Table of Contents
Title Page
Copyright Page
CHAPTER 1 - The World of Fraud
Definition of Fraud
The Man Types of Fraud
CHAPTER 2 - Why Is Fraud Committed?
A Rationalizing Society
Financial Statement Fraud
Financial Fraud Comes in Different Shapes and Sizes
Motivators Differ by Type of Business
Employee Schemes
In the End
CHAPTER 3 - Financial Statement Fraud Schemes
Where Do Thing s Go Wrong?
Trend Analysis
Beyond Traditional Audits
CHAPTER 4 - Employee Embezzlements
The Fraud Triangle
Areas for Concern
CHAPTER 5 - Other Fraud Schemes
Duplicate PaymentFraud
Multiple Payee Fraud
Shell Fraud
Defective Delivery Fraud
Defective Receipt Fraud
Defective Ship ment Fraud
Defective Pricing Fraud
CHAPTER 6 - Contract Rigging Schemes
Stage One: Obtaining the Contract
Stage Two: Contract Change Orders
Unbalanced Bidding
Detection Recommendations
Rotation Fraud
Where Do We Go from Here?
CHAPTER 7 - Responses to Fraud
Government’s Response to Fraud
Accounting Profession’s Response to Fraud
Internal Audit Profession’s Response to Fraud
New Credentials, More Training, Better Awareness
Articles, Books, and More Resources
CHAPTER 8 - The Importance of Internal Controls and Internal Audit
Why Have Internal Controls?
Déjà Vu
Good Internal Controls
Internal Audit
CHAPTER 9 - Evidence
What Is Evidence?
CHAPTER 10 - Conducting Fraud Investigations: A Practical Approach
Proactive Fraud Investigations
Discovery Investigations
Supportive Investigations
The Investigative Plan
Conducting the Procedures
Use of the Findings
CHAPTER 11 - Fraud Investigation Alternatives
Assessing the Feasibility of a Full Investigation
Monitoring Operational Areas at Risk of Fraud
Revamping Internal Controls: Closing the Barn Door
Doing Nothing?
Appendix A - Vending
Appendix B - Living a Façade
Appendix C - Disappearing Inventory


For Justin, Evan, and Kim

At the time of this writing of the third edition of Fraud 101, the U.S. economy is facing extraordinary challenges. Wall Street and the entire global economic and financial system are in steep decline, and the economy is in a worldwide recession. Financial institution Lehman Brothers recently filed for bankruptcy, the insurance giant AIG is in dire financial straits and required taxpayer bailouts to survive, and the mortgage giants Fannie Mae and Freddie Mac are in deep jeopardy. The U.S. federal government approved a historic funding package of up to $750 billion in stimulus payments to be made to various financial markets and industries in distress with the goal of stimulating the economy. Payments to date appear to have had little impact with no proven results on the economy.
In one of the most egregious cases in history, Bernard Madoff, a financier and investment manager, recently admitted to embezzling more than $50 billion of investors’ funds through an elaborate Ponzi scheme he perpetrated. Allegedly, the money he paid to early investors was from funds received from subsequent investors, and when too many investors demanded their funds in response to the failing economy, the scheme collapsed. Although Ponzi schemes are common and have occurred many times in history, Madoff’s scheme is the largest Ponzi scheme ever. The dimension of fraud cases is becoming unfathomable—multi-millions and even billions are becoming commonplace.
In one recent case detected in my home state of Connecticut last month, the sole equity partner of a six-office, 238-attorney law firm was accused of stealing more than $350 million in client funds. One person—$350 million. The question that remains is just how many of these schemes exist today and continue to go undetected?
“Identify theft,” a buzz word for the past two years, has been replaced by “subprime lending,” “mortgage fraud,” and record-setting foreclosures. Financial lending has come to a grinding halt, with money no longer moving between institutions, and interest rates have been cut to record lows by the Federal Reserve in the hope of jump-starting the economy. It’s not a particularly great time in history from an investor’s perspective, but an extremely interesting time for fraud professionals.
