Detecting Fraud the Old-School Way: How a Facility Tour Led to a Break in a Routine Audit

GUEST BLOGGER

Mary Breslin, CFE, CIA
President, Empower Audit

I recently returned from Jordan where I conducted a data analytics training for an internal audit banking group. As is often the case when learning to use data analytics within internal audit, people wanted to skip right to finding fraud. I wish it were that easy. While I sometimes feel like I could never conduct a fraud investigation without my data analytics tools, I've learned that I can never rely solely on analytics. We must continue to be students of the business and hone traditional methods while enhancing them with analytics. 

Many of my cases have been discovered and initiated by simply walking around and talking to people. One example is a recently settled federal case. Several years ago I was in Belgium at a factory location of an American company I worked for. I asked for a tour of the facility even though I knew most of my time would be spent with accounting records and documents. I wanted to understand the business. During my tour I spotted a large crate ready to be shipped. The core product was made in the U.S. and finished in Belgium before delivery to the customer. The crate was stamped “Made in the USA” in six-inch letters. Directly beneath that stamp was another that read “Ship to the Islamic Republic of Iran.” I did a double take. Iran was (and is) an embargoed nation — it was illegal to sell goods of any kind to Iran.

I assumed this was a lack of training, and the Belgian team wasn’t aware of the restrictions, and I proceeded as such. My team requested all sales to that customer, as well as to any other countries that were embargoed at the time for the prior 18 months. Much to my dismay, it was a long list of sales. 

In conversations with the general manager I reviewed the Code of Conduct and Handbook, where it explicitly forbade sales to those countries. I then reported the issue to the executive team and went about preparing the information that would be needed for counsel to self-report the issues to the necessary regulatory agencies. The situation was under control, right? But of course before my team and I went home, I added the location to our follow-up action plan for internal audit.

Three months later I returned to Belgium for an unannounced visit to the factory. Who stops by to see me? The general manager. She hands me a manila folder stuffed with evidence of the many sales to embargoed countries that had occurred since my departure just 90 days earlier, when it had seemed the executive team was clear on the problem and ready to make things right. As I flipped through the folder's contents I saw document after document that contained the written approval via email of every one of those sales by the COO himself. I was shocked. I immediately reported back to the executive team and was surprisingly met with the response, “We need those sales.” In their quest for revenue, executive management chose to break the law and go against legal counsel and internal audit’s recommendations. 

In the following week, our inability to agree on the handling of the issue resulted in my termination — as well as the termination of my entire team. The issue was then reported to the Securities and Exchange Commission (SEC) and appropriate regulatory agencies and a federal investigation ensued. In October of this year the case finally settled in court. The company pleaded guilty and paid a large fine. The executive management team has since been replaced.

If I had not walked the facility that day, the issue may have never been identified.  The likelihood of finding those illegal sales buried in all the sales for the year was minimal using normal audit techniques unless I knew to look specifically for that issue. While analytical tools can be invaluable, they should not replace understanding the business and the traditional methods — especially simply talking to people and touring a facility.

Hunting the Big Cats of Fraud

SPECIAL TO THE WEB

Robert Tie, CFE, CFP

Part 1 of 2: HealthSouth Corp.

In the economic crime jungle, is one predator more rapacious than all others? If so, who is king of the fraud beasts?

Consider this. A staggering $1 million was the median loss for the 133 financial statement fraud cases tallied in the ACFE's 2014 Report to the Nations on Occupational Fraud and Abuse. A far smaller amount — $145,000 — was the median loss for all 1,483 fraud cases the Report covered.

Clearly, the executive who falsifies financial statements is king of the fraud beasts. Alton Sizemore, CFE, CPA, knows the species well and has hunted down several of its members. Sizemore, a former FBI special agent, is owner of Alton Sizemore and Associates and a consultant with Forensic Strategic Solutions — a national financial investigation firm with offices in Alabama and North Carolina. Over a career spanning more than 30 years — 25 of them with the FBI — he has investigated numerous financial statement frauds.

By interviewing the executives who committed those crimes he learned to recognize and understand their fraud motives, opportunities and rationalizations. Sizemore also became proficient in trend and ratio analysis of financial statements to detect potential signs of falsification. And by observing those entries most frequently falsified, he developed a strong sense of those supporting documents to scrutinize. This article, in two parts, discusses these investigative principles and techniques in relation to two major financial statement frauds.

