In this month's article, part of a series written on employee frauds, I examine typical purchasing fraud schemes. The purchasing function of a business includes the acquisition of goods and services for the business. The acquisition function is especially vulnerable to fraudulent transactions because it involves the disbursement of company funds. It is where most cash leaves the company. Purchasing fraud probably contributes the largest fraud risk to most enterprises. Purchasing fraud does not necessarily require collusion with another employee or an outsider, although collusion often occurs. Employees of any level of an organization can perpetrate thefts.
There are four basic classifications of purchasing fraud schemes that employees commit: fictitious invoices; over-billing; checks payable to employees; and conflicts of interest.
A fictitious invoice is any invoice not represented by a legitimate sale and purchase. The offender will arrange for the excess purchase of goods or services that are then billed to the business. The excess goods are ultimately transferred to another location for their eventual sale. The purchase of excess services is different as the services are usually provided directly to the offender and billed to the company. These service invoices usually do not include enough detailed information to easily determine whether the services were actually for the business enterprise.
Another fictitious invoice scheme is for an individual to arrange for invoices to be sent to and paid by a company but the invoicing business does not exist. A bank's marketing and advertising director allegedly arranged for another individual to submit bills for advertising that had been placed in a trade publication but the trade publication did not exist. This type of scheme often involves collusion with the vendor and purchasing or accounts payable personnel.
Over-billing is a method where the individual submits an inflated or altered invoice for payment. The overpayment is then diverted, paid to the employee, or an accomplice. A 61-year-old employee of a national retail chain was indicted for defrauding his employer of more than $2 million. He was an employee for more than 15 years and was responsible for leasing building to house the company's stores. On 22 leases, he altered the documents, including the forgery of letters to the company for fictitious legal and maintenance services. He also altered the company's copy of the leases so that the billings for these services would match the leases.
Employees can create payments to themselves by circumventing the control system so that payments are diverted directly to themselves or to companies they control. Duplicate payments may occur anytime someone overrides the system to prevent duplicate payments. Collusion is probably necessary unless the individual intercepts the outgoing mail containing the payments. An accounts payable supervisor had the ability to over-ride the duplicate payment control mechanism. The supervisor authorized duplicate payments to an existing vendor, with the commas removed from the vendor's name it appeared as that of an individual rather than a business. An accomplice then opened a bank account in the fictitious name made up from the legitimate vendor's name. The duplicate payment was then deposited into this bank account.
Conflicts of interest occur when an employee, manager, or executive has an undisclosed economic interest in a transaction that adversely affects the company. It is not necessary that the company actually suffer damages in order for conflict of interest violation to be sustained. The effect need only be potentially adverse. Conflicts of interest may be part of schemes where services are never rendered. Conflict of interest schemes are variations of the rule that an employee has a fiduciary responsibility to his employer. A conflict of interest scheme can, and often does, involve other schemes. A manufacturer's purchasing agent was also the receiving department's supervisor. He had an affair with the accounts payable clerk. A material salesman proposed a fraud following a discussion regarding the volume of material used by the company. The purchasing agent knew that the actual material usage was significantly under the standard that had been established when the plant was in a start-up mode. The salesman established an out-of-state post office box and telephone number but used a legitimate company name. He provided invoices, bills of lading, and copies of freight bills. The purchasing agent prepared receiving reports and told the receiving clerk that he accepted the goods when the clerk was on break or after hours. The scheme totaled approximately $40,000. The purchasing agent, who had been with the company for two years was terminated and prosecuted.
Businesses can minimize the likelihood of thefts through strengthening its internal controls. There are numerous methods to detect purchasing frauds so if a business finds itself a victim of a fraud, it should consult its legal counsel, accountant, and a competent fraud examiner.
© 2019 McGovern & Greene LLP All rights reserved.