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The Fraud Triangle Nancy Bode, Assistant Legal Counsel

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1 The Fraud Triangle Nancy Bode, Assistant Legal Counsel
Office of the Minnesota State Auditor NASACT Middle Management Conference April 18, 2013 © 2013 Office of the Minnesota State Auditor

2 Office of the Minnesota State Auditor (OSA): Responsibilities
A Constitutional Office Financial oversight includes: Counties Cities School Districts Towns Volunteer Fire Relief Ass’n Pension Funds Soil and Water Conservation Districts Port Authorities Tax Increment Financing (TIF) Districts As well as approximately 150 other special districts Minnesota Legislative Auditor – state entities © 2013 Office of the Minnesota State Auditor

3 © 2013 Office of the Minnesota State Auditor
OSA Divisions Audit Practice Pension Tax Increment Financing Government Information Legal/Special Investigations © 2013 Office of the Minnesota State Auditor

4 Legal/Special Investigations Division
The Legal/Special Investigations Division investigates allegations of theft or misuse of public funds by local government units (LGU). It also provides legal compliance information and training to local government officials. © 2013 Office of the Minnesota State Auditor

5 © 2013 Office of the Minnesota State Auditor
The Fraud Triangle Motive/Incentive (Financial Pressure) Rationalization Opportunity © 2013 Office of the Minnesota State Auditor

6 Fraud Triangle: Motive/Incentive
Gambling Medical issues Spouse’s layoff or anticipated layoffs Declining financial condition © 2013 Office of the Minnesota State Auditor

7 Fraud Triangle: Rationalization
Minimize “I’ll pay it back” (just borrowed the money) Compensate for overtime A mistake/accident “They’ll never miss it” Everybody does it Blame “They don’t pay me enough” Fellow employee created the opportunity Unusual expenses in personal life © 2013 Office of the Minnesota State Auditor

8 Fraud Triangle: Opportunity
Cash Lack of segregation of duties Inadequate internal controls Management override Poor environment This is the one that can be controlled. © 2013 Office of the Minnesota State Auditor

9 © 2013 Office of the Minnesota State Auditor
Fraud Risk Factors Are employees/ management under pressure? Do they have an incentive to commit fraud? Do employees or management have an attitude that allows them to rationalize fraud? Does the opportunity to commit fraud exist? SAS No. 99; AU § 316 © 2013 Office of the Minnesota State Auditor

10 Reduce Risk of Fraud: Tools of Protection
Reduce “opportunity” with: Segregation of Duties Internal Control Procedures Environment © 2013 Office of the Minnesota State Auditor

11 Tools of Protection: Segregation of Duties
One person should not control an entire transaction (separate authorization, recording & custody) No employee should be in a position to commit fraud and then conceal it Build double-checks into process Cross-training (assignment/job rotation) “Trust but verify” © 2013 Office of the Minnesota State Auditor

12 Problem: School Gate Receipts Not Deposited
Athletic Director, acting alone, counts money from games and prepares deposits Solution: Athletic Director records starting ticket numbers & number of ticket takers and makes deposits Ticket takers record sales & turn in paperwork to main office Main office reconciles Athletic Director’s deposit and ticket takers’ records & resolves any discrepancies © 2013 Office of the Minnesota State Auditor

13 Problem: Fees Not Deposited
Fees collected by department not turned in to central office for deposit OR not deposited by central office Solution (check on dep’t): Dep’t issues pre-numbered receipts for fees collected & turns in copies to central office; central office reconciles fees with amount received from dep’t Solution (check on central office): Dep’t obtains pre-numbered receipt from main office and periodic (monthly) updates of collections posted to dep’t account (deposits); dep’t reconciles receipts and deposits © 2013 Office of the Minnesota State Auditor

14 Solution: Segregation of Duties for Receipts
Someone other than person collecting money compares items sold to money collected (movie theatre example) Person collecting money is not person preparing deposit Person collecting money receives periodic report of deposits Second person OKs all voids/refunds © 2013 Office of the Minnesota State Auditor

