FRAUD AND EMBEZZLEMENT AT THE LOCAL SCHOOL LEVEL

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1 FRAUD AND EMBEZZLEMENT AT THE LOCAL SCHOOL LEVEL Karen Lusk Smith, CSFO February 26, 2013 Disclaimer: The opinions expressed in this presentation are those of Karen Lusk Smith and are not meant to be a legal interpretation of the law. The material included in this presentation is dated as of February 26, 2013 and is subject to change. Official interpretation of particular questions or situations should be obtained through the board s legal council, the Alabama Attorney General s office or the Examiners of Public Accounts. HEADLINES Former school official pleads guilty Published: Friday, February 25, 2011, 6:25 PM Updated: Friday, February 25, 2011, 6:28 PM OZARK, Ala. A former chief financial officer for has admitted stealing money from the south Alabama district's school board. South Alabama employee diverted $30,000 into personal account Published: Tuesday, June 08, 2010, 7:01 AM MOBILE, Ala. The University of South Alabama last year fired an employee who diverted more than $30,000 in university related funds into a personal account, according to a state auditor s report. Jackson County employee accused of embezzling $125,000 Published: Thursday, November 12, 2009, 7:01 AM FRAUD/EMBEZZLEMENT Is a crime of opportunity involving a trusted person Rule 10 percent of people will never steal 10 percent will always steal 80 percent will steal given the right opportunity, motivation, or justification Usually the last person that you would expect the volunteer that is highly motivated, valued and trusted Someone facing severe financial or personal pressures, given the opportunity, may rationalize that borrowing isn t really a criminal act Especially since they have every intention of pay the money back later FRAUD Definition Fraud is an intentional deception made for personal gain or to damage another individual or business; the related adjective is fraudulent. Distinguished from errors or omissions or an infrequent failure to follow procedures or other noncompliance. Fraud is deceit, trickery, sharp practice, or breach of confidence. Perpetrated for profit or to gain some unfair or dishonest advantage. Embezzlement is the act of dishonestly appropriating or secreting assets by one or more individuals to whom such assets have been entrusted. 1

2 FRAUD Requirements MOTIVATION situational pressures OPPORTUNITY weakness in internal controls PERSONAL CHARACTERISTICS willingness to commit fraud INTERNAL CONTROLS The objective to reducing the likelihood of fraud is to improve and strengthen internal controls on cash management and bookkeeping by establishing and enforcing policies and procedures and utilizing systems and processes to decrease risk. Control environment Risk assessment Control activities Information and communication Monitoring INTERNAL CONTROLS Control Environment: Control consciousness of a system Competent people understand their responsibilities Committed to following policies and procedures Code of ethics and standard of conduct Management is responsible for setting the tone INTERNAL CONTROLS Risk Assessment: Central theme of internal control Identification and analysis of risks Management s responsibility proactive Failure to manage can result in lack of confidence by all stakeholders INTERNAL CONTROLS Control Activities: Actions supported by policy and procedures, that when carried out in a timely manner, reduce risk Include approvals, authorizations, verifications, reconciliations, reviews of performance, security of assets, segregation of duties and controls over information systems. Unusual items investigated and appropriate action taken No rubber stamps, no blank signed forms Compare budget to actual Current to prior period comparisons Follow up on unexpected results or unusual items INTERNAL CONTROLS Information and Communication: Reliable information in a form and timeframe that is useful Formal or informal Input and feedback 2

