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CPE for Government Auditors

Expense Reimbursement Fraud Schemes

We are still working through the cash disbursement schemes mentioned in the fraud tree.  For a picture of the fraud tree, see this link: http://www.acfe.com/fraud-tree.aspx. Last time we discussed the categories of fraudulent disbursements, we covered payroll schemes and billing schemes. This time we will cover the third out of five schemes classified by the Certified Fraud Examiners as cash disbursement schemes and expense reimbursement schemes.

 

Go tell that long tongue liar,
Go and tell that midnight rider,
Tell the rambler, the gambler, the back biter,
Tell ‘em that God’s gonna cut ‘em down.
Run on for a long time
You can run, Lord, for a long time.
You can run, Lord, for a long time
But let me tell you God Almighty’s gonna cut you down.
Traditional folk song

 

Expense Reimbursement Schemes

Another way to falsely extract money from your employer is to make up fake or inflated business expenses.  Under this section of the tree, the Association of Certified Fraud Examiners lists four components:

  1. Mischaracterized expenses
  2. Overstated expenses
  3. Fictitious expenses
  4. Multiple reimbursements for expenses

Mischaracterized Expenses 

When I was in college, I worked as an accounts payable clerk at a high tech company for a summer.  One of my jobs was to review travel expense reports for compliance with corporate policy.

The company did not pay for movies in the hotel room – especially not adult movies.  Adult movies are more expensive, so I knew that one executive was being – shall we say ‘creative’ – with his entertainment charges.  The phone call was a little tense, “Your film is not allowable, sir…”

Robert Half International, a professional recruiting firm, asked 150 senior executives with some of the nation’s largest companies, “What is the most outrageous thing that an employee has tried to pass off as a work-related expense?”  It turns out creative employees have tried to expense tropical fish, traffic tickets, the cost of transporting a pet gerbil overseas, ‘lodging’ at a storage facility, expensive silk sheets and silverware, excursions to Europe and the Masters, health care coverage for a pet, and my personal favorite, divorce costs.  I can see the reasoning there: employers expect so much nowadays, they probably trigger most divorces in the US.[1]

Overstated Expenses

I enjoyed working with a Medicare audit group in 2008.  They were responsible for finding fraud, waste, and abuse in the Medicaid program.  That is quite an undertaking since so many people and so many systems are involved, and so many folks are in need. Doctors, hospitals, nurses, pharmacies, suppliers, patients, and families can be mighty creative in getting just that little extra from the federal government by overstating expenses.  Here is another executive summary from a GAO audit.

Medicare Fraud, Waste, and Abuse: Challenges and Strategies for Preventing Improper Payments[2]

Summary

GAO has designated Medicare as a high-risk program since 1990, in part because the program’s size and complexity make it vulnerable to fraud, waste, and abuse. Fraud represents intentional acts of deception with knowledge that the action or representation could result in an inappropriate gain, while abuse represents actions inconsistent with acceptable business or medical practices. Waste, which includes inaccurate payments for services, also occurs in the Medicare program. Fraud, waste, and abuse all can lead to improper payments, overpayments and underpayments that should not have been made or that were made in an incorrect amount. In 2009, the Centers for Medicare & Medicaid Services (CMS) – the agency that administers Medicare – estimated billions of dollars in improper payments in the Medicare program. This statement will focus on challenges facing CMS and selected key strategies that are particularly important to helping prevent fraud, waste, and abuse, and ultimately to reducing improper payments, including challenges that CMS continues to face. It is based on nine GAO products issued from September 2005 through March 2010 using a variety of methodologies, including analysis of claims, review of relevant policies and procedures, stakeholder interviews, and site visits. GAO received updated information from CMS in June 2010.

GAO has identified challenges and strategies in five key areas important in preventing fraud, waste, and abuse, and ultimately to reducing improper payments. GAO has made recommendations in these areas. CMS has made progress in some of these areas, and recent legislation may provide the agency with enhanced authority. However, CMS faces continuing challenges. 1. Strengthening provider enrollment process and standards. Checking the background of providers at the time they apply to become Medicare providers is a crucial step to reduce the risk of enrolling providers intent on defrauding or abusing the program. In particular, GAO has recommended stricter scrutiny of providers identified as particularly vulnerable to improper payments to ensure they are legitimate businesses. 2. Improving pre-payment review of claims. Pre-payment reviews of claims are essential to helping ensure that Medicare pays correctly the first time. GAO has recommended that CMS further enhance its ability to identify improper claims through additional automated pre-payment claim review before they are paid. 3. Focusing post-payment claims review on most vulnerable areas. Post-payment reviews are critical to identifying payment errors and recouping overpayments. GAO has recommended that CMS better target claims for post payment review on the most vulnerable areas. 4. Improving oversight of contractors. Because Medicare is administered by contractors, overseeing their activities to address fraud, waste, and abuse is critical. GAO found that CMS’s oversight of prescription drug plan sponsors’ compliance programs has been limited. However, partly in response to GAO’s recommendation, CMS oversight of these programs is expanding. 5. Developing a robust process for addressing identified vulnerabilities. Having mechanisms in place to resolve vulnerabilities that lead to improper payment is vital to program management, but CMS has not developed a robust process to specifically address these. GAO has recommended that CMS establish an adequate process to ensure prompt resolution of identified improper payment vulnerabilities.

Here in Austin, the directors of an electric co-op, the Pedernales Electric Cooperative (of which I am a member), paid themselves ten times the salary of the nation’s second largest co-op!  Board members were reimbursed for about $700,000 in expenses between 2002 and 2006 for everything from first-class airfare to top-tier hotel stays to costly purchases of meals, furniture and concert tickets, according to court records. All of these board members were, thankfully removed in shame, but not before they lived the high life for a good long while.[3]

Fictitious Expenses

Yes, another Medicaid story!  The plethora of Medicaid stories shouldn’t be too surprising since over 20% of our federal budget is spent on Medicaid.[4]

The number one crime in Miami isn’t drug trafficking; it is Medicare fraud. A 60 Minutes investigation uncovered hundreds of tiny pharmacies and doctors’ offices in South Florida that weren’t staffed or open; some were really just storage facilities!

One fraudster shared with 60 Minutes how easy it is to set up a fake supplier or pharmacy and bill the feds using names and social security numbers of real patients. Hackers steal the names and social security numbers from legitimate doctors’ offices and pharmacies and sell them for up to $10 a name to these illegitimate ‘suppliers.’  One retired judge’s social security number was used to charge for a prosthetic right and left arm.  Only problem is, he still has both arms and they work just fine!

Medicaid auditors are understaffed and overwhelmed. And most scammers are able to operate without any trouble – quietly ripping off $20-40 thousand a day.[5]

An aversion to IT Cost a New Zealand Company $1.7 million!

A simple fraud, using Microsoft Excel templates to create the 350 bogus invoices, lasted six years and made Trevor Uialatea Esera richer by $1,758,193.  As the company’s IT manager, he was responsible for signing off expenditures, preparing the IT budget, and ordering equipment and computer software.

He created fake invoices from three companies. Two of the companies – Intergra Images and Software Plus – were bogus, and the third had no idea what he was doing. Court documents described the fake firms as “companies of his own invention.”

