Internal Control for Fraud
Deterrence
Shawn H. Miller, CPA, CFE
What is Fraud?
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Definition
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Any intentional or deliberate act to deprive
another of property or money by guile,
deception or other unfair means
Two main types of fraud
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Misappropriation of assets – theft of company
assets
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Overwhelmingly most common
Fraudulent financial reporting –
misrepresentations in financial reports
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Committed by top management
More common among publically traded companies
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Fraud Triangle
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For fraud to occur, you need the Fraud
Triangle
Opportunity is the one area we
can attempt to control
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What Makes Not-for-Profits Unique?
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More trusting culture – people are “supporters”
of cause
Excessive control by founder, director or
substantial contributor
Failure to include individuals with financial
expertise on Board of Directors
Reduced resources result in cuts to
administrative staff
Nonreciprocal revenue sources make it easier
to steal
Job security based on financial reports
(government grants)
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Internal Controls
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Most effective way to deter fraud
Important to ensure that controls are
followed 100% of the time
Segregation of duties is the key to fraud
deterrence and prevention
There are 2 types of internal controls:
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Deterrence
Detection
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Tone at the Top
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Refers to the attitude and mindset of the
Board of Directors and top management
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This attitude permeates throughout
organization
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Is a major deterrence control
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2012 ACFE Report to the Nation
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10% of frauds occur in not-for-profit
organizations
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Typically lasts 18 months
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Approximately 55% were committed by
single individual, median loss of $100,000
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Median loss for 2+ perpetrators was $250,000
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Does not include lost revenue from bad publicity
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2012 ACFE Report to the Nation
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Primary internal control weaknesses
noted:
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Lack of controls
Override of existing controls
Lack of Management review
Poor tone at the top
One of these factors was present
in over 80% of cases studied
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2012 ACFE Report to the Nation
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Behavioral red flags:
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Living beyond means
Financial difficulties
Unwillingness to share duties
Addiction problems
Refusal to take vacations
Unusually close relationship with
vendor/customer
Wheeler-dealer attitude
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Cash Disbursements
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Most common area for fraud
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Common schemes include:
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Billing schemes / fraudulent vendors
Check tampering
Expense reimbursement schemes
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Segregate Key Areas
Deterrence Controls
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Access rights in accounting system should be limited to only
the activities necessary to perform job and should be
reviewed regularly
Invoices and checks should not be approved by individual
who prepares checks
Individual who prepares check should not be allowed to add
vendors
Vendor codes should be used for all disbursements – there
should not be a “temp” or “misc” vendor code
Check should never be returned to individual who requested it
(“U-Turns”)
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Segregate Key Areas
Detection Controls
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Bank statements should be opened and reviewed
by individual who does not prepare checks
Bank reconciliations should be reviewed by
individual who does not prepare checks. All
unusual reconciling items should be thoroughly
investigated
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Vendor complaints should not be handled by
individual who prepares checks
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Implement positive pay with your bank
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Other Disbursement Controls
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All checks should be mailed, not hand
delivered
Vendor files should be purged on a
regular basis
Change reports for vendor records
should be reviewed by individual who
does not prepare checks
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Other Areas to Watch
Give Special Attention to Credit Cards
• Who reviews credit card statements?
• Who collects and cancels credit cards when
employees leave?
• Are cards used for personal charges as well?
• Who reviews expense reports, especially for top
management?
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United Way
United Way / United Way of the National Capital Area (UWNCA) / United Way of New York City
(UWNYC)
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All three entities had Executive
Directors accused of excessive
spending
Former head of national organization
spent six years in jail for misuse of over $1
million
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Founded organization
Personal condo in Miami
Concorde flights to Europe
Trips to Las Vegas for secretary/mistress
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United Way
United Way / United Way of the National Capital Area (UWNCA) / United Way of New York City
(UWNYC)
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UWNCA Executive Director stole
over $1.6 million
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Closely associated with national Executive Director
Fictitious expenses
Trips to Las Vegas
Cash advances that were never repaid
UWNYC Executive Director diverted over
$200,000 for his personal use
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Discovered when longtime assistant went out on extended
medical leave
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United Way
United Way / United Way of the National Capital Area (UWNCA) / United Way of New York City
(UWNYC)
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What was the impact? At UWNCA:
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Lost contract to run Federal worker
giving campaign
Total overhaul of governance
Contributions dropped 60%, had not totally
recovered by 2009
Exorbitant amount of time, effort, and money
spent on investigations and damage control
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United Way
United Way / United Way of the National Capital Area (UWNCA) / United Way of New York City
(UWNYC)
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What can we learn?
