Wk3 Discussion (Work Programming) - Post 1

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 1/24

PRINTED BY: . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

CHAPTER 4: BILLING SCHEMES

EXHIBIT 4-1: Billing Schemes

91

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 2/24

LEARNING OBJECTIVES

After studying this chapter, you should be able to:

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 3/24

4-1 List the five major categories of fraudulent disbursements

4-2 Define billing schemes

4-3 List the three categories of billing schemes

4-4 Understand what a shell company is, and how it is formed

4-5 List and understand the four ways false invoices are approved for payment

4-6 Understand why most shell company schemes involve the purchase of services rather

than goods

4-7 Understand how a pass-through scheme differs from the usual shell company schemes

4-8 Be familiar with the methods identified in this chapter for preventing and detecting

shell company schemes

4-9 Understand how pay-and-return schemes work

4-10 Understand how non-accomplice vendor schemes work

4-11 Be familiar with the methods identified in this chapter for preventing and detecting

non-accomplice vendor schemes

4-12 Understand how personal purchases schemes work

4-13 Be familiar with the methods identified in this chapter for preventing and detecting

personal purchases schemes

4-14 Be familiar with proactive audit tests that can be used to detect billing schemes

CASE STUDY: MEDICAL SCHOOL TREATS FRAUD AND ABUSE

Fraud seemed to plague a certain Southeastern medical college, with one bad case erupting

after another. One supervisor’s minor transgression opened a Pandora’s box of fraud

perpetrated by his assistant. It all began when Bruce Livingstone, a married supervisor at

the college’s three-person business office, took his girlfriend on a business trip using school

funds drawn from a suspense account (a temporary account in which entries of credits or

charges are made until their proper disposition can be determined). Livingstone did not

submit an expense report to offset the charges that month, a violation of a policy governing

the college’s extensive travel budget.

Once officials realized that employees had grown lax about submitting timely expense

reports, they attempted to reconcile the suspense account by requiring employees to settle

their own accounts before receiving their paychecks. Not wanting his indiscretion revealed,

Livingstone had to disguise the additional expense of taking his girlfriend on a business

trip. He submitted a phony expense report in which he unwisely named a female senior

auditor at the college as his traveling partner. He forged the auditor’s signature on a letter

that stated she had participated.

1

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 4/24

As luck would have it, the unsuspecting auditor herself reviewed the bogus report. She was

quite surprised to

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 5/24

PRINTED BY: . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

find she’d taken a trip with Livingstone. She immediately informed Harold Dore, the

director of internal audit for the institution, of the forgery. Dore alerted others.

Following a short interview with college officials, Livingstone admitted his wrongdoing and

was promptly terminated. The executive vice president authorized Dore to conduct a full

fraud examination. As they were soon to find out, they had not seen the worst of it yet.

Livingstone’s amorous business trip was just the tip of the iceberg.

“Whenever there’s fraud found here,” said Dore, “I automatically conduct what I call a

‘magnitude investigation.’” He has learned that perpetrators rarely limit themselves to the

fraud initially uncovered: “Chances are, they did something else.”

As part of the information-gathering portion of his investigation, Dore decided to interview

Cheryl Brown, the 30-year-old administrative assistant who had worked under Livingstone

for three years. The interview was to be conducted with the dean of the dental school

president, so Dore headed across campus toward the business office.

But Brown left before Dore arrived. She told coworkers that her uncle had been shot and

that she had to depart for California immediately. In her haste to get away, she even left her

paycheck behind.

Taking that as a sign, Dore immediately sealed the empty office Brown and Livingstone

shared and began searching its contents. The search uncovered bags of expensive dental

tools and prostheses, which it turned out he had been illegally selling to dental students for

years.

Knowing vendor kickbacks are common—and since one of the main functions of the

business office was to process invoices submitted by vendors—Dore started by reviewing

the master file. The list had never been purged and contained tens of thousands of names—

all the vendors who had ever supplied goods and services as part of the college’s annual

budget of $55 million. He selected 50 vendors, deliberately choosing those without a phone

number or street address.

Then Dore took his list to the next stop in the payment process, the accounts payable

department. After methodically pulling all corresponding documentation, he quickly

focused on one vendor: Armstrong Supply Company. It regularly billed two or three times a

month for strange items named but unknown by Dore, and always for amounts under

$4,500, thus eliminating the necessity of two authorized signatures. All of the request-for-

funds forms attached to the invoices either bore the signature of Livingstone or the dean of

91

92

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 6/24

the dental school. Furthermore, Dore could find no vendor application on file for

Armstrong Supply. He also failed to find any competitive bidding process in place.

“Once I looked at the actual invoices, that really got me going,” said the fraud examiner.

Some carried invoice numbers; others did not, but they did carry a four-digit post office box

number. (Subsequent research revealed that postal authorities had switched to five-digit

and six-digit PO boxes years earlier.) Billed items included such things as “3 dozen TPM

pins” (the identity of which baffled even the long-time stockroom manager).

“The invoices just smelled fake,” said Dore, who packs more than 20 years of auditing

experience. What’s more, he later found blank invoices for Armstrong Supply in one of

Brown’s desk drawers. He even noticed one completed invoice that had been readied for

submission. (Apparently, Brown left in too much of a hurry to dispose of the smoking gun.)

Based on those questionable invoices, the accounts payable department would issue a

check for the stated amount. On the request-for-funds forms attached, Brown always

indicated that she would personally present the check to Armstrong Supply. (Due to lax

controls, vendors and employees were allowed to pick up checks.) Canceled checks

revealed that a man named Claude Armstrong III cashed them at various check-cashing

services, which sometimes called Cheryl Brown for additional verification, as noted on the

backs of the checks.

Further research showed yet another scam, according to Dore. The office mail contained a

department store gift card with a note from a vendor to Brown, thanking her for her recent

business. The California vendor had billed the college for roughly $42,000 worth of copy

machine cartridges—running $4,500 apiece—and Brown had processed the invoices. After

a fruitless search for this valuable cache in the school’s storerooms and copy centers, Dore

called local dealers and discovered that their most expensive cartridge cost only $483.

Under his direction, private investigators located the vendor’s “corporate headquarters” in

a rental unit at a retail postal center, but the college abandoned their long-distance pursuit

of recovery when it proved too costly.

Although Dore tried to keep his three-month-long investigation quiet, the campus buzzed

with news of his activities. Brown’s many friends, including two in the accounts payable

department, kept her abreast of his movements.

Next he pulled in Livingstone for a chat about the new evidence supporting vendor fraud

and kickbacks, as well as his backroom sale of orthodontic supplies. According to Dore, it

became apparent during the interview that the philanderer knew nothing about the vendor

schemes. Brown had perpetrated the $63,000 vendor fraud without Livingstone’s help. He

seemed quite taken aback that it had occurred under his nose by someone he trusted so

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 7/24

much. In some cases, Brown had forged the signatures of her supervisor and the dean of

the dental school. In others, the unwitting bosses actually signed the bogus forms.

At the same time the Livingstone interview was being conducted, the school’s general

counsel received a call from Brown’s lawyer. “He asked if we had ever given leniency to an

errant employee in the past, if he were to admit to everything,” said Dore. Once the general

counsel deemed it a possibility, they scheduled a meeting for September. It was

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 8/24

PRINTED BY: . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

to be attended by both attorneys, Dore, the executive vice president of the college, and

Brown, who had never returned to work since her hasty departure. Her lawyer also

relayed her request to bring along a friend as a character witness, a nurse for whom she

had once worked and who could attest to the good nature of this unmarried mother

supporting three small children.

Brown was quiet and cooperative at the meeting. Dore took her through his voluminous file

folder on Armstrong Supply, the sham company she had created. She willingly identified

each and every document that detailed her duplicity, which had begun five months after

her hire. Dire cash emergencies prompted the first few deceptions, she said. As Brown

realized how easy it was in light of the weak controls, her confidence grew and she stepped

up her thefts with no signs of stopping. “It became addictive, in her words,” recalled Dore.

To illustrate her need, she explained that her husband had developed a drug and alcohol

problem and that she had been dragged into drug abuse as well. She claimed that after she

had become addicted, her husband abandoned her and the small children. She then broke

down and cried, the first of many times during the interview. Brown went on to point out

that she was seeing a doctor for her addictive behavior. When Dore asked how long she had

been seeing her doctor, “She said her first visit was going to be next week.” (Months later, a

casual conversation between Dore and a coworker who had once dated Brown raised

doubts about her excuses. “He swore she never touched drugs or alcohol,” said Dore.)

She said her accomplice, Claude Armstrong III, was a friend with a history of drug abuse.

(Background checks showed an arrest and conviction on drug charges for Armstrong;

Brown had no prior arrests or convictions, and her references proved favorable.) She also

admitted that her cover story about the uncle in California was fabricated.