Esera’s bosses were oblivious to his fake invoicing because senior staff at Rinnai, a water heater manufacturer, had little or no experience in IT.[6]

Multiple Reimbursements for Expenses

Have you seen the website that lets you create fake receipts?  Just Google ‘fake receipts,’ and Google lists pages and pages of sites.  One of the sites is generic, but for a small fee you can upgrade to get better logos for well-known companies.  Here is an image of what you can create using one of these sites:

Looks pretty good, doesn’t it?

If you think you can get away with it, why not submit the same expense more than once!  You’d score extra points for commiting two frauds at once – a fake receipt and double payment on the same receipt.  You over-acheiver you!

I receive ridiculous proposals and promises of riches every day via email. “Please let me introduce myself.  I am blah blah from X, Africa seeking to transfer funds to the United States.  I will share the proceeds with you, blah blah.”  A CPA in my class confessed that one of his elderly clients fell for this scam and lost $50,000 because he gave the scammers his bank account number.

I have heard of (but can’t tie down with a news story) scammers creating hundreds of fake invoices and sending them to every corporation they can find.  Even if only 2 out of a hundred pay, they still have something with which to buy that coveted wide-screen TV!

I can easily see this happening, because when I worked as an accounts payable clerk the summer of my junior year in college, one of my horribly boring tasks was to match up the vendors’ monthly statements to their invoices.  It was hard to reconcile the two because the vendors would call complaining that we weren’t paying them in a timely manner and the accounts payable supervisor would often pay whatever was in front of her… It was a mess.  Several times, we decided to pay whatever the came in through the mail because we were getting so backed up.   We wrote a check, crossed our fingers and hoped for the best.

 

 

[1] Robert Half International. Can You Expense a Tropical Fish?  What Workers Try to Put on the Company Dime. September 24, 2009.

[2] United States. Govt. Accountability Office. Medicare Fraud, Waste, and Abuse: Challenges and Strategies for Preventing Improper Payments. June 15, 2010. GAO-10-844T.

[3] Claudia Grisales. “Settlement Reached In Pedernales Co-Op Lawsuit.” Austin American Stateman. March 11, 2008.

[4] Policy Basics: Where Do Our Federal Tax Dollars Go? Center for Budget and Policy Priorities. April 14, 2010.

[5] Ira Rosen and Joel Bach. “Medicare Fraud: A $60 Billion Crime A.G. Holder Tells 60 Minutes More Oversight Is Needed; Scammer Explains How Easy It Is To Steal Millions.” Sixty Minutes. WCBS. October 25, 2009. Television.

[6] Kerry Williamson. “Bogus invoices got IT chief $1.75 million.” The Dominion Post [New Zealand]. December 12, 2009.

Fraudulent Disbursements – Billing Schemes and Payroll Schemes

More in the series on getting to know the fraud tree better. To get a better sense of where we are on the fraud tree and which branch we are talking about in this newsletter, please see the entire fraud tree at http://www.acfe.com/fraud-tree.aspx.

Learn to do good;
seek justice, correct oppression;
bring justice to the fatherless,
plead the widow’s cause.
Isaiah 1:17

Misappropriating cash through fraudulent disbursements is a sizable portion of the fraud tree because there is a lot of room for creativity.  See an illustration of the fraud tree here: http://www.acfe.com/fraud-tree.aspx   In this newsletter, we will cover billing schemes & payroll schemes.  In future newsletters we will cover expense reimbursement schemes, check tampering, and register disbursements.  Five creative categories under fraudulent disbursements in all!

With fraudulent disbursements, the fraudster causes an organization to disburse funds through some trick or device such as submitting false invoices or forging checks.  The disbursement is often disguised as a legitimate business activity so that it can slide through the accounting system undetected by controls.

And with these sorts of schemes, the fraudster is usually caught when they get too bold or too greedy.  If they would just keep it small, they could supplement their income for decades!

Billing Schemes

Here the fraudster creates a valid looking bill and causes the organization to issue payment for the fraudster’s personal benefit. The Association of Certified Fraud Examiners classifies billing schemes into three categories:

  1. Shell companies
  2. Non-accomplice vendors
  3. Personal purchases

Shell Companies 

In this creative scenario, the fraudster creates a fake company that has a valid sounding name and then sends checks from the victim company to their fake, or shell, company.

In my hometown, LouAnne Aponte stole over $800,000 from a large not-for-profit, Family Connections, for which she was the executive director. For six years she forged a well-known local CPA firm’s name on audit reports to avoid questioning by auditors and to satisfy federal grant requirements.

In March 1993, Aponte formed a business named Excite and Challenge, and then paid Excite and Challenge from Family Connections funds.  She used the money to pay her mortgage for a home in a tony Austin neighborhood and bought herself a convertible Mercedes.

For a decade LouAnne Aponte also volunteered as the treasurer for the Texas Association of Child Care Resources and Referral Agencies.  Aponte was accused of stealing over $100,000 from that organization.

Aponte had a history of theft dating back to the 1980s when she stole about $60,000 from two employers. In 1987, she served only four months of a four-year prison sentence for her crimes. Unaware of Aponte’s past, the nonprofit Austin Families hired Aponte in 1990 when she was still on parole.

Having served only two and a half years of her 25-year sentence for the crimes against Family Connections, Aponte was up for parole in May 2013.[1]

Straw students are like shell companies, aren’t they?

Creating fake students has always been a popular scam when it comes to milking money out of student financial aid programs.  When you actually see students in a classroom in college environments, it is hard to keep a scammer from succeeding – but how do you verify online students?

Between 2006 and 2009, Trenda Halton defrauded Rio Salada College in Arizona for over a half a million dollars.  Having discovered how to defraud the registration system of Rio Salado College, Halton worked with four accomplices to create 136 “straw” students.

In her scheme, she recruited “straw” students who prepared and filed bogus admissions applications, financial aid applications, and Pell Grant applications in the students’ names. The financial-aid recipients received aid money after Rio Salada deducted tuition.

Halton’s cover was blown when a Rio Salado employee noticed that the applications all had the same handwriting and the students were enrolled in the same classes. In 2009, Halton was indicted with 64 other defendants and charged with offenses such as conspiracy, mail fraud, financial aid fraud, and making false statements in connection with financial aid.

Rio Salada’s small distance learning college was a prime digital target for Halton. Other colleges that have been victimized by online financial-aid fraudsters include the University of Phoenix’s Axia College, Michigan’s Lansing Community College, and Texas’ Dallas County Community College.[2]

Non-Accomplice Vendors

My small business has several names, and I have been married 15 times.  OK, OK, I have wed only twice.  But I have three last names!  And the bank will take any check from me using any of my last names or business names.

A banker in one of my classes told me that the bank doesn’t check endorsements or names on the check if the amount is under $10,000.  The volume of checks is just too high for them to watch.  Banks also put on the back of your bank statement that you have 60 days from the date of the statement to resolve any discrepancy, otherwise the bank is not responsible.

So imagine taking a valid vendor name – say ABC Pest Control – that your organization would spend money on and changing the address on the payment to your own PO Box.  And if you have already succeeded depositing checks under ABC Enterprises, the bank will take it. You will enjoy the money, and your organization probably won’t know the difference.

Personal Purchases

Whether personal purchases are considered fraud by an organization depends on the type of organization.  In the corporate environment, use of the company credit card to buy golf equipment while entertaining clients could be perfectly valid.

2 shoesIn government, we never entertain!  OK, we seldom entertain, but governments would seldom find the purchase of golf equipment valid.  Remember our discussion about what fraud is, what abuse is, and whether something is worthy of the attention of those in charge of governance? That applies to personal purchases, big time.

