Joyti De-Laurey and Denise Ibbertson may not be household names, but you can guarantee their former employers at Goldman Sachs and HSBC won't forget them in a hurry. Between them they were responsible for defrauding their companies out of more than £4m, not to mention dragging the reputations of those businesses through the mud.

There is a school of thought that says a certain level of fraud is, quite simply, 'the cost of doing business' - the result of outdated and ineffective internal controls, aggressive accounting practices and the growing complexity of organisations. But what these examples - alongside high-profile cases at Parmalat and Enron - illustrate all too well is how often most large frauds are committed by those working inside a company.

In fact around 85% of frauds are committed by employees, according to our own research, and 55% of these are carried out by managers. Financial damage aside, fraud diverts a great deal of senior management time and can have a damaging effect on the morale of the organisation, not to mention its reputation.

But is the right response to treat all employees as budding Nick Leesons and create a big brother atmosphere of mistrust and constant employee monitoring? The answer is no, but there are a number of steps companies can take to reduce the risk of employee fraud - without creating an atmosphere of fear and suspicion.

It's essential to make sure you have a culture of honesty and openness in your company. This is not simply about spamming employees with emails outlining the company's ethics policy. Emails of this type are rarely read and, when they are, they are quickly forgotten.

Take a step back. Most business leaders cannot pinpoint their company's culture, nor do they really know how honest their employees are, as this tale from the 1990s illustrates.

The board of directors of a car parts manufacturer wanted a photograph of its workforce on the cover of the annual report, and commissioned a photographer to take photos of a happy smiling workforce leaving the premises on a Friday afternoon. But in order to get the whole workforce into the picture, the gates of the factory had to be shut at 4.30pm as the photographer set up his equipment outside.

The workforce was rather surprised to be kept in the car park with cameras pointed at them on a Friday afternoon. But once the photos were taken and the gates opened, the directors watching the spectacle from a window overlooking the gates were horrified to see £10,000 worth of car parts discarded in the car park.

It's a salutary lesson that most directors are not aware of the culture at the coal face in their business. Measuring the awareness of fraud and employees' reaction to it within the organisation is important in understanding how serious an issue it is. Surveys have found that a significant number of employees admit to being aware of fraud in the workplace, but an equally significant number would not report this fraud to the relevant management.

The question is, where does trust end and supervision begin? A company should strike a balance between the trust it needs to place in its employees and the level of supervision necessary to make the chances of discovery a significant deterrent to the fraudster. And there are a number of good practices that could be adopted to encourage the right type of culture in an organisation.

You should set the right tone from the top of the organisation by not tolerating dishonest or unscrupulous practices. At the same time, a sound code of corporate ethics and a fraud policy should be communicated and implemented. Management must be made aware of the risk of fraud, and active discussion about how fraud prevention policies can be tightened should be encouraged.

From an employee perspective, you should actively pursue employee references, particularly for sensitive positions in treasury, procurement or financial accounting. Psychometric testing and personality profiling can screen out those employees who display dishonest or unscrupulous characteristics - such testing is already employed by a number of high-profile organisations.

And keep an eye out for the warning signs. It's much easier with hindsight, but we have been called into investigate many instances of employees carrying out fraud where some fairly obvious indicators have been ignored.

In particular, you should look out for employees whose lifestyle is very different from their known sources of income. Other warning signs include key staff who work excessive hours, refuse to delegate apparently mundane tasks, don't take any holidays or refuse to take promotion. They may also come up with regular excuses for not carrying out mundane accounting reconciliation and control procedures.

Employers ignore these warning signs at their own peril. But while it is important to handle any enquires into employee's lifestyles very sensitively, having a culture where fraud is tolerated is potentially as bad for morale as a culture that instinctively distrusts all employees.

When a fraud is suspected or detected, it is important that it is thoroughly investigated and the results of the investigation are communicated to all those affected by it. In particular, you should make a positive statement about treatment of any fraudsters. It is more important that the organisation communicates openly and trusts its employees rather than attempt to sweep all rumours about fraud under the carpet. Such rumours rarely stay under the carpet for long.

John Smart is a partner at Ernst & Young and a fraud specialist in the firm's global investigations and dispute advisory practice.