How To Conduct A Fraud Investigation (HR Advisor 2003) PDF

HOW TO CONDUCT A
FRAUD INVESTIGATION
Arthur P. Murphy, Esq. and Quinn H. Vandenberg
On a daily basis, our society is mental and health care violations, MECHANICS OF A FRAUD
bombarded with newspaper and or asset misappropriation, just to INVESTIGATION
television stories headlining al- name a few. Major fraud scandals Before the issue of fraud arises,
leged or suspected fraudulent cor- and dramatic monetary losses re- employers and human resource
porate activity. More and more, sulting from the fraud have led leg- managers can attempt to prevent
the responsibility for dealing with islators and enforcement agencies or greatly diminish the likelihood
these allegations of fraud is falling to change the federal and state reg- of workplace fraud if certain issues
upon the shoulders of HR manag- ulatory environment, and this, in are addressed early on. Education,
ers, adding to the already increas- turn, has changed how HR profes- training, and written policies and
ing scope, complexity, and chal- sionals must deal with suspected procedures addressing internal
lenge of the HR role. How should workplace fraud. Even though fraud are systemic devices that a
a HR manager identify fraud, and employers should first of all under- company can use to deter or pre-
what are the skills needed to an- vent internal fraud. Combined
stand the necessity of a preventive
swer this question and investigate with systemic devices and preven-
approach to fraud in todays work-
the allegation of fraud? What op- tive efforts, addressing the fraud up
place, there are many instances
tions are available to HR managers front through consistent enforce-
where an internal investigation is ment and sanctions, (including dis-
when confronted with suspected
necessary. Employers can and do charging employees who commit
internal fraud?
successfully conduct internal fraud), will send a clear message to
Fraud comes in a variety of workplace investigations. The goal all that it will not compromise its
forms including: fraudulent finan- of this article is to instruct the HR integrity.
cial statements, financial fraud, ac- manager about the potential issues
counting irregularities, environ- Once an allegation of fraud aris-
surrounding an investigation and
es, the company is faced with
when it might be appropriate to many considerations, several of
ARTHUR P. MURPHY is the manag-
seek outside advice. Also, this arti- which are discussed below. The
ing partner of Murphy, Hesse, Toomey,
and Lehane, a law firm in Massachusetts cle attempts to instruct the HR twelve questions that follow gen-
specializing in representing management in manager about the issues of em- erally represent the different stages
labor and employment issues. ployee whistleblower protection in an internal fraud investigation
QUINN H. VANDENBERG is a law
clerk at Murphy, Hesse, Toomey, and Le-
and how it pertains to different sit- and will facilitate the HR profes-
hane, and is entering her third year of law uations throughout the internal in- sionals evaluation of the allegation
school at the University of Notre Dame. vestigation. of fraud.
2003 West, a Thomson business. Requests to publish material or to incorporate material into
HR ADVISOR computerized databases or any other electronic form, or for other than individual or internal
distribution, should be addressed to West, a Thomson business, 610 Opperman Dr., P.O. Box 64833,
SEPTEMBER/OCTOBER 2003 St. Paul, MN 55164-1801. This publication is designed to provide accurate and authoritative
information in regard to the subject matter covered. It is published with the understanding that West
16 is not engaged in rendering legal, accounting or other professional services.
HOW TO CONDUCT A FRAUD INVESTIGATION
Should the company even give the investigator the clearest in carrying out fraud investiga-
conduct an internal picture of the extent of the fraud in tions; (3) less objectivity than an
investigation?
the company and possible needed external investigation; (4) possible
Some practitioners argue that with safeguards i.e. as document re- conflicts between the companys
all the regulations, and increasing tention, external advice, and secu- well-being and managements
strictness in the application of rity concerns. professional obligations; and (5)
those regulations, a better alterna- possible loyalty issues between the
tive for a public company par- Who conducts the investigator and the employees
ticularly one that merely suspects investigation?
and lack of support.4 Although
fraud is to leave the matter HR managers are increasingly be- some of the disadvantages are not
alone. They caution that if the ing called upon to conduct in- damaging to the company general-
company conducts an in-house in- house investigations. The question ly, the existence of such factors
vestigation and prepares a written of whether to bring in law en- when conducting an in-house in-
report in connection with the in- forcement, a regulatory agency, vestigation might be problematic.
