Means, Motive, and Opportunity

November/December 2014

Workplace fraud and theft are more common than you might think. To reduce your risk, actively engage employees, reduce the opportunity to steal, and create an ethical culture that starts at the top.

By Christopher S. Bryan

Scrap recyclers face countless challenges in operating a successful and profitable business. In addition to those unique to the industry, you face more universal perils, including the prevention of occupational fraud. Businesses often give one employee or a few trusted employees the responsibility for preventing fraud, but research shows these employees are often the ones who commit fraud. While internal controls can help protect your assets, an ethical organizational culture and principled leadership also can lower the risk of fraud. Focusing on the company leadership’s actions and attitudes can help you transform your employees into allies in the fight against fraud and theft.

Learning From the Research

When a company is led by a small group of dedicated employees, discussions about the potential for fraud can be sensitive. Thus, in some cases, those discussions never take place. Co-workers might not want to believe that a trusted colleague could commit a crime against the company. But the prevalence and widespread impact of fraud, as seen in global surveys across a wide range of industries, are alarming.

According to the 2014 Report to the Nations on Occupational Fraud and Abuse by the Austin, Texas-based Association of Certified Fraud Examiners, occupational fraud has a global financial impact of $3.7 trillion a year. The most common type of fraud is asset misappropriation, and recyclers are particularly vulnerable because your companies tend to have high volumes of cash transactions, easily transportable materials, and decentralized operations, which are among the risk factors.

The 2014 Global Economic Crime Survey by PricewaterhouseCoopers (London) reports that 45 percent of survey respondents experienced at least one incident of fraud in the prior two years. The ACFE report reveals that the average organization loses 5 percent of its revenues to fraud schemes. Further, its research shows that such schemes last a median of 18 months and cost a median of $145,000 before someone discovers them.

One reason business executives and owners might underestimate the prevalence of occupational fraud and dismiss the idea they could become victims is that companies often don’t disclose it. Rather than face the negative publicity such incidents generate, victimized organizations work to unravel them quietly. A 2011 analysis of global fraud patterns by KPMG (Amstelveen, Netherlands) shows that in 77 percent of fraud cases, companies do not disclose the incident to the public. In 54 percent of cases, companies do not even communicate incidents of fraud to their own employees.

If more executives and owners knew the prevalence of fraud, they might seek to understand how and why it occurs. In an extensive study of embezzlers in the 1950s, criminologist Donald Cressey discovered three common factors that lead ordinary people to commit fraud: They experience an unshareable financial problem that requires immediate remedy; they perceive an opportunity to take funds without detection; and they develop a rationalization for the act. More than a half century later, Cressey’s fraud triangle endures and continues to explain most asset misappropriation schemes.

Common situations that produce unshareable financial problems are easy to identify. These can include divorce, health issues, death of a spouse, drug or gambling problems, or an unbearable level of personal debt. Opportunity also is an easy concept to understand. Most organizations implement rudimentary controls over opportunities for fraud, though many such internal controls are not adequate, especially those at small organizations.

Rationalization—why and how people justify their criminal behavior—is less clear. Speculation that some individuals have personality traits that predispose them to fraud has led to research that attempts to correlate certain personality and character traits with those found in convicted fraudsters. Such research has found mild—and unconvincing—connections between perpetrators of fraud and the traits of greed, narcissism, intelligence, hedonism, and low integrity. Most criminologists and business ethicists don’t believe that these correlations can predict occupational fraud, however. Business ethicist Joseph Heath, for one, advocates focusing less on individual personality and character traits and more on organizational culture. He maintains that organizational context and ethical culture are far more important than personality and character traits as predictors of occupational fraud.

The implications of that idea should be encouraging because it means that company leaders and managers, more than any other factor, can help shape the ethical culture of an organization. Thus, they can have the greatest impact on fraud. To create an ethical environment that raises cultural barriers against fraud, you can implement several simple practices that attack its elements: unshareable financial problems, perceived opportunity, and rationalization.

