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It Figures: The CRI Podcast

S1:E16 – When You Suspect Fraud: The Story of the Million Dollar Fajita Fraud

What do I do if I suspect fraud is occurring in my organization? Who can help me determine the extent of the fraud? Do I involve law enforcement? These are some of the questions that most business owners will unfortunately and inevitably face at some point. Join CRI Partners Ygnacio Garza and Jimmy Woodall on this episode of It Figures as they explore the ways finance officers and business owners can identify fraud, the steps to rectify and mitigate the fraud, and the internal controls to put in place to prevent it from happening again.

Intro:
From Carr, Riggs and Ingram. This is It Figures, the CRI podcast. An accounting advisory and industry focused podcast for business and organization leaders, entrepreneurs, and anyone who is looking to go beyond the status quo.

Jimmy Woodall:
All right. Good morning, everybody. My name is Jimmy Woodall. I am the assurance service line leader here at Carr, Riggs and Ingram. I’ve got a background as a CPA and have done a lot of internal audit in my career. And with that, we’re going to talk about for all of this morning. We’re going to talk about what you should do when you suspect fraud in an organization, what your organization should do. Joining me this morning, the main star here is Ygnacio Garza. But more affectionately known as nacho, out of our Rio Grande Valley practice. Nacho is a partner with us and does a lot of our forensic accounting. Nacho, tell me a little about yourself.

Ygnacio Garza:
Oh, I’ve been practicing in CPA for 47 years now. Lately, in the last 28 years or so, I’ve done a lot of litigation support. And so I’ve seen fraud and the consequences of fraud, not only as a fraud examiner, but the mitigation that can come from or as a result of different types of fraud. So this is something I’m familiar with, I’ve seen. And I think it’s something we need to make people aware of, and how they handled it when they see this in their organization.

Jimmy Woodall:
Absolutely. We’ll talk about that in a few minutes. But there’s definitely some implications or some things that when you get to the fraud that management and business owners have got to think past the actual identifying and finding out that the fraud is there. So great point, we’ll bring that up. So again, like you mentioned, it’s very important that we’re doing this. But I’ll bring up a stat here. The Association of Certified Fraud Examiners does a report every two years. And I was looking at the 2018 reports. Their report to the nations on occupational fraud and abuse. And that goes out across to all the world. And in that they looked at 2,600 fraud cases in 2018. And there’s just some staggering statistics in there related to fraud. I’ll just drop a couple here.
The first one says that typical, a business will lose about 5% of its annual income due to fraud. When you start looking at the median losses in these cases, you had about a hundred thousand dollars median losses that they looked at in their study. Larger businesses tend to lose less than smaller businesses. We’ll talk a little bit about that. And in the US I guess it was about 108,000, what it looks like. So comments on any of that?

Ygnacio Garza:
Jimmy, over the years, I’ve seen clients lose several hundreds of thousands of dollars to fraud. And beyond just the financial losses, there’s also just a loss of reputation, not to mention the loss of time that comes with dealing with the fraud. So there’s a lot of issues that go into the losses and the need to address that whole issue of fraud is a real issue when it comes to business.

Jimmy Woodall:
Yeah. Not just monetary, but opportunity losses there. Yeah. Okay. What do you… I guess, why are people committing these frauds? Why are they doing this?

Ygnacio Garza:
There’s the old fraud triangle. Generally, somebody has a need, living beyond their means. They have a family member that’s in trouble, they need more money. And then they begin to rationalize it. They say, “Well, I’m not getting paid enough. The company won’t miss it. I can get this money.” And then ultimately they decide they have the opportunity to follow through and commit a fraud. And so there’s all kinds of reasons that people commit fraud.

Jimmy Woodall:
Yeah. You should keep your mind open in thinking about, “This wouldn’t necessarily happen to me.”
Let’s jump back to one of those statistics that I mentioned earlier, is that smaller companies that this report from the Association of Certified Fraud Examiners says that employees with a hundred or fewer employees, it goes to $200,000. That’s the median loss they had, compared to those with over a hundred thousand employees, it was $104,000. Where’s that discrepancy? And what would you tell a company who thinks that, “Hey, we’re too small to have to worry about this. This is something that larger company deal with.”

Ygnacio Garza:
I think clearly what happens is the smaller companies may not have in place the necessary controls and procedures that prevent fraud. And they become more susceptible to fraud, because fewer people have more access to the records, to the money. They can commit that fraud, because there’s just not the checks and balances in the system.

