© 2013 Office of the Minnesota State Auditor The Fraud Triangle Nancy Bode, Assistant Legal Counsel Office of the Minnesota State Auditor NASACT Middle.

© 2013 Office of the Minnesota State Auditor

The Fraud Triangle

Nancy Bode, Assistant Legal CounselOffice of the Minnesota State Auditor

NASACT Middle Management Conference

April 18, 2013


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


OSA Divisions

Audit Practice Pension Tax Increment Financing Government Information Legal/Special Investigations


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.


The Fraud Triangle

Motive/Incentive (Financial Pressure)

Rationalization Opportunity


Fraud Triangle: Motive/Incentive

Gambling Medical issues Spouse’s layoff or

anticipated layoffs Declining financial

condition


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


Fraud Triangle: Opportunity Cash Lack of segregation of

duties Inadequate internal

controls Management override Poor environment

This is the one that can be controlled.

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


Reduce Risk of Fraud:Tools of Protection

Reduce “opportunity” with:

Segregation of Duties Internal Control

Procedures Environment


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”

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


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



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


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

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



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


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


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

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 (http://www.acfe.com/rttn-highlights.aspx)© 2013 Office of the

Minnesota State Auditor


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


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


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”

Problem: Unauthorized Payments Public funds used for personal

purchases Credit card Petty cash Expense reimbursements Electronic fund transfers Phantom vendors



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 . . .


Problem: Misuse of Public Property/Time

Personal use of public equipment or work hours

Solution: Written Policies and Procedures

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



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


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


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

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



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

Suspect Fraud?

Minn. Stat. § 609.456 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 609.456 reporter is private data (Minn. Stat. § 6.715, subd. 2)

Reporting form is on OSA website


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?


Suspect Fraud?Other Considerations

In addition to Minn. Stat. § 609.456 reporting requirement: Criminal matter? Disciplinary action? Collect on bond/insurance? Get advice



Number of 609.456 Reports to OSA

609 Reports

2007 34 2008 64 2009 54 2010 68 2011 73 2012 81


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?


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)


Website:www.auditor.state.mn.us

Statements of Position Investigative Reports Internal Control Letters E-Updates (Avoiding Pitfalls) 609.456 Reporting Forms And More . . .


Contact Information

Nancy Bode525 Park Street, Suite 500

St. Paul, MN 55103(651) 297-5853

[email protected]

NOTE: The OSA does not provide legal advice or representation to local governments.

© 2013 Office of the Minnesota State Auditor The Fraud Triangle Nancy Bode, Assistant Legal Counsel Office of the Minnesota State Auditor NASACT Middle.

Documents

minnesota state auditor

minnesota state auditor

central office central

main office main office

central office solution

voidsrefunds slide

self check check

employee check