❘❙ Fraud Prevention ❙❚
Case studies of Fraud in the
hospitality industry
A retrospective of how real frauds could have been prevented
By Anna McFarland , CFE, CHAE, CHTP, CPA and Phil Newman, CPA
A
t more than 270 pages, the
2012 Report to the Nations on
Occupational Fraud and Abuse
(the Report) issued by the Association
of Certified Fraud Examiners (ACFE)
can be difficult to digest. However,
as one might expect, the biannual
publication provides valuable insight,
supported by real world statistics, into
the various facets of fraud.
Financial professionals in the
hospitality industry might wonder
how much of this information is pertinent to their organizations and their
individual responsibilities in relation
to improving fraud prevention and
detection. This article offers a review
of two cases of fraud — one at a hotel
and one at member-owned club — and
demonstrates how the findings of the
Report could have been used to prevent or detect the frauds earlier.
For purposes of this article, the
major sections of the Report are
focused on: the cost of occupational
fraud; how it is committed; how
frauds are detected; the profile of
the organizations falling victim to
fraud, including a discussion of their
controls; and details regarding the
perpetrators of fraud.
While it is interesting to understand
the overall impact of controls in these
cases of fraud, the most powerful information to help companies develop
effective anti-fraud controls relates to how fraudulent schemes were uncovered
and how much the amount of damage caused by fraud was reduced when a specific control was instituted.
When determining the usefulness of a fraud prevention control for an organization, it is helpful to consider how fraud is typically uncovered from the
perspective of the size of the company affected, as well as from the type of fraud
occurred. Figures 1 and 2 (page 31) from the Report provide this information.
Anna McFarland , CFE, CHAE, CHTP, CPA (annamcfarland36@gmail.com ) is a global hospitality consultant based in Kaufman, Texas. She is also a project leader on the Global Hospitality Accounting Common Practices, HFTP Global Past President and a frequent speaker at HFTP educational events.
Phil Newman, CPA (philip.newman@mcgladrey.com) is a partner at McGladrey Pullen, LLP based in Ft. Lauderdale, Fla. He is also a frequent speaker at
HFTP educational events.
Reprinted with permission from the Fall 2013 Volume 28 Number 4 issue of The Bottomline, the journal of Hospitality Financial and
Technology Professionals. Learn more at www.hftp.org.
30
Fall 2013
❘❙ Fraud Prevention ❙❚
Regardless of the size of victimized
organization, a tip proves to be the
most common method of detection —
36 percent of the time for small entities
(defined as those with less than 100
employees) and nearly 47 percent of
the time for those larger organizations.
Management review is also shown to
be critically important for all companies in detecting fraud. Meanwhile, it
is interesting to note that fraud in all
classifications of organizations was
more likely to be caught by accident
than by external audit. This statistic
serves as a reminder of the purpose of
external financial statement audits as it
relates to detection of fraud.
The ACFE classifies fraud schemes
into three broad categories: Asset
Misappropriation Cases, Corruption
Cases and Financial Statement Fraud
Cases. Again, as depicted in Figure 2,
regardless of type of fraud, the most
common method of detection is a tip.
External audits prove to be more useful detecting financial statement fraud
than either of the other two categories
of fraud. Internal audits, uncommon in
private clubs, are frequently conducted
by hotel and casino organizations
and appear to be equally effective in
detecting all three types of fraud.
In another attempt to measure the
effectiveness of controls, the Report
compares the median loss suffered
by those organizations that had each
anti-fraud control in place with the
median loss in companies that did not
have that control (page 32). While all
controls were led to a reduced median
loss, formal management reviews, employee support programs and hotlines
were associated with the largest reductions in financial losses. Entities that
did not have any of these three controls in place suffered median losses
that were approximately 45 percent
larger than organizations with these
controls. These findings are interesting in that they suggest that managerial reviews and employee support
programs, at least in terms of dollars
of fraud prevented, are just as effective
as hotlines, with fraud training also
proving to be highly effective.
36.1%
46.6%
Tip
14%
15.1%
Management Review
12.8%
4.1%
Internal Audit
9.9%
16.5%
By Accident
7%
3.2%
Account Reconciliation
5.3%
4.7%
Document Examination
External Audit
4.8%
2.3%
Notified by Police
4.3%
2.3%
Surveillance/Montioring
2.4%
1%
Confession
1.9%
2%
Figure 1.
