What is Internal Fraud?

Internal or corporate fraud is the deliberate misuse or misapplication of a company’s resources or assets by an employee for their own personal gain. Put simply, internal fraud occurs when an employee, manager, or executive commits fraud against their employer. This is as opposed to external fraud in which customers, vendors or other parties commit fraud against a company.

Some examples of internal fraud include:

• Skimming: A form of theft where the offender steals money before it is registered in the accounting system. A common skimming method involves an employee collecting payment from a customer for the sale of a product and then retaining the money for themself without actually registering the sale.
• Theft: Money or stock is stolen by the offender that is already registered in the accounting system, often by stealing money from the cash register immediately after processing sales transactions.
• Invoice Fraud: The offender draws up fraudulent invoices and processes them in the supplier system, for example using company credit or debit cards for personal use.

• Wage Fraud: Similar to invoice fraud, the offender forges invoices, this time to force the company to pay a salary to third parties that they may be an accomplice with. 

• Expense Fraud: For this form of fraud, the offender manipulates expense claims to be reimbursed for non-commercial expenditure. 

According to the Australian Institute of Criminology, internal fraud resulted in a loss of $2.7 million to Australian businesses in 2018-19, which includes stolen stock, cash, and damaged business reputation. More concerning is the fact that much fraud still goes undetected and unreported each year. 

However, there are many ways that managers can prevent internal fraud from occurring within their businesses, and deter employees from engaging in this form of fraud in the future.

Tips

1) Develop Clear Policies

It is important to establish clear and easy to understand policies to keep rules from becoming arbitrary and ensure that all employees are conscious of what the company expects of them. These policies should cover areas such as:

• Serving or processing transactions for friends or family
• Personal purchases and transactions
• Personal use of company equipment like telephones, computers and printers

The reason for having these policies is twofold. Firstly, those who intend to commit internal fraud will be deterred knowing that management is aware of this fraud and has enacted clear policies to prevent it. Secondly, honest employees who will not commit internal fraud will become familiar with the possible signs of fraud and will be more likely to report it. These employees will also gain more clarity on what constitutes fraud so they can avoid accidentally committing it.

2) Have Clear Transaction Procedures

For similar reasons as above, companies should have clear procedures for dealing with transactions as this is often where internal fraud occurs. These procedures can include petty cash limits, keeping registers closed unless they are in use and the provision of receipts to acknowledge transactions. 

Companies should also segregate the processes of purchasing, receipting and paying, and have two people conduct daily banking if possible. The segregation of duties is an essential element of preventing internal fraud as it ensures that no employee has the ability to perpetrate and conceal errors or fraud during their normal course of duties. Additionally, employees will also be able to provide checks and balances on one another. 

3) Implement Strong Supervision of Staff

Employees are less likely to commit fraud if they know that they are being watched by management. When an employee is able to perform duties without supervision or authorisation from a higher up, there is a risk that they will act in their own self-interests. Some points to consider when implementing supervision include:

• Supervise employee compliance with procedures
• Regularly review cash shortages and investigate instances where an explanation is unsatisfactory
• Have supervisors consistently check receipts and documentation
• Look into suspicious transactions
• Review of personnel

4) Set up a Reporting System

Although supervisors may catch employees engaging in fraud by looking into suspicious activities, an important source of detecting fraud are the employees themselves. Although employees are often hesitant to report incidents to their employers, this can be overcome by setting up an anonymous reporting system. Other sources also include customers, vendors and competitors. 

The Association of Certified Fraud Examiners reports that 40% of occupational fraud is detected because of a tip, the most of any other source. Consequently, businesses must ensure that they have appropriate reporting systems in place. 

The most common formal reporting mechanisms used by whistleblowers that businesses should consider implementing are:

• Telephone hotline
• Email
• Web-based/Online Form
• Mailed Letter/Form

Reporting systems will act as an effective deterrent against employees who would engage in fraud but are afraid of being reported by their fellow employees.

5) Perform Accounting Reconciliations

Fraud is often successful when it is well concealed. A way of combating this issue is performing regular accounting reconciliations and catching irregularities that may point to a case of fraud. Again, potential perpetrators of fraud will be deterred from committing fraud if they know that the accounts are being frequently looked over. 

The accounting reconciliations that business should undertake at least on a monthly basis include:

• Bank reconciliations (for all accounts)
• Accounts receivable reconciliations (both month to month and general ledger to sub-ledger)
• Accounts payable reconciliations (both month to month and general ledger to sub-ledger

Not only will performing accounting reconciliations give an indication of potential fraud, it will also have the added benefit of helping managers make decisions and ensure the accuracy of the accounting records.

