Fraud in the executive suite - Fraud Findings

Internal Auditor, Oct, 1993 by Courtenay Thompson

"Although this landscaping plan is expensive, the project is long overdue. I heartily approve!" wrote the president of a West Coast company in an internal memo.

One year later the internal audit department conducted a routine review of significant expenditures involving the construction, renovation, and maintenance of corporate properties. One of the disbursements selected for review was issued in connection with the relandscaping of the company's corporate headquarters.

The contractor was an established local commercial landscaping firm. Based on the disbursement vouchers and vendor invoices, project payments totaled almost $1,000,000, including $800,000 under a written contract plus $200,000 in planning, design work, and enhancements not covered under the contract. Each of 12 invoices had been approved by the vice president responsible for corporate facilities or the recently retired former president.

When the auditors went to the facilities department to get the contract, design blueprint, bidding records, and other supporting documents, the manager informed them that the relandscaping had not been administered by his department, but by the department's vice president, who had approved most of the invoices.

The vice president confirmed that:

* He had administered the project personally, with the knowledge and approval of the president.

* There was no need for bidding because of the quality and integrity of the landscaping firm, a vendor to the organization for over 20 years.

The auditors decided to probe further because the landscaping cost seemed excessive, there was no competitive bidding, and because the contract was administered by high-level executives rather than those usually administering such contracts.

The auditors' first step was to verify compliance with the contract and blueprint by conducting a complete physical inventory of plant material installed, including several thousand trees and shrubs. The inventory disclosed several relatively insignificant shortages.

The second step was to have the project priced out by two other commercial landscaping contractors. These firms both valued the project at about $400,000, confirming the auditor's suspicion that the project was grossly overpriced.

The auditor initially considered these scenarios:

1. An unsuspecting executive was severely gouged by an unscrupulous landscape contractor who saw the opportunity to gain a large contract without competitive bidding.

2. A corporate executive or executives were in collusion with a landscape contractor to misappropriate company funds, perhaps through overcharges and vendor kickbacks.

The auditors interviewed the landscaping contractor on the pretext of discussing relatively insignificant discrepancies between the design blueprint and contract and the materials actually installed. The real purpose of the interview was to gain further information about the entire transaction and, ultimately, to determine why a contractor who had enjoyed a 20-year relationship with the organization would gouge the company.

The contractor initially defended his pricing as reasonable, due to adverse soil and site condition. However, after several intense meetings and discussion of possible legal action, the contractor reluctantly disclosed the true circumstances of the transaction. He was instructed by the vice president and former president to price the project so that it would also cover extensive landscaping and building renovation at each of their homes. The internal auditors' review of the contractor's records confirmed that excess charges of almost $600,000 covered the cost of a pool, hot tub, deck, marble patio, sprinkler system, fountain, dock, landscaping, and extensive building renovation at the homes of both executives. The contractor also said that the former president had contacted him during the audit to discourage cooperation.

The company went public with the audit findings, and the investigative file was turned over to the prosecutor. As a result of their no contest pleas, the two executives were convicted of obtaining money under false pretenses. Virtually all loses were recovered through successful bonding claims.

* Lessons to Be Learned

1. All fraud is committed by those we trust. These perpetrators were high-ranking corporate officers and pillars of the community. They were born and raised in the local area and were active in civic, charitable, and church affairs. The former president had been a strong and vocal supporter of the internal audit function and a proponent of ethical business practices. The vice president was a retired public official.

2. Professional skepticism and acting on instinct are essential for fraud detection. In this case the auditors followed through on what seemed unusual. It paid off for the auditors and the organization.

3. Audit that which is uncomfortable! Do not abandon testing or "reselect" because an item in the sample will be inconvenient or uncomfortable to review. it might have been tempting for the auditors to pass over the landscaping project. There were other projects with readily available supporting documentation that did not require a trip to the executive suite or adversarial interviews with executives and contractors. If the auditors had limited audit activity to that which was comfortable, they would have missed the fraud.