by David Carroll
In this series we have considered the problem of a rogue CFO, or other executive officer, who defrauds or steals from the company. The focus has been on measures that are designed to prevent the high-level fraud from occurring in the first place. But what actions should the company take when it suspects that an insider is defrauding the business?
The company first needs to assemble promptly the evidence regarding the suspected fraud. During the investigation the company must be careful not to defame the executive or let him or her know they are under suspicion. Keep all communications to a very small group and avoid written accusations. The suspected employee may attempt to destroy the evidence or cover their tracks, which may make matters difficult when the company later needs to prove its case. So, avoid alerting the suspected perpetrator until it is absolutely necessary. It would be wise to bring in a third party to verify the evidence, a party such as outside legal counsel, the firm’s accountants or a certified fraud examiner. One advantage of bringing in the company’s outside legal counsel is that communication with counsel will be protected by the attorney-client privilege, so it may be best to bring counsel in as early as possible. With each item of evidence the investigators should try to understand what alternative explanation may be possible to explain the facts. It is possible that there are benign explanations for what has occurred and management must insure that they do not falsely accuse the individual or give him or her cause to accuse the company of defamation. An interview with the employee at the right time is an important part of the process.
2. Preserve and Protect the Company’s Data and Information
At some point the evidence of misconduct will become clear enough to take action. Insure that the company has backed up all financial information, records and communications, including data from hand-held devises. This should include the relevant bookkeeping records, expense reports, financial entries. Preserve all e-mails, text messages and other forms of electronic communications. The preservation of electronic data is very important should litigation arise out of the circumstances, so every effort must be made to preserve and not delete files and data. When engaging the employee, insure that the company has the employee’s prior permission to view personal items or to search a hard drive.
3. Lock Up and Lock Out
During the investigation the company would be well advised to have a bias toward removing the offender from the situation as soon as it is determined that further access to accounts or other assets by the executive could jeopardize the company or evidence could be destroyed. When this time comes, the board of directors and supervisors should lock the individual out of computer servers, take away access cards, keys, and deny access to the company files, documents, records and accounts. Do not allow the executive to remove records from the premises. If needed, the board of directors through human resources can direct that the executive be placed on paid leave until the issues can be fully investigated. If the executive has an employment agreement management must be careful not to violate it or give the employee cause to claim that he or she was constructively terminated. This means that the company should have someone ready to fill-in for the executive. This will require some prior planning since the executives in higher offices are harder to replace.
4. Call In the Company’s Trusted Advisors
The board of directors or managers of the company need to be involved in the process throughout. The board and the senior officers should develop a plan of action to stop the fraud, disconnect the persons involved in committing the actions under investigation and assure the firm’s customers, employees, suppliers and investors that the directors are on top of the situation and taking decisive action. The company’s attorneys and accountants should be brought in to advise the board and to help the board to design a plan of action. They know what to look for, how to preserve the evidence, and what is required to build the case against the suspected perpetrator. Most importantly they know how to develop systems to insure that the fraud doesn’t happen again.
5. Determine the Consequences for the Executive
The company may decide to terminate the employee. This action will most likely allow for a “for cause” termination if the behavior falls within the definition of “for cause” termination in the employee’s employment agreement, if the employee has one, or the company’s employment manual or other applicable corporate documents. The board of directors must insure that if the employee is terminated, he or she will need to be removed from other positions of responsibility, such as the role of director, manager or officer. In addition to termination of the perpetrator’s employment, there are three basic approaches to confirmed acts of fraud that damage the company: criminal prosecution, civil litigation or a negotiated resolution. In addition to dealing with the perpetrator, the board must determine who has been defrauded. If the harm is external, for example, to a vendor, supplier, customer, lender or shareholder, then the company must analyze how to rectify the damage sustained by the outside parties.
One common reaction to insider fraud is to call the police and press criminal charges. This may seem appealing. It certainly gets the perpetrator’s attention and it sends a clear message to the other employees that actions which damage the company will be met with serious consequences. There are, however, disadvantages to contacting law enforcement. Depending on your jurisdiction this type of complaint may not bring swift action from the police. As the saying goes, law enforcement may have bigger fish to fry. They may not have the time or the resources to deal with the investigation. If there is not a danger to the community the file may go to the bottom of the in-basket and sit there for months or even years without law enforcement taking any action. Furthermore, the company may simply want to recover its losses rather than make an example of the perpetrator.
The board of directors could decide to work out a settlement with the offender. The company may want to consider a payment plan for the executive to repay the damages and stolen funds in consideration of the company not filing suit. This may not be possible for someone who has little or no net worth, however, if the executive is a person who has some considerable financial resources, a negotiated settlement can result in restoring the stolen property and funds to the company and paying other restitution damages. The repayment can be structured to provide the company with protections and security if the executive fails to repay the debt.
The board of directors must decide what its objectives are and whether or not the planned remedy will achieve those objectives and be in the best interest of the company. It may be better for the company to focus on the rogue executive returning what has been stolen and paying restitution for other damages. If the company can get over the desire to punish the offender, the concept of a work out with the perpetrator may be faster, less costly than full civil litigation or prosecution and result in full restitution of its losses.
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