Stealing While Dying: The Motive for Fraud Comes in Many Forms

Day 15 in 30 Days of Fraud

Some fraudsters steal while dying. What’s their motive? Possibly to avoid leaving their family with medical bills. Whatever the reason, it’s a strange thing. Today we visit a fraud that I encountered over twenty years ago.

stealing while dying

The Theft

In one of the stranger frauds I’ve seen, the bookkeeper of a small health department, Susan, stole money. And she did so while she was dying. In the last months of her life, she fought a battle with cancer. In between the chemo treatments, she continued her work. I’m sure she believed she would survive. After all, she was only thirty-six. 

I had provided external audit services to this health department for years and knew Susan well. She sent me thank-you cards–yes, thank-you cards–for my audit work. She was polite and great at her job. If ever I thought there was someone who would not (and could not) steal, it was her.

But external circumstances can make the best of people do the unexpected. The medical treatments resulted in numerous medical bills, many of which she received while still working. She died just before my annual visit for the audit.

Knowing that Susan had passed away, I knew the audit would be challenging, especially since the health department board had not hired anyone to replace her.

Upon my arrival, I requested the bank statements, but the remaining employees could not locate them. I thought maybe she had taken the bank statements home and had not returned with them due to her illness, but that was not the case. After the employees searched for some time with no result, the health department requisitioned the bank statements and cleared checks from the bank.

In reviewing the cleared checks, I quickly noticed round-dollar checks written to Susan. The first one was for $7,000. My first thought was, “Not Susan, I’ve known her too long. No way. ” But then there was another and another…

The Weakness

The weakness was a lack of segregation of duties. Susan did the following:

  • Keyed payables into the general ledger
  • Created checks for signing
  • Had signature authority on the bank account
  • Reconciled the bank statements
  • Created the monthly financial statements

Are you noticing a recurring theme in the 30 Days of Fraud? Yes, a lack of segregation of duties. It’s fundamental. One person should not be allowed to do everything.

The Fix

Segregate the accounting duties. Most importantly, Susan should not have been on the bank’s signature card. Additionally, someone other than Susan should have been reconciling the bank statement and examining cleared checks. For small organizations, have the bank statements mailed to someone outside the accounting department (e.g., a board member). This outside person should open the statements and review the cleared checks—then the statements should be sent to accounting.

How Bribery Works: How to Understand It and Prevent It

$1 trillion in bribes are offered each year

The World Bank estimates that over $1 trillion in bribes are offered each year. Today we look at how bribery works and how you can prevent it.

The Theft

The FBI performed a sting operation involving two mid-Georgia city council members. The Bureau’s court complaint alleged that two city council members contacted a city vendor requesting a bribe. The vendor, according to the complaint, had previously provided services to the city. But when the contract came up for renewal, the city officials sought monetary encouragement (also known as cash) to continue the arrangement.

how bribery works

Picture is courtesy of AdobeStock.com

The vendor’s president, once aware of the proposed bribe, contacted the FBI, which in turn conducted the sting. On the arranged date, the company CFO delivered $20,000 in cash to the city council members. The conversation was recorded as the payment was made. The arrests followed soon thereafter.

The bribe was unsuccessful in this case, but, all too often, the bad guys receive the cash, and the organization suffers. How?

Vendors usually don’t absorb the cost of the bribe. They pass the expense along to the organization in the form of increased invoice billings, or the vendor will, in some cases, provide substandard products or services. Either way, the organization suffers, and the villain walks away with cash or a free vacation or a free car or…well, you get the picture.

The Weakness

The root of bribery lies in unethical leadership. Organizations should vet each key employee before hiring, making sure the person has historically acted in an upright manner. (In the case above, the citizens must vote for ethical leaders.)

The city had no fraud hotline. The Association of Certified Fraud Examiners biennial survey has repeatedly shown that corruption is often unearthed by tips–often through a fraud hotline. What is a fraud hotline? It is any means that an organization provides its employees to report a potential theft. (See below.) Bribery can occur even when organizations have the best of controls, but hotlines are a key defense.

The Fix

Organizations can increase communications about potential theft by:

  • Providing a 24/7 phone number–it can be a 1-800 number (employees call and report any information anonymously)
  • Provide employees with an email address where they can report suspected fraud
  • Ask employees to report red flags (signs of fraud) to a designated person in your organization

To mitigate corruption, implement these controls (there are others, but these will help):

  • Require sealed bids that are opened in the presence of multiple people (mainly for larger purchases)
  • Implement a whistleblower program (include vendors)
  • Require announced periodic vendor audits
  • Implement a conflict of interest policy
  • Implement a bribery prevention policy (include gifts)
  • For significant construction contracts, monitor all phases of the project, including solicitation of bids, awarding of the bid, development of the contract, on-site construction, and related billing, and contract change orders (don’t trust the builder to do this for you).

