Iowa League of Cities September 22, 2011

1. Iowa League of CitiesSeptember 22, 2011 STEALING HOME: FRAUD AND ABUSE PROTECTIONDAVID A. VAUDT, CPA Auditor of State ANNETTE CAMPBELL,CPA Director

2. Fiduciary Duties and Ethical Responsibilities David A. Vaudt, CPA, Auditor of State

3. Fiduciary Duties • Understanding fiduciary duties • Duty to the public • Oversight • Accountability David A. Vaudt, CPA, Auditor of State

4. Public Purpose • Public Purpose/Public Benefit • Constitution of the State of Iowa • Article III, Section 31 • Public purpose test • Criteria • Documenting public purpose David A. Vaudt, CPA, Auditor of State

5. Public Purpose Doctrine • Public money must be spent for a public purpose • Numerous AG opinions and court cases require documentation of public purpose • The harder it is to document a public purpose, the less likely there is one • If it’s not for a public purpose why should the public pay for it? David A. Vaudt, CPA, Auditor of State

6. Creating an Ethical Environment • Setting the right tone at the top • Common ethical violations • Determinants of ethical behavior • Negative work environment • Positive work environment • Four steps to create and maintain a good ethical climate David A. Vaudt, CPA, Auditor of State

7. Setting the Right Tone at the Top • According to 2005 National Business Ethics Study: • Ethical atmosphere is created in the workplace by the organization's leadership • Good or bad, tone set at the top tends to trickle down to employees • Employees pay close attention to the behavior and actions of their bosses and follow their lead David A. Vaudt, CPA, Auditor of State

8. Common Ethical Violations • Abusive or intimidating behavior of supervisors toward employees • Lying to employees, customers, vendors or the public • Conflicts of interest • Violations of safety standards • Misreporting actual time or hours worked • Email and internet abuse • Discrimination • Stealing, theft or related fraud • Sexual harassment David A. Vaudt, CPA, Auditor of State

9. Determinants of Ethical Behavior • Behavior of superiors • Behavior of peers • Industry ethical practices • Society’s moral climate • Formal organization policy David A. Vaudt, CPA, Auditor of State

10. Negative Work Environment • Top management does not seem to care about or reward appropriate behavior • Lack of recognition for proper job performance • Negative feedback • Less than competitive compensation • Poor training and promotional opportunities • Poor communication practices or methods David A. Vaudt, CPA, Auditor of State

11. Positive Work Environment • Helps deter fraud • Recognition and reward systems are in tandem with goals and results • Equal employment opportunities exist • Team-oriented, collaborative decision-making policies are encouraged • Compensation and training programs are professionally administered David A. Vaudt, CPA, Auditor of State

12. Four Steps to Create and Maintain a Good Ethical Climate • Communicate what is expected of employees • Lead by example • Provide a safe mechanism for reporting violations • Reward integrity David A. Vaudt, CPA, Auditor of State

13. Doing the Right Thing • It is always the right time to do the right thing • Good judgment comes from experience, experience comes from bad judgment • If you have to work through a complex and/ or convoluted line of reasoning to justify an action, you probably should not be doing what you are doing David A. Vaudt, CPA, Auditor of State

14. INTERNAL CONTROL David A. Vaudt, CPA, Auditor of State

15. Internal Control Defined • Process effected by an entity’s governing board, management, and other personnel designed to provide reasonable assurance regarding the achievement of objectives in three categories: • Effectiveness and efficiency of operations • Reliability of financial reporting • Compliance with laws and regulations David A. Vaudt, CPA, Auditor of State

16. What are Internal Controls? • Keep copies of your tax return • Compare your monthly credit card statement to the credit card receipts • Lock your car doors • Other examples…??? David A. Vaudt, CPA, Auditor of State

17. What are Internal Controls? • To put it simply, internal controls are an exercise of common sense. You are practicing good internal controls when you: • Balance your checkbook • Keep your ATM/debit card pin number separate from your card David A. Vaudt, CPA, Auditor of State