Sizemore managed the 2003 FBI investigation of a $2.9 billion financial statement fraud at HealthSouth Corporation in Birmingham, Alabama. That probe led to the first prosecution of a CEO and a CFO under the Sarbanes-Oxley Act (SOX) of 2002 for fraudulently misstating information on financial statements they had certified were accurate. The second case is currently in federal criminal court in Manhattan and concerns the alleged $250 million financial statement fraud at the now-defunct law firm Dewey & LeBoeuf LLP. It will be discussed in part 2.

HEALTHSOUTH CORPORATION

In an earlier Fraud Magazine Special to the Web Sizemore described the case, the culprits and the investigative techniques the FBI used to uncover documentary evidence of this fraud.

HealthSouth's book-cooking scheme persisted for 17 years before its discovery led to the prosecution and conviction of the 21 senior managers who conspired to perpetrate and hide it. How could the auditors not detect such a massive fraud? Through their repeated failure to look behind the financial statements to see whether they were accurate.

"For example," Sizemore says, "the company's balance sheet showed $300 million was in clearing between one bank and another. But the money didn't exist. The auditors never found out, though. They neglected to check again later to see if that money actually had cleared."

At HealthSouth, the fraudsters' motivation for misstating the financials was to keep stockholders from learning about slumping profits. Their opportunity was the external auditors' ongoing failure to stand up to the HealthSouth CFO who intimidated them. And their rationalization was that eventually the company would generate enough actual profit to make up for the phony revenue planted in the current financials. That fantasy never materialized, though, and the whole scheme unraveled when persistent shareholder pressure led to an investigation.

Both the U.S. Department of Justice (DOJ) and the Securities and Exchange Commission (SEC) went after the fraudsters at HealthSouth. Its then-CFO William Owens pleaded guilty and agreed to cooperate with investigators in exchange for a lighter sentence. He wore a tiny recording device in his necktie when he met with CEO Richard Scrushy, whom he had told the FBI was the leader of the fraud.

Read more about the HealthSouth investigation in the full Special to the Web article on Fraud-Magazine.com.

Director Uses Experience to Challenge Business as Usual

MEMBER PROFILE

LaToya Lacey, CFE, CPA,
Global Audit & Risk Director, Diageo
Norwalk, Conn. 

LaToya Lacey, CFE, CPA, Global Audit & Risk Director at Diageo has climbed her way to a position that leverages all of her learned and innate skills: delivering internal audits, communication, leadership and the training and education received from earning and maintaining the Certified Fraud Examiner (CFE) credential. "I was working in finance training at Kraft Foods when I obtained my CFE," Lacey said. "At the time, a position in investigations was not available, so I stayed close to the industry and proudly displayed my CFE plaque at my desk. Over a year later, this very large plaque gained the attention of Kraft's CFO who wanted to know why I was in training instead of investigations. A few months later, I moved into a role within investigations. I believe this experience speaks to the value of this credential and being prepared to take advantage of potential opportunities."

How have you seen your roles and duties change as your career progressed?

Over the years, my responsibilities have increased, and I have developed a broader knowledge of business outside of the U.S. However, there are two very important things I look for in every position: I must be challenged in a way that positively contributes to my personal and professional development, and I must be empowered to challenge "business as usual" to increase efficiency and productivity and strengthen the control environment. Those have been the consistent factors that have ensured my continuous career progression.

How did you become passionate about fighting fraud? 

Years ago, I discovered what appeared to be fraudulent activity during an internal audit that I turned over to our investigations department. The investigation led to two individuals leaving the business. This is what sparked my interest. I became passionate about fighting fraud when I realized how often fraud occurs and how business is impacted. I spent a year working in investigations, and although I'm not currently in a position where I investigate fraud, the knowledge I gained from that experience has changed the way I conduct audits and how I think about controls.

What is a memorable case or project that you have worked on? 

The most memorable case was a kickback scheme we became aware of due to an anonymous call. Initially, we thought this was an isolated incident, but as we dug deeper into electronically stored information and conducted interviews, we determined the issue was more widespread and involved various levels within the company, including management.

What is your personal motto? 

I'm a lifetime member of the National Association of Black Accountants, Inc. (NABA) and currently hold the position of Immediate Past President of the Chicago Chapter. NABA has the motto of: "Lifting As We Climb" and I have adopted this as my personal motto. With this in mind, I have helped many college students obtain academic scholarships through my role in NABA and have served as a mentor to many young professionals. As I have benefited from others sharing their knowledge with me, I will continue to give back by doing the same.

