Many corporations are susceptible to a fraud scam so arcane that most fraud examiners know nothing about it. 

Promotional funds fraud is the embezzlement of hundreds of millions of dollars annually from the promotional budgets of consumer product manufacturers. Companies normally use these legitimate funds to pay supermarkets to sell their goods and display them in prominent spots. Most company departments (except for the sales staff) know nothing about the amounts of these funds so trade-spending moneys can transform easily into slush accounts, especially if companies lack good internal controls. I first discovered trade-spending fraud while working at a $6 billion corporation as the new director of corporate internal security in the early 1990s.

One morning, George “a manufacturing controller who worked for the vice president of finance for the consumer products division“ was standing at my office door with a napkin in his hand. He said he was concerned about something and he thought I should know about it.

As George talked, he referred to his notes on the coffee-stained napkin. He said he had received a call from the controller at a supermarket chain, one of our retail customers. The controller said two of our salespeople went to one of their grocery stores in Birmingham, Ala., and told the new manager they wanted to buy supplies for their office and keep the change for petty cash. The check was made out to the supermarket in the amount of $300. George (not his real name) said he thought this may have been customary procedure but he didn’t want to assume anything. (See sidebar article, "Chasing the Barking Dogs.")

George later sent me a fax of both sides of the check, which he had removed temporarily from the accounting system. The check showed me four important things: it was drawn from our corporation’s trade promotional fund, the sales manager of the Alabama region signed it, it was processed through a cash register, and change was given.

I called the administrative assistant of our national sales vice president and asked her if I could receive a list of all our sales offices and food brokers. From that information, I found we didn’t have an office building in Birmingham, but our salespeople worked out of their homes. I gave all this information to my supervisor – the vice president of finance for the consumer products division – and we recruited a customer services employee to help gather all the checks written by the Alabama sales region in the past two years.

The Alabama supermarket manager’s description of the two men who bought the office supplies matched the description of our Alabama sales manager and sales representative. Both had been good employees for our company for almost 20 years and were well-liked by colleagues. The sales manager was a deacon in his church.

The thousands of checks we reviewed, however, told much different stories. I found $360,000 in canceled checks from various supermarkets with the same type of cash register marks on the backs indicating that change had been provided. I knew I was on to something.

Description of Trade Spending 

While I was conducting this investigation I also was educating myself about promotional funding. Here’s a simplified explanation of what I learned. In most situations, a consumer products manufacturer (which could make anything from canned goods to paper towels) pays a supermarket to sell its products. The manufacturer wants the supermarket chain to buy, for instance, 100,000 cases of a product per year, but at the same time, the chain wants the manufacturer to pay by separate check for the right to sell the product in the stores.

The price companies pay to supermarket chains for trade spending depends on the number of cases sold, the market share of the product in that region, and the position of the product in the stores including special display, among other factors.

A company’s promotional-funding budget is classified information that would hurt the company if it fell into the hands of a competitor. Few know the size of these accounts but it’s probably in the billions of dollars. Promotional funds are the main source of income for supermarket chains; sales of food and products barely cover the chains’ salaries.

These funds have been fraudsters’ targets for years because a company’s promotional-funding budget is one of the best-kept, entrenched corporate secrets, the dollar amounts of the funds are huge, and internal controls often aren’t enforced.

Now knowing this information, I knew the $300 Birmingham check had grown into a $360,000 fraud or even more.

Management Doubts 

During this investigation, I didn’t want to give our customers (the supermarket chains) the impression that our company was a "runaway train" or that they may be entitled to more funds. So I cautiously contacted our customers’ security directors to confirm our data. I believed the supermarket managers would tell the truth to their own security directors because, at this point, they weren’t being accused of any crime. Also, I was hoping that my low-key manner would compel at least one of the store managers to tell our Birmingham sales manager about the investigation. I wanted the suspected sales manager to think about his misdeeds before I talked with him.