But HP wasn’t as lenient with their money as some other corporations.  They ousted their CEO, Mark Hurd, in 2010 for expense report irregularities and for hiring a model/actress that he had a personal relationship with to represent HP at trade shows for $5000 to $10,000 a pop.[3]

Payroll Schemes

Another way employees can extract money from their employers using a false disbursement scheme is to make false claims for compensation.  The fraud tree is divided into four parts under payroll schemes:

  1. Ghost employees
  2. Commission schemes
  3. Workers compensation
  4. Falsified wages

Ghost Employees

In this scheme, the government is charged for employee wages for fake employees or, if you prefer, “phantom” employees.

3 ghostsDo you remember Paul Bremer? He was the administrator of the Coalition Provisional Authority (CPA), the transitional Iraqi government. In 2007, Bremer acknowledged to the House Committee on Oversight and Government Reform that during the 2003 to 2004 rebuilding of Iraq, for which he was responsible, America had paid nonexistent “ghost employees.”

Bremer suggested that the organization feared the consequences of stopping payments to determine who were truly employed. Those who were employed supplied the Iraqi ministries with security, and Bremer did not want to anger these 74,000 armed men.

The problem of the “ghost” employees was just one piece of the puzzle of the missing $8.8 billion that the CPA distributed to Iraqi ministries. Stuart Bowen, the Special Inspector General for Iraq Reconstruction stated that the problem was not a major reason that so much money was unaccounted for. He blamed the lack of transparency for the missing funds.[4]

Commission Schemes

 

The Pyramid

Although I can’t imagine this happening in government, or that a commission/pyramid would be relevant in government, you may have personally been the victim of a pyramid scheme in your past.  In a pyramid scheme, the fraudster promises consumers or investors large profits if they can recruit others to join the program.  Some schemes purport to sell a product, but the product is really just a cover for the pyramid.

Victims of a pyramid scheme are often asked to inventory load – or buy stock inventory of a product in order to sell.  In this way, the company does make profit, and the folks on the top of the pyramid profit, but the front-line salesmen are stuck with a bunch of inventory they can’t sell!

Also beware of claims that the product is selling like hotcakes!  Who is buying the hotcakes: actual customers or just players in the pyramid?[5]

A few cautions about marketing ‘spin’!

I remember my mother buying a horrible car – a Ford Taurus – in the 90s because the dealer told her it was the best selling car in America.  Yes, it was, but only because Ford made incredible deals to get the rental car industry to buy beaucoup of them. Consumers hated the car and for good reason.  Ah, marketing spin wins again!

A well known vitamin company in the US is advertising that they are the first vitamin company to get clearance from an organization they say is an independent evaluator of vitamin quality.  Only problem is that the vitamin company founded, funds, and shares staff with this independent evaluator.

And it isn’t just creative Americans: Customer complaints against four of the United Kingdom’s largest energy firms led to an investigation of nPower, Scottish Power, Scottish and Southern Energy, and EDF Energy by the energy regulator Ofgem.

Many of the complaints were against door-to-door salespeople and telemarketers who were persuading customers to switch suppliers. Customers were given misleading information and quotes, which resulted in the customers being in worse positions than before switching suppliers.

Confirming the customer complaints, Ofgem’s 2008 investigation showed that changing firms at the persuasion of pushy door salespeople left almost half of gas customers and electricity customers worse off.

As of September 2010, energy regulators were considering fining suppliers a portion of their annual revenue if customer complaints proved true.[6]

A bit about the the Ponzi

Although a Ponzi scheme is not specifically mentioned on the fraud tree, it is definitely worth talking about!  A Ponzi scheme is similar to a pyramid scheme, except there is no product to sell, and the schemer doesn’t pay a commission to salespeople to find new recruits. A Ponzi schemer uses the money from new recruits to pay existing members.

The most notorious Ponzi schemer of our day is Bernie Madoff who defrauded investors out of $60 billion.  Madoff paid investors significant returns using money he collected from new investors, which he never truly invested.

Enticing new investors by paying his investors more money allowed Madoff to keep the scheme rolling for about two, maybe three, decades. Madoff told investors that their investments were earning high returns and would give them large payouts to keep them onboard.

While he probably believed that his venture could last forever, it couldn’t withstand the decline of the stock market. In 2008, he could no longer keep up his lie. Investors weren’t paid on time because of his inability to yield sufficient cash out of his holdings.

On March 10, 2009, Bernie Madoff was charged with eleven felony charges including securities fraud, investment adviser fraud, mail fraud, wire fraud, three counts of money laundering, false statements, perjury, false filings with the United States Securities and Exchange Commission (“SEC”), and theft from an employee benefit plan.  On June 29, 2009, Madoff was sentenced to 150 years in prison.[7]

Workers Compensation

5 boxI like to work, don’t you?  I like to get something done and create new things.  But not everyone is motivated to create – some people think the world owes them a living, and false workers comp claims are an easy route to income without exertion.

It makes me very sad to see a video on 60 minutes of a guy moving a piano who has been claiming workers comp for three years.  Can you imagine being related to that guy? How could he, and you, stand it?

Here is an executive summary from a report by the GAO on fraudulent benefits:

Social Security Administration: Cases of Federal Employees and Transportation Drivers and Owners Who Fraudulently and/or Improperly Received SSA Benefits[8]

Summary

This testimony discusses the results of our investigation of the disability programs managed by the Social Security Administration (SSA). SSA administers two of the nation’s largest cash benefit programs for people with disabilities: the Disability Insurance (DI) program, which provides benefits to workers with disabilities and their family members, and the Supplemental Security Income (SSI) program, which provides income for aged, blind, or disabled people with limited income and resources.

In 2008, the DI program provided about $104 billion to some 9 million beneficiaries, and the SSI program provided about $38 billion in financial benefits to some 7.5 million recipients. Given the magnitude of these cash benefit payments, it is important for SSA to have effective fraud prevention controls in place to minimize fraudulent and improper payments.

This statement summarizes our most recent report, describing cases of federal workers, commercial drivers, and commercial vehicle company owners who fraudulently or improperly received disability benefits. The objectives of the investigation were to (1) determine whether federal employees and commercial vehicle drivers and company owners may be improperly receiving disability benefits and (2) develop case study examples of individuals who fraudulently and/or improperly received these benefits. In conducting this investigation, we compared DI and SSI benefit data to civilian payroll records of certain federal agencies and carrier/driver records from the Department of Transportation (DOT) and 12 selected states.

We found the following:

1) Thousands of federal employees, commercial drivers, and owners of commercial vehicle companies received Social Security disability benefits during fiscal year 2008, though we could not determine the extent to which beneficiaries improperly or fraudulently received payments. Because further investigation is required to determine whether these individuals are entitled to receive payments, our analysis provides only an indicator of potentially improper or fraudulent activity. Federal salary data from selected agencies for October 2006 through December 2008 show that about 1,500 federal employees may be improperly receiving payments. These employees were (1) DI beneficiaries who received federal salary above the earnings threshold for more than 12 months after the start date of their disabilities or (2) SSI recipients who received more than 2 months of federal salary above the maximum SSA earnings threshold for the SSI program after the start date of their disabilities. Based on their SSA benefit amounts, we estimate that these federal employees received about $1.7 million in benefits a month.