Jimmy Woodall:
Right? Well, hey, I’ve got a few case studies here that I’ve encountered over my professional career. And wanted to bounce those off of you and get your thoughts and how you might tell a similar business, that’s encountering a similar situation, how they might approach that. The first one is as part of an internal audit engagement that I was on, we had a manufacturer, an international manufacturer distribution company. And they had a central American operation there. And part of their purchasing agent there was providing or getting kickbacks from a certain vendor. So the company was getting way overcharged for the products and services that this vendor was providing. And this purchasing agent was getting kickbacks. And so there was a tip, there was a hotline. We went in, we did the investigation, we found that. But we quickly found ourselves as internal audit over our heads, in terms of international law and some things, the way that the company wanted to approach that.
W what would be your thoughts on that? What would you suggest someone in a similar situation do?

Ygnacio Garza:
I think when you suspect fraud, or when you think fraud is going on, or you discover fraud, the prudent thing I think is to reach outside and get help from people who deal with this on an ongoing basis. Find those professionals. And it may be a diverse team of individuals, forensic accountants, forensic, computer specialist, investigators. You have to reach outside your organization. Partly because when you suspect fraud, you don’t want to tip off the fraudsters by doing it all internally. You need to reach outside, get a team to help you and then solve the problem.

Jimmy Woodall:
Yeah. And that’s where we hit it. When I did that, I was actually a member of an internal audit team for this company. So this was prior to my joining Carr, Riggs and Ingram. And we were able to get a professional team, like yourself, to come and involve and help us with that. Next one. This was an engagement at CRI, where we were looking over some government financial statements and we found… And this is not limited to governments. We’ve seen it in other places. But some employees who were stealing through expense reports, and that might be something that’s more common with some of our smaller business owners and smaller clients. They may have people kind of padding expense reports to get money.

Ygnacio Garza:
I’ve seen that. And actually, I became a witness at one of those matters. Because at the local chamber of commerce, one of the people there was padding their expense reports, and part of his expense report said he’d had lunch with Nacho Garza on two to three occasions.

Jimmy Woodall:
Their dragging you into it, right?

Ygnacio Garza:
I got a call and they say, “Hey, did you have lunch with this individual on these days?” I said, “No, I didn’t.” So that’s seeing it from that. And it sounds trivial. But if you allow any kind of fraud that go unpunished, or undealt with, it sets a bad tone for the whole organization. So we see that a lot.

Jimmy Woodall:
Yeah. So, well, another similar situation, we had one, this was a retail client. And we detect this on a financial statement audit, going through doing some of the inventory work and looking at turnover and cost. But we had employees who were stealing inventory. They were walking out every day with… Their pockets were a little heavier as they were going out the door. So, similar situations?

Ygnacio Garza:
We’ve seen that actually in our part of the world. Fajitas is a very common lunch meat or meat that we eat at night. And one of the people in charge of the commissary at the jail, the food service at the jail, was ordering fajitas. The only trouble is they never served fajitas at the jail. He was taking those out the back door and selling them. And it sounds small, but over the years he sold about a million dollars worth of fajitas-

Jimmy Woodall:
Worth of fajitas that weren’t there, right?

Ygnacio Garza:
That were paid for by the county and he’s sold outside. So that’s a real common issue. Controlling your inventory is critical to any business.

Jimmy Woodall:
Yeah, absolutely. Last example. I’ll give you here. This flips over to the other type of fraud, which is the financial statement fraud. And I will say that we’ve seen situations at CRI that where the misappropriation of assets, the stealing, the other things leads to this sometimes. Because they’re trying to cover up what they’ve done. So you get a double whammy there.
This one was a situation where we had management, and this is going to get to a little different level, because it’s going to rise up a little bit. We had some senior management and accounting folks who were managing income through estimates and accruals. And so they were like reserve, reserve, reserve reserve, on this very subjective estimates. Because we’re having a good year. And then the bad year comes along. “Oh, we’re just going to reverse that accrual, that sends all that money through income. We still make our bonus. We still don’t have to worry about the stock price. We’re still have those things that are occurring.” So somewhat financial manipulation and financial statement fraud there.

Ygnacio Garza:
Well generally the more senior the people in the organization, that are involved in the fraud, the more serious the fraud become or is. In that case, perhaps the organization didn’t lose money, because of that fraud. But clearly the reputation with lenders, with investors has been negatively impacted. And it’s still something that has to be dealt with by the overall organization, whether it be the board of directors or even more senior management. Or the shareholders have to address that. And once again, that’s where you reach out to competent professionals to help you deal with that issue.

Jimmy Woodall:
What would you do in that situation? If you’ve got a junior staff person, somebody who is in the accounting department. And they’re looking at this and they’re saying, “I don’t think this is right, but this is my boss doing this.” What would you suggest that person do?

Ygnacio Garza:
They need to follow whoever… And it’s hard, because the internal chain of command, they have to find somebody they can trust to go to and tell, “I believe this is happening.” Whether that’s the external auditors, the external accountants. Come to somebody and let them know what you think, because you have to report it.
If you don’t. And I’ve seen this too many times, where people, the controls are in place and people know that’s somebody’s doing something outside of the control structure, and they don’t report it. So the frog goes on and on and on. And they become complicit in that frog. So you have to report.

