hris, we have a problem,” said the
voice on the other end of the line. “Our purchasing
manager, Bruce, is on vacation and we think we have
discovered some irregularities.” Chris Rosetti, CPA,
swung into action. Rosetti—a partner with BST
Advisors LLC in Albany, New York—had done limited
work for the client, a state agency, in the past.
This time, he quickly discovered the agency had
two key internal control deficiencies. The first
was that Bruce hadn’t been forced to use his
vacation time in three years. Rosetti, a veteran
adviser in at least 100 fraud cases, had seen this
situation many times: Once employees start
committing fraud, they can’t take time off because
they need to constantly cover up what they’re
doing. The second deficiency was that Bruce was
allowed to approve new vendors. So, not only was
he approving the purchases, but he also was
selecting the vendors—a serious breach of
separation of duties. When he was forced to take
time off to attend to his sick wife, the agency
received requests for payment on three invoices
for which there were no vendor files. They were
later located in Bruce’s desk. That’s when Rosetti
was called in. In examining the vendor
files, Rosetti noted a number of oddities. For
one, Bruce had approved the purchase of a large
quantity of high-priced “computer cleaning
kits”—many more than the agency had computers. And
an employee remembered the so-called kits
consisted of nothing more than Q-tips, gauze pads
and rubbing alcohol. “And I noticed there were
multiple purchases just under Bruce’s $2,500
approval limit. Purchases over that amount would
have required supervisory approval,” Rosetti said.
The Kickback Checklist
One or more of these red
flags call for a closer look at the
operations of a purchasing agent.
He or she doesn’t take time
off.
The purchasing agent has
personal financial problems.
The agent’s lifestyle is
too extravagant for his or her income.
Close personal relationship
between purchasing agent and vendor.
| Favoritism toward one vendor.
Excessive purchases from
one vendor.
Prices charged are higher
than market average.
Expenditures come in just
under the review limit.
Multiple purchases over a
short period.
Substandard products or
services.
Accelerated payment of
invoices.
Sole-source purchases of
merchandise or services.
|
PRESERVING EVIDENCE BY THE BOOK
Rosetti made two photocopies of
the documents and returned the original files to
Bruce’s desk. “If Bruce had come back before I
completed my investigation,” said Rosetti, “I
didn’t want him to become suspicious and perhaps
destroy other key evidence I had not yet
identified.” Rosetti locked one set in his own
filing cabinet. In doing this, the CPA, also a
certified fraud examiner, was following a standard
industry practice. (Under the “best evidence” rule
accepted by courts, if the original documents are
lost or destroyed, a copy can substitute for the
original.) Examination of the documents
had revealed that although there were three
different vendor names, they all had identical
Atlanta addresses and used the same federal tax
I.D. number. Believing he was seeing only the tip
of the iceberg, Rosetti asked that his client do a
computer run on payments made to the suspicious
vendors over a five-year period. Bingo. The total
exceeded $350,000, with all of the payments just
under Bruce’s approval limit. Rosetti next
conducted discreet interviews with Bruce’s
coworkers and superiors. “As a state worker,”
Rosetti found out, “he had a rather modest salary
considering his responsibilities. And he was
married, had six children and a seriously ill
wife.” At its warehouse, Rosetti tried to confirm
the agency had actually received the items on
orders Bruce had approved. “No one there could
remember receiving more than a few computer
cleaning kits.” And the warehouse manager told
Rosetti that he recalled one vendor had given
Bruce a television that—boldly—was shipped
directly to the office.
CLOSING IN
The CPA felt he’d developed
enough evidence to confront his suspect. Through
experience and training Rosetti knew that a
confession was more likely if Bruce wasn’t
interviewed in the comfort of his own office. “The
key to obtaining a confession is to create stress
in the subject, who then will often admit
wrongdoing to alleviate it,” Rosetti said. When
Bruce returned from vacation, his supervisor told
him Rosetti was conducting an audit of agency
practices and needed to see him at the CPA’s
office. “It is best to conduct admission-seeking
interviews by complete surprise,” said Rosetti.
“You don’t want the subject to have time to think
about what to say. And you don’t want to schedule
such an interview with much advance notice,
because it is possible that a suspect simply
wouldn’t show up.” So when Bruce arrived
at the CPA’s office, he had no idea what was in
store for him. Rosetti had avoided any possibility
of a tip-off. He spent a few minutes asking Bruce
perfunctory questions about his duties and
procedures. Then he completely changed his tack.
