A flag used as a sign of danger:
You’re not allowed to swim when the red flag is flying.
7 ‘red flags’ for fraud and corruption
From the point of view of organisational culture, there are seven signals that can reveal an increased risk of integrity violations, such as corruption and fraud, within an organisation. We have established this based on an analysis of twenty-five cases in which violations occurred. The flaws in an organisational culture can ensure that violations take place sooner, are noticed less quickly, do not lead to countermeasures and can therefore develop. These red flags are discussed in this article. Knowledge of the red flags enables organisations to identify integrity risks at an early stage and provides input for the moral development of the organisation.
7 red flags: increased risk of fraud and corruption ■ Alex Straathof & Erik Essen & Wouter Smit
For decades, Volkswagen was known as a company with a reliable image and robust cars. Until September 2015, when it became known that emissions tests had been manipulated with sham software. The company’s reliable exterior proved to be in stark contrast to its fraud-prone corporate culture. Managers hardly dared to approach the demanding and hard-line chairman of the board, Winterkorn, and certainly not when it came to bad news. Volkswagen was characterised by a culture of fear. Employees prioritised job retention and meeting the demands of higher management. Ethical considerations turned out to be of less importance here. Raising sensitive issues and critical dissent were not tolerated and could even lead to dismissal. Internal problems, such as the enormous performance pressure, therefore remained under the radar. The top management’s focus on results translated into aggressive growth strategies and unrealistically high targets. Signs of software manipulation did exist internally, but were ignored due to the closed nature of the culture. The groupthink that was present, combined with a strong power distance, made employees choose not to report it, to downplay the signals of manipulation of the emission tests or simply to deny them.
7 ‘red flags’ for fraud and corruption
In recent years, various organisations have been embarrassed by fraud and corruption scandals. The diversity of organisations involved is striking. It is not only about the fast boys of the financial world and the real estate sector; it is also about sports clubs and organisations with public tasks, such as housing, care and the supervision thereof. Despite the large differences, similar patterns can be recognised. These patterns become visible by making an analysis of the inner world of the organisation, the organisational culture. Organisational culture involves the shared values, beliefs and behaviours within the organisation that are shaped by the group dynamics and (in)formal power relations present (Schein, 1992; Straathof, 2009).
For this study, cultural analyses were performed on twenty-five organisations where a violation had taken place. What emerged? The analysis of Volkswagen’s organisational culture shows striking similarities with other organisations where violations took place. Comparisons between twenty-five separate case analyses led to the identification of seven cultural flaws for the occurrence, continuation and spread of integrity violations. These cultural aberrations – defined as ‘red flags’ – are explained in this article. The cases vary widely in terms of organisational form, size and type of organisation (profit and non-profit). This implies that red flags are not tied to a specific organisation or context, but have significance for different organisations in different environments. Knowledge of the red flags is important in order to identify integrity risks at an early stage, so that further escalation can be prevented with appropriate measures. The red flags are shown and defined in the figure and accompanying text below, with an example being worked out first.
1. Power distance: Large difference in perceived power between (groups of) people. Influence is highly concentrated and those in power put pressure on employees to achieve goals without tolerating dissent.
2. Isolation: An organisational unit functions physically, emotionally or socially separated from other organisational units. Group norms can slip away and are imitated in behaviour by limited present correction mechanisms from the environment.
3. Secrecy constructs: Actors involved in a breach use the lack of openness and transparency to conceal non-independent actions and avoid the appearance of such actions. Information sharing is very limited.
4. Ring of silence: People have knowledge or signals about violations, but shield this from other employees. The limited room for discussion or critical questions means that (morally) sensitive subjects and conflicts are generally avoided.
5. Incorrect role model behaviour: the manager is a negative role model, does not attach enough value to integrity and does not intervene when there are signs of abuse. It blocks moral development and gives the impression that violations are permissible.
6. Weak operational management: The organisation is not capable of identifying violations, adequately intervening or consistently sanctioning them. Administrative organisation and internal control are weak and ethical standards and values are not sufficiently embedded in daily practices.
7. Results-driven: There is an intense desire to succeed, no matter how. Unethical behaviour then concerns an effective way of achieving goals and may be necessary to secure one’s own position or that of the organisation.