Several days later I was headed for Birmingham on the corporate jet with two vice presidents of sales, a corporate attorney, and the human resources director. I tried to convince these executives that criminals seldom confess their deeds when confronted by their superiors. I told them that I should interview the suspects without others in the room, but they wouldn’t heed my suggestions. They couldn’t accept the possibility that two of their most trusted and respected employees were robbing them blind.

One of the sales vice presidents actually tried to convince the others that the cashed checks probably were used to promote the company’s product. And then the human resources director lectured me about jumping to conclusions and that it would be inappropriate to accuse a person of committing a crime without presenting substantial evidence. Despite this crew’s skepticism, the attorney said upon landing in Birmingham, "Let Frank do what he has to do," and he advised the others to stay quiet during the interviews.

The interview room at the Birmingham hotel had no windows and no paintings on the walls, as I had requested. A long table was set up in the middle of the room. I would sit at one end and the interviewees would sit at the other end. The other company executives would sit in chairs away from the table. I planned to interview several sales representatives that day. I scheduled the interviews so as to minimize possible discussions among the interviewees about the questions I was asking. I also placed my two suspects at the end of the day so they wouldn’t be alarmed.

Interrogations 

I questioned the first three sales representatives “ none of whom were suspects“ and I didn’t gather any new evidence. My colleagues gave me looks that said "wild goose chase." However, things were about to change.

The fourth person was the suspected sales manager. I didn’t want to ask him the typical who, what, why, where, when, or how questions because that would give him the impression that I didn’t know the facts. So after placing file folders, stacks of checks, and video cassettes on the table (the files actually contained blank paper and the videos had no images), I said, "Mr. Sales Manager, I know how much money you embezzled from our company over the last 18 months and we want it back."

Then, without hesitating, I asked how much of the stolen money he still had and when the company could be reimbursed. "I don’t have much," he responded. "I paid for my daughter’s college education and other things." After I said I would be contacting the FBI he told me the specific items he had purchased with the money. He was in great distress, but then by now, so were my business companions. However, the worst was coming.

I interviewed the suspected sales representative last. I’m sure he saw the sales manager’s face as he left the room and he knew the gravy train had come to its final stop. Actually, the sales representative was quite cooperative. He told me he had been embezzling company trade funds since 1974. Now my colleagues were despondent; I knew they were trying to grasp the magnitude of this longtime fraud. "Everyone does this," confessed the sales representative. "You have a lot of work to do."

Strategic Planning and an Audit 

My colleagues said little on the return flight. I began to plan a strategy to not only determine the extent of this fraud and prosecute the Birmingham thieves but also to develop a corporate remedy.

Back at headquarters, I suggested we have two customer service employees and temporary office workers help me review the trade fund checks written in the previous two years for all sales regions. Management agreed and the audit began. In the beginning, the task seemed overwhelming – the corporate promotional and advertising programs were complex and we had stacks of checks to analyze. Luckily, our sales department gave us a short course in promotional funding, so I could organize the checks by region, customer, and the data on the backs of the checks.

After two weeks, I found several hundred checks with cash register markings on the backs that were similar to those on the suspect Birmingham checks. Many of the checks were issued to Boston-area customers and deposited into one of two bank accounts. We determined that both accounts were registered to two medium-sized independent grocery stores and checks going into the accounts were made out to large supermarket corporations. We also discovered that the checks, totaling $2.7 million, were written for less than $10,000 each and for even dollar amounts. These checks originated from a Boston food broker, which acted as the sales representative for our corporation in that area. (A food broker markets a manufacturer’s products to retail grocery stores. Unlike a distributor, a broker never actually takes title to the goods, but rather acts as the manufacturer’s agent by facilitating the distribution of products to retail markets and organizing their promotion.)