Any red flags?
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Handpicked Board of Directors and leader
of affiliates
Intimidated others in tax-exempt community
Pliant, overly agreeable Board of Directors
Flaunted lavish spending
Auditors were told to withhold information from Board
Rumors of improper spending
Employee terminated after raising questions
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United Way
United Way / United Way of the National Capital Area (UWNCA) / United Way of New York City
(UWNYC)
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How did UWNCA react?
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Commissioned a full top-to-bottom investigation
covering almost 30 years
Created Ethics, Polices, and Procedures task force
Formed new audit committee
Established code of ethics
Implemented best practice financial policies
Reduced size of Board of Directors by over 50% – smaller
but more engaged
Created a culture of accountability
and transparency
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City of Dixon, Illinois
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Former controller embezzled $53 million
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City budget in 1983 was only $9 million
(same year controller hired)
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Created fictitious bank account in the
city’s name at Fifth Third Bank
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City of Dixon, Illinois
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Transferred funds among various legitimate
city accounts and eventually into a fictitious
account.
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Created false invoices to support transfers.
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Used money to pay personal expenses
related to quarter-horse business
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Fraud started in 1990 and lasted 22 years
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City of Dixon, Illinois
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Started small but grew exponentially over
time. Stole under $200,000 in 1990
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Discovered when controller was on
vacation and another employee opened
bank statement from Fifth Third Bank
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City of Dixon, Illinois
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What was the impact?
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City’s current operating budget is $16.6 million in
the red
Capital development fund has deficit of $1.7
million
General fund has deficit of over $12 million
City is suing multiple auditors and banks
Exorbitant amount of time, effort,
and money spent on investigations
and damage control
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City of Dixon, Illinois
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What can we learn?
Any red flags?
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Blamed continued losses on money owed from
state
In 1997, the controller doubled the size of her
house and added an in-ground pool
Purchased 87.8 acre horse farm for $540,000
Built 19,000 sq. ft. horse barn, arena, office, and
stalls
In 2007 purchased 81 acres in Wisconsin. Her
salary was under $80,000 at the time
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City of Dixon, Illinois
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What can we learn?
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No oversight of controller’s work
Able to initiate and execute large wire
transfers without approval
No review of bank statements
Great example of what can happen if
there is a lack of segregation of duties
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Fraudulent Financial Reporting
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Improperly charging expenses to
restricted funds or Federal grants
Improperly classifying expenses to
improve functional allocation
Netting expenses with revenue to
improve financial statement revenues
Overstating receivables by either
improper recognition or understatement
of reserve for uncollectible amounts
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Motivation for Financial Reporting Fraud
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Better rating by watchdog groups
Impress Board of Directors
Impress donors/grantors
Obtain financing
Appear stable/strong in down economy
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Mitigate Reporting Risk
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Timely review of expenses and financial
reports by management
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Management must have an understanding
of what should be charged to each
program
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Communicate importance of accurately
reporting time and expenses
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Have an engaged and properly trained
audit committee
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What Else Can You Do?
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Set the tone – Follow control structure,
communicate the importance of controls
and accurate reports
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Adopt and communicate a “whistleblower” and “code of conduct” policy
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Take action against violators – make an
example of them
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What Else Can You Do?
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Be Observant – Look for unusual items in
financial reports
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Be Observant – Look for unusual behavior
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Be Observant – Be alert for individuals
who are reluctant to train their
replacement, accept promotions or take
vacations
among staff
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Questions?
Shawn H. Miller, CPA, CFE
Calibre CPA Group, PLLC
202.331.9880
smiller@calibrecpa.com
calibrecpa.com
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