Detection Method by Size
of Victim Organization
■ <100 Employees
■ 100+ Employees
1%
1%
Other
0.5%
1.4%
IT Controls
0
10
20
Tip
7.4%
4.3%
4.8%
By Accident
Account Reconciliation
4.5%
2.2%
1.9%
0%
Detection Method
by Scheme Type
2.6%
4.8%
14.3%
Notified by Police
IT Controls
5.3%
0.9%
3.8%
Figure 2.
External Audit
Other
42.1%
54.1%
41.9%
3.3%
3.3%
5.7%
2%
0.9%
1.9%
■ Asset /Misappropriation
Cases
■ Corruption Cases
■ Financial Statement
Fraud Cases
1.7%
0.9%
1.9%
Confession
1.1%
0.7%
1.9%
50
14%
14.3%
14.3%
Internal Audit
Surveillance/Montioring
40
15%
12.4%
6.7%
Management Review
Document Examination
30
1%
1.3%
1%
10%
20%
30%
40%
50%
60%
Source: 2012 Report to the Nations on Occupational Fraud and Abuse
The Bottomline
31
❘❙ Fraud Prevention ❙❚
Median Loss Based on Presence of Anti-fraud Controls
Control
Percent of Cases
Implemented
Control in Place
Control Not
in Place
Percent Reduction
Management Review
60.5%
$100,000
$185,000
45.9%
Employee Support Programs
57.5%
$100,000
$180,000
44.4%
Hotline
54.0%
$100,000
$180,000
44.4%
Fraud Training for Mgrs/Execs
47.4%
$100,000
$158,000
36.7%
External Audit of ICOFR
67.5%
$120,000
$187,000
35.8%
Fraud Training for Employees
46.8%
$100,000
$155,000
35.5%
Anti-fraud policy
46.6%
$100,000
$150,000
33.3%
Formal Fraud Risk Assessments
35.5%
$100,000
$150,000
33.3%
Internal Audit/FE Department
68.4%
$120,000
$180,000
33.3%
Job Rotation/Mandatory Vacation
16.7%
$100,000
$150,000
33.3%
Surprise Audits
32.2%
$100,000
$150,000
33.3%
9.4%
$100,000
$145,000
31.0%
Code of Conduct
78.0%
$120,000
$164,000
26.8%
Independent Audit Committee
59.8%
$125,000
$150,000
16.7%
Management Certification of F/S
68.5%
$138,000
$164,000
15.9%
External Audit of F/S
80.1%
$140,000
$145,000
3.4%
Rewards for Whistleblowers
Source: 2012 Report to the Nations on Occupational Fraud and Abuse
Application to the Hospitality Industry
Case Study 1:
Private Member-owned Country Club
The general manager (GM) of a private club pleaded guilty to stealing almost $2 million from the club through
fraudulent payrolls and illegally-written checks. He admitted to mail fraud,
wire fraud and money laundering in
connection with a scheme to steal
from the club.
Over a period of five years the
GM created fictitious employees, kept
former employees on the payroll and
placed individuals on the payroll who
provided personal services to him.
He made electronic payments to these
“ghost employees” and deposited
them into his personal accounts.
The GM also wrote checks drawn
on country club accounts to pay his
personal expenses, including leasing
and buying vehicles for his personal
32
Fall 2013
use. He wrote checks made payable to
his personal business. The GM and his
colleague, the controller of the club,
were indicted in U.S. District Court
on numerous counts each of wire and
mail fraud.
The scheme came to light after the
club appointed a new treasurer who
questioned duplicate invoices that had
been presented to her for approval
and payment.
This case ostensibly involved asset misappropriation, though some
financial statement fraud would have
been involved, as well to conceal
the fraudulent transaction. Focusing
therefore on the detection methods
discussed in Figure 2, it is evident that
this scheme could have been detected
in its infancy with a tip. Given that
the scheme lasted for approximately
five years, it is necessary to ques-
tion how such a large fraud, which
involved several functions of the clubs
finances (e.g., payroll, cash and fixed
assets), was not noticed or reported by
someone with the club. Presumably
the bogus expenditures were charged
to various departments — under the
noses of each department head.
Questions that emerge include
whether the department heads were
part of the scheme or simply too scared
to report anything for fear of losing
their jobs, and whether the club employees had a mechanism for reporting
any unusual occurrences. Given that
two senior members of the management team were involved, it could
have been that the employees would
not have known how or to whom they
were to report issues. Instances like this
make the value of a hotline unquestionable, though staff must be trained as to
its appropriate use.
