Detective Auditing – an internal auditor's journey
(Short story - based on true experiences)
Published by Frank Josey at Smashwords
Copyright 2011 Frank Josey
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Introduction
The author was an internal auditor for Maxlan Timber (name changed due to confidentiality requirements), at the time one of the largest forestry companies in Canada, later taken over in the late 1990's by a USA forestry giant. Earlier, the author qualified as a Canadian Chartered Accountant, having worked for Price Waterhouse & Co. (now PriceWaterhouseCoopers). The experiences are true – the year given is the best of the author's recollection.
Simply stated, fraud is an illegal intentional deception made for personal gain by one or many perpetrators.
A 2010 survey by a large accounting firm, asserts that losses in New Zealand and Australia amount to $350 million per year. The Australian Institute of Criminology reports that about 100,000 cases are reported to police per year. They allege that approximately 50% of frauds are not reported. Without much imagination, based on population and economy size differences, the losses from fraudulent activity in North America must be staggering.
In my experience, the major causes of fraud are "slow horses and fast women." That is, lavish lifestyle and gambling are the main drivers behind fraudulent behaviors. Another serious contender is an employee deciding "the company owes me."
The primary reasons why frauds go undetected are poor internal controls and managerial override of the controls that do exist, combined with less than satisfactory detection rates. Anecdotally, internal audit only detects 25% of frauds, the only other high percentage (roughly 25%) is "internal tip offs".
Who is the typical perpetrator? At a seminar, an Australian Federal Policeman opened his talk by asserting "5% of your employees are scum." This concurs with my experience, that is, this 5 per cent mainly comprises the profile of a fraudster - middle age men primarily in middle management line or finance positions. Compassion is not the internal auditor's domain when performing an audit – "Just the facts ma'am." (TV show, Dragnet).
The author had several experiences, when asked to investigate a fraud, that all that was committed was sloppy or incompetent accounting and reporting. For example, a large stock loss was solely the result of overstating unit production into stock due to counting packs (sold per pack) as 6 instead of 1 unit.
New York Mafia targets Frank (1977) – stock audit
Frank meets his Dad, Fred, at Costello's Tavern in Surrey. "Hi son, man you're travelling a lot for Maxlan Timber". "Yeh Dad, there sure have been some interesting audits I've been on". Fred responds "what's this Mum tells me that your life was in danger?" The waiter places a pitcher of beer on their table. "Thanks Pal." Fred waves to a next door neighbor, and then looks back to Frank.
“Yeh Dad, I was sent to several North American ports where Maxlan Timber's cargo ships discharge lumber. Each year we estimated that there was a significant shortfall in lumber produced versus lumber delivered. We could not find a common mill, originating port, ship or destination port. We then assumed most must be stolen during the Panama Canal leg. This Panama Canal possibility was investigated by the firm's external auditors.
The Audit Director decided it was too risky for me to travel undercover on the ship in the event any of the ship's staff were involved. Nevertheless, it was decided that I should review internal controls surrounding loading and unloading of Maxlan's timber.
A mill on Vancouver Island was chosen as the test sample as vast quantities of timber were being loaded for four ports.
So, tracking the ship, I flew to New York, then to Tampa Florida, then back to New York where I visited Boston, Providence, Port Elizabeth (NJ) and the Brooklyn docks. One of the steps I would do is watching the ship enter and leave port with my binoculars, looking for out-of-the-ordinary movements."
"While in New York I stayed at the UN Plaza Hotel." “I understand you had a funny embarrassing experience there” Fred commented.
"That’s right Dad (Frank chuckles), I just arrived from Providence Rhode Island, and I wanted to go to the pool in the Hotel, not only to swim, but get a fantastic view of Manhattan at night.
I went to the elevators, but when it opened at my floor, it was full. I saw the exit stairs, didn’t bother reading any signs - went up the stairwell, only to find all the doors were locked when trying to re-enter the pool floor – I kept walking up the stairs, until one opened, strangely, it was a large darkened boiler or water storage room. I walked along a workman’s deck bridge, and opened up the door on the other side, only to find my self in offices with Arabic writing.