After Brown expressed remorse over the fake invoices, Dore asked her about her

relationship with the phony cartridge supply firm. She totally disavowed any knowledge of

that scam. She insisted that the invoices were legitimate and the cartridges were stacked in

a storeroom. (Note: No one has found the cartridges to date.)

Even without owning up to the recent $42,000 cartridge scam, Brown seemed surprised to

learn that her Armstrong Supply fraud had netted $63,000 over two years.

Given the small percentage of the annual budget that was pilfered, college officials were

not surprised that the fraud went undetected by the Big Four firm that served as their

external auditor. Their contract stated that “audit tests are not all-inclusive and not

designed to find fraud,” a disclaimer that auditors rely on to absolve them from possible

92

93

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 9/24

culpability. “If they were that detailed, nobody could afford an external audit,” said Dore,

also a certified internal auditor.

Looking back, he saw that some good stemmed from the frauds. Since then, the college has

instituted much stronger controls and makes sure to enforce them. Dore said tales of his

dogged investigation enhanced respect for the audit function, “[a]nd probably instilled a bit

of fear among the 4,500 employees, because the college officials did pursue a criminal

prosecution against Brown.”

During the course of her trial, the district attorney informed Dore that his testimony was

not needed, even though it would have shown hell-bent intent on the part of the defendant.

With her lawyer acting on her behalf, Brown struck a deal with the prosecutor. She was

placed on probation and ordered to pay partial restitution. (Brown was found three-fourths

culpable and Armstrong one-fourth. Because half of the stolen funds came from federal

grants, $30,000 was charged off to the federal granting authority.)

As part of the deal, Brown was also sentenced to six months’ house arrest—with exceptions

granted for her to attend work and church.

Several names and details have been changed to preserve anonymity.

OVERVIEW

In Chapter 2, we saw that the vast majority of asset misappropriations target cash, as

opposed to noncash assets. We also saw that cash misappropriations are subdivided into

three categories in the fraud tree: skimming, cash larceny, and fraudulent disbursements.

Skimming and cash larceny have already been covered, so we will now turn our attention in

the next five chapters to fraudulent disbursement schemes. There are five major categories

of fraudulent disbursement in the fraud tree:

• Billing schemes

• Check tampering

• Payroll schemes

1

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 10/24

PRINTED BY: . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

• Expense reimbursement schemes

• Register disbursement schemes

The first category of fraudulent disbursements to be covered is billing schemes. These may

be loosely defined as schemes in which a fraudster causes the victim organization to issue a

fraudulent payment by submitting invoices for fictitious goods or services, inflated invoices,

or invoices for personal purchases. As the data from ACFE research shows, billing schemes

are among the most costly, and the most common, forms of occupational fraud.

Billing Scheme Data from the ACFE 2009 Global Fraud Survey

Among the fraudulent disbursement categories, billing schemes were most commonly

reported in the 2009 Global Fraud Survey (see Exhibit 4-2). Of 921 reported fraudulent

disbursement cases, 52 percent involved billing fraud. Billing schemes were also the second

most costly form of fraudulent disbursement, with a reported median loss of $128,000 (see

Exhibit 4-3).

EXHIBIT 4-2: 2009 Global Fraud Survey: Frequency of Fraudulent Disbursements

The sum of these percentages exceeds 100 percent because some cases involved multiple fraud schemes that fell into more than one category

93

94

a

a

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 11/24

EXHIBIT 4-3: 2009 Global Fraud Survey: Median Loss of Fraudulent Disbursements

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 12/24

PRINTED BY: . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

BILLING SCHEMES

In a billing scheme, the perpetrator uses false documentation—such as an invoice, purchase

order, credit card or purchasing card bill, and so on—to cause his employer to issue a

payment for some fraudulent purpose. The actual disbursement of funds is performed by

the organization in the same manner as would be a legitimate disbursement. The crux of

the fraud is not that a bogus payment is issued; instead, the key to these schemes is that the

fraudster is able to deceive his employer so that the organization willingly and unwittingly

issues the bogus payment.

Billing schemes generally fall into one of three categories:

• Shell company schemes

• Non-accomplice vendor schemes

• Personal purchases schemes

Shell Company Schemes

Shell companies, for the purposes of our discussion, are fictitious entities created for the

sole purpose of committing fraud. As we saw in the case study at the beginning of this

chapter, they may be nothing more than a fabricated name and a post office box that an

employee uses to collect disbursements from false billings. However, since the payments

received will be payable to the shell company, the perpetrator will normally also set up a

bank account in his new company’s name, listing himself as an authorized signer on the

account (see Exhibit 4-4).

Forming a Shell Company

In order to open a bank account for a shell company, a fraudster will probably have to

present the bank with a certificate of incorporation or an assumed-name certificate. These

are documents that a company must obtain through a state or local government. These

documents can be forged, but it is more likely that the perpetrator will simply file the

requisite paperwork and obtain legitimate documents from his state or county. This can

usually be accomplished for a small fee, the cost of which can be more than offset by a

successful fraud scheme.

94

95

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 13/24

If it is discovered that a company is being falsely billed by a vendor, fraud examiners for the

victim company may try to trace the ownership of the vendor. The documents used to start

a bank account in a shell company’s name can sometimes assist examiners in determining

who is behind the fraudulent billings. If the corrupt employee formed his shell company

under his own name, a search of public records at the local court house may reveal the

person as the fraudster.

For this reason, the corrupt employee will sometimes form his shell company in the name of

someone other than himself. For example, in Case 4737, an employee stole approximately $4

million from his company via false billings submitted from a shell company set up in his

wife’s name. Using a spouse’s name adds a buffer of security to an employee’s fraud scheme.

When a male employee sets up a shell company, he sometimes does so in his wife’s maiden

name to further distance himself from the fictitious company.

A more effective way for a fraudster to hide his connection to a false company is to form the

company under a fictitious name. In Case 4455 an employee used a coworker’s

identification to form a shell vendor. The fraudster then proceeded to bill his employer for

approximately $20,000 in false services. The resulting checks were deposited in the

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 14/24

PRINTED BY: . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

account of the shell company, and currency was withdrawn from the account through an

ATM.

EXHIBIT 4-4: False Billings from Shell Companies

95

96

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 15/24

The other issue involved in forming a shell company is the entity’s address—the place

where fraudulent checks will be collected. Often, an employee rents a post office box and

lists it as the mailing address of his shell company. Some employees list their

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 16/24

PRINTED BY: . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

home address instead. In Case 4434, a department head set up a dummy company using his

residence as the mailing address. Over a two-year period, this man submitted over $250,000

worth of false invoices. Eventually, the scheme was detected by a newly hired clerk. The

clerk was processing an invoice when she noticed that the address of the vendor was the

same as her boss’s address. (By a lucky coincidence, the clerk had typed a personal letter for

her boss earlier that day and remembered his address.) Had the department head used a

post office box instead of his home address on the invoices, his scheme might have

continued indefinitely.

One reason employees might be hesitant to use post office boxes in shell company schemes

is that some businesses are especially wary of sending checks to vendors that do not have

street addresses. Such an address, as we have already discussed, can signal fraud. For this

reason, fraudsters may use the address of a relative, friend, or accomplice as a collection

point for fraudulent checks.

Submitting False Invoices

Once a shell company is formed and a bank account has been opened, the corrupt employee

is in a position to begin billing his employer. Invoices can be manufactured by various

means such as a professional printer or a personal computer. As we saw in the case study at

the beginning of this chapter, false invoices do not always have to be of professional quality

to generate fraudulent disbursements. The phony invoices Cheryl Brown used to bill from

Armstrong Supply Company “just smelled fake,” according to Harold Dore, yet they were

sufficient to generate checks.

Self-Approval of Fraudulent Invoices

The difficulty in a shell-company scheme is not usually in producing the invoices, but in

getting the victim company to pay them. Authorization for the fictitious purchase (and

therefore payment of the bill) is the key. In a large percentage of the shell company cases in

the ACFE studies, the fraudster was in a position to approve payment on the very invoices

he was fraudulently submitting. In Case 446, for example, a manager authorized payment of

$6 million worth of phony invoices from a dummy company he had formed. Similarly, an

employee in Case 982 set up a bogus freight company and personally approved $50,000

worth of bogus invoices from it. It is only logical that those with authority to approve

purchases would be among the most likely to engage in billing schemes, since they have

fewer hurdles to overcome than other employees.

96

97

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 17/24

A slight twist to this method was used in Case 4542. The victim organization in this case

properly required vouchers to be prepared and approved by different persons. The

fraudster in this case had approval authority, but was not allowed to prepare the vouchers

that he approved. Therefore, this person created false vouchers and forged a coworker’s

initials as the preparer. Then the perpetrator approved the voucher for payment under his

own authority. It therefore appeared that two employees had signed off on the voucher, as

mandated by the organization’s controls.

