Know How to Help Catch Fraud at the Firm

Any lawyer responsible for running a firm needs to know that changing the observer’s point of view or frame of reference can help reveal a fraudster’s trick.

By Jeff Compton
February 24, 2014
Originally published in Texas Lawyer.

Successful fraud perpetrators are like good magicians. They know what people expect and cleverly exploit that expectation to disguise what actually is occurring. Any lawyer responsible for running a firm needs to know that changing the observer’s point of view or frame of reference can help reveal the fraudster’s trick.

Here’s a hypothetical example of how fraud can go undetected until a key observer changes her frame of reference. This doesn’t represent any particular people, events or entities, but it does reveal an all-too-common scenario.

Geri GC began her day reading a demand letter from one of her employer’s vendors. The letter, which was addressed to her as general counsel of Holdco from a supplier, Divot, claimed that Holdco was 120 days past due on five invoices equal to $5,600 total.

Remembering that Charlie Controller was out for the day, Geri called one of Charlie’s staff members, Andy Accountant. Andy called Charlie to get the OK, then he checked Holdco’s accounts payable records on his computer while Charlie held on the telephone.

Andy reported to Geri that the five invoices to Divot discussed in Divot’s demand letter showed in the Holdco accounting records as paid. Thanking him, Geri hung up and began to wonder what was going on; maybe Divot just was using sloppy accounting practices.

She called Andy back and arranged to visit his office where the bank records were kept, so she could obtain proof of payment to send Divot. When Geri and Andy opened the first bank statement containing one of the five checks, they were puzzled. Holdco’s bank had paid the check, which was in the exact dollar amount and check sequence number it was supposed to be, not to Divot but to D’vot.

Setting that aside for the moment, they moved through the next four checks in question. They discovered the same apparent typo in each. Then referencing a cleared Divot check that wasn’t in dispute, they realized the addresses of D’vot and Divot were completely different. Neither recognized the address for D’vot, which was a P.O. box.

Andy seemed a little defensive by this point. He explained he had not recognized this anomaly, even though he had reconciled all these bank statements. Andy explained to Geri that, like most accountants, he did not focus on the payee’s name but instead on the check’s sequence number and amount.

Andy further explained that Holdco had antifraud measures in place: Holdco had instituted a service its bank offered, under which the bank would process only checks bearing check numbers and amounts Holdco supplied to the bank before Holdco issued the checks.

Geri asked Andy if the bank extended this service to include verifying the payee. Andy paused then slowly replied that it could have, but Charlie had explained that Holdco didn’t need that service, given the unlikelihood that any potential forger would know the check number and amount. Andy recounted how Charlie had told him with great confidence that the bank would reject potential forgeries simply because the check number and amount did not match.

Geri obtained printed copies of the five suspicious checks, both front and back, then started to return to her office. Just before she left, Andy asked Geri what she had decided to do about Tee, another supplier.

Amanda asked him what he meant, and Jim produced a letter from Tee with unpaid invoices attached. Jim explained that Charlie had told him that Geri was handling the matter. Baffled, Geri briefly interviewed Jim to learn what other vendors were claiming past due amounts.

Geri hurried back to her office. She immediately logged into the Secretary of State’s online records to find out just who was behind D’vot. Her suspicion turned to anger when “Charlie Controller” appeared again and again on the formation form for D’vot. Printing the Secretary of State record from her computer, Amanda walked quickly to HR, where she confirmed the address on the form to be Charlie’s home address.

Geri called the company’s president and its chief financial officer. Geri nervously fidgeted with her social media pages, wanting to tell someone what she was thinking. Then, she decided to check Charlie’s social media page, where she saw pictures and descriptions of a recent trip to Europe. That caught her by surprise; Charlie hadn’t mentioned taking such an expensive vacation.

The revelation reminded Geri that she recently had seen pictures of a much more modest trip that Charlie posted on another social media site. When Geri went to that site, she found that the photos from the modest trip had been replaced by photos showing Charlie wearing expensive clothing and jewelry.

With a sinking feeling, Geri realized she needed to arrange for careful preservation of evidence. A query from an outside source was quickly uncovering a fraud inside Holdco.

See Differently

This change in perspective often is what allows lawyers and managers to uncover a fraud within their firms. This shift can occur when the referenced records are not those the perpetrator created or controlled but instead are those maintained by an independent third party.

The chain of events leading to Geri’s investigation of Charlie began with Geri looking outside the figurative box of company records. The Divot demand letter was a wake-up call from an outside source. In trying to resolve the discrepancy, Geri and Andy looked at the bank records. Geri pressed Andy for more information, and he brought up the additional demand letter from another supplier. When Geri went to the Secretary of State records and the social media sites, the final pieces of the puzzle fell into place.

Especially in small firms, installing effective controls to prevent an unauthorized vendor from receiving a check is difficult. Encouraging personnel to think beyond what they assume is happening may prevent misappropriation.