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Conflicts of Interest

What is occupational fraud?

Occupational fraud, or employee fraud, is fraud committed by an employee on an employer. They are more common and cause more financial loss to businesses than other third party frauds. As employees will continue to work at the business, they will generally try to hide these frauds permanently.

What is occupational conflict of interest?

A conflict of interest arises when an employee receives an undisclosed benefit in relation to a transaction he conducts for his employer, or where the employee is involved in a transaction that conflicts with his duties to his employer. It does not matter whether it directly causes a loss to the employer at that time - a conflict of interest arises from divided loyalties. An employee cannot serve two masters.

Why is a conflicted interest wrong?

The wrongdoing is related to a breach of trust more than an immediate financial loss. A conflict of interest arises when an employee uses his or her position to make or influence a decision on behalf of the employer, where the employee receives a benefit in some form. The result is that the employer will not obtain the goods or services at the most commercial price, or at the best quality, or under the best circumstances, and will ultimately suffer a loss.

Why doesn't there need to be an immediate loss to the employer?

A loss will usually be eventually suffered, but sometimes that loss is hard to determine at the time of the transaction. If the business buys widgets and the employee buys all the widgets from his wife's shop at the same price as other widgets on the open market, where is the loss?

The business will not be buying under competitive terms and may not always be obtaining the best price or the best quality. Without the supplier having to be competitive to obtain the orders, quality or service will eventually decline and/or price will eventually rise.

In fact, the employer does not need to suffer a loss at all. The fraud is centered upon the breach of trust by the employee getting an unauthorized benefit.

Must the interest be undisclosed?

Yes. There is no conflict if the interest is disclosed to the employer and the employer makes an informed commercial decision to enter into the transaction. Employees will generally not hide an interest if the transaction is commercial and they believe that the employer will approve of it. It is not uncommon for businesses to deal with parties related to employees. However, they must be conducted under commercial circumstances, and with full knowledge of the employer.

How does this differ from bribery?

They are similar but have one significant difference. Bribery entails the employee receiving something for promoting someone else's interest, not their own. The benefit to the employee is the receipt of the bribe. In a conflict of interest fraud, the interest promoted is not a third party's, but the employee's or an associate's.

How are conflict of interest frauds done?

They can occur when an employee buys or sells something on behalf of an employer or has the power to influence such a decision. There are four general places where this fraud occurs:

1. Sales to associated parties (sales schemes);
2. Purchases from associated parties (purchases schemes);
3. Diverting business to associated parties (business diversion);
4. Diverting the employer's resources for the benefit of an associated party (resource diversion).

What are a sales scheme?

This is where an employee sells a product to an associated party at a discount or a price that would otherwise not have been available. This creates a loss in revenue to the employer and the same amount of monetary benefit to the associated party. This problem is compounded if the employee also has the power to write off the debt owed by the associated party so that no money is received.

What are a purchase scheme?

This is where an employee purchases goods or services for his employer (and should do so on the best commercial terms) but favors a supplier in which they have a personal interest. There are three potential losses to the employer.

1. The good or service could be overpriced and the employer will pay too much, suffering an immediate monetary loss.

2. Quality could be less than expected for that price. The supply of substandard product or servicemay cause a loss in efficiency, effectiveness or quality. This may not immediately cause a monetary loss to the employee, but will damage efficiency and goodwill in the longer term and could cause rectification costs.

3. The employee or an associate may purchase an asset that the employer wants to purchase, and on-sell it on to the employer at a profit. If the ownership of the asset or the price paid for the original purchase is not disclosed, there is a fraud regardless of how reasonable the price to the employer. The loss arises as the employer could have purchased the asset for the original price without the markup.

What is business diversion?

It is not uncommon for senior employees to leave their employment and go into business on their own in competition with their old employer.What the employee takes with him and what he does prior to leaving may cause a conflict of interest.

An employee has a duty to act in the best interest of their employer while still employed. A conflict of interest arises when the employee takes product information or client listings, or tries to persuade clients to use his other business while still employed.

What is resource diversion?

Sometimes an employee will undertake some personal activity (write letters or make phone calls) on the employer's time and equipment. Most of this is overlooked by the employer, as long as it does not interfere with the employee's work. There is little real cost to the employer and the goodwill generated in employees may far outweigh any cost.

What if the employee was running a business from your premises and on your equipment? His attention would be divided between two causes. You would be subsidizing his other business and would suffer a loss. He would have a conflict of interest as he should be spending his work time acting for the employer, not to benefit personally.

FOR EXAMPLE

Example One

Mr S is a purchasing officer for ABC Manufacturers. Part of his role is to purchase industrial glue, a major item used in the manufacturing process. Mr. S sets up a business under his brother's name to supply glue to ABC. Mr. S has to decide whether he will supply the same quality glue at a higher price and risk someone questioning the increased cost, or whether he will supply an inferior glue at the old price.

He decides to supply an inferior quality glue at the price of the normal glue. ABC starts to incur rectification costs as the glue does not perform as it should, and suffers bad publicity due to their decreasing quality of product. Mr. S's brother gets a larger profit from the sales to ABC than would otherwise be obtainable from normal commercial dealings.

Example Two

Mrs. P is a salesperson for XYZ company, a wholesaler of widgets. Mrs. P has certain discretion on what discounts she can apply to orders for large orders. Her sister runs a retail outlet and purchases widgets from XYZ. Unknown to her boss, Mrs. P applies the greatest discount available to her sister's business, even though the orders do not justify the discount. XYZ losses revenues that it would otherwise have received.

LESSONS TO BE LEARNED

1. Employees do not need to remove or steal cash or other assets from a business to commit a fraud or cause damage to the business, they can do so while conducting their normal duties.

2. Losses occur when employees prefer their own or associated interests over the interests of their employer, though the loss may not be immediately evident.

3. The gain to the employee is the extraordinary profits from doing transactions that are not completely on commercial grounds.

4. The loss will usually be either:

(a) an increase in a purchase price or a reduction in a sale price;
(b) the loss of information; or
(c) obtaining supplies or services at a lesser quality than expected and the associated rectification costs.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Acknowledgment
The material in this Fact Sheet was sourced from various publications including those listed in the Reading List on the Fraud Awareness page on this website.

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Last Updated: 14.3.2008