Abstract
Senior accountant George Shaw finds evidence of poor internal controls and, ultimately, fraud, at a family of not-for-profits. In order to solve all of the problems with the organization's books, he ends up joining the staff.
Background
George Shaw, a senior accountant for the public accounting firm of Kettle & Company, was assigned as the in-charge auditor on a family of not-for-profits with primary operations in the healthcare and college industries. The client was made up of a parent corporation, JTL, Inc., and four subsidiaries (Rural Healthcare, the College of Advanced Nursing , JTL Foundation and JTL Assets).
JTL and Subsidiaries grossed over $30 million in annual revenue and held assets totaling over $30 million. The chief executive officer of JTL and Subs was Louise Robbins, who had been with the company for approximately ten years. The accounting department was headed by the accounts manager, Barbie White, who had been out of college for just under two years. Her live-in boyfriend, Butch Smith, was the administrator of Rural Healthcare, Inc. (RHI), and also functioned as the chief operating officer for all five companies. These three people had signature authority for all five companies, including a $750,000 county bond.
It is important to understand that the CEO was based in Knoxville , while the hospital, college and all other operations were located two and a half hours away in the mountains. Butch and Barbie, who were living together, essentially had control over all assets of the company with minimal oversight from Louise. These facts, along with the prior year audit workpapers, made George wonder about the internal control structure and the relatively high potential for collusion.
A Lack of Cooperation
George started his fieldwork before his two associates joined him in the field. When he arrived on site to meet with Barbie, he discovered that the client assistance list that was faxed to her two weeks earlier had not been completed. In fact, Barbie had only closed the books of one company and stated that she would get to the other companies at her earliest convenience. She was very short with George and seemed extremely agitated.
As George's second day in the field began, Barbie entered the basement where he had set-up his remote office. "Here is the school's trial balance," she said as she dropped the binder on the table. "I should have the rest by tomorrow, but who knows."
George said "Thank you" just as the door shut behind her.
After finally receiving trial balances for all five companies, George discovered Barbie had posted the prior year audit entries incorrectly. After correcting them, George proceeded with a preliminary analytical review. He and Barbie sat down to review the analytics so that George would have more insight into the companies' past year of operations and overall financial health.
"Barbie," George began, "can you explain to me why the school's tuition revenue has dropped by over 20%?"
"I wasn't even aware that tuition had decreased," Barbie responded. "I'll have to look into that and get back with you."
George continued with similar questions, but Barbie was unable to answer any of them directly. However, she did tell George that the financial statements were actually incomplete because she had not completed her year-end entries.
During the initial conversation, Barbie said the employee who oversaw all of the school had recently quit and therefore would not be able to answer many questions. Barbie's own lack of knowledge of the school and RHI was especially alarming, because these two companies comprised a large percentage of the transactions and contained a majority of the risk and liabilities of JTL and Subs.
George continued to probe through the audit and eventually his two associates joined him in the field. Due to Barbie's ignorance of the companies' operations, George decided to perform extensive testing. During one test, George discovered large dollar entries posted to cash and miscellaneous income that Barbie was unable to explain or support.
"Barbie, I am really concerned about these entries to cash and miscellaneous income and the fact that miscellaneous income has increased so dramatically over the prior year," he told her. "I need to see some sort of support for these transactions or, at a minimum, a verbal justification."
"I gave you my answer and I don't know anything else," she said angrily. "I have no idea why those entries were posted." Barbie turned her back on George as a clear signal that this conversation was finished.
George left her office, once again failing to shed any light on the matter. He decided to contact the audit partner, Charles Brown.
"I am becoming very frustrated with the progress I am making on this audit," he told Charles. "When I arrived on site, Barbie White did not have any of the trial balances ready, which already has put me behind schedule. Now that I have started asking questions and requesting supporting documents, all I get from Barbie is a show of agitation and disgust with my very presence. If I am unable to resolve some of these issues, I will be in the mountains for the entire summer."
Charles responded in his usual calming tone. "George, let me contact Louise and see how she can help us. I do know how frustrating it can be to work with a client that is completely uncooperative. We ran into the same problems on last year's audit. I will let you know how my conversation with Louise goes."
Charles contacted Louise to discuss the lack of cooperation and the inability to get any questions answered or supporting documentation from Barbie. The CEO told Barbie to address all of George's questions and concerns, but Louise failed to address any of the questions herself. Barbie never adequately addressed any of the issues George raised, and she seemed to grow more and more agitated as the audit progressed.
As George and his associates continued to follow-up on unresolved matters with RHI, George received a telephone call from RHI's administrator, Butch Smith.
"George," Butch shouted through the phone, "let me tell you something. When you have questions or concerns about the hospital, you call me. I am in charge of the hospital, not Barbie, so leave her alone and let her do her job. I assume you understand me."
"Butch," George started tentatively, "Barbie is the accounts manager and we have addressed our accounting questions to her. However, if you feel that you can shed some light on the unresolved issues, I will be happy to discuss them with you."