Not all companies require the completion of payment vouchers before they will issue

payments. In some enterprises, payments are issued based on less formal procedures. In

Case 4436, for example, the CEO of a nonprofit company simply submitted “check requests”

to the accounting department. As the CEO, his “requests” obviously carried great weight in

the organization. The company issued checks to whatever company was listed on the

request in whatever amount was specified. The CEO used these forms to obtain over $35,000

in payments for fictitious services rendered by a shell company he had formed. In this case,

invoices were not even required to authorize the payments. The check request forms simply

listed the payee, the amount, and a brief narrative regarding the reason for the check. This

made it so easy for the CEO to generate fraudulent

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 18/24

PRINTED BY: . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

disbursements that he eventually had three separate companies billing the victim company

at the same time. It is obvious that, as CEO, the fraudster in this case had a wide degree of

latitude within the company and was unlikely to be obstructed by one of his subordinates.

Nevertheless, this case should illustrate how the failure to require proper support for

payments can lead to fraud.

“Rubber Stamp” Supervisors

If an employee cannot authorize payments himself, the next best thing is if the person who

has that authority is inattentive or overly trusting. “Rubber stamp” supervisors like this are

destined to be targeted by unethical employees. In Case 4759, for example, an employee set

up a fake computer supply company with an accomplice and “sold” parts and services to his

employer. The perpetrator’s supervisor did not know much about computers and therefore

could not accurately gauge whether the invoices from the dummy company were excessive

—or even necessary. The supervisor was therefore forced to rely on the perpetrator of the

scheme to verify the authenticity of the purchases. Consequently, the victim company

suffered approximately $20,000 in losses.

Reliance on False Documents

When an employee does not have approval authority for purchases and does not have the

benefit of a rubber stamp supervisor, he must run vouchers through the normal accounts

payable process. The success of this kind of scheme will depend on the apparent

authenticity of the false voucher he creates. If the fraudster can generate purchase orders

and receiving reports that corroborate the information on the fraudulent invoice from his

shell company, he can fool accounts payable into issuing a payment.

Collusion

Collusion among several employees is sometimes used to overcome well-designed internal

controls of a victim company. For example, in a company with proper separation of duties,

the functions of purchasing goods or services, authorizing the purchase, receiving the goods

or services, and making the payment to the vendor should be separated. Obviously, if this

process is strictly adhered to, it will be extremely difficult for any single employee to

commit a false-billing scheme. As a result, the ACFE studies included several schemes in

which employees conspired to defeat the fraud prevention measures of their employer. In

Case 444, for example, a warehouse foreman and a parts-ordering clerk conspired to

97

98

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 19/24

purchase approximately $300,000 of nonexistent supplies. The parts-ordering clerk initiated

the false transactions by obtaining approval to place orders for parts he claimed were

needed. The orders were then sent to a vendor who, acting in conjunction with the two

employee fraudsters, prepared false invoices that were sent to the victim company.

Meanwhile, the warehouse foreman verified receipt of the fictitious shipments of incoming

supplies. The perpetrators were therefore able to compile complete vouchers for the

fraudulent purchases without overstepping their normal duties. Similarly, in Case 4099,

three employees set up a shell company to bill their employer for services and supplies. The

first employee, a clerk, was in charge of ordering parts and services. The second employee,

a purchasing agent, helped authorize these orders by falsifying purchasing reports

regarding comparison pricing, and so on. The clerk was also responsible for receiving the

parts and services; a third conspirator, a manager in the victim company’s accounts payable

department, ensured that payments were issued on the fraudulent invoices.

The cases above illustrate how collusion among several employees with separate duties in

the purchasing process can be very difficult to detect. Even if all controls are followed, at

some point a company must rely on its employees to be honest. One of the purposes of

separating duties is to prevent any one person from having too much control

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 20/24

PRINTED BY: . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

over a particular business function; it provides a built-in monitoring mechanism whereby

every person’s actions are in some way verified by another person. But if everyone is

corrupt, even proper controls can be overcome.

Purchases of Services Rather Than Goods

Most of the shell company schemes in our survey involved the purchase of services rather

than goods. Why is this so? The primary reason is that services are not tangible. If an

employee sets up a shell company to make fictitious sales of goods to his employer, these

goods will obviously never arrive. By comparing its purchases to its inventory levels, the

victim company might detect the fraud. It is much more difficult, however, for the victim

company to verify that the services were never rendered. For this reason, many employees

involved in shell company schemes bill their employers for things like “consulting services.”

Pass-through Schemes

In the schemes discussed so far, the victim companies were billed for completely fictitious

goods or services. This is the most common formula for a shell company fraud, but there is a

subcategory of shell company schemes in which actual goods or services are sold to the

victim company. These are known as pass-through schemes.

Pass-through schemes are usually undertaken by employees in charge of purchasing on

behalf of the victim company. Instead of buying merchandise directly from a vendor, the

employee sets up a shell company and purchases the merchandise through that fictitious

entity. He then resells the merchandise to his employer from the shell company at an

inflated price, thereby making an unauthorized profit on the transaction.

One of the best examples of a pass-through scheme in the ACFE studies came from Case

4763, in which a department director was in charge of purchasing computer equipment.

Because of his expertise on the subject and his high standing within the company, he was

unsupervised in this task. The director set up a shell company in another state and bought

used computers through the shell company, then turned around and sold them to his

employer at a greatly exaggerated price. The money from the victim company’s first

installment on the computers was used to pay the shell company’s debts to the real vendors.

Subsequent payments were profits for the bogus company. The scheme cost the victim

company over $4 million.

Preventing and Detecting Shell Company Schemes

98

99

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 21/24

Because shell company schemes are among the most costly of all forms of occupational

fraud, it is imperative that organizations have controls in place to prevent these frauds. As

is the case with all forms of billing fraud, it is critical that duties in the purchasing process

be separated. Most billing schemes succeed when an individual has control over one or

more aspects of purchasing, authorizing purchases, receiving and storing goods, and issuing

payments. If these duties are strictly segregated, it will be very difficult for an employee to

commit most forms of billing fraud, including shell company schemes.

Because shell company schemes, by definition, involve invoicing from fictitious vendors,

one of the best ways to counter this type of fraud is to maintain and regularly update an

approved vendor list. The legitimacy of all vendors on the list should be verified by

someone independent of the purchasing function, and whenever an invoice is received

from a vendor not on the list, independent verification of that company should be required

before the invoice is paid.

Identifying Shell Company Invoices

In addition to controls aimed at generally preventing billing fraud, auditors, accounting

personnel, and other employees should

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 22/24

PRINTED BY: . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

be trained to identify fraudulent invoices. One common red flag is a lack of detail on the

fraudulent invoice. For example, the invoice might lack a phone number, fax number,

invoice number, or tax identification number, or other information that usually appears on

legitimate invoices. Another common sign of fraud is an invoice that lacks detailed

descriptions of the items for which the victim organization is being billed. Finally, the

mailing address on an invoice can indicate that it is fraudulent. In most shell company

schemes, the mailing address for payments is a mail drop or a residential address. Any

invoice that calls for a payment to one of these locations should be scrutinized, and the

existence of the vendor should be verified before a check is mailed.

In some cases, a fraudster will print or create several invoices and then submit them to his

employer one at a time over an extended period so that the amount he is stealing will be

spread out, making it less noticeable. These schemes can sometimes be detected because the

invoices used by the perpetrator will be consecutively numbered. In other words, the

invoice numbers might be 4002, 4003, 4004, and so forth. This is clearly a sign of a shell

company, because it indicates that the vendor in question is only sending invoices to the

victim. Suppose, for example, that an organization receives invoice #4002 from a vendor on

September 1, and receives invoice #4003 on October 1. This would indicate that the vendor

issued only a single invoice in September—the invoice received by the company in question.

Obviously, a legitimate company could not operate this way and survive.

Organizations can detect this sort of anomaly by regularly reviewing the payables account

and sorting payments by vendor and invoice number. Also, in many shell company schemes

the perpetrator will repeatedly bill for identical or similar amounts. If the perpetrator has

purchase authority, these amounts will tend to be just below the perpetrator’s approval

limit. So if Employee X is committing a shell company scheme and is authorized to approve

purchases up to $10,000, his shell company invoices might tend to fall in the $9,000 to $9,999

range. This can be detected by sorting payments by vendor and amount.

Testing for Shell Company Schemes

As discussed above, sorting payments by vendor, amount, and invoice number is one way to

search out red flags that might indicate a shell company scheme. There are a number of

other trends and red flags that are frequently associated with these frauds, and

organizations should regularly test for them as part of a proactive fraud detection program.

Billing schemes will typically cause an organization’s expenses to exceed budget projections,

so organizations should be alert to large budget overruns, and to departments that regularly

99

100

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 23/24

exceed their budgets. Billing schemes will also tend to cause an increase in expenses from

previous years. In a small company a billing scheme could significantly affect the financial

statements and could be detected through horizontal analysis (comparison of financials on

a year-to-year basis). In a very large company, a billing scheme might not have a significant

impact on the overall financials, but it could still be detected by analyzing expense trends

on a departmental or project basis. Obviously, by fraudulently increasing purchasing

expenses, billing schemes will also tend to cause an increase in cost of goods sold relative to

sales, and therefore will tend to negatively impact profits.

