Feature Articles and Resources

• Preventing Fraud in the Treasury Function
  
• Proactive Fraud Prevention Measures
  
• "Red Flags" that Identify Employees at Risk for Fraud
  
• Tips to Prevent Bank Account Fraud
  
• Checklist of Internal Controls for the Investment Fuction
  
• Useful Resources on Internal Controls and Fraud Prevention
  
• GFOA Accepting Entries for Awards for Excellence
  

• Panel of Economists: Economic Outlook
  
• Interest Rate Outlook
  
• Snapshot of Economy and Interest Rates

• Performance Benchmarks
  • 10-Bill Index
  • Money Market Fund Index
  • LGIP Index
  • Key Rates: Cash Markets
  • Relative Value Yield Chart

Preventing Fraud in the Treasury Function

By Joseph R. Dervaes

This article will highlight the importance of using strong internal controls to prevent fraud in the treasury function.

Preventing fraud in cash disbursements. From my experience, I have learned that internal controls are particularly important when preventing fraud in cash disbursements. A significant number of transactions must be manipulated over a long period of time when a perpetrator, one of your trusted employees, steals a large amount of funds in a cash receipts fraud scheme. When this occurs, the risk of detection from inside and outside the government is quite high.

However, this large volume of transactions is not necessary when the same employee decides to steal a large amount of funds in a cash disbursements fraud scheme. Once the perpetrator determines that your procedures and controls do not detect a relatively small irregular cash disbursement transaction, such as by processing a “test” transaction, they immediately stop using small numbers and move on to bigger transgressions. This issue of the Treasury Management newsletter includes a list of "red flags" that identify employees at risk for fraud.

Since the amount of fraud is cumulative and increases progressively over time, all frauds will eventually reach a significant level and cause grave financial harm to the government – but it's the cash disbursements frauds that reach these levels quickly.

“Tone at the Top” and “Walking the talk.” For internal controls in the treasury function to be effective, all elected public officials, directors, and managers must continually send a message to government employees saying that internal controls are important. Auditors call this “tone at the top.” But, these officials must not only say the words. They must follow-up with actions to make this happen. We call this “walking the talk.” If managers are insincere about this extremely important message or compromise and over-ride internal controls under pressure, everyone will know where they really stand. It does not take very long for employees to develop the mind-set that says managers “don't care” about internal controls, even when that isn't their real intention. It just happens over time. Then the employees begin to do the same thing the managers do. After that, internal control failures abound. The risk of fraud dramatically increases over time. Eventually, fraud arrives on your doorstep. Do not let this happen at your government.

Fraud is not a matter of if , but when. You can never stop fraud from happening. All you can do is establish strong internal controls to deter such action. And, failing that, the internal controls you establish will detect fraud in its infancy when losses are small and manageable. But, regardless of the amount of the loss, make sure that your organization's policies ensure that all fraud cases are investigated or audited, and then referred to the appropriate law enforcement agency for prosecution. Fraud without personal consequences sends a horrible message to the remaining employees in the organization and to the citizens.

There is a cost to internal controls. Nothing is “free.” But, there is good news. All you have to do is to put internal controls in place that are designed to “protect your employees.” Over the years, I have found that managers are quick to implement such controls, because they want to protect their employees from being accused unjustly when the inevitable fraud loss occurs.

Auditors often fail to properly communicate “why” many internal controls are important to your financial well-being. Once you understand why you're doing what you're doing, and how that protects your employees, you will implement changes within your organization even before an auditor recommends the change. It will be automatic. I feel this understanding is critical if any improvements in financial operations are to be made. The ultimate issue is to “trust but verify” what employees actually do on the job. Auditor's call this re-performance. If you tell your employees what to do, expect them to do it, and then do not follow-up with monitoring procedures designed to determine if your expectations are being met, you will fail. This is called “blind trust.” One of the most common failures in government is that we trust our employees too much. As a result, we do not monitor our financial operations the way we should and we do not ensure a proper separation of duties between key employees and managers to reduce the likelihood that one person will be able to completely control one process or function from beginning to end.

Joseph R. Dervaes, CFE, ACFE Fellow, CIA, is the vice-chair of the ACFE Foundation Board of Directors and is the author of a byline column on Frauds Finer Points in Fraud Magazine, the Association of Certified Fraud Examiners' international journal. After 42.5 years of federal, state, and local government audit service, he retired as the audit manager for special investigations at the Washington State Auditor's Office, where he was responsible for managing the agency's fraud program. During the past two decades, he participated in the investigation of more than 730 fraud cases involving losses of greater than $13 million. His e-mail address is joeandpeggydervaes@centurytel.net.

Proactive Fraud Prevention Measures

By John P. Nacchio

1. Protect Check Paper Stock
   • Safety paper is used to prevent unauthorized reproductions or alternations.
   • MICR document design specifications are encoded for protection.
   