I found the elevators – when the door opened on the ground floor, 2 startled United Nations guards put their hands on their guns, but didn’t draw. I explained, in my swim trunks and towel, showing them my room key that I was trying to get into the UN Plaza Hotel’s pool and how I got there.
I do not know what was more embarrassing, explaining to two unbelieving guards, or walking two blocks at night in the City, in a bathing suit and towel draped over my shoulder, back to the hotel, and being stopped by the doorman. My walk through the lobby was humiliating too, a hotel where a jacket had to be worn just to get a rum and coke. There were many giggles I assure you from onlookers”
Dad interrupted, laughing, “You mentioned you were investigating a large theft, how was your life ever in danger?”
“When I visited the Brooklyn docks, the only high volume discharge port, I got out of my taxi, when two men approached me, motioning me towards a Cadillac sedan, just off the dock entrance. I got in and met a well dressed young man who said in a Brooklyn accent, “we don’t want you to find anything wrong, understand?" I was surprised they knew who I was.
He gave me an envelope containing cash. I was angered and refused, putting the envelope on the seat beside me. He shook his head and pointed a gun at me. Strange, I was more “pissed off” than frightened (the "curse of youth"). His eyes twinkled when he looked into my eyes then after a few seconds he yells to the driver “let him out" – the door was opened for me. He added "you better co-operate or you won’t see your family again." He offered me the envelope again. I shook my head.
As I had done at each of the four discharge ports, I entered the Brooklyn port facilities, went aboard ship and went to the Supercargo (title of the head wharfie or Longshoreman). Based on the shipping manifest from Vancouver, four slings of lumber were unloaded extra. I pointed this out and the Supercargo ordered the lumber to be re-loaded. Maybe he thought I had accepted the bribe.
After I completed the audit on board and checked the waybills of the several trucks leaving the dock, I became wary over the four slings of lumber placed back on deck. I rushed back to the hotel, packed and left early. It was not until the plane rolled down the runway for Vancouver, that I gave a sigh of relief.
To this day I wondered why the man in the Cadillac changed his mind, or if I was a victim of mistaken identity. I reported the incident in my working papers but it was deemed a misunderstanding and over-reaction."
Dad intervenes “Time’s gotten away from us Frank, gotta get ready for a fishing trip with your Uncle, Bye, and good story.”
"Good story?" "I'm lucky I'm still here, yeh, bye."
1978 trip to Brazil – payroll audit and psychic experience
Father Alexi wanted to know about Frank’s conversion from atheism to Catholicism. He asked him down to the Rectory for a drink.
Frank knocked and entered “brrr. Cold outside” “Coffee or Tea” Alexi asked. “Coffee – milk, no sugar thanks.”
“Frank, tell me about the trip to Brazil Lyn (Frank's wife at the time) told me about. I’d like to hear it in full if I may.”
“Sure Father, our timber grows 3 times faster in Brazil than British Columbia; Maxlan Timber was in a joint venture with a Brazilian forestry company. Anyways, the flight from Vancouver to Seattle to La Guardia in New York was uneventful. The trip by taxi to Kennedy Airport was stimulating. The Varig Airlines flight from Kennedy Airport, New York to Rio De Janeiro was a new experience, I heard Portuguese for the first time."
"Gee, I hope it gets more interesting than a travel itinerary". "Ha, sorry, father"
"We stayed in Rio (the Hotel Meridian, by Copacabana Beach), where the joint venture's headquarters were, I was surprised as to the open poverty in Rio and the amount of abandoned children there were. One morning, in a hotel on Copacabana Beach, I felt guilty eating a gourmet breakfast, watching peasants carrying water up the hill.
On my many walks around the beachfront, I was approached by young kids for money.
I was also amazed at how many servants the timber joint venture had. At Head Office, several waiters would serve coffee and bottled water and pastries throughout the day. The coffee was served in little china cups and was strong and thick, close to a consistency of syrup.
48 hours after arriving in Rio, we caught a local 6 seater plane to Joinville, where the tree plantations were located. Being in a country town in Brazil, where English is not understood, and no interpreter, was a challenge. “Bloody Audit Director, thinking all I need is a Berlitz Record and an English Portuguese dictionary” I thought. Even the taste of food was different - a glass of milk was warm and sour – considered normal.