Because billing schemes generally involve the purchase of fictitious goods or services, a

review of purchase levels can help detect this form of fraud. As we have stated, most shell

company schemes involve purchases of fictitious services, since these “soft account” items

cannot be traced to inventory, leaving no physical evidence that the transaction was

fraudulent. However, these schemes will cause an increase in service-related

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 24/24

PRINTED BY: . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

100

101

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 1/22

PRINTED BY: . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

expenses. So, for instance, a large, unexplained rise in consulting or training expenses could

indicate a shell company scheme. When this red flag shows up, the underlying purchases

should be reviewed, and both the performance of the service and the legitimacy of the

provider should be confirmed. By tracking approval authority for all purchases,

organizations can also run comparison reports looking for employees or managers who

approve an unusually high level of services based on their job function.

In cases where a shell company bills for goods, these goods either will be nonexistent or will

be overpriced as part of a pass-through scheme. In either case, this will cause expenses and

cost of goods sold to rise, as discussed above. Furthermore, if an individual causes his

organization to buy nonexistent goods, that means the quantity of items purchased will

increase by the number of fictitious items bought from the shell company. Unexplained

increases in the quantity of goods purchased should be investigated, particularly when the

increase does not translate to increased sales. Purchases of nonexistent goods will also

cause inventory shortages, because the purchased items will be added to the organization’s

perpetual inventory system but will never enter the physical inventory. Purchases that

cannot be traced to inventory are a clear red flag of shell company schemes.

Alternatively, if the shell company sells existing goods as part of a pass-through scheme,

then the price for these items will be substantially marked up. Organizations should

monitor trends in average unit price of goods purchased. Significant increases could signal

not only pass-through schemes, but also kickback schemes and other types of billing fraud.

If prices on a particular transaction or set of transactions seem out of line, other vendors

should be contacted to determine the industry norm. Assuming the pricing is way out of

line, the organization should review the transaction to determine how the vendor was

approved, and what employees were involved in the transaction. In addition, steps should

be taken to confirm that the vendor is legitimate, as discussed below.

In addition to reviewing quantities purchased, organizations should also pay attention to

types of goods and services that are purchased. In many shell company schemes and other

forms of billing fraud, the nature of the purchases is patently unreasonable, but the invoices

in question are nevertheless rubber-stamped. For instance, when a law firm buys a

truckload of gravel, red flags should immediately go up. This kind of test is really an issue of

common sense, and it requires that auditors, managers, and accounting personnel have a

good understanding of how their organizations function.

Because employees sometimes run shell company schemes using their home address to

collect payments, organizations should periodically run comparison reports for vendor

100

101

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 2/22

addresses and employee addresses. If a match occurs, the employee in question is probably

engaging in a shell company scheme.

Fraudulent vouchers are also generally run through the payables system more quickly than

legitimate ones. The employees who commit these schemes try to get their bogus invoices

paid as quickly as possible, both because they want their money immediately and because

once the invoice gets paid the likelihood of the scheme being detected drops considerably. A

report showing the average turnaround time on invoices sorted by vendor might show that

a particular company tends to have its invoices paid much more quickly than other

vendors. If so, steps should be taken to confirm that the company exists, and that the

purchases were appropriate.

Verifying Whether a Shell Company Exists

It is usually fairly simple to determine whether a particular vendor is legitimate. A good

first step is to simply look up

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 3/22

PRINTED BY: . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

the vendor in the phone book. The absence of a phone number for a vendor is generally an

indication that the company is a shell. It is also a good idea to contact others in your

industry to determine whether they are familiar with the vendor. If the vendor only

appears to have billed your company, or if no one else in your community seems to have

heard of it, the company may not actually exist. Finally, if questions persist about whether

the vendor is a shell, someone from the victim organization should verify the vendor’s

address through a personal visit or using satellite imaging software.

Identifying the Employee behind a Shell Company

Even when a company has been identified as a shell, there is still the matter of determining

who is behind the scheme. In most cases, the perpetrator will have been involved in

selecting the vendor or approving the purchase. However it may be necessary to gather

independent verification to prove the identity of the fraudster. This can make it easier to

obtain a confession during an investigative interview, and it will also serve as useful

evidence if the matter eventually goes to trial—a possibility that exists in any fraud

investigation. There are a number of ways to verify the identity of the person or persons

operating a shell company.

In many cases the person who creates a shell company will register the company with the

appropriate government authority, because such registration is necessary to open a bank

account in the shell’s name. These documents require the name, address, and signature of

the person who is forming the company. Therefore, a search of the company’s registration,

which is a matter of public record, may indicate who committed the fraud. Articles of

incorporation are maintained by the secretary of state (or the state corporation bureau or

corporate registry office) in every state. DBA (Doing Business As) information can usually be

obtained at the county level. These public records can be obtained without a subpoena.

When conducting a records search, it is important to remember that fraudsters might set up

a company under a false name to avoid being identified with the shell. One common

technique is to establish the shell in the name of a relative or accomplice who does not work

for the victim organization. If the perpetrator is male and is married, he might also form the

shell under his wife’s maiden name. When checking public records, investigators should be

alert for related names, as well as addresses, phone numbers, Social Security numbers, or

other identifiers that may match an employee’s personnel information.

Rather than conduct a records search, it may be possible to confirm the identity of the

fraudster based on other factors. For instance, a company could compare checks that have

101

102

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 4/22

been converted by the shell company with information from the suspect’s payroll checks or

direct deposits. Matching account numbers or signatures would indicate that the payments

were deposited into the same bank account. Similarly, handwriting samples on business

filings or communications from the suspected vendor can be matched against the

handwriting of suspected employees.

Another way to identify the perpetrator behind a shell company scheme is to conduct

surveillance of the mail drop to determine who collects checks on behalf of the shell

company. Finally, if a suspect or suspects have been identified, a search of their office or

workspace might also reveal trash. Many shell company schemes are detected when a

vendor’s invoices or letterhead are discovered in an employee’s work area. However, any

workplace search must be done carefully, ensuring that the employee’s privacy rights are

not violated. Workplace searches should be conducted only after consulting with an

attorney.

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 5/22

PRINTED BY: . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

BILLING SCHEMES INVOLVING NON-ACCOMPLICE VENDORS

Pay-and-Return Schemes

Rather than use shell companies as vessels for overbilling schemes, some employees

generate fraudulent disbursements by using the invoices of non-accomplice vendors. In pay-

and-return schemes, these employees do not prepare and submit the vendor’s invoices;

rather, they intentionally mishandle payments that are owed to the legitimate vendors (see

Exhibit 4-5). One way to do this is to purposely double-pay an invoice. In Case 4020, for

instance, a secretary was responsible for opening mail, processing claims, and authorizing

payments. She intentionally paid some bills twice, then requested the recipients to return

one of the checks. She would intercept these returned checks and deposit them into her own

bank account.

Another way to accomplish a pay-and-return scheme is to intentionally pay the wrong

vendor. In Case 756, an accounts payable clerk deliberately put vendor checks in the wrong

envelopes. After they had been mailed, she called the vendors to explain the “mistake,” and

requested that they return the checks to her. She deposited these checks in her personal

bank account and ran the vouchers through the accounts payable system a second time to

pay the appropriate vendors.

EXHIBIT 4-5: Pay-and-Return Schemes

102

103

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 6/22

Finally, an employee might pay the proper vendor, but intentionally overpay him. In Case

2649, an employee intentionally caused a check to be issued to a vendor for more than the

invoice amount, then requested that the vendor return the excess. This money was

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 7/22

PRINTED BY: . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

taken by the fraudster and deposited into her own account. Similarly, an employee might

intentionally purchase excess merchandise, return the excess, and pocket the refund.

Overbilling with a Non-Accomplice Vendor’s Invoices

In some cases employees use invoices in the name of existing vendors to generate

fraudulent payments. This occurs in kickback schemes when the vendor is an accomplice in

the fraud, but it can also occur when the vendor is unaware of the crime. The perpetrator

either manufactures a fake invoice for a vendor who regularly deals with the victim

organization or reruns an invoice that has already been paid. The perpetrator submits the

fraudulent invoice and intercepts the resulting payment. Since the bill is fictitious, the

existing vendor is not out any money. The only victim is the employer’s organization, which

pays for goods or services that it does not receive. In the following case study, Albert Miano

took a copy of a contractor’s invoice, replicated it, and used the phony invoices to bill his

employer for over a million dollars’ worth of false work. CFE Terence McGrane put a stop to

Miano’s scheme.

CASE STUDY: COVER STORY: INTERNAL FRAUD

Sometimes fraud is discovered by chance instead of deliberate effort. In the $4 million

embezzlement fraud by an employee of a magazine publisher, more than one coincidence

brought down the perpetrator.

