When There's a Team Effort to Defraud

by James Leisner , CPA
Director, Corporate Services
StoneBridge Business Partners

Reprinted with permission from Fraud Matters Newsletter of CPA America .

Collusion – a secret agreement between two or more individuals for a deceitful or fraudulent purpose – is one of the most difficult types of fraud to expose.

Auditors routinely excuse themselves from the responsibility of detecting fraud, collusion in particular. It is difficult enough to uncover fraud when it is committed by an individual, but detecting a team of individuals working together to defraud an organization can be especially difficult.

What steps can you take to detect and deter collusion?

Every organization should have a written and communicated policy regarding fraud: It will not be tolerated, it will be sought out and violators will be terminated. Employees should know they will also be swiftly prosecuted.

Tough words require tough actions. If only restitution is required, the message is, “The worst that will happen is I have to pay the money back.”

Require disclosure of relationships and awareness of organization policies – both inside and outside the organization. This should be obtained from all employees and members of the board of directors. It should be updated annually.

Inform suppliers and vendors that gifts and gratuities to employees of the organization are prohibited, and that they are encouraged and expected to notify the organization of any inappropriate behavior by its employees or agents.

Provide a means for individuals to report suspicious behavior and irregularities. Suspicious activity is often noticed by those outside the organization. Your organization needs eyes and ears – inside and out – to observe and hear, and a means to inform you, either by a phone call, voice mail box, Web page, e-mail, mail, personal contact or anonymously. These tips need to be directed to a central point where investigation can follow.

A recent example of a whistleblower exposing a collusion scheme was the massive Roslyn (Long Island) School District fraud. A Home Depot employee questioned why an individual was using the school district’s credit card for items that appeared to be for a residence. The card was being used at a Home Depot well outside the geographic area of the school district.

More than 20 individuals were abusing the district’s funds, and their outside auditor was helping to conceal the abuse. An outside whistleblower not only alerted the public and helped bring an end to the conspiracy, but led to a statewide audit initiative that will impact all school districts throughout New York State.

Potential abuses include one employee perpetrating a fraud while the other provides authorization. Examples include an overstated expense report and overstated work hours and payroll. The excess is shared between the perpetrators.

Budgets establish expected results. Variances from the expected should be investigated. Investigating expenses in excess of a predetermined budget can lead to detection.

A review of payroll might generate such questions as, “Why is this employee incurring overtime but others are not?” Surprise distribution of paychecks and spot checks for the existence of employees by someone other than the immediate supervisor might also reveal the perpetrators.

Analytical review can detect fraud and collusion. What are the expected results for revenues, gross profit margins and expenses? Why are those results expected, and why do actual results differ? Monitoring gross profit margins may detect collusion between a sales clerk and customer in which the customer is undercharged for items or issued excessive refunds for merchandise. Surveillance cameras and review of customer patterns and transactions may detect unusual activity.

Segregation of duties has been a cornerstone of effective internal controls and the deterrence of fraud. Management relies on each individual to be independent and act as a check or balance. In the case of collusion, individuals are failing the organization. If collusion does exist, periodic rotation of personnel and duties changes the relationships and conditions that permitted the collusion.

When employees and those outside the organization perceive that controls are in place and are tested, they may be deterred from fraud or theft.

Periodically evaluate and test internal controls. Interviewing personnel tells you what should be occurring; testing helps prove or disprove it.

Are incoming receipts immediately recorded and controlled? Is there support for disbursements? Is that supporting documentation reviewed and approved?

The perception that events and results are being monitored and evaluated can detect, as well as deter, collusion and fraud.

James K. Leisner, CPA

Jim is a partner at EFP Rotenberg. He works with the management of privately owned businesses and not for profits to provide traditional accounting services and also provides assistance with business acquisitions/dispositions, expansion, financing, and the safeguarding of related assets. Read more about Jim . Article republished with the permission of CPAmerica.