❘❙ Fraud Prevention ❙❚
That leads to the effect anti-fraud
training might have had in this case.
Had employees been made aware of
their responsibilities to prevent and detect fraud and to be attuned to instances of unusual practices, then the fraud
may have been detected much earlier.
The Report notes that anti-fraud training reduces the duration of fraud by
50 percent — the same reduction in
duration attributed to an entity having
a hotline in place. In fact, the ACFE
study notes that something as simple
as job rotation/mandatory vacation,
reduces the duration of a fraud scheme
by as much as 62.5 percent. In this
country club case study, forced vacations for the controller and general
manager could have led to a much
smaller loss.
While managerial review is noted
as a common detection method, by
size of organization or by type of fraud
scheme, in a case like this one, the
effectiveness of such activity might be
difficult to appreciate given that members of management were complicit in
the fraudulent activity. In the private
club world, a case like this highlights
the importance of board and committee oversight in financial governance
matters. While such bodies should not
be involved in day-to-day operations,
given the limited controls in most
clubs, those who are in financial stewardship roles, such as the treasurer,
must be diligent in their duties. In this
case, ultimately it was the treasurer
who exercised her role as a reviewer to
uncover the size of the ongoing fraud.
Case Study 2:
Prestigious Boutique Hotel
The owners of a well known boutique
hotel in a major metropolitan area announced that an investigation into an
alleged fraud scheme at the property
had recently been concluded. The vice
president (VP) of operations of the
management company that operated
the hotel had admitted to stealing
more than $500,000 from the hotel and
similar properties also managed by
the management company. The scheme
was uncovered during the first financial statement audit of the hotel in
many years when unusual items on the
bank reconciliation were questioned
by the auditors.
With the assistance of the hotel’s
controller, the VP had used cashiers
checks to withdraw funds from the
hotel’s bank accounts for personal
use. The scheme had been hidden from
auditors of other hotels in the group
by circulating funds from one hotel to
another just before the financial statement audit commenced.
The investigation into the fraud had
uncovered numerous discrepancies in
the hotel’s records, including checks
that had been cashed without signatures, as well as notices to auction the
hotel, issued by local taxing authorities, for non-payment of real estate
taxes. It was also discovered that the
VP had stolen payroll tax deposits
from his previous employer and was
working through a payment plan to
repay the amounts stolen.
This case also involves financial
statement manipulation to disguise
the theft of assets, namely cash.
Given that the fraud focused on the
theft of cash under the control of two
individuals, one might question the
impact a hotline would have had in
this situation. That is until noticing
that the fraud was hidden from other
audit firms in the group by circulating
funds among the various properties.
What questions did the controllers at
the other hotels ask when transfers
were made close to year-end and
before the annual external audit might
have commenced? If those controllers had a hotline to which they could
have reported concerns, the losses
could arguably have been reduced by
as much as 45 percent.
The hotel case highlights an area of
the Report that not yet touched upon,
but is one that deals with an impor-
tant aspect of fraud prevention. In the
Report, less than six percent of the
fraudsters had prior convictions, while
a similar proportion had been charged,
but not convicted. These statistics
should not diminish the importance
of background checks on employees
in positions of trust. In this hotel scenario, such a background investigation
would arguably have uncovered a prior
offence(s) committed by the VP.
The hotel case lasted about three
years before the auditor uncovered the
discrepancy in the bank reconciliation.
While the duration of a fraud scheme
ranges from 12 to 36 months in the
Report, depending on the category
of the fraud, the median duration for
all cases in the study was 18 months.
It would seem that a greater level of
financial review by other management
company personnel, including but not
limited to an effective internal audit
department, would have prevented or
expedited the discovery of this fraud.
Hospitality
Clearly, hindsight is always 20/20 and
it is easy to look back at cases of fraud
to identify what could have been done
differently to stop or prevent the fraud
in the first place. The reality is that no
organization or department is immune
to fraud. All members at any organization have roles to play in respective
positions and everyone has an inherent
responsibility to understand what constitutes fraud as well as how to prevent
and detect it.
For those who are committed to
fraud detection and prevention, a detailed review of the 2012 Report to the
Nations on Occupational Fraud and
Abuse is highly recommended. ■
Source
• Association of Fraud Examiners.
2012 Report to the Nations on Occupational Fraud and Abuse. http://
www.acfe.com/rttn.aspx
The Bottomline
33