A popular magazine and large direct-mail publishing house decided to outsource much of

its direct-mail operations to specialized mail vendors. The company began converting its

plant in Pleasantville, New York, from a direct-mail-order factory to an office complex. Part

of the office complex construction involved building an auditorium that was to be identical

to another auditorium in historic Williamsburg, Virginia. Terrence McGrane had just begun

his third day on the job as chief internal auditor. In an effort to get to know his new

company, he had scheduled a series of interviews with all the vice presidents. His first

interview was with the vice president of administrative services, Harold J. Scott, who was

in charge of many construction projects and maintenance services. Because of the massive

renovation project, it was not unusual for hundreds of invoices to be forwarded to Scott.

Coincidence one: McGrane stopped by the accounts payable department and retrieved a

series of recently submitted invoices for various trade expenses related to the auditorium

construction project. “One of the things I wanted to accomplish was to understand how the

103

104

2

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 8/22

accounting codes worked—what was capitalized; what was expensed; how it was recorded,

etc.” So he grabbed a stack of processed invoices with accounting codes and went up to the

construction site to meet with the vice president for an hour-long interview.

As the two walked around the grounds, McGrane asked the vice president if he could

explain the accounting codes to him: “He stared at the [top] invoice for approximately 30

seconds and said: ‘That is not my signature on the invoice!’

As he looked through the stack, he found what appeared to be about three or four other

forgeries. He was completely baffled.”

The initial investigation revealed that all of the forgeries were in the painting division,

budgeted at approximately $500,000 a year. The company employed only one person to

oversee the painting operations in its facilities department: Albert Miano.

Miano, a 35-year-old from New Fairfield, Connecticut, earned about $30,000 a year. It was

his job to coordinate time-and-materials contracts with the scores of painters, carpenters,

electricians, and plumbers who toiled daily on the renovation, repair, and construction of

the building complex. As facilities supervisor, Miano regularly forwarded invoices to the

vice president of administration services for approval.

Miano launched his scheme by crafting false invoices for the jobs done by the painters. He

took a copy of a trade invoice from an existing painting contractor and, using his home

computer, created a replica into which he would record slightly different hours for the

trade contractors’ work.

McGrane related a probable scenario of how Miano executed his scheme. “Let’s say he

knew that during the month of February, as an example,” McGrane said, “there were

twenty-seven painters on the grounds during the course of one week.” Miano also knew the

total number of hours and the volume of materials used in that time. “He would create

invoices that were similar in nature, but record only eleven painters on the grounds,”

McGrane said. Miano would not reinvoice exactly the same work done during a week, but

he

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 9/22

PRINTED BY: . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

would make it look so similar that no one’s suspicions were ever aroused. Effectively, there

were no work orders on the “phantom work” he created on these invoices. Miano always

listed fewer painters on the false invoice than the actual number who had worked that

week, and he registered less time for their services than they had actually worked.

As part of his job, he regularly brought the trade invoices into the administrative VP’s office

for signature approval. After delivering a stack of these invoices, he would return to collect

them within the next day or two and deliver the approved invoices to the accounts payable

department. “It was this opportunity,” McGrane said, “that this individual was allowed to go

and collect the approved invoices and insert his own replicated fraudulent invoices as

approved. This was the first piece of an ‘electronic circuit’ that allowed him to commit the

fraud.” The second piece of the circuit for the fraud to ignite, McGrane said, was allowing

this same employee to transport the invoices to the accounts payable department, and

ultimately to collect the check.

After seeing how easy it was to slip in his own false invoices in the stack of approved ones,

Miano became bolder in his scheme. He began calling accounts payable, claiming that a

carpenter or painter had arrived on the grounds and needed his check “immediately.” To

keep the project flowing, the employees in the accounts payable department

accommodated him. Many employees knew and liked Miano, who had worked for the

company for nearly 15 years.

Eventually, this routine became so familiar to employees in accounts payable that Miano

did not even need to make up an excuse to pick up checks. Each time he would collect them,

he stashed the check for the false invoice in his pocket. When he returned home to New

Fairfield, Connecticut, he took the check to his bank, forged the contractor’s name on the

back, then endorsed it with his own name and deposited the check.

McGrane explains that Miano was able to pull off the scam due to failure of internal

controls and employees not following standard accounting procedures. “For any business

transaction, the invoices should be dispatched independently to the approving authority.

Once signed, the approved invoices should be sent independently to accounts payable.

When the check is prepared by accounts payable, they should mail it directly to the third

party. Under a strong internal control system, the employees and/or contractors should not

be allowed to come in and collect checks directly. Direct contacts with accounts payable

personnel make it too tempting for someone to try to misappropriate funds.”

Accounts payable also failed to combine the invoices into a single check—they wrote a

check for each invoice. “Had they combined it,” McGrane said, “his false invoice would

104

105

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 10/22

have been added into the legitimate painter’s monthly invoice summary, and the money

would be mailed to the legitimate contractor,” McGrane said. Accounts payable neglected to

study the invoice signatures for forgeries, and the accounting department dropped the ball

by not perusing processed checks for dual endorsements, another red flag for potentially

misappropriated funds.

Miano’s first transaction totaled $1,200. His second transaction jumped to $6,000—his third,

$12,000. His largest single transaction came to over $66,000. Miano refined his strategy by

pacing, on a parallel basis, a certain amount below the total due the painter. “If the painter

submitted an invoice for $20,000 a month,” McGrane said, “Miano would submit an invoice

for, say, $14,000. If the painter submitted a $6,000 invoice, he’d submit one for $3,000.” The

individual invoice amounts, because of the continuing construction, would not have

alarmed even an auditor.

Miano’s behavior at the office was the same as ever. He dressed the same way, drove the

same car to work, and shared little of his private life with other workers. He had not taken

a vacation in over four years, and his boss thought he should be promoted (a move Miano

resisted, for reasons now obvious). After hours, however, Miano was a different person.

Coincidence two: McGrane’s secretary was not only on Miano’s bowling team, she was also

his neighbor. They saw each other regularly at the local bowling alley. She took notice

when Miano’s behavior became somewhat extravagant. At first he took to buying the team

drinks, a habit most appreciated by his teammates. However, the secretary began

wondering where all the money was coming from when he showed up in his new Mercedes

(one of five cars he bought) and talked about a new $18,000 boat. He also invested in real

estate and purchased a second home costing $416,000.

McGrane’s secretary approached Miano one night after he had spent some $800 on drinks

for the team. “Did you win the lottery, or what?” she asked. He explained that his father-in-

law had recently died and left a substantial inheritance to his wife and him. Miano’s father-

in-law was actually quite alive, but no one ever bothered to check out the claim. No one

suspected Miano of doing anything sinister or criminal. All of his associates considered him

“too dumb” to carry out such a scheme. One person described him as “dumb as a box of

rocks.”

Coincidence three: After four years without a vacation, Miano took what he considered a

well-deserved trip to Atlantic City. But he wasn’t there long before he was called back to

Pleasantville. One can imagine his chagrin at having to leave the casinos and boardwalks

and head back to the office. Little did he know that things were about to get a lot worse.

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 11/22

Upon his return, Miano found himself confronted by the auditor, the vice president, and

two attorneys from the district attorney’s office. He readily admitted guilt. “He said he had

expected to get caught,” McGrane said. “He did it strictly based on greed. Miano claimed

there was no one else involved, and the sum total of his fraud was about $400,000.” But the

internal audit found that Miano had forged endorsements on more than fifty checks in

those four years, totaling $1,057,000. Ironically, the auditors could only identify about

$380,000 spent on tangible items (boats, cars, down payment

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 12/22

PRINTED BY: . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

on a home, etc.). The investigators could not account for the other $700,000, although they

knew Miano had withdrawn at least that much from the bank.

Miano served only two years of an eight-year sentence in a state penitentiary. At the time of

his indictment, his wife filed for divorce, claiming she knew nothing of her husband’s

crimes. Miano told a reporter in jail that the loss of his family and the public humiliation

had taught him his lesson.

“For a nickel or for $5 million, it doesn’t pay,” Miano said. “You enjoy the money for a while,

but you lose your pride and your self-respect. It ends up hurting your family, and no money

can ever change that.”

Several names and details have been changed to preserve anonymity.

Preventing and Detecting Fraudulent Invoices from a Non- Accomplice Vendor

Prevention of non-accomplice vendor invoicing schemes is largely dependent on the

purchasing function controls already discussed in this chapter. Efforts at detecting these

schemes should focus on several red flags that are common to non-accomplice vendor

invoicing. For example, if an employee produces invoices designed to mimic those of a

known vendor, the mailing address or electronic payment information might differ from

that of the real vendor. This variation is necessary so that the perpetrator can collect the

payment. As discussed previously, organizations should maintain up-to-date approved

vendor lists that include contact, mailing, and electronic payment information for approved

vendors. Deviations from this information, such as a change in mailing address or

electronic payment information, should be flagged, and the changes verified as legitimate

before a disbursement is issued. In addition, a fraudulent invoice prepared by an employee

to mimic that of a legitimate vendor might have an invoice number that is significantly out

of sequence. A sort of disbursements by vendor, date, and invoice number could reveal this

type of anomaly.