18. Segregation of Duties • An internal control procedure whereby no one individual is placed in a position of being able to both commit and conceal an irregularity by performing incompatible duties. David A. Vaudt, CPA, Auditor of State

19. Components of Internal Control • Control Environment - sets the tone for an organization. Consider the following: • Communication and enforcement of integrity and ethical values • Commitment to competence • Participation of those charged with governance • Management’s philosophy and operating style • Organizational structure • Assignment of authority and responsibility David A. Vaudt, CPA, Auditor of State

20. Components of Internal Control • The entity’s risk assessment process – an entity’s identification, analysis and management of risks relevant to the preparation of the financial statements, such as: • Changes in operating environment • New personnel • New or revamped information systems • Rapid growth • New accounting standards • New technology David A. Vaudt, CPA, Auditor of State

21. Components of Internal Control • Information and communication • The information system relevant to financial reporting objectives includes the procedures (automated or manual) and records established to initiate, authorize, record, process, and report entity transactions. • Communication involves providing an understanding of individual roles and responsibilities pertaining to internal control over financial reporting. David A. Vaudt, CPA, Auditor of State

22. Components of Internal Control • Controlactivities – policies and procedures that help ensure management directives are carried out. Examples include: • Authorization • Segregation of Duties • Safeguarding assets • Asset Accountability David A. Vaudt, CPA, Auditor of State

23. Components of Internal Control • Monitoring of controls – obtain information regarding the types of activities that the entity uses to monitor internal control over financial reporting, including how those activities are used to initiate corrective actions to its controls. David A. Vaudt, CPA, Auditor of State

24. Auditor’s Responsibility • “The auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud.” David A. Vaudt, CPA, Auditor of State

25. Fiscal Accountability • Risk Based Approach to Audits: • Based on internal control • Based on inquiries and interviews • Based on audit risk • Inherent risk • Control risk • Detection risk David A. Vaudt, CPA, Auditor of State

26. Expectations • Auditor should provide guidance and suggestions • Internal control • Deficiencies in controls • Operating procedures • Statutory compliance David A. Vaudt, CPA, Auditor of State

27. Management’s Responsibility • “It is management’s responsibility to design and implement programs and controls to prevent, deter, and detect fraud.” David A. Vaudt, CPA, Auditor of State

28. Management’s Responsibility • Management’s responsibility includes: • Setting the proper tone • Creating and maintaining a culture of honesty and ethics • Establishing appropriate controls David A. Vaudt, CPA, Auditor of State

29. Expectations • Management’s responsibility includes: • Establishing appropriate controls • Implementing policies and procedures • Creating and maintaining a culture of honesty and ethics • Through words and actions David A. Vaudt, CPA, Auditor of State

30. Exercise: Fraud Risk Factors David A. Vaudt, CPA, Auditor of State

31. Internal Control and Fraud David A. Vaudt, CPA, Auditor of State

32. Fraud Triangle David A. Vaudt, CPA, Auditor of State

33. Fraud in Government Accounting • There are two significant types of financial fraud . . . • Misappropriation of assets • (aka employee fraud) • higher number of cases • lower dollar impact • Fraudulent financial reporting • (aka management fraud) • lower number of cases • higher dollar impact David A. Vaudt, CPA, Auditor of State

34. Fraud in Government Accounting Factors contributing to fraud in governmental entities: • Frequent cash collections • Limited administrative and other personnel • Lack of segregation of duties • Lack of oversight—”blind” trust • Lack of profit-motive • Perception that “money is unlimited” compared to employee’s finances David A. Vaudt, CPA, Auditor of State

35. Fraud in Government Accounting • Internal Controls • Very important deterrent • Provides fear of detection and punishment • Helps remove / reduce temptation David A. Vaudt, CPA, Auditor of State

36. Fraud in Government Accounting Internal Controls • Internal control weakness = controls do not exist • Internal control deviations = instances when controls are not followed David A. Vaudt, CPA, Auditor of State

37. Why Controls Don’t Always Work • Inadequate knowledge of policies or governing regulations. “I didn’t know that!” • Inadequate segregation of duties. “We trust ‘A’ who does all of those things.” • Inappropriate access to assets. Passwords shared, cash not secured… David A. Vaudt, CPA, Auditor of State