It is not unusual for policies and practices to have a direct link to increases in fraudulent activity. To examine identify theft for a moment, we would start by looking back to see how personal and financial information was safeguarded. We would not have to look far into the past to see that Social Security numbers appeared on many items, including insurance cards, voter registration cards (a matter of public record), and class lists posted on every professor’s office door in most every college and university. The use of shredders has only become commonplace in most businesses and homes since identity theft became an issue. The earlier practice was to simply throw away old and unwanted information, which allowed thieves to capture critical information merely by going through the garbage. With so much personal and financial information proliferated under past practices, it is no wonder identify theft became such an issue.
The same holds true with the new mortgage fraud industry. Prior to subprime and other questionable lending practices, would-be borrowers were required to substantiate their income and assets and support their applications for loans with credible documentation. The application package was scrutinized and verified, and the borrower would be allowed to borrow only up to a maximum value of the property. Borrowers could only borrow funds up to a limit they could afford to repay monthly, including real estate taxes and insurance costs, and also have some residual funds for living expenses. Loan products offered as late as 2006 and 2007 offered borrowers the ability to purchase homes well beyond their price range, with little to no income verification performed. Borrowers could state their income without providing any support and could borrow up to 100% of the value of the property with no money down. It is no wonder the foreclosure rate has reached historic levels, leading to the discovery of mortgage fraud in many of these deals. Individuals participating in real estate closings were often compensated with a commission for each closing, creating a financial incentive for lenders and mortgage brokers to solicit and close as many purchases and refinances as possible, at any cost. It is only after the mortgage industry’s collapse that we are finding out that many real estate professionals, including real estate agents, appraisers, lenders, mortgage brokers, and real estate attorneys fudged documents, inflated values, and perpetrated other intentional acts to ensure closings occurred.
Although it is too recent for reaction, the Madoff investment scandal will no doubt forever have an impact on the investment community and industry. New rules will likely result, and investors will review their accounts and investments in a different light, especially if an outside investment firm is involved. Future investment decisions and the ways those investment decisions are tracked will forever be examined in light of Madoff’s scheme, with the goal of ensuring what happened with the funds invested with Madoff never happens again.
According to the Association of Certified Fraud Examiners’ 2008 Report to the Nation on Occupational Fraud and Abuse, approximately 7% of an entity’s gross revenue is lost to fraud. When the 7% estimate is applied to the Gross Domestic Product, the loss due to fraud approximates $994 billion each year. In reality, the figure is likely even higher, as most frauds go unreported—or worse, have yet to be detected.
When assessing the frequency of fraudulent activity to gauge just how much fraud has been occurring, it is important to remember that only the most egregious fraud cases receive media and legislative attention. In fact, fraud is not limited to large international corporations like WorldCom and Enron. Fraud can and does occur in any size company or organization, large or small, regardless of their for-profit or nonprofit status, and in every industry. The majority of smaller frauds never appear in the media and become public knowledge, partly due to their size and frequently by investigative design.
Fraud is also not limited to financial statements, disclosures, and reports issued to investors and lenders alike. Employees are stealing from companies at alarming rates, and individuals concoct new schemes almost daily to defraud some program or system for their own personal gain.
It is clear that fraud has become a growth industry and not only for the perpetrators. Fighting fraud through education, prevention, detection, investigation training, and ultimately prosecution and punishment offers unprecedented growth opportunities in various career paths and industries. The passage of the Sarbanes-Oxley Act (SOX) alone, enacted to address fraud and the dire need for adequate internal controls and procedures within publicly traded companies, has resulted in a whole new industry in and of itself.