3 INTERNAL CONTROLS Monitoring: The assessment of internal control performance over time On going monitoring of activities Separate evaluations of internal controls self assessments and internal audits Spot check transactions FRAUD INCREASE RISK Segregation of duties break down Segregation of duties is not practical Supervisory review is slack or absent Controls and standard procedures are not in place Transactions which are exceptions to the rule DETECTING FRAUD Financial reports are consistently late Bookkeeper turns in sloppy work Negative balances Bookkeeper not consistent with coding/lumping everything as donations DETECTING FRAUD Backing into the ticket forms Teacher receipt books missing Master receipts out of sequence on teacher receipt book due to second master receipt book DETECTING FRAUD Frequent checks written to the bookkeeper Corrective actions ignored Large dollar invoices paid against small dollar amount purchase orders Invoices dated prior to purchase orders Activity balances are not consistent from year to year CASE STUDY #1 FACTS Basketball Coach DEMANDS an Activity Report Coach reports to School Principal that there are NO gates receipts reported for five games Principal reports to Superintendent Superintendent instructs Principal to check with bookkeeper and find out facts Bookkeeper states that she simply posted gate receipts to incorrect account 3

4 FACTS CSFO questioned and reviewed correcting journal entry Funds were reclassified with debits to expenditure accounts in various activities and credits to admission accounts in the Basketball activity Bookkeeper made up the journal entry because she did not know what happened to the money FACTS Principal and Assistant Principal admitted that funds collected as gate receipts were not counted prior to being left with the bookkeeper Both indicated that bookkeeper always took care of that Neither had any idea how much petty cash or gate change cash was reflected in the monthly financial report Principal had signed each month SURPRISE!!! BOOKKEEPER RESIGNS CSFO, Central Office Bookkeeper, Examiner with State Department of Examiners begins investigation Met with Principal and Assistant Principal Reviewed work piled in the bookkeepers office Found loose change and cash not receipted Invoice for over $25,0000 from previous year yearbook vendor found in desk drawer never recorded Only 8 purchase orders properly issued in software for the entire fiscal year Checks and records indicated payments against 272 purchase orders Numerous past due account statements found from vendors Reviewed schedules for all sports activities Gate receipts were accounted for and reconciled Basketball schedule reflected four cancelled games Score books were pulled games were played as scheduled No gate receipts were recorded Athletic ticket sales were reconciled, but bookkeeper kept and issued tickets and prepared reconciliation reports No reports for cancelled games 4

5 Request for activity reports were ignored or denied Yearbook activity held numerous fundraising activities but was a year behind in vendor payments False entries were found to expenditure accounts to offset amounts recorded as revenue in basketball accounts Cash collected from concession sales were not deposited into school accounts. False entries were made to reclassify and move revenues from Pep Club and Spanish Club to Concession account False entry was made to move Concession expenditure into the Senior Class activity to cover concessions for resale Funds collected by FFA Director for fruit sales were posted into the basketball account in lieu of gate receipts Checks were written to obtain gate change to be used at Athletic events Funds were not re deposited additional checks were written Principal approved each time without verifying that the funds were actually there Principal received telephone call from collection agency for Sam s Discover card Principal was the Personal Guarantor on a card issued to the bookkeeper for $7, RESOLUTION Employee plead guilty to First Degree Theft of Property Received a term of five years probation Paid restitution of $28, to the Board CASE STUDY # 2 FACTS Principal turned in invoices to bogus companies Approved invoice to wife for workshop training at school workshop never took place Checks written to wife no documentation for why Wrote checks to relatives for cleaning school Wrote check to himself for carnival door prizesno documentation to support RED FLAGS!! Principal started staying home from work Avoided bookkeeper and stopped attending staff meetings as well as Board meetings 5

6 Audit Process Researched bank statements and found checks written to the Principal and his wife totaling $16, Checks written to relatives for $1, No invoices, receipts or documentation to support any of the expenditures Further research showed deposits to personal account for the $16, RESOLUTION Board filed claim against employee bond received $10, CASE STUDY #3 FACTS Cash embezzlement from sale of athletic tickets Private checking account set up for Athletic Director Contributions placed in checking account Unauthorized expenditures as well as personal expenditures paid from account Unapproved loan recorded as contribution in the books WARNING SIGNS Examiners cited school for continued deficit balances Previous audits, corrective actions no improvements made Lack of communication with Central Office Disregard of recommendations from Central Office Lack of organization to the point of complete chaos Board and Superintendent required immediate control over school s finances Detailed cash audit required Internal audit to determine extent of deficit and causes Discovery of possible legal and criminal issues Consulted legal counsel recommended forensic audit Cash sale of tickets never deposited School continued to issue purchase orders for the deficit activities and let other activities go into deficit balances Purchases made without purchase orders Unauthorized purchases (often personal) Open purchase orders were not being posted in the system to reflect encumbrances and show accurate activity balances 6

