Checking Account Fraud: When Employees Steal (Part 6)

It was a classic fraud scenario: a key employee who was dishonest and an enterprise without critical internal controls. It cost the employer a whopping $188,037. The combination enabled "Julie," the custodian for two checking accounts, to steal from both an employee union fund and an advance travel fund.

Julie regularly took checks from a wide variety of miscellaneous revenue sources and deposited them into the two school bank accounts but in ways that profited her - not her employer. The scheme lasted five years before external auditors detected it during a routine audit of the advance travel fund. That was when the auditors noticed the name of the payee on the front of some redeemed checks didn't match the endorsement information on the back. It was that simple to uncover.

THE EMPLOYEE UNION FUND 

After receiving school district revenue checks totaling $130,510, Julie deposited them into the employee union fund bank account, a private nonprofit organization that had the school district's identification included as part of the name on the account. It was easy for her to deposit the checks into the account without bank employees noticing the check endorsement irregularities because of the subtle similarities in the payees on the checks and in the account names on the check endorsements.

She then paid many of her personal bills (such as utilities, retail and grocery stores, personal loans, etc.) and several credit card companies from this bank account. Julie didn't prepare any supporting documents for these fictitious disbursement transactions because she alone was in control of the account. Excess funds accumulated in this account because the fictitious disbursements were sometimes less than the amount of the deposits.

Also, there were more deposits shown on the monthly bank statements for this account than would normally have been expected. But nobody noticed. Julie's supervisor didn't review monthly bank reconciliations, and no one audited the checking account. The normal flow of transactions in this account was a bank deposit followed by a disbursement. Confident she wouldn't be monitored, Julie simply filed the completed monthly bank reconciliations.

THE ADVANCE TRAVEL FUND 

Julie stole an additional $57,797 from school district revenue checks that she held onto until she needed them. In this part of the scheme, she first issued checks to herself from the advance travel fund account; then she concealed these false disbursements by waiting a short period of time and depositing a batch of stolen revenue checks in the account in the same amount. Why? Because this was the normal flow of transactions in the account: first a disbursement, followed by a repayment.

The imprest fund bank account had to balance because it was audited annually by the external auditors. Julie accomplished the theft by writing the checks with a correcting typewriter. She typed her name on the payee line and deposited the checks in her personal bank account. When the redeemed checks came back with the monthly bank statement, she used the typewriter to erase her name on the payee line and replace it with the name of another district employee who frequently traveled on official business. Julie used a rubber stamp to imprint "received" over the change to conceal the alteration. She used most of the money in an obsessive-compulsive buying spree, accumulating a huge doll collection. Strangely enough, she never bothered to open most of the shipping boxes to enjoy the dolls she had purchased.

School district managers and union officials never discovered any of these irregularities because they didn't monitor Julie's work, and they didn't assign an independent party to review the monthly bank reconciliations. These are two common failures I've seen in organizations' internal control procedures that help set the stage for checking account frauds.

The court sentenced Julie to a nominal period in jail and ordered her to make restitution to the school district for the amount of the loss, plus audit costs.

HOW TO MAKE IT EASY FOR EMPLOYEES TO STEAL 

Julie succeeded for as long as she did because of several fatal flaws. First, the procedures for processing revenue checks in many departments were deficient. Employees didn't issue receipts for revenue checks when they received them; instead, employees sent them directly to Julie without requiring her to sign for the checks transferred to her. Thus, no one had established accountability for the checks before or after they arrived at her work station. Second, duties weren't segregated, which gave Julie almost complete control over two bank accounts and routine access to many miscellaneous revenue streams within the school district. Third, her supervisor didn't properly monitor her actions.

The stolen revenue checks in this case came from a soft drink company, a telephone company, student fees, facility rent for athletic fields and buildings, parent donations, reimbursements for food-service catering and print shop activities, individual and business contributions, and governments.

While fraud examiners must establish the amount of the loss in cases such as this, they also must determine the source of all stolen revenue checks because these are the areas in which internal control procedures need to be improved. In my opinion, managers won't address these weaknesses unless they're highlighted in the fraud examiner's report.

KEEP YOUR EYE ON THE PETTY CASH - IT'S A FAVORITE TARGET 

In prior columns, we discussed situations in which employees forged endorsements on checks and either cashed them or deposited them into personal bank accounts. But here, we'll discuss situations in which employees deposit stolen revenue checks into other types of checking accounts within the organization.

Once employees have stolen revenue checks, they do a number of things - even beyond what Julie contrived - to convert the funds for their own uses. For instance, they use the organization's normal check-endorsement procedures such as rubber stamps indicating "for deposit only" to the checking account they'll manipulate.

Money laundering in checking accounts usually involves two separate and distinct actions - extra bank deposits in, and extra disbursements from, checking accounts. We'll cover the first of these issues in the remainder of this column and then address the second issue in the next column.

I'll use the petty cash fund as an example of how fraud occurs in checking accounts and what managers should look for. The petty cash fund is an imprest fund because it has a specified amount of funds in it at all times - comprising currency on hand, funds in the bank, and expenditure documents to support transactions of employee purchases. (See a related discussion of fraud in imprest funds in the July/August 2006 and September/October 2006 columns.)

