Fraud from the factor of fear: Management by Intimidation

This article by Slemo D. Warigon and Betsy Bowers was adapted from one they wrote that appeared in the summer 2006 issue of the College and University Auditor Journal.  

Managers who use intimidation and fear to run their organizations prevent employees from being their best and encourage fraud, waste and abuse. Here's a framework for combating the tactics of these managers and deterring fraud. 

Mr. Zero, the CEO, wanted his staff to be efficient, quick, and savvy. And he wanted them to make their sales quotas every month. Nothing unusual there. But his tactics didn't follow the classic textbook management style. He told his employee, Sam, that his days could be numbered after one bad sales month, even though he previously had four good ones. He reprimanded Betty when she complained about working conditions. He fired Hilary when she questioned his actions. And he routinely hand-picked the members of the board of directors. His actions lowered morale, stressed the workforce, and laid the foundation for major fraud cases.¹

We're familiar with the buzz words "management by objectives" and "management by the seat of your pants." But few of us have studied insidious "management by intimidation" practices.

Here we'll describe the ways management by intimidation can negatively affect employees and expose an organization to fraud, waste, and abuse. We'll also provide a framework for managing employees that can narrow an organization's risks. The characteristics of MBI practices listed here are based on our observations as career internal auditors with at least 15 years in the higher education sector. Our discussions with victims of MBI practices helped refine issues.

Management by Intimidation (MBI) is managing or governing people based on fear. Costs increase, productivity diminishes, and revenue decreases. MBI also has adverse effects on the morale of employees and the ethical climate of an organization. All of us have known (or had) bosses who use MBI practices to get what they want but these practices are inconsistent with W. Edward Deming's eighth point of management.2 Deming says that managers should "drive out fear" to help employees become secure enough to express ideas and ask questions. Deming has steadfastly viewed management by fear as counterproductive to the long-term health of an organization because it prevents employees from acting in their best interests.

WARNING SIGNS OF MBI
After years of consulting and management reviews, we've discovered patterns of behavior that characterize MBI. Do you see these common characteristics of MBI in your organization?

• Use of threats: MBI practitioners threaten or intimidate people to try to perform and not to inspire people to do their best. Popular tactics are letters of warning, informal threats of dismissal, and informal requests to resign. The center of their operating philosophy is showing unchecked power.
• Ineffective oversight body: MBI practitioners carefully screen and hand pick members of the oversight body such as the board of directors who won't habitually question their activities. The board will then give the MBI practitioners carte blanche to administer with unchecked powers. (There's that unchecked word again.) The board will then view fraud examiners and auditors as necessary evils rather than partners who will assist its members to responsibly oversee the organization in discharging their oversight responsibilities. Board members previously needed to avoid micro-management as an excuse for this kind of hands-off oversight philosophy. Hand-picking cronies as board members promote rubber-stamping practices in the oversight body. Additionally, board members often allow MBI practices to fester in organizations without intervention - claiming that they don't want to micro-manage.
• Censored communications: MBI practitioners don't want employees to communicate openly and frankly about their views on organizational matters. They manipulate communication channels to ensure that employees only say and write positive things about the organization to external parties. Supervisors who subscribe to the MBI philosophy routinely reprimand employees who express unfavorable opinions about working conditions. There's no commitment to truth. MBI practitioners will censor or sanitize communications to board members, CFEs, external auditors, and regulators to conceal the real organizational climate and culture.
• Self-centeredness: MBI practitioners are self-centered leaders who make decisions that are usually best for them, their favorite subordinates, their friends, and their business partners. Personal agendas are disguised as organizational agendas.
• Unchallenged authority: MBI practitioners routinely eliminate employees who challenge their authority or question them.
• Lack of accountability: MBI practitioners are the least accountable people in organizations. They're quick to take credit for successful initiatives and blame others for their failures. They meticulously build cases against dispensable employees or scapegoats. MBI practitioners last long in many organizations because an accountability culture doesn't exist.
• Lack of transparency: MBI practices aren't transparent to people who aren't directly or indirectly affected by them. They either experience or learn about them from affected colleagues. MBI practitioners are so concerned about leaving audit trails that they seldom document their activities and tacitly ask their subordinates to do the same.
• Questionable hiring practices: MBI practitioners tend to ignore good personnel policies and resort to cronyism and nepotism when hiring. They covertly ensure that friends and relatives receive preferential considerations. They occasionally conduct ruse interviews just to satisfy legal requirements.
• Lack of diversity: MBI practitioners preach but don't practice diversity. They develop policies, procedures, and plans that extol the virtues of diversity and organize events that create the illusion that their organizations believe in diversity. A closer look reveals that the key leaders with which they surround themselves aren't diverse. They typically award lucrative positions, contracts, and bonuses to people who look, think, and act like them.
• Double standards: MBI practitioners accept activities that other employees might not. MBI practitioners circumvent rules if it suits their whims and purposes but employees who commit the same acts are terminated.
• Disdain for independent reviewers: MBI practitioners treat fraud examiners, internal auditors, external auditors, and other independent reviewers with open disdain. They don't want anyone to review and criticize their activities or the activities of their "trusted" employees. They operate under the illusion that their actions are beyond reproach and aren't subject to audit. MBI practitioners prefer to have "other people" audited or investigated so they can gather the ammunition to eliminate hindering employees and managers and show that they won't tolerate specific conduct. "Trust but verify" is foreign to MBI practitioners.
• Management myopia: MBI practitioners are inherent reactive managers. They like status quo and dislike people who rock the boat or think outside the box. They rarely communicate their expectations in a clear, unambiguous manner. They officially evaluate employees based on their moods. They harshly criticize disliked employees and reward "trusted" employees. MBI practitioners survive as long as possible to aggrandize themselves, not to ensure the long-term health of their organizations.
• Bliss in feigned ignorance: The less MBI practitioners know how bad things are in their organization, the better. They harbor visceral hatred for whistle-blowers or employees who they perceive as "bad news" messengers. They erect corporate buffers that will block unfavorable news from reaching their attention. When confronted by reality they're quick to use the standard excuse of "I didn't know" or "I wasn't aware" of the problems and their associated risks.