That night I and a fellow auditor went to a restaurant and had beefsteak dinner. Surprisingly, several waiters hovered, replacing each portion of the main course when finished, causing me to shout “Hey, no thank you” when a third huge steak was put on my plate.
The audit was uneventful. One employee was interesting – the Bombardier. His job was to stomp ants at the bottom of trees with oversized shoes. I had to see it for myself, as it seemed like a practical joke.
In Joinville I noticed I was having diarrhea more frequently, until I could not stop it – I had caught Montezuma’s Revenge. It got worse and worse. “Onde fica o banheiro?” was my most used Portuguese phrase (where is the toilet?). I lost 20 kilos in 3 weeks.
We went to Foz De Iguacu, wonderful waterfalls and a hotel that was for the very rich. It was there that I had a favorable psychic experience that changed my life – but it is beyond the scope of this short story to report it (I told Father Alexi who was visibly shaken).
That night, feeling better, my friend and I went to the Casino in Paraguay – we caught a ferry from the Brazilian side, a short walk from the Hotel. When we disembarked, Customs asked for Passports.
However, two army regulars, unshaven, pushed me and my friend back into the bushes. They looked at our Canadian Passports, then spit at our feet and unshouldered their machine guns muttering “Turistas”. They waited, talked to each other in Spanish, handed back our passports and then prodded us back to the main party. For a split second we both thought we were going to be executed. We didn’t stay very long, as we wanted to get back to the hotel, afraid of those two soldiers."
"Have you any water Father; this story is making me thirsty."
"Back to the story, Father Alexi. My faithfulness was tested again, although sick, a secretary took me out dancing and later, a walk on the beach, she hugged and kissed me. “Eu te amo” she uttered softly, her lingering perfume and sensuality were seductive. But I kissed her on the forehead and replied “Não, eu sou casado” (No I’m married). I took her hand and went to the company car; she dropped Frank off at the hotel. I thought of Lyn, my wife, in Canada all that night – I could not betray her.
Other experiences were interesting to Father Alexi. "One day I drove by a Shell station and “nature called furiously”. I recall that the toilet was a hole in the cemented floor – used toilet paper was in a box next to the hole. The user had to pick out the unused portions to use. I was disgusted with some Brazilian hygiene standards.
However, I was amazed once when I was on a walk, witnessed a poor family eating their dinner. The laughter and joy was so refreshing. I thought how could they be happy and be so poor.
When I returned to the Meridian Hotel, Montezuma's Revenge had taken its toll - a Doctor knocked on my door and forced me to drink 1.5 liters of dextrose infused water. “Hotel management does not want guests to die” was his only comment."
Father Alexi, stared uncomfortably at Frank, and then asked "another coffee?" "No thanks."
In Brazil, Frank eventually recovered his strength and caught a plane to London from Rio, to meet Lyn and Joan, his daughter, for a short vacation. The flight to London on British Caledonia airlines was difficult, as Frank had to sit in the smoking section, still suffering from dehydration.
When he arrived in London, he took a taxi to the hotel, where he happily reunited with Lyn and Joan, after 4 weeks apart. Sadly, he fell ill again and returned to Canada, cutting short their trip.
Frank started going to Church, based on the psychic venture at Foz De Iguacu. The religious journey is still ongoing over 30 years later. Anyways, back to the topic, internal audit experiences.
1979 Trip to London – Tilbury Docks
In Vancouver, the Audit Manager Cooper called Frank into his office. ”Hi Frank, we need you to investigate our missing lumber from the UK. You’ll go with John, the Supervisor, to England, OK?” “Yes - when?” "In 48 hours, so go home and pack and spend some time with your family”.
Frank caught the early Metro Transit Bus for Surrey BC. “Great to leave early” he thought. “Bloody traffic over the Port Mann Bridge, blocked again” he said to the lady sitting next to him. She nodded without turning her head from the window.
Lyn and Frank went out to their favorite steakhouse. The Calona Red wine went well with dinner. “Where do you think we’ll be in 10 years?” Frank asked. Lyn smiled and answered “don’t know”, withholding from him her growing homesickness for her hometown.