6) Establish Strong Human Resource Procedures

One of the best ways to prevent a problem is to stop it from the source. For fraud, this means hiring the right people and training them. 

Businesses can implement procedures such as:

• Check references and perform background checks. This includes employment, credit and criminal history. 
• Have formal, specific job descriptions. A red flag for fraud is when employees perform duties outside their job description.
• Appropriately train employees. Not only will employees learn what constitutes fraud, they will also be able to recognise and report any suspicious behavior.
• Implement an equitable remuneration system. Some employees may engage in fraud if they feel their remuneration is inadequate.

7) Constantly Monitor Your Assets

Although quite a simple measure, constantly monitoring your physical assets is a crucial step to prevent employees from engaging in stealing. Businesses should also have stringent control over their intangible assets, such as their knowledge and information. 

Examples of measures that businesses can put in place include:

• Conducting regular stocktakes
• Restricting physical access to only those who require it to perform their job function
• Locking doors, desks and filing cabinets
• Implementing electronic surveillance systems
• Using employee IDs and passwords

These measures are the most visible to potential offenders of fraud and are therefore the strongest deterrent. While these measures do not necessarily entirely eliminate the risk of fraud, reducing the potential offender’s access to these assets will reduce the likelihood of fraud occurring.

8) Get Expert Help

Sometimes the numbers still won’t add up, even after implementing all of the above fraud prevention recommendations. If that is the case, then it may be worthwhile hiring a professional auditor to have a look at the company’s books. 

A Certified Practising Accounting (CPA) or Certified Fraud Examiner (CFE) can perform an extensive review of the company’s accounts and control processes, without having any personal relationship with the company to cloud their judgement. They can help with fraud detection and prosecution if necessary. 

These auditors will also ensure the books comply with government regulation, add credibility to the financial statements after their review, and point out key processes that may need improvement. However, a key factor to consider is the steep cost of hiring these auditors.

Conclusion

Employee fraud can take on many forms, but all of them represent a detriment to the business. It should be the priority of all businesses to implement procedures that prevent and deter internal fraud to prevent further losses. Not only will this have a substantial financial benefit, it will also promote a healthy company culture, with new employees learning the correct way of doing their job, that minimises errors and promotes good communication throughout the organisation.

Navigating a workplace investigation is often a difficult task. Errors in investigations can result in tribunal hearings or court cases and may jeopardise subsequent decision-making. If you are conducting a workplace investigation that may adversely affect the rights and interests of an employee, it is particularly important that you ensure your decision-making is procedurally fair.

In this blog we will discuss the 10 things you can do, to ensure your investigation is fair and robust.

What is Procedural Fairness?

Procedural fairness in a workplace investigation relates to fairness of the procedure by which a decision is made, as distinct from the fairness of the decision or outcome itself.

To ensure a workplace investigation is procedurally fair, as well as any decisions based on that investigation, there are a few key considerations:

• the employee must be informed of the case against them, including all of the relevant facts and evidence, policies and legislation to be relied upon
• they must be provided with a fair opportunity to provide their version of events, or their response to the allegations
• the decision maker or investigator must fairly consider the employee’s response when making their decision
• the investigation, and subsequent decision, must be free from bias – both actual bias and apprehended bias.

If you follow these steps, you are ensuring you are complying with both the ‘hearing rule’ and the ‘bias rule’ of procedural fairness.

It may not always be clear if a duty to afford procedural fairness exists in general employment decision making, such as when declining a period of leave. However, an investigation is a much more serious matter and so comes with an obligation to follow a fair and transparent process.

When you are conducting a workplace investigation that may lead to an adverse outcome for the employee, such as disciplinary action or termination, you must ensure your decision-making is free from bias, and that the employee receives a fair hearing.

Many unfair dismissal applications are successful at the Fair Work Commission due to the absence of procedural fairness, so it is vital to understand the fundamental requirements of a fair workplace investigation.

This guide is designed to provide you with an understanding of the essential components of procedural fairness and how this applies to both the investigator and employee.

It’s important to remember that what procedural fairness requires will change on a case-by-case basis. For example, there is no hard and fast rule about what a fair length of time may be to enable an employee to respond to allegations of misconduct.

Allowing seven days for a response will not be sufficient in every situation. For instance, if your investigation has produced 2TB of evidence, and you intend to rely on this to make an adverse decision, its highly likely the employee will need more than seven days to fairly consider the adverse evidence, and make a statement in reply.

So, what steps can you take make sure your workplace investigation is fair?

1. Inform the employee of the case against them.

The first step is to make sure the employee is aware of the case as soon as practical, so they feel they have been involved in the whole process. Of course, this must be balanced with other considerations in certain cases – such as the safety of any possible complainants while you make alternative work arrangements.