Fraud can be and often is broadly defined, but to really understand fraud, it needs to be contextualized to identify the characteristics and issues unique to each type of fraud. One of the goals in writing this third edition of Fraud 101 is to provide the reader with a working definition of fraud in the broad sense, followed with as many examples as possible of various types of fraud based on my personal experience as a forensic accountant and fraud professional for more than 20 years. Unlike many fraud professionals who have spent their careers investigating a specific range of fraud schemes, I have been fortunate in having the opportunity to apply my knowledge and experience in fraud prevention and investigation in a wide variety of contexts.
Building on the previous editions of Fraud 101 by Howard Davia and then Howard Silverstone, this third edition brings to focus two areas of fraud: financial statement fraud and employee fraud, including embezzlement. The new edition also provides an investigative approach and new discussion regarding investigative issues, including alternatives for resolving fraud-related matters. Lastly, as with previous editions, new case studies are included to illustrate various fraud schemes in rich detail.
In updating this book, I recognized that many great books exist detailing the history of fraud, various theories on fraud, fraud motivators, deviant traits and tendencies, prevention recommendations, investigative techniques, and other generalized information. Those books provide the depth and detail needed to become and remain proficient in this specialized field. I own most of them. However, there is also a need for books designed to introduce professionals, as well as non-accountants, to the specialized field of fraud. This book is meant to be a valuable introduction to the subject of fraud for those who have little to moderate experience dealing with it, whether preventing, detecting, or investigating it.
The approach used in this third edition is to explain fraud in a practical, easily understood manner, supplementing discussions with real-world case studies that clearly illustrate the fraud issues and schemes discussed. Three detailed cases based upon actual fraud investigations have been included as Appendices to illustrate examples of how fraud schemes are perpetrated, detected, and investigated. Each case concludes with practical advice on how the fraudulent activity could have been prevented or detected earlier, thus minimizing the loss experienced by each victim organization. Experienced fraud professionals seeking to expand and enhance their well-developed skill set may feel this book is basic, although the cases may enlighten even the most seasoned investigator.
While it would be ideal and efficient to discuss every possible aspect of fraud in every possible context all in one book, it would also be an impossible undertaking. As you will learn, the details of any one specific type of fraud could be expanded and detailed within a book dedicated only to that type of fraud, and many of those books exist today. My hope is that you will find this book a valuable introduction to how fraud works and how to prevent, detect, and prosecute fraud that could be occurring in your organization.
Stephen Pedneault
January 2009

To my family, who has both supported and tolerated my undertakings and at times crazy schedule, setting the bar high and expecting nothing less.
To my friends and trusted advisors, who have supported my career decisions, have taken personal interest in my success, and have helped bring to light the things they saw in me.
To Helen Koven, my friend and publicist, who gave me the push I needed to begin to document more than 20 years of experience in fraud and forensic accounting in a way that takes the complex and makes it easily understood by accountants and non-accountants alike.
To the folks at Wiley, who gave me this opportunity to expand into the world of writing, opening new doors into my future.
To Joseph T. Wells, founder of the Association of Certified Fraud Examiners, for his foresight into the need for a specialist cross-trained between accounting and investigations, and for providing me with someone to follow as my role model in becoming a national expert in this specialized field.
And to James Ratley and everyone in the Association of Certified Fraud Examiners down in Austin, Texas, who, unbeknownst to them, have contributed so much towards my success as a fraud examiner.

It was a bright sunny day in November. The first frost had set in; leaves were still falling, but most had made it to the ground. I was at my desk when Jim Maxwell called. Jim was a lender at the local branch of a bank just down the street. Jim indicated that one of his customers had called him yesterday to inform him that his company would not be meeting its financial covenants when the company submitted its financial statements at the end of December. Jim indicated that the call came as a surprise to him, as the monthly financial reports the company had been submitting right up through September showed the company performing well and within the covenant ratios. A member of the bank’s asset review team had even met with the company’s president, Bob Silver, during the summer, and nothing unusual was noted. Jim indicated the bank had a term loan outstanding with Bob’s company for $2.5 million, along with a maxed-out revolving line of credit of $1 million.
