Practical Deterrent Measures For Disloyal Employees Who Are Threatening Your Business

Tuesday, May 31, 2011 - 00:00

Even in a struggling economy, one industry thrives - employee disloyalty.According to a recent report from the Association of Certified Fraud Examiners, the average employer loses 5 percent of its annual revenue to fraud.

Unfortunately, there is no prototype for a disloyal employee. More often than not, the miscreant is a highly trusted, hard working employee - the proverbial "least likely suspect." He or she can be a high-level decision maker or an hourly employee; a long-term employee or a new hire. Sometimes the motivation is complex; more often than not it is simply opportunity and greed.

The potential schemes are limited only by the disloyal employee's imagination and often involve the following: embezzlement; theft of trade secrets or confidential information; diverting customers or business opportunities; vendor kickbacks; sabotage; interference with business relationships; abuse of technological resources; threats to the workforce or public; or other misconduct affecting an employer's bottom line and public image, as well as employee retention and morale.

How can an employer protect itself?

Every business should be alert during events that can be breeding grounds for disloyal acts, such as mergers, acquisitions, restructurings and layoffs. Businesses also should be aware that disloyalty in the workplace can often be traced to one or more of the following: misplaced trust on the part of the employer, situations that increase the likelihood a company policy or internal control will be circumvented, and/or an employee facing personal adversity.

On an ongoing basis, all businesses, regardless of size, should consider preventative steps, including:

• Best hiring practices, including lawful use of criminal conviction and consumer record background checks.

• Protection of trade secrets and confidential information through confidentiality agreements for all employees.

• Use of restrictive covenant agreements (non-solicitation, non-disclosure and non-compete) for upper management and the sales force.

• Effective, efficient and legal internal controls, workplace rules and employee handbook policies, enforced consistently and fairly.

• Annual employee certifications requiring that employees be in compliance with their obligations under agreements, workplace rules and policies.

• Carefully observing employees who have undergone sudden or substantial changes in behavior or lifestyle.

• Conducting anti-fraud training for employees.

• Creating an anonymous fraud hotline or reporting mechanism.

• Implementing the measures contained in your auditor's management letters.

After employee misconduct is suspected or discovered, an employer's initial reaction might involve denial or retaliation. Time is of the essence when consulting with counsel to oversee a prompt and appropriate investigation and legal response.

Employers should review any applicable insurance, and provide notice as required. (While complying with the cooperation provisions of a policy, an employer should be cautious about having the insurer drive the investigation.)

Termination is almost always a given for a disloyal employee. It should be planned and executed properly to reduce legal or further financial exposure. (The best time to properly secure evidence of wrongdoing may be prior to termination.) Depending on the situation, the employer should address the issue with board members, shareholders, employees, customers and the media. A proactive approach is usually advisable.

Proper handling of evidence is essential. Whether the task involves reviewing financial records or documents, collecting electronic data, or witness interviews, the investigation should be conducted under the instruction of counsel to ensure that evidence is not tainted and the proper chain of custody is maintained.

Consideration should be given to both civil lawsuits and criminal prosecution.

Civil remedies may be available for breach of confidentiality, non-solicitation or non-compete provisions of an agreement with the business, but they may hinge on the answers to several questions. Can the stolen material be classified as trade secrets or other confidential information protected under the law? Did the employee convert company material for his or her benefit? Has a third party interfered with the business's contracts or with prospective business opportunities?

The civil liabilities imposed upon a disloyal employee can be substantial. In New York, for instance, an employee found to have breached his or her duty of loyalty is not only liable for direct damages, but he or she also forfeits all compensation for the period of disloyalty, even if the employer suffered no provable damage as a result of the breach.

Criminal prosecution should also be considered. It sends the proper message to employees and customers, and it may result in a court imposing restitution as a part of the disloyal employee's sentence. The employer should also recognize that while federal, state and local prosecutors are responsive and helpful, a criminal prosecutor's obligation is to the public, and the public's interests might not coincide entirely with the employer's business interests.

There is no silver bullet, but the aforementioned measures should help a business protect itself from disloyal acts, maximize recovery of damages if the unthinkable does occur and deter future acts of disloyalty by others.

James D. Donathen and John G. Schmidt Jr. are Partners at Phillips Lytle LLP.They have counseled employers and litigated numerous employee disloyalty cases.

Please email the authors at jdonathen@phillipslytle.com or jschmidt@phillipslytle.com with questions about this article.