Calibrate your professional skepticism: How to modulate your skepticism threshold to better spot red flags

Organizations usually detect occupational fraud via tips. External audits detect just 4% of frauds, according to the 2020 ACFE Report to the Nations. But an external auditor in Washington state defied the norm when she detected a $6.9 million misappropriation — the largest government asset misappropriation in the state’s history. This auditor found the loss by using red flags to finely calibrate her professional skepticism.

Professional skepticism is an attitude that includes a questioning mind and a critical assessment of audit evidence. This mindset is a foundational principle for all investigators, especially fraud examiners. (Professional skepticism is included in the ACFE Code of Professional Standards.)

But applying the right level of skepticism can be challenging. Eager investigators might be too skeptical, which could result in extra or unnecessary audit procedures, time spent and audit costs. Others might be too trusting or averse to conflict and ignore red flags that warrant further attention. (See “How to calibrate professional skepticism” at the end of this article.)

Think of professional skepticism like a scale — we should calibrate sensitivity based on what it’s measuring. Weighing gold requires fine calibration and heightened sensitivity to even the smallest change in quantity. Similarly, when an audit or fraud examination client has a poor control structure, a concerning tone at the top or other red flags, investigators should calibrate their skepticism accordingly. They should be more sensitive to smaller errors or inconsistencies, and should require additional evidence to satisfy audit questions. In Washington, then-Assistant State Auditor Christina Solis did just that.

Increased skepticism? Pivotal decision

Solis was starting her third year in the Office of the Washington State Auditor in July 2019. One of her first responsibilities was to lead the routine financial statement audit of Pierce County Housing Authority — a public agency that provided housing opportunities and assistance. [Editor’s note: The author oversaw the investigation detailed in this article as assistant director of local audit and special investigations in the Office of the Washington State Auditor, and wrote the investigation report.]

Solis’ task on July 29 was routine: compare payroll expenses from the general ledger to the bank activity. To be thorough, she reviewed the bank statement for anything odd or unusual as well. She discovered a $275,000 transfer to a bank the housing authority didn’t typically use.

At this pivotal moment, Solis had to make a choice. She was near the end of the audit engagement and budget. The dollar amount wasn’t significant to the housing authority’s $35 million in annual expenses and wasn’t related to the financial statement balance she was testing.

Solis had many reasons to move along, but she’d been calibrating her skepticism of the situation during the past several weeks based on other red flags, including the housing authority’s tense office environment. The finance department was unnaturally subdued. Wall signs reminded staff to remain quiet so as not to disturb other employees. Employees seemingly didn’t interact outside of necessary work-related conversations. Many even ate lunch alone in their cars. Finance Director Cova Campbell, who had worked there for decades, was the leader in this environment.

Solis noticed a large division between finance staff and housing authority management. Not only were they located in separate buildings (Campbell was the only member of management whose office was in the finance-staff building), but Solis observed little interaction among finance staff and management. Campbell was the conduit for all communication. In Solis’ words, “All roads led to Cova."

One of the biggest red flags was Campbell’s treatment of others. Solis saw Campbell talk down to her employees and even raise her voice to them. However, Campbell was kind to the state auditors. Solis wondered if Campbell was trying to flatter them so they might find it harder to question her.

Throughout the audit, each of Solis’ observations calibrated her level of skepticism. She found herself becoming more sensitive to each red flag, so she couldn’t ignore that $275,000 transfer. But Solis’ decision would lead to new challenges.

Beware of roadblocks to skepticism

Even when investigators have calibrated their level of skepticism, roadblocks or challenges can tempt them to settle for less. Difficulties in obtaining a higher degree of evidence might lead investigators to rationalize that what they have is good enough. Solis began facing hurdles to finding answers almost immediately after she started investigating the $275,000 transfer.

