Virginia, after pleading guilty to conspiracy in a parts-stealing case brought by his former employer. Why did he do it?

Mr. X: "At the time, I really didn't feel I was stealing. I felt the company owed it to me. My boss had promised me a raise a year earlier, and I felt I was working harder than some better paid employees. I realize now I never should have taken matters into my own hands. It wasn't worth it. I paid a huge price. The worst part is, although I know I learned my lesson and will never steal again, convincing prospective employers is another story. I did manage to find a fairly decent job, but it's nothing like the one I lost. I just thank God my wife stuck by me. I lost many friends over this. Even close relationships have suffered, such as with my parents. This incident will be a blemish on my record for the rest of my life."(21)

Mr. X's sentiment seems to be a common theme among employees who have been caught committing crimes at work. There is a real sense that it is not stealing if it is from an employer. There is often an "everybody does it" type mentality. Sometimes employees who know better succumb to peer pressure.

Another common sentiment is employees who convince themselves they were not really stealing - they were only borrowing and intended to pay it back but got in over their heads.(22)

Incentive and Opportunity Many experts believe that most workplace crimes are not committed by evil people seeking to destroy their companies. Generally they occur because of these two factors: incentive and opportunity.(23)

Some common examples of incentive include:

* Pressure to meet unrealistic performance goals, especially for short-term results (this contributes heavily to the falsification of financial statement data);

* Performance-dependent bonuses;

* Peer pressure;

* High stress created by financial needs. In most cases there is some heavy debt to pay off, usually gambling, drugs, or alimony.(24)

Some common opportunities include:

* Nonexistent or ineffective internal controls;

* Decentralized organizational structure which leaves upper management unaware of many actions taken at lower levels;

* Weak or no internal audit committees;

* Ineffective boards of directors;

* Disciplinary actions that are weak or unpublicized and therefore not valuable as deterrents.

A corporate culture that allows one or more of these incentives to combine with one or more of the opportunities is creating an atmosphere that almost asks for employee crime to occur. Unfortunately, with the recent trend toward downsizing, some companies are actually dedicating less resources than ever to combat this problem.(25)

Other Motivating Factors Some motivating factors are beyond the immediate control of companies. For example, many hold that the upswing in white-collar crime is largely due to the deregulation of the financial industry.(26) Until companies learn to police themselves in this situation, this type of crime will continue to escalate.

Many experts consider greed the biggest motivator for employee crime.(27) Employees motivated by greed would likely commit crimes given any opportunity. This means companies must take greater measures to ensure elimination of all opportunities.

Detection

Detection of employee crime is perhaps the most complicated of all management tasks. Most managers are experts in their fields, but normally they know very little about police work. Employees involved in crimes often have the advantage because they are adept not only at the legitimate aspects of their jobs, but have also had time to formulate a plan to steal which integrates itself into the company's overall scheme. These employees also have the advantage of knowing to look over their shoulders since they are the perpetrators. Often, employee crime goes unpunished because the guilty party backs off as he or she realizes that management is becoming suspicious. This is especially true of computer crimes. Many computer crimes are so difficult to detect that criminals must be caught in the act. In one case, someone at a large bank programmed its computer to transfer 12 to 25 cents periodically from hundreds of accounts to a bogus account. This amounted to tens of thousands of dollars over a one year period. By the time the bank got suspicious, the person had stopped and was never apprehended. Because of the circumstances, it almost certainly had to be an employee.(28)

Another problem with detection is that managers often are unwilling to assume the position of "office policeman." Part of a manager's responsibility is to foster an environment of mutual loyalty, and this is difficult to achieve when employees feel they are being spied upon.

Because of these management/employee relations issues, many companies rely on third party methods of detection. The most common are independent auditors, private investigators, and a somewhat new type of detection, the Certified Fraud Examiner (CFE).

Independent Auditors One of the biggest problems with using outside auditors for fraud detection is that it is beyond their scope. While it is true that the tests performed by independent auditors can uncover evidence of fraud, it is not an auditor's responsibility to detect employee fraud. The auditor's responsibility is to gather enough evidence to support management's assertion that financial statements are not materially misstated. The key here is materiality. For many large companies, even a fairly large crime would not necessarily cause a material misrepresentation of their financial statements. To the reader who is not familiar with the terminology, materially may be thought of as something "really large."

A common misconception is that auditors test every transaction and therefore should catch every instance of fraud. This is not the case at all. Auditors are only required to test enough information until they are reasonably satisfied that they have sufficient evidence to support any conclusion they might have regarding the company's financial statements. Granted, there have been some very large cases of fraud that should have been uncovered by the auditors, but generally an auditor would have to rely on blind luck to reveal the typical fraudulent transaction.

Ironically, auditors sometimes do find evidence of fraud but do not act upon their suspicions due to fear of lawsuits or because of confidentiality concerns. If the evidence is inconclusive, auditors will not act out of fear of not being able to prove these suspicions. Again, as long as they feel financial statements are not materially misstated, auditors frequently issue unqualified opinions even in cases where some evidence of fraud is present.

