False or Altered Disbursement Documents (Part 1)

This column, the first in a series of three, begins a discussion about some of the most common issues fraud examiners face when they detect false or altered documents in the organization’s disbursement records.

IMPORTANCE OF ORIGINAL SOURCE DOCUMENTS 

Auditors and fraud examiners have always known that original- source documents are critical in determining if disbursements have been made to a valid vendor for official business purposes. An organization’s first line of defense against the risk of fraudulent disbursements must be to obtain original source documents for all expenditures. But is this always possible? Some would say: “Yes, absolutely!” But, others might say: “No, there must be some exceptions.” Let’s explore these responses.

COPIED SUPPORTING DOCUMENTS  

Copies of documents might support legitimate disbursement transactions but only rarely, in my opinion. You should independently verify the authenticity of these transactions. My first question to an organization is: “How did you get these copies?” Staff members usually casually say that they made copies of the original documents for the files. “Where are the original documents?” I ask. The conversation generally deteriorates at this point. Don’t be too eager to accept staffers’ first plausible answers. Inquisitive fraud examiners must use other investigative steps to determine if the transactions actually represent payments to valid vendors for official business purposes. I’ll illustrate in this case.

Case History: Multiple Expense Reimbursement Scheme
A department director, Milton, who worked for a college and an international foundation, occasionally traveled on business for both organizations. After each trip, he filed separate travel vouchers to obtain reimbursement for expenses. However, in the last year of Milton’s employment with the college, he got greedy and submitted the same expenses to both organizations.

He claimed per diem for meals on his college travel voucher (no receipts required) and then submitted the actual meal receipts with his foundation travel voucher so he received two payments. He was also reimbursed twice for gasoline purchases. He submitted the actual purchase receipts on his college travel voucher when he used the college’s credit card to purchase gasoline for his personal vehicle; then he submitted copies of the gas station receipts with his travel voucher to the foundation. The foundation didn’t question why it had paid travel claims using copies of documents rather than originals.

During a routine travel audit, the college’s internal auditor uncovered these duplicate payments when he compared the supporting documents Milton attached to his college and foundation travel vouchers. The internal auditor was inquisitive and simply wondered if the college and foundation were paying their fair share of Milton’s travel expenses on these trips. Milton reimbursed the college $1,782 in travel overpayments and resigned. The county prosecutor declined to criminally prosecute.

One organization should be designated as the host when an individual takes official travel benefiting more than one organization. This host organization then reimburses the individual for all travel expenses using only original source documents and bills the other organizations for their agreed-upon share of the employee’s total travel costs. This reimbursement procedure eliminates the need for honest employees to copy documents and deters unscrupulous employees from claiming duplicate expenses on travel vouchers.

FALSE OR ALTERED SUPPORTING DOCUMENTS  

We must ask one critical question when reviewing disbursement documents: “What’s the difference between a false original document and a truly original document?” Managers are often perplexed by this question. However, fraud examiners must respond: “A false original document doesn’t represent a valid expense because the organization didn’t receive any goods or services associated with the transaction. Truly original documents always meet this criterion.” Just because original supporting documents are on file doesn’t necessarily make them legitimate.

A good fraud examiner must be inquisitive and ask the staff a lot of questions about the details related to the transactions. To detect fraud, he or she should also thoroughly know details about the business activity and the organization’s actual vendors. Analyze the documents to determine if one person is too involved in such transactions as ordering, receiving, and authorizing payment, or those outside his or her normal job responsibilities. Sometimes simple intuition plays a role. Continue your research on any suspicious transactions to conclusively resolve any concerns you might have about the legitimacy of the transactions. Always ask: “Does this transaction involve a valid vendor and a purchase for an authorized business purpose?”

ADDITIONAL INVESTIGATIVE STEPS 

Consider at least these five additional investigative steps when examining suspicious disbursement documents.

1. Review the vendor file to determine who initially established it and if a supervisor properly approved the transaction. The same person should never be able to both initiate and approve a new vendor file in an organization’s accounting records. This step might uncover an inappropriate segregation of duties for certain employees or even identify the individual responsible for any fictitious disbursement transactions detected during disbursement transaction testing. Witness Jim’s embezzlement case.

Case History: Shell Company Scheme
In a previous column, I reported that in three years Jim had embezzled more than $2 million from the finance office of a small Air Force base. His scheme wasn’t discovered until one of his girlfriends got mad at him and reported his irregular activities to a federal agency. As the lead accountant in the procurement division, he circumvented the organization’s internal controls over disbursement transactions by both initiating and approving one false vendor file in the organization’s accounting records. Jim then recorded all the unauthorized purchase transactions in this vendor account so that he could keep track of all the fictitious activity in his scheme. Nobody ever monitored his work or questioned his actions because he was a department supervisor and a trusted employee in the organization.

2. Review other manual or computer files in the organization to determine if the contact information for the vendor matches that of an employee. For example, consider comparing employee administrative and payroll file information with vendor file data to identify matches on employee or spouse names; telephone numbers, street addresses, or post office boxes; and bank account information for electronic payments. Except for travel and other nominal or miscellaneous expenses, an employee doing business with his or her employer usually results in a conflict of interest and a violation of the organization’s ethics policy.

3. Review Web sites and the white and yellow pages of the telephone book for the vendor’s name, address, and telephone number. If you can’t find this basic vendor information in these sources, you should ask: “Why would the organization want to do business with a vendor who doesn’t have a physical location or a public telephone number?” Finding the answer to this question might provide the clues needed to resolve this dilemma.

If you do have a street address, drive by to see if it’s an empty lot, an abandoned building, or a different company. The identities of this other company’s owner or employees might uncover a link.