vestigation, a governmental agen- external audit teams, a private law
cy could use that report as a road firm, or handle the matter in- Who is being defrauded?
map for conducting its own inves- house is an open one. This deci-
If the harm is internal, the compa-
tigation. Yet, allowing the fraud to sion is fact and case specific, and
ny can deal with the issue through
go unaddressed in any company will depend upon the duration and
targeting the offender and dealing
could be problematic. Sound busi- breadth of the potential problem as
with the offender appropriately,
ness and legal judgment supports well as potential in-house investi-
definitively, and swiftly. If the
conducting an investigation but gatory skills. Many times the in-
harm is external i.e. a vendor,
proceeding with skill, caution, and house investigations are coordinat-
supplier, customer, or sharehold-
confidentiality. In the end, an in- ed with outside counsel. If the
er-the company should analyze
ternal investigation should be con- company initially decides that it
how to rectify the current situation
ducted if for no other reason than will conduct an internal investiga-
with the outside parties. In these
to stop the fraud or send a message tion instead of an external investi-
situations, outside advice should
throughout the company that gation, the roles of the individuals
be sought, and the investigator and
fraud will not be tolerated. involved in the investigation
the employer must be aware that
should be clearly delineated. If the
companies are generally liable for
What is the extent and investigation is conducted in-
pervasiveness of the fraud? the fraud committed by its direc-
house under the supervision of an
tors, officers, employees, and
Assuming the company decides to HR manager, the benefits may in-
agents.5
conduct an investigation, an inves- clude: (1) heightened knowledge
tigator must continually address about the companys business, em- Should the employee have
the timing, scope, and viability of ployees, and procedures; (2) in- known that certain conduct is
conducting an internal investiga- creased control over the investiga- fraudulent or against company
policy?
tion. (1) Timing: a fraud investigation as well as the possible resulting
tion must be prompt and swift. (2) publicity; and (3) an unfiltered In answering this question, a com-
Scope: if the alleged fraud involves view of the fraud and the extent of pany must examine its policies and
high level employees, an investiga- it. Keeping the investigation in- procedures, its education and
tor must get the support of the top house will also prevent possible training concerning workplace
level executives to conduct an in- problems with the Fair Credit Re- fraud, and its outward commit-
vestigation and to have full author- porting Act (FCRA).2 The FCRA ment to preventing internal fraud.
ity to interview those high level applies generally to workplace in- The answer to this question is im-
employees.1 (3) Viability: the seri- vestigations, but does not apply portant later on in the investiga-
ousness, duration, and frequency when the investigation is done tion process when the company
of the possible fraud will help in completely in-house.3 On the oth- will have to decide what to do
determining whether an internal er hand, the disadvantages to keep- with an employee who is found to
investigation can competently and ing the investigation in-house may have engaged in fraudulent acts ei-
swiftly uncover and deal with the include: (1) lack of attorney-client ther against the company or
fraud. Addressing these issues will privilege; (2) insufficient training against external entities.
What is the purpose of the type of recording the investigator agitate an employee and make
investigation? decides to use runs the risk of ei- the employee less forthcoming.
Either through an anonymous tip, ther too little recorded factual in-
an external source (supplier, ven- formation and faulty memories What happens when an
employee does not want to
dor, etc.), a suspicion from upper- in the future or too much infor- cooperate?