   
2. Positive Pay
   • Checks that are presented for payment at a depository bank are compared against the electronic check issuance file to identify unauthorized payments.
   • Daily bank reviews are conducted to accept or reject items that are unmatched or considered suspect items.
   • The City uses the following positive pay options:
     • Basic Positive Pay – compares checks presented for payment against an issuance file with no hard copy account reconcilement reports.
     • Teller Positive Pay - matches checks presented over-the-counter at any teller against an issuance file prior to cashing the check.
     • Payee Match Positive Pay – detects any differences in payee name (in addition to check number and dollar amount).
   
   
3. ACH Fraud Control
   • Prevents unauthorized ACH transactions from unexpectedly settling against an account.
   • ACH Fraud Control options:
     • ACH Block – returns all ACH debits or credits attempting to post to an ACH blocked account.
     • ACH Control – accepts authorized ACH transactions based on a list of designated originators.
     • ACH Control with Positive Pay – option to review and decide on any items appearing as an unauthorized ACH transaction.
   
   
4. Account Dollar Limits – The city sets maximum dollar limits for checks clearing in specific accounts.
   
   
5. Account Reconciliation – Provides timely information on checks that are presented for payment. The city performs monthly statement reconciliations for monitoring and control reports.
   
   
6. Stop Checks – Lost or stolen checks are placed on “stop” to prevent possible occurrences of theft or inappropriate receipt of funds.
   
   
7. Maximize the Use of Electronic Payments – Maximizing the use of electronic payments to employees and vendors is an effective way to reduce the risk of loss or stolen paper checks.

John P. Nacchio is the treasurer of the City of Philadelphia, Pennsylvania.

"Red Flags" that Identify Employees at Risk for Fraud

1. An employee with unusual work habits, such as an individual who:
   • Comes to work early or leaves late.
   • Works nights and weekends.
   • Is seldom missing from the office, even to take leave or vacation.
   • Reports to the office during brief absences (one day or less), by telephone or in person.
   • Asks others to hold their work for them without processing it until they return.
   
   
2. Employees who are the only people who can authorize certain types of transactions, transactions in restricted accounts, or transactions in excess of certain levels. No one else performs these tasks if and when they are absent from the workplace.
   
   
3. An employee whose deferred compensation deductions are unreasonable given their living circumstances.
   
   
4. An employee whose spouse or significant other has recently lost a job.
   
   
5. Employees who are living beyond their means, such as those with lots of new “toys” (i.e., cars, boats, travel trailers, motor homes, vacation property, home remodeling projects, etc.).
   
   
6. Employees who have high debt, such as those who are being “dunned” by creditors that frequently call them at the office in a collection campaign.
   
   
7. Employees who spend more money taking the staff to lunch than they make on the job.
   
   
8. Employees who brag about recent gambling winnings or family inheritances.
   
   
9. Employees who have a life style or pattern of gambling, and who frequently travel to gambling Meccas (they are probably losing).
   
   
10. Employees who “act out of character” by performing tasks which are not a part of their primary job duties.
    
    
11. Cashiers who always balance and are never over or short.
    
    
12. Cashiers who do not follow the organization's standard cash handling policies and procedures.
    
    
13. Employees who are always behind in their work and are content to exist in a “messy” work area. This is often by design and a mechanism used to conceal irregular or inappropriate activity.
    
    
14. Employees who are secretive on the job and are unwilling to let others review their work.
    
    
15. Customers frequently provide customer feedback about the employee's errors and irregularities.
    

This list was developed by Joseph R. Dervaes, CFE, ACFE Fellow, CIA.

Tips to Prevent Bank Account Fraud

In its recommended practice "Bank Account Fraud Prevention," the GFOA recommends that governments consider the following steps to protect themselves against bank account fraud:

1. Implement positive pay on all disbursement bank accounts and reconcile daily. Positive pay is the single best fraud prevention device available.



2. Instruct your bank to return all non-conforming positive pay items as the default instruction.



3. Ensure that a clear policy exists to differentiate between staff approving positive pay exceptions and staff initially preparing the check.



4. Designate all depository accounts to reject any and all withdrawals other than intra-bank transfers.



5. Place total ACH blocks on all accounts that are not disbursement accounts. (Disbursement accounts should never be the depository accounts; see Recommendation 4 above.)



6. Place total or selective ACH blocks on all disbursement accounts.



7. Develop a formal plan to review ACH blocks. At a minimum, this should be done on an annual basis.



8. Conduct periodic and surprise audits or reviews of procedures. At a minimum, this should be done on an annual basis.



9. Provide for the physical security of returned checks and check copies or digital images. Electronic storage of check images is preferred over retaining paper copies.



10. Provide for the physical security of electronically deposited checks including storage in a secure facility, timely destruction via secure shredding and incineration, and dual control of the process. The depositing governmental entity is liable for any fraudulent usage of these checks.