Jim asked me to schedule a meeting with Bob to review the company’s most recent financial reports, and he sent over the company-provided monthly financial statements and reports for my review prior to meeting Bob.
I called Bob and we set a meeting for later in the week. In the meantime, I received the past two years’ financial statements and reports, which Bob had provided to the bank. I surveyed the monthly balance sheet and income statement amounts, looking for any anomalies or unusual trends. Nothing significant or unusual noted. I noticed the annual financial statements issued for the past two calendar years had been prepared by a local CPA, a good sign.
I went to the company, and as I waited to meet Bob, I watched a well-dressed man leave the shop area and exit the building through a side door. As he closed the door he glanced back, catching my eye as I watched him leave. Later, I learned he was Bob’s CPA.
Bob met me in his conference room and gave me a stack of printed reports. Bob indicated he didn’t have much time to spend with me, as he had meetings all day, but said that if I needed anything at all I should ask his business manager, Mary, for whatever I needed.
After a few minutes of general conversation, Bob left for a “meeting,” never to be seen again that day. As I flipped through the reports he provided, I noticed right away the reports were merely summarized balance sheets and income statements for October and November, and the most recent bank statement. Not much to spend an entire day examining, and certainly nothing that would identify why the company looked so promising through September, only to have financial issues two months later.
After about ten minutes, I walked around until I found Mary. I introduced myself and asked if Bob could be interrupted to shed light on the financials and answer questions. Mary called someone and was told Bob would not be available. Mary, feeling sorry for me not having what I needed and Bob not being available, asked if there was anything she could do while Bob was tied up. She played right into my plan.
I told Mary that Bob had said she could provide me anything I needed, and asked her if she could generate a detailed general ledger report for the full year, in as much detail as possible. Mary said she had never run a general ledger, but would be willing to run it if she could find it on the report menu. With me leaning over her shoulder, she found the report option on a menu. She generated a complete detailed general ledger for the current year, as well as for the complete prior year. Bingo! This level of detail was what I needed but hadn’t been given by Bob.
I thanked Mary and told her there was no need to bother Bob any further. If I had any further questions, she and I could figure them out. I didn’t want Mary to tell Bob that she had just provided me all the financial details for both years.
As I opened the report and began flipping through the pages, it was hard not to smile. It felt like finding a puzzle solution that the creator thought was well concealed but was actually sitting in plain view. There were general journal entries, adjustments, posted every month—to sales, costs of sales, and various expense accounts. Then the other side of those entries—fixed asset accounts. Journal entries to fixed asset accounts?
I went back to Mary and showed her how to generate the ledgers with details of every adjustment and journal entry posted in the past two years. More pieces of the puzzle. Mary was unknowingly providing me with the rope I’d use to hang Bob by identifying in detail how her boss had been fooling the bank for at least the past two years. And she was so happy to be learning how to run all these new and wonderful reports she never ran before. Wouldn’t Bob be happy with her new skills development?
I spent the day detailing how Bob would record fictitious sales at the end of each month, only to reverse them in the following month. I also found that Bob was identifying expenses in both the cost of goods section and the general and administrative areas, and reclassifying them in total as fixed asset additions. The result of these entries—strong monthly sales, consistent gross margins, and decreasing expenses—led to a stable or improving net profit (bottom line). More good news for the lender was found on the balance sheet side of things: A balance sheet with increased receivables, mostly under 60 days, low accounts payable, and increases to fixed assets (equipment) needed to accommodate the increases in volume. Not a sophisticated scheme, but one that had never been identified because the bank was never provided (or had requested) any details. Bob simply provided the same summarized balance sheet, income statement, and accounts receivable aging month after month.
Toward the end of the day, I once again asked Mary whether Bob could meet with me. Mary indicated that Bob asked me to leave a list of questions and stated that he would review the questions and gather whatever I needed for my review in the morning. I left three questions along with copies of select general ledger pages.