How Fraudsters Steal with Inflated Invoices

Day 13 of 30 Days of Fraud

Fraudsters can steal with inflated invoices. In the story below, you’ll see that a school maintenance director was able to take millions by doing so. Today, we look at how this scheme works and how you can prevent it.

The Theft

The school maintenance director, Derek Brown, purchases materials from two local hardware stores; also, the school contracts with a nearby electrical services company. Each of these businesses is owned by relatives of Derek. While the school board knows about the familial relationships, they are accustomed to the use of these vendors. After all, it’s been that way for years.

steal with inflated invoices

This picture is courtesy of AdobeStock.com

What the board doesn’t know is that Derek often receives inflated invoices from these related parties. For example, if the school orders $30,000 of supplies, it receives an invoice for $45,000. Derek approves the purchase orders, the physical receipt of the goods, and the payment of the invoice. (At times, one of Derek’s assistants counts the physical goods received, but he is party to the fraud as well.) It’s easy for Derek to approve the overstated bills. 

Additionally, some of Derek’s business friends (persons doing business with the school) send invoices to the school for services never provided. He approves these payments as well. 

About once a month, the related-party vendors pay Derek 50% of the excess billings.

The above fraud example is based (partially) on an ongoing case involving the Floyd County Schools where millions were stolen.

The Weakness

The weakness lies in the lack of segregation of duties. Derek approves:

  • The purchase orders
  • The physical counts of goods or services received
  • The approval of the invoices

A contributing element is the school board going to sleep–these types of relationships should be vetted. If no other vendors are available–often the reason for using such local businesses–then additional scrutiny should be brought to bear upon the related payments.

The Fix

Segregate the duties, especially the purchase order approval. A conflict-of-interest policy should be adopted requiring all school officials and key administrative personnel to disclose questionable relationships. If key conflicts are not eliminated, the related activity should be subject to audit by an outside CPA or Certified Fraud Examiner.

Additional Fraud Prevention Assistance

If you work with local governments, you will find my fraud book useful in identifying and preventing fraud. See the book on Amazon by clicking the icon below.

 

How to Steal by Double Paying a Vendor

Day 12 of 30 Days of Fraud

The Theft

Fraudsters can steal by double paying a vendor. In this article, I show you how duplicate payments sometimes end up in an employee’s pocket and how to prevent this fraud.

John, an accounts payable clerk, works for Zoom Inc. Last year, he accidentally sent two checks to the same company for the same invoice. To recover the second disbursement, John called the vendor, and they quickly returned the extra payment. While he was embarrassed about his mistake, he realized that had he not recovered the check, no one would have noticed.

steal by double paying a vendor

Picture is courtesy of AdobeStock.com

Steal by Double Paying the Vendor

John has the itch to buy a new BMW. He saved some money, but he needs more–much more. Then he remembers the accidental double payment and has an epiphany. Yeah…that might work.

John intentionally pays the company’s vendor, River Merchants, twice for the same invoice of $47,540. The checks are signed electronically by computer, so no one is physically inspecting the checks or invoices. Liz, John’s coworker, mails all vendor payments. Consequently, he can’t steal the second check before mailing.

Liz mails the checks. The next day John calls River Merchants saying, “Sorry, but I just realized I sent two payments to you for the same invoice. Would you please return the second check? My address is…”

John receives the second check Monday morning. Now he converts the check to cash by opening a bank account in the name of River Merchants and depositing the check. John is the authorized check signer on the account, so he writes a check to himself. He’s soon cruising the boulevard in his new red Beemer.

The Weakness

No one is monitoring the accounts payable process. While the company did implement the policy of having a second person mail the checks, no one is reviewing check disbursements for double payments.

The Fix

Periodically download the check register to Excel; you only need the following columns:

  1. Vendor name
  2. Check number
  3. Invoice number
  4. Check amount (amount paid)

Sort the payments by vendor name; then scan the list for same amounts paid to the same vendor. If you see payments to the same vendor with the same invoice number and the same dollar amount, then dig deeper. (Accounts payable software should not allow the processing of two checks with the same invoice number–even so, some systems allow overrides; alternatively, the fraudster may bypass this restriction by altering the invoice number.) If it appears that a double payment has occurred, call the vendor to see if a refund has been issued.