38. Why Controls Don’t Always Work (Cont.) • Form over substance. “You mean I’m supposed to do something besides initial/sign it?” • Control override. “I know that’s the policy, but we do it this way. Just get it done, I don’t care how!” David A. Vaudt, CPA, Auditor of State

39. Fraud in Government Accounting Since 1996, 193 Special Investigations have been issued on governmental entities in Iowa: • Most common type of entities: • Cities – 78 • Counties – 35 • Schools – 33 • State Agencies/Universities – 16 • 28Es – 13 • Other – 18 • Of the 78 Cities, population of: • Less than 700 – 41 • 700 to 2000 – 12 • Over 2000 – 25 David A. Vaudt, CPA, Auditor of State

40. Fraud in Government Accounting • 5-Step approach for fraud detection: 1. Know fraud exposures in specific terms. • What could go wrong? • Who could do it? • What opportunities exist? • The pressures. • Understand systems and controls. David A. Vaudt, CPA, Auditor of State

41. Fraud in Government Accounting 2. Know exposure-specific symptoms of fraud Symptom — a condition that is directly attributable to dishonest or fraudulent activity. 3. Be alert for fraud symptoms 4. Incorporate steps into routine processes that are likely to reveal fraud 5. Follow through on all observed symptoms David A. Vaudt, CPA, Auditor of State

42. Fraud in Government Accounting In entities with lack of segregation of duties insist on appropriate oversight - Examples: • Council Member or Administrator: • Review and approve invoices and compare to checks before counter signing • Don’t sign blank checks • Receive bank statement directly • Review and approve bank reconciliations David A. Vaudt, CPA, Auditor of State

43. Fraud in Government Accounting In entities with lack of segregation of duties, insist on appropriate oversight (cont.) - Examples: • Council Member or Administrator: • Review and approve payroll • Review and approve utility billing reconciliations • Document all decisions in minutes (payroll increases, changes in policies, etc.) David A. Vaudt, CPA, Auditor of State

44. Fraud in Government Accounting Oversight provides protection: • Oversight by officials is the most critical ingredient to fraud prevention / detection especially in smaller entities due to the lack of segregation of duties. • The governing body must play a more active role to compensate for lack of segregation of duties. David A. Vaudt, CPA, Auditor of State

45. Fraud in Government Accounting • Fraud prevention / detection techniquesBe alert for misuse of entity assets: • Credit cards • Vehicles / gas • Supplies • Cell phones • Office telephones • Computers / internet David A. Vaudt, CPA, Auditor of State

46. Red Flags of Fraud Fraud Danger Signals… (Red Flags) • Borrowing money from co-workers • Creditors or collectors appearing at the workplace • Gambling beyond the ability to stand the loss • Excessive drinking or other personal habits • Easily annoyed at reasonable questioning David A. Vaudt, CPA, Auditor of State

47. Red Flags of Fraud (Cont.) • Providing unreasonable responses to questions • Refusing vacations or promotions for fear of detection • Bragging about significant new purchases • Carrying unusually large sums of money • Rewriting records under the guise of neatness in presentation David A. Vaudt, CPA, Auditor of State

48. What to do when you Suspect or Discover Fraud • Notify Office of Auditor of State • Annette Campbell 515-281-5834 • Tami Kusian 515-281-7002 Note: The remaining steps must be tailored to each specific situation • Notify: • Auditor of State • CPA firm • Governing body (Consider quorums) David A. Vaudt, CPA, Auditor of State

49. What to do when you Suspect or Discover Fraud (Cont.) • Secure all necessary records • Consider need to: • Stopping access to bank accounts • Stopping access to certain financial records and/or processes • Securing physical access to items at risk • Change locks if necessary David A. Vaudt, CPA, Auditor of State

50. What to do when you Suspect or Discover Fraud (Cont.) • Discuss with management and legal counsel advisability of placing individual on administrative leave. • Take notes and write up any pertinent information. David A. Vaudt, CPA, Auditor of State