Are You Teaching Your Employees to Steal? (Part 3)

Continued from "Are You Teaching Your Employees to Steal? Part 2"

WHEN DO PEOPLE EMBEZZLE OR ABUSE THE COMPANY?

Generally, three things have to be present before someone commits fraud or embezzles: need, opportunity, and rationalization. This is known as the "triangle of fraud." (See Figure 1.)

Need takes two forms—direct and indirect. Direct need is stealing to fund cash needs and is often driven by an addiction—drugs, alcohol, gambling, or an extramarital affair. So the next time someone brags about an affair, warning flags should go up. Indirect need, on the other hand, is usually keeping the company afloat. This results in cooking the books to make sure the loan is obtained or renewed to buy time to fix the problem.

Opportunity is defined as the perception that there’s a low probability of being detected. In accounting we call this "poor internal controls."

Rationalization is the employees’ mental process of making the action fit within their personal code of conduct. In other words, the employees must be able to "talk themselves into the action" — "the ends justify the means."

RATIONALIZATION OFTEN RESULTS IN "SITUATIONAL FRAUD"

Employees’ propensity to steal or embezzle can be described as a normal distribution. (Remember that from college?) About 5% to 10% of employees would never—ever—do anything wrong. About 5% to 10% of employees are always scheming. (I hope you don’t have many such folks working for you.) The real problem is that 80% to 90% of employees who’ll commit "situational fraud." Remember: Who are the only employees who can steal from you? Employees you trust. This isn’t meant to imply you shouldn’t trust your employees. It simply means you don’t go soft on internal controls because you trust employees.

Here are some warning signs and risks to watch for:

  • Employees who are being downsized;

  • Employees who are bored and may steal for excitement;

  • Employees who make an honest mistake, discover a hole in internal controls, benefit from it, and are going to "pay it back";

  • Thrill seekers who like bending the rules;

  • Employees who are under personal stress: money, divorce, illness (especially spouse or children);

  • Employees whose financial problems suddenly disappear;

  • Employees with addictions: drugs, alcohol, extramarital affairs, gambling;

  • Employees who always have to be number 1 and/or can’t stand not being the center of attention.

CREATE A "SELF-CORRECTING" SYSTEM

Modern CFOs know a lot about human behavior. Behavior never remains static. World-class CFOs understand that any time they change a reward, the compensation system, or the control system, people will always change their behavior to maximize the benefit to themselves.

Example: Many years ago traffic engineers set out to reduce the accident rates at intersections. They set up cameras and videotaped the traffic patterns. At that time, the green light would turn red and the red light would turn green at the same time. But that one last car tried to get through while cars with the green light had permission to go. So the engineers changed the sequence to add two or three seconds’ delay (both lights are now red), giving that one last car time to go through the intersection. The accident rate declined significantly for two or three months. Then what happened? Drivers coming to an intersection with a yellow light or just-changed-to-red light realized they had several extra seconds to make it through the intersection. Instead of one car going through on the red, now it’s three or four. The drivers adjusted their behavior to benefit themselves.

Change the compensation system, and employees will change their behavior. Count on it. You may solve one problem but create an even worse problem. Hockey players don’t skate to where the puck is, they skate to where the puck is going to be. To become an indispensable member of the management team, you must anticipate how employees (and executives) will react to any changes.

MINIMIZE FRAUD

Sometimes you can minimize risks with a little creativity. For example, an owner of a small company where there’s little segregation of duties can have the bank statement sent to his or her home, not to the company. To show he/she’s paying attention to the statements, the owner reviews them and then asks about several items in each statement. This procedure creates the perception that a theft will probably be detected, thus reducing the "opportunity" and increasing the risk of getting caught. Minimizing the opportunity for theft and embezzlement is probably the most powerful deterrent—they might "get caught." (This would have prevented/detected Beverly Kunkel’s $1 million embezzlement.)

If you’re an outsider (accountant, auditor, whatever), be aware that you have to "sell" this idea from the bottom up. Few small business owners will make this change. It sends the message to the long-time employee that he or she isn’t trusted anymore. Get the employee (probably a bookkeeper or controller) to ask for the change. Say, "You know, you have complete control of everything. You pay the bills, you make the bank deposits, and you reconcile the accounts. If any money is missing, who do you think Sally (the owner) will suspect? For your own protection, you should get Sally to look at the bank statements and initial the envelope every month. I know she’s busy, but it won’t take her more than five or 10 minutes."

DRIVE BEHAVIOR

Theft and embezzlement are a serious drain on company resources. Your job as CFO is to protect the company’s assets. Simply assuring compliance with company policy isn’t enough. World-class CFOs create self-policing or self-correcting systems. You must understand how your internal controls, compensation, and measurement systems drive behavior and structure them so people will do what you want without intervention. The job of the 21st Century CFO is to "drive" the desired behavior.

Less work. Happier employees. More profits. Anyone interested?

Gary Zeune, CPA, is CEO of "The Pros & The Cons," the only speakers bureau in the U.S. for white-collar criminals. His books include The CEO’s Complete Guide to Committing Frauds, Outside the Box Performance: How to Beat Your Competitors’ Brains Out, and over 35 articles on fraud and performance measures in national publications. Gary teaches fraud classes for the FBI, the U.S. Attorney, over 30 state and national CPA societies, and numerous banks and accounting firms. You can reach him at gzfraud@bigfoot.com or 614-761-8911, or visit www.bigfoot.com/~gzfraud.

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