She found the transfer in the general ledger categorized as an “investment purchase.” Campbell was responsible for investments. When Campbell was out of the office for several days, Solis asked other finance staff members about the transfer. While they attempted to help Solis, they couldn’t do so without Campbell. Each conversation eventually ended with, “You’ll have to ask Cova.”

Solis then asked to meet with the housing authority’s executive director, but he said he was too busy. Solis insisted. Finally, he agreed to meet. He said he wasn’t aware of this investment purchase. He said the housing authority had liquidated all its investments, and he couldn’t recall any discussion of purchasing new ones.

By the time Campbell returned to work, Solis had researched the bank to which Campbell had transferred the $275,000 and found two separate banks that coincidentally had the same name — one in Missouri and the other in Oklahoma. Solis asked the banks if they’d ever done business with the housing authority. She then found two wire transfers in bank statements to an out-of-state title company with offices in Oklahoma.

An eventual conversation with Campbell again tested Solis’ skepticism threshold. Campbell said she’d purchased the investments but later canceled them after realizing she didn’t have proper approval from the housing authority’s board.

Campbell’s story was plausible. The housing authority had liquidated investments with its usual bank. So, maybe it was seeking new investment opportunities. Solis also noted wire transfers into the authority’s bank account, which could presumably represent the “refunding” of those canceled investments.

Solis weighed the plausible explanation with what she’d observed about the housing authority’s internal controls and office environment. Her skepticism hadn’t waned. She decided to keep probing.

Questionable wire transfers

Solis again turned to the bank statements. While she did see wire transfers into the housing authority’s bank, she eventually determined those transfers actually came from a different authority bank account. Campbell had transferred funds from the housing authority’s primary account to a secondary account and back for no discernable reason. But if someone was trying to construct support for a story about canceled investments, this might be one way to do it.

Solis heard back from the banks in Missouri and Oklahoma. Both banks confirmed they didn’t have accounts for the housing authority — a significant red flag. This and the transfer to an Oklahoma title company led Solis to suspect Campbell had used the questionable wire transfers to purchase property. Solis then began working with her colleagues on the Office of the Washington State Auditor’s fraud investigation team.

The team followed a hunch and took an unusual step: searching publicly available social media postings for insight into Campbell. They learned her husband lived in Oklahoma where both the bank and title company had offices. The team then used an online property search for Oklahoma and confirmed Campbell had purchased property for the same dollar amount and in the same month as the wire transfers.

The team informed the housing authority’s executive director, who put Campbell on administrative leave and began assisting the team in any way he could.

The team expanded the investigation to cover more time and additional potential schemes. They found that Campbell’s first dabble into misappropriation was a few years earlier when she used the housing authority’s credit card for personal purchases. The card charges, from vendors including online gaming companies, would clearly stand out to anyone reviewing the credit card statements. To cover her tracks, Campbell flagged the transactions herself.

In an email to housing authority management, she wrote, “Four of our VISA cards have experienced a large volume of fraudulent charges in the past few weeks,” and, “Don’t want you to fall out of your chair when we get the next VISA bill. I’ll take care of the fraud claims […].” She even encouraged authority management to improve their policies over credit cards.

The audit team discovered in Campbell’s housing authority email inbox dozens of messages from an online gaming site and other credit card vendors, which showed she’d initiated the transactions — not some anonymous fraudster.

As the team began to analyze housing authority vendor payments made through the Automated Clearinghouse (ACH), they only saw known, valid vendors on the check register. However, by this time, their skepticism was high.

In an unusual operating strategy, the housing authority used two general ledger software systems, and periodically reconciled them to each other. However, the team found that ACH payments shown on the authority’s bank statements were reflected in one general ledger system but recorded as voids in the other system. The team unpacked each voided transaction and determined Campbell had falsified invoices using the names of actual vendors. She then changed the bank payment information on file for those vendors to redirect the ACH payments to her personal bank account.

