Steps to Prevent Detect Occupational Fraud in Government (Final)

Steps To Prevent & Detect
Occupational Fraud in Government
May 20, 2015
Ron Steinkamp, CPA, CIA, CFE, CRMA, CGMA
314.983.1238 | rsteinkamp@bswllc.com
6 CityPlace Drive, Suite 900 │ St. Louis, Missouri 63141 │ 314.983.1200
1520 S. Fifth St., Suite 309│ St. Charles, Missouri 63303 │ 636.255.3000
2220 S. State Route 157, Ste. 300 │ Glen Carbon, Illinois 62034 │ 618.654.3100
1.888.279.2792 │ www.bswllc.com

WHAT IS THE LARGEST MUNICIPAL FRAUD IN US HISTORY?
Question?
© 2015 All Rights Reserved
Brown Smith Wallace LLC 1

City Comptroller (Rita Crundwell) embezzled over $53 million from
1990-2012.
Facts
• City of 15,000 south of Chicago.
• Home of Ronald Reagan.
• Annual City budget $8-9 million.
Perspective
• Per FBI, 5 months ending February 2012:
- Police - $1.1 million
- Rita’s pocket - $3.2 million
Dixon, Illinois

How did she do it?
• Minimal oversight and small town trust.
• Lack of segregation of duties.
• Opened a secret bank account and transferred in City funds from
other accounts.
• Used funds to pay for her personal and private business
expenses.
- Horse farming/ranching operations and shows.
- Personal credit cards.
- Trips.
- Real estate.
- Vehicles.
• Fooled the auditors by creating fictitious invoices from State of
Illinois.
Dixon, Illinois

How was it detected?
• Comptroller took 12 weeks of approved vacation.
• Interim replacement received bank account and determined
transactions had nothing to do with City business.
Warning signs
• Her lifestyle changed from modest to lavish.
• Inadequate segregation of duties.
Results
• Rita got 20 years in prison.
• Sold off Rita’s assets.
• City of Dixon awarded $40M from lawsuit against the auditors and
bank.
Dixon, Illinois

Lessons Learned
• Segregate duties.
• New bank accounts approved by the Mayor and Council.
• Two responsible members of management approve all invoices.
• Payments exceeding a certain amount require two signatures.
• City Council reviews and approves all fund transfers.
• Mayor and Council review and discuss financial reports and
audits.
• Anti-fraud orientation provided to all new employees.
• Mandatory annual fraud reorientation for all employees.
• Anonymous fraud hotline.
• Mandatory job rotation.
• Mandatory annual vacations.
• Surprise audits.
Dixon, Illinois

Agenda
Brown Smith Wallace LLC
• What is Occupational Fraud?
• 2014 ACFE Global Fraud Study
• Red Flags
• Common Areas of Abuse in Government
• 7 Keys to Fraud Prevention & Detection
• Key Process Controls
• Fraud Self Assessment
6

WHAT IS OCCUPATIONAL
FRAUD?

The use of one’s occupation for personal enrichment through the
deliberate misuse or application of the employing organization’s
resources or assets.
Three general categories:
 Asset misappropriation
 Corruption
 Financial statement fraud
Definition

Perpetrator steals or misuses an organization’s resources.
- Examples:
• Clerk stealing cash receipts.
• Payroll Clerk creating a ghost employee.
• Purchasing Clerk creating a fictitious vendor and false
invoice.
• Street Department personnel “borrowing” equipment.
• City Manager purchasing personal items on the City credit
card.
Asset Misappropriation

Employee’s use of his/her influence in business transactions in
a way that violates his/her duty to the employer for the purpose
of obtaining benefit for him/herself or someone else.
- Examples:
• City Council member trading votes for personal favors.
• Purchasing Department Manager awarding a City contract
to a vendor for a kickback.
• Human Resources Director hiring unqualified “friends” to fill
positions.
Corruption

Intentional misstatement or omission of material information in
the organization’s financial reports.
- Examples:
• Inflating City revenues on the Consolidated Annual
Financial Report.
• Forcing actual expenditures to match budget by moving
expenses between accounts.
• Improperly accounting for grant receipts and expenditures.
Financial Statement Fraud

2014 ACFE Global Fraud Study
2014 Report to the Nations on Occupational Fraud and Abuse

1. Typical organization loses 5% of annual revenue to fraud – applied to 2013 Gross World
Product translates to potential fraud loss of more than $3.7 trillion annually.
2. Median loss in the study was $145,000 with more than 22% of the cases involving losses
over $1 million.
3. Fraud lasted a median of 18 months.
4. Asset misappropriation schemes (fraudulent disbursements, theft of cash receipts, other
asset misappropriations) were the most common form of fraud, representing 85% of the
cases and least costly at a median loss of $130,000.
5. Financial statement fraud schemes were the least common form of fraud, representing
9% of the cases and most costly at a median loss at $1 million.
Summary of Findings

