Weights That Don’t Measure Up (Part 1)

"Richard" was a rising political star in the community. He worked on voter registration projects, was the campaign manager for a gambling initiative, and donated to many state political campaigns. Known as a high roller, he entertained local dignitaries at his rented home on a lake near a major metropolitan city and hosted parties on an 80-foot, leased yacht.

To fund his extravagant lifestyle, Richard began a trucking business and used his political contacts to secure a lucrative freight contract with the Washington state Liquor Control Board (LCB). Unfortunately, he wasn’t a good businessman, so he eventually resorted to submitting false invoices to the LCB and received nearly $840,000 in unauthorized payments over a three-year period for services he didn’t provide. “Gerry,” the complicit LCB supervisor, processed the fraudulent payments, which included inflated weights on legitimate deliveries, deliveries that didn’t occur, and duplicate billings. In fact, 76 percent of all Richard’s invoices to the LCB were false.

A MAN OF MEANS? 

The Washington state legislature established the LCB in 1934 to enforce Prohibition laws. Now, the LCB’s mission is to serve the public by preventing the misuse of alcohol and tobacco through licensing, education, enforcement, and controlled distribution and merchandising systems. The LCB operates about 2.3 percent of all liquor stores in the state (with the rest being private retail businesses), and contracts with 14 freight vendors to haul products from its central warehouse to every store in the state. During any given fiscal year, the LCB pays about $45 million to these freight vendors.

The LCB had selected Richard as a contract vendor for one of its smallest liquor delivery routes. He began delivering freight from the central warehouse to liquor stores along a 90-mile stretch of the interstate highway. (It’s still a mystery why the LCB decided to hire Richard as a contractor. Investigators later found only two records in his LCB file: a staff member’s memorandum that said Richard had dropped the name of an LCB executive when he first approached the state board for a job, and Richard’s letter of resignation.)

Richard didn’t have a clue about how to configure mandatory invoices to the LCB because he lacked accounting skills. But he had a little inside help. Richard had cultivated a relationship with “Gerry,” the LCB accounts payable supervisor. Every month, Gerry processed about 1,400 invoices totaling $420,000 for freight vendors that delivered liquor products in the statewide distribution system.

Gerry would batch all invoices, enter the data into the computer accounting system, and process the invoices for payment once approved by another accounts payable employee. She also was required to verify information from vendor invoices for all freight shipments made from the central warehouse.

Gerry valiantly tried to help Richard complete his invoices during his first year of business with the LCB, but because of the extra time she had to spend with him, he wasn’t getting paid promptly and she was wasting her days. So, eventually, Gerry decided to prepare all his invoices from scratch rather than fix them.

However, things still went awry. One of Richard’s payments was lost in the mail. Another payment was mailed to the wrong company.

Richard called Gerry. “What’s wrong?” he asked.

“I don’t know. But I’ll fix the problem.”

Rather than have the LCB mail the delayed payments to Richard, Gerry made arrangements to pick them up at the headquarters building where she worked and hand deliver them to Richard.

She then called the supervisor of the LCB’s check distribution section. “Will you return Richard’s checks directly to me in the future rather than mail them?” she asked. “Sure I can,” said the supervisor. “Think of all the stamps we’ll save.”

Richard began to exploit his relationship with Gerry for his personal and business advantage. Gerry was a 42-year-old single mother with two teenage children. She had just ended a relationship with her boyfriend of four years. Richard knew she was vulnerable and felt he needed her now more than ever, so he decided to exploit her kindness.

When Gerry was transferred to another department, she continued to prepare Richard’s invoices and give them to the accounts payable staff to process. Because she had already verified the information, the staff simply entered the information into the computer accounting system without question.

INITIAL DISCOVERY 

One year after the LCB hired Richard, the agency’s budget was cut significantly. In response, the LCB reduced the accounts payable function staff by one person.

The LCB partially compensated this staff cut by no longer verifying that all freight deliveries listed on vendor invoices actually represented valid freight shipments from the central warehouse. The staff merely checked vendor invoices for mathematical accuracy and ensured that they agreed with the authorized rate structure specified in the contract negotiated with the freight vendors. This was a huge mistake.

The LCB still maintained a computer database of freight shipments from its central warehouse, but the accounts payable staffers no longer used this important information. This change in operations was the critical internal control weakness that allowed Richard’s fraud to go undetected for about three years.

When Gerry transferred to another department, she trained another employee to perform her duties in the accounts payable function. One day, while assisting the accounts payable staff on a project, Gerry noticed that one of Richard’s invoices significantly overstated the weights of some deliveries. That was when Gerry realized all his invoices significantly overstated delivery weights; some were off by more than 20,000 pounds. She was shocked and called Richard.

“Please meet me right away,” Gerry demanded.

“What’s wrong?”

“Nothing specific. Let’s just get together.”

Richard picked her up at the LCB headquarters, and they drove to a nearby park. Gerry confronted him with her discovery.

“You’ve been over-billing the agency.” She hoped he would say that these transactions were only mistakes.

