Learning objectives

• Identify how procurement policies of a fictitious governmental organization can be circumvented and lead to possible fraud.
• Determine the effect technical expertise plays in the development and execution of procurement policies in a fictitious governmental organization.

Before we start

Governmental organizations typically focus controls more on cash receipts than on cash disbursements in order to prevent, deter, or detect the misappropriation of cash. Fraud schemes to misappropriate cash also can occur when an entity pays for goods or services it does not receive. Factors contributing to this particular situation include the following:

• Highly technical transactions
• Insufficient number of trained personnel
• Lack of personnel, or lack of trained personnel, in support functions

Typical situations that might indicate the existence of procurement or contracting fraud include the following:

• Unusual vendor names and addresses
• Copies of invoices, purchase orders, or receiving documents rather than original documents
• Missing paper or electronic supporting documentation such as invoices, purchase orders, or receiving documents
• Orders for materials and supplies already on hand in sufficient quantities, scheduled for disposal, or no longer used due to obsolescence
• Orders for materials and supplies not consistent with the operations or mission of the organization
• Delivery addresses not part of the purchaser’s physical locations
• Payments to vendors not on approved vendor lists
• Signature of management or supervisory personnel on documents typically signed by subordinate personnel
• Suppliers and contractors receiving significant amounts of business from the organization

Background

Riverside is a primarily blue-collar small city located in a major metropolitan area. It borders the county seat, St. Charles. Most of the city’s residents are retired or work outside the city in other areas of the metropolitan area. Although the metropolitan area’s population has increased significantly over the last 20 years, Riverside’s population has steadily declined. The decline in population has reduced the need for city services; and, as a result, the city employs about half as many people as it did 20 years ago. Four years ago, the city hired the director of St. Charles’ planning department as its city manager.

Riverside has limited personnel in the accounting and information technology (IT) functions, both of which report to the city manager. The accounting function is led by an accounting manager who supervises one accounting clerk and one utility clerk. In the IT function there is only one position, the IT manager position. Both the accounting manager and the utility clerk have worked for the city since they graduated from high school 50 years ago. The accounting clerk was hired two years ago upon graduation from the region’s premier university.

When the city’s current financial management system was installed four years ago, it became evident to the accounting manager and city manager an IT manager was needed. The salary advertised for the position was far less than market salaries for similar positions in the area and very few qualified individuals applied for the job. After advertising the position for almost a year, the city hired a recent information systems graduate from a small out-of-state college. The IT manager is responsible for overseeing operation of the financial management system and for administering the city’s internal and external networks, website, and social media.

Knowledge check

1. Which is accurate of Riverside?
   1. Riverside is located in a rural area.
   2. Riverside is a growing city.
   3. The majority of the residents of Riverside work in Riverside.
   4. Riverside employees about half the number of people it did 20 years ago.
2. Which is not accurate of Riverside’s IT function?
   1. The IT manager position was created four years ago.
   2. Very few individuals applied for the IT manager position when it was first advertised.
   3. The IT manager graduated from the area’s premier university.
   4. The IT manager position is responsible for overseeing operation of the financial management system and for administering the city’s internal and external network, website, and social media.

The case

The following conversation occurs between Accounting Clerk Savanah Zhang and IT Manager Justin Barnes as they are walking into city hall early on a Monday morning. They are discussing Utility Clerk Gloria Elker and Accounting Manager Mercedes Slater.

“Hi there, Justin. What brings you in this early on a Monday morning?”

“Oh, hi there yourself, Savanah. I’m usually in this early to make sure everything is all good for you, Mercedes, and Gloria. What’s in the bakery box?”

“It’s Ms. Slater’s 50-year work anniversary today and we’re celebrating with her favorite yellow cake with chocolate frosting. Yum, yum.”

“I can’t believe Battle-Ax Mercedes has worked here 50 years. You would think she would have retired by now along with crazy Gloria.”

