Executive Culture is Essential in Preventing Employee Fraud

I was recently involved in a fraud investigation of the CFO of a privately held company that spent years following the directives of the majority shareholder to run the majority shareholder’s personal and/or nonexistent expenses through the company. In addition, the CFO was directed to implement other schemes that the majority shareholder designed to defraud the minority shareholders. After a few years, the CFO saw an opportunity to enrich himself by embezzling funds from the company. He did so to the tune of more than $7 million. When caught, he explained his actions by stating he was just doing the same thing that his boss did.

“Tone at the top” refers to the ethical atmosphere created by company management. The Association of Certified Fraud Examiners has established a direct correlation between the tone at the top and the risk of employee fraud in companies. If company management sends the message – either explicitly or implicitly – that fraud is acceptable to management, then some employees will rationalize that it is OK for them to commit fraud. Management may send this message by engaging in such fraudulent behavior as:

  • Overstating revenues or understating expenses so that the company appears more profitable than it really is (financial statement fraud).
  • Understating revenues or overstating expenses so that the company appears less profitable than it really is (tax fraud).
  • Giving or accepting bribes, kickbacks or inappropriate gifts.
  • Engaging in price fixing.
  • Submitting false or inflated expense reports for reimbursement.
  • Having the company pay personal expenses.
  • Lying to employees, customers, vendors, regulatory officials or the public.

Because it is almost impossible for management to engage in such behavior without involving one or more employees (for example, having accounting employees submit improper entries to the financial reporting system; directing staff to pay knowingly false expense reports; or approving vendors who are not the lowest cost quality bidders), this fraudulent behavior becomes known to other employees.

Even if management is not committing fraud, its failure to communicate disapproval of employee fraud will lead employees to believe that those at the top are indifferent to fraud.

To prevent employee fraud, management must set the tone and actively communicate disapproval of fraud. This requires management to take the following steps:

Communicate to employees what is expected of them. This means establishing policies and procedures to let employees know that fraud is unacceptable to management and that the company is taking active steps to prevent such schemes. Employees should also receive regular fraud and ethics training.

  • Lead by example. Regularly demonstrate that management finds fraud unacceptable and will not engage in such violations.
  • Provide a safe mechanism for reporting violations. This can include establishing a confidential hotline for reporting fraudulent activity.
  • Reward integrity. Include acting with integrity in employee incentive programs.

By setting the right tone at the top, management can demonstrate ethical leadership in preventing employee fraud.