A case I worked on several years ago provides an excellent example of a failed fraud prevention effort. The idea was great – an owner of three convenience stores had one management-level employee who was to oversee all the stores.
In order to keep tabs on his money, Brad (the owner) had all bank statements and cancelled checks sent directly to his home. That way, he could see how Joe (the manager) was spending the company’s money.
In theory, this is a nice little internal control. It really costs the company nothing, and it is helpful because it allows the owner to examine the bank documents while being assured that no one has tampered with them.
In many cases of internal fraud, an employee is able to cover the theft for a period of time because she or he removes suspicious canceled checks from the bank statements, and no one notices. So in this case, Brad was taking a nice precaution to prevent against such concealment of a fraud scheme.
The problem was that Brad never opened any of the bank statements. He quite literally filed away the sealed envelopes and never thought twice about it. Even when the number of canceled checks was rapidly multiplying and therefore the envelopes were getting noticeably thicker, Brad did not examine the contents.
A Check Kiting Scheme
What was going on? Joe perpetrated a massive check kiting scheme, removing funds for his own personal use, and kiting ever larger checks to cover his tracks. He would write a check from Account A and deposit it into Account B. Account A did not have enough funds to cover the check, so an even larger check was written from Account B, and deposited into Account A.
With each increase in the check amount, there was a little more phantom money for Joe to take for himself. The problem with this type of scheme is that it requires ever larger checks to be written back and forth. Joe took money for himself that didn’t really exist, so another larger fraudulent check was required to be written as paper (and not real money) was continuously passed back and forth between the bank accounts.
The Financial Damage
After nearly a million dollars was stolen, Brad was still none the wiser. The scheme unraveled the day some large checks bounced. Joe made a miscalculation in the timing of his fraudulent check writing and depositing, and the checks started to bounce.
When all was said and done, there was a shortfall of almost one million dollars in Brad’s bank accounts, and the bank wanted its money. Brad pulled out the old bank statements and began ripping the envelopes open. What he found were hundreds of kited checks, increasing in dollar amount and volume over time. At the end of the scheme, about 30 checks per day were being kited, each in the amount of $30,000 to $40,000.
It was clear by examining the bank records that Joe had started the scheme on a very small scale. He sent a few small checks through the bank account to see if Brad would notice them. It quickly became apparent to Joe that Brad was not looking at the bank statements, as he never questioned any of the checks that were written. And this was Joe’s green light to move forward with his scheme.