15 Problem: Employee Writes Self Check
Check written to employee Check recorded as “void” or as written to a vendor Amount of check changed from that approved Check to phantom vendor/employee No one notices © 2013 Office of the Minnesota State Auditor

16 Problem: ATM Cash Advances Using Entity’s Credit Card
Person with PIN number & credit card also received bills, made copies of bills for board review/approval, wrote checks & entered in ledger Cash advances & finance charges removed from credit card bills submitted for approval 1 check paid approved credit card bill; 2nd check (never approved by board) paid for cash advances & finance charges; phony or other legitimate vendor entered in ledger for 2nd check © 2013 Office of the Minnesota State Auditor

17 Solution: Segregation of Duties for Disbursements
Review of bank statement and canceled checks (optical images) completed by someone not involved with check writing Amount altered? Void check cashed? Unauthorized checks written? Checks out of sequence or gaps in check sequence? Compare with claims approved Small entities: Involve board member or other employee © 2013 Office of the Minnesota State Auditor

18 Solution: Segregation of Duties for Disbursements (continued)
Do not pre-sign checks, deposit slips, or receipts Obtain all required signatures on checks (> 1) Beware of signature stamps © 2013 Office of the Minnesota State Auditor

19 Solution: Segregation of Duties
Involve the bank: No cash back during deposits No cashing of checks made payable to public entity No fund transfers without written authorization Up-to-date authorized signatures All required signatures on checks © 2013 Office of the Minnesota State Auditor

20 Tools of Protection: Internal Controls
Safeguard funds Efficient & effective management of assets Maintain integrity of financial systems Protect employees Primary internal control weakness contributing to fraud: Outright lack of controls (35% overall; 45% for small entities) Overriding of existing controls (19%) Lack of management review (19%) Source: ACFE 2012 Report to the Nations on Occupational Fraud and Abuse (http://www.acfe.com/rttn-highlights.aspx) © 2013 Office of the Minnesota State Auditor

21 Problem: Receipts Not Deposited
Special risks with cash receipts Skimming Cash removed prior to deposit (un-receipted cash) Lapping Receipted cash replaced with un-receipted checks © 2013 Office of the Minnesota State Auditor

22 Solution: Internal Controls for Receipts
Timely, intact deposits Timely reconciliation of receipts with deposits No cashing of personal checks out of un-deposited receipts No “borrowing” from public funds (no IOUs or “markers”) Note if payment is by cash or check (& check number) & compare to deposit Detect lapping Confirm intact deposit List issuer’s name and amount of checks on bank deposit slips © 2013 Office of the Minnesota State Auditor

23 Solution: Internal Controls for Receipts (continued)
Pre-numbered receipts for all payments/sales; pre-numbered tickets for events Gap in sequence? Second approval on voids? Consolidate cash collection points Do not leave receipts unattended Endorse checks “For Deposit Only” © 2013 Office of the Minnesota State Auditor

24 Problem: Unauthorized Payments
Public funds used for personal purchases Credit card Petty cash Expense reimbursements Electronic fund transfers Phantom vendors © 2013 Office of the Minnesota State Auditor

25 Solution: Internal Controls for Disbursements
Require original invoices & original itemized receipts (prevent the “slice & dice”) Reference claims approved (with amounts) in minutes Retain voided checks See OSA’s Statements of Position: Credit Cards Petty Cash The Importance of Internal Controls See OSA’s Avoiding Pitfalls: Petty Cash (3 part series) Electronic Funds Transfers Fuel Purchases Phantom Vendors And many more . . . © 2013 Office of the Minnesota State Auditor

26 Problem: Misuse of Public Property/Time
Personal use of public equipment or work hours © 2013 Office of the Minnesota State Auditor