Richard was reluctant at first, but then he finally said, “I wondered how long it would take you to find that out. I’ve inflated weight information several times. I’ve even fabricated the information on entire shipments and falsified all of the invoices to obtain start-up funds for a new business venture. It’s no big deal. Once the new business is operating, I’ll have plenty of money to repay the agency.”

Essentially, Richard was using the state disbursement system to obtain temporary loans.

“Don’t worry about what you’ve found,” he told her. “I’ll eventually correct everything. Besides, does anyone else even suspect that anything is wrong?”

Gerry was appalled. “No, nobody else knows. But Richard, this is theft!”

He didn’t react much to her accusation. Gerry was now concerned about her participation in the fraud.

Richard made feeble attempts to comfort her. “Nothing will happen to you, Gerry. You don’t know anything about the scheme, anyway. I’m the only person involved. If detected, I’ll blame everything on the agency’s lack of shipment tracking.”

Gerry couldn’t condone the theft. “Richard, please stop doing this,” she begged.

“I will, eventually. If you get fired because of my actions, I’ll pay for a defense attorney for you, give you a job at my firm, and provide for your needs during the ordeal.”

The meeting came to an abrupt end.

Gerry did nothing further to disclose Richard’s scheme to LCB officials. Soon after, Richard and Gerry’s relationship turned personal. They began meeting for lunch to discuss her crumbling life. One day, Richard handed Gerry an envelope full of cash.

“Please take this money,” he said. “I want to help you through your hardships.”

Gerry didn’t immediately open the envelope. When she got home, she counted $6,000. She thought it was a nice gesture. A week later, Richard gave her another envelope containing $4,000.

Over the next several weeks, Gerry tried to justify keeping the money for personal use. She even spent part of it to pay her living expenses. She needed the money, but she finally told Richard, “I just can’t keep doing this.”

After about six weeks, she returned $6,000 to Richard and promised to soon pay back the remaining $4,000. Gerry felt that keeping the money would make her an accomplice in the case. She didn’t want to face the consequences of being prosecuted for her actions if she later turned Richard in for his fraudulent billing scheme. She hoped the problem would go away and that he would start submitting accurate information.

During the next several months, she stopped helping him with his invoices, so he had to send them directly to other staff in the accounts payable function. She didn’t want to have to blow the whistle on him. She even lied to him, saying, “The auditors are in the office and are requiring us to properly verify the accuracy of all freight shipments.”

Gerry rationalized that her personal relationship with Richard wasn’t a conflict of interest because processing his firm’s invoices wasn’t her real job, even though she previously did perform this task. Besides, their relationship was purely social. If the scheme was detected, she would only be guilty of being his friend. She continued to accompany Richard to parties and baseball games. She also spent endless hours on the telephone talking with him about what she hoped would develop into a lasting relationship. Unfortunately, Richard thought otherwise because he planned to end their relationship in the near future. 

Gerry then had a slew of medical and family problems: She was diagnosed with high blood pressure, a relative was killed in an automobile accident, and her stepfather died of a heart attack. She was barely able to do her job and cope with life at the same time.

Richard became depressed; though he was taking home plenty of money, his emotional state made it increasingly difficult to keep up his lifestyle as a high-rolling political activist.

“I think drugs and alcohol are contributing to my depression,” Richard told Gerry. “Worst of all, my new business venture has failed.”

Gerry was devastated. She decided to determine the extent of Richard’s fraudulent billing scheme. Gerry knew he was supposed to be making about $144,000 per year, but soon found that he had been paid about $685,000 in 2001 alone – almost five times the normal annual amount he should have received! Horrified, she now knew that she would have to blow the whistle on Richard. She decided to meet with him one last time. Richard came with his attorney.

“I’ll hire an attorney for you, too, if the agency finds out what we’ve been doing,” he promised.

“No thanks,” Gerry responded. She was now more worried and depressed than ever, and she soon began to fear for her life because Richard seemed to be getting desperate and was acting differently. She even prepared a will.

One day, Richard called Gerry to ask her to help him process a large invoice. “Prepare the invoice yourself,” Gerry snapped. Richard knew his days were
numbered.

“I’m packing up my house and moving out of the state to get away from this mess!” he exclaimed.

Even though Gerry had become romantically involved with Richard, she finally reported him to the LCB six months after discovering his scheme.

LESSONS LEARNED 

Let’s review some of the finer points of fraud deterrence and detection for false billing schemes as illustrated in this disbursement fraud case:

• Accounts payable staff should compare information from vendor invoices to the agency’s shipping records for agreement.

• No one outside the accounts payable function should perform accounts payable duties.

•The internal control structure is compromised when disbursement checks make a U-turn in either the accounts payable or check distribution functions and are returned to agency staff.

RICHARD AND GERRY’S FATES 

In part two of this two-part series we’ll discuss the final results of this disbursement fraud case, additional lessons learned, and recommendations to prevent future occurrences of false billing schemes. Stay tuned for the rest of the story.

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. 

This column was adapted from a case study by Joseph R. Dervaes, CFE, ACFE Fellow, CIA, published in “Fraud Casebook: Lessons from the Bad Side of Business,” edited by Dr. Joseph T. Wells, © 2007, by the Association of Certified Fraud Examiners Inc. Published by John Wiley & Sons Inc. Available in the online ACFE Bookstore.