When the hotline rings

By Roddy Allan
Illustration: Steve Adams

A company with a fraud hotline can reduce its fraud losses by half, not to mention learn where it is most vulnerable to wrongdoing

The news couldn’t have come at a worse time for the CEO of Superchairs Inc., a Canadian-based multinational manufacturer of expensive ergonomic office chairs (some details have been disguised for confidentiality). A few months earlier, Jake Mc-Kenna had convinced his board of directors to close down two plants in Western Canada and move production to its large facility in Malaysia. It was a bold decision, but one he felt would increase the company’s profits — until he was told of a phone call to Superchairs’ fraud hotline.

McKenna convened a small group of senior managers, including outside counsel and a forensic accountant, to review a transcript of the call. “Local management in Malaysia is not to be trusted,” the caller stated. “There is massive fraud at the plant. You are losing millions. They are laughing at you.”

Apoplectic with rage, McKenna wanted to find out who made the call, but the lawyer advised him to focus on the allegations and suggested the forensic accountant visit the plant to investigate. When he cooled down, McKenna agreed.

When the forensic accountant arrived at the plant, he was treated with respect and openness by the management team, all from Singapore. Following initial meetings with management and discussions with workers in the plant — during which the forensic accountant sensed a level of animosity between the local workers and the Singaporean managers — he began reviewing the plant’s books and records. Nothing seemed wrong, so he scheduled more meetings with senior managers, from whom Superchairs had acquired the plant a few years earlier.

During a break in one of his meetings, the forensic accountant noticed a large conveyor belt loading scrap metal onto a truck in the far corner of the yard. “What’s that?” he asked. An evasive response made him suspicious and led him to investigate. He discovered that the managers were selling scrap metal from the plant to a local dealer with criminal ties. By the time the investigation was concluded, the forensic accountant reported to management in Canada that close to $1 million of scrap revenue was being lost every year. The scrap proceeds were paid to the Singaporean managers in cash and were not accounted for: the bank account to which the funds were deposited was not in the company’s name nor on its balance sheet.

Thanks to the anonymous call to its hotline, Superchairs was able to detect, investigate and ultimately end a fraud. It was another example of the effectiveness of fraud hotlines, which have become prevalent in the wake of the Sarbanes-Oxley Act (SOX). The onus is now on companies and governments to provide whistleblowers with a means of communicating their concerns.

Under Section 301 of SOX, the audit committee of a publicly traded company must provide a mechanism for employees to remain anonymous when reporting concerns about accounting or audit irregularities. The audit committee also has to provide a process for the receipt, retention and treatment of complaints regarding financial irregularities. In Ontario, under Bill 198, the government proposed a similar requirement. Known as MI 52-110, publicly traded companies under the jurisdiction of the Ontario Securities Commission have to establish a confidential and anonymous process for the receipt and treatment of complaints by employees regarding questionable accounting or auditing matters.

For most publicly traded companies one of the most effective means of fulfilling these new requirements is through an external hotline operated by one of many service providers throughout North America. Although some companies set up their own hotline, they need to ensure the system is not only free from any management interference but also has the appearance of being at arm’s length from the company. If it doesn’t, it might not meet the regulatory requirements, and it may not win the trust of employees or others who use the hotline.

Beyond any regulatory compulsion to establish a fraud hotline, there are many reasons for companies, public and private, to consider setting up this kind of resource.

The most obvious is it can help reduce their losses to fraud. According to a 2002 study by the Association of Certified Fraud Examiners, a US-based international organization, companies with fraud hotlines cut their fraud losses approximately in half. The study also found that companies with hotlines suffered median fraud losses of US$77,500 compared with median losses of US$150,000 for companies without hotlines.

The city of Toronto established a fraud-and-waste hotline — the only one of its kind in Canada — three years ago. In January, Auditor General Jeff Griffiths reported that his office had investigated 347 cases, up 73.5% from the 200 reported in the year to August 2003. One anonymous tip led to criminal charges against a property manager for misappropriating $65,000. Another led to the end of a $120,000 scam with the arrest of a member of the public who was selling replicas of the city’s yellow garbage bags used by commercial customers.