6. Corruption schemes fell in the middle, comprising just over 37% of cases and causing a
median loss of $200,000.
7. Occupational frauds are most likely to be detected by tips (40%) followed by
management review (15%) and Internal Audit (14%).
8. Small organizations are disproportionately victimized by occupational fraud.
9. Government/public administration was one of the most commonly victimized
industries.
10. Anti-fraud controls appear to help reduce the cost and duration of occupational fraud
schemes.
11. High-level perpetrators cause the greatest damage to their organizations.
Summary of Findings (cont.)

12. 77% of frauds were committed by individuals in one of seven departments:
 Accounting
 Operations
 Sales
 Executive/upper management
 Customer service
 Purchasing
 Finance
13. More than 85% of fraudsters had never been previously charged or convicted for a
fraud-related offense.
14. Fraud perpetrators often display warning signs – most common behavioral red flags
reported in the survey were perpetrators living beyond their means (36%) and
experiencing financial difficulty (27%).
15. Nearly half of victim organizations do not recover any losses that they suffer due to
fraud.
Summary of Findings (cont.)

RED FLAGS

The Fraud Triangle

 Pressure or incentive – need the fraudster is trying to satisfy.
 Opportunity – ability to commit the fraud.
Organizations can influence this characteristic the most = strong internal controls that avoid
putting employees in positions to commit fraud and that detect fraudulent activities if they
occur.
 Rationalization – ability to justify the fraud.
 AKA = Fraud Triangle
Common Characteristics of Fraud

• High personal debts.
• Living beyond their means.
• Excessive investment speculation.
• Excessive gambling.
• Substance abuse.
• Extra-marital affairs.
• Job frustration.
• Resentment of superiors.
Pressure “Red Flags”

• Inadequate internal controls.
• Too “cozy” with suppliers.
• Annual vacation or sick days not taken.
• Weak management or excessive turnover.
• Ineffective or no internal audit.
• No rotation of job duties among employees.
• Procedures not well understood/always in crisis mode.
• Large amounts of cash on hand or processed.
Opportunity “Red Flags”

• Not compensated fairly.
• No recent raises/cost of living adjustments.
• Everyone else does it.
• Intended to pay it back.
• Needed the money.
• Felt cheated and wanted revenge.
• Bribe/kickback too tempting.
Rationalization “Red Flags”

 Middle aged male, employed by the organization for a number of years and in a position of trust.
 Educated.
 Works in the financial department.
 Member of management.
 Driven by money and opportunity.
IS THIS TRUE FOR GOVERNMENT?
Typical Fraudster

COMMON AREAS OF ABUSE
IN GOVERNMENT

• Skimming
• Check Tampering
• Billing Schemes
• Fraudulent Expense Reimbursement
• Payroll Fraud
• Bribery and Conflicts of Interest
Common Areas of Abuse in Government

Employee steals cash from the employer before it is
recorded on the employer’s books and records. Skimming
typically occurs when an employee:
• Has access to customer payments
• Directs intercepted receipts to personal accounts
Skimming

How can skimming be prevented/detected?
• Segregate cash receipts and accounting
responsibility.
• Issue receipts.
• Track receipts in system and reconcile daily.
• Surprise cash counts.
• Cameras.
Skimming

Any scheme in which an employee steals employer’s funds
by:
• Forging or altering a check on the employer’s bank
account.
OR
• Stealing a check the organization has legitimately
issued to another payee.
Check Tampering

How can check tampering be prevented/detected?
• Check stock should be locked in a secure location to
ensure blank checks are not accessible to potential
fraudsters.
• Checks should be mailed immediately after signing to
reduce the risk of legitimate checks being stolen.
• Positive pay.
• Bank reconciliations.
Check Tampering

Billing schemes occur when an employee submits a false
invoice or alters an existing one, thus causing the employer
to willingly (but unknowingly) issue a check for false
expenses.
Billing Schemes

How can billing schemes be prevented/detected?
• Prior to authorizing payment, invoices should be checked for
validity of the vendor, validity of the goods or services invoiced,
accuracy, and authenticity.
• Prior to processing payment, invoices should be checked for
proper authorization, accuracy and authenticity. This will prevent
overpayment, as well as payments being made to fictitious
vendors.
• Strictly control access to vendor master data.
• Regular vendor master file analysis.
Billing Schemes

Expense reimbursement schemes occur when an
employee submits false expenses in the hope of being
reimbursed.
Fraudulent Expense Reimbursements