Read LaToya's full profile in the Career Center on ACFE.com.
 

Are You Being Swindled and Don’t Even Know It? 

GUEST BLOGGER

Misty Carter, CFE, CIA
ACFE Research Specialist

If you were to ask business owners how many times they thought one of their vendors ”got one over” on them, the majority would probably say something like, “I trust my vendors. They would never steal from me. I have used them for years and never had any problems.” In a perfect world, that might be true, but unfortunately, we live in the real world and that is just not realistic. I mean, let’s face it — even with the best controls in place, you cannot eliminate vendor fraud. Consider the vendor fraud that occurred against one of the nation’s largest consumer electronics companies, Best Buy. This company, duped by several vendors, lost close to $42 million with the help of a company employee. This employee colluded with several vendors to defraud the company by approving fraudulent online bids. The vendors would bid low and then charge high after being awarded the contract. In fact, over the course of three years, one vendor submitted bids for $24 million in parts, but ended up charging the company $66 million. In exchange for his help in this scheme, the company employee was treated to lavish vacations, given envelopes full of money weekly or bi-weekly, and was even extended a $300,000 “loan” to help his father start a business. Sounds like the good life, right? Well, maybe until you are caught. And yes, this scheme finally caught up with them. 

Many might ask how these vendors were able to steal so much money from this large, publicly traded company for so long before getting caught. According to the defendants (the vendors), it was the company’s fault. They blamed company executives for “turning a blind eye” and having weak internal controls. In other words, it was the company’s fault that they were defrauded. What do you think? Could this fraud have been detected earlier or even prevented if anti-fraud measures had been in place? Based on the outcome, it certainly appears that something was lacking. It’s too late to prevent this fraud, but fortunately for other business owners, the ACFE has a new self-study course to help management in its fraud prevention and detection efforts related to vendor fraud.

The new online self-study course, Auditing for Vendor Fraud, is a great “go-to” guide for anyone interested in learning about vendor fraud and how to conduct effective vendor audits. This course walks you through the process of preparing for and conducting vendor audits, both internally and externally. It offers guidance on what to include in right-to-audit clauses for vendor contracts and is designed to help you learn about various types of vendor fraud schemes and red flags to identify these schemes as you perform vendor audits. 

Read more about the new course at ACFE.com.

Maintaining Strong Ethical Culture is All in a Day's Work

MEMBER PROFILE

Dora Gomez, CFE, Global Fraud Officer, AXA Tech 
Jersey City, N.J.

Dora Gomez, CFE, a native New Yorker, began an early passion for travel, thanks to her parents, and was even a DJ for four years during college. But it was Gomez's passion for fighting fraud that led her to her current position as Global Fraud Officer at AXA Tech.

Where were you born and raised?

I was born in Brooklyn, New York, a first-generation American to Ecuadorian parents. I grew up in a multi-cultural neighborhood, which taught me to build friendships with people of other ethnicities. I also learned to love an array of international foods, which I appreciate to this day. At heart, I am still a true New Yorker.   

How did you become passionate about fighting fraud?

I think I always had the "bug" inside of me to fight fraud. When I worked in public accounting and internal audit I was exposed some cases of fraud and learned how to spot the signs of fraud. It’s vital for the company to have strong ethical principles where employees feel empowered to speak up when something seems wrong. It’s not just about the company’s reputation, it also about working for a company we feel proud to be a part of.

What is your personal motto?

Take risks in life, be confident, and don’t underestimate yourself. I learned that during an expat assignment in Paris. Not only was it an eye opener to learn how the company functioned at the headquarter level, but I also learned about the French culture and those of other European countries. I overcame obstacles (not speaking French, making new friends, working with new colleagues, etc.) but tackled them and learned from that experience. The only constants that I brought with me were my two small dogs … that also learned to bark in French!

What do you consider your greatest achievement to date?

I don’t know if I can actually name one great achievement. I think I did pretty well in my career and personal life for a middle class ‘kid’ from Brooklyn, NY. Let’s face it, being a minority and a woman has its challenges and tackling them requires persistence and determination. I have overcome many obstacles in life (both personal and work related), and I am proud and happy with the person I am today.

Read Gomez's full profile on ACFE.com in the Career Center.