2) Based on our overall analysis above, we selected 20 nonrepresentative examples of federal employees, commercial drivers, and registrants of commercial vehicle companies who received disability payments fraudulently and/or improperly. The 20 cases were primarily selected based on our analysis of SSA electronic and paper files for the higher overpayment amounts, the types of employment, and the locations of employment, and thus they cannot be projected to other federal employees, commercial drivers, or commercial vehicle owners who received SSA disability payments. In each case, SSA’s internal controls did not prevent improper and fraudulent payments, and as a result, tens of thousands of dollars of overpayments were made to individuals for 18 of these 20 cases. For the 20 cases, our investigations found the following: (1) For five cases, we believe that there is sufficient evidence that the beneficiaries committed fraud to obtain or continue receiving Social Security disability payments by withholding employment information. (2) For 10 cases, SSA improperly increased the benefit amounts of the disability payments because the individuals had increases in the reported wages on which the disability benefit payments are based.

(3) Several individuals from our cases were placed in long-term, interest-free repayment plans for improperly accepting disability overpayments, even though SSA can charge interest. One individual’s $33,000 repayment plan was in $20 monthly installments–resulting in a repayment period of 130 years. For 10 cases, the individuals were continuing to receive disability benefits as of October 2009. For 18 of these 20 cases, the individuals also received $250 stimulus checks as part of the American Recovery and Reinvestment Act of 2009 (Recovery Act) while they were improperly receiving SSA disability payments. According to SSA officials, most of these individuals were entitled to and would have received the $250 stimulus checks even if SSA had properly suspended the disability payments to them. Specifically, SSA officials stated that beneficiaries covered under the DI program would have been covered under an extended period of eligibility (EPE), which is a 36-month period in which SSA does not pay any benefit amounts (i.e., payments are suspended) if the beneficiary has earnings above the substantial gainful activity (SGA) threshold. According to SSA officials, all working DI beneficiaries covered by an EPE received the $250 stimulus check.

 

Falsified Wages

Here is a report from the NY Attorney General regarding contractors who falsified employee wages:6 nurse

Three Contractors Arrested For Underpaying Employees And Falsifying Business Records In Connection With New York City Housing Authority Construction Projects[9]

State Attorney General Spitzer and New York City Department of Investigation Commissioner Rose Gill Hearn today announced that three construction contractors were arraigned on felony and misdemeanor charges arising out of their falsification of records that made it appear that $367,000 in legally required prevailing wages were paid to 19 workers on New York City Housing Authority projects, when, in fact, such wages were not paid.

Mohammed Abdur Rashid, and his company Columbus General Construction Inc., and Tarcisio Ferreira and Harrison Jarvis, whose construction companies are now defunct, were charged with failure to pay wages, falsification of business records, false filings and perjury in connection with Housing Authority contracts at the Edgemere and Arverne Houses (Ocean Bay) located in Far Rockaway.

The defendants entered “not guilty” pleas in Queens County Criminal Court, and were ordered to return to court on October 15, 2003.

“The message is clear: falsifying records and failing to pay the prevailing wages on a public work project are serious violations of the law. Contractors who engage in such tactics can expect criminal sanctions,” Spitzer said.

“These contractors unjustly chose to enrich themselves rather than pay employees their rightful wages. DOI will not tolerate this type of fraud or other acts of dishonesty and will investigate them with vigor. Upon recovering any improprieties, DOI will seek to prevent the company in question from obtaining future contracts with the City,” said Commissioner Gill Hearn.

The joint investigation by the Attorney General’s office and the Department of Investigation’s Office of the Inspector General for the Housing Authority revealed that between July 2, 2001 and December 31, 2002, Rashid, Ferreira, Jarvis, and their respective companies employed nineteen workers at the Edgemere and Arverne Houses. The work was subject to federal and state prevailing wage laws, which dictate the hourly rates that must be paid to employees working on public projects. In each case, the defendants are alleged to have failed to pay workers prevailing wages, and attempted to conceal their wrongdoing by filing false payroll showing that their employees were paid properly. The workers received between $70 to (sic) $110 per day instead of up to $48.53 per hour, which they were entitled to by law.

The Attorney General is also seeking restitution for the underpayment of wages to employees, which totals more than $367,000.

As a result of the continuing cooperation between the OAG and DOI, over one million dollars in wage restitution orders have already been obtained this year. 

Next time… more on fraudulent disbursement schemes including expense reimbursement schemes.



[1] Andrea Ball. “Woman who stole from nonprofit up for parole two years into 25-year sentence.” Austin American Statesman. May 14, 2013.

[2] Marc Parry. “Online Scheme Highlights Fears About Distance-Education Fraud.” The Chronicle of Higher Education. January 13, 2010.

[3] Ben Worthen and Joann S. Lublin. “Mark Hurd Neglected to Follow H-P Code.” Wall Street Journal. August 8, 2010.

[4] Melinda Henneberger. “Bremer paid ‘Ghost Employees’ to avoid ‘Real Trouble.’” Huffington Post. February 6, 2007.

[5] Debra A. Valentine.  Prepared statement. “What is a Pyramid Scheme and What is Legitimate Marketing?” International Monetary Fund’s Seminar On Current Legal Issues Affecting Central Banks. Washington, D.C. May 13, 1998.

[6] Tim Webb. “Ofgem investigates doorstep gas and electricity sales agents.” The Guardian [UK]. Web. September 2, 2010.

[7] New York State. Department of Justice. United States v. Bernard L. Madoff and Related Cases. FBI, August 5, 2009.

[8] United States. Govt. Accountability Office. Social Security Administration: Cases of Federal Employees and Transportation Drivers and Owners Who Fraudulently and/or Improperly Received SSA Benefits.  August 4, 2010.

[9] New York. Office of the Attorney General. Three Contractors Arrested For Underpaying Employees And Falsifying Business Records In Connection With New York City Housing Authority Construction Projects. Media Center. September 2003.

Defining Corruption per the CFE’s Fraud Tree

More in the series on getting to know the fraud tree better.  To get a better sense of where we are on the fraud tree and which branch we are talking about in this newsletter,  please see the entire fraud tree at http://www.acfe.com/fraud-tree.aspx.

Objectives: 

  • Distinguish between the four major types of corruption and their subcategories

Corruption is the broad title for any behavior on the part of a person in a position of authority to further her own interests, forgetting her responsibilities to the people she serves.  In other words, corruption is when a powerful person acts selfish and greedy. This bad stuff has been going on since the beginning of time!  Was the apple offered by the serpent in the Garden of Eden a bribe?

Corrupt in the dictionary is defined as, “The act of corrupting or making putrid, or state of being corrupt or putrid; decomposition or disorganization, in the process of putrefaction” or “The act of corrupting or of impairing integrity, virtue, or moral principle; the state of being corrupted or debased; loss of purity or integrity; depravity; wickedness; impurity; bribery.”

Corruption is when a fraudster uses his influence in a business transaction to procure some benefit for himself or another person contrary to his duty to his employer (in our case, the citizen or taxpayer) or the rights of another.

For those of you who already work in the government environment, you will appreciate the references that follow.  For the rest of you, put on your red or blue taxpayer hat, this is going to get political!

When a public servant is corrupt, she forgets her duty to serve the public, as the GAO’s Yellow Book calls us to do, and instead serves herself.