Private Investigators The modern private investigator has graduated from the Hollywood stereotypical image of a loner working in a seedy office with only a loyal secretary by his side. Ed Pankau, the aforementioned Houston-based private investigator, employs 46 people in a posh office that resembles an accounting firm.(29)

As criminals have become increasingly sophisticated, so too have private investigators. Most employ state-of-the-art techniques to track down criminals.

Because the complexity of crimes has increased, companies are turning more and more toward experts in crime detection to expose perpetrators. Employee crime detection is a booming business. In 1988 alone the Federal Bureau of Investigation recorded 3,448 cases of white-collar crime that exceeded $100,000 per occurrence. And for each of these cases over $100,000, there were 10 cases of lesser value.(30)

Despite the new technologies, private investigators still rely on time-honored tricks of the trade. They interview disgruntled ex-employees and estranged spouses. They interview secretaries who double as notaries. They look at itemized telephone bills and look for matchbooks to identify hotels where suspects might have stayed.(31)

According to Pankau, although technology has changed, thieves have basically remained the same since the beginning of time. He says, "The white-collar criminal is the same guy who had a club and a loincloth in the Stone Age, except now he has a three-piece suit, a gold watch and drives a fancy car."(32)

Certified Fraud Examiners Because of their training, Certified Fraud Examiners (CFE's) are well-suited to work as corporate cops. To become a CFE, applicants must meet strict educational and experience requirements, must display the highest ethical standards, must adhere to the group's code of ethics, and must pass the Uniform CFE Examination. This exam tests their knowledge of financial transactions, investigation of fraud, criminology, ethics, and legal matters pertaining to fraud.(33)

CFE's have numerous duties. These include obtaining evidence, taking statements, writing reports, testifying in court, and advising companies on fraud prevention.

Many Certified Public Accountants who are interested in criminology have opted to become CFEs as well. Although they have been relatively obscure (the organization was not founded until 1988), CFEs promise to become a more prominent weapon in the fight against the current climate of employee crime.

Prevention

Management's most effective weapon in the battle against employee crime is the use of preventive measures. It may sound corny, but the best deterrent is for a company's top officials to set a good example.(34) Employees have an amazingly active and accurate grapevine, and they generally are aware of executive "perks" such as falsified expense reports and personal travel at company expense. Only when managers set a good example can they expect their employees to behave morally.

Some other important deterrents are developing and maintaining internal controls and screening job applicants:

Internal Controls Although effective internal controls have always been important, they are becoming more important than ever with the passage of the new Federal Sentencing Guidelines. These guidelines contain mandatory fines for companies whose employees commit federal crimes. The more lax a company's internal controls, the higher the fine it can expect to pay.

Some important components of internal control are:

* Separate duties;

* Establish and adhere to strict accounting measures;

* Have employees sign requisitions for supplies and inventory;

* Periodically change locks on doors and file cabinets;

* Change computer passwords frequently;

* Publish and enforce a code of ethics;

* Enforce vacations;

* Rotate employees;

* Form strong internal audit committees;

* Eliminate "executive override," whereby managers have the power to ignore internal controls. Much employee crime is committed by executives.

Screening Employees This is an often overlooked item when discussing prevention of employee theft. Companies tend to screen employees in terms of job-related traits such as skills, experience, attendance, and punctuality and quite often place less emphasis on qualities such as honesty.(35) It is becoming more difficult to screen new employees. Due to fears of lawsuits, many companies do not give references regarding former employees, only acknowledgments that the employees did, in fact, work there. Because of this attitude dishonest employees are often able to find employment, and the vicious cycle continues.

Companies are employing innovative new ways to screen job applicants. For example, companies are looking at prospective employees' life-styles and spending habits. A certain company hired a lower level employee who drove a Mercedes. In fact, he parked it beside the boss for two years before it was discovered that he was involved in inventory theft. It turns out he had been fired from his previous employer for the very same reason!(36)

Another somewhat controversial method of employee screening which is gaining popularity among employers is honesty testing.(37) Honesty testing consists of giving the prospective employee a psychological profile which supposedly predicts future behavior based on the test-taker's attitudes and confessions of past conduct. The exams are administered at a cost to the employer of $8.00 to $20.00, including scoring. These tests have become especially attractive to employers since most businesses cannot use lie detectors due to the Polygraph Protection Act of 1988. Although illegal in Massachusetts and boasting a host of critics, honesty tests do seem to work. London House surveyed five major retail chains last year and found that all had cut their shrinkage by approximately 40% after two years of testing.(38) Employers should use caution in choosing an exam that meets rigorous professional standards of validity and reliability. The most common criticisms are that the tests lead to discrimination and invasion of privacy.