How can fraudulent expense reimbursements be prevented/detected?
• Expense reimbursement policy.
• Require original itemized receipts.
• Receipts should be scrutinized to detect alterations or forgeries.
• Other means of proving incurred expenses, such as airline
itineraries, credit card statements, etc. should not be accepted
unless approved by a supervisor.
• All expense reimbursements should be reviewed and
immediately processed upon approval.
• Use a specific credit card for all business expenses. Receive this
information electronically from credit card company and require
electronic filing of expense reports by employees. This will
minimize the possibility of fraud and, if fraud is occurring, will
provide an easier means to identify it.
Fraudulent Expense Reimbursements

Payroll fraud occurs when an employee submits false documentation
(i.e., timecards) in an effort to inflate his/her wages/salary. Such
documentation prompts the organization to unknowingly disburse funds
to the perpetrator.
Possible ways in which Payroll Fraud can occur:
• Falsified hours and salary
• Ghost employees
Payroll Fraud

How can payroll fraud be prevented/detected?
• All timecards should be reviewed for validity and accuracy.
• Once submitted for approval, employees should never see their
timecard again.
• Overtime hours must be authorized by a supervisor.
• If employees use a time clock to “punch in” and “punch out”, they
must do so when they arrive for work, take breaks, go to lunch,
leave for the day, etc.
• Monitor employees to ensure one employee is not punching out
for another.
• Strictly control access to payroll master data.
Payroll Fraud

Schemes involving the employee’s use of his/her
influence in transactions in a way that violates duty to the
employer for the purpose of obtaining a benefit for
themselves or someone else.
Usually involves collusion.
Bribery and Conflicts of Interest

How can bribery and conflicts of interest be prevented/detected?
• Well publicized fraud hotline.
• Strong ethics and conflict of interest policy.
• Required reporting of potential conflicts of interest.
• Limiting gifts from vendors and contractors.
• Well defined procurement process.
• Rotate buyers.
• Contract audits.
Bribery and Conflicts of Interest

7 Keys To Fraud
Prevention And Detection

Anti-Fraud Culture
Fraud Policy
Fraud
Awareness/Training
HotlineAssess Fraud Risks
Review/Investigation
Improved Controls

 Set the tone at the top = Lead by Example
 Responsibility of Directors and Officers
 Behave ethically and openly communicate expectations to employees
 Treat all employees equally
 Zero tolerance
 Create a positive workplace environment
 Focus on employee morale
 Empower employees
 Communicate
 Hire and promote appropriate employees
 Conduct background investigations before hiring or promoting
 Check candidate’s education, employment history, references
 Continuous and objective evaluation of compliance with entity values
 Violations addressed immediately
1. Anti-Fraud Culture

 Code of Conduct
 Formalized and founded on integrity
 Defines acceptable employee behavior
 Communicated to all employees
 All employees are held accountable for compliance
 Discipline
 Sends a strong message throughout the entity
 Should be appropriate and consistent
 Consequences of committing fraud clearly communicated throughout
the entity

 Oversight Process
 Audit Committee or Board of Directors
 Evaluate management’s “tone at the top”, identification of fraud risks and
implementation of anti-fraud controls
 Ensure that management implements anti-fraud measures
 Consider the potential for management override of controls
 Management
 Directs, implements and monitors anti-fraud controls
 Sets the ethical tone
 Trains employees
 Internal Auditor
 Identifies fraud indicators
 Assesses fraud risks
 Evaluates anti-fraud controls
 Recommends actions to mitigate risks
 Investigates potential frauds

 Demonstrate commitment to combating fraud
 Apply to all Directors, Management, employees,
consultants, vendors, contractors, etc.
 Should include:
 Statement of organization’s position on fraud
 Scope of the policy – who does it apply to
 Management’s responsibility for prevention and detection of fraud
 Definition of fraud
 Actions constituting fraud
 Fraud reporting process/procedures
 Fraud investigation process/procedures
 Unit responsible for administration of the policy and investigating
fraud allegations
 Statement on anonymity/confidentiality
 Consequences
2. Fraud Policy

 Reviewed and updated regularly.
 Signed off and agreed to by the CEO and Board Chair.
 See the ACFE for an example Fraud Policy.
http://www.acfe.com/uploadedFiles/ACFE_Website/Content/documents/Sample_
Fraud_Policy.pdf
2. Fraud Policy

 All new employees should be trained at time of hiring
on the Code of Conduct and Fraud Policy.
 Training should include:
 Their duty to communicate certain matters
 A list of the types of matters to be communicated along with
examples
 How to communicate those matters
 Affirmation from senior management regarding employee
expectations and communication responsibilities
 Refresher training periodically
3. Fraud Awareness/Training