2.07     A distinguishing mark of an auditor is acceptance of responsibility to serve the public interest.

Have you seen the corruption index?  A group called Transparency International ranks the corruption of the world’s countries on its website: http://www.transparency.org/policy_research/surveys_indices/cpi/2010/results.  America is ranked #22. Denmark is ranked number one as the least corrupt country?

The Association of Certified Fraud Examiners has divided the corruption section of the fraud tree into four parts:

  1. Conflicts of interest
  2. Bribery
  3. Illegal gratuities
  4. Extortion

3-9-1 Conflicts of Interest

Conflicts of interest arise when a fiduciary, agent, or employee does not act in good faith, with full disclosure, in the best interest of the principal but instead is serving other interests.

Conflicts of interest occur when persons in power have interests outside of their job and sway their decisions to benefit these interests.

In auditing, a conflict of interest threatens your independence and objectivity. The Yellow Book reminds you to stay clean and avoid corruption:

3.07     Auditors participating on an audit assignment must be free from personal impairments to independence. Personal impairments of auditors result from relationships or beliefs that might cause auditors to limit the extent of the inquiry, limit disclosure, or weaken or slant audit findings in any way.

In a small town, conflict of interest is a constant threat.  If you know everyone in town, how do you keep your objectivity?

The mayor of the City of Brandon says he was not in a conflict of interest when he voted along with City Council to allow a local developer to purchase $812,000 in land from the city.  This local developer was one of the mayor’s campaign volunteers.

“I don’t gain personally from anything to do with the applicant or any of the other applicants as well,” he told the Sun. “Of the five applicants (for the land), I know every single one of them.”

The Municipal Council Conflict of Interest Act states that a conflict of interest exists where a person stands to either directly or indirectly financially benefit from a decision of council.1

3-9-1A Purchases Schemes

Purchasing professionals have a lot of power that may go unchecked.  When I work for a government entity, they usually make me jump through hoop after hoop after hoop to prove that they were objective in their choice, although usually we both know that I am their first choice.

I frequently get requests for bids from governments with which I have no relationship.  But, I know they are usually just going through the motions.  I am not going to waste my time bidding on a job that I know someone else has locked in. And, unfortunately, a lot of people’s time is wasted in the process, especially when the bidding documents are 20 pages long!  But looks can be everything when it comes to purchasing. Is this the ideal?  No. True? Yes.

State criminal investigators are looking at efforts by the Oregon Department of Energy to steer federal money to a company run by the Governor of Oregon’s girlfriend after her firm lost the bid on a state contract. The winner of the bid was encouraged by the Department of Energy to include the girlfriend in the contract. The girlfriend was eventually employed as a subcontractor.  Three Energy Department officials happened to be on leave during the investigation.2

3-9-1B Sales Schemes

If you watch Fox News, you are familiar with Goldline Commercials.  In mid-2010, Congress formally opened an investigation of Goldline following an exposé on ABC News which detailed Goldline’s business model.3

Goldline employs several conservative pundits including Glenn Beck, Mike Huckabee, Laura Ingraham, and Fred Thompson to sell gold coins on the air. By feeding public fears during the recession, conservative pundits encourage their listeners to invest in gold.

Glenn Beck, for example, has dedicated entire segments of his program to explaining why the U.S. money supply is destined for hyperinflation with Barack Obama as president. He often promotes the purchase of gold as the only safe investment alternative for consumers who want to safeguard their livelihoods. When the show cuts to commercial break, viewers are treated to an advertisement from Goldline.

Goldline marks up its coins an average of 90% over the melt value of the coin.  The largest markup on any coin was 208% above the melt value. By selling gold at twice the melt value, the price of gold would need to double for consumers to break even on their “investment.” However, since Goldline is not licensed as an investment advisor, they have no responsibility to advise their clients.

Paul Harvey, the radio newsman whom my grandmother listened to on country radio, used to use a similar sales scheme. He’d talk about a snowstorm in Montana and, before you know it, you were being pitched some sort of miracle skin lotion. He was smooth. But I remember all of his ads as being relatively benign and for products that cost under $100.  I could be wrong.

3-9-1C Other Schemes

Wouldn’t it be great to create the rules you later have to follow?  Should consultants on government contracts draft the rules regarding those contracts?

Science Applications International Corporation served as an advisor to the Nuclear Regulator Commission to develop rules for recycling radioactive materials released from nuclear facilities.  At the same time, they entered into a partnership with another corporation, British Nuclear Fuels, to perform the recycling.

In a 2008 decision, a federal jury concluded that the firm’s executives knowingly concealed business interests that stood to benefit from its consulting role at the NRC. It found that SAIC had made 17 false statements and 60 false claims under the Federal False Claims Act.4

That story reminds me of a friend of mine who ran an internal audit shop at a state agency.  She hired an experienced CPA from inside the agency as a senior auditor.  Not until after she hired her and tried to assign her to projects did she realize her mistake.

The CPA had worked for the agency for five years in a variety of capacities. She was also married to one of the division directors and socialized with most of the others.  She was useless as an auditor because she was not independent of the audit subjects. Interestingly enough, my friend became a director of one of the divisions, and the administration decided to promote the less-than-objective CPA to director of audit.  Hmm.

3-9-2 Bribery

Bribery is when a person pays an official to make a decision in his favor.  The person in need offers or gives something of value to influence the action of an official in the discharge of his public duties.

Contractors for the federal government frequently appear in the news for bribing federal officials in hopes of landing lucrative contracts.

What follows is a portion of a press release from the
Department of Justice regarding one of our honorable congressmen:

Former Congressman William J. Jefferson Convicted of Bribery, Racketeering, Money Laundering, and Other Related Charges5In August, 2009, after a month of testimony in a federal court, a jury found former Congressman William J. Jefferson guilty on 11 charged counts, including solicitation of bribes, honest services wire fraud, money laundering, racketeering, and conspiracy.“We have been reminded today that we are a nation of laws, and not men,” said Dana J. Boente, U.S. Attorney for the Eastern District of Virginia. “It should be a clear signal that no public official – and certainly not a U.S. Congressman – can put their office up for sale and betray that office. It cannot be tolerated. It cannot just be another cost of doing business. And today, a jury of his peers held Congressman Jefferson accountable for his actions.”

“Trust and integrity in public officials is at the heart of our democracy,” said Joseph Persichini Jr., Assistant Director of the Washington Field Office of the FBI. “What a better way to ensure those virtues, than to expose those who breach that trust.”

According to evidence at trial, from August 2000 to August 2005 Jefferson used his position as an elected member of the U.S. House of Representatives to corruptly seek, solicit and direct that things of value be paid to himself and his family members in exchange for his performance of official acts to advance the interests of people and businesses who offered him the bribes. The things of value, according to evidence at trial, included hundreds of thousands of dollars worth of bribes in the form of payments from monthly fees or retainers, consulting fees, percentage shares of revenues and profits, flat fees for items sold, and stock ownership in the companies seeking his official assistance.

Evidence at trial showed that Jefferson performed a wide range of official acts in return for things of value, including leading official business delegations to Africa, corresponding with U.S. and foreign government officials, and utilizing congressional staff members to promote businesses and businesspersons. The business ventures that Jefferson sought to promote included telecommunications deals in Nigeria, Ghana, and elsewhere; oil concessions in Equatorial Guinea; satellite transmission contracts in Botswana, Equatorial Guinea and the Republic of Congo; and development of different plants and facilities in Nigeria.

