Wk4 Discussion (NON CASH ASSET FRAUD) - Post 2

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EXHIBIT 9-5: 2009 Global Fraud Survey: Median Loss in Noncash Cases by Type of Asset Misappropriated

NONCASH MISAPPROPRIATION SCHEMES

Noncash tangible assets, such as inventory and equipment, are misappropriated by

employees in a number of ways. These schemes can range from taking a box of pens home

from work to the theft of millions of dollars’ worth of company property. In general,

misappropriations of noncash tangible assets fall into one of the following categories:

• Misuse

• Unconcealed larceny

• Asset requisitions and transfers

• Purchasing and receiving schemes

• Fraudulent shipments

Misuse of Noncash Assets

There are basically two ways a person can misappropriate a company asset. The asset can

be misused (or “borrowed”), or it can be stolen. Simple misuse is obviously the less

egregious of the two. Assets that are misused, but not stolen, typically include company

vehicles, company supplies, computers, and other office equipment. In Case 1421, for

example, an employee made personal use of a company vehicle while on an out-of-town

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assignment. The employee provided false information, both written and verbal, regarding

the nature of his use of the vehicle. The vehicle was returned unharmed and the cost to the

perpetrator’s company was only a few hundred dollars, but such unauthorized use of a

company asset does amount to fraud when a false statement accompanies the use.

Computers, supplies, and other office equipment are also used by some employees to do

personal work on company time. For instance, an employee might use his computer at work

to write letters, print invoices, or do other work connected with a business that he runs on

the side. In many instances, these side businesses are of the same nature as the employer’s

business, so the employee is essentially using his employer’s equipment to compete with the

employer. An example of how employees misuse company assets to compete with their

employers was provided by Case 1406, in which a group of employees not only stole

company supplies, but also used the stolen supplies, in conjunction

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with their employer’s equipment, to manufacture their own product. The fraudsters then

removed the completed product from their work location and sold it in competition with

their employer. In a similar scheme, the perpetrator of Case 2579 used his employer’s

machinery to run his own snow removal and excavation business for approximately nine

months. He generally did his own work on weekends and after hours, falsifying the logs that

recorded mileage and usage on the equipment. The employee had formerly owned all the

equipment himself, but had sold it in order to avoid bankruptcy. As a term of the sale, he

had agreed to go to work for the new owner operating the equipment, but in truth, he never

stopped running his old business.

The preceding cases offer a good illustration of how a single scheme can encompass more

than one type of fraud. Though the perpetrators in these schemes were misusing company

materials and equipment—a case of asset misappropriation—they were also competing

with their employers for business—a conflict of interest. The categories ACFE researchers

have developed for classifying fraud are helpful in that they allow examiners to track

certain types of schemes, noting common elements, victims, methods, and so on; but those

involved in fraud prevention should remember that every crime will not fall neatly into one

category. Frauds often expand as opportunity and need allow; a scheme that begins small

may grow into a massive crime that can cripple a business.

The Costs of Inventory Misuse

The costs of noncash asset misuse are difficult to quantify. To many individuals this type of

fraud is viewed not as a crime, but rather as “borrowing.” In truth, the cost to a company

from this kind of scheme may often be immaterial. When a perpetrator borrows a stapler

for the night or takes home some tools to perform a household repair, the cost to his

company is negligible, as long as the assets are returned unharmed.

But misuse schemes can also be very costly. Take, for example, situations such as those

discussed above in which an employee uses company equipment to operate a side business

during work hours. Since the employee is not performing his work-related duties, the

employer suffers a loss in productivity. If the low productivity continues, the employer

might have to hire additional employees to compensate, diverting more capital to wages. If

the employee’s business is similar to the employer’s, lost business could be an additional

cost; had the employee not contracted work for his own company, the business would

presumably have gone to his employer. Unauthorized use of equipment can also mean

additional wear and tear, causing the equipment to break down sooner than it would have

under normal business conditions. Additionally, when an employee “borrows” company

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property, there is no guarantee that he will bring it back. This is precisely how some theft

schemes begin. Despite some opinions to the contrary, asset misuse is not always a harmless

crime.

Unconcealed Larceny Schemes

Though the misuse of company property might be a problem, the theft of company property

is obviously of greater concern. As we have seen, losses resulting from larceny of company

assets can run into the millions of dollars. The means employed to steal noncash assets

range from simple larceny—just walking off with company property—to more complicated

schemes involving the falsification of company documents and ledgers.

The textbook definition of larceny is too broad for our purposes, as it would encompass

every kind of theft. In order to gain a more specific understanding of the methods used to

steal noncash assets, we have narrowed the definition of larceny. For our purposes, larceny

is the most basic type of theft, exhibited in schemes in which an employee simply takes

property from the company premises without attempting to conceal it in the

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books and records (see Exhibit 9-6). In other fraud schemes, employees may create false

documentation to justify the shipment of merchandise or tamper with inventory records to

conceal missing assets, but larceny is more blunt. The culprit in these crimes simply takes

company assets, without trying to account for their absence. In the case study at the

beginning of this chapter, for instance, Larry Gunter simply walked out of his warehouse

with several hundred thousand dollars’ worth of computer chips.