Petty cash expenses are reimbursed from the organization's general disbursement checking account at least once a month and at year-end so the expenses can be promptly recorded in the organization's accounting records. Managers would expect to see only one deposit per month - the petty cash reimbursement check - on the bank statement for this checking account. But when unscrupulous employees use petty-cash checking accounts to commit fraud, they make many deposits in the bank account each month.

The extra bank deposits usually mean there's too much money flowing through the account. To analyze irregular activities, managers should compare the bank deposit documents on the bank's microfilm records with the organization's financial activity. Promptly investigate any discrepancies.

The reviewer should also be alert for any "cash back" withdrawals shown on deposit slips. These transactions usually mean that an unscrupulous employee has deposited stolen revenue checks in the bank account and then taken back some of the money in cash. I recommend organizations try to include a provision in their banking agreements prohibiting cash-back transactions on deposits for their checking accounts.

INDISPENSABLE STEPS TO DETER CHECKING ACCOUNT FRAUD 

One of the most common questions I'm asked about fraudulent checking accounts activities is: "How do employees get access to revenue checks?" Cashiers receive revenue checks from customers throughout the organization in the normal course of business, but they often don't issue cash receipts for them at the time the transactions occur, just like Julie's case above. When this happens, there's no accountability for the money employees receive because the transactions haven't been recorded. These checks are simply "free" money in the eyes of dishonest employees.

To deter fraudulent activities and establish accountability, organizations should implement internal-control procedures that record incoming revenue checks immediately on receipt. Organizations also should require employees to endorse all checks "for deposit only to the organization's account" immediately on receipt.

Employees should obtain signed transmittal documents, or signed receipts for the money, to acknowledge the amount of funds transferred from one person or one location to another within the organization. This procedure will fix responsibility for funds to a particular person at a particular point in time.

However, few managers correctly deal with the risk associated with employees who routinely steal revenue checks. They either ignore or are unaware of these internal control procedures, or they simply accept the risk that a small fraud might occur without detection under these circumstances.

TELLTALE SIGNS REVIEWERS SHOULDN'T IGNORE 

Disbursement fraud is most frequently conducted in small checking accounts such as petty cash funds, advance travel funds, trust funds, and purchasing funds. Business owners and managers must be on the lookout for at least the following irregularities:

• Too many deposits, too many disbursements. One of the primary attributes of checking account fraud is an excessive number of deposits and disbursements. The independent party performing the monthly bank reconciliation should scan the bank statement for this activity.
   
• The check writer as payee or no payee named. A key, dishonest employee will simply issue company checks made payable to him- or herself, or to cash, or might even leave the payee blank. This makes it easy to deposit the checks into a personal bank account, to buy cashiers' checks from financial institutions, or to purchase money orders.
   
• Vendors as bogus payees. The employee will issue company checks in the name of false vendors or a financial institution. The vendor names are usually valid businesses, but the vendor will never see these checks. Once issued, the employee uses the checks to pay personal bills. Checks issued to false payees are deposited into the employee's personal bank account by altering the payee name on the check front to his or her own or by using the vendor name followed by a "pay to the employee's name" endorsement on the back of the check.
   
• Missing or phony documents. There are usually no supporting documents on file for any of these irregular disbursement transactions, a condition that occurs primarily because the bank account custodian knows that managers don't properly monitor his or her work. Most unscrupulous employees don't spend a lot of time or energy concealing their actions when they don't have to. But be aware that when there's some supervision, employees might try to conceal their actions by creating false documents to support irregular disbursements. 

LESSONS LEARNED 

Let's review some of the finer points of fraud deterrence in checking accounts:

• Mail or deliver the unopened bank statement and check enclosures directly to an independent party designated by the organization.
   
• If possible, the owners of small businesses should perform the monthly bank reconciliation. But if they can't, they should at least review bank statements and redeem checks for any irregularities before giving them to the treasurer or account custodian who will perform the bank reconciliation.
   
• A business owner or designee should ensure the payees for the redeemed checks match the check register, the organization's accounting system or disbursement records, and the check endorsement. Then he or she can determine if each disbursement transaction represents a payment to a valid vendor for a legitimate business expense.
   
• A business owner or designee should scan the bank statement to determine if there are more deposits and more disbursements in the checking account than normally would be expected.
   
• Organizations should implement procedures designed to set accountability for incoming revenue checks on receipt by immediately recording them. In addition, employees should endorse all checks "for deposit only to the organization's bank account" immediately on receipt.
   
• Organizations must ensure that all employees immediately record every revenue transaction for accountability purposes, and then obtain signed transmittal documents or signed receipts to acknowledge the amount of funds transferred from one person or one location to another within the organization.

COMING NEXT 

We'll discuss the issue of extra disbursements from checking accounts in the next column. Stay tuned because there's more to learn about the risk of fraud in checking accounts in any organization.

Regent Emeritus Joseph R. Dervaes, CFE, CIA, ACFE Fellow, is retired after more than 42 years of government service. He remains the vice chair of the ACFE Foundation Board of Directors. 

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.