Obviously, some payments to vendors should be for the same amount (such as rent)–these should be ignored for this test.

Sometimes, in performing this test, you will find double payments–made by mistake–that the vendor has not returned. The first time I did this test, I found such a payment for over $75,000.

More Fraud Prevention Tips

For more information about fraud prevention, check out my book on Amazon. Click the book icon below.

How Accounting Tricks Inflate Earnings: How to Understand It and Prevent It

Day 11 in 30 Days of Fraud

The Theft

Accounting tricks can inflate earnings.

One Wall Street Journal article said a California company used “a dozen or more accounting tricks” including “one particularly bold one: booking bogus sales to fake companies for products that didn’t exist.” These machinations inflated earnings, making the company look more profitable than it really was. 

Today I show you how fraudsters use financial statement fraud to magically transform a company’s appearance. Then you will better know how to prevent these schemes.

Accounting tricks inflate earnings

The picture is courtesy of AdobeStock.com

Financial Statement Fraud

Companies can magically create earnings by:

  • Accruing fictitious income at year-end with journal entries
  • Recognizing sales for products that have not been shipped
  • Inflating sales to related parties
  • Recognizing revenue in the present year that occurs in the next year (leaving the books open too long)
  • Recognizing shipments to a re-seller that is not financially viable (knowing the products will be returned)
  • Accruing projected sales that have not occurred
  • Intentionally understating receivable allowances

Think about it: A company can significantly increase its net income with just one journal entry at the end of the year. How easy is that?

You may be thinking, “But no one has stolen anything.” Yes, true, but the purpose of most revenue inflation tricks is to increase the company’s stock price. Once the price goes up, the company executives sell their stock and make their profits. Then the company can, in the subsequent period, reverse the prior period’s inflated entries.

The Weakness

Such chicanery usually flows from unethical owners, board members, or management. The “tone at the top” is not favorable. These types of accounting tricks usually don’t happen in a vacuum. Normally the top brass demands “higher profits,” often not dictating the particulars. (These demands are typically made in closed-door rooms with no recorders and no written notes.) Then years later, once the fraud is detected, those same leaders will plead ignorance saying their lieutenants worked alone.

The Fix

The fix is transparency. This sounds too simple, but transparency will usually remove the temptation to inflate earnings. If you work for a company (or a boss) that is determined to “win at any cost,” and repeatedly hides things (“don’t tell anyone about what we’re doing”), it is time to look for another job. When people hide what they are doing, they know it is wrong–otherwise, why would they hide it?

A robust internal audit department can enhance transparency. The board should hire the internal auditors. Then these auditors should report directly to the board (not management). The company’s internal auditors should know that the board has their back. If not, then you’ll continue to have opaque reporting processes. Why? The internal auditors’ fear of reprisal from management (or the board itself).

And what if the leaders of an organization won’t allow transparency? If possible, remove them. Unethical leadership will destroy a business.

Also, use retrospective reviews of the receivable allowance account. By comparing current period allowances with the prior period, you might detect the intentional lowering of receivable allowance accounts. Why would a company do this? Lower allowances result in higher profits. It’s another form of financial statement fraud.

A Fraudster’s Refuge: The Appalachian Trail

Day 10 of 30 Days of Fraud

The Theft

Some fraudsters steal money by opening a fraudulent bank account and funneling funds into that account. Today, I show you how one controller did this and walked away with millions.

In May 2015 James Hammes was arrested for the theft of $8.7 million from his former employer, G&P Pepsi-Cola Bottlers. After Mr. Hammes was confronted about the theft in February 2009, he left his home and hid on the Appalachian Trail, which runs from Georgia to Maine. Hammes assumed a hiking name of “Bismarck” and spent several years on the popular trail. Fellow hikers enjoyed Bismarck since he seemed to be one of them.

Wanted poster from the FBI

Wanted poster from the FBI

How the Funds Were Stolen

The FBI reported the following:

Court documents show that Hammes’ embezzlement began around 1998. As a controller, he was responsible for all financial accounting and internal controls for his division, including supervising accounts payable to several hundred outside vendors. He carried out the fraud by establishing a new bank account for an existing vendor at a different bank. He then deposited hefty payments to that vendor—often $100,000 at a time—in the phantom account that he alone controlled. He then could transfer money from the phantom account to his personal accounts.

“He knew how to cover his tracks by manipulating audits and ledger entries,” Jones said. “He got away with it for so long because he knew how to manipulate his subordinates and how not to raise accounting red flags.”

So, Hammes opened a fraudulent bank account at another bank (one the company did not use) and deposited vendor checks into that account. Then he transferred funds out of the fraudulent bank account to himself.  Since he opened the account, he was the authorized check signer. Simple but effective.