Traditional managers also might use some or most of these MBI tactics when they're stressed, insecure, or afraid they'll be found out.

CONSEQUENCES OF MBI PRACTICES
As auditors and fraud examiners, we often see some consequences of MBI practices on employees in our organizations. How many times have we reported these issues during a management review or audit?

• Unmotivated employees: Employees won't be sufficiently motivated to give their best and work harder and longer when needed beyond the required daily eight hours. Unmotivated employees will engage in unproductive activities or sabotage work to make their MBI supervisors look bad.
• Overstressed workforce: Employees operate under enormous stress. They'll work in constant fear of their MBI supervisors and so won't be consistently productive. Increased stress also will affect their health, family, and work habits.
• Non-enterprising employees: Employees will believe that they're not empowered creatively and can't think and accomplish anything without the blessings of MBI practitioners. They'll be afraid to frankly express opinions or suggestions in meetings and skeptically view the corporate stance on employee empowerment. They'll eventually find excuses for participating in synergistic corporate initiatives.
• High employee turnover: Competent employees, especially middle management and frontline staff, will leave. MBI practitioners will make some of these proficient employees into scapegoats. Others will just decide to leave the unhealthy corporate culture of their organizations to preserve their integrity, health, sanity, and/or careers.
• Inequitable compensation: MBI practitioners will always pay more to the "favored" or "trusted" employees than those they deem expendable. Experience and qualifications will be irrelevant. The perception that some people are more equal (but not necessarily better) will eventually percolate causing bitterness and divisiveness.
• Climate of distrust: Employees won't trust MBI practitioners and vice versa. The climate of distrust will escalate so that working conditions will become unhealthy and disruptive.
• Climate of vindictiveness: Vindictive MBI practitioners will punish employees who dare to think outside the box, are disgruntled, or become whistle-blowers by calling them names and worse. Lack of a checks-and-balances system will worsen the vindictiveness.
• Ineffective disputes resolution: Employee complaints and disputes will escalate. Offices established to comply with equal employment opportunity and labor laws to handle complaints or disputes will be ineffective in achieving satisfactory resolutions because they will usually report to MBI superiors who are themselves the subjects of escalating employee complaints. Employees will feel that wolves are guarding the henhouse until they believe that it's pointless to file formal grievances. Lawsuits will be the only recourse for victimized employees, and costly out-of-court settlements will be the standard solutions for the affected organizations.
• Fire-fighting management: MBI practitioners will be locked in a fire-stomping, crisis mode but the sparks will eventually reignite and cause major third-degree burns.
• Hostile audit environment: When auditing the activities of MBI practitioners, some internal auditors will feel they're risking their job security, and external auditors will feel they're risking their engagement contracts. The environment will be decidedly hostile for quality assurance work. MBI practitioners will tenaciously obstruct and be uncooperative. Poor audit trails will make the review process a Herculean task and MBI managers will significantly curtail access to audit committee members.
• Disregard for established controls: MBI practitioners feel that preventive and detective controls are established only to be conveniently circumvented. They'll consistently exhibit little or no regard for established controls and are major threats to their jobs. Thus, opportunities to commit occupational frauds will abound, and anti-fraud measures won't find fertile grounds.
• Unethical culture: The environment will foster a corporate culture where anything goes. Ethical misconducts will be widely tolerated. Even some trusted employees might see the twisted tone at the top and perceive that they can get away with anything except murder. Employees who are caught and prosecuted for unethical and illegal acts will rationalize that their MBI supervisors were engaging in similar improprieties. Of course, this type of behavior will eventually attract the keen eyes and ears of local, state, and federal regulators.