Siemens pays huge fine
In 2008, the German engineering conglomerate Siemens paid an $800 million dollar fine to the Securities and Exchange Commission and the Department of Justice for widespread bribery of government officials. Among the billions authorities accuse Siemens of paying out to government officials is a $2.6 million payout to former Argentinean president Carlos Menem in order to win a bid to manufacture national ID cards for the country. Other allegations include a $55 million bribe to Russian officials for a medical devices contract, and $22 million to China for a metro trains contract.6

Chinese Officials Love Gucci!
Our fascination with China continues. They have really good taste, after all.

China seems to be the fastest growing country in every category, and now we can add fastest growing luxury market to the list.  Gifts to government officials are prohibited in China, but who can resist a Swiss watch?  Especially a $30,000 diamond studded one? It is just one little watch!

Bain & Company, a global consulting firm, estimated luxury sales of $7.6 million in 2008.  Industry experts say gifts to government officials make up close to 50% of that figure.  During the Communist Party meetings in March of 2009, sales of luxury goods in Beijing spiked.

One snobby land confiscation official in Chongqing was sentenced to 13 years in prison for accepting kickbacks.
Chinese officials confiscated 200 pairs of luxury shoes, 100 luxury suits, and a luxury car.  He even had the nerve to tell his female trial lawyer that she needed to polish her low quality shoes. I wonder what sort of shoes they will issue him in prison. Gucci?

China is countering this corruption with talk of creating a national registry to track the assets of government officials. 7

3-9-2A Invoice Kickbacks

Invoice kickbacks cause a client to be overcharged while the vendor and their fraudster friends share in the proceeds!

You wouldn’t steal food from a kid, would you?
What about stealing money that was intended to pay for kids’ lunches? Sodexo, the world’s largest food purchaser, had received rebates from food suppliers that it failed to pass on to the districts.

In order to continue to do business with the state, Sodexo paid a $15M fine to the state of New York for overcharging New York School district cafeterias. The organization also agreed to disclose rebates in writing to clients, establish a hotline for clients and whistleblowers, and pay for an independent audit of their compliance with rebate provisions of their contracts.8

3-9-2B Bid Rigging

Will I ever feel good about banks and Wall Street again?  I don’t think so.  I am afraid our business schools are churning out opportunistic financiers looking for a quick buck!  And unsophisticated governments are easy targets with lots of money.

Local governments beware of big banks offering investments!
Local governments often hire brokers to help them find investment contracts so that the government earns interest on millions of bond proceeds set aside for long-term projects. The U.S. Treasury requires that these contracts be bid on competitively to maintain the tax-exempt status of the proceeds.

Bank of America, however, decided in advance which bank would be the winner of certain contracts. They did their best to cover their tracks.  They occasionally submitted intentionally losing bids so that the bidding would look legitimate. As a result of bid manipulation, the Justice Department said Bank of America won investment contracts at “artificially determined price levels, which deprived municipal issuers of money and property.”  And, as of this writing, the investigation has only just begun.  On June 22, 2012, Moody’s downgraded Bank of America’s public finance obligations.

“This ongoing investigation has helped to expose widespread corruption in the municipal reinvestment industry,” said Robert Khuzami, director of enforcement at the SEC, one of the agencies in the probe. “The conduct was egregious – in return for business, the company repeatedly paid undisclosed gratuitous payments and kickbacks and affirmatively misrepresented that the bidding process was proper.”

As a result, four federal agencies and 20 states received a sweeping $137 million in their settlement with Bank of America for its role in a bid-rigging scheme that ripped off state agencies, cities, towns, and not-for-profits seeking to invest yet unspent bond proceeds.9

Here is a press release from the Department of Justice in a related case.

Former Agent Of Financial Products And Services Company Pleads Guilty For Role In Fraud Conspiracies Involving Proceeds OfMunicipal Bonds10A former agent of a financial products and services company pleaded guilty today for his participation in fraud conspiracies related to contracts for the investment of municipal bond proceeds and other municipal finance contracts, the Department of Justice announced.According to plea proceedings today in U.S. District Court in New York City, Adrian Scott-Jones, a resident of Morriston, Fla., pleaded guilty to participating in two separate fraud conspiracies with companies that provide a type of contract, known as an investment agreement, to public entities throughout the United States, such as state, county and local governments and agencies. These public entities were seeking to invest money from a variety of sources, primarily the proceeds of municipal bonds that they issued to raise money for, among other things, public projects. Scott-Jones also pleaded guilty to one count of wire fraud. According to the plea agreement, Scott-Jones has agreed to cooperate with the ongoing investigation.

The department said in court documents that Scott-Jones’ former company, located in North Palm Beach and Ocala, Fla., marketed financial products and services, including services as a broker or advisor to various public entities that issue municipal bonds. Public entities typically hire a broker to conduct a competitive bidding process for the award of investment agreements. Major financial institutions, including banks, investment banks, insurance companies and financial services companies, are among the providers of investment agreements and other related municipal finance contracts. Competitive bidding for these agreements is the subject of regulations issued by the U.S. Department of the Treasury and is related to the tax-exempt status of the bonds.

According to court documents, Scott-Jones participated in one fraud conspiracy from as early as September 2001 until at least November 2006, and in a second fraud conspiracy from as early as August 1999 until at least November 2006. In each conspiracy, Scott-Jones gave co-conspirator providers information about the prices, price levels or conditions in competitors’ bids, a practice known as a “last look,” which is explicitly prohibited by U.S. Treasury regulations. Scott-Jones also solicited and received intentionally losing bids for certain investment agreements and other municipal finance contracts. As a result of the bid manipulation, the co-conspirator providers won contracts at artificially determined price levels, which deprived municipal issuers of money and property.

The court documents also charge that Scott-Jones and co-conspirators misrepresented to municipal issuers or their bond counsel that the bidding process was in compliance with U.S. Treasury regulations. This caused the municipal issuers to award investment agreements and other municipal finance contracts to providers that otherwise would not have been awarded the contracts if the issuers had true and accurate information regarding the bidding process. Such conduct caused municipal issuers to file inaccurate reports with the Internal Revenue Service (IRS) and thus placed the tax-exempt status of the underlying bonds in jeopardy.

Each of the fraud conspiracies for which Scott-Jones is charged carries a maximum penalty of five years in prison and a $250,000 fine. The wire fraud charge carries a maximum penalty of 20 years in prison and a $250,000 fine. The maximum fines for each of these offenses may be increased to twice the gain derived from the crime or twice the loss suffered by the victims of the crime, if either of those amounts is greater than the statutory maximum fine.

This is the sixth guilty plea to arise from an ongoing investigation into the municipal bonds industry, which is being conducted by the Antitrust Division’s New York Field Office, the FBI and IRS Criminal Investigation. The department is coordinating its investigation with the Securities and Exchange Commission, the Office of the Comptroller of the Currency and the Federal Reserve Bank of New York.

Three former employees of Rubin/Chambers, Dunhill Insurance Services Inc., also known as CDR Financial Products, a Beverly Hills, Calif.-based financial products and services firm that acted as a broker of investment agreements and other municipal finance agreements, have pleaded guilty to bid-rigging and fraud conspiracies in relation to the ongoing investigation. Two other individuals have also pleaded guilty to charges related to the ongoing investigation.