The first thing I asked was for Bob to provide every original vendor invoice for my review for every fixed asset addition in the last two years. The second was for Bob to provide the original sales invoices for all the sales recorded each month via general journal entry. The third and last item I requested was to have the original bank statements available along with the cancelled checks, with the cancelled check supporting each fixed asset addition pulled out for my review. I then left before Bob could emerge and ruin the surprise I had left for him.
The next morning I arrived. There was Bob, pacing, waiting for me in the lobby. We went back to the same conference room, and I asked Bob how he had made out with my list. Bob said he did not have invoices or cancelled checks for the fixed asset additions, as there were no invoices for the additions. I told Bob I knew that when I left last night, but wanted to ask him for them anyway. Bob then went into a diatribe about how he was responsible for 50 employees and their families, and that his entries month after month kept the business open, preserving all 50 positions. Bob said he was never late on any debt or interest payment and that the bank was never harmed by his accounting entries. Rationalization at its best.
The bank brought in a workout team, called some of Bob’s debt, and fined Bob through increased interest rates and tighter terms. In the end, the bank retained Bob as a customer, but was committed to keeping a closer eye on him. In my last meeting with Bob, he told me that if he had to do everything all over, he wouldn’t do things the same way again.
Six months later, I heard from Jim again. Jim thought I would be interested in a new development involving Bob. Jim’s bank auditors visited Bob and obtained general ledger reports (identified by my project). They found Bob was back to adjusting his monthly financial reports again, but this time he was recording fictitious sales with offsets to accounts payable, as well as holding off recording legitimate purchases and expenses until subsequent months. Then I remembered that Bob had told me that if he could go back, he would do things differently. And he had!
Fraud has become a risk for any size organization. However, small businesses continue to be especially vulnerable, as the median loss to employers with less than 100 employees was $200,000 according to the Association of Certified Fraud Examiners’ 2008 Report to the Nation. Education is the key to addressing the growing frequency of fraud. The more an organization can learn about fraud in general and the potential fraud risks that threaten the financial stability of the organization’s cash flows, the better equipped that organization will be to design and implement measures to prevent fraud schemes from occurring in the first place. In areas where fraud could not be prevented, an organization should implement additional measures to detect fraudulent activity as early as practical. Knowledge of different schemes commonly perpetrated, along with signs and symptoms of each scheme, will increase the likelihood that detection will occur.
This book will serve as a great starting point in providing such knowledge and education, but it shouldn’t end here. More detailed information exists in every area of fraud, building on the information provided in this book. I encourage you to seek out additional books, materials, and articles on fraud, which are easily accessible online, in libraries, and in stores, with the goal of staying abreast of changes in the fraud field. It is only through this commitment to constant education that organizations, employers, and individuals alike will remain well-informed of the latest schemes and fraud issues.

The World of Fraud
I am often asked for my thoughts on fraud. A common question posed is whether I believe fraud is on the rise. My response usually goes like this: “When you say fraud, what do you mean by fraud, and what kind of fraud are you talking about? If you are asking me about fraud in general, my answer is yes, I believe fraud in general has significantly increased during my professional lifetime. If you are asking me if society has become less honest and more accepting of individuals who are trying to beat the system, my answer again would be yes. However, are you referring to a particular area of fraud?”

Definition of Fraud

What is fraud? Although there are common definitions of fraud, no two definitions are the same. If an employee brings home some office supplies for their kids to use with their school projects, is that fraud? Or is it simply an employee stealing office supplies? Or is it just an accepted practice in business that some office supplies may end up being used for personal purposes—a cost of doing business, if you will? Or are we saying the same thing, but three different ways? How about a business that overstates reserve balances on their financial statements, only to use those overstated balances in future periods to “smooth” earnings trends? Is that considered fraud, or is it simply a widely accepted business practice—technically incorrect, but otherwise allowed and accepted? Lastly, how about a family who wants to have their children attend a particular college that they can’t afford? In preparing the financial aid forms, they don’t report certain bank and investment accounts, and underreport their true earnings so that their child will be eligible for financial aid. Are they committing fraud, or are they simply working the system to gain access to funds available for that specific reason—to assist families with high tuition costs?
