Fraud – Prevention, Policies and Procedures

1. Fraud – Prevention, Policies and Procedures Roselli, Clark and Associates Certified Public Accountants

2. Introduction • Presenters: • Tony Roselli, CPA, Partner • Chad Clark, CPA, Partner • Cash handling • Frequency of fraud • Detection of occupational fraud • Case studies • Auditors’ responsibility to detect fraud

3. Introduction • Typical deficiencies • Implementation of procedures • Obtaining a fraud policy template • Conclusion

4. Cash Handling • Cash handling = actual receipt of funds by a government • Takes on several forms: cash, currency, checks, credit cards and on-line payments • Of these, cash is most susceptible to misappropriation • Treasurer maintains legal custodial responsibility • In most instances however, the Treasurer does not handle the cash • Cash is typically handled at the department level by clerks

5. Frequency of Fraud • Inverse relationship between frequency of fraud and level of economy • Vibrant economy = lower existence of fraud • Struggling economy = higher existence of fraud • Due to spousal layoffs, lack of pay raises, market deterioration of portfolios and other financial related situations • Fraud Triangle • Current fraud climate reaching historic levels due to adverse conditions in the economy

6. Frequency of Fraud - continued

7. Frequency of Fraud - continued • Approximately 40% of our clients have been exposed to some manner of fraud in the last 3 years • Mostly at the clerk level • Range from $2,000 to over $500,000 • Lack of controls • Lack of policies • Lack of training • Easily preventable • Taxpayer is ultimately the victim

8. Frequency of Fraud - Fraud Triangle

9. Frequency of Fraud - Types • Building permits – 2 situations • Vending machine – 1 situation • Council on Aging – 2 situations • Transfer station – 2 situations • Recreation receipts – 1 situation • School lunch receipts – 1 situation • School lunch inventory – 1 situation • Petty cash reimbursements – 1 situation • Athletic receipts – 1 situation • Real estate tax refunds – 1 situation • Contract kickbacks – 1 situation

10. Detection of Occupational FraudStatistics per Journal of Accountancy – June 2010

11. Case Studies • Building permits (both cases) • Cash collected was reduced and the reduced amount was placed on Treasurer turnover report. • Amount reduced was misappropriated. • Treasurer and Accountant reconciled since they both agreed to reduced amount. • No independent reconciliation was performed to the department detail. This would have detected the theft. • Employee resigned in both situations, with no charges filed.

12. Case Studies - continued • Real estate refunds case • Collector allowed unpaid real estate refunds to accumulate into the millions of dollars • Collector Clerk created fictitious refund requests in the name of acquaintances; in some instances, numerous times • The control in the system for refunds was bypassed and Clerk was allowed to process requests manually • Collector did not reconcile with Accountant until year end • Over $500,000 was stolen over a 15 month period • Clerk is serving two years in jail and was ordered retribution

13. Case Studies - continued • Recreation receipts case • Recreation Director created a separate bank account, with Town’s name but without Treasurer approval • Cash received for activities was deposited partially to the separate bank account and partially to the Town • Money was misappropriated from bank account • Over $100,000 was stolen • Director went to jail for one year with retribution • Off the books cash accounts are very common and should be abolished

14. Case Studies - continued • Petty cash reimbursements • Director for senior activities had created separate bank account for seniors • Director incurred cost in administering the activity • Director reimbursed himself from separate bank account and submitted reimbursement request to Town • In effect a double reimbursement • Was not discovered until Director was vacated and someone else tried to reconcile separate account • About $80,000 was taken over a 10-year period

15. Case Studies - continued • Vending machine • Same Director operated a soda machine • Town was unaware of the soda machine • Director kept funds and paid for supplies from cash receipts • Approximately $40,000 was taken over 10 years • Was not discovered until Director vacated position

16. Case Studies - continued • School Lunch receipts • School lunch turnover manipulated prior to turnover to Treasurer • No independent verification of turnover back to cashier register performed, unknowing staff instructed to destroy records • Accountant and Treasurer reconcile since reduced amount is reported amount • Deposits turned over infrequently thereby allowing manipulation more easily • Director was relieved of their employment • Director was awarded unemployment benefits at hearing

17. Case Studies - continued • School Lunch inventory • Cafeteria Director took turkeys to supplement catering business • Was caught through video surveillance • Claimed to be only be borrowing turkeys • Arbitrator sided with Director since there was no policy prohibiting the unauthorized borrowing and assumed subsequent payback of items • Director was awarded back pay for time since firing • School was required to give Director their job back