Employee Engagement

Leaders can fight fraud by opening the lines of communication that increase the odds an employee will share a financial challenge if one arises. The difficulty is that many managers and executives still hold to the old-fashioned notion that they should keep employees at a distance. This is unfortunate because staff members easily detect this attitude, and it fails to create the human connection needed to increase engagement. Managers can hire heads and hands, but to engage the heart is to unleash ardent loyalty, unending energy, and thoughtful imagination.

After you learn about an employee’s financial hardship, what can you do about it? A financial hardship fund is one option. The company can build a strong sense of community by donating into the fund and inviting employees to donate as well. The costs associated with the fund would be a small price to pay compared with the potential cost of fraud or theft. Even when the fund can only partially eliminate the financial need, individuals are likely to find it more difficult to rationalize fraud against an organization that has helped them.

Checks and Balances

In small companies or accounting departments, it’s difficult to segregate duties sufficiently to ensure against fraudulent activity. Even so, here are three simple steps you can take to decrease the perception of opportunity.

First, develop a system of surprise audits, including cash counts, payroll audits, account reconciliations, and random documentation checks.

Second, design a system for employees, customers, and suppliers to anonymously send tips on potential fraud and theft to someone who can investigate. The ACFE report finds that tips are nearly three times more likely to detect a fraud scheme than any other method, and tip lines also create an effective deterrent. Tip lines might be especially effective in large scrap recycling companies, where operations are highly decentralized.

Third, require each employee to take one week—at least five consecutive days—of vacation a year. Why is this important? Because the conceptualization and development of an occupational fraud scheme can take little effort, but the ongoing management and concealment of a scheme require constant vigilance. Under threat of discovery, employees who are defrauding their employer must answer phone calls, receive mail, and reconcile accounts to maintain the secrecy of the scheme. When vacationing employees are away, supervisors or other staff members who are taking on their responsibilities should question any unusual phone calls, inquiries, or correspondence.

Employees in highly sensitive areas of responsibility might welcome these simple steps. They remove the temptation the unchecked responsibility for cash and other assets can create by decreasing the perception that an opportunity exists to operate an undetectable scheme.

Creating an Ethical Culture

The culture of the organization significantly affects the crucial process of rationalizing fraud and theft. Most fraudsters want to maintain their sense of integrity while committing their offenses. They look for rationalizations to calm or silence their offended conscience. Common rationalizations include “I’m just borrowing the money,” “I deserve a raise,” or “I was wronged.” Such rationalizations are made easier when company leaders avoid the subject of ethics or when their words don’t match their deeds. They can expect to eventually see the best—and worst—of themselves in their organization’s culture.

Focusing on the ethical “tone at the top” gained prominence when analysis of the accounting and fraud scandals of the 1990s and 2000s found cultures where leaders commonly disregarded ethics policies, circumvented controls, and demanded self-serving loyalty. Such executives clearly crossed ethical lines. That said, for leaders who want to set the proper tone at the top, the path is not an easy one.

Leaders with the best intentions face the challenge of sending the right message 100 percent of the time. Followers are keen to spot inconsistencies in attitudes, words, and deeds. Leaders also face a disadvantage due to what may be a quirk of ethics psychology: According to ethics researchers, employees believe their own ethical standards are higher than the standards of the managers and supervisors leading their organization. The important lesson of this research is that if you inadvertently create ambiguity related to an ethical question, employees are more likely to infer you are hinting at an unethical solution to the problem.

Even with those challenges, you can take important and necessary steps to create an ethical culture that will make it more difficult for employees to rationalize fraud and theft.

Develop and communicate an organizational code of ethics. This is an important formal step you can take to strengthen the organizational culture, but don’t think of a code of ethics as a panacea. Nearly all the companies involved in accounting scandals in the early 2000s had organizational codes of ethics. Research has consistently shown that codes of ethics are effective only to the extent that leaders of the organization support them. Leaders who demonstrate their support consistently by both word and deed lay the strongest and most enduring foundation for a culture of ethics.