7 Missing documentation invoices, purchase orders Inadequate accountability of ticket sales no controls or reconciliations RESOLUTION All employees involved either retired, resigned or were terminated DA, nor the Ethics Commission, filed charges CASE STUDY #4 FACTS New CSFO came into the system Red flags went off when bank reconciliations were not performed in a timely manner Internal audit started and found discrepancies Department of Examiners called in for a special examination Cash receipts turned into the bookkeeper were not deposited on numerous occasions during the examination period. This resulted in deficit balances in 21 of 65 athletic, academic and club accounts All cash receipts should be recorded in the proper activity and deposited in the bank account. Money received from athletic gates and football parking fees were originally documented on Ticket Reconciliation forms and given (both money and forms) to the bookkeeper for processing. The bookkeeper did not issue receipts or record revenue for many athletic events or parking fees. The number of games played and attendance were determined by reviewing athletic schedules and interviewing coaches. All athletic gate receipts and parking fees should be properly receipted and deposited. Concessions were sold at athletic events. Two concession stands were operated during football season and one during the other seasons. Monies collected were documented on Receipt Sheets. These sheets and the money were turned into the bookkeeper. Revenues were missing from one or both stands throughout the examination period. All concession sales should be properly receipted and deposited. 7

8 Ticket Reconciliation Forms(for athletic events) and Receipt Sheets (for concessions) were missing, altered and were falsified for various athletic events. Ticket Reconciliation Forms and Receipt Sheets should be retained for review in the original, unaltered form. Checks were routinely issued for change cash to make change at the athletic games and concessions. This change cash was to be re deposited (at the latest) at the end of the sports season but was held out for lengthy time periods. Checks were cashed over the examination period and were never re deposited. Change cash should be promptly re deposited into the school s accounts after each event. Invoices were routinely paid from the wrong activity accounts. For example, the band account might pay for the concessions for an athletic event. Funds were transferred from activities that had money to activities that did not have money without proper authorization. Reports documenting account revenues and expenditures were not being issued to the principal or teacher by the bookkeeper. Account balances were communicated verbally, by e mail, or by adding machine tape. Care should be taken to properly pay invoices from the appropriate activity account. Transfers among activities should be approved by the sponsor/teacher and principal. Monthly reports should be issued to the principal and teachers showing account information and details. Resolution Employee was terminated Charges against employee totaling $157, Meeting with Chief Examiner employee failed to show just cause as to why the amount should not be repaid Report certified to the Attorney General/District Attorney for collection Case Study #5 FACTS Enrollment down Bookkeeper was working for three schools Had degree in accounting Audit recommendations were numerous from prior year New CSFO came in and non renewed bookkeeper due to performance and low enrollment Principal reported tuition missing at her school CSFO researched teacher receipt books as well as master receipt book. FACTS Realized there were two different master receipt books Checks were receipted in one and cash in another Cash never hit the bank account Report to the Board and to the State under Fiscal Accountability Law State Examiners brought in to audit all schools Examiners scheduled several meetings with bookkeeper Examiners wrote report and turned over to District Attorney Special Agent came in and preformed examination 8

