How to Prevent and Detect Fraud: Implementing Internal Controls

1. How to Prevent and Detect Fraud: Implementing Internal Controls Office of the State Auditor Nancy Bode Assistant Legal Counsel Presentation for the 2008 MMBA Annual Conference Copyright: 2008 Office of the Minnesota State Auditor

2. Office of the State Auditor Role and Responsibility • Oversight includes: - Counties - Cities - School Districts - Towns - Police and Volunteer Fire Relief Ass’n Pension Funds - Soil and Water Conservation Districts - Port Authorities - TIF Districts - As well as approximately 150 other special districts Copyright: 2008 Office of the Minnesota State Auditor

3. Office of the State AuditorDivisions • Audit Practice • Pension • Tax Increment Financing • Government Information • Legal/Special Investigations Copyright: 2008 Office of the Minnesota State Auditor

4. Legal/Special Investigations Division www.auditor.state.mn.us 525 Park St., Suite 500 St. Paul, MN 55103 Nancy Bode 651-297-5853 Nancy.Bode@state.mn.us • The Legal/Special Investigations Division investigates allegations of theft or misuse of public funds. It also provides legal compliance information and training to local government officials. Copyright: 2008 Office of the Minnesota State Auditor

5. Types of Fraud Reviewed by the Office of the State Auditor • Theft • Minn. Stat. § 609.52 • Includes temporary taking • Even small amount of public funds is a felony • Embezzlement – Minn. Stat. §§ 609.445 and 609.54 – Refuse or omit to turn over public funds – Felonies Copyright: 2008 Office of the Minnesota State Auditor

6. Type of Fraud Reviewed by the Office of the State Auditor (continued) • False Claims - presenting (Minn. Stat. § 609.465) - allowing or paying (Minn. Stat. § 609.455) - felonies • Forgery - altering a public record with intent to defraud (Minn. Stat. §§ 609.625 or 609.63) - felonies • Misuse of Public Funds/Assets Copyright: 2008 Office of the Minnesota State Auditor

7. Opportunity We can control Rationalization I’ll pay it back They don’t pay me enough They’ll never miss it Motive/Incentive (Financial Pressure) Often gambling The Fraud Triangle Copyright: 2008 Office of the Minnesota State Auditor

8. Reduce Risk of Fraud:Tools of Protection • Segregation of Duties • Internal Control Procedures • Environment Copyright: 2008 Office of the Minnesota State Auditor

9. Segregation of Duties • No employee should be in a position to commit fraud and then conceal it • Example: Person collecting/receipting cash should not: • Post cash receipts to the general ledger system • Process cash disbursements • Prepare billings • Make bank deposits, wire transfers Copyright: 2008 Office of the Minnesota State Auditor

10. Segregation of Duties - Examples • Rentals handled by City Clerk • Entertainment – City Clerk issues check • Compensating Controls for Deposits • Turn in Z-tapes to City Clerk with deposit information • Each employee has own drawer that the employee counts at the end of his/her shift • Liquor Store manager approves all voids/refunds • Mandatory vacation policy – need for cross training Copyright: 2008 Office of the Minnesota State Auditor

11. Numbered receipts for all payments/sales Reconcile receipts with deposits daily Daily deposits Do not leave receipts unattended Why? If no receipt, no one notices if not deposited Detect receipts never deposited Detect “lapping” (replace cash with check) Reduce risk of loss Internal Controls Receipt of Funds Copyright: 2008 Office of the Minnesota State Auditor

12. Ring all sales into register Use cash/check function Review voids or over-rings Honest report of over/short each day Why? Record of receipts Detect “lapping” Frequent voids may indicate cash removed Internal ControlsCash Registers Copyright: 2008 Office of the Minnesota State Auditor

13. Endorse check for deposit as received Cash personal checks or 3rd party checks? Amount over purchase? Made out to public entity (e.g., not “cash”) Employee initials on checks received Nsf check policy Why? Reduce chance checks will be taken and cashed Public entity is not a bank Reduce nsf checks Internal ControlsChecks Received Copyright: 2008 Office of the Minnesota State Auditor

14. Employee & supervisor attest to hours worked See OSA’s Statement of Position on Employee Timekeeping Procedures Why? Statutory requirement (Minn. Stat. § 412.271) Accurate & reliable payroll system Internal ControlsEmployee Timekeeping Copyright: 2008 Office of the Minnesota State Auditor

15. Detailed receipts Original receipts Reference claims approved (with amounts) in minutes Why? Minn. Stat. § 471.38 Prevent unauthorized payments Prevent “slice and dice” Internal ControlsEmployee Expenses Copyright: 2008 Office of the Minnesota State Auditor

16. Internal ControlsWork with Entity’s Bank • No cash back from deposits • No check cashing • No fund transfers without Council resolution Copyright: 2008 Office of the Minnesota State Auditor

17. Check handling procedures Cell phone usage Use of public entity’s property Why? Avoid problems Allow discipline where appropriate Consistency for all employees Internal ControlsWritten Policies Copyright: 2008 Office of the Minnesota State Auditor

18. Environment • The same rules apply to all • Don’t belittle internal control procedures • Don’t allow management to override procedures • Be alert to employee’s outside interests • It’s the public’s money Copyright: 2008 Office of the Minnesota State Auditor

19. Red Flags: Segregation of Duties • No vacations • Takes records home • Takes on segregated duties • Works when others gone • Time sheets not reviewed or signed • Only person who knows the job/computer Copyright: 2008 Office of the Minnesota State Auditor

20. Red Flags: Internal Controls • Noncompliance with internal controls • Missing or late reports • Missing or late documentation • Late deposits • Outstanding or out of sequence checks Copyright: 2008 Office of the Minnesota State Auditor

21. Red Flags: Environment • Unexpected or poorly explained losses • High level of refunds, returns, voids • The “bully” • Too busy to deal with “mere details” Copyright: 2008 Office of the Minnesota State Auditor

22. Licenses Building permits Rentals Park & rec classes Swimming pool Water/utility bills Liquor stores Know the amount in any change fund (starting balance) Internal controls Segregation of duties Cash ReceiptsSpecial Risks Copyright: 2008 Office of the Minnesota State Auditor

23. Suspected Fraud Criminal? Disciplinary Action? Get Advice Copyright: 2008 Office of the Minnesota State Auditor

24. Suspected Fraud Minn. Stat. § 609.456 Report to: State Auditor (in writing) Law Enforcement Copyright: 2008 Office of the Minnesota State Auditor

25. Bonds • Have bonds in place • Two main types of official or employee bonds • Fidelity Bond: covers employee dishonesty • Faithful Performance (Surety) Bond : covers any loss to public entity or member of public caused because employee failed to faithfully perform duty Copyright: 2008 Office of the Minnesota State Auditor

26. www.auditor.state.mn.us Our NEW website includes: Statements of Position Investigative Reports Internal Control Letters E-Updates (Avoiding Pitfalls) Other Copyright: 2008 Office of the Minnesota State Auditor