Talk about ethics and the potential for fraud throughout the organization. Be explicit; discuss common rationalizations and unequivocally reject them. Your goal is to raise the ethical expectations of everyone, not to set an unhealthy culture of suspicion. Even properly handled, this discussion might be uncomfortable, but it can still be a valuable way to convey your ethical standards and provide a forum to discuss issues.

Develop a culture of personal responsibility. Often leaders will accept rationalizations for minor offenses to avoid confrontation. In doing so, followers learn that these rationalizations allow them to avoid personal responsibility. A better approach is to intently seek and reject baseless excuses (rationalizations) for undone tasks, unmet objectives, and poor performance. This will strengthen the culture of personal responsibility, which will improve productivity and decrease the chance that a fragile rationalization will lead to fraud.

Develop a culture of curiosity and questioning. The accounting, auditing, and investigative professions have long recognized the value of professional skepticism and sought ways to develop healthy skeptics. They help identify waste, inefficiency, and new opportunities—and they also can help identify fraud schemes. Start by asking questions yourself. Demonstrate a genuine interest in the work of others and carefully weigh their responses.

An additional strategy is “ask to ask.” When you ask to ask, you engage others in your curiosity. This strategy has two levels. The first is to communicate that “It’s OK for me (the manager) to ask you (the employee).” When individuals in the organization believe you value their opinion, knowledge, and insight, they will respond by raising valuable points of interest.

The second level often is more difficult for leaders. It’s communicating that “It’s okay for you (the employee) to ask me (the manager).” When this level of skepticism becomes a part of the organization, leaders yield their own personal interests and ego to the interests and well-being of the organization.

Handle employee issues that create friction promptly. Organizations tend to underestimate the strong motivational power of revenge. Arbitrary and onerous employee policies, reprimands, and disrespect create strong emotions. The human capacity for revenge is enormous, and scorned employees are often irrational. Behavioral research shows that individuals will seek revenge even when the vengeful act is detrimental to them. A common rationalization for occupational fraud is revenge for a perceived wrong. Leaders should recognize issues that create friction among employees or between employees and supervisors and seek to make peaceful amends.

While it’s essential to implement adequate internal controls to prevent fraud, it’s also important to focus on the human element—and that starts by looking in the mirror. Set an ethical tone at the top, implement sufficient checks and balances, and build employee engagement to reduce the likelihood that employees will align the three elements that lead to fraudulent behavior.

The Red Flags of Fraud

The 2014 Report to the Nations on Occupational Fraud and Abuse by the Association of Certified Fraud Examiners (Austin, Texas) states that in the 1,483 cases studied, 92 percent of fraudsters exhibited at least one of the behavioral “red flags” listed below; 64 percent exhibited two or more red flags. Keep in mind that a behavioral red flag you observe in an employee is not evidence of fraud; however, it should give you cause for additional diligence.

Living beyond one’s means. Perpetrators in 44 percent of fraud cases showed a flair for luxury beyond those in similar positions while the fraud schemes were operational.

Financial hardship. Perpetrators in 33 percent of cases indicated or spoke about financial hardships before or during the time when fraud schemes were ongoing.

Close associations with customers or vendors. In 22 percent of cases, business colleagues of the perpetrators noticed a close and unusual association between the perpetrator and vendors or customers prior to the discovery of the fraud scheme.

Control issues. In 21 percent of the cases studied, colleagues noted that the perpetrators showed an unusual reluctance or refusal to share duties or information related to their work. For those who do not normally exhibit control issues, this red flag becomes more important.

A wheeling-and-dealing attitude. Colleagues of 18 percent of perpetrators noted the perpetrator had an unusual propensity to play fast and loose with company policies and procedures to make and close deals of questionable integrity.

Family and divorce problems. Family and divorce issues were evident in 17 percent of the cases studied. Examples include legal and health problems, unusual living arrangements, and special child-care requirements.

Workplace fraud and theft are more common than you might think. To reduce your risk, actively engage employees, reduce the opportunity to steal, and create an ethical culture that starts at the top.