Depending on who is asked each of these questions, we may get consistent answers or (more likely) we will get disparity based on each individual’s background, values, and beliefs.
Therefore, before we can get into discussions and cases relating to fraud, it would be a good idea to make sure we are all talking about the same thing—fraud. One of the best resources for an objective, defendable definition of fraud is Black’s Law Dictionary. According to Black’s Law Dictionary, fraud is defined as “a knowing misrepresentation of the truth or concealment of a material fact to induce another to act to his or her detriment.”1
As mentioned earlier, to further define and understand fraud, it has to be discussed within a specific context. Fraud can be further broken down into subcategories of fraud, along with various methods used to commit each type of fraud. Unfortunately, fraud has become prevalent within virtually every aspect of our lives, is accepted by many as the status quo, and acts as a constant reminder of the sad state of society in which we live. Personal characteristics that were likely found within individuals living a socially responsible life, things like ethics, morals, and pride, have been replaced by greed, self-promotion, and the “what’s in it for me” mentality.

The Man Types of Fraud

Names like WorldCom, Enron, and Arthur Andersen have become more than commonplace in discussions regarding fraud. Their names and others—such as Martha Stewart, who was found guilty of lying to authorities about possible insider trading, and Richard Hatch, a Survivor winner who failed to pay the taxes due on his winnings, can and often are used in analogies of what can go wrong. Instances of fraud occur every day and either go undetected or are deemed not worthy of attention. Only cases involving overwhelming amounts of money or some other news-grabbing aspect make the headlines. Traditionally, only one in nine fraud cases ever appears in the media, which means that for every fraud you read or hear about, eight more will never appear in the public eye.
Two main areas of fraud exist in the world of accounting: management fraud, commonly known as financial statement fraud, and employee fraud, or embezzlement. Many of the notorious frauds of this and past decades fall into one of these two categories. However, many other categories of fraud or fraudulent activity exist. If you watch the news, read the newspaper, or scan news posts on the Internet, you should be able to name a few more categories. How about political malfeasance? These frauds are committed by elected officials who abuse their office or position, usually for some form of personal enrichment. Bribes, gifts, preferential treatment, bid rigging, and kickbacks involving politicians and elected officials have been the target of many investigations and convictions as seen in so many news stories.
Then, of course, there is tax fraud. Tax fraud can be carried out by any business, organization, or individual, at the federal or state level. And for all the types of taxes that are imposed at the local, city, county, state, and federal level, there exists an equal number of tax fraud schemes committed to minimize each type of tax. Based on personal experience, the rate of occurrence of some form of tax fraud, whether a large scheme or simply minor cheating, is present on virtually every tax return filed.
Rounding out the top most widely known fraud categories are crimes committed at the federal level: wire fraud, mail fraud, and bank fraud, to name a few of the most common. Convictions on these types of fraud are generally easy to obtain. A scheme to defraud involving an electronic banking transaction or simply mailing a check or payment is all it would take for a violation. The use of either means, common in so many schemes, can lead to a conviction of a federal law. The only conviction easier to obtain is obstruction of justice. Simply provide any false statement or fact to a federal investigator and you have committed obstruction of justice.
There is a risk for fraud in every type of social program that exists. Unfortunately, the reality of the situation is that every program in existence has a certain level of fraud; due to limited resources available to combat the issue, many individuals successfully defraud the programs. At the local level, for example, many towns offer residents below a set income level assistance with their town tax bills. Typically, a form needs to be completed by each applicant, along with a copy of the most recent tax return. Change the amounts to lower figures, copy the return, and submit it with the form and you will receive assistance. At the state level, complete the forms required for state aid, remain silent about the children’s father working, earning a decent amount, and living in the same home, and the household income then falls below the set levels so that rent assistance will be provided by the state.
