Investigative techniques to help mitigate risk
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Real Life Examples
A whistleblower at a large manufacturer alleged that an employee in the procurement department was colluding with a vendor to bill the company for security services that were allegedly never rendered. The investigation revealed several large round dollar invoices billed for security at events that the company had no record of ever occurring. The vendor admitted in an interview that some of the invoices were in fact fictitious while other invoices were for legitimate services rendered to the company. This scheme lasted several years and cost the company hundreds of thousands of dollars before the whistleblower, who worked for the employee in procurement, tipped off internal audit.
An analysis of purchases by the maintenance department of another large company revealed that the price paid for various supplies was two and sometimes three times higher than “market” value. An investigation revealed a connection between the vendor and maintenance department procurement officer.
These two real life examples have a common thread. Both companies had controls in place such as segregation of duties and supervisor approval that were either overridden by either collusion or abuse of approval authorities. Learning from the investigative process that uncovered the techniques used to perpetrate the frauds, and employing similar investigative techniques to assess procurement activity on a periodic, proactive basis may be helpful in identifying anomalies like relationships between employees and vendors and anomalies in the pattern of purchasing.
The Association of Certified Fraud Examiners describes occupational fraud as the use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization’s resources or assets.
Fraud is a potential risk in most businesses. Organizations instill a certain amount of trust in their employees in order to operate, and those within the procurement function are entrusted with access to vendor selection, vendor files, accounts payable, invoice approval, and purchase orders, which can provide an opportunity to commit fraudulent activity such as
- Bid rigging
- False billing schemes
- Vendor kickbacks
- Conflicts of interest
Whether the employee is a purchasing agent, controller, accounts payable manager, or any other employee essential to the operations of a business, a dishonest employee can present a potential fraud risk for the organization.
Degree of Risk
The degree of risk a business may face can be assessed by examining Donald Cressey’s Fraud Triangle and determining if any of its factors might be an issue for employees with purchasing responsibilities. Cressey proposed that employees are more likely to commit fraud if three factors exist:
- Incentives and pressures
Given the increased financial tension in today’s economy, more and more employees could be feeling increased financial pressure and reductions in resources due to layoffs may compromise segregation of duties potentially creating more opportunity for dishonest behavior. In addition, because of the current economic environment, some employees may feel they can justify, or rationalize, their behavior.
This situation can be perceived as an ideal opportunity by dishonest employees, including those who might be involved in procurement duties within an organization. If dishonest employees feel an increased pressure to perform or produce results, and if an organization is simultaneously lacking appropriate controls and segregation of duties, such employees might view this situation as an opportunity to use their procurement role to commit fraud.
Some of the methods a procurement employee may use to commit potential fraud include:
- Kickbacks: Kickbacks are the giving or receiving anything of value to influence a business decision. Kickbacks may be undisclosed payments made by vendors to employees in return for favorable treatment, such as bid rigging or inside bidding information. The vendor may also approach an employee about submitting or approving invoices for goods or services that were never received, and in exchange the vendor provides the employee with a kickback. Kickbacks can be payments of cash, but can also be in a form that is more difficult to detect, such as payment of personal loans or credit card bills, transfers of property or vehicles at less than fair market value, lavish vacations, or a hidden interest in the vendor’s business
- Conflicts of interest: If an employee has an interest in the financial well-being of a vendor, a conflict of interest could exist. This may take the form of being a part-owner in the vendor company, or knowing someone close, e.g., a spouse or other family member, who works for the vendor and can receive rewards for business the employee provides. Any of these situations can impair a dishonest employee’s ability to conduct business with the organization’s best interests in mind
It is important to be aware of anomalies in the purchasing function such as:
- Expenditures do not make economic sense (dollar amount and timing)
- Orders are consistently made from one vendor without inquiring with other vendors for comparison purposes
- Costs of goods or services are higher than competing vendors
- Poor documentation for expenditures
- One-time payments to vendors (vendor often not officially set up and cleared through accounts payable)
- Large round-dollar payments
Data analysis can help with identifying anomalies in purchasing.
For example, analyzing the vendor database, payroll database, and accounts payable database can assist organizations identify potential undisclosed relationships between employees and vendors and identify anomalies in purchasing for potential follow-up such as:
- Common bank account, address, and phone numbers between vendors and employees that may indicate a potential conflict of interest
- Duplicate invoices with the same supplier
- Invoices from different suppliers with the same dollar amount, date and invoice number
Data analysis can provide trend data, such as the number of invoices from suppliers over time, unusual invoice number sequencing, and dollars spent for goods and services purchased from a particular vendor. This can assist with answering the question, “does the dollar amount and timing of purchases from a particular vendor make sense?” Furthermore, analyzing the actual purchase orders and invoices can assist with answering the question, “does the price paid for the goods and services make sense?”
In addition to data analysis described above, some commonly used investigative techniques can also be used to help identify anomalies in purchasing:
- Employee interviews can be useful in discovering potential procurement fraud. Interviewers sometimes find that employees have information about potential inappropriate relationships between employees and vendors or are suspicious about certain transactions. Interviews at all levels within the company can give insight into the daily operations and can reveal fraud risks which may be otherwise unknown to the organization.
- Background checks can provide information on the background, integrity, and reputation of selected individuals and entities. A small amount of time spent performing a background investigation, such as Secretary of State records searches, might reveal connections between employees and vendors. Additionally, it can provide history on vendors’ performance, legal proceedings, and other relevant information.
- Electronic discovery, such as extracting and analyzing e-mail files, can identify any questionable correspondence between vendors and employees using an organization’s computers.
These tools can be used proactively by organizations to help identify potential fraudulent activity. Recognizing the red flags commonly associated with procurement fraud and using tools such as data analysis, in addition to other investigative techniques such as interviews and background checks, can go a long way in helping the organization mitigate the risk of fraud in the procurement function.
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As used in this document, ‘Deloitte’ means Deloitte LLP (and its subsidiaries). Please see www.deloitte.com/us/about for a detailed description of the legal structure of Deloitte LLP and its subsidiaries.