The next morning, Frank arrived at the airport – the smell of jet fumes excited Frank for that meant an adventure always lay ahead. The Maxlan Timber Ltd audit team of 5 boarded the same flight. Before he fell asleep, Frank looked forward to performing a review of internal controls in the company’s shipping operations. He enjoyed reviewing systems, standards and procedures for suspected flaws. From leaving Vancouver on a typical overcast day to arriving at Heathrow, took about ten hours.
The taxi ride to the Towers Hotel, near the Tower of London, was at night. The next morning Frank awoke to the bustling commotion of the City of London. After breakfast he left by taxi to work. It was a Friday, looking forward to the weekend off.
On Saturday he visited the Tower of London, and walked further to where St. Thomas More was executed. He then took a train and walked around central London. Westminster Cathedral was a handsome cathedral, but contained the hung drawn and quartered remains of a Jesuit priest. “Shit that’s gruesome” as he looks at the sarcophagus. Frank was repulsed by the superstitious behavior of several people.
He was stunned at the high cost of restaurant food in London – twice Canadian rates. His favorite restaurants were the Mandarin Chinese establishments - food was absolutely delicious.
While visiting the subsidiary at the London docks later that week, Frank got the invoice book producer’s supplier's invoice with sales invoice book numbers printed thereon and compared them to those used. Two books were found to be missing. Several audit steps later he alleged that some the night shift employees were fraudulently using invoices from these books to deliver products, then receive payment in cash from corrupt customers.
The audit manager met with Scotland Yard detectives and presented his findings. All Frank was told back in Vancouver was that two suspects were later arrested and charged with the dockyard theft of lumber.
Trip to New York's Twin Towers 1979
Frank got a call at home one night. "Hi, it's Cooper", have a rush audit in New York, can you leave in the morning?" "Sure Cooper, what airlines?" "United, Flight 58". "Okay".
Lyn wasn't happy as she was heavily pregnant with their son Paul. Unfortunately, Frank, career conscious, always put work ahead of family responsibilities. But he knew his Mum would come up and help Lyn.
After another uneventful trip to the airport, at check-in, Frank was annoyed his ticket was economy, not the usual Business Class. He called the Audit Director's secretary who replied "Business Class is now only for international flights, not the States."
In New York, Frank gets in a taxi that goes to Waldorf Astoria the long way. After being threatened when he complained, Frank pays the driver.
That night, while walking home from a restaurant, he was approached three times by prostitutes, never before were they so bold. Frank said "No thanks", surprised their reply was civil. Later that month, it was discovered that many street hookers had the newly discovered HIV virus.
Leaving the hotel early, he had breakfast at a restaurant in the North Tower. Floor 83 was where the New York Maxlan Timber offices were. The audit took a turn for the worst when sales representatives travel claims were investigated.
Frank had that ability to "go with his instinct". He visited a restaurant wondering why meals were so expensive. He found a brothel at the address, no restaurant. Under questioning, 2 sales rep.s admitted they were entertaining customer buyers to ensure sales orders were submitted.
After discussions, it was decided no personal gain was made by the 2 representatives, although the ethics of the company were breached, the men were reprimanded but their services retained.
Trip to New York and New Jersey 1980
The Audit Director announces "Frank, we're sending you on a very sensitive audit. A general manager is suspected of fraud. We need you to leave first thing in the morning. Oh yeh, he knows why you are coming and has not been stood down."
The following morning, Frank awoke late "Damn, bloody alarm". The taxi he ordered the previous night honked twice. Frank jumped out of bed, startling Lyn. Opened the window and yelled "Give me five", the taxi flashed its high beams twice in acknowledgement.
All remaining travel was uneventful; Frank stayed at his favorite hotel, the Waldorf Astoria, and took the sub-way to Jersey City, where the plant was located. He was escorted by the General Manager to his office. "Judas Priest" Frank thought "the desk for me is in his office."
Frank found two frauds had occurred, but cannot disclose them in this e-book because of confidentiality requirements still applicable. Frank reported his findings by telex to Vancouver and personally to the plant's Head Office in Alabama.
