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When the governing board of a governmental entity fails to carry out its oversight responsibilities, fraud or related problems can result. Most fraud is committed by basically honest people. However, when leadership fails, an environment is created in which people can be tempted to commit illegal acts.
For a political subdivision of a states--be it a county, city, town, utility district, or a local board of education--the buck stops with the governing body The members of a governing body or board are responsible for the entity's operations, which includes establishing the policies and procedures the governmental entity operates under. They are also responsible for seeing that the entity is operated in accordance with those policies and procedures. The board may delegate such responsibility, but in the end, they are ultimately responsible.
But sometimes governing boards rail to adopt adequate policies and procedures. Or they adopt inadequate policies and procedures. Or they do adopt adequate policies and procedures but fail to see that fail to ensure compliance. In such cases, bad things can happen, and often do. The entity might operate inefficiently, or fail to adequately maintain its infrastructure, or assets may be misappropriated.
WHEN FRAUD OCCURS
For an honest person to commit fraud, three things must be present: opportunity, need, and rationalization. Opportunity can exist for years, often because duties are not sufficiently segregated or because the entity is lacking basic internal controls. If an individual does not also have a need, however, that person will not usually act on the opportunity. Needs can manifest in a very short period of rime, though, and someone who may not have a need today may have one tomorrow. In this situation, rationalization is soon to follow.
In one example, the city recorder in a small Tennessee town had tremendous opportunities for years to steal money from the city because she did all the accounting. It was a one-person operation, and the city had a lot of money She never took advantage of the situation, though, because she never had a need. Then, on a weekend trip with a friend, she gambled for the first time and won $45,000. The gambling bug bit hard and she started going back to the casino on the weekends, losing her $45,000, and then $72,000 of the city's money. When confronted, her response was, "I'm going to win it all back, and I'll repay the city." She was a basically honest person, so she had to be able to rationalize that she was not stealing the money, but only borrowing it. She was going to pay it all back. And if she had won the money, she probably would have paid it all back--but she did not.
Opportunity, need, and rationalization are often referred to as the fraud triangle, but it may be better to think of the situation as a three-legged table. How many legs must a three-legged table have in order to stand? Three. If any one leg is removed, the table will fall. Of the three legs, the one management (the governing body) provides is opportunity A board may delegate authority to someone to make sure adequate internal controls are in place and working, but the board still has a responsibility to monitor the entire process, making sure such controls are in place and are working. Ignorance is no excuse--it is the board's job to know.
NO EXCUSES
The best-laid plans are worthless unless hey are put into operation and monitored. From time to time--say, once a month--at least one member of the governing body should examine the records to make sure that adequate collection records are being created and retained, and adequate supporting documentation for disbursements is being obtained and retained. If there is a documentation problem, it should not be discovered when the board reads the annual audit report. The poorest response to such findings is "We were not aware of this." Documentation deficiencies that are identified during the periodic reviews should not be tolerated; such deficiencies may very well provide an opportunity
No excuses should be accepted for inadequate records. If discrepancies are blamed on computer software glitches, have the software vendor come out immediately and determine if there really are problems. The problem often lies with an individual, not the software. If reports are not printed because of printer problems, investigate and replace the printer, if necessary. New printers are not that expensive. If discrepancies are blamed on a bank error, contact the bank and get the issue straightened out immediately
Non-compliance with the board's policies and procedures should not be tolerated. After one warning, individuals who do not comply should be dismissed. In addition, do not allow employees to entrench themselves in certain tasks; any resistance to giving up a task should be viewed with suspicion. So should resistance to changing procedures, especially when the changes are made to strengthen internal controls. Similarly, procedures that seem to serve no purpose but linger because "We've always done it this way" are cause for misgivings.
These suggestions may look like a lot of extra work for the board members, but these are not additional duties--they are responsibilities. Otherwise, someone is going to be in the position of trying to explain how a fraud was allowed to occur without being detected early on. Board members should have some basic awareness of the functions and responsibilities of staff positions so they are in a better position to flag insipient problems. Board members should bring issues to the attention of the auditor, not the other way around.
OPPORTUNITIES FOR FRAUD
Organizations supply employees with opportunities for committing fraud in a number of ways. Opportunities the Tennessee Division of Municipal Audit's investigations have turned up include:
* Duties are not properly segregated (the main opportunity for fraud)
* Cash receipts are not deposited on a timely basis
* A member of the board is involved with a conflict of interest
* Bid requirements are not observed or do not exist
* Capital assets records are not maintained (if you do not know what you have, you also do not know what is missing)
* Deposits are not itemized or made intact
* Cash is used to make small purchases
* Billing adjustments are not approved, or approval is made by the billing clerk
* The date paid is not stamped on billing stubs
* The bank account is not reconciled, or the reconciliation is not done on a timely basis
* Accounts receivable subsidiary records are not reconciled to the general ledger
* An agency has a high loss rate (e.g., the water utility has a loss rate of more than 20 percent)
* The individual who opens the mail also makes the bank deposit
* Personal checks are cashed through either the petty cash fund or daily receipts
* More than one employee has access to the same cash drawer
* The individual who collects receipts also posts those receipts
* Background checks are not run on employees, especially those responsible for handling cash
* Members of the board rail to comply with the district's policies and procedures ("Do as I say, not as I do")
* The designated individual does not properly review invoices prior to approval for payment
* Checks are pre-signed
* Credit card and gas card charges and payments are not reviewed
* There is not an adequate travel reimbursement policy in place
* Personal use of the entity's assets is allowed
* Members of the board or employees are not billed for services provided by the entity's utilities (e.g., monthly water bill or tap fee)
CONCLUSION
Members of an organization's governing body are responsible for setting and carrying out the entity's policies and procedures. The governing body sets the tone for the organization and its employees. There are five elements of internal control (see Exhibit 1), but the control environment determines the success or failure of all other internal controls. The control environment is established by management. Employees look to management to set an example, and if management does not emphasize internal controls or does not follow them, employees will follow management's lead every time.
One thing is certain: If opportunity is available, fraud will occur. Maybe not today or tomorrow, maybe not next month, or even next year; but it will occur. It is just a matter of time.
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DENNIS F. DYCUS, CPA, CFE, CGFM, is director of the Office of the Comptroller of the Treasury, Division of Municipal Audit, for the state of Tennessee.
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