EXHIBIT 9-6: Noncash Larceny

Most noncash larceny schemes are not very complicated. They are typically committed by

employees (such as warehouse personnel, inventory clerks, and shipping clerks) who have

access to inventory and other assets. A typical example of this type of scheme was

committed by the perpetrator of Case 968, a warehouse clerk who simply removed

inventory from outgoing shipments and left it in plain sight on the warehouse floor as he

went about his duties. If someone noticed that a shipment was short, the fact that the

merchandise was sitting out in the open made it appear that the omission had been an

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oversight rather than an intentional removal. In most cases, however, no one noticed that

shipments were short, leaving the excess inventory available for the perpetrator to take. If

customers complained about receiving short shipments, the company sent the missing items

without performing any follow-up to see where the missing inventory had gone. The culprit

was eventually caught when someone noticed that he was involved in the preparation of an

inordinate number of short shipments.

When we speak of inventory theft, we tend to conjure up images of late-night rendezvous at

the warehouse or merchandise stuffed hastily under clothing as a nervous employee beats a

path to his car. Although sometimes this is how employees go about stealing inventory and

other assets, in many instances fraudsters do not have to go to these extremes. In several of

the cases in our studies, employees

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took items openly during business hours, in plain view of their coworkers. How does this

happen? The truth is that people tend to assume that their friends and acquaintances are

acting honestly. When they see a trusted coworker taking something out of the office, people

are likely to assume that the culprit has a legitimate reason for removing the asset. In most

cases, people just don’t assume that fraud is going on around them. Such was the situation

in Case 728, in which a university faculty member was leaving his offices to take a position

at a new school. This person was permitted to take a small number of items to his new job,

but certainly exceeded the intentions of the school when he loaded two trucks full of

university lab equipment and computers worth several hundred thousand dollars. The

perpetrator simply packed up these stolen assets along with his personal items and drove

away.

Though it is true that employees sometimes misappropriate assets in front of coworkers

who do not suspect fraud, it is also true that employees may be fully aware that one of their

coworkers is stealing, yet refrain from reporting the crime. There are several reasons why

employees might ignore illegal conduct, among them a sense of duty to friends, a

“management versus labor” mentality, intimidation by the thief, or poor channels of

communication—or the coworkers may be assisting in the theft. When high-ranking

personnel are stealing from their companies, employees often overlook the crime for fear

that they will lose their jobs if they report it. For example, a school superintendent in Case

2462 was not only pilfering school accounts, but also stealing school assets. A search of his

residence revealed a cellar filled with school property. A number of school employees knew

or suspected the superintendent was involved in illegal dealings, but he was very powerful,

and people were afraid to report him for fear of retaliation. As a result, he was able to steal

from the school for several years. Similarly, in Case 144, a city manager ordered

subordinates to install air conditioners—known to be city property—in his home and in the

homes of several influential citizens. Although there was no question that this violated the

city’s code of ethics, no one reported the manager because of a lack of a proper

whistleblowing procedure in the department.

Ironically, employees who steal company property are often highly trusted within their

organizations. This trust can provide employees with access to restricted areas, safes, supply

rooms, or even keys to the business. Such access, in turn, makes it easy for employees to

misappropriate company assets. Case 716 provides an example of how an employee abused

his position of trust to misappropriate noncash assets. In this case, a long-term employee of

a contractor was given keys to the company parts room. It was his job to deliver parts to job

sites. This individual used his access to steal high-value items that he then sold to another

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contractor. The scheme itself was uncomplicated, but because the employee had a long

history of service to the company, and because he was highly trusted, inventory counts were

allowed to lapse and his performance went largely unsupervised. As a result, the scheme

continued for over two years and cost the company over $200,000.

Employees who have keys to company buildings are able to misappropriate assets during

nonbusiness hours, when they can avoid the prying eyes of their fellow employees as well

as management and security personnel. The ACFE studies revealed several schemes in

which employees entered their places of business to steal assets during weekends, as well as

before or after normal working hours. Case 1766 provided an example of this after-hours

activity. In this scheme two employees in management positions at a manufacturing plant

would set finished items aside at the end of the day, then return the next day an hour before

the morning shift and remove the merchandise before other employees arrived. These

perpetrators had keys to the plant’s security gate, which allowed them to

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enter the plant before normal hours. Over the course of several years, these two fraudsters

removed and sold approximately $300,000 worth of inventory from their company.

It can be unwise for a fraudster to physically carry inventory and other assets off the

premises of his company. This practice carries with it the inherent risk and potential

embarrassment of being caught red-handed with stolen goods on his person. Some

fraudsters avoid this problem by mailing company assets to a location where they can pick

them up without having to worry about security, management, or other potential observers.

In Case 1465, for instance, a spare-parts custodian took several thousand dollars’ worth of

computer chips and mailed them to a company that had no business dealings with the

custodian’s employer. He then reclaimed the merchandise as his own. By taking the step of

mailing the stolen inventory, the fraudster allowed the postal service to unwittingly do his

dirty work for him.