Not only has the city recovered money as a result of hotline tips, the calls have contributed to the implementation of 21 recommendations by the auditor general to improve the city’s internal controls.

Most hotlines offer employees (or anyone who makes use of the line) the option of speaking to a trained interviewer on a 24-hour basis, 365 days a year, leaving a message on a telephone answering machine or filing a complaint through a website. According to leading hotline provid- ers, this latter method is becoming more attractive to complainants than the telephone option. One reason is that some complainants are more comfortable using a website than speaking to a live interviewer. An online component is particularly of value to companies that conduct business in offshore locations, where English is not the local language.

A prominent US company used a website to communicate with a disgruntled employee who called a hotline alleging that a current manager was receiving kickbacks from contractors in return for selecting them to provide lucrative services to the company. The complainant made it clear that unless the company took action, she would take her allegations to regulators, the company’s board of directors and the media.

The company took the allegation seriously and quickly provided the complainant with a password for a secure website where the company would provide limited information concerning its response to the allegation and also be able to request further information from the complainant. Through this method, the company was able to have an anonymous and private communication with the whistleblower, a process that continued until the investigation — which proved the allegation to be true — was completed.

In addition to helping detect and prevent fraud and theft (as well as other serious matters such as ethical and compliance violations, workplace violence and sexual harassment), hotlines can also provide valuable insight as to where companies are most susceptible to wrongdoing.

One national company, for example, noticed that several tips received on its hotline dealt with incidents involving the manipulation of its inventory system at different locations across the country. The common denominator was the nature of the manipulation, which led to the discovery of a weakness in a recently implemented system. Not only was the company able to prevent an ongoing fraud, it also fixed the problem to prevent future occurrences.

Another, less obvious, benefit of a hotline is that it can serve as a safe and controlled outlet for an employee, supplier or other complainants to release their anger or frustration over what they perceive as wrongdoing within the workplace. If there is no structured means for them to vent their feelings, they could resort to such solutions as personally taking action against a perceived fraudster, or possibly deciding that if one employee can get away with fraud then why shouldn’t they do the same?

In considering a hotline, small private companies should be aware of a study by William S. Laufer, associate professor of legal studies at Wharton School at the University of Pennsylvania. He found that of all corporations convicted of unethical business practices in US federal courts, more than 90% were small businesses and more than 95% were privately held. In 2000, 72% of the companies prosecuted in federal courts were ordered to pay fines, according to the US Sentencing Commission, with the average fine being almost US$1.6 million, plus legal costs. In other words, although the onus is on large public companies to establish fraud hotlines, the need for them would appear to be equal, if not even greater, at smaller, private firms.

Although costs will likely be a factor when determining what kind of hotline to select — it’s estimated a hotline costs between US$1 and US$2.50 per employee — it is generally accepted that the most effective hotline is one operated around the clock by skilled interviewers. One reason is that approximately 50% of calls to hotlines occur outside of regular office hours. Another is that callers (or people who write letters or use a website) are often unclear or provide incomplete information. A two-way conversation with a trained interviewer can help clarify the exact nature of the concern.

It’s also interesting to note that while SOX and Bill 198 emphasize the need for companies to establish an anonymous process, about half of all hotline callers willingly offer their names and contact information.

Once the decision to set up a hotline is made, the next step is to make sure everyone within the company is aware of its existence and how it works. Just the fact that the hotline exists can act as a deterrent to fraud and other wrongdoing. As well, companies should evaluate the program on a regular basis to determine if it’s working and whether improvements need to be made. Lastly, one of the most important steps is to keep employees up-to-date on the success of the hotline. If everyone knows a bad apple was fired or prosecuted thanks to a hotline tip, the hotline is likely to be seen — and therefore used — as one of the best ways within a company to expose wrongdoing that may otherwise have never been detected.