By Guest Blogger Lisa A. Myers, CPA, CFE, MAFF | Boyer & Ritter LLC 

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Opportunity, motivation, rationalization, and poor internal controls are the root of most fraud schemes executed by management, employees, or volunteers at school districts across the nation. Typically, successful fraud schemes can be classified into six basic categories:

1. Fraudulent financial reporting
2. Misappropriation of assets
3. Expenditures and liabilities for an improper purpose
4. Revenue and assets obtained by fraud
5. Costs and expenses avoided by fraud
6. Financial misconduct by senior management

School districts must protect themselves with adequate insurance policies (such as Employee Dishonesty Coverage) to ensure recoupment of financial losses suffered as a result of employee theft. The best protection against many fraud schemes, however, is halting them before they begin. One of the most commonly discussed fraud schemes identified at school districts is asset misappropriation, more specifically, employee embezzlement. Proper internal controls coupled with managerial oversight can provide a proactive defense mechanism against these internal predators.

Examples of School District Fraud

Conspiracy Scheme
A school district lost more than $2.5 million of public funds to an employee embezzlement scheme executed from August 2001 to December 2013. According to court, the manager and security and fire systems security support specialist, both former employees of the school district, schemed with accomplices to fraudulently invoice the school district for fire and security alarm support services never performed. The employees and accomplices formed two companies, allegedly in the business of maintaining fire safety and security systems, and generated fraudulent invoices. Funds collected from the school district as payment for the invoices were split amongst the fraudsters.

How it could have been prevented: Conspiracies involving collusion are difficult to identify and prevent. However, certain controls could have triggered red flags for school officials. The fraudulent entities contracted to perform the fire and security services should have been required to go through a bid approval process by upper management, excluding the involvement of the security and fire systems manager and specialist. Additionally, conflict of interest forms should be maintained for all management-level employees and reviewed against information received from external vendors.

Invoices received from the alleged fire and security alarm service providers should have gone through an approval process by an individual outside the security and fire services department. The business office should have prepared a budget that estimated the expected cos

ts of the services, and regularly compared the actual expenses to the budget. Scheduled periodic observation of the service providers performing the fire and security maintenance would have provided school officials with proof the service providers were shell companies and the school was being charged for nothing.

Student Activities Fraud

A former student activities secretary embezzled more than $100,000 from a school district, committing the largest single theft in the history of that school. From 2006 to 2009, the secretary stole funds collected from students and parents by neglecting to deposit the monies into school- issued bank accounts. School business records were tampered with by shuffling monies from various other accounts to hide the fraud scheme, thus misleading the public and school officials.

How it could have been prevented: Cash handling procedures for student activities must be established and enforced. One individual should never have the ability to collect, count, and prepare deposits. All collected funds must be counted in the presence of more than one individual, logged on a control sheet, and secured. Checks received should be restrictively endorsed “For Deposit Only” immediately upon receipt. The individual preparing the deposit slip should never have been involved in the initial counting of funds, and individuals collecting monies should have no access to the books of record.

On a monthly basis, the business office should require all student activities to submit financial reports, control logs, and bank statements in order to perform review procedures.

Convicted Felon Strikes Again
A school district’s former benefits coordinator embezzled school funds from June 2012 to October 2013 by fraudulently writing checks for their own benefit. The coordinator began the embezzlement by writing modest checks, totaling just over $1,000 a month, but by the last month of the embezzlement stole over $19,000 a
month.
After the termination of the coordinator, it was discovered the individual was a convicted felon. Around 1998, prior to being employed by the school district, the now-terminated benefits coordinator had actually been convicted in a grant embezzlement scheme in another state. When the coordinator was hired by the school district in 2007, the state background and fingerprint check system did not identify the prior conviction.

How it could have been prevented: Adequate background checks must be performed, especially by school districts which care for public funds and minors. Nation-wide background and fingerprint searches must be performed to adequately identify individuals hopping from one state to another. No single database contains an individual’s entire criminal history; therefore, multiple sources must be used, such as county criminal records search, PSP PA Access to Criminal history, federal criminal records (FBI), child abuse clearances, and the sex offender/Megan’s Law registry. The costs associated with performing multiple background checks are higher, but the reward of finding valuable employee information may prove to be even greater.

Individuals with access to generate cash disbursement checks should not have check signing abilities. Blank checks must be secured in a locked location by someone who is not an authorized signatory. School policy should require dual live signatures on all prenumbered checks, and at no time should signed checks be given back to an individual capable of manipulating the checks or the accounting records. To the extent possible, vendors should be paid either via ACH or procurement cards, reducing manual check processing and the inherent risks associated with it.

Many banks offer payee positive pay a cash management system offered to assist with reducing incidents of check fraud. The system enables banks to review various aspects of a check presented for payment and compare them against a supplied list of checks issued by the school district. Banks using payee positive pay only honor checks that have been verified. The payee positive pay system helps identify altered checks or checks issued fraudulently and halts payment.

School districts using payee positive pay compile a list of checks issued each day and send the list electronically to their bank. The list includes the school’s bank account number, check number, the date, and the amount for which the check is issued. When vendors present checks from the school for payment, the bank’s electronic system automatically compares the checks against the daily-issued check list. Only those checks matching completely are paid. Checks with any variations from the list are not paid, and a copy of the check is forwarded to the school district for investigation.

Banks also provide positive pay security for ACH transfers issued by school districts. Predetermined vendor accounts, IDs, and dollar thresholds are used to assist in identifying fraudulent transfers. Though internal controls can prevent many aspects of fraud, there are flaws in every system and employee theft is still possible. However, employees will think twice if management or members of the board are checking on them. The rule will always stand: employees are less likely to steal if they believe there is oversight and they may be caught. This is the key to deterring theft.


Lisa A. Myers, CPA, CFE, MAFF, FCPA, CGMA is a principal with Boyer & Ritter CPAs in Camp Hill. She is a PICPA member, and serves as chair of the Budget and Finance Committee, Governance and Structure Task Force, and Forensic and Litigation Truth in Finances Subcommittee. Lisa is also a member of the Forensic and Litigation Services Committee and Subcommittee. She is a frequent lecturer for the PICPA School District Conference.