James Madison, fourth President of the United States and one of the drafters of the Constitution, famously said that no limits on government would be necessary if we were ruled by angels.  Of course, we know better regarding the human capacity for wrong-doing.  Yet when academic advisers to management write about how leaders should exhibit great trust, it is almost as though they think that all employees and co-workers really are angels.

One example is the July 2017 Harvard Business Review article “Want Your Employees to Trust You?  Show You Trust Them,” by Professors Holly Henderson Brower, Scott Wayne Lester, and Audrey Korsgaard.  The authors extol at length the productivity benefits of trusting employees, blame managers for the fact that many employees say they do not feel trusted, and state that “the onus to grow mutual trust is on the manager.”  They recommend risk-tolerant policies and hedge their advice only by advising that employees be shown “prudent, incremental trust,” whatever that means.

Could we be suffering from an epidemic of excessive management oversight, not detected until now?  The facts suggest otherwise, which our authors do not address in this rather utopian view of employees.

First, there are the widely familiar annual survey numbers on employee engagement in the U.S., which say that eight to 10% are actively or fully disengaged, with higher numbers in other countries.  That is a significant percentage of employees who should not be trusted with much of anything.  Unfortunately, they are not always easy to identify because they may be very energetic and busy, while furtively pursuing their own agendas as well as undermining yours.  Once they are identified they need to be turned around or dismissed.

Annual worldwide loss due to employee fraud is estimated to be $4 TRILLION!

Secondly, anyone advising management on employee trust needs to be aware of the Report to The Nations: 2018 Global Study On Occupational Fraud And Abuse from the Association of Certified Fraud Examiners (AFCE).  According to the report, annual worldwide loss due to employee fraud is estimated to be $4 TRILLION!  This astonishing number represents 5% of annual revenues of all organizations, for-profit and not-for-profit, in all industries.  The report breaks down the 2,690 cases studied in 125 countries between 2016 and 2017, costing over $7 billion, which cases are estimated to be a small but representative sample of the total.

The AFCE definition of fraud covers everything from outright theft of cash or inventory to misappropriation of funds, kickbacks, and falsification of financial reporting of all kinds.

Here are some of the more salient details from the report:

  • The median loss in the U.S. from a case of employee fraud is $108,000; essentially the mid-point in the list of loses. No industry sector is exempt.
  • In the U.S., the median loss per case for companies of fewer than 100 employees is almost twice as much, $200,000.
  • Fraudsters who had been with the organization five years or longer stole twice as much, $200,000 versus $100,000, as those with less than five years longevity.
  • While the median loss for all cases in the study was $130,000, the average was $2.75 million, the total loses divided by the number of cases. This does not count damage to reputation and goodwill or lost opportunity.
  • Executives and owners accounted for only 19% of cases of fraud, but their median fraud cost is nearly seven times the overall number—$850,000.
  • As might be expected, most cases of fraud by corruption, in which organizational position is used for personal gain at the expense of the employer, were perpetrated by someone in authority.
  • The most common and therefore most costly types of fraud are tampering with checks, payments, and billing; and outright theft of noncash assets.
  • A large number of fraud scheme types continue for two years or more before being detected. Some last over five years and are the most costly.

How do you protect yourself?  The short answer is to be alert for “red flags,” many of which are listed in the report as being the precursors of fraud.  The following are among the top ones in a long list:

  • Employee is living beyond his or her means
  • The relationship with a vendor or customer is unusually close
  • Personal financial difficulties have arisen
  • Employee exhibits a “wheeler-dealer” attitude toward business
  • Defensiveness, irritability, suspiciousness
  • Unwillingness to share duties, including refusal to go on vacation
  • Addiction problems
  • Complaints about low pay.

Beyond watching for red flags, various anti-fraud controls are recommended.  They include:

  • Anti-fraud tone from the top
  • Codes of ethical and professional conduct
  • Proactive data analysis and review
  • Surprise audits
  • Management review
  • Hotlines for reporting violations or suspicions
  • External audits.

According to the study, when a defrauded company has these controls in place, the median duration of the fraud is from 33% to 58% shorter than for victim companies without these controls.

The danger of the utopian view of placing trust in employees is that it will induce leaders to ignore red flags and neglect the establishment of sound, anti-fraud business practices.  It may even stimulate a sense of guilt for just thinking of establishing such practices and fear of being seen as cynical, paranoid, risk-averse and just not “cool.”

As the ACFE report says, most employees will never commit fraud.  However, one might also have said to James Madison that most government officials will never abuse their power.  History shows that the few who will violate their trust if given the chance can destroy a society, government or organization.  As a leader, you are entrusted with protecting your company assets, even if you are the owner. Living up to that trust is to fulfill your fiduciary responsibility.  Doing so will not alienate your employees if you explain your reasons; on the contrary, it will increase their respect for and trust in you.

In an earlier newsletter article, https://mulkernassociates.com/leadership/trust-engine-ascent/, we emphasized the importance of leaders gaining the trust of their employees, but also the fact that trust has to be earned.  The same goes for employees—the onus is on them as well, not just managers.  To put all of the responsibility on the leaders as the HBR authors and other management gurus do, is to imply that employees are, if not like angels, like children with little capacity for human agency and whose character and behavior we as very clever managers can shape to our purposes.  This is elitist arrogance masquerading as deep humility.

How do you decide who to trust in your team and based upon what?  It is not a question of positive image, who you might like the most, or what feels “prudent.”  The bullet points below can serve as a check list, and you can add others.  Trust-worthy employees…

  • Go beyond what is required and show initiative to offer solutions and bring to your attention new opportunities
  • When delegated new projects, check in carefully to make sure they are on track with your requirements
  • Are open to feedback and actively search it out
  • Keep their promises
  • Show great discretion with sensitive and confidential matters
  • Neither start nor participate in gossip
  • Are willing to be objective about their own team’s performance
  • Make efforts to be clear on your priorities and objectives and are flexible when they change
  • Help both you and other team members to succeed
  • Do not engage in “malicious obedience” but have the guts and commitment to tell you when they think your direction is off course
  • Own up to mistakes
  • Sometimes point out their own mistakes that you might never have detected
  • Do not lie, fudge, or cover-up
  • Treat all others with decency and respect, regardless of position, title, income, or status
  • Focus more on achievement of the company’s goals than on who gets credit.

If someone who works for you complains that your trust in them is insufficient, hear them out, discuss your possible short-comings, and then hand them this list on how to earn your trust.  Ask them to carefully review it, and then come back and discuss where they could improve.  They will appreciate your clarity on what it takes to move ahead and will more likely reward you with greater loyalty and trust—if they are trustworthy.

If you would like an electronic copy of the ACFE report, email me with a request at ajmulkern@sbcglobal.net .