11. Secure check stock daily. Remove continuous forms from printer, lock printer, and secure check stock in a locked environment.



12. Ensure that there is appropriate security over signature plates, cards, and software.



13. Require all checks over a specified amount to have an additional review process.



14. Ensure that your financial institution provides for multi-factor identification when using on-line banking services. Ensure appropriate separation of transaction duties for administration of the on-line system.



15. Consider the usage of Universal Payments Identification Codes (UPIC) for all disbursement accounts. This protects all bank accounts from identification from outside sources.



16. Review signature cards and authority levels at least annually and whenever any changes occur. Ensure that your financial institution provides a quarterly listing, by account, of all approved signers and access-only individuals.



17. Ensure proper segregation of duties among staff initiating, authorizing, preparing, signing, and mailing payments and reconciling bank statements.



18. Consider outsourcing the disbursements process.



19. Consider outsourcing the payment receipt process to an outside lockbox provider. This may provide additional separation of duties, security of confidential account information, and added reporting capabilities. A careful consideration of the cost versus benefit should accompany this consideration.

Checklist of Internal Controls for the Investment Function

• The government should have a written investment policy that has been approved by the governing body. The policy should be reviewed and revised periodically and approved by the governing body.



• The investment policy should specify permissible investments by type and provide guidelines describing diversification and credit quality requirements for each type of permissible investment.



• For each type of permissible investment, there should be an approved list of financial institutions and broker/dealers.



• The investment policy should describe the process of selecting financial institutions, broker/dealers, custodians, etc., and require written contracts and agreements with these entities. The selection process should be carried out in conformance with the policy.



• Investment transactions and strategies should be documented. The process of initiating, reviewing, and approving investment purchases and sales should be recorded in written documents and the documents should be retained for audit purposes.



• Selected investments should be reviewed for: type, authorized trading partner, custodial arrangements, written authorizations, accounting, and disposition of interest earnings.



• The government should have a written wire transfer agreement with the bank outlining various controls and security provisions for making and receiving wire transfers. Written confirmations of telephone transactions for investments and wire transfers should be required.



• Duties should be segregated so no one person has responsibility for investment transactions from beginning to end.



• The credentials and references for all investment position candidates should be carefully reviewed and verified. The finalists for investment positions with bona fide security requirements should be screened for past records of indiscretion or criminal activity. Care should be taken so that all such candidates are treated equally in the selection process. Such screening should conform with applicable federal and state laws.



• Investment procedures should be clearly documented. The documentation should include descriptions of employee responsibilities, the process for conducting and recording transactions, and clear delineation of authority to approve the transactions.



• The government should have a training plan to ensure that each employee understands the tasks they are required to perform. The training plan should include updates and refresher training for investment staff that are responsible for making judgments about investment selection.



• Confirmations of investment transactions should be obtained from the custodial bank.



• The custodial bank should provide monthly verifications of both principal and market values of all investments and collateral. This information should be compared against internal records. Staff should immediately follow up any discrepancies.



• Investment reports should be produced on a periodic basis. The reports should include descriptions of investment amounts, transaction dates, interest rates, maturities, bond ratings, market prices, and other related income. Investment yields should be monitored by an investment committee and compared against expectations.



• Periodic internal control audits should be performed to verify that controls are functioning properly and in compliance with investment policy.

GFOA Accepting Entries for Awards for Excellence

Eight criteria are examined when considering an application for the award: local significance and value, technical significance, transferability, documentation, the cost/benefit analysis, efficiency, originality, and durability. Membership in the GFOA is not required to apply for an award; however, nonmembers and students must be sponsored by an active GFOA member.

To request information about the Awards for Excellence program, send an e-mail to AwardsforExcellence@gfoa.org. For your convenience, the application forms and instructions are available for download in Adobe Acrobat® Reader format.

Economic Outlook

This month, Treasury Management asked its panel of economists how the problems in the sub-prime mortgage market will affect the economy and interest rates. We also asked the panelists to provide their forecasts of the economy.

Eugenio J. Alemán of Wells Fargo Bank says that the sub-prime problem will continue to linger and could make economic actors more nervous regarding the stance of the U.S. economy. He expects economic growth to continue, but the risks of a recession have increased. Through its recent rate cut, the Fed has tried to reassure the markets that it is on top of the game. However, Alemán believes that this injection will have little effect on the housing market.

Lacy Hunt of Hoisington Investment Management predicts that the economy will be in recession by the end of this year or early in 2008. He expects that unemployment will move above 5 percent, inflation will continue to moderate, and short- and long-term interest rates will fall further. Hunt notes several factors supporting his view, including an unprecedented leveraging of the economy over the past six years, an equally unprecedented housing bubble, and more than two years of monetary restraint.