27 Solution: Written Policies and Procedures
Prevent problems Allow discipline where appropriate Create consistency for all employees Set the environment See, e.g., OSA’s Statement of Position on Employee Timekeeping Procedures for Employees Paid on an Hourly or Daily Basis; OSA’s Avoiding Pitfall on Documentation of Accounting Policies and Procedures © 2013 Office of the Minnesota State Auditor

28 Tools of Protection: Environment
Set the tone at the top Create a culture of accountability All employees understand the importance of internal controls & their role Monitor compliance © 2013 Office of the Minnesota State Auditor

29 Problem: Weak Control Environment
Disengaged or otherwise engaged governing body or management Employees reluctant to voice concerns No action taken when noncompliance with internal controls, late deposits or reports Governing body and management fail to set the “tone at the top” Management override © 2013 Office of the Minnesota State Auditor

30 Solution: Control Environment
The same rules apply to all Don’t belittle internal control procedures It’s the public’s money Avoid conflicts of interest Take appropriate discipline for violations Be alert to employee’s outside interests © 2013 Office of the Minnesota State Auditor

31 © 2013 Office of the Minnesota State Auditor
Red Flags Red flags exhibited in fraud cases, according to ACFE 2012 Report to the Nations Living beyond means (35.6%) Experiencing financial difficulties (27%) Having an unusually close association with vendor/customer (19%) Displaying excessive control issues/ unwillingness to share duties (18%) Often multiple red flags © 2013 Office of the Minnesota State Auditor

32 © 2013 Office of the Minnesota State Auditor
Common Myth “No fraud here – see our recent audit.” Reality: Entities over-rely on external audits to detect fraud Initial detection of fraud, according to ACFE 2012 Report to the Nations: 43.3% tips (of those, 50.9% were from employees) 14.6% management review 14.4% internal audit 7.0% by accident 3.3% external audit © 2013 Office of the Minnesota State Auditor

33 © 2013 Office of the Minnesota State Auditor
Suspect Fraud? Minn. Stat. § LGU employee/officer who discovers evidence of theft, embezzlement, unlawful use or misuse of public funds or property Must promptly report to state auditor (in writing) and to law enforcement Identity of reporter is private data (Minn. Stat. § 6.715, subd. 2) Reporting form is on OSA website © 2013 Office of the Minnesota State Auditor

34 OSA’s Response to 609.456 Report
Do you need OSA’s help investigating? Has matter been reported to law enforcement? What internal control changes have you made to prevent/detect similar problems in the future? © 2013 Office of the Minnesota State Auditor

35 Suspect Fraud? Other Considerations
In addition to Minn. Stat. § reporting requirement: Criminal matter? Disciplinary action? Collect on bond/insurance? Get advice © 2013 Office of the Minnesota State Auditor

36 Number of 609.456 Reports to OSA
© 2013 Office of the Minnesota State Auditor

37 © 2013 Office of the Minnesota State Auditor
More Common Myths “The accountants/auditors are responsible for internal controls.” “Sound internal controls will eliminate all fraud.” “We have an accounting policy & procedure manual.” Do individual departments follow it? Is it current? © 2013 Office of the Minnesota State Auditor

38 © 2013 Office of the Minnesota State Auditor
More Common Myths “It can’t happen here.” “Only big entities (with big budgets) can have internal controls.” Reality: Small entities are particularly vulnerable to fraud (ACFE 2012 Report to the Nations) © 2013 Office of the Minnesota State Auditor

39 Website: www.auditor.state.mn.us
Statements of Position Investigative Reports Internal Control Letters E-Updates (Avoiding Pitfalls) Reporting Forms And More . . . © 2013 Office of the Minnesota State Auditor

40 © 2013 Office of the Minnesota State Auditor
Contact Information Nancy Bode 525 Park Street, Suite 500 St. Paul, MN 55103 (651) NOTE: The OSA does not provide legal advice or representation to local governments. © 2013 Office of the Minnesota State Auditor


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