Placentia Embezzlement Lesson: Trust But Verify

Trust but verify are wise words popularized by President Reagan, and words to live by, especially in government or business. The recent embezzlement in the City of Placentia is just another case of municipalities that fall victim to a system that can break down easily if left unchecked.

The first important rule is to never put all your eggs in one basket. In other words, don’t have one person making all the decisions for financial transactions in an organization.  In accounting parlance, this is called internal control or more specifically, segregation of duties.  The idea is to have several individuals, who do not have a direct-report relationship, responsible for a part of the process, but not the whole process. This is fairly easy to accomplish in large organizations such as the county, but in smaller organizations, this can be a difficult and costly thing to do.

Management fraud, like what appears to have happened in the City of Placentia, can be the most difficult to detect because the defrauder overrides the internal controls put in place to safeguard taxpayer assets. A good internal control system will have steps in place to try to detect this kind of fraud early to minimize any losses.

Orange County Auditor-Controller Eric Woolery

At the County of Orange, our wire transfers originate in the department that is requesting the transfer. That request is forwarded to the independently-elected Auditor-Controller’s office who verifies the invoice, amounts, contracts, payee etc.  When everything is approved, the information is sent to the Treasurer Tax-Collector, another independently elected official who initiates the wire transfer.  After the transfer, the Auditor-Controller reconciles the transaction to verify that the proper funds went to the proper payee.  Currently the reconciliation of wire transfers done by the elected Treasurer Tax-Collector’s office with the bank statements and approved payments processed by the elected Auditor-Controller’s office is a great check and balance in the county’s financial system. It would be extraordinarily difficult for any one individual along the chain to hijack the system and divert the payment inappropriately.

The wire transfer system is just one of many internal controls that help us manage the county’s $5.5 billion annual spending.  Internal Audit is another very important part of the internal check and balance system that had been missing from the Auditor-Controller’s office for nearly 20 years. With this function back in place, we are now able to review our processes and procedures more efficiently allowing us to spot potential problems much earlier.

Unfortunately, there are countless ways fraud can find its way into the taxpayer’s pockets. Another popular scam is to set up a phony employee, consultant, bank account or project with payments that go right into the embezzler’s pocket.  A clever person with criminal intent can create the paper trail that looks legitimate and often this individual has the power to force, bribe or intimidate employees to look the other way.

Elected officials, city managers and business owners should make sure that protocols are in place so multiple individuals sign off or review funds transfers, whether by wire, check, ACH, journal voucher or cash. The key lesson then is to make sure that there is always a system of checks and balances and, more importantly, that employees are empowered to speak up if they see something amiss. The most important thing is to insist that the tone is set from the top.  If employees see leadership acting ethically, they are far more likely to do the same.

When I became Auditor-Controller, I soon realized that our staff needed training and inspiration to do more than process paperwork. I wanted them to embrace the concept that their job, from receptionist to top management, is to look out for the taxpayer.  We initiated the “Taxpayer Watchdog” program which provides encouragement and incentive to not just ask the question: “Is this accurate?” but to go to the next step and ask “Does this make sense?”  The idea is to have best practices modeled from the top down and bottom up, which fosters an equilibrium that results in better judgement and right actions throughout the organization.

In the past year, employees have stepped up with new innovative cost-savings ideas, and we recently gave our OC Taxpayer Watchdog Award to several members of the accounting and IT team for Orange County Community Resources who developed a streamlined invoicing process for Animal Care which saves the taxpayers $27,498 annually.  (We are accountants; of course we will give you the number down to the dollar.)

Preventing fraud is something that needs to be built into management systems and more importantly, management must demonstrate and encourage a culture that inspires and empowers employees to do the right thing.  But, for your own peace of mind, continue the vigilance and verify everything.

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