Case Study 1.1 - Public Aid Goes “Fraud Proof”
In my state, we have a publicly funded social program available to low-income individuals whereby qualifying recipients receive state aid to purchase food and other qualifying provisions. Our food stamp program used to require individuals to apply for assistance, and once qualified, the individuals received food stamps in the mail each month to be used similar to cash for purchasing food.
There were many fraud schemes perpetrated involving the food stamp program. Food stamps were often mailed to recipients on the same day each month, and the theft of recipients’ mail became commonplace, as did simply robbing the recipient of his or her food stamps as they redeemed them. Food stamps became a form of currency on the black market, used in exchange for virtually any item and service. Recipients would pay for things never intended to be covered by food stamps, and in turn the individuals who were redeeming food stamps for food purchases were often living well beyond the intended income levels of the program.
There were also individuals who received multiple food stamp allocations each month by applying and qualifying using different names and multiple addresses. Children of qualified individuals were often claimed by several different individuals in their own qualification process, enabling each applicant to receive more food stamps per month than they were entitled to by listing children who were actually someone else’s children who were already receiving food stamp benefits.
I remember waiting in the supermarket checkout lines behind individuals purchasing groceries with food stamps. Although the program required recipients to purchase generic labeled items, they were purchasing brand-name labels intermixed with generic items. I also saw alcohol, cigarettes, magazines and many other non-covered items being purchased. In the stores with more sophisticated registers, the non-covered items would be segregated and could not be paid for using food stamps. The clerk would collect food stamps for the covered items and then I would watch as the customer pulled out a large roll of cash to pay for the remaining items. I often wondered how the person could have qualified for food stamps with such a large amount of cash. In less sophisticated stores, though, all the items (even those specifically deemed as non-qualifying items) went through and were purchased with food stamps.
Once I asked a cashier after the customer had left why the non-covered items were allowed to be paid for by food stamps. The clerk told me that the store is reimbursed by the state for the same amount either way, so why should they tell customers what they can and can’t buy with the food stamps? That mentality made the store an accessory to defrauding the food stamp program.
A few years ago, the state recognized the extent of the fraud issues, or more likely decided to finally address the issue and developed a new system. I attended a session sponsored by the food stamp program in which the two individuals who designed the new automated system presented the way the new food stamp system would work. The individuals explained that they had developed a debit card system to eliminate fraud within the program.
Each recipient would be issued a card similar to an ATM card that could be used to purchase qualifying food items. Each card would have an account associated with it, and each month the card would be replenished with the individual’s qualifying amount. There would be no mailing of coupons, theft of mail, or robbing recipients. One card would be issued to each recipient, eliminating the risk that recipients would trade cards or use the monthly proceeds as trade in other transactions.
The presentation ended with the individuals feeling confident that their new system would eliminate the prior fraud and abuse, allowing the program to become a better steward over the public’s funds.
The program wasn’t even a month old when I found myself behind a customer using one of the new cards. I remembered the session, and my interest was piqued to see how this new system would work. I watched as the groceries were rung, and items not covered were segregated for the customary separate cash payment. The individual opened her wallet and removed her state card, then swiped it on the credit card terminal used for debit and credit card purchases. Three swipes later the clerk told the customer the balance on the card was insufficient to cover the cost of the groceries. Without blinking an eye, the customer opened her wallet again and removed three similar cards. By the third card swipe, there were sufficient funds to complete her purchase.
So much for the state’s new program! And how much did they invest in this new system?
Financial aid programs are generally available at every private school, from pre-school through college, to assist families who qualify based on income limits and other requirements. Once again, the families often complete the forms and provide a “version” of the latest tax return showing lower than actual income. These fraud schemes are perpetrated against every program in existence.