It usually takes front-page news before an organization feels the need to change its culture and abolish MBI practices. In some cases, the efforts to change are genuine, but they might instead be purely cosmetic. If anything, the major corporate scandals have taught us that MBI practices are inconsistent with 21st century management best practices. Any benefits from MBI practices always will be short-lived.

TIPS FOR DEALING WITH MBI PRACTICES
A review of existing leadership literature indicates that outstanding leadership is more of an art than a science. It's all about using education and experience to inspire people to love their work, love learning, reach their potential, serve others selflessly, adapt to changes gracefully, manage conflicts effectively, and achieve the desired results. It's also about managing complex people management issues with a caring heart.

Good management principles, such as these, can counter insidious MBI practices:

• The primary goal of an organization is to create and maintain an environment in which people can wake up in the morning and look forward to going to work.
• People have integrity and value. It's vitally important to maintain the integrity of the organization and its employees.
• Each employee is unique, comes from a different background, and has distinct interests, capabilities, skills, and familial responsibilities. Recognizing such distinctive individual characteristics helps to effectively manage people.
• Respecting people for their talents implies that senior leadership continually strives to forgive people's weaknesses. Managers see the glass half full by focusing on employees' proficiencies rather than seeing the glass half empty by focusing on their deficiencies.
• Only people who enjoy work, achievement, and teamwork are employed. Each individual has the opportunity to maximize achievements, contributions, and personal potential regardless of age, race, gender, national origin, disability, marital status, or sexual orientation.
• Teamwork is the key to success in any worthwhile endeavor. Nobody has all the skills it takes to be successful. People with different skills or ideas are brought together to work and achieve organizational symbiosis or synergy. For instance, charismatic administrators might spend most of their time tending to clients; creatives might have more time to devise new and clever solutions to solve problems.
• In an ideal situation, people who consistently exhibit a positive attitude in support of the performance and objectives of the organization, management, employees, and clients are always respected and appropriately rewarded.
• The primary objective of management is to identify, nurture, and develop the strengths and skills of employees. A good manager doesn't take lightly the accomplishment of this objective.
• The primary responsibility of management is to ensure that all problems are addressed and resolved while they are small problems. A good manager doesn't abdicate or shirk this responsibility.
• Satisfied clients - external customers, employees, and vendors - are the foundation of an organization's future. Corporate success is measured by how well the needs of such stakeholders are being met.
• Synergy is vital to the survival of an organization. The organization must have a minimum of two people in charge. There are four major roles to be played: (1) administration; (2) entrepreneurial; (3) communication; and (4) productivity. All these roles must be done well for an organization to succeed and they require several people to do it. It's virtually impossible for an administrator to always be a creative entrepreneur because of daily administrative tasks.
• The most difficult thing to do in management or business is to find good people, and to let them go when it just doesn't work. The decision to let them go is generally easy, but telling them is extremely hard, regardless of the justification.
  Great leaders use these management principles in their "statement of values" document, which is typically made available to all stakeholders. Such principles are the building blocks of a framework for the effective management of an organization's human capital in the 21st century.

IMPLICATIONS FOR FRAUD EXAMINERS, AUDITORS
Fraud examiners and internal auditors must realize that MBI practices are seriously detrimental to organizational effectiveness. Their risk-based reviews should assist their organizations in identifying and eliminating such practices. This entails performing assurance and consulting engagements with independence and objectivity. Job security should be made secondary to compliance with the audit standards and professional code of ethics.

Because of the hostile environment they operate in, fraud examiners and internal auditors should be prepared to resign from their positions if it's the only option to make their audit observations known to the internal and external stakeholders. Of course, cultivating a good working relationship with members of the audit committee is of paramount importance in the fight against pervasive MBI practices.

