hris, we have a problem,” said the voice on the other end of the line. “Our purchasing manager, Bruce, is on vacation and we think we have discovered some irregularities.” Chris Rosetti, CPA, swung into action.

Rosetti—a partner with BST Advisors LLC in Albany, New York—had done limited work for the client, a state agency, in the past. This time, he quickly discovered the agency had two key internal control deficiencies. The first was that Bruce hadn’t been forced to use his vacation time in three years. Rosetti, a veteran adviser in at least 100 fraud cases, had seen this situation many times: Once employees start committing fraud, they can’t take time off because they need to constantly cover up what they’re doing. The second deficiency was that Bruce was allowed to approve new vendors. So, not only was he approving the purchases, but he also was selecting the vendors—a serious breach of separation of duties. When he was forced to take time off to attend to his sick wife, the agency received requests for payment on three invoices for which there were no vendor files. They were later located in Bruce’s desk. That’s when Rosetti was called in.

In examining the vendor files, Rosetti noted a number of oddities. For one, Bruce had approved the purchase of a large quantity of high-priced “computer cleaning kits”—many more than the agency had computers. And an employee remembered the so-called kits consisted of nothing more than Q-tips, gauze pads and rubbing alcohol. “And I noticed there were multiple purchases just under Bruce’s $2,500 approval limit. Purchases over that amount would have required supervisory approval,” Rosetti said.

The Kickback Checklist One or more of these red flags call for a closer look at the operations of a purchasing agent. He or she doesn’t take time off. The purchasing agent has personal financial problems. The agent’s lifestyle is too extravagant for his or her income. Close personal relationship between purchasing agent and vendor.

Favoritism toward one vendor. Excessive purchases from one vendor. Prices charged are higher than market average. Expenditures come in just under the review limit. Multiple purchases over a short period. Substandard products or services. Accelerated payment of invoices. Sole-source purchases of merchandise or services.

PRESERVING EVIDENCE BY THE BOOK
Rosetti made two photocopies of the documents and returned the original files to Bruce’s desk. “If Bruce had come back before I completed my investigation,” said Rosetti, “I didn’t want him to become suspicious and perhaps destroy other key evidence I had not yet identified.” Rosetti locked one set in his own filing cabinet. In doing this, the CPA, also a certified fraud examiner, was following a standard industry practice. (Under the “best evidence” rule accepted by courts, if the original documents are lost or destroyed, a copy can substitute for the original.)

Examination of the documents had revealed that although there were three different vendor names, they all had identical Atlanta addresses and used the same federal tax I.D. number. Believing he was seeing only the tip of the iceberg, Rosetti asked that his client do a computer run on payments made to the suspicious vendors over a five-year period. Bingo. The total exceeded $350,000, with all of the payments just under Bruce’s approval limit.

Rosetti next conducted discreet interviews with Bruce’s coworkers and superiors. “As a state worker,” Rosetti found out, “he had a rather modest salary considering his responsibilities. And he was married, had six children and a seriously ill wife.” At its warehouse, Rosetti tried to confirm the agency had actually received the items on orders Bruce had approved. “No one there could remember receiving more than a few computer cleaning kits.” And the warehouse manager told Rosetti that he recalled one vendor had given Bruce a television that—boldly—was shipped directly to the office.

CLOSING IN
The CPA felt he’d developed enough evidence to confront his suspect. Through experience and training Rosetti knew that a confession was more likely if Bruce wasn’t interviewed in the comfort of his own office. “The key to obtaining a confession is to create stress in the subject, who then will often admit wrongdoing to alleviate it,” Rosetti said. When Bruce returned from vacation, his supervisor told him Rosetti was conducting an audit of agency practices and needed to see him at the CPA’s office. “It is best to conduct admission-seeking interviews by complete surprise,” said Rosetti. “You don’t want the subject to have time to think about what to say. And you don’t want to schedule such an interview with much advance notice, because it is possible that a suspect simply wouldn’t show up.”

So when Bruce arrived at the CPA’s office, he had no idea what was in store for him. Rosetti had avoided any possibility of a tip-off. He spent a few minutes asking Bruce perfunctory questions about his duties and procedures. Then he completely changed his tack. “Bruce,” Rosetti said quietly, “we have evidence that you have been receiving kickbacks from vendors.” The color completely drained from Bruce’s face. “As confessions go, this one was easy,” the CPA said. “In less than an hour, I had the whole story, which I put in the form of a written statement for Bruce to sign. Like many other suspects, he was relieved that it was finally out in the open.”