Jimmy Woodall:
Yeah. What would you say that… And again, you touched on this a second ago. But the extent that you take some of these things? Like I said, I’ve seen situations, that we’ve just talked about, where you’ve got a simple termination. Management says you’re fired, you’re gone, whatever. Sometimes you’ve got a board settling with high end management and saying, “We’re going to settle this claim. Move on. Just walk your way, because we’ve got contracts.” Sometimes there’s legal action. What are the criteria that I guess a business owner, small business owners in particular, should consider and go through when you’re saying, “Okay, how far do I take this? What should my situation be?”

Ygnacio Garza:
I think they need to decide in terms of on a case by case basis. My view is you need to make sure the fraud is punished. You cannot fail to take action, because if you do everybody else in the organization notices you didn’t take that fraud in their mind seriously. So they think, “Well, I can do it too.” But you have to take it. And that’s part of the issue in bringing together that diverse team of professionals. You need to have some attorneys to consult with, because you may… If you fire the person and say, “Hey, I think you did this. I’m firing you.” You’re opening yourself up for a Rockwell termination lawsuit.
And there may be civil lawsuits and criminal lawsuits coming out of any fraud. A civil trying to get the money back or recover the assets that have been taken, or dealing with a bank or an investor who says, “Your fraudulent financial statements induced me to invest and lend money.” Or a civil lawsuit with an insurance company trying to enforce insurance coverage that would cover that loss. So there’s a lot of potential litigation that could come from any fraud. So you need to go ahead and hire not only the upside accountants and forensic experts, but consult with outside attorneys.

Jimmy Woodall:
Yeah. Let’s, let’s switch gears. So you’ve got a fraud. You’ve found a fraud. You’ve gone through maybe all of steps. Some of or all of these steps that you just talked about. Let’s talk about preventing this thing from going on, or being able to detect. And so let’s talk about some of the controls and things that we need to put in place. Certainly I would recommend, my background is internal audit, and I would recommend internal audit. CRI provides internal audit services. And I think those are key to helping you build and start strong controls. Anything that you would recommend specifically on there that you’ve seen to help prevent?

Ygnacio Garza:
I think the first thing, and this is easier said than done. When somebody suspects fraud, the first thing I tell them is, “Be calm, be patient, don’t overreact.” And that’s hard to do because when you see what happens there’s an element of surprise. There’s an element of shock.

Jimmy Woodall:
There’s trust. I mean it could be someone you trust.

Ygnacio Garza:
There’s a violation of trust. There’s anger, because somebody you’ve trusted has now done something bad to you. So it’s hard not to overreact. But the way you handle the first few days of a suspected fraud can have real longterm implications to how the investigation ultimately goes.
If you overreact, you’re tipping off the fraudsters, they can destroy evidence. They can move on, they can hide things. So you need to stay calm and not overreact. Don’t panic. But then ultimately not only do you want to investigate the fraud, but you want to determine how do I prevent this from happening again? What controls failed? What controls do we need? And who can I turn to? And normally we think that’s you’re outside trusted advisor, which are the accountants and attorneys.

Jimmy Woodall:
Absolutely. Yeah. So again, you want to look at what you think. Analyze, get those folks in, those professionals and help you determine what caused the fraud and then what you could do to prevent that. Yeah. Great thoughts on all of that. So I hope today you’ve seen this. We’re going to wrap this up. But I hope you have seen the importance of the fraud, and the things we’re talking about today.
CRI has got a lot of great services that we can provide in terms of internal audit services. Nacho leads up a great group on the forensics team, on the litigation support and helping some of those things. Nacho, any final thoughts on your side?

Ygnacio Garza:
Fraud’s going to happen. The chances are that you will see something in your organization. And over the years we’ve seen it in private businesses, in charitable organizations, religious organizations, governmental entities. It doesn’t happen often, but when it happens to you, it’s a real hurt. Not only emotionally, but to the institution or the company you’re working with. So be prepared, make sure you try to prevent it. And if you suspect it, deal with it logically.

Jimmy Woodall:
Absolutely. All right. Well, listen, thanks again to everybody for joining us today, we encourage you to go out to cricpa.com. Check us out and give us a call. If you’re looking for a service provider, if you’re looking for somebody to help you with some of these situations in terms of helping establish controls and preventing fraud, or if you’ve got a suspected fraud situation yourself. I’m Jimmy Woodall, this is Nacho Garza, we appreciate your time today. Thanks.

Outro:
If you want more CRI insights or interested in learning about our firm, please visit our website at cricpa.com. Thanks for listening to this episode of It Figures, the CRI podcast. You can subscribe to It Figures on iTunes, Spotify, or wherever you prefer to listen to your podcasts. If you liked what you heard today, please leave us a review.

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