Fraud in Government

1. Fraud in Government Frank Crawford, CPA Crawford & Associates, P.C. www.crawfordcpas.com frank@crawfordcpas.com

2. The Fraud Triangle Exacerbated in economic downturn Perceived opportunity to commit fraud Perceived pressure facing individual Person’s rationalization or integrity

3. Victim Organizations

4. Victim Organizations Occupational Fraud Schemes in Government and Public Administration (106 cases)12 12The sum of percentages in this chart exceeds 100 percent because several cases involved multiple schemes from more than one category.

5. Profile of Fraud Perpetrator • Male or female • No prior criminal history (<8%) • Well liked by co-workers • Likes to give gifts/compulsive shopper • Gambling problems not unusual • Long-term employee • Rationalizes: Starts small or “borrows” • Lifestyle clues

6. Cash Schemes • Stealing cash funds processed or on hand • Not recording & stealing the cash receipts • Under ringing & stealing the difference in cash receipts • Altering bank deposits

7. Accounts Receivable Schemes • Lapping • Forging checks received • Altering credit card receipts • Granting bogus credits • Bogus bad debt write-offs or account adjustments

8. Accounts Payable & Purchasing • Personal bills • Fictitious suppliers • Kickbacks • Ordering personal items • Petty cash funds • Employee expense accounts • Credit cards

9. Payroll Schemes • Ghost employees • Manipulated time records • Unclaimed payroll checks • Writing extra payroll or bonus checks • Leave time manipulation • Withholding fraud • W-2 fraud

10. Sick and Vacation Leave Fraud - Actual Case September, 1997: • Top city official convinces City Council to allow him to sell (cash out) unused leave time back to the City he worked for • Added an amendment to his existing employment contract • City Council approves

13. Sick and Vacation Leave Fraud Sample Leave Fraud Activity: Leave time: June 11, 2002 contract 442 days Leave sold back in next 8 weeks 107 days 335 days So the pattern was to…… • Get City Council to approve a new contract • Pass it off as a “minor” change • After approval: Sell batches of leave time • A few months (or weeks) later - another contract

14. Leave Buyback Scheme: End Result • 7 year period: over 2,000 days of leave sold • Equivalent to 60 years worth of leave • Final tally: $675,000 in leave time cashed out • He became bolder: other benefits added • Convicted • Sentenced to 51 months in federal prison

15. Top Ten Reasons Frauds Beat Internal Controls in Government

16. 1. Goin’ Through the Motions • Process mentality • Just doing the steps in the process • Not thinking about what one is doing Example: Two signatures required on checks. Both check signers fail to notice the check has no payee and still sign the check. Remedy: Reinforce the need to pay attention and the consequences for failure.

17. 2. See No Evil, Hear No Evil • Blind trust • Failure to acknowledge warning signals Example: Failure to follow up on a customer complaint of an incorrect bill for service and relying on the experienced and valued billing clerk’s response that it was just an error. Remedy: Realize that anyone can commit fraud. Assume discrepancies are fraud and prove to yourself it is only an error.

18. 3. It’s Good to be The King • Positional immunity • Rationalizing that controls don’t apply to me because I am in upper management. • Often referred to as management override. Example: Executive director doesn’t report leave used, but still gets paid for unused leave annually. Remedy: Identify someone within or outside the entity that you can report these circumstances to and not jeopardize your job.

19. 4. New Kid on the Block • Situational incompetence • New employee not in a position to question why Example: New accounts payable clerk questions why purchases from a certain vendor do not require bids, and is told that such purchases are exempt. Remedy: If you are the supervisor, don’t assume new employee just doesn’t understand. Take their questions seriously and ask your self why. If you are the employee, ask more than one person.

20. 5. Where’s All the Time Gone? • Workload overload • Not enough time to perform control procedures Example: Knowing that the supervisor is too busy to reconcile accounts receivable, a billing clerk steals cash and posts unauthorized adjustments. Remedy: Reevaluate assignment of duties, and when needed, demand more resources by focusing on the consequences of fraud.

21. 6. Can’t We All Be Happy? • Conflict avoidance • Responsible employees not comfortable in confronting other employees Example: A supervisor recognizes that the cash drawer is always short at the end of the day, but is uncomfortable in confronting the employee. Remedy: Reinforce supervisory responsibilities. Provide employee management training. Don’t tolerate poor performance.

22. 7. Where’s the Beef? • Informational restraint • Responsible employees lack the information they need to identify an improper transaction Example: An accounts payable clerk is not provided a contract that includes a not-to-exceed price limit and vendor takes advantage by over-billing. Remedy: Reinforce with employees the openness and availability of records and information.

23. 8. It’s None of My Business • Behavioral ignorance • Responsible employees ignore behavioral signs or indicators of possible fraud Example: Management and other employees fail to investigate or question an employee that is living well above their means or salary level. Remedy: Create an environment within the government that fosters ethical and responsible behavior. Create an anonymous hotline.

24. 9. It’s Over My Head • Informational ignorance • Officials ignore fraud warning signs in reports because they don’t understand the reports Example: Highway patrol fine revenue was embezzled and monthly budget report shows a potential problem, but the report is too complicated for management and governing board to understand. Remedy: When it comes to reports, use the KISS principle and train the users.

25. 10. A Bad Apple in the Bunch • Ethically challenged • Employees responsible for controls are just not ethical and morally responsible individuals Example: Purchasing supervisor is dishonest and convinces an accounts payable employee to process fake invoices for payment and split the money between them. Remedy: Don’t hire crooks.

26. Protection Mechanisms • Fraud risk assessment • Internal controls • Proper environment • External review • Reporting mechanism • Hire right • Fidelity bonding • Establish “Perception of Detection” • Forensic data mining

27. Protection Mechanisms • Segregation of duties • Effective bidding processes • Vendor approval controls • Policies • Code conduct, fraud policies • Conflict of interest, gifts, gratuities • Etc. • Fraud awareness training • Internal audit

28. Detection of Fraud Schemes Initial Detection of Occupational Frauds4 4The sum of percentages in this chart exceeds 100 percent because in some cases respondents identified more than one detection method.

29. Resources • Managing the Business Risk of Fraud: A Practical Guide (AICPA & IIA) – REQUIRED READING • Management Anti-Fraud Programs & Controls (exhibit to SAS 99) • ACFE Fraud Prevention Check-Up • ACFE Best Practices in Ethics Hotlines • ACFE Sample Code of Conduct • ACFE Sample Ethics Policy

30. Management Antifraud Programs and Controls Creating a Culture of Honesty & High Ethics Developing an Appropriate Oversight Process Evaluating Antifraud Processes & Controls

31. Creating Culture of Honesty and High Ethics • Setting the tone at the top • Creating a positive workplace environment • Hiring and promoting appropriate employees • Providing sufficient training • Confirming accountability for code of conduct • Implementing effective discipline

32. Evaluating Antifraud Processes and Controls • Identifying and measuring fraud risks • Mitigating fraud risks • Designing and implementing appropriate internal controls • Monitoring compliance with internal controls • Don’t miss the obvious…

33. Developing and Appropriate Oversight Process • Oversight by the audit committee or equivalent • Oversight by management • Use of an effective internal audit function • Open and candid dialogue with independent auditors • Take advantage of the COSO internal control element “Risk Assessment” by taking some time to “aim”…