If the suspicious vendor only uses a post office box or other similar retail rental mailbox service, confirm the box’s owner with the organization providing delivery. If you don’t have subpoena power to obtain these documents, you’ll need the help of a law enforcement agency. Here’s a case of purchasing collusion that involved a dummy shell business that had a physical address, but definitely not for customer visits.

Case History: Pass-Through Scheme
Ray, a purchasing manager at a public transit authority in the state of Washington, stole $14,000 in one year by manipulating purchases to inflate the cost of bus parts he bought in an interstate fraud scheme.

Rather than buy bus parts directly from an authorized legitimate distributor in Ohio, “Bacme Parts,” Ray told Bacme that it would have to purchase all parts through another supplier in California. No one knew the other supplier was a dummy shell company owned jointly by Ray and his father. The chart on page 11 depicts the flow for both legitimate and illegitimate purchases.

Ray would first order bus parts from Bacme by telephone, directing Bacme to ship the order to the California dummy shell company, which Bacme did. Once the shipment was confirmed, Ray would order these same items from a legitimate parts vendor in Washington, directing it to obtain the parts from the California dummy shell company. The Washington parts company did so and took their normal profit markup on the transactions – a legitimate but unnecessary expense in this case. Ray and his father, through the California dummy company, would add to the purchases an excessive profit markup and they would split these proceeds.

The California dummy shell company’s business address – a children’s daycare center where Ray’s father worked – didn’t even have a warehouse. Ray and his father only used the address as a drop-shipment point.

These transactions violated the public transit authority’s purchasing policies. Employees weren’t allowed to participate in any transaction that benefited them such as, in this case, through joint ownership of the California dummy shell company. Of course, the shell company didn’t appear in the transit authority’s accounting records as a vendor for bus parts.

Transit authority managers were investigating Ray for other unrelated ethics violations when Bacme contacted them to complain about these unusual purchasing requirements. Bacme explained that the transit authority could save money by purchasing the bus parts directly from it.

The transit authority discovered that Ray had been making frequent telephone calls to California, even though he conducted no known official business in that state. It then traced the telephone number to a specific address in California and asked the transit authority in that city to drive by the location. They found that the address was solely a children’s daycare center, the drop-shipment facility used in this scheme.

The transit authority discovered the details of the collusion scheme after more research and after interviewing Ray about these unusual purchases further. He pleaded guilty and made full restitution of the loss amount to the transit through a pre-trial agreement with the U.S. District Attorney’s Office. As a result, neither Ray nor his father had to do jail time.

4. Meet with a representative of the vendor. You could do this by visiting the vendor’s office, contacting the company by telephone or fax machine, or by writing a letter describing your concerns. Be prepared to provide the vendor with a copy of any unusual documents in your possession.

Case History: Personal Purchases Scheme
Sarah, the clerk-treasurer for a city, was responsible for processing all disbursement transactions at the city including all purchases on the city’s credit card. The city’s external auditors examined credit card purchases and discovered that Sarah might have made some suspicious purchases.

They identified several credit card purchases from a local computer store, which had no supporting documents. The auditors contacted the city’s computer consultant, but he wasn’t aware of any purchases from this source.

The auditors called the local computer store, and a vendor representative faxed documents that showed Sarah had signed for a computer, monitor, software, games, and accessories – all charged to the city credit card for $5,320. The auditors couldn’t find any of these items at city hall.

Sarah had made all payments on time, but she destroyed all the supporting documents that listed the details of the purchases. She had hoped that retaining only the monthly credit card statements on file for the auditors would be sufficient to conceal her irregular activities. She was wrong. The clerk-treasurer was sentenced to three months in a work-release program.

5. Contact the state agency that has the official records identifying the owners of businesses in the private sector. In my state, this is the corporations division in the secretary of state’s office. Many of these offices have searchable Web databases at which you can find links between vendors and employees.

Case History: Conflict of Interest
During a routine annual audit, the external auditors for a community college reviewed the supporting documents for several petty cash purchases from a small business. However, they couldn’t find the vendor’s address and telephone number in the white or yellow pages. The auditors used the secretary of state’s office Web search engine to discover that the coach was the owner of the business. The college disciplined the coach for violating its ethics policy. He transferred to a state university during the investigation but subsequently resigned when the audit report was issued describing his previous activities at the community college.

LESSONS LEARNED 

Let’s review some of the finer points of fraud detection from the five fraud cases, each an example of false or altered supporting documents for disbursement transactions:

• Fraud examiners must determine if payments have been made to valid vendors for official business purposes when suspicious disbursement documents are found.
• An organization’s first line of defense against fraudulent disbursements is to obtain original source documents for every transaction.
• When one individual performs official travel that benefits more than one organization, travel expenses are split between the organizations. One organization should act as the host to pay all expenses based on original source documents the traveler provides at the conclusion of the trip. The host organization should then bill the other organizations for their fair share of the individual’s travel expenses.
• Learn the difference between false original documents (no goods and services received) and truly original documents.
• Review vendor files to determine if one person both initiated and approved a new vendor file in the organization’s accounting records.
• Review manual or computer files in the organization to determine if the contact information for vendors matches the data recorded for any employee (vendor file and personnel/payroll file comparisons).
• Review Internet Web sites and the white and yellow pages to verify information about a vendor’s name, address, and telephone number.
• If other methods prove unsuccessful, contact vendors in person, by telephone, by fax, or write them a letter to verify purchasing information.
• Contact the state agency that holds the official records identifying business owners in the private sector.

MORE ATTRIBUTES 

There are many more attributes that can determine if a vendor is false or if disbursements have been made for unauthorized business purposes. We’ll continue our discussion in the next column.

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.  

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