At this point, we called the FBI. I told them of my concerns about the Boston food broker and that I believed there was a misappropriation of almost $3 million in the two bank accounts. The FBI quickly secured a warrant for the accounts and met with my corporation’s managers. We called the suspect, an account executive who worked for the food broker, and the owner of the company into our headquarters for interviews. I interviewed the suspect, then the FBI questioned him, and shortly after he admitted his guilt and confessed to receiving 75 percent of the almost $3 million. We also discovered that he stole the money with assistance from another account executive with the same firm. (The night before the meeting, the FBI had moved in on the two grocery store owners. They admitted their crimes and surrendered information about the food broker’s account executive and his co-conspirators.)

The two Boston food broker account executives began their scheme in 1987. They would requisition checks from my corporation’s promotional fund and have them made out to a wide variety of eastern and central Massachusetts grocery stores even though they hadn’t designed marketing incentive programs for these stores and didn’t intend for the stores to receive the checks. My corporation didn’t know that they hadn’t designed the incentive programs.

Instead, the two account executives delivered the checks to the two grocery store owners who interspersed them with their daily store receipts and deposited them with those receipts in their business checking accounts. In exchange for the checks, the two store owners gave the food broker account executives some of their businesses’ cash receipts totaling 75 to 85 percent of the amount of the checks and kept the rest of my corporation’s money. In effect, the grocery store owners purchased the misappropriated checks at a discount from the account executives with their cash receipts. From 1987 through 1992, the account executives embezzled $3,010,746.13.

Eventually, a number of people were indicted for the promotional funds fraud against my corporation. The FBI discovered that in the city of Boston alone, 29 other manufacturers were victimized for at least $1 million each in the previous year. We eventually recovered the $3 million because we were the first to uncover the fraud and we quickly filed a civil complaint. This was an unprecedented recovery rate for such a substantial fraud.

During the audit of the checks, we also found $360,000 embezzled in Detroit as well as hundreds of thousands of dollars in other parts of the country. We recovered most of the stolen money, but there were approximately 300,000 questionable checks that I was unable to process before the statute of limitations ran out on the crime.

In the Birmingham case, the sales manager and sales representative both were charged, given probation, and are paying restitution. In the Boston case, one of the food broker account executives was sentenced to five years and restitution. 

Road to Resolution

Our audit and investigation team’s next task was to develop internal controls to protect our company from further promotional funds fraud. We established a new payment procedure and other checks and balances. The year after beginning the controls, we saved thousands of dollars and decreased our promotional fund budget by millions. This obviously helped our company become healthier and more productive and strengthened our competitive position. Fraud examiners from other companies heard about our success and sought advice. However, many found that their executives were reluctant to tamper with their almost sacrosanct trade-spending programs. Consequently, business as usual will continue to breed fraud.

In November of 1992, the U.S. Congress passed into law the Sentencing Commission Guidelines. These mandatory guidelines require corporations to account for preventing, investigating, and reporting any occurrence of crime (including promotional funds fraud). Corporation officers are personally liable for not complying.

According to the Association’s "Report to the Nation," organizations lose 6 percent of revenue and $400 billion annually due to occupational fraud and abuse. The average organization loses more than $9 a day per employee to fraud and abuse. All of these dollars are taxable income and represent bottom-line profits.

If a company works on a five-percent profit margin and loses $5,000 to theft, the company will have to sell an additional $100,000 of product to recover the $5,000. However, the original $5,000 will never be replaced.

I was fortunate that I worked for a progressive company. Management was not only interested in the promotional funds problem but was pro-active in applying preventative internal controls. Unfortunately during prosperous times – when businesses are most vulnerable to employee fraud – many corporations are less likely to impose internal controls.

As fraud examiners, corporate security managers, and internal audit directors, it’s our responsibility to educate our managers about such esoteric schemes as promotional funds fraud. The financial health, and possibly the survival, of our corporations depend on it.

Frank A. Pinto, CFE, is the president of Research Services International, LLC, a security consulting company in Monroe, Conn. He is a retired detective division commander of the Norwalk (Conn.) Police Department and past director of corporate internal security for a Fortune 100 company.