1. Power distance
Vestia CEO Staal, acting as the sole director of this housing corporation, decided almost everything alone. Because of his intimidating appearance, nobody within Vestia liked to have a deviating view. The almost blind trust in Staal led to supervisors remaining uncritically at a distance and hardly offering him any counterweight. Staal increased his freedom of action by selecting favourable commissioners from his own network, which created a close relationship between controller and controlled. More than once, Vestia under Staal has been characterised as a large one-man business. Power distance implies a large difference in the degree of formal or informal power within the organisation. The casuistry showed that some directors enjoyed an almost blind trust from co-decision-makers and supervisors. Often, a dominant, oppressive and manipulative leadership style is used and critical dissent is not tolerated, which increases their freedom of action within the organisation. This gives room to abuse the power position and force employees to move in a direction that is favourable to them. Under such power conditions, people often do not consider themselves capable of resisting (Hannah et al., 2013).
Rabobank’s Libor traders operated in an isolated branch in London. They had little contact with other staff and showed little concern for the rest of the organisation. As long as the money was being made, the traders were not looked after. Due to a combination of lack of knowledge among Rabobank managers at the head office in Utrecht, the complex work processes and poor supervision, this group was able to set up a fraudulent system of interest rate manipulation and thereby benefit themselves. A feeling of ‘we are not looked after’ leads to a stronger mutual identification, the development of group norms and appropriate group behaviour. Involvement in and loyalty to the organisation decrease. The top of the organisation hardly feels responsible for the isolated group and takes its hands off it, as long as no complaints or visible problems arise. The group experiences this as disrespect and feels insufficiently recognised by the top. Such perceptions of injustice increase the likelihood of unethical employee behaviour (Treviño & Weaver, 2003). Because control and supervision are often limited, the chance of correction is limited. This gives room for local management to ignore directives from the top of the organisation.
3. Secrecy constructions
A group of civil servants from the Department of Sewerage and Water Management in The Hague had a particular style of bringing their wishes to the attention of well-known contractors. They were happy to be fêted, in exchange for the award of future contracts. The hands-on mentality of these officials and their aversion to paperwork meant that a lot of work was awarded orally to contractors without a quotation in advance. If there were formal requirements for an award, the job was labelled a ‘rush job’, for which the rules were less strict. This created an informal circuit in which half a word was enough. Employees who do not follow the rules very closely have a strong preference for the hidden informal circuit. They circumvent formal control procedures whenever possible and offer little in the way of transparency. They make agreements verbally, they are rarely recorded on paper and they shield them from others within the organisation. The work mentality is hands-on and ad hoc. Crucial information and knowledge are not or only to a very limited extent accessible to others. Information that is released usually turns out to be deliberately unclear, incomplete or partly incorrect. The closed atmosphere and lack of transparency creates room for unethical actions and creates a condition to keep these actions hidden (Kaptein, 2008).
4. Ring of silence
In the ENT department of Utrecht University Medical Centre, an internal closedness prevailed about a number of incidents. This closedness – partly maintained by an authoritarian department manager – meant that issues were not discussed among themselves and conflicts were systematically avoided. People in the department were played off against each other and expected to choose sides under pressure. Doctors only dared to report the state of affairs on the ward anonymously, for fear of reprisals. Doctors who functioned well and spoke out openly about medical errors were removed from the organisation. Due to a lack of openness and failure to call each other to account for behaviour, norms and values shift within the organisational culture. As a result, employees become – consciously or unconsciously – blind to signals of abuse within the organisation. Silence then becomes the norm within the team or department. If violations are suspected, people prefer to stay on the sidelines. If someone does decide to criticise or report an abuse, retaliatory action is taken to scare the others off. Participating in this silent spiral is appreciated and increases the chances of personal success within the organisation. Organisations characterised by strong loyalty, non-intervention and conflict avoidance are therefore characterised in research on corruption as vulnerable (Nelen & Nieuwendijk, 2003).