management, or a complaint from mation that could be damaging to
an employee, someone in manage- the company in the event of a In general, every employee owes a
ment realized that there may be lawsuit (any records generated duty to cooperate and a duty of
fraud going on in the company throughout the investigation may loyalty to the employer. This duty
and it must be ferreted out. The be subpoenaed). Any legal ques- obligates an employee to comply
company realizes that the goal is to tions about what documents will with the directions from the em-
either (1) find fraud or no fraud or be discoverable should be direct- ployer during an internal investi-
(2) find fraud and identify who is ed to legal counsel. gation as long as those directions
responsible.6 Prior to any inter- are reasonable. Unwilling or un-
viewing, the investigator should How to conduct an interview?8 truthful employees should be dealt
have a clear understanding of the The investigator should initially with immediately. Regard must be
alleged violation, any documents inform the employee why the in- given to the employees possible
or statements that support the vio- vestigator is there and what is go- contractual rights, federal and state
lation, and a working knowledge ing to be discussed with the in- law, and the specific facts of the
of the area to be investigated. terviewee. For example, there situations. Before terminating an
Next, the investigator (1) gathers are issues concerning the way the employee for failure to cooperate
as many facts and documents as goods are accounted for or with an internal investigation, the
possible, (2) develops a strategic how the cash management sys- company should consider a com-
order to interview the employees tem is being administered are mon issue of the employee re-
or the accused, and, finally, (3) es- two ways in which the investiga- questing to have an attorney
tablishes some sort of measuring tor can avoid saying fraud present.11 In the initial investigato-
system by which to gauge the while at the same time informing ry stage, most companies do not
credibility of the sources of the in- the interviewee of the purpose of allow individuals to have an attor-
formation. the interview. All employees in- ney present, but the investigator
terviewed should be informed should be aware of possible inter-
How will the investigator that it is expected that they will view requirements.12
document the investigation? keep the information discussed
How to evaluate the findings of
On the one hand, documentation and the fact that the interview the investigation?
is vitally important to show that took place confidential (See
the company took the complaint Whistleblower section for possi- The conclusion of the investiga-
seriously and investigated the ble issues). The investigator tion will result in finding fraud, no
matter. On the other hand, if should inform the interviewees fraud, or no conclusion. No matter
documentation is not done prop- that the company cannot prom- what the investigator finds, the in-
erly it could lead to numerous ise absolute confidentiality, in vestigator should be careful to sup-
complications.7 The decision of order, among other reasons, to port any findings with facts. Thus
how to document the interviews minimize the possibility of alle- the following global checklist
should be made with regard to the gations of defamation 9 or self- will be helpful to a company faced
specific facts of the case. In partic- publication defamation. 10 During with a decision about how to pro-
ular, before an interview, the in- the actual interview, focusing on ceed after the completion of any
vestigator must decide to either who, what, where, when, and investigation:
take notes, take notes and then how questions about the alleged Assess offenses or possible of-
have the interviewee initial them, fraud will present the company fenses.13
or have the interviewee sign a with a complete picture about
written statement in order to sup- the scope of the alleged fraud. Review company policies
port allegations and prevent possi- Inquisitive language encourages and procedures to assure that
ble problems in the future with open communication, whereas they cover the alleged viola-
inconsistent stories. Whatever accusatory language will tend to tions.
Decide whether the offense In informing the employee of the the allegation of fraud and has
is historical or on-going. reason for dismissal, the employer, been consistent in applying dis-
if possible, should link whatever charge as a penalty, the employer
Address parallel issues of
fraud the employee committed should be on safe grounds to ter-
governmental intervention,
with one of the specific companys minate the employee. Although
shareholder derivative suits,
policies and procedures. This will this may not prevent an employee
and third party actions.
allow the employer to inform the from bringing an action, it should
Decide whether a final re- employee that the termination is a put the employer in a defensible
port should be written. reponse to a violation of a compa- position.
nys policy and procedure instead
Consider what steps should Even with the facts to support
of an undefined fraudulent act. the allegation of fraud and a con-
be taken as to disciplining the
Taking this approach reduces the sistent application of discipline to
employee or terminating the
possibility of falling into a trap of fraudulent acts in the company,
employee.
