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Red Flags of Municipal Fraud: Preventing Employee Dishonesty
 

Red Flags of Municipal Fraud: Preventing Employee Dishonesty

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On average, organizational loss from employee dishonesty is estimated to claim 6% of revenue. Most is never discovered and continues for years. ...

On average, organizational loss from employee dishonesty is estimated to claim 6% of revenue. Most is never discovered and continues for years.

This webinar outlined fraud schemes common to municipalities as well as methods to prevent opportunities for theft. Best practices related to handling an incident, evidence gathering and security, proper reporting, whistleblower systems, and use of forensic professionals were discussed.

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    Red Flags of Municipal Fraud: Preventing Employee Dishonesty Red Flags of Municipal Fraud: Preventing Employee Dishonesty Document Transcript

    • Red Flags of Municipal Fraud Presented by:   Mary O’Connor, ASA, MRICS Partner, Valuation and Dispute Advisory Services Sikich LLPAgenda • Distinction between fraud and occupational dishonesty • Uniform Occupational Fraud Classification System • Interesting statistics • Common fraud schemes • Conducting the investigation • Systems to prevent employee dishonesty © 2012 Sikich LLP. All rights reserved. 1
    • Distinction Between Fraud and Occupational Dishonesty Fraud is a much larger legal concept specifically related to a criminal act as  defined in the law.  Fraud is both a civil and criminal matter in litigation. Fraud has four elements: 1. Material false statement 2. Knowledge that the statement was false 3. Reliance on the statement by the victim 4. Damages © 2012 Sikich LLP. All rights reserved.Distinction Between Fraud and Occupational Dishonesty Occupational fraud, also known as employee dishonesty, is the use of  employment to commit fraud for personal enrichment through deliberate  misuse or misapplication of employer’s resources and assets.  © 2012 Sikich LLP. All rights reserved. 2
    • Uniform Occupational Fraud Classification System © 2012 Sikich LLP. All rights reserved.Uniform Occupational Fraud Classification System © 2012 Sikich LLP. All rights reserved. 3
    • But My Auditor Gave a Clean Opinion • An unqualified audit opinion does NOT mean that there is no employee  dishonesty occurring in the organization • Employee dishonesty can be significant and the books can still balance • SAS 99, professional skepticism and materiality © 2012 Sikich LLP. All rights reserved.Interesting StatisticsInteresting Statistics • Losses estimated at twice the annual budget of the US Department of Defense • Direct correlation between age of fraudster and size of theft • Direct correlation between job title of fraudster and size of theft • Overwhelmingly happens in small operations • External auditors rarely identify fraudulent activity © 2012 Sikich LLP. All rights reserved. 4
    • Interesting StatisticsInteresting Statistics Fraud Incidents By Age © 2012 Sikich LLP. All rights reserved.Interesting StatisticsInteresting Statistics Median Loss by Age © 2012 Sikich LLP. All rights reserved. 5
    • Interesting StatisticsInteresting Statistics Occupational Position and Fraud © 2012 Sikich LLP. All rights reserved.Interesting StatisticsInteresting Statistics Fraud Incidents By Gender © 2012 Sikich LLP. All rights reserved. 6
    • Interesting StatisticsInteresting Statistics Median Loss by Gender © 2012 Sikich LLP. All rights reserved.Interesting StatisticsInteresting Statistics Median Loss per Number of Employees © 2012 Sikich LLP. All rights reserved. 7
    • Interesting Statistics Initial Detection of Frauds © 2012 Sikich LLP. All rights reserved.Why are municipal governments vulnerable to fraudulent employee activity?   • Denial culture – don’t rock the boat  • No invoice/receivable cycle: revenue as a gift • Many part‐time employees • Wink and nod • Budget constraints © 2012 Sikich LLP. All rights reserved. 8
    • Who is the fraudster? • Otherwise honest and responsible citizen • Computes the likelihood of capture and  believes it is worth the risk • Tends to be middle‐aged, of either  gender and well‐regarded in the  organization © 2012 Sikich LLP. All rights reserved.Fraud Hot Spots • Departments with independent  • Sensitive information on desks systems • Insecure checks • Police: local adjudication • Mail handling • Cash and cash registers • Deposit handling • Too many bank accounts • Deficient IT system • Voucher system • Reliance on part‐time employees • Stop payments, outstanding  checks © 2012 Sikich LLP. All rights reserved. 9
    • Red Flags of Municipal Fraud • Independent IT systems without proper interface • Poor separation of duties • Poor internal controls – no one is really looking • Over‐reliance on certain employees • Extravagant lifestyles © 2012 Sikich LLP. All rights reserved.The Problem with Departmental Systems Municipalities are composed of numerous sub‐units and many are located  remotely from the main office.  A manual interface with the departmental  system and the Finance Office is a major red flag that requires investigation.  Manual  Interface Dept. System General Accounting  System © 2012 Sikich LLP. All rights reserved. 10
