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In episode 105 of Fraud Talk, author Stephen Griffin speaks with Mandy Moody, CFE, communications manager at the ACFE, to share an illuminating story about how his professional and personal lives changed after discovering fraud and corruption in a youth sports company.

In this excerpt from the full transcript, Mandy and Steve discuss the red flags that initially alerted Steve to potential fraud, including one harrowing moment in the board room, which ultimately led to a robust investigation. Download the full transcript of “Case Study: Fraud and Corruption in Youth Sports” in PDF form or listen to the episode at the bottom of this post.

Mandy: So tell me, you’re investing in a company, so where did you… I guess looking back, you can see the red flags, but when were you thinking something isn’t right?

Steve: Even writing the book, it’s interesting. At the time of putting the book together I had 20/20 hindsight, and so I had to be careful. I wanted to write the book in a way that, if a fraud examiner or an internal auditor or a college student is reading it, I wanted them to be walking with me along that journey and not make the red flag so obvious along the way, but I wanted them to be there so that they could look back and go, “Oh, yeah, that should have been a moment in time where questions were raised.” In hindsight, pretty early on. I did a little lecture thing, virtual lecture, with the internal audit, the Institute of Internal Audit, a couple of weeks ago, and I grasped it for everybody, which is interesting.

I would say, even some of the early first meetings with management, their communication style, it was a little bit inconsistent. One meeting you’d leave feeling like they were really excited to have somebody from the outside or new investors getting involved and rolling their sleeves up and adding value. Then there would be this unusual gap in time and you’d think, “Gah, that’s weird. Why aren’t they responding as quickly to next steps that I would have thought they normally would?”

There were a few initiatives that the company had in process that we thought just strategically didn’t make any sense, and instead of, again, looking at those as signs of either poor decision-making or poor strategic thinking or something potentially nefarious, we just dismissed them as, “Those are bad ideas, and you know what, those will be add backs with EBITDA when we value the business. Even in the pre-acquisition phase, there were things that I would say concerned us, but then there were things that outweighed those. The company had a functioning board of directors and had a few outside board members, who, while we didn’t know them personally, we got to know them and felt like those guys were providing … they seemed like the kind of guys who would provide good corporate governance. We felt better about that.

We knew there was an existing bank relationship and that they appeared to have a good relationship with the lender. We felt there was a little bit of third-party validation there. The company had never been subject to a financial statement audit, but they had been subject to a review. Again, we felt like there’s an outside CPA firm, who’s not issuing an opinion, but they’re under the hood. We used some third-party diligence providers for financial diligence and legal diligence. Those types of things helped us get past those early red flags.

However, I would say within a month or two post-closing, it was really a couple of things that happened leading up to and at our first board meetings — that early — that were real red flags. While these things may not sound that interesting to a general consumer audience, I think they’re probably interesting to people who work in our fields.

One was, we started to see gaps in systems … where representations were made that systems were seamlessly integrated. We quickly realized that wasn’t the case, that they were disparate general ledger systems. Consolidating entities was an extremely manual exercise. We had been under the impression that that was not the case. Now you’re thinking, “Gah, why would you represent when that isn’t the case?”

There’s a lot of them, but I’ll get to that. That was one that concerned me immediately. The second was that we had offered, we had provided a template as a newly reconstituted board. We had provided a template to the management team of, “This is what we would expect to see on a monthly basis.” We offered to help populate that template and even suggested, “Hey, let’s try to get this delivered to all board members, three to five days in advance of the first board meeting so we really have time to dig in and be fully informed and engaged at the physical board meeting.”

While it sounds incredibly qualitative, the days leading up to the board meeting, we didn’t receive anything. When they’re proceeding the board package the night before the board meeting, it didn’t even resemble our template. At that board meeting, we realized we weren’t provided a full set of financial statements, particularly, the cash flow statement, which for me, is critical. At that board meeting, our sense was that maybe this management team’s a little bit overwhelmed, and on the fly, we hoped that was the case. On the fly, we suggested as a board, let’s clean up this organizational structure a little bit and take finance and accounting away from the flat structure that it had at that moment and give it to a board member.

In that case, it was me. I was really the only CPA or former CPA on the board. It was like a moment out of a case study — your management may be up to no good. The CEO pushed back aggressively. “Absolutely not. Finance and accounting has to report directly to him.” It was glaringly obvious that they didn’t want anybody to have unfettered access. In my opinion, they didn’t want anybody to have unfettered access to the books and records of the company.

Mandy: Did this worry you?

Steve: Mandy, when I say, did it worry me, I even mentioned it — not to keep going back to the book — but I call it out in the book. There was this very uncomfortable moment in the board meeting where the most inherently senior and respected member of the board looked at the CEO and said, “Hey, we’re going to do this. You got too much on your plate. You need to focus on maybe this dev and ops and let finance and financial reporting slide over here.”

Because a big part of the investment thesis was that we were going to be growing this business both organically and through acquisitions. And if we couldn’t have accurate, real-time reporting, that was going to slow that expansion strategy.

When the CEO pushed back, I’ll never forget my fellow board member was across from me. He just was staring at me, making eye contact, like, “Are we thinking the same thing?” It was that palpable in the room. After the board meeting, we actually, three of us as board members, met immediately afterwards in a separate office and all shared the same feeling that that did not feel right. Something is wrong.