the legal definition of fraud and the employer should proceed with
Address public relations is- minimizing the risk of counter- caution if: (1) the employee makes
sues and possibilities of dis- suits. There should be documenta- an allegation of workplace or ex-
closing the fraud to the ap- tion of the meeting with particular ternal fraud either to a superior, a
propriate regulatory agency emphasis on what the accused ad- governmental or regulator agency,
or criminal agency.14 mitted or denied. or criminal agency right before
To whom does the investigator termination; (2) the employee
report? WHAT INVESTIGATORS claims that there was coercion to
Reporting to the correct decision- SHOULD KNOW ABOUT commit the fraud; or (3) the em-
maker in a respective area i.e. WHISTLEBLOWER LAW ployee was prevented from dis-
accounting, division head, presi- HR managers are aware of the var- closing the fraud through threats of
dent, etc. is essential to con- ious protected categories ranging dismissal by the company. Also,
ducting a fraud investigation. from age, sex, nationality, ethnici- the employer should be aware that
Embarrassment often accompa- ty, disability, and union activity. even though an employee com-
nies fraud investigation, especial- Recently, the issue of whistle- mitted workplace fraud, if the em-
ly by the one who might have blower protection has been in ployee subsequently discloses the
overseen the area where the fraud many national headlines. Since fraud to governmental or regulato-
was committed. The investigator employees are consistently increas- ry agency, the court might still af-
should make sure that the person ing their awareness of the protect- ford whistleblower protection to
to whom she or he reports is ed category of whistleblower pro- that employee.15
someone who will take action tection, HR managers should also During the interview stage of
pursuant to the investigations be aware of the changes to whistle- the fraud investigation process, an
findings and consistent with the blower protection in order to treat employer must be aware of the is-
companys policies and proce- employees with due regard to their sue of instructing the interviewee
dures. Just as promptness was im- appropriate rights and protect (the employee) about the expecta-
portant during the internal fraud themselves. tion of confidentiality of the inter-
investigation, promptness and ac-
Whistleblower status could pos- view. In 2002, Congress enacted
curacy is critical when reporting
sibly affect different stages of the the Civil Whistleblower Retalia-
to the decision-maker.
internal fraud investigation process tion Provision in the Sarbanes-
How to handle the actual including a decision to dis- Oxley Act of 2002 (the Act),
termination? charge an employee. When an which put employers on notice
After the completion of the inves- employer discharges an employee about terminating whistleblowers
tigation, if it is determined that an for fraudulent acts, the employee even in at-will employments at
employee has committed fraud, might claim that the real reason for publicly traded companies.16 The
the employee can be terminated the termination is not the alleged Act states that the company or its
immediately. The employee fraud, but due to the fact that the agents may not discharge, de-
should be told clearly and concise- employee is a whistleblower. If the mote, suspend, threaten, harass, or
ly the reason for the termination. employer has solid facts to support in any other manner discriminate
against an employee17 for any CONCLUSION 95 S. Ct. 976, 43 L. Ed. 2d 171 (1975), con-
formed to, 511 F.2d 1163, 89 L.R.R.M.
lawful act by the employee to dis- Companies must face the realities (BNA) 2192, 76 Lab. Cas. (CCH) 10829
closes fraud in the company. Thus, of workplace fraud. A companys (5th Cir. 1975). Also, unions might have
during the interview, the employ- legal responsibilities are increas- specific rights that affect the confidentiality
er must make sure that the compa- of the interviews.
ingly dictated by regulations from
9. Defamation is the act of harming the rep-
nys expectation of confidentiality many different governmental utation of another by making a statement to
on the part of the employee does agencies requirements. At first a third person. Blacks law Dictionary
not reach the point of threatening glance, conducting a workplace (1996).
or harassing the employee from fraud investigation might seem 10. In order to maintain an action for defama-
potentially making a disclosure un- tion, the employee must be harmed by
daunting, but in reality, it is only unprivileged publication of false and defa-
der a whistleblower statute. slightly different from any other matory information communicated to a
Employers should also be workplace investigation. As with third party. In general, there is no publica-
tion where the employer communicates the
aware of their respective state all investigations, preparation,
alleged slanderous statement to the employ-
statutory whistleblower protec- documentation, findings of credi- ee who then communicates it to a third
tion. While the general rule to at- bility, and conducting the investi- party. Yet, some courts have recognized the
gation in a fair and impartial man- doctrine of self-publication defamation as a
will employment is that an em- narrow exception to the rule requiring
ployee can be dismissed at any ner are the essential characteristics publication to a third party.