Instead of producing fraudulent vendor invoices, some employees simply rerun invoices

from existing vendors and divert the payments that result from the second run. This type of

fraud should be easily detectable if an organization has an effective duplicate checking

system to ensure that the same invoice cannot be run through the payables system twice. In

manual systems, every paid voucher should be clearly marked “paid” to prevent

105

106

2

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 13/22

reprocessing. In an electronic system, duplicate invoice numbers should be automatically

flagged. In order to dodge a duplicate checking system, some fraudsters will slightly alter

the invoice number. For instance, invoice #44004 might be changed to #44004a, or a zero in

the number might be changed to the letter O so that the number will look the same to the

naked eye but will not show up as a duplicate in the accounting system. However, a sort of

invoice numbers from a particular vendor in ascending or descending order will reveal

these as out of sequence.

Pay-and-return schemes can be mostly prevented if the duties of purchasing, authorizing,

and distributing payments are separated and if all invoices are matched to purchase orders

before payments are issued. Incoming mail should also never be delivered directly to an

employee. All incoming mail should be opened by mailroom personnel to ensure that every

incoming check is recorded. In addition, each incoming check should be photocopied, with

the copy attached to the remittance advice. This will help prevent a dishonest employee

from being able to recover an amount that was intentionally double-paid.

When the targeted vendor in a pay-and-return scheme returns an overpayment to the

fraudster, it is often as a check payable to the victim organization. To make it more difficult

to convert such a check, organizations should instruct their banks not to cash checks

payable to the organization.

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 14/22

PRINTED BY: . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

Finally, if a pay-and-return scheme is suspected, organizations should spot-check past

accounts payable files for overpayments. Identify all persons involved in processing any

overpayment, and review their transactions for similar “mistakes.”

PERSONAL PURCHASES WITH COMPANY FUNDS

Instead of undertaking billing schemes to generate cash, many fraudsters simply purchase

personal items with their company’s money. Company accounts are used to buy items for

fraudsters, their businesses, their families, and so on. In Case 649, for instance, a supervisor

started a company for his son and directed work to the son’s company. In addition to this

unethical behavior, the supervisor saw to it that his employer purchased all the materials

and supplies necessary for the son’s business. In addition, the supervisor purchased

materials through his employer that were used to add a room to his own house. All in all,

the perpetrator bought nearly $50,000 worth of supplies and materials for himself using

company money.

Conceptually, one might wonder why a purchases fraud is not classified as a theft of

inventory or other assets rather than a billing scheme. After all, in purchase schemes the

fraudster buys something with company money, then takes the purchased item for himself.

In Case 649 discussed in the preceding paragraph, for example, the supervisor took building

materials and supplies. How does this differ from those frauds that will be discussed in

Chapter 9, whereby employees steal inventory, supplies, and other materials? At first glance,

the schemes appear very similar. In fact, the perpetrator of a purchases fraud is stealing

inventory just as he would in any other inventory theft scheme. Nevertheless, the heart of

the scheme is not the taking of the inventory but the purchasing of the inventory. In other

words, when an employee steals merchandise from a warehouse, he is stealing an asset that

the company needs, an asset that it has on hand for a particular reason. The harm to the

victim company is not only the cost of the asset, but also the loss of the asset itself. In a

purchasing scheme, on the other hand, the asset that is taken is superfluous. The

perpetrator causes the victim company to order and pay for an asset that it does not really

need, so the only damage to the victim company is the money lost in purchasing the

particular item. This is why purchasing schemes are categorized as billing frauds.

Personal Purchases through False Invoicing

Most of the employees in our studies who undertook purchases schemes did so by running

unsanctioned invoices through the accounts payable system. The fraudster in this type of

106

107

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 15/22

fraud buys an item and submits the bill to his employer as if it represented a purchase on

behalf of the company (see Exhibit 4-6). The goal is to have the company pay the invoice.

Obviously, the invoice that the employee submits to his company is not legitimate. The main

hurdle for a fraudster to overcome, therefore, is to avoid scrutiny of the invalid invoice and

obtain authorization for the bill to be paid.

The Fraudster as Authorizer of Invoices

As was the case in the shell company schemes we reviewed, the person who engages in a

purchases scheme is often the very person in the company whose duties include authorizing

purchases. Obviously, proper controls should preclude anyone from approving his own

purchases. Such poorly separated functions leave little other than his conscience to

dissuade an employee from fraud.

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 16/22

PRINTED BY: . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

EXHIBIT 4-6: Invoice Purchasing Schemes

107

108

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 17/22

Nevertheless, we saw several examples of organizations in which this lapse in controls

existed. As we continue to point out, fraud arises in part because of a perceived opportunity.

An employee who sees that no one is reviewing his actions is more likely to turn to fraud

than one who knows that his company diligently works to detect employee theft.

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 18/22

PRINTED BY: . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

An example of how poor controls can lead to fraud was found in Case 888, where a manager

of a remote location of a large, publicly traded company was authorized to both order

supplies and approve vendor invoices for payment. For over a year, the manager routinely

added personal items and supplies for his own business to orders made on behalf of his

employer. The orders often included a strange mix of items; technical supplies and home

furnishings might, for instance, be purchased in the same order. Because the manager was

in a position to approve his own purchases, he could get away with such blatantly obvious

frauds. In addition to ordering personal items, the perpetrator changed the delivery address

for certain supplies so that they would be delivered directly to his home or side business.

This scheme cost the victim company approximately $300,000 in unnecessary purchases. In

a similar case, 770, an employee with complete control of purchasing and storing supplies

for his department bought approximately $100,000 worth of unnecessary supplies using

company funds. The employee authorized both the orders and the payments. The excess

supplies were taken to the perpetrator’s home, where he used them to manufacture a

product for his own business. It should be obvious from the examples cited above that not

only do poor controls pave the way for fraud, a lack of oversight regarding the purchasing

function can allow an employee to take huge chunks out of his company’s bottom line.

In some situations, the perpetrator is authorized to approve purchases, but controls prevent

him from also initiating purchase requests. This procedure is meant to prevent the kinds of

schemes discussed above. Unfortunately, those with authority to approve purchases are

often high-level employees with a good deal of control over their subordinates. These

persons can use their influence to force subordinates to assist in purchases scheme. In Case

95, for example, purchases under $1,000 at a certain utility company could be made with

limited-value purchase orders (LPOs), which required two signatures—the originator of a

purchase request and the approver of the request. An LPO attached to an invoice for less

than $1,000 would be paid by the accounts payable department. In this case, a manager

bought goods and services on company accounts, and prepared LPOs for the purchases. (In

some cases, the LPO would falsely describe the item to conceal the nature of the purchase.)

Once the LPO was prepared, the manager forced a clerk in his department to sign the

document as the originator of the transaction. The clerk, intimidated by her boss, did not

question the authenticity of the LPOs. With two signatures affixed, the LPO appeared to be

legitimate and the bills were paid. The scheme cost the victim company at least $25,000.

Falsifying Documents to Obtain Authorization

108

109

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 19/22

Not all fraudsters are free to approve their own purchases; those who cannot must rely on

other methods to get their personal bills paid by the company. The chief control document

in many vouchers is the purchase order. When an employee wants to buy goods or services,

he submits a purchase requisition to a superior. If the purchase requisition is approved, a

purchase order is sent to a vendor. A copy of this purchase order, retained in the voucher,

tells accounts payable that the transaction has been approved. Later, when an invoice and

receiving report corresponding to this purchase order are assembled, accounts payable will

issue a check.

So in order to make their purchases appear authentic, some fraudsters generate false

purchase orders. In Case 634, for example, an employee forged the signature of a division

controller on purchase orders; thus, the purchase orders appeared to be authentic and the

employee was able to buy approximately $3,000 worth of goods at his company’s expense.

In another instance, Case 434, a part-time employee at an educational institution obtained

unused purchase order numbers and used them to order computer equipment under a

fictitious name. The employee then intercepted the equipment as it arrived at

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 20/22

PRINTED BY: . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

the school and loaded the items into his car. Eventually, the employee began using fictitious

purchase order numbers instead of real ones. The scheme came to light when the

perpetrator inadvertently selected the name of a real vendor. After scrutinizing the

documents, the school knew that it had been victimized. In the meantime, the employee had

bought nearly $8,000 worth of unnecessary equipment.