George sent a fax with his questions to Butch, but he also was unable to resolve any of the remaining open items.
The Decision
During the audit, George came across numerous items that raised his suspicions about Barbie, Louise and Butch, as well as the entire organization. Near the end of the audit, George decided that he needed to document all of his concerns. He was fully aware that the income derived from JTL as a client was material to Kettle, his CPA firm employer, but issuing an unqualified opinion was not a viable option, and George refused to compromise his ethics and values. He knew that a CPA's integrity was an invaluable commodity and asset to companies, investors, management, clients and boards. Thus, he decided to request a meeting with Butch and Louise.
"There is a risk of fraud and abuse at JTL, Inc," George began in a tentative voice. "However, due to an overall lack of internal controls, sloppy record keeping and a general lack of cooperation during the audit, I am unable to determine the extent of the fraud. I recommend we issue disclaimer of opinions on the audits and request a meeting with the audit committee of the board of governors."
There, it was out in the open. George had taken the first step. In addition to his presentation at the meeting, George documented his concerns in a narrative. In his conversations with Charles at the CPA firm, George questioned the integrity of Louise, Butch and Barbie.
Charles never approached George about the narrative and never inquired any further about any of the difficulties that were incurred while working on the audit. Instead, the firm elected to issue unqualified opinions with no exceptions on all four of the audits (JTL Consolidated, RHI, the College and the JTL Foundation). Furthermore, to George's knowledge, Charles never discussed any of the audit issues with any of the members of the board of governors. Instead, they discussed some of the issues with Louise but none of the suggestions of fraud and abuse.
A Series of Fraud and Abuse
In response to recommendations for better accounting systems and controls, the board followed up on its earlier decision to move the accounting offices to Knoxville . This move would allow the company to recruit and retain qualified accounting personnel. Louise's intent was to relocate the accounts manager to Knoxville as well, because she truly believed in Barbie's abilities. However, Louise would require Barbie to work with someone from the CPA firm as a mentor. When Barbie learned about this condition, she quit within the week.
Louise was forced to ask Charles to assign someone from Kettle to be the interim chief financial officer/controller while she recruited for the position. George was selected because of his familiarity with the client and his overall skill level and abilities.
George immediately began working to clean up the accounting records. He instituted the necessary controls and systems to ensure the accuracy of the accounting records and to safeguard the companies' assets. During implementation of the internal controls, George uncovered a series of fraud and abuse.
He found that the plant operations manager, Buck Short, had set up multiple fictitious companies and was submitting invoices to JTL and Subs for work that was never performed. The fictitious invoices totaled over half a million dollars spanning a three-year period.
RHI was having major cash problems during this time and therefore its accounts payable were over sixty days. However, Butch would always approve the fictitious invoices for immediate payment and the accounts payable clerk was instructed to hand deliver the checks to Buck.
It was further discovered that Buck had a heating and cooling business on the side. RHI and JTL Assets were purchasing all of the heating and cooling units and necessary supplies for installation. Buck used his maintenance staff at RHI to install these systems while RHI paid their salaries.
George also discovered that Buck used RHI supplies, equipment and maintenance staff to renovate his house from a purchase price of $60,000 to an appraised value of over $240,000. On some invoices, the "ship-to address," was Buck's home address.
Conservative estimated costs for the heating and cooling supplies and the supplies and equipment used for renovating Buck's house totaled over $500,000. These figures do not include the wages of Buck and his maintenance staff.
Several of the fictitious invoices were submitted for payment through the county bond that was being managed by Seventh Street Bank. One invoice said that it was for the purchase of a new generator for $80,000. However, Barbie never recorded the new generator as a fixed asset. Instead, she recorded the $80,000 expenditure and the receipt of the bond money to the same expense account in the same month.
This "washing" of the $80,000 essentially left no trail in the financial statements. It was just one example of many questionable transactions that George discovered while functioning as the interim CFO/controller. He uncovered many more questionable activities, but due to collusion and the lack of clean accounting and paper trails, these were never pursued.
The fraud and abuse case was eventually handed over to the Federal Bureau of Investigation and the Internal Revenue Service Criminal Investigation Division. Buck was sentenced to three to five years in federal prison. Butch was forced to resign shortly after the discovery of the fictitious invoices because the theft occurred on his watch. No action was ever taken against Louise, and she still is the CEO of all five companies. In fact, the board of governors frequently praised her for her efforts in seeing the internal investigation through to the end.
George's refusal to compromise his ethics and values was the key reason that the fraud and abuse at JTL and Subs was uncovered. He eventually was offered a position with JTL and Subs as the CFO/controller over all five companies. He accepted because he felt board members and the CEO had a keen interest in strengthening the accounting and financial systems of the companies, including the internal control structure.
The internal control systems that George implemented and continually reviewed while employed by JTL created the foundation to catch and deter further fraud and abuse.