time, some states protect at-will of a thorough and successful inves- 11. In Porterfield v. Mascari II, Inc., 374 Md. 402,
whistleblower employees under a tigation. 823 A.2d 590, 19 I.E.R. Cas. (BNA) 1697,
public policy exception or statu- 148 Lab. Cas. (CCH) 59740 (2003), the
court found that an employee who alleged
tory scheme. For example, New that she was wrongfully discharged for im-
Jersey has a strict whistleblower NOTES: plying an intent to seek legal advice did not
state a claim for wrongful discharge. See al-
provision,18 and the courts have 1. Upper level managers might have contrac- so, endnote nine for a discussion of the We-
interpreted its whistleblower stat- tual rights of varying degrees, possibly in- ingarten rights.
cluding a right to company-paid represen-
ute to include retaliation allegedly 12. This topic is outside the scope of this arti-
tation. Also, employees might have certain
taken against an employee who cle.
rights addressed in endnote nine.
reports a co-employees fraud 2. 15 U.S.C.A. 1681 et seq. See also, Vail 13. The decision to terminate an employee
Opinion Letter from FTC Commission should take into consideration whether
without any company complicity there was a series of offenses or a single se-
Staff (April 5, 1999), at http://www.ftc.gov/
in the fraud.19 os/statutes/fcra/vail.htm. While the Opinion rious offense or other contractual obliga-
Letter refers directly to sexual harassment, tions. In the case of fraud, one instance
Lastly, employers should be should be enough for termination.
the statutes broad definitions include other
aware that various regulatory internal investigation conducted by outside 14. This list is not exhaustive but merely illus-
agencies are adopting rules and entities. trative. The specific issue of disclosure is a
regulations to implement the 3. 15 U.S.C.A. 1681. complicated topic and outside of the scope
4. This list is merely illustrative and not ex- of this article.
standards of the Acts whistle-
haustive. 15. When the whistleblower is involved in
blower protection. One in partic- 5. U.S. v. Automated Medical Laboratories, Inc., wrongdoing, courts have often excused the
ular, the Occupational Safety and 770 F.2d 399 (4th Cir. 1985); U.S. v. Cin- employees own misconduct. See, Paolella v.
Health Administration (OSHA), cotta, 689 F.2d 238, 241-42, 11 Fed. R. Ev- Browning-Ferris, Inc., 973 F. Supp. 508
id. Serv. 423 (1st Cir. 1982). (E.D. Pa. 1997), affd, 158 F.3d 183, 14
issued an interim final rule estab- I.E.R. Cas. (BNA) 705, 137 Lab. Cas.
6. If the internal investigations findings are
lishing the procedures and time insufficient to make a conclusion, the com- (CCH) 58505 (3d Cir. 1998).
frames for the handling of em- pany might rethink soliciting the advice of 16. Sarbanes-Oxley Act of 2002 P.L. 107-204,
ployee complaints to OSHA.20 an external source. 806.
Besides OSHAs interim final rule 7. Documentation of a fraud investigation is a 17. Sarbanes-Oxley Act of 2002 P.L. 107-204,
complex matter and beyond the scope of 806.
establishing the procedures and this article. 18. N.J. Stat. 34:19-3.
time frames for handling the in- 8. The current NLRB policy is that before an
19. See, Higgins v. Pascack Valley Hosp., 158 N.J.
vestigation by OSHA, its rules interview with an employee, the employee,
404, 730 A.2d 327, 15 I.E.R. Cas. (BNA)
and regulations also address the represented by a union or not, has the right
289 (1999).
to request that a co-worker be present at an
appeals of OSHA decisions to an investigatory interview if that employee 20. 29 C.F.R. Part 1980. This is the interim fi-
administrative law judge, hearings has a reasonable belief that the interview nal rule effective on May 28, 2003 of the
might result in disciplinary action. Epilepsy Procedures for the Handling of Discrimina-
by administrative law judges, and tion Complaints Under 806 of Sarbanes-
Foundation of Northeast Ohio, 331 NLRB
judicial review of the Secretary of No. 92 (2000); National Labor Relations Oxley Act.
Labors final decisions.21 Board v. J. Weingarten, Inc., 420 U.S. 251, 21. 29 C.F.R. Part 1980.

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