Question

You Be the Consultant "Controlling Employee Theft" (Page 546).

Managers at Holt of California, a heavy equipment dealer based in Pleasant Grove, California, noticed some “unusual” accounting transactions and began to investigate them. Gradually, they discovered that over seven years, their controller, “Stan” (not his real name), who had worked for the company for nine years, had stolen $4.8 million from the company. Stan had used company credit cards, some of which had been issued to former employees, to purchase goods and services, including electronics, cars, airline tickets, landscaping for his home, a country club membership, cosmetic surgery, season tickets to professional sporting events, and online games, for his personal use. In an unusual twist, authorities discovered that Stan had spent $1 million of his employer’s money playing Game of Fortune. To cover his theft, Stan had vendors send bills to his home, where he could alter them, and created a steady stream of false financial reports. Fortunately, Holt was able to survive its employee theft incident, but some entrepreneurs have to close their businesses because employee theft and fraud destroy their cash flow.

Because small businesses often lack the financial and control procedures that large companies impose, they are disproportionately more likely to be victims of employee theft. Small companies are common targets of employee theft because employees, especially long-term employees, know the weaknesses in the company’s systems, procedures, and controls and take advantage when the opportunity presents itself. Indeed, the longer the tenure of an employee who steals, the greater the amount stolen. According to a recent study by the Association of Certified Fraud Examiners, the median theft by perpetrators who had been with a company more than 10 years is $250,000; the median theft for those who stole from a company in their first year of employment is $49,000. One expert cites the following “formula” for employee theft:

Pressure + Rationalization + Opportunity = Employee theft

The only factor in the equation that employers can control is opportunity, which is why entrepreneurs’ money is better spent preventing employee theft than detecting it.

As mentioned earlier, although 64 percent of small businesses report being victims of employee theft, only 16 percent reported the theft to the police. Business owners cite four reasons for failing to report theft by employees: (1) They do not perceive the theft as one warranting any more attention than firing the employee, (2) their attorneys often advise them that the cost in time and energy to prosecute the thief would likely outweigh any benefits, (3) the decision to prosecute is charged with emotion because the employee has worked alongside the owner for many years or is a family member, and (4) they see the police and criminal justice system as ineffective. The median amount stolen among small companies is $150,000, an amount significant enough to threaten the existence of many businesses. Oftentimes, such theft leaves the business in a cash bind from which it is unable to recover. In fact, the U.S. Chamber of Commerce estimates that one-third of all small business bankruptcies result from employee theft. In small businesses, the typical fraud goes on for 18 months before the owner discovers it. Nearly 30 percent of the time, an employee tips off the owner to the theft, twice the percentage of thefts that are discovered by management review (14.5 percent). Seven percent of thefts are discovered by accident.

Many entrepreneurs are shocked to discover that the people who are stealing from their businesses are their most trusted, highly valued employees—the last people they would suspect. In the United States, managers are more likely to steal (43.0 percent) than are employees (30.8 percent), and they cause 2.7 times more damage. The median theft by managers is $173,000, compared to $65,000 by employees. Managers’ thefts also are more difficult to detect, requiring a median of 18 months to detect, compared to 12 months for those that employees commit. The most common red flags that lead to detection are employees living beyond their means, having financial difficulties, having an unusually close association with a company vendor, and being unwilling to share their job duties (for fear of detection).

The most effective way to deal with employee theft is to prevent it. Entrepreneurs can take the following steps to reduce the threat of employee theft:

• Screen potential employees thoroughly. Statistics show that, on average, 1 out of every 38 employees is caught committing employee theft. A business owner’s most useful tool against theft is a thorough pre-employment screening. The best time to weed out prospective criminals is before hiring them.

• Monitor inventory closely. Business owners who fail to keep up-to-date, accurate inventory records are inviting employee theft. When the co-owners of two ice cream stores realized that their employees were stealing, they began to take inventory of their stock twice each day. Once employees knew that controls were in place, the thefts stopped, and profits went up.

• Use technology to discourage theft. A variety of technology tools help business owners minimize losses to employee theft and fraud at very reasonable prices. Simple video camera systems, such as the ones used on the Food Network’s show Restaurant Stakeout, are responsible for nabbing many employee thieves, especially cameras that are focused on checkout stations and cash registers.

• Set up a hotline. One of the most effective tools for minimizing employee theft is to encourage employees to report suspicious activity and give them a mechanism for reporting. Remember that the most common way that managers detect employee theft is by getting tips from other employees.

• Embrace a zero-tolerance policy. When business owners catch an employee thief, the best course of action is to fire the perpetrator and to prosecute. Most owners take the attitude “Resign, return the money, and we'll forget it.” Letting thieves off, however, only encourages them to move on to other businesses where they will steal again.

1. Identify the factors that led Holt of California to become a victim of employee theft and embezzlement. What impact does this crime have on a company’s cash flow and survival?

2. Are small businesses more likely than large ones to be victims of employee theft? Explain.

3. List at least five steps, in addition to the ones described here, that entrepreneurs should take to prevent their businesses from becoming victims of employee theft and embezzlement.

Answer 1

1. Factors such as:

• Not having proper control systems,
• Not having proper accounting systems,
• Having seniority by the employee.

are the reasons for being the victim of employee theft. The company has faced a loss of $1 million. Though the company was able to survive this incident but most of the entrepreneurs are not that lucky.

2. Two main factors that small companies are at greater risk for workplace fraud:

• A lack of effective accounting standards.
• A larger degree of misguided or perceived trust.

In a small to medium-sized enterprise, to know the numbers, it is usually the person who does the bookkeeping You count on this guy. You put your faith in them. They're right-handed.

In other words, the one you least expect is usually the one who committed the crime. This person sees all of the money coming in. They see what you file out your expenses. They say to themselves, "I deserve a little piece of the cookie." It may start here at $20 and can quickly turn into hundreds of thousands of stolen dollars.

3. Steps to prevent employee theft.

• Let workers feel respected
• Pre-screen candidates
• Placing the office under control
• Organize staff schedules to be responsible for conducting impromptu assessments
• Setting up a secure whistleblowing line
• Speak the penalty out