The Weakness

If extra payments were made to vendors (and it appears that occurred), then the company may not have been reviewing vendors payments. It’s easy to just make vendor payments without seeing patterns, especially if hundreds of checks are processed each month.

Also, it appears the company may have lacked sufficient segregation of duties since Hammes was able to disburse extra vendor payments without detection.

The Fix

Periodically, review total payments made to each vendor. For example, generate the total monthly payments made to XYZ Company. Then compare the monthly payments over a two to three year period. If payments dramatically increase, then someone within the company may be making additional payments and stealing those checks. Or there may a legitimate reason for the increase. Either way, it’s wise to review vendor payments for anomalies. 

Fraudsters Writing Checks to Themselves: How to Understand It and Prevent It

Day 9 of 30 Days of Fraud

The Theft

Fraudsters do write company checks to themselves. Today I tell you how they do so and how you can prevent this type of theft.

Randy Toms, a city accounting clerk, creates a manual check for $5,200 that is made out to himself and signs it with a signature stamp. (The stamp is used when the mayor is out of town.) Randy enters the transaction into the accounting system–using a journal entry–as a payment to Macon Hardware. The result: The general ledger reflects a payment to Macon Hardware, but the check is made out to Randy. Also, he codes the disbursement to an account with sufficient remaining budgetary balance. The subterfuge works since the expense accounts reflects appropriate vendor activity (a check to Macon Hardware), and expenses don’t exceed budget. Randy performs the monthly bank reconciliation, so he alone sees the cleared checks.

Given Randy’s success with the first check, he continues the fraud for several years.

(Here’s another twist to this type of theft. Some companies print their checks with the signature affixed, so the computer (in effect) signs the check. When this is true, some fraudsters will print the check to a legitimate vendor. Then they will destroy the check and write a manual check (from other company check stock) to themselves. In such cases, they are either authorized signers or they forge the signature.)

Fraudsters writing checks to themselves

This is picture is courtesy of AdobeStock.com

The Weakness

The following provides the perfect environment for this theft:

  1. The existence of the signature stamp
  2. The clerk posts journal entries without a second-person review (approval)
  3. The clerk reconciles the related bank account (ensuring that no one–other than Randy–sees the cleared checks)

As you can tell there is a lack of segregation of duties. Many small organizations are unable to segregate accounting duties since they have a limited number of employees. Even so, there are steps you can take to reduce the possibility of theft.

You may be thinking, “Wouldn’t the auditors catch this type of fraud?” Probably not. Auditors seldom compare cleared checks to supporting invoices. (If you’re an auditor, you may want to consider this potential theft in your fraud brainstorming sessions.)

The Fix

The fix includes the following:

  1. Get rid of the signature stamp
  2. Require second party approval of all journal entries
  3. Have someone other than the clerk reconcile the bank account (and review cleared checks)

Some governments or businesses have bank statements mailed to someone outside the accounting department such as the city mayor or business owner. This person opens the bank statement and performs a cursory review of the cleared checks–once done, the bank statement is routed to the accounting department. Since cleared checks are viewed by someone else, there is less of a chance that the accounting staff will write checks to themselves.

Converting Company Checks to Cash: How to Understand It and Prevent It

Day 8 of 30 Days of Fraud

The Theft

In a recent post, we saw that John opens the mail and receipts checks made out to the City of Whoville. He was stealing cash by using the check-for-cash fraud scheme. That’s one way to steal.

But consider that converting company checks to cash—even without using a check-for-cash scheme—is possible. 

In this post, I show you how fraudsters turn company checks into cash.

converting company checks to cash

Picture is courtesy of AdobeStock.com

John can open a new bank account in the name of the city. Everyone in the community knows that John works in the city’s accounting department; so it appears perfectly normal for him to open a new bank account. John conveniently signs the signature card as the solely authorized signature. The name he uses for the bank account is Whoville Projects. So, the account name appears reasonable, and John has what he wants–a bank account for which he is the solely authorized signer.

John alone opens the mail. Now he steals checks made out to the city and deposits them into the Whoville Projects bank account (the new account is never set up in the city’s general ledger). Then John writes checks from his fraudulent bank account to anyone he chooses–including himself. (Rita Crundwell used an off-the-books checking account to steal $53 million dollars.)

Many companies incorrectly believe that fraudulent bank accounts can’t be opened in their name, especially if they are incorporated. Why? Because most banks ask for copies of company corporate documents. But consider that fraudsters can open a “doing business as” bank account in the name of ABC Company. Since the bank account is a personal (and not a corporate) bank account, the bank will not ask for corporate documentation.