2. Let them know the likely timeframe for conducting the investigation, and keep them informed if there are any delays.

This sets reasonable expectations for all parties in the investigation.

3. Let the employee know of any supports available, such as an Employee Assistance Program or that they can bring a support person with them to an interview.

An employee is likely to be affected emotionally by an investigation, and they may need support. Additionally, this may cause them to have problems presenting their version of events during an interview, for reasons more to do with their emotional state than the strength of their case, which may leave them feeling that the interview was unfair. Allowing them a support person will prevent this.

4. Make sure you follow the investigation steps as outlined in your Workplace Investigation Policy/Procedure.

A key part of procedural fairness is a transparent, repeatable process which will be the same regardless of the circumstances. An employee should feel comfortable that they are receiving the same treatment regardless of their role, internal relationships, demographic factors, or otherwise.

To this end, you should have or develop a workplace investigation policy which you follow as much as possible. In the event that you cannot follow the policy exactly, the employee should be informed about any deviation.

5. Ensure the employee has a fair chance to respond to the allegations, and make their case in reply.

Perceptions of fairness rely heavily on an employee feeling heard, and you cannot make a fair decision without evaluating their version of events. The employee who is being investigated must always be given a chance to respond to the allegations. 

6. If you vary any allegations, or obtain any new evidence, along the way, ensure the employee is aware, and has an additional opportunity to respond.

Additionally, you cannot change allegations or obtain further evidence after an employee has responded, without giving them an additional chance to respond to the new allegations or evidence. By the time the investigation concludes, the employee must have had an opportunity to respond to the entire case against them, not a partial case at some earlier stage.

7. Keep an open mind.

Investigators are people, and people are prone to bias, however an investigator must keep an open and impartial mind as much as possible. Certain workplace investigations may be emotionally laden, and may drive you to lean towards one conclusion or another, because of how you feel about the alleged behaviour (whether proven or not) or the circumstances or persona of the subject or any complainants.

However you must keep an open mind until the end of the investigation, and let the evidence guide you. Someone may have done the wrong thing even if they’re a ‘nice’ person, and someone may be innocent of the allegations even if they come across as a ‘bad’ person. 

8. When drawing any conclusions, ensure they are supported by a fair weighting of the available evidence, and are not arbitrary or irrational.

To that end, you must consider all evidence with a fair weighting. For example, if independent witnesses, computer records, or CCTV footage fail to corroborate an allegation, this must be given more weight than if the employee seemed suspicious or hostile in an interview. They could be hiding something, but that thing may have nothing to do with the investigation. Or, they may simply, understandably, be annoyed at being investigated if they feel they did nothing wrong.

9. Communicate your decision, and the reasons for your decision, to the employee.

Obviously, you must communicate your decision to the employee. If the allegations are not proven, then they should not have the stress of the unknown hanging over their head. If the allegations are proven, then they should have some warning or personal contact before any further action is taken against them – it should not come as a surprise.

Additionally, providing the reasons for you decision will help increase perceptions of procedural fairness, as they may not agree with the outcome but they can understand how it was reached. That is, they may not feel the decision was fair – it is natural for people to feel an adverse decision was somehow unfair – but they can accept that the process itself was fair.

10. Keep good records of your investigation process, to rebut any procedural fairness arguments that may be raised once your decision has been made.

This last step is less about the employee’s perception of fairness and more about ensuring that you can prove the process was fair should an employee feel aggrieved after the investigation and appeal, internally or especially externally. You should maintain a complete record of the process and all of the evidence to ensure that you can present this to a reviewer, a tribunal, or a court.

We know that employees are more likely to accept an unfavourable decision if they feel they have had a fair decision-making process. That’s why communication is so important throughout the above steps.

How can Polonious help?

Polonious Case Management System (PCMS) is designed to provide a rigorous, repeatable process that is compliant with any regulatory requirements. PCMS can turn your workplace investigation policy into a workflow, with gated decision points, reminders, and tight security, to ensure you always follow step 4 above.

Additionally, as the system is process centric, you can focus on following the evidence to the conclusion, instead of focusing on making case notes on a personnel file (step 7).

Our secure portal and email integration make investigations easy for investigators, as well as ensuring the employee has a chance to respond to allegations (step 4) and will stay informed throughout the investigation (steps 1-6 and step 9).

Lastly, Polonious keeps a full record of the process and any evidence obtained, including reasons for decisions and timeframes (steps 8 and 10).

Further, our system automates much of the paperwork and communication, meaning you can focus on conducting a thorough and fair investigation, instead of completing paperwork and updating other systems.