“Wait a minute there, Justin. That’s a terrible name for Mercedes, and Gloria is not crazy. She may have five cats and be as old as Mercedes but it doesn’t make her crazy. In fact, I think she’s one of the least crazy people I know. I hate to think what will happen when she and Mercedes decide to retire, though. Thank goodness both of them still love what they do here at the city.”

“Whatever. Have a great day, Savanah.”

Justin walks down the hall to his office while Savanah goes into the breakroom to put Mercedes’s cake in the refrigerator. As she is getting her desk ready for the day, Savanah mutters:

“I was going to ask Justin what was up with the sweet ride I saw him get out of this morning but, nooooo, he couldn’t be bothered to hang with me much past the door.”

“What’s that, Savanah?”

“Oops, hi Mercedes. I didn’t realize you were already here. Sorry, I was talking to myself and thinking about Justin’s car.”

“What car? He drives a 10-year-old F150 his daddy passed down to him.”

“Well, I don’t know about the F150, but the car he got out of this morning was some sporty little number. I couldn’t tell you what make or model, but it was definitely new, or new to him, because it had a temporary license tag. It was a color somewhat like lapis lazuli.”

Utility Clerk Gloria Elker walks in saying:

“Who’s lazy, Savanah, Justin? Oh, hi Mercedes. How was the weekend with the grandkids?”

“Holy buckets, Gloria, are your hearing aids turned on? She said lapis lazuli, which is apparently a color. I’m not sure what color it is but it sounds exotic. Oh, yes, the grandkids were wild, but I loved every minute they were with me.”

“You guys are nuts. Lapis lazuli is my favorite shade of blue and the color of Justin’s new car.”

“Well, well, well. Lazy Justin got a new car. I guess he’s too good for a beat-up 10-year-old F150 now that he is a homeowner in the ritzy new condo building in uptown St. Charles. Where is he getting the money for all of these things, anyway?” Whispering, Gloria says to Savanah, “Did you remember the surprise?”

“Gloria, stop whispering. You two talked about the cake every time I turned my back last week.”

“Mercedes, you are no fun, but we should have known it would be impossible to pull one over on you. Gloria, I’ll get the cake if you’ll call everyone in to wish Mercedes a happy work anniversary.”

“Sure thing, Savanah.”

A few days later Savanah is processing invoices for payment while Gloria is getting ready to print utility bills.

“Savanah, I’ll be done with printing the bills in about 30 minutes. Do you want to go to lunch together? Mercedes is working through lunch because she needs to leave early for a dental appointment. She said she would hold down the fort while we’re gone.”

“It sounds great, Gloria, but I have a ton of invoices to enter by noon tomorrow if I’m going to get checks in the mail Friday. You know these crazy vendors we use always want to get paid on time. What’s up with that, anyway?”

“How about I bring you something back from Blossoms? Isn’t their strawberry salad one of your favorites?”

“Would you? By the time you get back, I should be able to sneak 15 minutes in the breakroom to eat it. Gloria, you always know everything going around town. Have you heard if we have a new tech shop in town? Justin sent in paperwork to set up a new vendor and I haven’t heard of them.”

“I haven’t heard anything about a new tech shop coming into town, but I haven’t talked to my cousin at the Chamber lately.”

“No problem. I’ll see what I can find out about them but there may not be much if they’ve only been in business a short while.”

Later in the afternoon while Savanah is eating lunch in the break room, she sees Justin walking to his car with several boxes and his laptop bag. City manager, Grant Martin, walks in while she is there.

“I wonder where he’s going with those boxes. He’s got his laptop, which makes it look like he’s heading home for the day. A six-hour workday must be nice.”

“Who are you talking to, Savanah?”

“Oh dear. Hi, Grant. I hate to admit it but I’m talking to myself. I’d like to say I picked up the habit from Gloria and Mercedes but I’ve talked to myself for as long as I can remember.”

“What is it they say, it’s when you answer yourself you have to worry. Isn’t it a bit late to be eating lunch?”

“I guess it is, but I need to get everything entered by noon tomorrow for the weekly check run. I’m taking a short lunch to make sure I have time to get everything done on time.”

