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Using Tips & Technology to Prevent Fraud Schemes


Adolfo Pesquera and Carolyn Newman

Local government entities rely on tips and complaints to sniff out corruption within their departments. Once the appropriate officials receive some hint of wrongdoing, or are notified of an irregularity, the auditing department plays an important role in proving the case.

Tom Wiss, legislative auditor with the Unified Government of Wyandotte County-Kansas City in Kansas, wrapped up such a case in early 2010 that involved two employees of the county's Auto Licensing Department.

The case began when a police officer pulled over a driver on a routine traffic stop. The driver's license tag documents were checked and came back as unregistered with the state, even though they appeared authentic.

The driver had in fact paid for his license tag and he returned to the Auto Licensing Department and complained. The employee he dealt with found the driver's registration was voided at the office by another employee. No further explanation was provided.

Suspecting fraud, the driver then notified the district attorney's office, which in turn notified Wiss.

Wiss ran computer reports of transactions going back two years. He found that two employees were randomly taking registration fees from citizens, then voiding their registrations after giving the citizens tags and receipts. The employees pocketed the money.

"There were over 200 transactions involving $130,000 in stolen cash," Wiss said. The fraud began about two years ago, and had been accelerating as time progressed. The employees were charged May 17, 2010 with theft and computer crime, Wiss added.

Data analysis provides the forensic accountant, and even less specialized accountants, the means to sift through the most complex and voluminous data bases in order to spot anomalies and violations of company accounting policy. Data analysis, as a tool for fraud detection, provides accountants the ability to find these anomalies much quicker than is possible through conventional means, delve deeper than is possible by conventional means, and test these anomalies through statistical sampling.

There is no better technological tool for mining databases, safeguarding their integrity and bringing government agencies into full compliance with federal fraud detection mandates.

Alex Valadez, an IT auditor at the city of San Antonio, worked a fraud case dealing with city inventory. In coordination with the city's Office of Municipal Integrity, he acquired documents and converted them to a database format.

He wanted to see if certain products were purchased at a normal periodic rate. Using data mining software, Valadez said the auditor learns the characteristics of the data, then he runs statistical samples to look for abnormalities.

"If there is an abnormality, you check to see if it corresponds with the tip," Valadez said. "If it does, you go ahead and get the supporting evidence."

Tips and complaints from fellow employees or the public are the most common method by which fraud in government is initially discovered.

According to the Association of Certified Fraud Examiners (ACFE), 40.2 percent of fraud cases are initially detected through tips, usually by employees who know the offender. Internal and external audits combined, only detect 18.5 percent of fraudulent activities.

Consequently, fraud hotlines are common in local government. Danica Rogers, spokesperson for Long Beach, Calif., said their department set up a hotline, which was inspired after attending a 2006 ACFE conference.

In the years since its launch, Rogers said two-thirds of the calls relate to the city of Long Beach. Time card fraud is among the most common complaints, Rogers said.

Long Beach uses a third-party provider to assure employees of anonymity.

"They don't want to worry that we're going to figure out who they are," Rogers said.

Tips of some kind are very important to public officials. Less than 20 percent of fraud cases get discovered directly through some form of audit, but even in these situations, the details of a specific fraud scheme are most likely to be unraveled by specially trained investigators.

Certified fraud examiners bring skills that most accountants do not have. Among certified public accountants like Ralph Summerford, a CFE in Birmingham, Ala., this skill set includes knowledge of data analytic software tools.

"Virtually all business is done through computers," Summerford said. "To do an investigation properly, the investigator needs to know how to use the tools that can reach the data."

These tools eliminate old methods such as random sampling by running statistical scripts that examine anomalies in the entire data base, even if the database contains millions of transactions.

Summerford cited the example of a case involving the Los Angeles Unified School District. He searched vendor contract records for contracts issued at a range just below the threshold for mandatory bids. The threshold was $15,000.

"We found one painting contractor who had three contracts at the same school, at the same time, for the same type work, all of them at around $14,800," Ratley said.

It was obviously a $45,000 contract that avoided the bid process. It was illegal contracting, Summerford said.

"Once we find something like that, then we start looking into the individuals who gave the contracts," he added.

This normally involves inspection of the vendor's books. The auditor looks for diversions of funds into accounts belonging to government employees or their relatives. But the local government agency must have access to the vendor's records.

"This is why we always recommend that government entities have in their vendor contracts a 'Right to Audit' clause," Summerford said.

James D. Ratley, ACFE president, said most fraud occurs because of a failure of internal controls. There must be a separation between the recording of an asset and the custody of an asset.

But it is common for this crucial separation to periodically disappear. What often happens is policy makers, in an effort to cut costs, cut corners. One person is laid off and the employee in charge of record-keeping also becomes custodian of the asset.

This can occur in many departments, Ratley said, including tax collections, the handling of vendor fees, or confiscated property held in the storeroom of a police station or sheriff's office. 

Another high-risk situation for fraud is where the public official has some control over a government-contracted vendor's access to income. This can lead to bribes and kickbacks.

Such a kickback scheme came to light recently in Dallas, Ratley said, when media reports exposed the relationship between a Dallas County constable and a tow truck company.

Because of the persistent economic effects on government budgets at every level, there exists a greater sense of urgency to combat fraud today.

About the authors: Adolfo Pesquera is a journalist and independent business writer. Carolyn Newman is a CPA, CITP and president of Audimation Services, Inc


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