As a result of the ongoing investigation, three former financial services executives were indicted on July 27, 2010, for participating in fraud schemes and conspiracies related to the bidding for investment agreements. In addition, CDR, two of its employees and one former employee were charged in October 2009 for participating in bid-rigging and fraud conspiracies and related crimes. The CDR trial is scheduled to begin on Sept. 12, 2011.

3-9-3 Illegal Gratuities

When someone gives a public official a gift that isn’t necessarily tied to any particular favor, it is probably intended to influence the official’s future decisions.

Imagine a government official who encourages corporations to fund his campaign.  The corporations and the official understand that the corporations will experience preferential treatment.  Sound like some remote South American banana republic?  Unfortunately, this is how our ‘system’ works in America.

If a lobbyist gives a government official a significant campaign contribution and helps her raise more money for her campaign while at the same time explaining his position on, let’s say, health insurance, is that bribery, extortion, or illegal gratuities?  Or is the congresswoman suffering from conflict of interest?  The behavior of our U.S. Congresswoman might be considered all three at once.

I got in hot water a few years ago with one of my government clients. One of my last names is Hart, and so I thought it would be cute to send out Valentine’s gifts to my clients instead of Christmas presents. Get it? Hart, Valentines?  So, I sent a small heart-shaped dish full of dove chocolate to one of my legislative audit clients.  And they promptly sent it back to me with a scolding letter from their lawyer admonishing me never to give them a gift again.  I guess they thought an $8 gift would make them hire me for the next decade.  I wish it were that easy to get business!

3-9-4 Extortion

Some people mistakenly call bribery “extortion” and extortion “bribery.” The difference between bribery and extortion is in who makes the first move.  The person wanting a favor from a powerful person initiates bribery.  And the person in power initiates extortion: in extortion the public official asks for goodies instead of being offered goodies.

One contractor conveyed that the head of the purchasing department for a large city always held a meeting with the bidders on a project before the project was awarded.  The experienced contractors realized that he was asking for gifts when he said things like, “My car is so filthy.  It needs a detailing!” “Or, my lawnmower sure is getting tired.” Whichever contractor took care of his car or his lawnmower got the job.

David Letterman was in the news in 2009 because the boyfriend of the woman with whom he was having an affair threatened to expose his infidelities to the public unless David Letterman paid the boyfriend several million dollars.  David Letterman decided to fess up on the air, but he turned the boyfriend into the authorities first.  What an interesting turn of events for the boyfriend.  He is broke, girlfriendless, and in prison for extortion.

If you have the power, you can demand the money!
Broward County Public School Board member Beverly Gallager, was arrested for extortion, wire fraud, and bribery after undercover FBI agents passed $12,500 to her in return for her awarding construction contracts.  U.S. Representative, Debbie Wasserman Shultz, was appalled saying, “It shakes the confidence of the public in their elected leaders.”11


1 Allison Dowd. “Mayor says decision didn’t put him into conflict of interest.” The Brandon Sun. September 29, 2010.
2 Brent Walth and Michelle Cole. “Department of Energy officials promoted firm run by ex-Gov. John Kitzhaber’s girlfriend for project.” The Oregonian [Portland]. August 23, 2010.
3 Matthew Mosk. “Exclusive: Glenn Beck’s Golden Advertiser Under Investigation.” ABC Nightline. ABC. July 19, 2010. Television.
4 Robert O’Harrow Jr. “Potential for Conflict Grows With Government’s Use of Contractors.” Washington Post. August 18, 2008.
5 United States. Department of Justice. Former Congressman William J. Jefferson Convicted of Bribery, Racketeering, Money Laundering, and Other Related Charges. FBI. August 5, 2009.
6 “Siemens Pays out $800M in Fraud Settlement.” National Association of Corporate Directors Directorship. Web. December 15, 2008.
7 David Barboza. “For Bribing Officials, Chinese Give the Best.” The New York Times. March 13, 2009.
8 Lucy Komisar. “Sodexo, exposed by Komisar for kickbacks, agrees to $20m settlement.” The Komisar Scoop. Web. July 21, 2010.
9 Rick Rothacker. ”Bank of America reaches bid-rigging settlement.” Charlotte Observer.  December 7, 2010.
10 United States. Department of Justice. Former Agent of Financial Products And Services Company Pleads Guilty For Role In Fraud Conspiracies Involving Proceeds Of Municipal Bonds. Press release. Washington, D.C. September 8, 2010.
11 “Broward County School Board member arrested.” Sunshine Review Gazette. September 24, 2009.

Fraud Risk per the GAO’s Green Book

Just because you’re unaware of the risk, doesn’t mean it isn’t there

Just because you aren’t conscious of something dangerous, doesn’t mean it isn’t lurking.   One of the most important themes of the GAO’s Green Book (and the 2013 COSO model it is sourced from) is consciousness.  Instead of just playing along with the crowd without regard to the risk, the Green Book encourages you to become conscious of risk, imagine the worst, and then plan to prevent it.

Do you think that people in the 1940’s had a sneaking suspicion that smoking was unhealthy?  Or do you think their desire to be glamorous like all those smoldering (forgive the pun) Hollywood movie stars overrode their common sense?

And in the 70’s my mom and dad slathered themselves with olive oil and lay in the sun to get a reddish brown ‘tan’.  Coppertone products promised to magnify the power of the sun.  Now my dad gets skin cancer removed from his face, arms, and hands every six months or so.

Everybody went nuts buying non-stick cookware in the 80’s only to find out that the Teflon emits dangerous gasses into your food when heated.  In the 90’s we all started drinking bottled water with no concern for the environmental impact, and in the 2000’s we went ‘wireless’ and may be exposing our brains to harmful radio waves.  Lately, we all have to concede that if we transact with the world at all, our personal data is out there and available to criminals in Russia.

I am thinking of that classic parental line here, “If your crazy friend Carl jumped off a bridge, would you do it to?”  Going along with the crowd can be dangerous.

Sometimes you can pre-empt negative consequences

It is all very nice to look back in hindsight and realize that you shouldn’t have followed the crowd and jumped off that bridge.  But sometimes, you can work ahead of a problem to prevent bad results.

For instance, I opened a new business account at a bank recently.  And I know that it is dangerous to give my bank account number to folks who are making deposits into my account and/or who have the power to withdraw money from my account.  But I put the risk out of my mind because I didn’t think I could do anything about it.

Hand me the Coppertone, I’ll play along!  My thinking was, “That’s how business is done and I want to play.”

But my new bank has thought about this risk and offered me not one, but two checking accounts.  I can share one checking account number with vendors and customers who are coming in and out of my account and the other account – where the bulk of my money is – is accessible and known only to me and my bookkeeper.  Nice.

Fraud is real but it isn’t entirely unavoidable

The Certified Fraud Examiners estimate that 5% of an organization’s annual revenue is lost to fraud.   http://www.acfe.com/rttn2016/docs/Staggering-Cost-of-Fraud-infographic.pdf

And although the Certified Fraud Examiners don’t say it outright, they are implying that most organizations suffer fraud.   If an organization grows to over 100 employees, someone is probably doing something squirrely.

I spent a year writing a self-study book on Fraud for Government Auditors.  Unfortunately, I wrote it in 2008 as our economy was crashing.   As I wrote, I became hyper-aware of bad behavior and fraud everywhere I went.  It was exhausting and disheartening to see fraud every time I left the house or read the news, so 8 years later, I have turned the consciousness dial down quite a bit and become mostly numb to it once more. There is only so much moral outrage you can muster day after day after day.

