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									 The following article was published in the May 2004 issue of The Informant, a bi-monthly publication for
 members of the Illinois Chapter of the International Association of Investigation Units.

Investigating an Employee Dishonesty Claim
By Jim Howe, CPA, CFE – Hutton, Kruse & Fink, Ltd., Buffalo Grove, Illinois
Daniel Nolan, Esquire - O'Hagan, Smith & Amundsen LLC, Chicago, Illinois

  Based on the results of a study performed by the          independent contractors and others may be covered
Association of Certified Fraud Examiners and                by a separate coverage or policy.
reported in their 2002 Report to the Nation -
Occupational Fraud and Abuse, the organization                The purpose of this article is to discuss some of the
estimated, at that time, that six percent of revenues       information that should be gathered during the
are lost as a result of occupational fraud and abuse.       objective investigation of an employee dishonesty
Applied to the U.S. Gross Domestic Product, this            claim. The initial goal is to determine whether or
translates to losses of approximately $600 billion, or      not the claim can be sufficiently documented and if
about $4,500 per employee at the time the report was        so, whether the preponderance of the evidence
issued.                                                     supports the conclusion that the suspected employee
                                                            is most likely responsible for the claimed
  Insurance companies offer employee dishonesty             misappropriation(s).
coverage and pay a good portion of the billions of
dollars stolen annually from insured employers by
employees. Once an employer has been paid, the              Employee or Independent Contractor?
respective insurer often attempts to recover their
payment from the dishonest employee (depending on              One of the easiest ways to determine that a
the policy limit and the amount of theft). This is          suspected individual is an employee is to ask the
referred to as subrogation.                                 insured for evidence that, in administrative and tax
                                                            matters, the individual is treated as an employee.
  To be successful in recovering a payment from a           One key document is the most recent Federal Tax
dishonest employee in a civil trial, the plaintiff          Form W-2: Wage and Tax Statement, which should
insurer must prove by a preponderance of the                show the insured as the employer and the suspected
evidence that the defendant caused the plaintiff            individual as the employee. According to the
injury, in this case a financial injury. The plaintiff      Internal Revenue Service, an employer must
must show the facts are more than 50 percent in their       withhold income taxes, social security taxes and
favor as opposed to the defendant’s favor. It is the        medicare taxes for an employee and this information
duty of the individuals investigating the claim to          must be reported to the Internal Revenue Service and
develop sufficient facts and evidence such that             the employee on an annual basis on Form W-2.
counsel for the insurer can easily establish, by a          Therefore, if you are provided a Form W-2
preponderance of the evidence, that the defendant           indicating the insured is the employer and the
owes the plaintiff.                                         suspected individual is an employee, you can be
                                                            certain that the suspected individual is being treated
  The most important part of any insurance related          as an employee of the insured business. Depending
employee dishonesty investigation is verifying that         on the situation, you may want to verify that the
the suspected individual is an actual employee of the       Form W-2 the insured provided you was actually
insured business. The employee dishonesty policy            filed with the Internal Revenue Service and was not
covers only thefts by employees.          Thefts by         created by the insured in an attempt to falsely

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document the claim. Reference to payroll registers      specific individual in order to be covered under the
will also corroborate the employment issue. A copy      employee dishonesty policy.
of the Form W-2 actually filed by the employer can
be requested by using IRS Form 4506.                      First, you should learn what the suspected
                                                        employee’s job responsibilities were, which allows
  If the suspected individual is an independent         you to determine what financial records the
contractor and not an employee, the insured would       employee had access to and how the system of
be unable to provide a Form W-2. The amounts paid       financial records can help in your investigation of
to an independent contractor by a business are          the theft.
reported to the Internal Revenue Service on Form
1099. If the insured provides you a Form 1099 in an       To isolate the loss to an employee, you should
attempt to satisfy the request for a Form W-2, you      review the financial records before and after the
know the suspected individual is being treated as an    employee’s employment to determine no thefts were
independent contractor and not an employee.             occurring.

  As an example (based on an actual case), the            In order to successfully isolate the theft to an
employee versus independent contractor issue            employee, you must determine that the thefts only
surfaced in the following manner in the investigation   occurred on days the employee worked and thefts
of an employee dishonesty claim involving a             did not occur on days the employee did not work.
dentist’s office. An individual had worked full time    You also must determine that the employee’s job
at the same dentist office for about 5 years as the     responsibilities provided them the opportunity to
office manager. The individual was suspected of         steal and, if applicable, manipulate the financial
stealing $17,000 in cash receipts over a 5-month        records.
period. The insured submitted a claim to the
insurance company under the employee dishonesty
coverage of their policy. In the initial document       Obtain Information from the Suspected
request to the insured, a request was made for the      Employee
suspected individual’s most recent Form W-2. The
insured provided a Form W-2, however the insured        Before rendering a conclusion regarding the validity
was not listed as the employer on the Form W-2.         of the claim for misappropriations by a suspected
When questioned about this, the insured indicated       employee, it is recommended (when possible) to
that they lease their employees from an employee        obtain information from the suspected individual.
leasing service. The insurance company concluded        This may be accomplished by obtaining police
that the claimed theft was not covered by the           reports and/or interviewing the reporting officers,
employee dishonesty policy, denied the claim and        obtaining copies of signed statements and
closed the file. Although the individual appeared to    confessions or conducting interviews or obtaining
be an employee, they were actually an employee of       testimony from the suspected individual. This
the leasing company.                                    information may tie up loose ends and lend support
                                                        for the claim or may provide evidence that what
                                                        appeared to be a loss to the insured is actually not a
Isolation of the Loss to the Suspected                  loss at all and may be explained by other information
Employee                                                provided by the suspected individual. Further
                                                        information may be obtained from a combination of
  Another important part of an employee dishonesty      sources, including insurance personnel, attorneys,
investigation is isolating the theft to a specific      police or forensic accountants.
individual. Once the insured has provided financial
documentation supporting assets were stolen from
the business, you need to isolate the theft to a
                                                Page 2 of 3

The investigation of employee dishonesty claims
varies from insured to insured because no two
businesses operate exactly the same way. Each
business has a structure and record keeping system
that is unique to the business and its industry. The
preceding information should serve as a basis for
beginning the investigation of an employee
dishonesty claim. The initial goal should be to
objectively determine whether or not the claim can
be sufficiently documented. If so, your ultimate goal
should be to convince a jury in a civil trial by the
preponderance of the evidence that the suspected
employee is the individual responsible for the
claimed misappropriations.

 Jim Howe, CPA is a Manager with the forensic
 accounting firm of Hutton, Kruse & Fink, Ltd. in
 Buffalo Grove, Illinois. The firm investigates a
 variety of claims involving employee dishonesty,
 financial motive and other fraudulent claims and
 has Certified Public Accountants and Certified
 Fraud Examiners on staff.      The firm may be
 reached at hkf@hkf-cpa.com or (847) 419-0369.

 Daniel Nolan is a senior associate with O'Hagan,
 Smith & Amundsen LLC, one of Chicago's largest
 litigation firms. Dan concentrates his practice in
 the areas of insurance coverage, extra-
 contractual and property litigation. He can be
 reached at dnolan@osalaw.com or (312) 894-

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