The Unsanctioned Invoice

Of all the frauds classified as occupational, one of the most pernicious encountered by CFEs is the personal purchase with company funds scam. I say pernicious because not only is this type of fraud a cancer, devouring it’s host organization from within, but also because this basic fraud scenario can take on so many different forms.

Instead of undertaking externally involved schemes to generate cash, many employed fraudsters choose to betray their employers by simply purchasing personal items with their company’s money. Company accounts are used by the vampires to buy items for their side businesses and for their families. The list of benefiting recipients goes on and on. In one case a supervisor started a company for his son and directed work to the son’s company. In addition to this ethically challenged behavior, the supervisor saw to it that his employer purchased all the materials and supplies necessary for running the son’s business. As the fraud matured, the supervisor purchased materials through his employer that were used to add a room to his own house. All in all, the perpetrator bought nearly $50,000 worth of supplies and materials for himself and various others using company money.

One might wonder why a purchases fraud is not classified by the ACFE as a theft of inventory or other assets rather than as a billing scheme. After all, in purchases schemes the fraudster buys something with company money, then takes the purchased item for himself or others. In the case cited above, the supervisor took building materials and supplies. How does this differ from those frauds where employees steal supplies and other materials? On first glance, the schemes appear very similar. In fact, the perpetrator of a purchases fraud is stealing inventory just as s/he would in any other-inventory theft scheme. Nevertheless, the heart of the scheme is not the taking of the inventory but the purchasing of the inventory. In other words, when an employee steals merchandise from a warehouse, s/he is stealing an asset that the company needs, an asset that it has on hand for a particular reason. The harm to the victim company is not only the cost of the asset, but the loss of the asset itself. In a purchasing scheme, on the other hand, the asset which is taken is superfluous. The perpetrator causes the victim company to order and pay for an asset which it does not really need in the course of business, so the only damage to the victim company is the money lost in purchasing the particular item. This is why purchasing schemes are categorized as invoice frauds.

Most of the employees identified by the ACFE as undertaking purchase schemes do so by running unsanctioned invoices through the accounts payable system. The fraudster buys an item and submits the bill to his employer as if it represented a purchase on behalf of the company. The goal is to have the company pay the invoice. Obviously, the invoice which the employee submits to his company is not legitimate. The main hurdle for a fraudster to overcome, therefore, is to avoid scrutiny of the invalid invoice and to obtain authorization for the bill to be paid.

As in the many cases of shell company related schemes we’ve written about on this blog, the person who engages in a purchases scheme is often the very person in the company whose duties include authorizing purchases. Obviously, proper controls should preclude anyone from approving her own purchases. Such poorly separated functions leave little other than her conscience to dissuade an employee from fraud. Nevertheless, CFEs see many examples of small to medium sized companies in which this lapse in controls exists. As the ACFE continues to point out, fraud arises in part because of a perceived opportunity. An employee who sees that no one is reviewing his or her actions is more likely to turn to fraud than one who knows that her company applies due diligence in the attempt to detect all employee theft.

An example of how poor controls can lead to fraud was the case where a manager of a remote location of a large, publicly traded company was authorized to both order supplies and approve vendor invoices for payment. For over a year, the manager routinely added personal items and supplies for his own business to orders made on behalf of his employer. The orders often included a strange mix of items; technical supplies and home furnishings might, for instance, be purchased in the same order. Because the manager was in a position to approve his own purchases, he could get away with such blatantly obvious frauds. In addition to ordering personal items, the perpetrator changed the delivery address for certain supplies so that they would be delivered directly to his home or side business. This scheme cost the victim company approximately $300,000 in unnecessary purchases. In a similar case, an employee with complete control of purchasing and storing supplies for his department bought approximately $100,000 worth of unnecessary supplies using company funds. The employee authorized both the orders and the payments. The excess supplies were taken to the perpetrator’s home where he used them to manufacture a product for his own business. It should be obvious that not only do poor controls pave the way for fraud, a lack of oversight regarding the purchasing function can allow an employee to remove huge amounts from the company’s bottom line.

Not all fraudsters are free to approve their own purchases. Those who cannot must rely on other methods to get their personal bills paid by the company. The chief control document in many voucher systems is the purchase order. When an employee wants to buy goods or services, s/he submits a purchase requisition to a superior. If the purchase requisition is approved, a purchase order is sent to a vendor. A copy of this purchase order, retained in the voucher, tells accounts payable that the transaction has been approved. Later, when an invoice and receiving report corresponding to this purchase order are assembled, accounts payable will issue a check.

So in order to make their purchases appear authentic, some fraudsters generate false purchase orders. In one case, an employee forged the signature of a division controller on purchase orders. Thus the purchase orders appeared to be authentic and the employee was able to buy approximately $3,000 worth of goods at his company’s expense. In another instance, a part time employee at an educational institution obtained unused purchase order numbers and used them to order computer equipment under a fictitious name. The employee then intercepted the equipment as it arrived at the school and loaded the items into his car. Eventually, the employee began using fictitious purchase order numbers instead of real ones. The scheme came to light when the perpetrator inadvertently selected the name of a real vendor. After scrutinizing the documents, the school knew that it had been victimized. In the meantime, the employee had bought nearly $8,000 worth of unnecessary equipment.

Purchase orders can also be altered by employees who seek to obtain merchandise at their employer’s expense. In one instance, several individuals conspired to purchase over $2 million worth of materials for their personal use. The ringleader of the scheme was a low-level supervisor who had access to the computer system which controlled the requisition and receipt of materials. This supervisor entered the system and either initiated orders of materials that exceeded the needs of a particular project or altered existing orders to increase the amount of materials being requisitioned. Because the victim organization had poor controls, it did not compare completed work orders on projects to the amount of materials ordered for those projects. This allowed the inflated orders to go undetected.

Another way for an employee to get a false purchase approved is to misrepresent the nature of the purchase. In many companies, those with the power to authorize purchases are not always attentive to their duties. If a trusted subordinate vouches for an acquisition, for instance, busy supervisors often give rubber stamp approval to purchase requisitions. Additionally, employees sometimes misrepresent the nature of the items they are purchasing in order to pass a cursory review by their superiors.

Instead of running false invoices through accounts payable, some employees make personal purchases on company credit cards or running accounts with vendors. As with invoicing schemes, the key to getting away with a false credit card purchase is avoiding detection. Unlike invoicing schemes, however, prior approval for purchases is not required. An employee with a company credit card can buy an item merely by signing his or her name (or forging someone else’s) at the time of purchase. Later review of the credit card statement, however, may detect the fraudulent purchase.

As with invoicing schemes, those who committed the frauds were often in a position to approve their own purchases;, the same is often true with credit card schemes. A manager in one case, reviewed and approved his own credit card statements. This allowed him to make fraudulent purchases on the company card for approximately two years.

Finally, there is, the fraudster who buys items and then returns them for cash. A good example of such a scheme is that in which an employee made fraudulent gains from a business travel account. The employee’s scheme began by purchasing tickets for herself and her family through her company’s travel budget. Poor separation of duties allowed the fraudster to order the tickets, receive them, prepare claims for payments, and distribute checks. The only review of her activities was made by a busy and rather uninterested supervisor who approved the employee’s claims without requiring support documentation. Eventually, the employee’s scheme evolved. She began to purchase airline tickets and return them for their cash value. An employee of the travel agency assisted in the scheme by encoding the tickets as though the fraudster had paid for them herself. That caused the airlines to pay refunds directly to the fraudster rather than to her employer. In the course of two years, this employee embezzled over $100,000 through her purchases scheme.

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