The Green Book asks the leaders of the organization to think about fraud before it happens.  It is asking them, for at least a few days while they prepare a risk assessment, to muster some moral outrage before the organization actually suffers fraud so that they can plan around it, just like my new bank.

Fraud risk specifically

So in our last chapter, we discussed inherent risk in general and how the Green Book encourages us to think about the risk of death, injury, shame, loss of money or non-achievement of goals.

Now, we are going to focus on fraud risk specifically.  Fraud can cause injury, shame, loss of money, or non-achievement of goals.  But occupational fraud, the fraud discussed in the Green Book, is not likely to cause death.

The GAO dedicates a good portion of the chapter in the Green Book on risk assessment to assessing fraud risk.

Principle 8 states: 8.01: Management should consider the potential for fraud when identifying, analyzing, and responding to risks. 

Luckily, the GAO’s green book doesn’t stop there, but instead, shares several models that will help us be more conscious of fraud as we are assessing fraud risk: the fraud tree and the fraud triangle. We are going to discuss each in turn.

Like a good spiritual guide, the fraud tree and fraud triangle enhance consciousness

Both the fraud tree and the fraud triangle have helped me see fraud where I didn’t see it before.  And once your consciousness has been raised, you see new things everywhere.

You may have experienced this with your car.  I am the happy owner of a plain white Lexus sedan.  Before I owned a Lexus, I was oblivious to how many were on the road. Now I see them everywhere.  You remember that weird movie called The Sixth Sense… where the lead declares “I see dead people!”?  I see Lexi.

A broad overview of the fraud tree

As a supplement to this article, I am also going to publish a series of chapters from my book on fraud so you can get to know the fraud tree in more detail.  Be looking for those over the next few weeks. But in this short article, we are just going to do a broad overview of the fraud tree.

So don’t read any of those newsletters or read the rest of this newsletter unless you want to see fraud everywhere.

THE FRAUD TREE

A fraud investigator once told me, fraud is lyin’, cheat’n, and steal’n.  But the Certified Fraud examiners are more formal about classifying fraud and use much better grammar.  The Certified Fraud Examiners came up with a whole taxonomy of occupational fraud which they dubbed the ‘fraud tree.’  If you are having a hard time reading the graphic below, visit the Certified Fraud Examiners page at http://www.acfe.com/fraud-tree.aspx for a clearer graphic.

Fraud Tree

The fraud tree divides fraud into three categories:

Corruption

Misappropriation of assets

Fraudulent reporting

Corruption includes bribery and extortion – which are flip sides of the same coin.  When a person without power pays a person in power for a favor, it is a bribe. When a person in power demands payment from someone who needs a favor, it is extortion.

A contractor with a Texas county told me that he and all of the other contractors knew that in order to win contracts, they would have to give expensive gifts to the county purchaser. Whenever requests for proposals were discussed with contractors, the purchaser would mention things he needed for his house – like a new grill or a lawnmower.  The contractors knew that whoever was first to buy the grill or lawnmower would win the contract. Eventually, the purchaser’s requests became more extravagant and frequent. The contractors had to take turns bidding on contracts, so they could distribute the extra expense more evenly among them.

Corruption also includes illegal gratuities.  An illegal gratuity is when you reward or pay someone in advance in hope of future favor. This is the way the US Congress works. Corporations and lobbyists support campaigns and slather favors on Congressmen in hopes that the Congressman’s decisions on future legislation will be favorable to them.

The last category in corruption is conflict of interest.  This is a wide category of bad behaviors where favors are granted to friends and family.  My friend has recently been elected treasurer of her homeowner’s association.  She has already found out that the chairman of the board is awarding work to companies that his daughters own.  My friend suspects, but cannot prove yet, that the chairman owns the companies and that the daughters are owners on paper only.

The second branch of the tree is misappropriation of assets. Misappropriation of assets is when cash or other assets of the organization are stolen or misused.  Notice that the fraud tree has two main branches under misappropriation of assets – 1. cash and 2. inventory and other assets.

fraud2

Cash can be stolen in three ways; cash can be taken after it has been captured in the accounting records (larceny), or before it hits the accounting records (skimming), or it can be disbursed in what looks like legitimate transactions for illegitimate purposes, like payments to fake (ghost) emplo

yees or fake (shell) companies.  As you can tell from the tree, cash misappropriation includes a wide variety of creative categories for fraudsters to choose from.

Other assets, like inventory and fixed assets can be stolen or misused.  The mail clerk in a state agency I worked for was using the state’s van on weekends to deliver pizzas!

And the last category is fraudulent statements.  We are all aware of the infamous financial statement fraud scandals at Enron and WorldCom that wreaked havoc on our national economy.  But we might not be as well acquainted with non-financial statement fraud.  A false claim or statement for personal gain falls into this category.  Fifty-eight percent of hiring managers said they’ve caught a lie on a resume per a Career Builder Survey concluded in 2014. http://www.careerbuilder.com/share/aboutus/pressreleasesdetail.aspx?sd=8%2F7%2F2014&id=pr837&ed=12%2F31%2F2014  And many governments use performance measures to convince grantors and the citizenry that they are doing a good job handling public resources. But as you can imagine, sometimes these performance measures are altered, manipulated, or even completely made up.

One of my favorite stories about fraudulent performance measures is about the Public Works Department in the City of San Deigo. Their Public Works Department said they filled potholes within a week, when the truth is most potholes took months to repair.  When asked about the discrepancy, the Public Works Department said that their definition of repaired does not meet most people’s definition of repaired.  Tricky?  Yes.  Fraudulent?  I’d say so because the managers in the Public Works Department benefited from exaggerating the Department’s effectiveness.  See the amusing article about this fraud here: http://www.voiceofsandiego.org/topics/government/the-citys-false-pothole-pledge/

When I audited performance measures at a state department of criminal justice (the state prison system), I found that most measures were pulled directly out of the sky.  They were estimates that made the department look good, not measures of real results.

If you were reading closely, you might have noticed a small difference in wording

I don’t really know why the GAO and the COSO model chose to leave out non-financial statement fraud from their literature, but they did.  Here is the quote referring to the fraud tree in the Green Book:

Green Book 8.02 Management considers the types of fraud that can occur within the entity to provide a basis for identifying fraud risks.  Types of fraud are as follows:

  • Fraudulent financial reporting - Intentional misstatements or omissions of amounts or disclosures in financial statements to deceive financial statement users. This could include intentional alteration of accounting records, misrepresentation of transactions, or intentional misapplication of accounting principles.
  • Misappropriation of assets - Theft of an entity’s assets. This could include theft of property, embezzlement of receipts, or fraudulent payments.
  • Corruption - Bribery and other illegal acts.

See how the Green Book doesn’t talk about fraudulent statements in general but fraudulent financial statements only.

If you are an aficionado of SAS 99 (now AU 316), the AICPA’s guidance on an auditor’s responsibility for detecting fraud, you may recognize that the AICPA focuses their discussion of fraud on fraudulent financial statement reporting only.  This makes sense because the AICPA is clear about its audit objective – to opine on whether the financial statements are created in accordance with an accounting standard (usually GAAP).  But the Green Book – because it covers an entire organization, should include all components of the fraud tree.

If you know the reason for this, please share.  Otherwise, I am going to say it is a flaw of the Green Book until someone can convince me otherwise.

Next time, we will discuss the fraud triangle and do an example fraud risk assessment.

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