Question

At the old city hall, mail was sorted in a glorified closet—not the sort of place you’d expect to be frequented by a high‐ranking city official with multiple degrees. However, the city of Weston’s chief financial officer, Steve Kaufmann, had an unusual interest in the mail. He was often known to greet the postal carrier at the door to receive the day’s delivery, take it to the mail closet, then immediately remove selected envelopes and parcels and take them to the privacy of his own office. Other times, he would request hand delivery of incoming payments, circumventing the mail closet altogether. These activities were part of an elaborate embezzlement scheme that resulted in the loss of millions of dollars for the city. Mr. Kaufmann was intercepting checks written to the city and endorsing them to his personal bank account.

The procedural manual for Weston’s accounting department described mailroom policies, including the requirement for a clerk to log checks into a computer file and prepare a receipt. Another employee was responsible for preparing an independent verification of the amount of the receipts, and a third employee made the bank deposit. Despite these written guidelines, Mr. Kaufmann was often known to carry out some of these tasks himself, or to claim to be doing so. In response to the news of this fraud, the CFO of a neighboring community commented that many cities are unable to achieve strong internal controls because of the limitations of small staff size and tight operating budgets. Rather, small cities often have no choice but to rely on the integrity of their employees.

 

Required:

a. Which internal control activity was violated in order for Mr. Kaufmann to perpetrate this fraud?

b. Do you consider this case to be an example of management fraud or employee fraud?

c. Was the city’s procedural manual adequate for prescribing internal controls to prevent this type of fraud? Why, or why not?

d. Why do you think no one reported the unusual mailroom practices of Mr. Kaufmann? To whom would such a violation be reported?

e. Do you think a business in Weston could be guilty of customer fraud if it agreed to deliver its payments to Mr. Kaufmann personally rather than send them to the city’s mailing address?

f. The comments made by the neighbor CFO express which type of limitation of internal control systems discussed in this chapter?

 

Answer 1

a.

A case could be made for any or all of the internal control activities were violated in this scenario. With regard to authorization, it can be said that Mr. Kaufmann abused his authority by circumventing the established controls in order to carry out these transactions on his own. His interference in the mailroom procedures made it impossible for any segregation of duties to occur. There was apparently inadequate security and documentation for the assets and transactions with which he was involved, and there was no one willing to come forward to review or reconcile these transactions.

b.

Although it involves misappropriation of assets, which is typically an employee fraud, this was conducted by the chief financial officer. Accordingly, it would be considered a management fraud. It is not likely that Mr. Kaufmann would have been able to carry out his fraud if it had not been for his high-ranking position, which apparently prevented anyone from stopping him.

c.

Although the case states that written guidelines were in place regarding the mailroom and bank deposit policies, requirements for logging checks received and performing an independent verification of receipts, these guidelines were obviously not followed when Mr. Kaufmann stepped in. Rather than being a problem with the documented policies, this case seems to present a situation marked by circumvention of controls.

d.

Since Mr.Kaufmann was the highest ranking financial officer in the organization, employees who suspected misconduct likely believed that there was no one with authority over Mr. Kaufmann to whom the problem could be reported. If management is involved in fraud, it should be brought to the attention of the board of directors. In the case of a municipality, the problem could be reported to the chief administrator, mayor, or the city’s advisory council.

e.

A business that agreed to deliver its payments to Mr. Kaufmann personally would not likely be guilty of fraud. Customer fraud requires the intent to deceive, so unless the business had knowledge or was otherwise involved in Mr. Kaufmann’s fraud scheme, it would not be guilty of customer fraud.

f.

The limitation of small staff size typically means that the business organization does not have sufficient resources to accomplish segregation of duties. Accordingly, controls can be easily circumvented. 

The comment regarding the tight operating budget reflects upon the cost/benefit limitations of internal controls.