Pre-School Fraud: Changing the Diapers

Pre-schools, which often receive state dollars, can be breeding grounds for fraud and abuse. Absentee owners, cash payments, employee access to funds, salaried remuneration, and a lack of supplier and vendor controls are common pre-school risk factors. Here are practical ways to deter these conditions that can be applicable to any situation.

The owner of a pre-school (we’ll call her Eva) was shopping for supplies in a local supermarket and saw the school’s director relaxing in the local coffee shop when the director was supposed to be at work.¹ The school’s managers were allowed to take breaks, but the state regulations on staff-child ratios were quite strict. An absent manager in a department store isn’t an emergency, but in a pre-school it normally is a rules violation. Eva immediately called the school and was told that the director (we’ll call her Sally) had called in additional staff to cover her absence so Eva dismissed her concerns. She shouldn’t have.

Later, Eva was reviewing payroll and she noticed that staff members had marked additional hours in the previous weeks. She asked the assistant director about the extra hours and was told that Sally, the director, had assigned other workers to her tasks because she just wasn’t present at work. Obviously, the school had been charged for unnecessary hours because Sally wasn’t there. Eva confronted Sally. Sally argued that as a salaried employee she worked at home on the weekends to fulfill her job requirements. Eva reminded Sally that the state requires her presence as a director for a certain amount of hours, which she wasn’t fulfilling, and she had violated state regulations. Sally agreed and said that, in the future, she wouldn’t leave the pre-school during unauthorized times. However, Eva made a surprise visit to the school one day and found that Sally wasn’t there. During the same time, employees told her that cash was missing and parents weren’t paying on time. At this point, Eva, the owner, called in a CFE.

Pre-school fraud is increasing throughout the world. In California alone, it’s alleged to have grown to $1.5 billion per year.² Pre-schools, pre-kindergarten, child-care, day-care, and early childhood programs receive their income from private sources and governmental funding. Parents pay tuition and the schools provide educational and meal services. Some schools opt to have parents bring their children’s meals. For parents who can’t afford tuition, the state provides funding to the schools.

EXTERNAL PRE-SCHOOL FRAUD 

External fraud concerns the misuse of governmental funds with an intention to deceive. Either a recipient (a parent) or a provider (a school) intentionally provides false information to receive funds. (U.S. Department of Health and Human Services, 2006) The perpetrators can be sponsors, operators, directors, financial managers, beneficiaries, or a combination of any of these in collusion.

External fraud is exemplified by a recipient who:
• understates income: the parent fails to report all the hours worked in the household;
• applies with a false address: benefits might only be provided in one locale;
• identifies a provider falsely: benefits might only be given to particular providers who have satisfied particular criteria;
• falsely claims to be working: if a parent loses his or her job in New Jersey, all benefits cease; and
• falsely claiming a child-care expense when none exists: in Minnesota, a woman applied for child-care expenses even though she ran a home child-care center in another county.

External fraud also occurs when a pre-school:
• bills for services but doesn’t provide them;
• provides services at higher rates than a school that doesn’t accept government funds;
• colludes with recipients and splits the payments received;
• charges the funding source for meals and supplies not given; and
• falsely identifies recipients for receiving meals and supplies.

INTERNAL PRE-SCHOOL FRAUD 

Internal fraud occurs when the employees or vendors of a pre-school intentionally misrepresent their hours worked, expenses, or supplies used or needed, or when they engage in kickback schemes or bribery. Some recipients of pre-school services engage in fraud by intentionally receiving additional service hours and not paying for them.³ 

Thomas Lokaszewski, a CPA involved in examining pre-schools, noted that pre-school owners and managers should be on the lookout for internal fraud telltales such as:
• strange employee behavior;
• invoices for equipment or supplies not present on the property;
• being paid for time not worked: the manager is paid for a 40-hour week but works only 25 to 30 hours;
• hiring others to perform the manager’s hours;
• allowing non-employees to use equipment and supplies;
• allowing children to attend for additional hours without paying for them or for free;
• receiving kickback monies from vendors to perform services;
• keeping supply monies;
• personally using school supplies;
• asserting that vendors and contractors provided services when they didn’t;
• asserting that vendors and contractors performed extra work when it didn’t occur;
• hiring employees when they weren’t needed;
• doctoring time sheets; and
• mysterious cash losses.⁴ 