“All of you in accounting work too hard for what the city pays you. I wish I could tell you things would get better, but I’d be lying. It’s no secret next year is going to be tighter than this year as everyone knows we haven’t had any new construction or any commercial growth for almost three years.”

“Funny thing. Justin gave me paperwork today for a new IT shop in town, which could mean things are about to get better. As for next budget year, you might want to mention this to him as his IT budget has increased dramatically since I started here two years ago. I seem to process more invoices for IT than I do for any other department, including the police department!”

“I realize we spend a lot on IT, but Justin has a strategic plan for our IT future and it apparently does not come cheap.”

“Well, the buck stops with you, Grant. I sure wouldn’t want your job.”

“Some days I don’t want it either, Savanah. See you later and don’t work too late.”

The next morning Savanah is reviewing the accounts payable edit report while Gloria is sorting utility bills into carrier routes for mailing.

“Gloria, could you look at something for me?”

“Sure, Savanah. What do you need?”

“Yesterday when I was in the breakroom eating my very late lunch—thank you again for bringing me the salad—Grant came in and we talked for a bit. He mentioned next year is going to be tighter than this year. I was thinking last night on my way home about Justin and all of his spending. I couldn’t wait to get in this morning to look at a few things in this week’s check run that bothered me yesterday.”

“Gloria, look at these invoices Justin submitted for payment this week. Do you know what any of this stuff is? He’s coded this invoice to computer supplies in the police, fire, and public works departments. This invoice here is coded to computer parts and he charged it to his department. How do we know these are even computer parts, much less computer parts we need?”

“I don’t know, Savanah. We’ve always taken Justin’s word for these things. When I helped out with AP before we hired you, I used to think the same thing. Doing two jobs every day didn’t leave me much time to worry about it though.”

“What are you two up to now? You already had an anniversary cake for me. What’s next—a recognition dinner?”

“No, Mercedes, the cake was all we had up our sleeves. I’m showing Gloria some of Justin’s invoices which are in this week’s check run. Here, let me show you too and see what you think.”

Savanah shows the invoices to Mercedes and points out what she and Gloria discussed.

“This is all pretty interesting, Savanah. Are there any other invoices like this?”

“I’m not sure, Mercedes, but I wouldn’t mind working late to see what I can find.”

“You do that but don’t stay too late. Life is yours to enjoy at your age. I don’t want to be the reason you burn out before you’re 30.”

“No worries there, Mercedes. If I get into things can I keep looking? I really don’t mind staying late or coming in this weekend.”

“I don’t have a problem with it but please don’t work too late. If you do, call Dispatch and have someone come over to escort you to your car.”

“Yes, Mom.”

Over the next two weeks, Savanah looks into all amounts Justin charged departments and his IT function for anything technology related. She also uses the Internet to check out vendors she isn’t familiar with and those Justin requested to be added to the approved vendor list during his four-year tenure. During her investigation she noted a number of invoices were paid over a three-year period to two vendors for “consulting services.” When invoice details were sparse, she used the Internet to determine the purpose of the various parts listed on the invoices. She noted five vendors supplied “computer parts” to the city but never provided any supporting documentation for the amounts invoiced.

After two weeks, Savanah meets with Mercedes in her office to discuss what she found in her investigation.

“I’m looking forward to hearing what you have to report Savanah. For the record, I am not pleased with the amount of time you spent investigating instead of enjoying yourself. You are too young to be spending all of your free time at work.”

“Mercedes, it’s really all right. It’s especially all right because what I found makes everything worth all the extra hours. I’ll send you copies of everything I have when we’re finished here if you want them.”

“This sounds ominous, Savanah. What did you find exactly?”

“Here is a summary of my findings and I have the backup documentation with me if you would like to see it as well.”

“It’s all right, Savanah. The summary is fine for now.”