    • The Problem with Department Systems Departments often run autonomously and many collect significant amounts  of cash in total annually.  However, the daily deposits to the Finance  Department may be small and seemingly immaterial. Cash theft can easily  occur and the entity’s books still balance.  Note that theft can occur and the  department system can be accurate:  the public may not be complaining. © 2012 Sikich LLP. All rights reserved.The Problem with Department Systems Departments tend to be staffed with insufficient personnel to separate dutiesappropriately. One employee – often working there for years – controls andhandles everything. Management believes that the department just couldn’tfunction without this person. © 2012 Sikich LLP. All rights reserved. 11
    • The Problem with Department Systems  The one trusted employee tends to handle, and therefore can abuse, all the IT passwords so that the malfeasance can be blamed on other employees. © 2012 Sikich LLP. All rights reserved.Uniform Occupational Fraud Classification System © 2012 Sikich LLP. All rights reserved. 12
    • Common Fraud Schemes Corruption • Conflicts of interest • Schemes with and without vendor knowledge • Grant fraud • Bribery and kickbacks • Bid rigging and procurement fraud – Use of shell intermediary companies – Improper use of minority companies – Multiple names for same vendor – Different rules for different vendors – Material substitution – Change order game © 2012 Sikich LLP. All rights reserved.Uniform Occupational Fraud Classification System © 2012 Sikich LLP. All rights reserved. 13
    • Common Fraud Schemes Financial Statement Fraud – Fictitious revenues – Concealed liabilities – Journal entry fraud – This is the focus of the external auditor © 2012 Sikich LLP. All rights reserved.Uniform Occupational Fraud Classification System © 2012 Sikich LLP. All rights reserved. 14
    • Common Fraud Schemes Skimming • Recorded and unrecorded revenue • Write‐offs of receivables • Voids and restarts • Lapping • Refunds © 2012 Sikich LLP. All rights reserved.Common Fraud Schemes Fraudulent Disbursements • Billing: shell companies, pass‐through entities • Payroll: ghost employees, falsified time record, failure to terminate • Expense reimbursement • Check tampering • Register disbursements: false voids,  false refunds © 2012 Sikich LLP. All rights reserved. 15
    • Common Fraud Schemes Inventory Misappropriation • False acquisitions and transfers • Simple theft • Conversion to personal use © 2012 Sikich LLP. All rights reserved.Conducting the Investigation  Goals to this process are: – Follow‐up on all credible tips and complaints – Follow‐up on all management letter issues to fraud – Form a response team that preserves the secrecy of the situation – Avoid the “Dick Tracy” syndrome – Create a plan that allows the organization to work together in the future  – Notify Board and management © 2012 Sikich LLP. All rights reserved. 16
    • Conducting the Investigation  Goals (continued): – Preserve the evidence, especially the computer record – Deal with the administrative leave and other employment issues – Deal with employee morale issues – Keep the place going!!!! – Work for restitution, insurance claim preparation  and possible criminal referral – Learn from mistakes of the past and fix the  problems – Communicate effectively to the public © 2012 Sikich LLP. All rights reserved.Conducting the Investigation Reasons to call in a forensics team • Preserve the relationship of audit team and staff • Tasks for the forensics team – Surveillance – Proof – Security of computer evidence – Interviewing – Insurance claim – State’s Attorney support © 2012 Sikich LLP. All rights reserved. 17
    • A System to Prevent Employee Dishonesty First and foremost: secure the IT system – Passwords and encryption – Laptops and cell phones – Clean desk policy – One system among departments – Sufficient firewalls to prevent hacking © 2012 Sikich LLP. All rights reserved.A System to Prevent Employee Dishonesty Create a tone at the top – Clear policies and procedures – Clear policy of punishment for malfeasance – Lead by example – Training, training, training – Employee background checks and hiring practices © 2012 Sikich LLP. All rights reserved. 18
    • A System to Prevent Employee Dishonesty Install an effective whistle‐blowing system – Anonymous – No reprisals – Off‐site answering service – Must follow‐up on tips © 2012 Sikich LLP. All rights reserved.A System to Prevent Employee Dishonesty Internal control system – Separation of duties – Authorizations; look at limits – Computer passwords – Independent and surprise checks – Separation of Treasury and Accounting functions – Think through each system – Where are the holes? – Rotate and cross‐train © 2012 Sikich LLP. All rights reserved. 19
    • A System to Prevent Employee Dishonesty Alert vendors and install strict controls – Contract language to include right of audit – Master vendor file – Review addresses and relationships – Physical verification – Statistical analysis © 2012 Sikich LLP. All rights reserved.A System to Prevent Employee Dishonesty Secure the physical assets of the organization – Clean desk policy – IT policy related to laptops, desktops, phones, iPads – Checks!!!!!! – No passwords on computer screens!!!! – Secure receiving dock – Semi‐annual inventory of major assets © 2012 Sikich LLP. All rights reserved. 20
    • Questions?Contact Information Chad Lucas, CPA Mary O’Connor, ASA, MRICS Stephanie Lombardi, CPA Partner Partner Partner Sikich LLP Valuation and Dispute Advisory Services Sikich LLP 3201 West White Oaks Drive Sikich LLP 6815 Weaver Road Suite 102 123 North Wacker Drive, Suite 1500  Suite 100 Springfield, IL 62704 Chicago , IL 60606 Rockford, IL 61114 T: 217.793.3363 & T: 815.282.6565 Email: clucas@sikich.com 1415 West Diehl Road, Suite 400 Email: slombardi@sikich.com Naperville, IL 60563 T: 312.648.6652  M: 708.646.8737 Email: moconnor@sikich.com © 2012 Sikich LLP. All rights reserved. 21