9 The Board has policies and procedures in place which require that all moneys collected shall be receipted, accounted for, and directed without delay in proper location of deposit. The following discrepancies were noted: Tuition for out of district students, totaling $29, was collected and not recorded into the accounting system or deposited into each school s respective bank account. Fines imposed on the high school football team by the Alabama High School Athletic Association and collected from individual players were not properly entered into the accounting system or deposited into the high school s bank account. These amounts totaled $1, Funds collected for field trips, totaling $2, were not properly entered into the accounting system or deposited into the school s bank account. Locker fees were collected by a teacher and only a partial amount was entered into the accounting system and deposited in the bank account. Recommendation: The Board should ensure that policies and procedures regarding receipts and deposits are being followed An adequate system of internal controls require that all master and teacher receipts be retained and safeguarded. A master book and numerous teacher receipt books were not properly retained for review purposes. All receipt books should be retained for review purposes. An adequate system of internal controls requires that only one master receipt book be used to receipt funds. The former bookkeeper was utilizing two different master receipt books at one time. The funds collected and recorded in one of the receipt books were not deposited into the respective bank accounts and were not recorded in the accounting software. The Board should take steps to ensure that only one master receipt book is used at each school receipting. An adequate system of internal controls requires that a list of out of district students to be maintained which includes the students name, tuition amount, amounts paid, and amounts owed. The Board could not provide a detailed list of all out ofdistrict students. Enrollment forms for Non Resident Tuition Students and the accompanying Release form, along with teacher receipts and master receipts, were reviewed to determine the number of out of district students. The Board should take steps to maintain proper records on out of district students. An adequate system of internal controls identifies financial transactions by separate activities. The former bookkeeper did not properly record revenues and expenditures by the appropriate activity. This resulted in the activities not showing a true representation of the actual transactions. The Board should take steps to ensure that procedures are in place to properly record financial transactions. Resolution Charges against employee of $36, Meeting with Chief Examiner employee failed to show just cause as to why the amount should not be repaid 30 days jail time 3 years probation Restitution for the full amount 9

10 FOUR ELEMENTS MUST EXIST Opportunity Low chance of getting caught Rationalization in the fraudsters mind Justification that results from the rationalization EVENTUALLY THEY WILL GET CAUGHT!! THINGS TO KNOW LEGAL AND REGULATORY REQUIREMENTS Consult Legal Counsel to determine if legal or criminal issues exist Public information issues Personnel issues Ethics Reporting Requirements School Fiscal Accountability Act Reporting Requirements THINGS TO CHECK AS A PRINCIPAL MONTHLY REVIEW : CASH BALANCES ACTIVITY BALANCES CHANGE CASH OTHER RECONCILABLE ITEMS DEFICIT BALANCES EXPLANATIONS THINGS TO CHECK AS A PRINCIPAL THINGS TO CHECK AS A PRINCIPAL Always sign financial forms never use a signature stamp Always receive bank statement unopened, review the balance, and scan through the cancelled checks and deposits. Look for unfamiliar vendors, suspicious signatures, or suspicious endorsements. Randomly ask questions when reviewing the bank statement, ask to review documentation for canceled checks. Ask questions about items that you sign. Keep your ears open the most common method of finding fraud is by a tip. Look for trends Are you using a vendor more than in the past? Is your bank balance going down? Do the profits from the bookstore sales or fundraisers seem smaller than in the past? The culture of an organization starts at the top if you demonstrate ethical behavior and place importance on financial matters, those who report to you will reflect your attitude. All events that take cash, where a fee is charged, such as athletic events, dances, or parking fundraisers, should have two employees with the cash at all times. Prenumbered tickets should be used whenever possible. Ticket stubs should be reconciled to cash received reconciliation forms. Sponsors should review reports and understand receipts, disbursements and transfers in/out on a monthly basis. Any discrepancies should be reported immediately. When reviewing payroll look for OT and excessive hours. When you feel uncomfortable call your CSFO. 10