5. Wrong example
At the National Health Care Authority (NZa), Arthur Gotlieb was for years the victim of bullying, exclusion, neglect and humiliation. Several supervisors, some of whom rose to management positions, exhibited this behaviour. This assumes that the behaviour was transferred to others and that his treatment became part of the culture in the department. Even the NZa top management, aware of the signals of conflict of interest and non-compliance with privacy standards that Gotlieb was giving off, saw him more as a problem and did not offer a helping hand. The battle Gotlieb faced was one that could not be won. After his suicide, his notes were incorporated into a book. When violations occur on a large scale, managers often acted as negative role models or adopted a passive leadership style, which did not discourage improper organisational behaviour. In such a case, the top ignores signals of wrongdoing or excludes employees. Top management does not set a good example of moral conduct, creating a culture in which integrity is seen as something of secondary importance, a view and attitude easily adopted by employees. This can lead to employees underestimating the importance of regulations or losing sight of the customer’s interests. Unethical leadership leads to employees being more likely to violate regulations (e.g. Brown & Mitchell, 2010).
6. Weak business operations
Imtech barely supervised individual organisational units, which meant that the German and Polish branches of the company were able to commit fraud unnoticed and make huge losses. This ultimately resulted in the bankruptcy of the entire Group. The top management, which had previously decided that the company did not need its own internal audit department, took the decision not to have its figures audited by the external auditor. Imtech left the management of thousands of projects entirely to local managers. Partly as a result of this the organisation’s management had no idea where the money was coming from, what it was being spent on and what risks were being run. The policies were in order: there was supervision, an integrity policy, a whistleblower regulation, code of conduct, confidential advisor and so on. But in some of the cases investigated, these ‘paper’ measures were not followed up in practice. There is a lack of critical internal control and the administrative organisation is of a low quality level. Signals of violations are therefore not noticed, or are noticed too late. Unclear delineation of duties, powers and responsibilities leads to employees feeling a limited sense of responsibility and only a few take the initiative to report a suspicious situation. Violations are reported less quickly because it is unclear what effect this has and to what extent the reporter is protected after making the report (Read & Rama, 2003).
FC Twente – under the reign of chairman Munsterman – saw the unexpectedly won championship in 2010 as a new reality, in which the club would become a structural part of the European and national football top. The pressure was high to keep performing above par and opportunistic goals went hand in hand with heavy investments and risky spending. Difficult questions and dissatisfaction about the financial state of affairs were shrugged off. Critical minds were accused of a lack of courage and vision. There was only one road and that was the road to success. Solid business management was subordinate to this. Fraudulent activities proved necessary to hide the club’s shaky financial position. A one-sided focus on the result – such as sharp targets, high bonuses and status – leads to extreme competitiveness and performance pressure within organisations. Unrealistically high expectations and ambitions lead to short-term thinking and opportunistic behaviour. The organisation (top) often has narcissistic characteristics, which, according to Duchon and Drake (2009), contributed to the downfall of American global players such as Arthur Andersen, Salomon Brothers and Enron. Success is mainly attributed to the qualities of employees, which reinforces the feeling of exceptionality and superiority. Often, this leads to self-aggrandisement and a feeling of superiority at the top, which carries over to the work floor. Unethical actions are rationalised as necessary to strengthen one’s own position or that of the organisation. It has thus become part of the survival strategy of (employees of) the organisation. Red flags to promote moral development Information on the red flags present can be used to strengthen the moral development of employees within the organisation. Teams on location can enter into a dialogue about how they deal with personal interests and organisational interests. Commercial institutions can organise sessions in which their own result focus is evaluated. Managers within organisations can be trained in their role as role models. The chance of corruption and fraud is greatly reduced when a culture of moral dialogue is created. This is created when employees and managers find it normal to determine together what the right decision is in work situations where moral issues arise. By discussing integrity risks with each other in the form of a choice issue, group pressure is created against abuse and blurring of standards. Through regular discussion of ethical dilemmas, people in the organisation are trained to make the right decisions. This can be set up as follows: violations that have occurred in similar organisations are elaborated in a choice dilemma. In separate team meetings, employees are asked what they think is the right course of action. Choosing a situation from another organisation, such as correct invoicing, gifts from customers, private work during office hours, makes the discussion less threatening and yet appealing. Specific groups can be chosen, such as executives or officials who perform vulnerable functions. In this way, it becomes clear that obvious ways of thinking and acting are judged very differently by others. This makes cultural differences visible and teaches people to look at what is usual in a different way. Learning to look at things differently leads to different behaviour.
30 aug. 2019