“If you look at the summary, you’ll see we paid five vendors over $250,000 for ‘computer parts’ or ‘computer supplies.’ These five vendors were set up at Justin’s request over the last four years. I find it odd that there are no receiving reports for any of the invoices from these five vendors. In fact, the only supporting documentation for any payment is the purchase order and invoice, both of which Justin approved. I looked at all of the invoices to see who ordered the parts and in every single case it was Justin, even when the parts were charged to another department. Because we paid these vendors a significant amount of money, I called all of them to ask what some of the parts were. Almost all of the parts we paid for are for types of computers and other hardware we don’t use at the city.”

“What are you saying, Savanah?”

“I don’t know where the parts are or what Justin did with them, assuming he received them, which isn’t a fact since there are no receiving reports. Justin ordered them and if they aren’t compatible with our city hardware, I can only think Justin ordered them for personal purposes. Maybe he has a computer business on the side or maybe he sells the parts on Amazon, eBay, or Craig’s List. I don’t know anything for sure other than things look suspicious.”

“What else did you find, Savanah?”

“We paid two vendors $75,000 each for ‘consulting services’ and I can’t find any evidence the vendors even exist. The invoices look legit, but the vendors are ghosts. I searched the Internet, white and yellow pages, chambers of commerce in the cities the invoices indicate they’re located in, as well as the Better Business Bureau. I called the phone numbers we have on file for them in our vendor master file and they are not in service. None of the invoices indicate a physical address, only a post office box, which means I couldn’t use Google Maps to find them.”

“Oh dear, even I can see where this is going. Are you saying what I think you’re saying, Savanah?”

“If you think I’m saying Justin looks to have scammed the city out of $150,000, then yes, this is what I’m saying.”

“Let me think about this tonight and we’ll talk again tomorrow.”

“Sure thing, Mercedes.”

“Before you go, do you have a few minutes to look at something with me?”

“Sure.”

“Pull your chair up to my desk since everything is on my computer.”

“Wow, you’ve got a ton of screens open right now!”

“Bear with me while I go through them with you. For the last six months, the bank recs have been a bit off. Every month there seems to be a lag between the dates the state says it processes our electronic funds transfers, or EFTs, and the dates they are hitting the bank. With cash being as tight as it is, I monitor the bank balances daily and especially on payroll weeks. The last thing I need is to bounce employee paychecks!”

“Switch places with me Mercedes so I can see look at all the screens.”

A few minutes later Savanah looks at Mercedes and sighs.

“I’m not sure why, but there is a difference in the dates, and it seems as if most months the lag is five days. Have you called the bank or the state about it?”

“Not yet because I needed to have another set of eyes look at things. If you still have time, let’s call them now.”

After spending 20 minutes on the phone with the state department of revenue and the city’s banking representative, Mercedes learns the bank routing number and the account number the state is using for the EFTs are not correct. She also learns the bank information for the incoming EFTs is likewise not correct. The bank sends Mercedes a copy of a memo authorizing the change to the bank’s EFT information.

“I wish the bank would hurry up and send me the memo. The last time I made any changes was 10 years ago when the city switched banks. I am the only one authorized to make changes to either the state or bank EFT information . . . oh dear. Two years ago, I was out on disability for six weeks when I had my back surgery. We added Justin to the list in case anything came up when I was out, but he told me nothing did. Do you think, no certainly not . . . ”

“Mercedes, you have a new message and it’s from the bank.”

“Move over and let me open the message and print the attachment.”

Mercedes and Savanah both look at the memo sent from the bank.

“That little slimy-faced, son of a fraudster, snit. Do you see this Savanah? Look at this! Justin sent this memo to the bank the first week I was out of commission. Why would he do it and what are these account numbers? Let me pull up our account information on file with the department of revenue and see what routing and account numbers are on file.”

“Well I’ll be . . . the account information for the outgoing state EFTs is the same as the account information on file with the bank for the incoming EFT but neither are city account numbers. Trust me, after all these years, I know our account numbers by sight. Looks like the bank information was changed, thanks to Mr. Barnes. What do you think is going on Savanah?”`

“This may sound crazy, Mercedes, but what if Justin is routing the state EFTs to an account he controls and is in his name? If I had to guess, I’d say he lets the funds sit in this personal account of his for a few days while he earns some interest before he transfers money from it to the city’s account at the bank.”