11 TRANSPARENCY IS CRITICAL Audit Investigates Middle School Cheer Team's Finances. WBIR TV Knoxville, TN (8/30, Welsch) reported on its website, "Knox County School records show the Bearden Middle School cheer team took in more than $35,000 between 2009 and 2011" for things such as "fundraisers, parents payments for clothing orders, and fees collected for camps." Eventually, "concerned parents sparked an audit," and the district was able to account for the majority of the funds, but roughly $800 "can't be traced," although auditors say it was spent on things like "food for the team" and "gifts for the squad." Some parents, however, dispute the finding and say the amount of money that is unaccounted for is higher. WBIR noted that an audit by the State of Tennessee Comptroller in 2009 "recommended changes to the way teachers and coaches collect money from students and purchase orders are handled." TRANSPARENCY IS CRITICAL Cash raised in prep player s name may be missing 9:12 AM, Sep 12, 2011 FENNVILLE,Mich. (AP) Authorities are investigating claims that thousands of dollars are missing from T shirt sales to benefit a foundation that was created to honor a Michigan basketball player who died in March. TRANSPARENCY IS CRITICAL The Allegan County sheriff's department says its investigation could be completed in a few days. More than 1,000 T shirts were sold with assurances that money would go to Wes Leonard s family or the Wes Leonard Heart Team foundation. Marie Flores of the foundation says the shirts were not sold by the foundation itself. She says the allegations make her sick. The 16 year old Leonard died moments after hitting a winning shot for Fennville High School last season. AP TRANSPARENCY IS CRITICAL Transparency is critical to maintain confidence to all stakeholders involved. It implies openness, communication and accountability. Transparent procedures include: Financial committee Monthly meetings to review and discuss financial information Financial disclosure statements Budgetary reviews open meetings Audits Principal Perspective Petty cash (if high volumes are processed) Cash receipts ( continuing ed programs, gifts, donations, special events, bookstore, athletic programs, performances, etc.) Consultant Payments and Other Payments for Services Travel expenditures Scholarships Payments to non vendors Equipment delivered directly to department Sole Source Equipment moved off location Software licensing issues Grants (meeting terms, not overspending) FROM THE CENTRAL OFFICE PERSPECTIVE MONTHLY CHECKLIST FOR IMPORTING LOCAL SCHOOL FINANCIALS CONTINUOUS PRESENCE/MONITORING IN SCHOOLS REQUIRE WRITTEN AND PRECISE CORRECTIVE ACTIONS/DATES FOLLOW UP REVIEWS CONSEQUENCES FOR NONCOMPLIANCE CONSIDER INTERNAL AUDIT POSITION 11

12 FROM THE CENTRAL OFFICE PERSPECTIVE ALLOW SCHOOLS TO FOCUS ON EDUCATION TECHNICAL ASSISTANCE AND TRAINING OF STAFF Monthly bookkeeper meetings Credentials for bookkeepers LSFM Certificate Background in LSA if possible Continuous professional development An effective control system provides reasonable, but not absolute assurance for the safeguarding of assets, the reliability of financial information, and the compliance with laws and regulations. Reasonable assurance is a concept that acknowledges that control systems should be developed and implemented to provide management with the appropriate balance between risk of a certain business practice and the level of control required to ensure objectives are met. The cost of a control should not exceed the benefit to be derived from it. It is unique to each individual situation. Ethics Violations Key Factors to consider: Coaches did not know they were doing anything wrong when they accepted the gifts They did what they had always done A long time tradition of booster clubs giving gifts No one thought that they were violating the law Ethics Violations Every penny raised by a booster club is important Athletic clubs rely heavily on financial support In public s mind the safeguarding of these funds are the responsibility of the athletic department In everyone's best interest to recognize that booster club have violations and thefts do occur Internal controls should be in place Consider background checks for booster club member filling a fiduciary duty Mandatory annual training Consider purchasing additional insurance REFERENCES OPPAGA and the Auditor General, Best Practices and Indicators Muns, Edward D., CPA, Jefferson County Public Schools, Louisville, Kentucky, Fraud Detection in Public Schools McMannon, Cynthia, CMAA, Assistant Executive Director for Finance and Human Resources at the Arizona Interscholastic Association, Watching Every Penny Jones, Ronald L., Chief Examiner, Department of Examiners of Public Accounts, Special Report 12

13 Karen Lusk Smith, CPA, CGFO Chief School Financial Officer Mountain Brook City Schools