Altering Existing Purchase Orders

Purchase orders can also be altered by employees who seek to obtain merchandise at their

employer’s expense. In Case 1334, for example, several individuals conspired to purchase

over $2 million worth of materials for their personal use. The ringleader of the scheme was

a low-level supervisor who had access to the computer system that controlled the

requisition and receipt of materials. This supervisor entered the system and either initiated

orders of materials that exceeded the needs of a particular project or altered existing orders

to increase the amount of materials being requisitioned. Because the victim organization

had poor controls, it did not compare completed work orders on projects to the amount of

materials ordered for those projects. This allowed the inflated orders to go undetected. In

addition, other employees involved in the scheme were in charge of receiving deliveries.

These employees were able to divert the excess materials and falsify receiving reports to

conceal the missing items. In addition, the victim institution did not enforce a central

delivery point, meaning that employees were allowed to pick up materials from the vendors

in their personal vehicles. This made it very easy to misappropriate the excess merchandise.

The supervisor’s ability to circumvent controls and initiate false orders or alter genuine

ones, though, was the real key to the scheme.

False Purchase Requisitions

Another way for an employee to get a false purchase approved is to misrepresent the nature

of the purchase. In many companies, those with the power to authorize purchases are not

always attentive to their duties. If a trusted subordinate vouches for an acquisition, for

instance, busy supervisors often give rubber stamp approval to purchase requisitions.

Additionally, employees sometimes misrepresent the nature of the items they are

purchasing in order to pass a cursory review by their superiors. For example, in Case 1015,

an engineer bought over $30,000 worth of personal items. The engineer dealt directly with

vendors and was also in charge of overseeing the receipt of the materials he purchased. He

was therefore able to misrepresent the nature of the merchandise he bought, calling it

“maintenance items.” Vendor invoices were altered to agree to this description.

109

110

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 21/22

Of course, the problem with lying about what one is buying is that when delivery occurs, it

is the perpetrator’s personal items that arrive, not the business items listed on the purchase

requisition. In the case discussed above, the problem of detection at this stage of the crime

was avoided because the engineer who made the fraudulent purchases was also in charge

of receiving the merchandise. He could therefore falsify receiving reports to perpetuate the

fraud. We have also encountered cases in which fraudsters in the purchasing department

enlisted the aid of employees in the receiving department to conceal their crimes.

Another way to avoid detection at the delivery stage is to change the delivery address for

purchases. Instead of being shipped to the victim company, the items the employee buys are

sent directly to his home or business. In a related scenario, an accounts payable supervisor

in Case 592 purchased supplies for her own business by entering vouchers in the accounts

payable system of her employer. Checks were cut for the expenses during normal daily

check runs. To avoid problems with receiving the unauthorized goods, the perpetrator

ordered the supplies from the vendor and had them shipped directly to a client of her side

business.

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 22/22

PRINTED BY: . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

110

111

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 1/14

PRINTED BY: . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

Personal Purchases on Credit Cards or Other Company Accounts

Instead of running false invoices through accounts payable, some employees make personal

purchases on company credit cards, purchasing cards, or running accounts with vendors.

As with invoicing schemes, the key to getting away with a false credit card purchase is

avoiding detection. Unlike invoicing schemes, however, prior approval for purchases is not

required. An employee with a company credit card or purchasing card can buy an item

merely by signing his name (or forging someone else’s) at the time of purchase. Later review

of the card statement, however, may detect the fraudulent purchase. In invoicing schemes

we saw how those who committed the frauds were often in a position to approve their own

purchases. The same is often true in credit card and purchasing card schemes. A manager

in Case 446, for example, reviewed and approved his own credit card statements. This

allowed him to make fraudulent purchases on the company card for approximately two

years.

Of course, only certain employees are authorized to use company credit cards or issued

purchase cards. The manager in Case 446 above, for instance, had his own company card.

Employees without this privilege can make fraudulent purchases with a company card only

if they first manage to get hold of one. To this end, company cards are sometimes stolen or

“borrowed” from authorized users. A more novel approach was used by an accountant in

Case 1481, who falsely added her name to a list of employees to whom cards were to be

issued. She used her card to make fraudulent purchases, but forged the signatures of

authorized cardholders to cover her tracks. Since no one knew she even had a company

card, she would not be a prime suspect in the fraud even if someone questioned the

purchases. For over five years this employee continued her scheme, racking up a six-figure

bill on her employer’s account. In addition, she had control of the credit card statement and

was able to code her purchases to various expense accounts, thereby further delaying

detection of her crime.

An executive secretary in Case 521 used her access to the statement for a different purpose.

After making hundreds of thousands of dollars’ worth of fraudulent purchases on corporate

cards, this employee destroyed both the receipts from her purchases and the monthly credit

card statements. Eventually, duplicate statements were requested from the credit card

company, and the fraud was discovered. The fact that no statements were received by the

company therefore led to detection of the scheme. Some fraudsters, having destroyed the

110

111

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 2/14

real copies of credit card statements, produce counterfeit copies on which their fraudulent

purchases are omitted. By taking this extra step, the fraudster is able to keep his employer

in the dark about the true activity on the account.

Charge Accounts

Some companies keep charge accounts with vendors with whom they do regular business.

Office supply companies are a good example of this kind of vendor. Purchases on charge

accounts may require a signature or other form of authorization from a designated

company representative. Obviously, that representative is in a position to buy personal

items on the company account. Other employees might do the same by forging the signature

of an authorized person at the time of a fraudulent purchase. In some informal settings,

purchases can be verified by as little as a phone call, making it very easy to make fraudulent

purchases.

Returning Merchandise for Cash

The cases we have discussed in the fraudulent purchases section to this point have all

involved the false purchase of merchandise for the sake of obtaining the merchandise. In

some cases, however, the fraudster buys items

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 3/14

PRINTED BY: . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

and then returns them for cash. The best example of this type of scheme in our survey was

Case 1510, in which an employee made fraudulent gains from a business travel account. The

employee began by purchasing tickets for herself and her family through her company’s

travel budget. Poor separation of duties allowed the fraudster to order the tickets, receive

them, prepare claims for payments, and distribute checks. The only review of her activities

was made by a busy and rather uninterested supervisor who approved the employee’s

claims without requiring supporting documentation. Eventually, the employee’s scheme

evolved. She began to purchase airline tickets and return them for their cash value. An

employee of the travel agency assisted in the scheme by encoding the tickets as though the

fraudster had paid for them herself. That caused the airlines to pay refunds directly to the

fraudster rather than to her employer. In the course of two years, this employee embezzled

over $100,000 through her purchases scheme.

Preventing and Detecting Personal Purchases on Company Credit Cards and Purchasing Cards

The most important step in preventing credit card and purchasing card fraud is conducting

thorough reviews of each card statement. This duty should be performed by someone

independent of those who have signature authority on the account. During review, a

business purpose should be verified for each listing on the statement, and the person who

incurred the expense should be required to provide original support for the expense.

To prevent falsifications of the statement, organizations should direct the card issuer to

send two copies of the statement to two different individuals within the organization. Both

individuals should reconcile the statements separately and then compare the results. In the

case of credit cards, it is advisable to establish spending limits for credit card users in order

to prevent large abuses.

Card statements should be compared with employee expense vouchers for duplications, and

card expenses should be monitored for any unexplained increase in purchasing levels.

Excess purchases can be traced to a particular cardholder, and that person can be

interviewed to determine the reason for the increase.

PROACTIVE COMPUTER AUDIT TESTS FOR DETECTING BILLING SCHEMES

111

112

1

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 4/14

Title Category Description     Data file(s)

Perform a trend analysis of vendor payments.

All Special note should be given to vendors that have had minimal purchases in prior periods, yet have large payments in current periods.

• Invoice payment

Identify duplicate payments based on various means.

All Duplicate payment tests can be enacted on the vendor, invoice number, and amount. More complicated tests can look for instances in which the same invoice and amount are paid, yet the payment is made to two different vendors. Another advanced test is to search for same vendor and invoice when a different amount is paid.

• Invoice payment

Summarize debit memos by vendor, issuer, and type.

All Debit memo trends that appear unusual should be investigated as attempts to cover unauthorized payments.

• Invoice payment

Summarize accounts payable activity by general ledger account, sort from high to low, and review for reasonableness.

All Expense account trends that appear unusual should be investigated as attempts to cover unauthorized payments.

• Invoice payment

• General Ledger distribution

Extract manual checks and summarize by vendor and issuer.

All Manual checks are more prone to abuse and therefore should be scrutinized, especially if a particular issuer is drafting the majority of manual checks.

• Check register

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 5/14

Title Category Description     Data file(s)

Extract all purchases having no purchase order and summarize by vendor and issuer.

All Purchases having no purchase order are more prone to abuse and therefore should be scrutinized, especially if a particular issuer is drafting the majority of payments without purchase orders.

• Invoice payment

Extract all round-dollar payments.

All Round-dollar payments have a higher likelihood of being fabricated and, therefore, fraudulent.

• Invoice payment

Calculate the ratio of the largest purchase to next-largest purchase by vendor.

All By identifying the largest purchase to a vendor and the next-largest purchase, any large ratio difference may identify a fraudulently issued “largest” check.

• Invoice payment

Compare check register to invoice payment file to identify any checks with no related system invoices.

