Beyond the Whistle Blower: A Forensic Case Study
In most forensic investigations, the scope of an examination is focused on the theory of the suspected bad act(s) or issue(s). For example, the procedures used to determine suspected falsification of financial statements to inflate profit would be different than those for suspected embezzlement of funds. However, many times the evidence obtained while investigating one area will point to an entirely different bad act. Below is an actual case illustrating this point, with some of the facts and details changed for client confidentiality.
ABC, Inc. was a large privately held U.S. manufacturer of consumer goods, with annual sales just north of $1 billion. ABC had previously been a publicly held company but had gone private in the early 2000s. In the fall of 2012, ABC merged with U.S. publicly held XYZ, Inc., becoming the ABC operating division of XYZ. During the integration into XYZ, Sarbanes-Oxley type control procedures were implemented across the new ABC division by XYZ management. One of those control procedures was a whistleblower mechanism whereby any employee could anonymously report suspected illegal or ethical violations.
In March 2013, a report came into the hotline asserting that the reporter believed the general manager of a certain ABC plant was manipulating inventory in order to hit profit margin goals. Because of the specific details of the claim, and since ABC was then just becoming part of XYZ, an independent investigation was authorized. In June 2013, two independent forensic accountants visited the plant, along with one representative from XYZ’s internal audit team. The exact reason for the examination was kept confidential to everyone outside of XYZ internal audit.
Gaining online and manual access to confidential system data was achieved through the XYZ internal auditor. Additionally, documents were obtained and interviews conducted with employees across a wide assortment of departments in order to disguise the true focus of the investigation. Sprinkled into most of the interview questions were hotline-type questions about whether the employee was aware of harassment, violation of company polices, illegal or unethical behavior, etc.
During an interview with a supervisor from one of the production lines, the supervisor noted that it seemed strange to him that the plant controller’s brother, Bob, had been seen in the local town with an expensive new truck and had bragged about acquiring a very nice boat for cruising in the nearby ocean. Bob’s one-person company, Handyman, LLC, was often hired by ABC to do odd jobs. Because it was a close-knit community and most everyone knew each other, the supervisor could not think of any good reason that Bob would be able to afford these things. Even though Bob regularly did some work at the ABC plant, the supervisor believed that the economy of the area had not fully recovered from the Great Recession. He further suggested that the controller should be looked at to see if there was any “funny business” with his brother Bob.
With the unexpected claim of possible embezzlement emerging during the interview, the scope of examination was expanded to include analysis of the internal controls surrounding payment of vendors, and specifically all payments to Handyman, LLC for the last two years. Through direct request of plant personnel as well as access to online and hard copy files through internal audit, it was determined that Handyman, LLC was paid almost exclusively by manual check rather than the accounts payable check processing system.
An analysis of the manual check system revealed a very weak control structure, especially prior to ABC’s merger with XYZ. There was no dual signature required on manual checks, and the controller was the only person with access to these checks. The checks were kept locked in the file cabinet in his office, and he was the only person with a key.
Upon examination of the documentation, it was determined that Handyman, LLC had been paid an average of approximately $25,000 per year of work for ABC. However, for the 12 months or so prior to the merger, payments to Handyman, LLC ballooned to approximately $235,000. Of this amount, only $45,000 appeared to be supported with enough detail to conclude that the payments were valid. The remaining payments had no documentation in the file and were in large, even amounts, such as $22,500. The payments that were determined to be valid were never this large and were always for odd amounts.
The accounting records also reflected that the vast majority of the undocumented payments were charged to a special account, “construction in progress,” which was set up to capture payments for a large multi-million dollar expansion to the plant. Upon examination, it was determined that the payee as recorded in the system for these checks to Handyman, LLC was falsified to appear that the payments were made to another approved contractor actually working on the expansion. It was further determined, by analyzing the journal entries and login data, that the controller himself had posted these fraudulent entries to the accounts, bypassing the accounting clerk who normally posted all manual and computer-generated payments.
As a result, it became apparent that the controller had taken advantage of the weakness in oversight over the manual checks as well as the knowledge that the construction in progress account would not receive the same level of scrutiny as the normal operating accounts. With the merger into XYZ in 2012, and the normal chaos and write-offs that typically occur during mergers, it appeared that the controller and his brother were convinced they would never be caught. After the merger, there were no further unsupported payments.
Upon presenting these findings to XYZ management, it was decided that the controller would be terminated the next day. Ironically, the original claim of financial statement manipulation by the general manager could never be substantiated. XYZ did not press charges, satisfied to just terminate the corrupt controller and move forward with better internal controls.
This particular assignment illustrates that sometimes evidence will point in an entirely unexpected direction….kind of like a box of chocolates. You never know what you are going to get!