PRACTICAL TIPS TO REMEMBER

When closing in on a fraud suspect Make copies of all suspicious documents. Don’t alert a suspect he or she is about to be interviewed. Interview the suspect in a location unfamiliar to him or her when seeking an admission of guilt. Don’t show the suspect evidence unless necessary for a confession. Convert a verbal confession into a written statement.

THE ENVELOPE, PLEASE
According to Bruce, his life of crime began when he received a $100 money order sent to his home. There was no return address on the envelope, no note, nothing. The purchasing agent, who was financially strapped, cashed the money order and spent the funds.

A few days later, he received a telephone call from a vendor who had recently started doing business with Bruce. “Did you get the $100 I sent to your home?” the vendor asked. Bruce replied, “Oh, that money was from you?” The vendor chuckled, “Yes, I just wanted to send you a little gift to thank you for your business.” The “vendor gift” is one of the most common ways unwary employees are compromised.

“Once Bruce had spent the hundred dollars, he was hooked,” said Rosetti. “The vendor told the purchasing agent there was more to come if he continued to do business with his company. Being the needy guy he was, he started approving purchases in exchange for regular cash payments from the vendor.”

In such schemes, the products or services eventually become substandard, overpriced or nonexistent, which brings up one big problem with purchasing agents who receive kickbacks: They’re hardly in a position to complain. So there is little the bribe-taker can do about it. In Bruce’s case the vendor just stopped shipping merchandise altogether. “The vendor told Bruce that unless he continued to approve invoices for payment, he would reveal his conduct to the agency,” Rosetti said. “That’s one of the reasons Bruce was relieved when he confessed; he always worried he would be discovered.”

Considering all of that worry, Bruce sold out cheap. For $350,000 in inflated or nonexistent purchases, the state worker got only about 1%, or around $3,500. The vendor sent the $100 payoffs—either in cash or by money order—to a service station owned by Bruce’s father-in-law, who didn’t know their real purpose.

“Because Bruce was very cooperative and contrite about his activities, I asked him to help get evidence against the vendor,” Rosetti said. “We recorded a series of his telephone calls with the vendor, and sure enough, the vendor offered to send money for approving invoices.” The case was turned over to the United States Attorney.

Unfortunately, the prosecutor could not press charges against the vendor because the voice on the tape recording—analyzed by a spectrograph—was not sufficiently distinct from that of the vendor’s son, who worked at the same company. Crime didn’t pay for Bruce, though: He was fired, ordered to pay restitution, spent six months in jail and was placed on five years’ probation. By any measure, that’s a hefty price to pay.

PREVENTING KICKBACKS
The agency could have easily avoided this crime by using simple but effective control measures such as

Job rotation. Bruce had been in the same position for more than six years. Purchasing agents are subject to constant temptation by unscrupulous vendors. Therefore they shouldn’t be in the same job and deal with the same vendors indefinitely. But many small organizations don’t have enough staff to rotate jobs. In that case a CPA should be hired to closely examine key risk areas such as purchasing, even if a full audit is not necessary.

Closer supervision. The agency’s manager knew of Bruce’s financial woes. After adding up the facts—an employee in financial straits who has the authority to approve purchases—Bruce’s supervisor should have been more diligent in overseeing his duties by periodically examining the purchases. Without invading employees’ privacy, managers should be alert to workers’ money pressures.

Separation of duties. The most effective control mechanism to prevent employee fraud is the separation of duties. Ideally, different personnel will handle the following duties: vendor approval, purchase requisitions, purchase approval, receiving and payment. This will not prevent collusion, but most frauds are committed by one individual acting alone.

As in most fraud cases, there were no winners in this one. The agency lost money and public trust; the vendor lost what could have been a long-term customer; and Bruce lost his job, reputation and freedom. As Rosetti succinctly put it, “With basic controls and oversight, this crime wouldn’t have happened.”

Joseph T. Wells, CPA, CFE, is founder and chairman of the Association of Certified Fraud Examiners and professor of fraud examination at the University of Texas at Austin. He won the Lawler Award for the best JofA article in 2000 and 2002 and has been inducted into the Journal of Accountancy Hall of Fame. His e-mail address is joe@cfenet.com.