 Enable employees, vendors, customers and others to
communicate concerns about known or suspected
wrongdoing.
 Telephone, email, internet.
 Anonymous.
 Adequately publicized.
 Internal or external.
 Complaint monitoring and investigation/resolution.
4. Hotline

 Conduct an annual fraud risk assessment.
 Assists management in systematically identifying where and how fraud may
occur and who may be in a position to commit fraud.
 Focus on fraud schemes and scenarios to determine the presence of internal
controls and whether or not the controls can be circumvented.
 General steps:
 Identify areas and processes to assess
 Identify potential fraud schemes in each area/process
 Assess likelihood and significance of each scheme
 Map existing anti-fraud controls to potential fraud schemes
 Test operating effectiveness of anti-fraud controls
 Identify any control gaps and/or deficiencies = Residual risks
 Document and report on the fraud risk assessment
5. Assess Fraud Risks

 Mitigate Fraud Risks
 Make changes to activities and/or processes = transfer or eliminate the risks
 Improve anti-fraud controls
 Monitor Fraud Risks
 Develop data analytics for management to use to monitor fraud risks
 Utilize Internal Audit to conduct audits of risk areas
5. Assess Fraud Risks

 All concerns/suspicions of wrongdoing should be reviewed
and determination made whether a fraud investigation is
warranted.
 Develop a policy for fraud reviews and investigations that
specifies:
 Who is responsible for the review/investigation
 Roles of Legal Counsel, Human Resources, Internal Audit, others
 Process for conducting the review/investigation
 Documentation requirements
 Reporting requirements
 When to involve law enforcement
6. Fraud Review/Investigation

 Gather sufficient information and perform procedures
necessary to determine:
 Whether fraud has occurred
 Loss or exposure associated with the fraud
 Who was involved and how it happened
 Must prepare, document and preserve evidence sufficient for
potential legal proceedings.
 Include experts = Certified Fraud Examiner (CFE)
6. Fraud Review/Investigation

 Periodic internal control reviews.
 Use lessons learned from any reviews or investigations to
improve anti-fraud controls.
 All reviews and investigations should include a report to
management with recommendations for control
improvement.
7. Improved Controls

KEY PROCESS CONTROLS

• Code of conduct
• Policies and procedures manual
• Segregation of duties
• Records retention
• Documentation of transactions
• Budgetary
• Fraud Policy and reporting
• Access to systems
General Controls

• Policies and procedures.
• All bank accounts opened and maintained in
organization’s name with proper approval.
• Segregate access to cash from accounting for cash.
• Monthly reconciliation of recorded balances to bank
account detail by employees not involved in cash
activities.
• Control credit cards and reconcile to receipts on a
timely basis.
Cash Management Controls

• All orders received are processed and recorded.
• All orders processed are invoiced.
• All invoices are posted to customer accounts.
• Billings are accurate.
Revenue Cycle Common Controls

• All purchase orders are authorized.
• All vendors are authorized.
• Individuals have authorization limits.
• Check stock is controlled.
• EDI/ACH transactions require authorization.
• Credit card purchases are controlled and statements
are reconciled to detailed receipts.
Procurement Cycle Common Controls

• Procedures for adding, changing, removing employees
and related pay and benefits.
• Payroll personnel can not add/change/delete
employees and related pay and benefits.
• All changes are authorized by management.
• Payroll preparation segregated from payroll
authorization, check signing and distribution.
• Access to payroll is restricted.
• Safeguard checks.
• Reconciliations.
Payroll Common Controls

• Procedures for adding and removing fixed assets.
• Detailed records of all fixed assets.
• Tracking of fixed assets.
• Inventory fixed assets and reconcile to records
periodically.
Fixed Assets Common Controls

• Accurate, Timely, and Consistent Reporting.
• Recorded balances should be periodically
substantiated and evaluated.
Management Reporting Common Controls

• Exception reporting
• Shipping/Receiving
• Physical inventory monitoring
• Perpetual records
• Controlling slow-moving and obsolete inventories
• Scrap
• Adjustments are controlled
• Cycle counting
• Disposal
Inventory Monitoring Common Controls

• Back-ups
• Disaster Recovery
• Security (physical & logical)
• Virus Protection
• Administrative
- Change control
- Trouble reporting
- Helpdesk
- Systems Development Life Cycle
IT Common Controls

Ron Steinkamp, CPA, CIA, CFE, CRMA, CGMA
Member, Advisory Services
Brown Smith Wallace, LLC
314.983.1238 (Direct)
rsteinkamp@bswllc.com
Contact Information

Steps to Prevent Detect Occupational Fraud in Government (Final)

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