The One-Woman Show

Article, Internal AuditorAugust 2007

Insurance / Legal / Forensic Investigation

With one person overseeing all phases of a business - without checks and balances - there are many opportunities for dishonest behavior. Paul Sutphen examines the lessons that can be learned from this type of situation.

Barbara Gillman worked her way up the corporate ladder from document processor to executive vice president of operations and chief operating officer (COO) at Pacific Funding, a 12-year-old U.S. factoring business with 10 employees. Barbara began working for the company at its inception. Pacific Funding provided a cash flow service to trucking companies by purchasing their accounts receivables for freight deliveries. Pacific Funding advanced approximately 80 percent of the expected freight payment to the trucking company and then released the remainder, less various fees, when payment on the invoice was collected. Because the company did not have internal auditors, an external accounting firm prepared its annual review.

As COO, Barbara Gillman was responsible for all phases of the business, including oversight of two wholly owned subsidiaries that supported the factoring operation. Two of Gillman’s daughters held leadership positions in the subsidiary that handled collections on the purchased receivables. A second subsidiary secured funding for the factoring transactions from an outside source using the receivables as collateral. Although the functions were spread across different companies, all of Pacific Funding’s operations were located in a single office space.

Ed Perry was the company’s chief financial officer (CFO), but did not have the authority or responsibility typical of the title. Instead, he reported to Gillman, who performed most of the traditional CFO duties, including preparing and sending the monthly financial reports to Pacific Funding’s absentee owner, Charles Owen. Owen had other business interests and lived in another state, which, for all practical purposes, left Gillman in charge of the entire business.

Gillman was a tough boss with an irregular leadership style. Each employee at Pacific Funding had an official job description and set of duties, but Gillman changed or redirected employee responsibilities at random, resulting in an imprecise and unsettled work environment. However, although her management skills were questionable, Gillman was fair and the employees respected her abilities. For many years, the business made a healthy profit under Gillman’s leadership. But a series of events –– both business and personal –– eventually changed the dynamic and almost destroyed the business.

Gillman was going through some personal hardships ­–– she was beginning to lose her battle with obesity and was experiencing marital trouble –– that provided an opening for an opportunist to exploit her lowered self-esteem. Joey Kolnick, a smooth-talking ladies’ man, had a trucking company on the other side of the country that had conducted business with Pacific Funding some years earlier, before he was imprisoned for extortion. Looking to get back into the trucking business after being released from prison, Kolnick called Gillman, who remembered how charming he was.

Kolnick sympathized with Gillman’s personal struggles, and in response, she was understanding and compassionate about his legal problems. She believed Kolnick when he told her that he was wrongly accused and she commiserated about how hard it must be to start over in business with an unjustified conviction. To help him get back on his feet, Gillman waived the standard background check that was completed on any principal of a business looking to work with Pacific Funding.

Before long, Kolnick’s trucking company was submitting invoices to Pacific Funding for factoring. The invoices initially went through the standard qualification and approval process: The recipients of the freight were researched and found to be creditworthy, and maximum advance limits were established for each receivable. Convinced that Kolnick was a good man in need of a break, Gillman let her relationship with Kolnick taint her judgment and, at his urging, she began to break the rules. She helped Kolnick with his cash flow problems by circumventing the normal approval process. She even went so far as to resubmit his legitimate invoices for multiple payments –– in many instances, the same invoice was processed up to eight times. The word in the office was that Kolnick’s situation was “special” and his company’s invoices were to be expedited.

The purchased invoices were typically paid to Pacific Funding by check or wire transfer, but because so many of Kolnick’s invoices were actually duplicates of receivables that had already been submitted, the number of unpaid invoices was piling up. As a policy, Pacific Funding’s collection subsidiary –– staffed in part by Gillman’s daughters –– identified any receivables that remained unpaid after 120 days. Any significant increase in delinquent accounts was cause for concern as 120 days was the maximum invoice accepted as collateral by Pacific Funding’s lender.

Knowing no customer payments would come in to pay Kolnick’s outstanding invoices, Gillman accessed funds from the general operating account and instructed her daughters to pay Kolnick for his aging invoices with those funds. To cover the shortfall of incoming payments on the fraudulent invoices, Gillman transferred the funds for these payments between the subsidiary and parent companies through journal entries from the general account. Her daughters did not know about the source of the funds, only that a special account had been set up to pay Kolnick’s invoices. This procedure allowed Gillman to run the invoices through the factoring and financing processes repeatedly, remitting a portion of the advances from the lender to Kolnick and using the remainder to help replenish the general fund.

Perry, the powerless CFO, knew something was wrong, but was having trouble pinpointing the problem. The tension level in the office was at an all-time high, and there was a noticeable change in the employees’ manner when the “Kolnick bills,” as Perry called them, were being discussed. He knew Kolnick called Gillman often and even traveled across the country to visit her once.

Perry was also bothered by a series of unusual and complicated journal entries between the factoring and collection subsidiaries. When he asked Gillman about them, she said she would look into them, but never did. Perry dismissed the issue until he noticed a steady decline in the general account cash balance. This situation worried him enough to contact Pacific Funding’s owner directly.

Upon hearing Perry’s concerns, Owen immediately flew into town, inspected several of Kolnick’s accounts, and interviewed personnel. Owen put Gillman on administrative leave pending an investigation and terminated her employment several weeks later. It was ultimately determined that several hundred thousand dollars had been stolen from the company over a three-year period. Gillman and Kolnick are currently under investigation by federal and state authorities for a variety of charges, including wire fraud. Owen went to his lenders “hat in hand” to work out a deal to repay his loan default, which will be funded, in part, with insurance proceeds.

Lessons Learned:

  • Pacific Funding’s lack of an internal audit department, lack of direct company oversight by the owner, and lack of an independent external audit, coupled with the amount of trust placed in Gillman, was a recipe for disaster. No one in any organization should have that much unchecked authority.
  • The key breakdown in internal control was the watered-down authority and responsibility of Perry, the CFO. Although the check and balance of having a CFO in place looks good on an organizational chart, Perry’s authority and control in the company was not much more than that of a bookkeeper. An audit of the actual job function versus job description would have exposed the disconnect between the two. Additionally, altered job descriptions should be reviewed in the context of how internal controls may be compromised as a result of the change. A responsibility chart reflecting actual job functions and lines of reporting, prepared based on observation of duties and employee interviews, would have uncovered the weaknesses that evolved under Gillman’s leadership.
  • Although Gillman’s daughters were not privy to the deception, they chose to accept the new rules regarding Kolnick’s accounts rather than question what was going on. A look at the lines of reporting would have exposed the fact that Gillman’s daughters had positions of responsibility that could result in abuse if the appropriate checks and balances were not in place. Accepting nepotism in the workplace means special accommodations for reporting may be necessary to offset the potential of even unwilling collusion.
  • Exceptions to the accepted procedures –– especially those related to processing significant transactions –– should require dual authorization from individuals who do not report to one another and who are accountable. Gillman’s journal entry scheme would have never succeeded if Perry had been a fully empowered CFO and had not reported directly to Gillman.
  • Employees need a safe place to voice concerns. Hotlines and anonymous tip boxes should be available for employees. While contacting an owner is not an unusual step for a CFO, this should have happened much sooner than it did. There was no protocol in place for Perry to contact anyone besides Gillman, which was why he hesitated for as long as he did. Had there been a mechanism for him to act earlier, several hundred thousand dollars could have been saved.

 

As appeared in Internal Auditor, August 2007.

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