United States: The Case Of The Shrinking Margins

When Timothy P. Anglim, CPA, CMA, founder of the FraudDetectives Consultant Network, accepted an assignment as CFO for a struggling family-owned manufacturer in the early 90's, he expected to find a company that was in need of financial and operational discipline, given its known recent track record of operating deficits. And initially, the assignment focused on upgrading manual financial systems and consolidating several operating entities into one, to improve reporting visibility. Cash flow was negative. So at this stage, and in the absence of any prudent margin analysis capability, Anglim developed measures based on known raw material standard usage rates to track and compare to actual consumption rates, in pounds of raw material as reported in the new financial system. Before long, it became apparent that there was an unusually large and consistent usage variance that could not be explained away with typical scrap rates.

Coincident with this development, the books had been converted from a cash basis to an accrual basis, resulting in an even more depressing financial picture (i.e., purchases of raw material required a significant "catch-up" entry to accrue for all open and unpaid vendor invoices). Yet once this charge was recorded, the excessive raw material usage variance continued unabated. Scrap rates, as verified independently through the sale of waste product, could not begin to explain this variance. It soon became clear that only one cause seemed possible. That somehow vendor purchases were overstated. Since several vendors were selling this key raw material, at varying levels throughout the year, it didn't seem likely that one vendor could account for any potential over-billing since the variances did not fluctuate. So he looked inward to the financial staff.

Although the principal of the firm had relinquished most financial control to the new CFO, a first for this family business, the principal still personally signed all checks. He also insisted that his long-term controller continue to personally prepare all checks for the owner's signature on a weekly basis and prepare the bank reconciliation, with the CFO doing a review. The controller no longer supervised accounts payable. But, it did become known that although the principal of the firm did in fact sign and approve all disbursement checks, the signed checks were still being returned to the controller for mailing.

The margin analysis continued to show no or little improvement over the ensuing weeks. Additionally, there appeared to be more inconsistencies in the accounts payable records as the mechanization process moved forward. Many invoices from the prior year's payable records appeared to have been paid from invoice copies, not originals, although the backup appeared to be original (i.e. bills of lading and vendor packing slips). Common sense did not offer any clues as to what to do next, but Anglim decided to re-visit the cancelled checks for the potentially duplicate invoice payments. Every cancelled check appeared, as before, to be fine. The payee in each instance was identical to all other payments to that vendor, both before and since, although the vendor's full name was never completely correct. For example, "ABC Material Co., Inc." would appear as "ABC Company" as the payee on each check. And this was true for all of their payments. But when reviewing endorsements, something was not right. It appeared that every so often, an endorsement appeared to blur, or "bleed" into the check stock. The older the check, the more it "bled." Upon closer examination, it could be determined that the original endorsements on "bleeding checks" were covered over with a typing correction fluid, matching the gold or yellow check background nearly perfectly. Only the faint security feature lines on the back of the check seemed to fade out. Our fraudster, whoever this was at this point, was pretty clever about this too. Apparently, once the cancelled checks were received from the bank, our fraudster would cover up the original endorsement and would then stamp these now-altered checks with a copy of the vendor's actual endorsement stamp, even matching the color of the stamp pad ink used by that particular vendor. Upon review, these altered checks would appear to be fine, when compared to legitimately cancelled checks that were cashed by the vendor. Only a thorough review of the actual bank routing details as printed on the backs of cancelled checks could point to any discrepancy.

Anglim still didn't have the proof to show who altered and converted these checks yet. To do so, took some luck. It appeared that the controller kept a stock of envelopes in his desk drawer. Staying late one evening, the CFO needed a few company envelopes, so he helped himself to some from the controller's desk. The drawer seemed odd, in that there were very few envelopes in it, yet there was a back section to it behind the envelopes, that contained other envelopes, some of which could be seen to be full. In fact they were being used to store checks. These checks, all pre-signed blank business checks, were drawn on several local banks, in names that closely resembled actual company vendors (again, no "Inc" in the name). Additionally, another file drawer yielded other evidence, the phony endorsement stamps and bank statements that matched the names on the checks.

Faced with the altered checks, a reluctant owner finally accepted the obvious fact that his trusted controller stole an estimated $2.5 million dollars covering a five year period, nearly driving him out of business. The fraudster, who was then immediately confronted, quickly admitted his guilt. But was amazingly unfazed, remarking: "I guess that means you want me to leave"! He "left" and subsequently made significant restitution.

The company is still in business today.