By the time the investigators began unravelling Campbell’s schemes, she’d misused a credit card and manipulated ACH payments without being caught by the housing authority. Her biggest scheme was in the last year, and it was brazen: Campbell initiated wire transfers from the authority’s bank account to her personal account. These transfers were clear to anyone who looked at the bank statements.

Ultimately, the investigators determined Campbell misappropriated $6.9 million from Pierce County Housing Authority over four years. (See chart below.)

Campbell took responsibility for the loss in a recorded deposition in October 2019, a written declaration she subsequently filed with a county court, and in a November 2019 interview with state auditors. The housing authority reached a civil restitution agreement with Campbell in March 2020 to recover a portion of the total loss. At the time of publication, the housing authority has recovered over $2 million from Campbell.

In January 2021, the U.S. Department of Justice announced that Campbell had pleaded guilty to wire fraud in connection with her scheme. She faces up to 20 years in prison at her sentencing, which was pending at time of publication. (See Former Pierce County public housing executive pleads guilty to multi-million-dollar embezzlement scheme, U.S. Department of Justice, Jan. 15, 2021.)

Campbell was able to carry out her schemes in part because of the housing authority’s reliance on her as the proverbial “trusted employee.” Campbell had broad access to all systems with little to no oversight of her activities. What’s more, she impaired the few oversight activities that were in place. When finance staff reviewed Campbell’s credit card and bank statement activity, she directed them to forward any questions back to her. After the investigation, the housing authority hired a firm to help redesign their internal control processes and protect against future fraud.

Never take anything at face value

Investigators, through experience and training, develop an attitude of professional skepticism. But, like Christina Solis, investigators still must vigilantly evaluate the total environment of cases and adjust their level of professional skepticism to detect anomalies that could reveal huge misappropriations like the $6.9 million initially lost in this case.

Brandi Pritchard, CFE, is assistant director of local audit and special investigations in the Office of the Washington State Auditor. Contact her at Brandi.Pritchard@sao.wa.gov.

How to calibrate professional skepticism

Finding that right level of skepticism can mean the difference between discovering the first hint of a fraud or missing it; between focusing on the responsible person or falsely accusing someone; between gathering sufficient evidence or falling short.

It’s not easy to stay calibrated and act consistently throughout an investigation. Here are some tips.

Barriers to calibrating

Lack of confidence can take many forms in an investigation:

Fear of missing the big one: You might think “under-confident” investigators would be less skeptical than an audit calls for, but sometimes the opposite is true. Under-confident people might overcompensate with too much skepticism. They might hear stories from fellow investigators, or read articles about investigators who missed a fraud or wrestle with discomfort from “that one time” they passed on a red flag. They might now wonder, years later, what might have happened if they’d probed a little more.

They might fear becoming that investigator who missed the big fraud and might calibrate their skepticism to a heightened sensitivity, regardless of the true risk factors for the engagement.

BTTWWADI: This odd acronym, pronounced “Buh-twad-dee,” stands for a phrase all investigators have heard at some point in their career: “Because that’s the way we’ve always done it.” Experienced but set-in-stone investigators, unwittingly acting on their “familiarity bias,” could dissuade new or less-confident investigators from following red flags.

Time and budget: Whether you bill a client for investigative work, conduct internal investigations or even volunteer your expertise, most investigators operate under at least some time or budget constraints. Each decision to keep investigating and requests for clients and investigations subjects will typically mean additional time or cost.

Client satisfaction: Applying enhanced skepticism might leave clients feeling targeted or defensive, which could lead to uncomfortable or heated conversations, or risk damaging relationships.

Inherent desire to believe people: Investigators might originally intend on seeking a high level of evidence in an engagement but be tempted to empathize with interviewees and take their statements at face value without verifying them. Trust but verify.

Conscious and unconscious bias: Bias limits our ability to correctly calibrate professional skepticism. Everyone has biases, but allowing them to affect investigations and our levels of skepticism can be detrimental.

How to Overcome Barriers