Employers are becoming more scrutinizing in examining job resumes. One in four resumes contains false information pertaining to educational credentials, skill levels, or past experience. An amazing number of these applicants are hired because of inadequate background checks. People have even gone so far as stealing someone else's identity. Many companies hire outside investigative services to verify the credentials of prospective employees.(39)

Other Prevention Techniques There are literally scores of other methods for the prevention of employee crime. Some worth mentioning are:

Provide a 1-800 Number One-half of employee crooks are reported by informants.(40) By making available an anonymous toll-free calling system, employers can open the way for informants. Companies should make it clear that whistle-blowers will not be punished nor otherwise ostracized.

Prosecution of Offenders In the past, some companies were reluctant to turn in offenders to authorities for fear of embarrassment or negative publicity. But what message does this send to other employees who may be tempted to steal? Companies should aggressively prosecute perpetrators to the fullest extent of the law. Companies can also lobby their legislative bodies for better laws and better punishment to deter crime.

Better Treatment of Employees Employees are more likely to steal if they feel a company treats its employees unfairly and especially if they feel personally mistreated.(41) Companies should attempt to cultivate a mutually caring environment. This can be done by striving for desirable workplace characteristics such as low management turnover, a high percentage of full-time jobs, and employee child-care centers. Some companies even provide psychological, drug, alcohol, and financial counseling that may help an employee before he or she decides to steal.(42)

The Use of Stealth This may seem to contradict the previous technique, but many companies have used stealth to deter thieves. A common example is closed-circuit television, a highly effective tool for deterring and detecting employee crime.

Technology Finally, since employees are becoming more sophisticated in the commission of crimes, companies need to take advantage of new technology as a deterrent to crime. Many companies have purchased modern telephone accounting systems. Personal long-distance calls can be all but eliminated by requiting employees to input an identification code before long-distance lines will activate. This simple action and other uses of technology can save companies thousands of dollars.

Conclusion

As long as there are dishonest people, employee crime will never be completely wiped out. But it is refreshing to know that companies are beginning to address this very serious issue and gain ground on the culprits. Only by taking the challenge head-on can companies ever expect to cut their substantial losses and emerge victorious.

Notes

1 Dale Buss, "Ways to Curtail Employee Theft," Nation's Business, (April, 1993), p. 36.

2 Dale Buss, p. 36.

3 Dale Buss, p. 36.

4 Briane Dumaine, "Beating Bolder Corporate Crooks," Fortune (April 25, 1988), p. 193.

5 Dumaine, p. 194.

6 Dumaine, p. 194.

7 Dale Buss, p. 36.

8 Wall Street Journal (Staff, September 30, 1993), "IBM Cooperates with FBI on Probe of Alleged Fraud," p. A12.

9 Donn B. Parker, "Better Laws can Deter Computer Crime," Crime and Criminals (St. Paul, Minnesota, Greenhaven Press, 1984, Second Edition Revised), p. 131.

10 Dumaine, p. 193.

11 Dale Buss, p. 37.

12 Dumaine, p. 194.

13 Sandy Sheehy, "Super Sleuth-White Collar Criminals Beware," Profiles (July, 1992), p. 39.

14 Thomas W. Golden, "Employee Crime Can Cost You Millions," Management Accounting (August, 1993), p. 39.

15 Nation's Business (Staff, September, 1988), Small business Update, p. 16.

16 Dale Buss, p. 37.

17 Dumaine, p. 194.

18 Sheehy, p. 38.

19 Golden, p. 39.

20 Sheehy, p. 38.

21 Mr. X (personal interview, October 10, 1993, name withheld as condition of interview).

22 Golden, p. 40.

23 Golden, p. 40.

24 Dumaine, p. 198.

25 Dumaine, p. 40.

26 Dumaine, p. 39.

27 Dumaine, p. 194.

28 Dumaine, p. 202.

29 Sheehy, p. 38.

30 Sheehy, p. 39.

31 Sheehy, p. 40.

32 Sheehy, p. 40.

33 Management Accounting (Staff, August, 1993), "Wanted: Corporate Cops," p. 43.

34 Dumaine, p. 198.

35 Robert Half, editor, "How Can I Hire a Flawless Employee?," Management Accounting (September, 1993), p. 14.

36 Martin D.J. Buss and Lynn M. Salerno, "Better Management Policies Can Deter Computer Crime," Crime and Criminals (St. Paul, Minnesota, Greenhaven Press, 1984, Second Edition Revised), p. 128.

37 James D. Walls, Sr., "The Workplace-America's Hotbed of Crime," Vital Speeches of the Day (April 1, 1988), p. 383.

38 Dale Buss, p. 36.

39 Sheehy, p. 40.

40 Dumaine, p. 198.

41 Dale Buss, p. 37.

42 Dumaine, p. 198.

Randall M. Hogsett, III is Accounting Supervisor at Big Sandy Terminal. Arch Mineral Corporation, Huntington, West Virginia, and William J. Radig is Professor of Accounting in the College of Business, Marshall University, Huntington, West Virginia.