A True Story of AP Fraud ...
a Woeful Failure to Segregate AP Duties
Posted by Rakesh Shukla on Tue, Feb 10, 2009 @ 03:17 PM
In my last blog entry, I explored the importance of segregating AP duties.
Today, I will present a fascinating case study of AP Fraud that highlights the risks of poor AP internal controls.
This is a true story.
Our tale concerns a husband-wife team who colluded with an outside vendor to fleece their company of at least $2 million over a seven-year period. As related in one of our AP fraud white papers, the target of this sustained fraud was the well-respected newspaper, The Charlotte Observer, where poor internal controls contributed mightily to the scandal they were, to their considerable embarrassment, obliged to report in their own pages.
The Profile of an AP Fraudster
The mastermind of the scheme was a Mr. Johnson, a white male and 22-year employee of the newspaper with an unblemished record. Believe it or not, this is the typical profile of an AP Fraudster.
It was Mr. Johnson's good fortune to serve as a purchasing manager who also had authority to both receive goods and services and approve invoices for the same. The invoices would naturally flow through the AP department, where Mr. Johnson's wife happened to work. All the Johnsons needed to complete a seamless scam was a cooperative and unscrupulous vendor. Mr. Johnson cultivated a friendship with a favorite supplier until they became close enough that he could propose his ploy: for every two shipments you send me, invoice The Observer for three, and we'll split the payment for the phantom shipment!
Too Many Hats for One Head
The breakdowns in internal controls that allowed this arrangement to prosper over a 7-year period are manifold. Consolidating so many responsibilities in the hands of even the most trusted of employees is the first bright-red flag. A married couple with entangled duties connected with AP is another red flare. Significant budget variances, on the order of $50,000 of bogus charges per month per department, were overlooked as boom times created a lax atmosphere that tolerated such large discrepancies. Poor inventory controls allowed non-existent shipments to be processed and paid for. To top it all off, nobody involved was bonded and the company wasn't insured against such a loss.
NASCAR Insider?!? Where was the Common Sense?
While there is no question that better systems and procedures might have excised this cancerous scheme, simply bringing common sense to bear would have at least curtailed the loss. During the seven years that the Johnsons were siphoning off a substantial chunk of The Observer's revenue, their lifestyle took a dramatic turn for the better. They sold their old home, moved into a new lakefront mansion in an exclusive neighborhood, added a swanky boat, traveled like pashas and stockpiled fancy automobiles. Indeed, not only did Johnson flaunt his new-found wealth, he abandoned discretion entirely by incessantly insinuating himself into the picture - literally - in the very high profile world of NASCAR. Every week, it seemed, he would be photographed bear-hugging the winner at the victory celebration, an awesome display of insider status in the region's most revered sport.
Meanwhile, his demeanor around the office was quite the opposite. Formerly out-going and hands-on, Johnson retreated into his office where he spent most of each day behind a closed door and drawn blinds.
How could anyone, indeed everyone, have failed to notice? The answer is that of course people noticed, but they didn't trust their intuition enough to call Johnson's bluff. All Johnson had to do to deflect curiosity over the course of the better part of a decade was claim an aunt died and left him an inheritance. Naturally, once the fraud was unmasked, the aunt was discovered to be as imaginary as the stream of phantom shipments Johnson authorized and his wife paid for.
AP Internal Control Breakdowns
Clearly, a woeful failure to segregate duties was at the heart of this calamity. Had Johnson not had the power to approve his own actions, this fraud might have been prevented altogether. Improved transparency and more disciplined approval framework would also, at the very least, make a fraud such as Johnson's more difficult to launch and impossible to sustain.
While Mr. and Mrs. Johnson eventually received their comeuppance - curiously, The Observer did not take immediate legal action upon their exposure - the newspaper nonetheless took a substantial hit, both in terms of financial loss and tarnished reputation. Nor were the perps the only people to suffer: managers who presided over the slipshod operations were sacked, steering lives and careers off track. The real tragedy of this tale is that if today's AP automation software and associated best business practices had been in place at The Observer, this entire fraud, and all the damage that ensued, would never have happened in the first place.
-Rakesh Shukla
@rakesh170
Related White Papers
- 7 Pillars of Strong Internal Controls:
This white paper explores how technology such as business process automation and imaging software can strengthen internal controls in 7 significant ways. (Download White Paper )
- AP Fraud Case Studies:
This white paper uses a series of real-world tales of fraud - some novel, some notorious - to illustrate how business process automation & imaging software provides improved internal controls, particularly where the unstructured world of paper meets the structured world of the ERP transaction record. (Download White Paper)
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