SALLY, THE TROUBLESOME DIRECTOR 

Let’s get back to our opening composite case. The CFE (we’ll call her Deb) began to investigate the pre-school and quickly found significant problems and possible fraudulent activities:
• Eva, the hands-off owner, totally trusted Sally (who commanded the entire operation) and offered her little direction and monitoring.
• Although the pre-school had an employee manual and a parent handbook, management seldom heeded them when dealing with parent problems or employee misconduct.
• Copying machine costs were excessive, teachers didn’t keep accurate copy tallies, and some teachers (plus Sally) made copies for personal use.
• Parents were utilizing additional hours and not paying for them. Some were paying for a half-time program but their children actually were present all day.
• A check addressed to Sally by a vendor suggested that she might be accepting kickbacks. (Normally checks are made out to the school.)
• The school was missing $1,900 in cash payments.
• Sally and some employees allegedly worked extra hours not in proportion with the number of children. She said the extra hours were necessary due to “maintenance problems” but she couldn’t identify those problems.
• Some parents weren’t even paying tuition.
• The supplier of educational products allowed all employees, including terminated employees, to obtain school supplies when only the director was allowed to sign for supplies.
• The weekly supply monies provided to Sally maintained a surplus each week but she never used that surplus. Instead of using the surplus for school materials, she pocketed the surplus and requested new monies for additional materials.
• Employees didn’t fill in their time sheets on the days they worked but later.
• Vendors that were hired to clean, remove snow, and other jobs failed to perform or added unnecessary hours.
• Sally, who was on salary for 35 hours a week, was only working 20 to 25 hours.
• Parents who had agreed to pay tuition through bartering arrangements failed to do so.

Sally’s seemingly innocuous behavior of leaving her post to have a cup of coffee represented a flagrant disregard for the owner and managers of the pre-school and was the tip of abuse and fraud. Her behavior said, “No one is watching; I’m in control and I can do almost anything I want.”

DIAPERING THE ABUSES  

Some might think that Eva, the owner of the pre-school, should have fired Sally immediately when she found out she was misrepresenting her work time. But it could be argued that hastily firing Sally, without having a prepared successor, could have fostered chaos and possibly more fraud. Also, removing an individual without a thorough investigation is a knee-jerk response that could cut off potential leads to other fraudsters.

Here are some recommendations for controlling and preventing fraud and abuse in a pre-school setting:
1. Shareholder ownership must be replaced with active ownership. The owners must monitor and inspect daily to ensure that the operation is following the state regulations.
2. Handbooks provided must be handbooks followed. Such handbooks must outline the exact prohibited behavior and the corrections or punishments.
3. Owners must at all times control the spending of money. Managers and employees should never have access to spending without the approval of ownership. (Of course, a director should have the authority to spend pre-school money for a container of milk or a bag of diapers.)
4. Parental bartering shouldn’t be permitted because it’s a potential conflict. A parent might dutifully promise to perform a service but might not do it well or not at all.
5. All employees, including management, should be paid hourly. Salaried employees become problems because they believe that 30 or 40 hours per week should be the maximum or that they can work at home when they feel it’s necessary. They fail to realize that state regulations require their presence.
6. Ensure time sheets are signed daily. Open-ended time sheets encourage abuse and fraud. If time isn’t marked on the sheets, it doesn’t exist.
7. Install computerized hardware to clearly identify entering and exiting times.
8. Give each teacher a password to control and identify copy machine users.
9. All cash payments must be stopped and replaced with checks or credit card payments.
10. All suppliers and vendors must work through the owners. Only owners should sign contracts.
11. Parents must sign their children in and out every day for the times their children use the school’s services. If more time is used than the amount paid, a parent must pay for the additional time
12. Parents must pay tuition regularly at the beginning of the month. Non-payers aren’t welcome.
13. In most cases, owners shouldn’t give weekly money to directors for supplies but provide the actual supplies.

AND CHANGE THOSE DIAPERS 

A pre-school small business, if operated wisely, requires a small amount of the owner’s effort and time to prevent fraud and abuse. Cash payments, a shareholder attitude, employee access to funds, salaried remuneration, a poor use of documents controlling proper and improper conduct, no contract monitoring, and a lack of supplier and vendor controls are the seeds and driving forces leading to fraud and abuse.

John F. Daab, CFE, and his wife have been involved in pre-school operations for more than 21 years. He’s an art fraud and forgery researcher working on his doctorate in business at Northcentral University. 

References 

¹ This is a composite case used for illustrative purposes. The facts and events occurred over a period of years at different schools.
² Anderson, T. 2006. “Welfare Fraud.” Los Angeles Daily News. From the National Association of Bunco Investigators.
³ Lukaszewski, T. “Who Can You Trust? Protecting Your Organization from Internal Fraud.” Child Care Information Exchange. 116, July-August. 1997.
⁴ Ibid. Pp. 20; 22-24.  

The Association of Certified Fraud Examiners assumes sole copyright of any article published on www.Fraud-Magazine.com or ACFE.com. Permission of the publisher is required before an article can be copied or reproduced.