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 (
© 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