Trust, But Verify: Protecting Your District from Embezzlement

Recently, two well-publicized cases of employee embezzlement and dishonesty of public workers in Colorado have put the spotlight on special districts. In one instance, an employee was implicated in the embezzlement of over a million dollars, and in another, a former fire chief was charged with the theft of over half a million dollars in online purchases. These districts suffered great financial losses because they did not have the appropriate Best Practices in place. Most Crime coverage limits are completely inadequate to handle losses of this magnitude, meaning that unless they purchased higher limits, the district itself is financially responsible.

In the first example, the district’s board unanimously approved an attorney’s contract as a management consultant despite him having spent nearly four years in prison for previous financial crimes. The attorney was not a signatory on district bank accounts, yet hundreds of district checks were allegedly forged and moved among local banks. Over four years of involvement, an independent accounting company found no issues. Now that attorney has been accused of embezzlement and a second district is reporting more than a quarter of a million dollars in missing funds when that same attorney was employed by them.

In the second example, the fire chief’s misuse of funds continued from January 2010 to March 2013, until funds dried up. In his unpaid position as chief, he was allowed to approve his own expenses. Many purchases that he made on the district’s credit card were reimbursed without verifying the receipts. These types of abuse are not confined to outside contractors.

A common component these cases is the lack of separation of duties. When the scope of job duties includes both the approval and issuing of funds, there is a greater chance of fraud or misappropriation. Another component in these and many other cases of fraud is a lack of verifiable oversight. A board may take an employee’s word that they have paid a vendor or that a vendor truly exists, but without proof, such as in-person meetings, receipts, or other communication, funds could easily fall into the wrong hands.

It may appear that this sort of fraud was fairly obvious, with little effort employed by the perpetrators to conceal their crimes. But often, employee fraud can be well-hidden with extensive efforts made to cover up crimes. Fake receipts and reports can be purchased from websites or easily manufactured. Non-existent vendors, under the guise of ‘consultants,’ can be set up and not questioned or vetted. These things are not easy to discover and on average, investigations of fraud take approximately eighteen months.

According to the Association of Certified Fraud Examiners’ 2012 Report to Nations, small businesses with less than 100 employees are particularly at risk of occupational fraud. These smaller entities tend to have fewer controls and restrictions, such as hotlines and surprise audits, in place to deter fraud. Worryingly, small businesses tend to have a bigger fraud loss than larger businesses. A business with 100 employees has a median loss of $147,000 as opposed to a business of 10,000 or more employees with a median loss of $140,000.

There are a few things special district management can do to safeguard against this type of fraud. They include:

  1. Division of Duties: No single person should have control of the checkbook
  2. Management Interaction: Touch base with staff verbally, making it clear you are present, engaged, and alert
  3. Require Time Off: Ensure employees take their appropriate time off regularly, this allows others to ensure nothing is being misappropriated
  4. Make Daily Deposits: Do not keep large amounts of cash or checks on hand; those funds are safer in a bank
  5. Cash Controls: Keep petty cash and blank checks in a safe; cash boxes are okay for short term use
  6. Back-up Records Daily: Back-up financial records online to ensure they are not tampered with or lost
  7. Don’t Allow Employees to Take Work Home: While some types of telecommuting are acceptable, allowing employees to work with the district’s cash or funds offsite restricts management’s ability to maintain oversight

Out of almost a thousand special districts participating in the Pool’s Crime coverage, 75% only carry the minimum $5,000 limit for Crime. In both examples, the losses were well beyond that amount. The cost of higher limits for Crime coverage is much smaller than the expense of fraud that may go undetected for years and be ultimately unrecoverable. If your district would like to discuss higher limits, please give us a call. The Pool can provide limits up to $5 million with underwriter approval.

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