The Fake Sale

Asset misappropriations are not always undertaken solely by employees of the victim

organization. In many cases, corrupt employees use outside accomplices to help steal an

organization’s property. The fake sale is one method that depends on an accomplice for its

success. Like most larceny schemes, the fake sale is not complicated. As reflected in Case

1963, a fake sale occurs when the accomplice of the employee-fraudster “buys” merchandise

but the employee does not ring up the sale; the accomplice takes the merchandise without

making any payment. To a casual observer, it will appear that the transaction is a normal

sale. The employee bags the merchandise, and may act as though a transaction is being

entered on the register, but in fact, the “sale” is not recorded. The accomplice may even pass

a nominal amount of money to the employee to complete the illusion. In Case 1963 the

perpetrator went along with these fake sales in exchange for gifts from her accomplice,

though in other cases the two might split the stolen merchandise.

Accomplices are also sometimes used to return the inventory that an employee has stolen.

This is an easy way for the employee to convert the inventory into cash when he has no

need for the merchandise itself and has no means of reselling it on his own.

Preventing and Detecting Larceny of Noncash Assets

In order to prevent larceny of noncash assets, the duties of requisitioning, purchasing, and

receiving these assets should be segregated. To provide additional checks and balances, the

payables function should be segregated from all purchasing and receiving duties. In

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addition, physical controls are a key to preventing theft of noncash assets. All merchandise

should be physically guarded and locked, with access restricted to authorized personnel

only. Access logs can be used to track those who enter restricted areas, or each authorized

individual could be given a personalized entry code. In either case, a log will be created that

shows who had access to restricted assets, and at what times. Not only will this help identify

the perpetrator in the event that a theft occurs, but—more important—it will help deter

employees from attempting to steal company merchandise.

Another potentially effective deterrence method is the installation of security cameras in

warehouses or on sales floors. If security cameras are to be used, their presence should be

made known to employees to deter misconduct. Security guards can also be used for the

same purpose.

In order to help detect inventory thefts in a timely manner, organizations should conduct

physical inventory counts on a periodic basis, and someone independent of the purchasing

and warehousing functions should conduct these counts. Physical counts should be

comprehensive. Also, boxes should be inspected to make sure they actually contain

inventory. Physical inventory counts should be subject to recounts or spot checks

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by independent personnel. Also, shipping and receiving activities should be suspended

during physical counts to ensure a proper cutoff. Significant discrepancies between physical

counts and perpetual inventory (shrinkage) should be investigated before adjustments are

made to inventory records.

One common way to commit inventory theft is to remove items from outgoing shipments of

merchandise. It is therefore important for organizations to have in place a mechanism for

receiving customer complaints regarding, among other things, “short” shipments. An

employee who is independent of the purchasing and warehousing functions should be

assigned to follow up on complaints. If a large number of complaints are received, the dates

of shipment can be compared to employee work schedules to help identify suspects.

Asset Requisitions and Transfers

Asset requisitions or other documentation that enable noncash assets to be moved from one

location in a company to another can be used to facilitate the misappropriation of those

assets. Fraudsters use these internal documents to gain access to merchandise that they

otherwise might not be able to handle without raising suspicion. Transfer documents do not

account for missing merchandise the way false sales do, but they allow a fraudster to move

assets from one location to another. In the process of this movement, the fraudster takes the

merchandise for himself (see Exhibit 9-6).

The most basic scheme occurs when an employee requisitions materials to complete a work-

related project, then steals the materials instead. In some cases the fraudster simply

overstates the amount of supplies or equipment it will take to complete his work, and pilfers

the excess. In more extreme cases, the fraudster might completely fabricate a project that

necessitates the use of certain assets he intends to steal. In Case 2744, for instance, an

employee of a telecommunications company used false project documents to request

approximately $100,000 worth of computer chips, allegedly to upgrade company computers.

Knowing that this type of requisition required verbal authorization from another source,

the employee set up an elaborate phone scheme to get the “project” approved. The fraudster

used his knowledge of the company’s phone system to forward calls from four different

lines to his own desk. When the confirmation call was made, it was the perpetrator who

answered the phone and authorized the project.

Dishonest employees sometimes falsify property transfer forms so that they can remove

inventory or other assets from a warehouse or stockroom. Once the merchandise is in their

possession, the fraudsters simply take it home with them. In Case 653, for example, a

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manager requested that merchandise from the company warehouse be displayed on a

showroom floor. But the pieces he requested never made it to the showroom, because he

loaded them into a pickup truck and took them home. In some instances he actually took the

items in broad daylight and with the help of another employee. The obvious problem with

this type of scheme is that the person who orders the merchandise will usually be the

primary suspect when it turns up missing. In many cases the fraudster simply relies on poor

communication between different departments in his company and hopes no one will piece

the crime together. The individual in this case, however, thought he was immune to

detection, because the merchandise was requested via computer, using a management-level

security code. Because the code was not specific to any one manager, he thought there

would be no way of knowing which manager had ordered the merchandise. Unfortunately

for the thief, the company was able to record the computer terminal from which the request

originated. The manager had used his own computer to make the request, which led to his

undoing.

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