Case Study 1.2 - Creative Approaches to Funding Higher Education
Many programs have an application process that requires supporting information to be provided to corroborate the information provided. Unfortunately, the programs’ screening processes are often inadequate or outdated. Home computers and inexpensive software packages have made it relatively easy to create supporting documentation that, unless scrutinized and challenged, can easily meet the requirements for eligibility for the program. Bank statements can be easily scanned and then altered to reflect any desired balances. Tax returns can be run over and over again using packages like TurboTax to produce different results.
One great example of this type of fraud is the application process for college financial aid. In addition to completing the required forms, the applicant must also provide copies of tax returns and bank statements.
In one of my recent cases involving a business owner, I obtained copies of his personal income tax returns for the past three years. I identified that he was married with two children, and he owned a home estimated at a value of $500,000, located in one of the best sections of our state. The taxes on his home alone were in excess of $10,000, and the total of his itemized deductions in the latest year was nearly $20,000.
The total income he reported on their jointly filed tax return was $3,500. I was beyond words. A family of four, living in a $500,000 house in the most expensive section of our state was living on $3,500 per year? Sure!
On the bottom of each page of their tax returns, there was a reference to the daughter’s name and Social Security number. I found a similar reference on each page of the returns for all three years. That was when I realized that the copies of the returns he had given me were the copies he had used to obtain financial aid for his daughter, the one whose name was written on each page of her parent’s return—a requirement of the financial aid system.
With a little research, I learned that the daughter was attending the most expensive college in our state. By giving her school versions of their tax returns reflecting little to no income, I surmised the daughter was likely attending based on funds received through financial aid.
It turned out the tax returns were prepared by her father on his home computer using TurboTax and this was simply the “version” he generated to support his application for financial aid for his daughter’s college education.
Here’s my question: How could this very sophisticated school’s financial aid process not be able to identify that the returns provided were obviously false and that the reported income was unreasonably low based on the other information in plain view on the same returns?
Let’s look at the world of insurance. How many types of insurance fraud can you name? First, there is the fraud committed in the application process to obtain coverage, regardless of the type of coverage. Fraud can be committed in virtually every type of insurance known to exist. Leave the past health issues off the health insurance application, fail to mention that the vehicle will be used primarily for business on the automobile application, or indicate that you will be living in the property when a tenant has already been lined up. Then there are the insurance claim fraud schemes. Staged accidents, torched cars (especially when the amount owed on the vehicle exceeds the car’s value), faked injuries, previous undisclosed health conditions, burglaries that never occurred, fires that were set, water damage that was intentional, thefts that never occurred, and inflated inventories supporting a loss claim are just a few scheme areas. The goal is to obtain free money from the insurance company, who supposedly can afford the pay out, especially since high premiums have been paid to the insurance company on time all along—a “return on investment” rationalization.
Case Study 1.3 - How Many Did I Say It Was?
While attending college, I worked in construction, often building or renovating shopping plazas. The money was better than what I could earn anywhere else, and I was learning a trade that I still use to this day.
In my last year on the job, we were renovating a small shopping plaza that included a jewelry store. We knew all the shop owners and employees, as we interacted with them daily while rebuilding their shops. One sunny afternoon, a man ran out of the jewelry store, followed seconds later by the owner. The owner yelled to stop the guy, as he had just stolen a Rolex watch. The owner chased the thief a short distance, but he had disappeared. It happened so fast, that our crew never had time to come down from the staging to assist in the apprehension.
Within minutes, the police were at the plaza and cruising the neighborhoods looking for the thief. As the store owner spoke with police, he knew pretty quickly that the guy had successfully eluded police apprehension. We overheard the shop owner recount the individual’s actions in the store.
The owner stated that the individual came into the store and asked to see different watches. Several were taken out and he tried on different ones. Then all of a sudden he grabbed three watches and ran out the store.