Conducting a Fraud Investigation

A whistleblower at a large manufacturer alleged that an employee in the procurement department was colluding with a vendor to bill the company for security services that were allegedly never rendered. The investigation revealed several large, round dollar invoices billed for security at events that the company had no record of ever occurring. The vendor admitted in an interview that some of the invoices were in fact fictitious while other invoices were for legitimate services rendered to the company. This scheme lasted several years and cost the company hundreds of thousands of dollars before the whistleblower, who worked for the employee in procurement, tipped off internal audit.

In another case, an analysis of purchases by the maintenance department of a large company revealed that the price paid for various supplies was two, and sometimes three, times higher than market value.  An investigation revealed a connection between the vendor and maintenance department procurement officer.

These two real-life examples have a common thread. Both companies had controls in place such as segregation of duties and supervisor approval that were overridden by either collusion or abuse of approval authorities. Organizations should learn from the investigations that uncovered these fraud techniques. And they should employ similar techniques to assess the procurement activities within their own businesses periodically to identify anomalies among the purchasing patterns between employees and vendors.

The Association of Certified Fraud Examiners describes occupational fraud as the use of one's occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization's resources or assets. Fraud is a potential risk in most businesses. Organizations instill a certain amount of trust in their employees in order to operate, and those within the procurement function are entrusted with access to vendor selection, vendor files, accounts payable, invoice approval and purchase orders, which can provide an opportunity to commit fraudulent activity such as bid rigging, false billing schemes, vendor kickbacks and conflicts of interest.

The degree of risk a business may face can be assessed by examining Donald Cressey's Fraud Triangle. Cressey proposed that employees are more likely to commit fraud if three factors exist: (1) incentives and pressures, (2) opportunity, and (3) rationalization.

Given the tension throughout today's economy, more and more employees could be feeling financial strains at home, along with the increased pressure to produce results at work in a tough business climate. Meanwhile, resource reductions due to layoffs may have compromised the segregation of duties that previously existed, potentially creating more opportunity for dishonest behavior. And given that workers have been watching the top-level executives throughout the financial sector be bailed out by their tax dollars for poor performance, it may become easier to rationalize skimming a little off the top.

With all three of these factors present-and with the organization simultaneously lacking appropriate controls-these procurement employees be tempted to commit fraud. These days, many people are looking to make ends meet anyway they can.

There are two major methods a procurement employee may use. A kickback is the first. Kickbacks are the giving or receiving of anything of value to influence a business decision. They may be undisclosed payments made by vendors to employees in return for favorable treatment, such as bid rigging or inside bidding information. Or the vendor may approach an employee about submitting or approving invoices for goods or services that were never received, and in exchange, the vendor provides the employee with a kickback. It can be a cash payment, but it can also come in a form that is more difficult to detect, such as payment of personal loans or credit card bills. In other situations, there might be a transfer of property at less than fair market value or a lavish vacation.

The other problem comes from conflicts of interest. If an employee has an interest in the financial well-being of a vendor, a conflict of interest could exist. This may take the form of being a part-owner in the vendor company or knowing someone who is invested, such as a spouse or other family member who works for the vendor and can receive rewards. Any of these situations can impair a dishonest employee's ability to conduct business with the organization's best interests in mind.

To detect such misconduct, it is important to be aware of purchasing anomalies. Data analysis can help in this regard. For example, analyzing the vendor database, payroll database and accounts payable database can help identify undisclosed relationships between employees and vendors and uncover anomalies in purchasing for potential follow-up. (For example, discovering a common bank account, address and phone numbers between vendors and employees may indicate a potential conflict of interest, while duplicate invoices with the same supplier, dollar amount, date and invoice number might show direct fraud.)

Data analysis can provide trend data, such as the number of invoices from suppliers over time, unusual invoice number sequencing, and dollars spent for goods and services purchased from a particular vendor. All this helps answer the key question: "Does the dollar amount and timing of purchases from a particular vendor make sense?"

If it does not, it might be time to start looking a little deeper into the employees you trust with your accounts.