“Savanah, I think you may be on to something. I have never had a good feeling about Justin but couldn’t put my finger on why. Everyone around city hall knows I’m not a fan and now it seems I’ve had good reason not to like him.”

“Mercedes, I think you need to take this to Grant as soon as possible and let him decide what needs to be done. This is way above both our pay grades.”

“Why don’t you pull together a memo under my name summarizing your investigation and what we learned this afternoon? After I review it and your other documentation, I’ll let you discuss it with Grant.”

“No, Mercedes, you need to be the one to discuss this with Grant.”

“Savanah, it will be a lot better if the messenger is someone without a known grudge against the apparent fraudster.”

“I see your point and I’ll do it, but I still think you should be the one to discuss things with Grant.”

The following discussion takes place in the office of the city manager, Grant Martin, one week later.

“Hi, Savanah. I was expecting to meet with Mercedes.”

“I know and she sends her apologies. Based on what we will be talking about, Mercedes thought it best you hear it from me. It concerns Justin and she has never really hidden how she feels about him. She thought you might be more receptive to listening if it came from me because I don’t have any issues with Justin. At least I didn’t until a few weeks ago.”

“Well, I am certainly intrigued, Savanah. You have my undivided attention.”

Over the next 15 minutes, Savanah explains her analysis to Grant as well as what she and Mercedes learned about the EFTs from the state to the bank.

“Savanah, you and Mercedes have done a great analysis here and I’m having a hard time believing what I think I’m seeing. What prompted you to do your analysis anyway?”

“Well, it all started last month when I walked in with Justin and noticed his new lapis lazuli sports car in the parking lot . . . ”

“Lapis what?”

“It’s a gorgeous deep blue color and my favorite shade of blue, which is probably why I noticed it.”

“All right, finish what you were saying before I interrupted you.”

“Umm, yes. It all started when I saw his new car. When I mentioned it to Gloria and Mercedes, Gloria mentioned Justin having bought a condo over in the new upscale community in St. Charles. This got me to thinking about other things such as the designer labels Justin wears and how he vacations in places no one I know can afford. He has season tickets for both the basketball and soccer teams, and he travels to some of their away games. This lifestyle doesn’t make sense with what I know he makes. Don’t look at me like that. I know what he makes because I enter pay changes in the human resources system. Besides, it’s public record.”

“You make a pretty convincing argument for a lavish lifestyle and even I know this is a fraud indicator. Have you or Mercedes talked to our auditors about this? I know the St. Charles auditors talked to employees all over the city about where they thought fraud might be occurring or if they thought they worked with honest people.”

“In the two audits I have been through the auditors only talked to me, Mercedes, and Gloria and one of the department heads. All of us in accounting work closely with the auditors but we’ve been hesitant to call them about this. I told Mercedes we needed to discuss it with you first and she agreed.”

“There is one more thing Mercedes discovered late yesterday, which isn’t discussed in her memo. Mercedes spent some time going over the state EFTs we received since Justin changed the account number information. She finished her analysis right before our meeting. You can look at it, but the bottom line is there are differences between several of the EFT amounts the state says they sent and what was ultimately transferred to our bank account. The only time the amounts differed was the six-week period Mercedes was out recovering from her back surgery. It looks like the bank received $25,000 less than what the state transferred to us during this time.”

“All right, Savanah. You and Mercedes have given me a lot to think about and I appreciate your candor and courage in coming forward. Tell Mercedes I’m going to look into things. I don’t think I need to ask you to keep this conversation between the two of us, do I?”

“No, Grant. Let me know if you need any additional information.”

Exercises

1. What type of controls could be put in place to deter procurement-related fraud such as suspected in this case?

    

    

    

2. What type of centralized internal controls and procedures would be appropriate to determine if this type of situation was occurring?

    

    

    

3. What type of decentralized internal controls and procedures would be appropriate to determine if this type of situation was occurring?

    

    

    

4. What type of audit procedures might be appropriate to determine if this type of situation was occurring?

    

    

    

5. What would you do if you were the city manager and why?