Investigating Occupational Fraud

Bert Davis

By Bert Davis Jr.

In the late 2000s, a manufacturing company in North Carolina with about $30 million in annual sales discovered that over one million had been embezzled from its operating account.

The theft was detected when a member of the company’s independent audit firm staff observed unusual ATM debits coming from the bank account for items from Walmart, Hickory Farms and cash withdrawals. The audit partner raised the issue with the company CFO. The CFO explained that the layoff s caused by the economic downturn had caused much hardship and that he would buy items such as hams and turkeys for the laid off families during the holidays.

However, a quick review of the bank statements indicated that several thousand dollars had been spent at times other than the holidays. The audit partner escalated the matter to the CEO who requested the audit firm do a complete investigation. Thus, began a classic finance professional- driven investigation that started at the top with the perpetrator CFO and worked down from there.

This sounds like a logical investigation method, but law enforcement professionals will often recommend an investigation start at the bottom of the organizational chart and work up. For example, any banker will tell you that when the FDIC comes in to do an inspection, they start with the tellers and the customer service professionals rather the vice presidents.

Four Layers of Investigation
I have handled a number of these investigations. Investigators are typically called in by attorneys who frequently are the first person called when a client discovers a possible embezzlement. We understand that if a fraud scheme is being perpetrated, quite often there are different layers of awareness of the scheme at different levels of the company.

As an investigator, I have the benefit of starting at the outer layers of awareness and working in. I can learn much more information this way. Also, the perpetrators will be aware that an investigation is ongoing and will begin to worry greatly about what is being discovered. This creates pressure for the perpetrators to start to reveal what they’ve done in more honest detail sooner rather than later.

First Layer. The first awareness layer is that of the perpetrator(s). They are the ones active in and benefitting from the scheme.

Second Layer. The second layer of awareness includes the people who work closely with the perpetrators. These people quite often know something is going on, but may not have a complete understanding of the extent of the fraud scheme. These folks may work directly under the perpetrators or in some proximity to them. The second layer folks quite often will discuss obliquely what they know with other colleagues in the organization, but they won’t say too much for fear of reprisal should they be discovered by the perpetrators.

Third Layer. This creates a third layer of awareness comprising folks who know something is going on, but know even less about the extent of the scheme than the second layer people.

Fourth Layer. There may even be a fourth layer of awareness of people far removed from the scheme. In the case of this manufacturing company, even the guys in the warehouse knew that something wasn’t right in the company. These fourth layer folks figured that if they knew about something, then everybody including the CEO must know what’s going on and are okay with it. This results in a culture of corruption where the people with least knowledge assume the worst.

More than Hams and Turkeys
In the case of this manufacturing company, despite many people in the company suspecting a large fraud scheme, only three people were involved: the CFO, the accounting director and the human resources director. Obviously, in a case like this one, where people at this level in a company are colluding, they can steal a lot of money before being detected.

The extent of the scheme was much broader than just hams and turkeys. The three management employees embezzled excess compensation for themselves and gave extra severance checks to laid off employees. The auditors determined that over five years as much as $1.3 million had been misappropriated with only about 10 percent actually benefitting the laid off employees.

Bert Davis Jr., CPA, CFE, CFF, is the owner of Davis Forensic Group. His firm provides financial investigation support to attorneys and their clients. Bert has conducted forensic investigations and testified as an expert witness. He also worked as a special master in the NC Business Court and as an examiner in the U.S. Bankruptcy Court. Bert is a regular presenter for professional groups and was recently awarded the 5.0 Speaker Award by the NC Associations of CPAs. He has a master’s degree in accounting from UNC Chapel Hill and an MBA from Wake Forest University. Contact Bert at bdavis@davisforensic.com or (336) 543-3099.