Shell Company

Check payments that do not appear on the invoice register may be an attempt to hide unauthorized payments.

• Invoice payment and check register

Match vendor master file to accounts payable invoice file.

Shell Company

Identify payments to a potentially unapproved vendor by joining the vendor to the invoice file on vendor number. The joining of these two files should be done in an “unmatched” format so that only those vendor numbers in the invoice file not appearing in the vendor file are shown.

• Vendor master

• Invoice payment

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 6/14

Title Category Description     Data file(s)

Extract vendors having no telephone or tax ID number.

Shell Company

Vendors without this information are more prone to abuse and should be scrutinized.

• Vendor master

Identify vendors added during the period under review.

Shell Company

The issuers of new vendor additions should be reviewed using this report to determine whether a particular issuer is drafting the majority of vendor additions.

• Vendor master

List all vendors having an address that is not designated as a business address.

Shell Company

The identification of whether an address is legitimately a business address can be done using some software databases.

• Vendor master

List all vendors who had multiple invoices immediately below an approval limit (e.g., many $999 payments to a vendor when there is a $1,000 approval limit), highlighting a circumvention of the established control.

Shell Company

Invoices below an approval limit may be an attempt to circumvent a management review.

• Invoice payment

Match the vendor master file to the employee master file on various key fields.

Shell Company

Compare telephone number, address, tax ID numbers, numbers in the address, zip code, and post office box in the vendor file to those in the employee file, especially those of employees working in the accounts payable department.

• Vendor master

• Employee master

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 7/14

Title Category Description     Data file(s)

Review payments having little or no sequence between invoice numbers.

Shell Company

Employees developing shell companies often invoice the company with no gaps in invoice sequence, highlighting that the victim company is the shell company’s only customer.

• Invoice payment

List payments to any vendor that exceed the twelve-month average payments to that vendor by a specified percentage (e.g., 200%).

Shell Company and Non- Accomplice Vendor

Large payments are unusual and should be scrutinized as potentially fraudulent.

• Invoice payment

Extract vendor payments that are a specified percentage (e.g., 200%) greater than the last largest payment to that vendor.

Shell Company and Non- Accomplice Vendor

Large payments are unusual and should be scrutinized as potentially fraudulent.

• Invoice payment

Sample vendor open invoices for confirmation with vendor.

Non- Accomplice Vendor

Vendor invoices may remain open on the subledger when the vendor believes such invoices have been paid.

• Invoice payment

Extract SIC codes from card payments normally associated with personal purchases.

Personal Purchases

Personal purchases with company cards may be a sign of abuse.

• Procurement card

Extract multiple charges of the same product type (using SIC code) below a predefined card expense limit.

Personal Purchases

Charges below an approval limit may be an attempt to circumvent a management review.

• Procurement card

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 8/14

Title Category Description     Data file(s)

Summarize card use by employee and sort from high to low.

Personal Purchases

High usage of credit or purchasing cards by certain employees may be a sign of abuse.

• Procurement card

List all vendors with differing billing and delivery addresses.

Personal Purchases

Company purchases sent to a delivery address different from the billing address may signal personal purchases made on account of the company.

• Vendor master

Extract all delivery addresses that do not correspond to company locations.

Personal Purchases

Company purchases should normally be sent to known company locations. Shipments to other locations are a potential sign of fraud.

• Vendor master

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 9/14

PRINTED BY: . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 10/14

PRINTED BY: . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 11/14

PRINTED BY: . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

SUMMARY

Billing schemes may be loosely defined as frauds in which an employee causes the victim

organization to issue a fraudulent payment by submitting invoices for fictitious goods or

services, inflated invoices, or invoices for personal purchases. Billing schemes are among

the most costly, and the most common, forms of occupational fraud. These frauds generally

fall into one of three categories: shell company schemes, non-accomplice vendor schemes,

and personal purchases schemes.

A shell company is a fictitious entity set up for the sole purpose of committing fraud and

may be nothing more than a fabricated name and an account number or a post office box

that an employee uses to collect disbursements from false billings. Shell company schemes

usually involve the purchase of fictitious goods or services, although in pass-through

schemes a shell company might supply a real product or service by simply acting as the

middleman between a real vendor and the victim organization, inflating the purchase price

along the way.

In non-accomplice vendor schemes, a fraudster overbills his organization using the invoices

of a legitimate vendor that is uninvolved in the fraud. This can be accomplished by

producing counterfeit copies of a legitimate vendor’s invoices, or by simply running an

invoice through the payables system twice and keeping one of the resulting disbursements.

A distinct subcategory is the pay-and-return scheme, in which a fraudster intentionally

overpays an invoice and steals the excess payment when it is returned by the vendor.

An employee may make personal purchases with company money or using company credit

cards or purchasing cards. In the first case, the employee purchases a personal item and

runs the invoice through the accounts payable system; in the second, the employee makes

personal purchases using company credit cards or running accounts with vendors.

ESSENTIAL TERMS

Billing scheme

A scheme in which a fraudster causes the victim organization to issue a fraudulent payment

by submitting invoices for fictitious goods or services, inflated invoices, or invoices for

personal purchases.

Shell company

112

115

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 12/14

A fictitious entity created for the sole purpose of committing fraud.

Collusion

A situation in which two or more employees work together to commit fraud by overcoming

a well-designed internal control system.

Pass-through scheme

A subcategory of a shell company scheme in which actual goods or services are sold to the

victim company, with the fraudster acting as a middleman and inflating the prices of the

goods or services.

Pay-and-return scheme

A fraud in which an employee intentionally mishandles payments that are owed to

legitimate companies, then steals the excess payments when they are returned by the

vendor.

Personal purchases scheme

A category of billing scheme in which an employee simply buys personal items with his

company’s funds, credit card, or purchasing card.

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 13/14

4-1

4-2

4-3

4-4

4-5

4-6

4-7

4-8

4-9

4-10

4-1

4-2

PRINTED BY: . Printing is for personal, private use only. No part of this book may be reproduced or transmitted without publisher's prior permission. Violators will be prosecuted.

REVIEW QUESTIONS

(Learning objective 4-1) What are the five categories of fraudulent disbursements, and

where did billing schemes rank in terms of frequency and cost in the 2009 Global Fraud

Survey?

(Learning objectives 4-2 and 4-3) How is the term billing schemes defined, and what are

the three categories of billing schemes covered in this chapter?

(Learning objective 4-4) What is the purpose of a shell company, and how is it normally

formed?

(Learning objective 4-5) There are four ways that fraudulent invoices are approved for

payment. What are they?

(Learning objective 4-5) Why does collusion among employees in the purchasing

process make it very difficult to detect billing schemes?

(Learning objective 4-6) Why do most shell company schemes involve the purchase of

services rather than goods?

(Learning objective 4-7) What is a pass-through scheme, and how does it differ from a

typical shell company billing scheme?

(Learning objective 4-9) What is a pay-and-return scheme? List three examples of how

this type of fraud can be committed.

(Learning objective 4-10) How does an employee use a non-accomplice vendor’s invoice

to generate a fraudulent payment?

(Learning objective 4-12) How does an employee make personal purchases on company

credit cards, purchasing cards, or running charge accounts?

DISCUSSION ISSUES

(Learning objectives 4-3 and 4-4) In the case study of Cheryl Brown, the administrative

assistant at a Southeastern medical school, what type of billing scheme did she commit?

(Learning objectives 4-8, 4-11, and 4-13) Explain how separation of duties contributes to

the prevention and detection of billing schemes.

115

116

3/12/2018 Bookshelf Online: Principles of Fraud

https://online.vitalsource.com/#/books/9781118233566/cfi/6/12!/4/2@0:0 14/14

4-3

4-4

4-5

4-6

4-7

4-8

(Learning objectives 4-8 and 4-14) List and explain at least four proactive audit tests

that could be performed to help detect a shell company scheme.

(Learning objectives 4-4, 4-5, and 4-8) What are some of the ways shell company

invoices can be identified?

(Learning objectives 4-4 and 4-7) Sharon Forsyth worked in the purchasing department

of a retail store. She was in charge of ordering merchandise inventory and various

supplies for the organization. She purchased merchandise through a fictitious shell

company and then resold it to her employer at an inflated price. What is the name for

this type of fraud?

(Learning objective 4-9) Karen Martinis was responsible for opening mail, processing

vendor claims, and authorizing payments. She was involved in a scheme in which she

either double-paid vendor invoices, paid the wrong vendors, or overpaid the right

vendors. What type of billing scheme is being described in this case?

(Learning objective 4-9) What type of internal controls can be utilized to help prevent

pay-and-return billing schemes?

(Learning objective 4-12) In terms of classifying frauds under the fraud tree system,

how does a scheme in which an employee fraudulently orders merchandise for his

personal use differ from a scheme in which an employee steals merchandise from his

company’s warehouse?

ENDNOTES

1. Lanza, pp. 48–50.