Strange, the President of US Operations asked "How do you feel about this?" "Sick Mr. Gee, he was a nice guy that was tempted, like we all can be." "If you had responded any other way I would have kicked you out of my office, he was a personal friend of mine."
Other Frauds
When auditing a large pharmaceutical company's payroll in 1976 as a Price Waterhouse employee, Frank noted several casual employees' cheques were being deposited into the manager's personal bank account; and that many casuals had signed their payroll cheques, but were sacked several weeks before.
Regarding the first allegation, the manager told Frank that they had lost their wages playing poker with him each pay night. Re the second, the manager responded "must be our payroll department's error, bloody incompetents."
Later, after review of Frank's file, the manager was sacked but never charged.
Conclusion
Frank enjoyed reviewing business systems and was proud of his ability to be practical. Over the years he's come to realize that Maxlan Timber's Audit Director was advanced for the time, in that non-traditional systems were reviewed.
It is impossible to eliminate fraud, yet, it is possible to have practical systems and procedures to prevent or detect fraudulent behavior. It's safe to assert the smaller the business the higher the risk (due to informalities in small business).
Management need system and procedures that ensure financial reports are accurate, useful, timely and complete; in addition assets and intellectual property must be protected. However, many senior executives agree with the concept, but view the necessary detailed steps and processes that are required as "red tape".
The author was surprised how he never forgot the main principles of internal control reviews. A large accounting firm's audit committee asked him to audit their payroll and supplier payment systems. It was like "riding a bike, one never forgets." In 2007 Frank completed the audit in one month. Although he found no fraud, he reported several weaknesses. Sadly, "internal politics" erupted (Frank asserted the prior year's audit was incompetently done) and his report was not fully acted upon. Nevertheless, the author was happy knowing he did a good job.
Interestingly, the major control weaknesses in many businesses that the author has noted, in a 35 year career, are as follows:
* Major risk factors are not identified by the Board of Directors, along with action plans never formulated in the event the risk eventuates,
* There is a great ignorance among executives regarding the importance of instituting and maintaining sound internal controls to reduce significant errors or frauds occurring,
* Allowing some staff not to take their annual vacation. This creates an opportunity for a fraud going undetected due to repetitive cover-ups,
* Allowing one person or department to have charge of a complete transaction cycle,
*Poor division of duties, for example, having the trade creditor's clerk reconciling the main bank account,
* Electronic payments by-passing the controls normally present when a cheque is issued; And not confirming payee's true bank account details,
* Reprocessing of source documents not properly cancelled when first processed,
* Managers bypassing or over-riding control systems; either involving their staff, or threatening them,
* Overstated travel claims for reimbursement,
* Too much trust in employees without checks and balances to reduce temptation and improve chances of detection, and
*Many, many more, tragically.
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About the Author
Frank Josey is a dual citizen of Canada and Australia, with a deep love for both countries and their peoples. He currently resides in a country Australian town.
Born in New Westminster, B.C. Canada, he grew up in a typical Canadian family in Burnaby, B.C. He has two brothers who reside in Canada.
His high school years were at St. Thomas More Collegiate, Burnaby, B.C. whilst attending Simon Fraser University, he was awarded a Bachelor of Arts, Commerce Major. From 1977 to 1992 he was a Canadian Chartered Accountant and from 1992 to 2009, an Australian Chartered Accountant. He is a registered Management accountant (AMA).
He believes that there are many faiths but only one true religion – the religion of love (of neighbor and our creator).
He enjoys various genres of music from good heavy metal to Big Band Jazz. His hobbies are drumming (jazz and military styles), researching theological issues, and “dancing in the rain”. He loves baseball, and Rugby League.
Of the many capable drummers, he enjoys Dave Weckl, Dennis Chambers, Buddy Rich (dec.) and Louis Bellson (dec.) and Neil Peart.
Of the many comedians that he enjoys, his favorites are Billy Connelly, Robin Williams, John Cleese, Rodney Dangerfield (dec.) George Carlin (dec.) and Bob Hope (dec).
He is divorced and has a son and daughter of whom he is very proud and several grandchildren, all residing in Australia.
His motto - “Things are never as bad as they seem”.
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