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Luis Ramos
CEO
The Network, Inc.

Editor's note: Each month, we ask a Directors & Boards reader to comment on critical issues facing directors today. If you'd like to participate in this section in the future, please email Scott Chase.

What sectors are most hard hit by employee fraud and misconduct in economic downturns?

During 25 years in the corporate compliance business, we’ve learned that no industry is immune to acts of fraud and misconduct. It seems to cut across all sectors and organizational demographics. But lately, we’re definitely seeing more evidence that suggests a link between the economic downtown and spikes in fraud.

Research by our company certainly points to an increase in reporting of fraudulent behavior. We publish a bi-annual benchmarking report, and the 2009 version, which was just released, looks at hotline reporting among our client organizations over a five-year period. This report showed the highest year over year increase of fraud-related reports in retail trade and the finance, insurance and real estate industries. This is in line with what one would expect as these industries have been hit particularly hard in this downturn.

In addition to the industries mentioned, the report showed an alarming increase in the number of fraud-related reports (issues like corruption, misuse of corporate assets or information, conflicts of interest, FCPA violations, etc.) across all industries rising from 10.9 percent in the first quarter of 2006 to 21 percent in the first quarter of 2009. We don’t expect improvement in the short term, but we do see a lot of variability across organizations within an industry--the ones that fare the best have an ethical culture where employees are clear about their company’s commitment to an honest workplace.

What steps should directors and boards take to combat employee fraud and theft?

There are both tactical and strategic steps that directors and boards should take to combat employee fraud and theft. The first, a more strategic role for leaders and upper management, is to demonstrate their commitment to an ethical workplace on a regular basis and consistently exhibit the kinds of behaviors they want to instill in their employees. They should communicate about behavioral expectations in both internal- and external-facing messaging. Words like trust, honesty, values are part of the corporate vernacular in an ethical company.

On a more tactical front, directors and boards can ensure that their employees have the resources and tools they need to do the right thing when it comes to their own actions and to speak out against unethical activity by others when they see it. This includes readily-accessible hotline programs, user-friendly codes of conduct and ethics training that’s relevant to their employees and the kinds of issues they face on the job.

In addition, many organizations incorporate incentive programs for those making reports or for those with information that leads to actionable consequences. This shows employees and other stakeholders that you are serious about stopping fraud and other forms of misconduct. These types of investments in combating fraud and theft and building an ethical workplace can deliver real dividends, not only in terms of fewer incidents of fraud, but also in terms of real dollar savings.

Why do you think there is an increase in fraud reports?

I believe that there are a number of factors at play and that these factors are working in concert to drive increased reporting of fraud. The primary factor seems to be that as the economy has slowed, fraud has actually increased. We see evidence of this in the numbers published in a recent Kroll study, which shows that the average cost of fraud of the preceding three years is now $8.2 million and that this number is up 22 percent over the prior year. Of course, the scarier part of this number is that it is a trailing look a fraud costs and will likely spike higher.

Another key factor, however, is that those employees who are not committing fraud are seeing the state of their companies, rising unemployment rates and corporate failures and feeling the need to speak out against unethical and illegal acts that may pose threats to their companies. They’re being proactive in terms of mitigating risk in order to protect their jobs and secure their companies’ futures. It seems that the same catalyst, an economic downturn, is simultaneously driving both more fraud and a greater willingness to speak out against fraud.

How can directors leverage whistleblower and ethics hotlines to prevent an employee fraud spike within the corporation?

In order for whistleblower and ethics hotlines to be effective in preventing an employee fraud spike, directors and boards need to ensure the hotline program is much more than a simple telephone line; the hotline needs to be part of a larger drive to build an ethical culture. The Ethics Resource Center (ERC) found that the strength of an organization’s ethical culture offers the greatest reduction in ethics risk, reducing misconduct to roughly one-third to one-half the rates experienced by companies with weak ethical cultures. With that in mind, I would encourage directors to communicate well and often about doing the right thing, making sure employees at every level know how and when to use the hotline. Make the hotline available 24/7 through both phone and Web to make it easy for stakeholders to speak up. Notice I used the word “stakeholder” – the best working hotlines are made available not just to employees but to vendors, sub-contractors and others who do business with your employees.

Also, make sure everyone understands what happens after a hotline report is made. According to an ERC survey, roughly half of the people who did not report witnessed misconduct were skeptical that their report would make a difference and more than a third feared retaliation from at least one source. By outlining what happens once a report is made, you not only encourage employees to come forward, but also help to dispel their fears about reprisals.

Finally, I would encourage directors to benchmark their hotline activity to help assess their organizations’ ethical health. Benchmarking data can help them compare their hotline activity against organizations, identify where gaps may exist and introduce any critical internal controls going forward to prevent acts of fraud or other misconduct before they happen.

Luis Ramos became CEO of The Network, Inc. in early 2009. In this capacity, he is responsible for the overall strategic direction and leadership of the organization toward the achievement of the company’s vision, strategic goals and financial objectives. In addition, Mr. Ramos oversees all functional areas of the organization including operations, IT, finance and sales.

Prior to this, he has held positions as Chief Operating Officer, Sr. VP of Operations and Technology and VP of Risk Management Services. Mr. Ramos was critical in the development and launch of The Network's proprietary application, NetClaim™, which standardized all reporting services and created scalability for highly customized reporting programs. NetClaim has enabled The Network to develop intricately tailored reporting solutions that use real-time quality assurance to maintain exceptionally high accuracy levels. Mr. Ramos is a 10-year veteran of The Network, which he joined after stints at ADP and Crawford & Company. His writing has been featured in National Underwriter Magazine and Risk Management Magazine.