Similarly, external auditors shouldn't let contracts or monetary issues cloud their independence and professional judgment. They should know that weak internal controls contributed by pervasive MBI practices can generate fraudulent financial statements and opportunities for other types of occupational frauds.

In addition, internal and external auditors and fraud examiners should avoid credibility problems by not engaging in MBI practices themselves or appearing to turn a blind eye to such practices during internal control reviews. Thus, self-assessment is a critical step toward objective reviews and the effective fight against MBI practices. Lack of credibility has been known to hamper quality audit work.

Finally, the Enron and WorldCom cases showed that internal and external auditors can pay heavy prices if they know but fail to act on red flags in auditable areas.

REALITY CHECK
MBI practices benefit self-centered leaders at the expense of organizational effectiveness. Ask these simple reality check questions:
(1) Is our organization engaged in widespread MBI practices?
(2) Are we contributing to MBI?
(3) How can we help eliminate harmful MBI practices?

MBI evils negate the premise that employees need to be treated as diverse human beings with feelings and circumvent governmental regulation compliance. Internal and external stakeholders who value successful organizational performance, ethical culture, and social responsibility should join hands in proactively preventing and fighting such practices.

And if employees believe that their managers are still practicing MBI, despite lofty pronouncements, nothing will change.

Organizations that are decisively proactive in rooting out MBI will be the ones left on a solid footing in the 21st century's competitive global marketplace where only the fittest survive.

The framework for effective management practices discussed here can help organizations build an environment conducive for a highly motivated workforce, transparent accountability, ethical decision-making, shared governance process, proactive problem-solving and satisfied customers. These will reduce fraud, waste, and abuse and contribute to a vibrant corporate culture that helps build and sustain a healthy bottom line for the organization.

REASONS TO COMBAT MBI PRACTICESOrganizations need to combat MBI practices because they minimize employee productivity, ensure operational efficiency, and enhance organizational effectiveness all of which transform employees into major destabilizing forces.

Also, MBI practices don't comply with U.S. federal regulations. For instance, Section 406 of the Sarbanes-Oxley Act of 2002 (SOX) requires the adoption of a code of ethical conduct or formal performance standards with the necessary controls to help organizations in promoting: (1) honest and ethical conduct; (2) accurate and timely disclosure of public financial reports; (3) compliance with regulations; (4) internal reporting of ethical code violation; and (5) accountability for adherence to the code of ethical conduct. Similarly, Sections 301, 806, and 1107 of SOX:

• require organizations to establish procedures for the receipt, retention, and treatment of complaints and the confidential anonymous submission by employees on accounting, internal controls, and auditing matters;
• grant employees the right to sue their employers for retaliation by filing a formal charge with the U.S. Department of Labor; and
• provide for criminal penalties, including up to 10 years in prison for retaliation against employees or whistle-blowers.

In addition, the Federal Sentencing Guidelines enacted in 1991 by the U.S. Congress state that organizations are liable to sentencing and fines for federal offenses connected with securities, bribery, embezzlement, fraud, money laundering, and other criminal business activities. The guidelines hold that an organization operates only through its agents - usually managers - and, is, therefore, liable for the offenses committed by its managers. The guidelines are intended to: (1) achieve just punishment; (2) achieve sufficient deterrence; and (3) encourage the development of internal mechanisms to prevent, identify, and report on criminal behaviors in organizations. Furthermore, in the final and supplemental reports issued by the Panel on the Nonprofit Sector (see www.nonprofitpanel.org) initiated by Sen. Chuck Grassley (R-Iowa), specific formal recommendations were made for strengthening transparency, governance, and accountability in the non-public, not-for-profit sector.

Finally, MBI practices lead to additional expenses because of increased absenteeism and turnover and MBI practitioners who are blatantly blind to their foibles.

1. This is a fictitious composite case. 
2. Deming, Edwards W. "Out of Crisis." The MIT Press, Cambridge, Mass. (2000)

Slemo D. Warigon, CIA, CISA, CICA, MBA, is the director of Audit and Management Advisory Services at Gallaudet University, Washington, D.C. He has written extensively on information systems control and security. The Institute of Internal Auditors presented him with the 1999 Outstanding Contributor Award for his article, "Data Warehouse Control and Security." 

Betsy Bowers, CFE, CIA, CGFM, is associate vice president of internal auditing and management consulting at the University of West Florida in Pensacola, Fla. She's the president of the Association of College and University Auditors.