“Bruce,” Rosetti said quietly, “we have evidence
that you have been receiving kickbacks from
vendors.” The color completely drained from
Bruce’s face. “As confessions go, this one was
easy,” the CPA said. “In less than an hour, I had
the whole story, which I put in the form of a
written statement for Bruce to sign. Like many
other suspects, he was relieved that it was
finally out in the open.” |
PRACTICAL TIPS TO
REMEMBER
| |
When closing in on a
fraud suspect
Make copies of all
suspicious documents.
Don’t alert a
suspect he or she is about to be
interviewed.
Interview the
suspect in a location unfamiliar
to him or her when seeking an
admission of guilt.
Don’t show the
suspect evidence unless
necessary for a confession.
Convert a verbal
confession into a written
statement.
| |
THE ENVELOPE, PLEASE
According to Bruce, his life of
crime began when he received a $100 money order
sent to his home. There was no return address on
the envelope, no note, nothing. The purchasing
agent, who was financially strapped, cashed the
money order and spent the funds. A few
days later, he received a telephone call from a
vendor who had recently started doing business
with Bruce. “Did you get the $100 I sent to your
home?” the vendor asked. Bruce replied, “Oh, that
money was from you?” The vendor chuckled, “Yes, I
just wanted to send you a little gift to thank you
for your business.” The “vendor gift” is one of
the most common ways unwary employees are
compromised. “Once Bruce had spent the
hundred dollars, he was hooked,” said Rosetti.
“The vendor told the purchasing agent there was
more to come if he continued to do business with
his company. Being the needy guy he was, he
started approving purchases in exchange for
regular cash payments from the vendor.” In
such schemes, the products or services eventually
become substandard, overpriced or nonexistent,
which brings up one big problem with purchasing
agents who receive kickbacks: They’re hardly in a
position to complain. So there is little the
bribe-taker can do about it. In Bruce’s case the
vendor just stopped shipping merchandise
altogether. “The vendor told Bruce that unless he
continued to approve invoices for payment, he
would reveal his conduct to the agency,” Rosetti
said. “That’s one of the reasons Bruce was
relieved when he confessed; he always worried he
would be discovered.” Considering all of
that worry, Bruce sold out cheap. For $350,000 in
inflated or nonexistent purchases, the state
worker got only about 1%, or around $3,500. The
vendor sent the $100 payoffs—either in cash or by
money order—to a service station owned by Bruce’s
father-in-law, who didn’t know their real purpose.
“Because Bruce was very cooperative and
contrite about his activities, I asked him to help
get evidence against the vendor,” Rosetti said.
“We recorded a series of his telephone calls with
the vendor, and sure enough, the vendor offered to
send money for approving invoices.” The case was
turned over to the United States Attorney.
Unfortunately, the prosecutor could not press
charges against the vendor because the voice on
the tape recording—analyzed by a spectrograph—was
not sufficiently distinct from that of the
vendor’s son, who worked at the same company.
Crime didn’t pay for Bruce, though: He was fired,
ordered to pay restitution, spent six months in
jail and was placed on five years’ probation. By
any measure, that’s a hefty price to pay.
PREVENTING KICKBACKS
The agency could have easily
avoided this crime by using simple but effective
control measures such as
Job rotation. Bruce had
been in the same position for more than six years.
Purchasing agents are subject to constant
temptation by unscrupulous vendors. Therefore they
shouldn’t be in the same job and deal with the
same vendors indefinitely. But many small
organizations don’t have enough staff to rotate
jobs. In that case a CPA should be hired to
closely examine key risk areas such as purchasing,
even if a full audit is not necessary.
Closer supervision. The
agency’s manager knew of Bruce’s financial woes.
After adding up the facts—an employee in financial
straits who has the authority to approve
purchases—Bruce’s supervisor should have been more
diligent in overseeing his duties by periodically
examining the purchases. Without invading
employees’ privacy, managers should be alert to
workers’ money pressures.
Separation of duties. The
most effective control mechanism to prevent
employee fraud is the separation of duties.
Ideally, different personnel will handle the
following duties: vendor approval, purchase
requisitions, purchase approval, receiving and
payment. This will not prevent collusion, but most
frauds are committed by one individual acting
alone. As in most fraud cases, there were
no winners in this one. The agency lost money and
public trust; the vendor lost what could have been
a long-term customer; and Bruce lost his job,
reputation and freedom. As Rosetti succinctly put
it, “With basic controls and oversight, this crime
wouldn’t have happened.” Joseph T. Wells, CPA, CFE, is
founder and chairman of the Association of
Certified Fraud Examiners and professor of fraud
examination at the University of Texas at Austin.
He won the Lawler Award for the best JofA
article in 2000 and 2002 and has been
inducted into the Journal of Accountancy
Hall of Fame. His e-mail address is joe@cfenet.com
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