18. Case Studies - continued • Transfer station • Patrons paid cash at gate to dump trash • Not all cash was recorded on turnovers to Treasurer • Scheme was discovered when Transfer Station Agent was replaced and revenue spiked significantly • Difficult to prove if cash was in fact stolen so no charges were filed

19. Auditor’s Responsibility To Detect Fraud • Statement on Auditing Standards (SAS) #99 – Consideration of Fraud in a Financial Statement Audit • Issued in 2002 and effective 2003 • This was a major change for audit firms • Due to fraud at World Com, Enron and other large SEC firms, this SAS required auditors to focus on the risk that the financial statements may be misstated due to fraud • However, the responsibility of preventing fraud was and continues to be Management’s responsibility

20. Auditor’s Responsibility To Detect Fraud – continued • SAS 99 specifically states it’s Management’s responsibility to: • Understand the risks of fraud • Set the proper philosophical tone • Create and maintain a culture of honesty and ethics • Develop and implement controls to prevent, deter and detect fraud • Develop procedures to monitor internal controls • Follow up with identified fraud risk areas communicated from your auditors

21. Auditor’s Responsibility To Detect Fraud – continued • Numerous audits typically result in findings related to Management’s risk of preventing or detecting fraud • These are communicated via a Management Letter • It is Management’s responsibility to correct these findings

22. Typical Deficiencies • Inadequate departmental receipts policy • Lack of internal audits • Lack of segregation of duties • Receipt trends not monitored • No formally accepted fraud policy • No student activity policies • Lack of adequate training • Lack of background checks

23. Implementation of Procedures - Departmental Receipts Policy • Cash handlers are bonded • Use of pre-numbered receipt forms • Mandatory vacations for cash handlers • Reasonable turnover period, especially for large amounts of cash • Secure, on-site storage between turnovers • Internal reconciliations of cash handler’s documentation

24. Implementation of Procedures - Internal Audits • Internal audits by accounting or Treasury personnel • Unannounced • Reconcile cash reported per turnover back to source document such as number of permits issued • Cycle departments, so that all cash handling activities are internally audited at least twice during the year • Add departmental reviews to annual audit process, such that the independent auditor will audit 1 or 2 departments per year

25. Implementation of Procedures - Segregation of Duties • Where practical, assure that cash handlers are independent of the cash recording and cash reconciliation function • Always have reconciliations reviewed independently

26. Implementation of Procedures - Monitor Receipt Trends • Establish a spreadsheet that includes historical receipt data (up to 5 years) • Determine revenue trends and create expectations based on known facts • Investigate where revenue trends deviate from the expectation • Expectations for Transfer Station could be comparing the amount of trash produced from tipping fee invoices to prior years and developing a revenue ratio

27. Implementation of Procedures - Formal Fraud Policy • Create a policy that communicates the City/Town understanding of fraud to its employees • Designate a fraud officer • Emphasize the whistleblower statute within the policy • Review policy with Legal Counsel • Assure no contradiction with collective bargaining agreements • Formally accept policy through Selectmen or City/Town Council • Disseminate policy to all employees • Conduct training to assure understanding of policy

28. Implementation of Procedures - Formal Fraud Policy • Fraud policy template in a downloadable and customizable form, available at: www.roselliclark.com • From home page, click on “Industries” • Then click on “Municipalities” • Go to bottom of page under caption “Key Note Presentations”

29. Implementation of Procedures - Student Activity Policies • Develop policies to comply with MGL • Require reconciliations monthly • Train secretaries to assure proper cash handling and cash disbursement procedures • Conduct independent audits every three years

30. Implementation of Procedures - Institute Formal Training • Many times, departmental cash handlers are not sophisticated bookkeepers • These cash handlers should undergo adequate training procedures on a periodic basis • This will help eliminate careless errors • Even we CPAs are required to take 80 hours of training every two years

31. Implementation of Procedures – Formal Background Checks • Implement a policy of performing background checks when hiring employees • Consider using CORI; which is required if working with minors • Consider performing credit check as studies show that there is a correlation between bad credit and fraud

32. Conclusion • The pressure and motivation to steal money is at historic highs • City/Town officials need to understand this • Put policies in place to mitigate these risks • Once its happened its too late to say I should have done something about it • End fraud and protect the taxpayer