Also, fake corporate documents can be created, if Susie wants to go the route of opening the bank account in the name of ABC Company, Inc.

The Weakness

The fundamental weakness is John opens the mail and receipts the checks by himself. Also, this type of theft often occurs when no one is comparing revenues to budget or prior period amounts. A lack of security cameras allows John’s thefts to go undetected.

The Fix

Two people should be present when the mail is opened and receipted. Another alternative is to use a lockbox; that way, all checks go directly to the city’s bank rather than to the city.

The city should install security cameras and record all activity.

Periodically request a list of all accounts from the bank. Then see if each account is set up in the city’s general ledger.

Theft of Capital Assets: How to Understand It and Prevent It

Day 7 of 30 Days of Fraud

The Theft

In businesses, nonprofits, and governments, the theft of capital assets happens often. Today I explain how these thefts occur and how you can prevent them.

A USA Today article began with, “Stolen and sensitive U.S. military equipment, including fighter jet parts wanted by Iran…have been available to the highest bidder on popular Internet sales sites.” The article went on to say that the equipment, “purchased with taxpayer money,” was available for purchase on eBay and Craigslist and included “components from F-14 fighter jets” and “used Nuclear Biological Chemical protective suit.”

Capital asset theft

Picture is courtesy of Adobe pStock.com

Capital assets often go missing because no one is paying attention, and the thief knows it. Such assets can be stolen with the intent to sell and convert to cash or simply for personal use.

The thefts often occur when employees place equipment or other capital assets in their vehicles and drive home. If the employee wants to cover their tracks, they might complete accounting paperwork for disposal of assets (saying the equipment was junked). More often than not, however, the asset is just stolen because the employee knows that no one will notice, or, if someone does, he can say, “I don’t know what happened to that piece of equipment.”

Long-term employees realize that the external auditors seldom audit existing capital assets. Yes, the auditor will examine an invoice, but how many auditors physically inspect plant, property and equipment?

The Weakness

The main enabling factor is usually a lack of accountability. Many companies, nonprofits, and small governments do not perform periodic fixed asset inventories. Often equipment is purchased and added to the depreciation schedule, but no one–at a later date–compares this master list of fixed assets to what is (or should be) physically present.

The Fix

Performing periodic inventories is the key to lessening the threat of capital asset theft.

First assign each capital asset to a person (usually a department head or a supervisor); let this person know that he or she is personally responsible for the item. Then have someone external to each department perform periodic inventories of departmental assets.

Also, install security cameras to record all activity.

Check-for-Cash Fraud: How to Understand It and Prevent It

Day 6 of 30 Days of Fraud

The Theft

The check-for-cash fraud scheme is a simple yet effective way for employees to steal. Today I explain how this type of theft occurs and how you can prevent it.

Kelly is a receipts clerk in the City of Whosville. She usually collects about $25,000 each day with $8,000 of this being in cash and the remainder in checks. Kelly, based on city policy, receipts all monies she receives, but she does not note on the receipt whether the payment is cash or check.

check-for-cash fraud

Kelly also opens the mail and receipts those checks. Each month the city receives about a dozen alcohol tax checks–each made out to the City of Whosville–in the range of $3,000 to $6,000 each. These payments are paid by the alcohol distributors based on their sales, so the revenue is recognized upon receipt (and no receivable is accrued before payment).

Kelly wants to take a trip overseas, but she needs about $15,000 which he doesn’t have. But then she has a novel idea.

Since she opens the mail, she can steal cash in the following manner:

  1. Don’t receipt a check received in the mail (e.g., an alcohol tax check for $4,503)
  2. Place that check in her cash drawer
  3. Take $4,503 from her cash drawer and place it in her purse

The $4,503 in cash came from legitimate collections. Receipts were written for the payments, but Kelly did not note whether cash or checks were received. 

Over a three month period, Kelly steals $17,505, and no one notices.

The Weakness

Though receipts are issued, the type of payment (cash or check) is not noted. No one (such as a supervisor) is reconciling the composition–total cash and total checks–to the receipts.

The Fix

As receipts are issued, require collection personnel to note the type of payment received (whether cash or check). A supervisor should reconcile the amount of cash and checks in the collection drawer to the receipts. If total cash and total checks don’t reconcile to the receipts, then the check-for-cash fraud might be occurring.

Compare the budgeted alcohol tax amount to the total received.

Also, consider installing a camera to record cash collections activity and do not allow purses or other bags in the collections area.