Dealing with employee theft and fraud

Employee theft and fraud is often perpetrated by a trusted senior employee. It can take many forms.

It may involve fictitious suppliers, inflated supplier invoices, sham invoices, inventory theft, secret payments, fraudulent payment of money to accounts and the overpayment of employee wages and entitlements. The misuse of sensitive business information, intellectual property and diversion of business may also occur.

Typically, in a misappropriation matter, the perpetrator exploits a gap in the system that is lacking management overview and review. The manipulation of data and false reporting to hide the activity often occurs. The fraud may take place over a long period, initially at irregular intervals and for smaller varying amounts that increase over time.

To guard against employee fraud, the implementation of appropriate policies and procedures is important. Building checks into the system with compliance monitoring is critical.

The discovery of fraud sometimes occurs through an external audit or a due diligence process. Key performance indicators may be at variance with historical results or industry norms, raising a red flag. Sometimes a suspicious co‑worker is the catalyst for an investigation that uncovers the fraud.

First priorities

When concerns are raised about a potential employee fraud, the first priority is to lock down systems and safeguard information.

A difficult threshold issue is the risk of putting the employee on notice before completing an investigation. Correctly handling the employee investigation, any show cause and termination is imperative.

You should check your insurance policies to see whether you have any cover and what notice needs to be given to your insurer.

When investigating the fraud, consider whether you should engage solicitors to appoint external forensic investigators. Other investigations commonly include the carrying out of property and company searches and monitoring of the real estate dealings of the employee.

Recovering the loss

The legal demand seeking recovery will normally follow the employee termination.

In some cases, you might have a caveatable interest entitling you to lodge a caveat over property owned by the employee. A caveat freezes the title of a property preventing it from being sold.

It is important to obtain legal advice before lodging a caveat because you can be liable to pay court costs and damages if you wrongly lodge a caveat. Sometimes the employee may agree to provide a consent caveat or a written undertaking not to deal with the property.

Depending on the circumstances, it may be appropriate to seek a court order, known as a ‘freezing order,’ to prevent the disposal of, or dealing with, assets. The purpose of a freezing order is to preserve the status quo pending a trial. It is not to provide security for a judgment. On a freezing order application:

• you would need to show a reasonably arguable claim on the factual and legal matters and that there is a real or substantial risk the assets will be disposed of or diminished in value pending a trial
• the person seeking a freezing order is required to provide an undertaking to pay damages
• the court can make ancillary orders requiring the disclosure of information, such as the nature, value and location of assets.

In matters involving intellectual property rights or business diversion, seeking an injunction pending a trial may be the preliminary relief sought. Search orders may be able to be obtained to enter premises to inspect, remove or make copies of documents or computer records. The court also has power to order a third party to disclose information that may assist to identify the persons involved in the wrongdoing.

A third party may be liable to pay compensation in certain situations, for example:

• where misappropriated money is given by a thief to a third party (who received the money as a volunteer)
• accessorial liability, where the third party knowingly received a benefit from the breach of fiduciary duty or where they knowingly assisted the person in committing the breach of fiduciary duty.

A brief illustration

In a recent court case, an employer sought compensation against its former employee and the former employee’s company. The employee was a senior employee who assisted in the creation of false invoices where a supplier rendered invoices to the employer for work not done or where work performed was charged at rates that exceeded the agreed contract rates.

The supplier then made secret payments to the employee’s company. The supplier was in liquidation. The employee’s company was said to be a ‘one-man’ company and was held to be the alter ego of the employee, with the employee’s knowledge imputed to his company.

The amounts received by the employee’s company was the product of the employee’s breach of fiduciary duty: not to use your position for profit or personal gain and not to put yourself in a position of conflict with your employer. The court held that the former employee was liable to account for the profits received and his company was liable to account for the benefit knowingly received in breach of the employee’s fiduciary duties.

Employee fraud can occur in many forms varying in complexity and sophistication. The civil recovery action will depend on the nature and extent of the fraud and largely the response of the employee and of any third parties involved.

If you would like more information about these issues, please contact partner Graham Roberts on +61 7 3231 2404.