The Favored Vendor
Article, Internal Auditor – December 2007
Insurance / Legal / Forensic Investigation
Randy Wilson detailed the controls measures that can reduce losses or lead to earlier discovery of fraudulent schemes.
Robert Grant was the manager in charge of the metal casting department of a manufacturer in the southeast United States. His duties included supervision of the maintenance of the heavy equipment utilized in the department. This involved the completion of requisition forms for the necessary purchase of outside resources such as outsourced maintenance, parts, supplies and production consumables. Grant was also responsible for the development of departmental cost budgets and he approved the vendor invoices for payment that were originally requisitioned through his department and authority.
Grant reported to the facility manager. The facility manager relied upon Grant’s judgment and honesty in completing the responsibilities associated with managing the metal casting department.
Grant made a good living, but somehow always found it tough to make ends meet. It didn’t take him long to realize that the accounting controls over the requisition of outside goods and services at his company were extremely weak or in some cases, non-existent. As someone with a motive to misappropriate funds from his employer, he devised a scheme that would allow him to easily circumvent the controls that were in place.
When functioning appropriately, the transaction cycle at the manufacturing company was fairly straightforward. All requisitions associated with the purchase of manufacturing consumables had to be approved by the Department Manager. Once approved, the requisition was submitted to accounting for the issue of a Purchase Order. The issuance of the purchase order required that the vendor be an approved vendor, and that the amount was within the budgetary constraints for the coinciding expense category, although the budget was broad in scope, amount and category description. While the accounting department required that approved vendors provide a company name, address, telephone and principal contact, there was no verification or due diligence process associated with the establishment of an approved vendor in the accounting system – a weakness that Robert found too good to resist.
Grant’s scheme began with the vendors who supplied goods and services to his department. He knew that these vendors relied on his satisfaction and approval in order to continue their business relationship with the manufacturing company. Grant began to take advantage of his position of authority by requiring that the vendors provide him with monetary gifts in order to remain on the rotation for sales of goods and services from the company.
Grant also required that a ‘commission’ (or kickback) be paid to him personally on all of the vendors’ sales to the company. The vendors did not report this activity to the company’s management, due to fears of reprisal and the substantial loss of business revenue.
His greed increased over time, and he began to favor one vendor company in particular, owned by a man named Willie Bradshaw. Of all the vendors involved in Grant’s scheme, Bradshaw submitted to paying a larger ‘commission’ to Grant in order to knock out his competition and get a larger volume of business from the manufacturing company.
As Grant’s and Bradshaw’s bank accounts grew, Grant became further motivated to advance his scheme by setting up his own fictitious vendor. When he submitted the application for a new vendor, the accounting department didn’t even notice that the President of the new vendor company was the very same “Willie Bradshaw” who owned a competing vendor company. They also didn’t notice that the vendor address listed on the application was a post office box. At the minimum, a routine check of the legal status through a Secretary of State search would have quickly revealed that this vendor was fictional.
Through the fictional company, Grant and Bradshaw defrauded the manufacturing company of even larger sums of money. Grant used Bradshaw to sell the products to his new fictional company at a mark-up rate. In what can clearly be defined as a case of occupational fraud, Grant and Bradshaw were living large.
Grant’s scheme unraveled when he became ill and the company was forced to delegate his duties to another employee during his absence. When his replacement contacted a vendor regarding the purchase of needed manufacture consumables, the vendor’s response was ‘it isn’t my turn yet.’ This unusual response led to further inquiry and the discovery of the commissions (kickbacks) required by Grant in his fraudulent dealings.
As the investigation continued, Grant’s employer uncovered the fictitious vendor he set up with Bradshaw. When confronted, Bradshaw denied any involvement in the scheme, but could not explain why his company received checks from the company that were invoiced by the fictitious vendor concocted by Grant.
Perhaps the greatest lesson to be learned from Grant’s and Bradshaw’s story is that when it comes to occupational fraud, any entity, company or department is susceptible. Often the control systems and environment surrounding the accounting and finance departments are primary areas of analysis and investigation, when all areas are at risk of occupational fraud. Corporations and their management commit a critical error and actually contribute to the opportunity of employees, vendors or suppliers to defraud them simply by believing that fraud cannot happen to them. Fraud prevention is as much awareness of the existence and potentiality of fraud as it is the development of key controls to safeguard assets through the segregation of duties, and periodic comparisons of actual to recorded transactions.
Another critical lesson to be learned is that in many cases, the person or persons you might least expect to commit fraud are the ones who do it. Often, the unconditional trust of those involved with the con artist allows the fraud to perpetuate undiscovered. Also, keep in mind that the most honest and trustworthy employee can be derailed when motive and opportunity meet to commit fraud.
In this particular instance, there are several controls measures that would have reduced the loss or led to earlier discovery of Grant’s scheme. These include:
- The establishment of a ‘Fraud Hotline’ where employees can anonymously report suspicious activity of employees or vendors. The hotline must guarantee that reporting employees will not face discrimination or reprisal for reporting the fraud of his or her supervisor.
- An internal communications campaign that clearly and frequently communicates company policy with regard to fraudulent activities, and advertises the fact that those discovered will be prosecuted to the full extent of the law. This campaign should also remind employees to be alert to fraud, extortion or embezzlement and other suspicious activity.
- Division of job responsibilities to separate the functions of requisitioning of goods and services from the selection of vendors, price comparison and ordering of goods and services.
- Development of a new vendor policy that requires due diligence on the part of the accounting department, to include verification that the business is a legal entity in the state represented, has a legal federal identification number, liability insurance, and that the owners are checked against other vendors’ owners and employees of the entity. When vendors provide a post office box as an address, confirmation of the firm’s physical location must be verified.
- Development of a system that requires physical control of the receipt of goods and services that are delivered to the facility before the payment of invoices. Frequency of discrepancies should be investigated by someone independent of the department and its supervisors. Also, physical sign in and out of all consultants or independent contractors should be considered.
Finally, “get an attitude.” To truly be effective, fraud prevention and deterrence is an attitude that must permeate all aspects of management and ownership of organizations. You’ll find this is one attitude that will be welcome and beneficial to the workplace.
As appeared in Internal Auditor, December 2007.