The AuditNet Guides

EMBEZZLEMENT PREVENTION AND

DETECTION GUIDE
with case studies

AuditNet 2010

EMBEZZLEMENT PREVENTION AND DETECTION with case studies

FRAUD INTERVIEW TECHNIQUES
Embezzlement in the United States defined as misappropriation of assets by
an employee or agent of a company for his or her own purposes.
Five key high-dollar cases are analyzed, along with an explanation of Internal
Controls that could have prevented or detected them. This is followed by a
multi-section report on Fraud Interviewing Techniques. A table of contents with
hyperlinks to each section follows.
Koss Corporation
G & J Pepsi Cola Bottlers
ING Reinsurance
SE Petro Distributors
Quest Resources
Why Perform a Fraud Interview
Elements of a Conversation
Establish an Interview Baseline
Routine Fraud Inquiries
Asking Open Questions
Asking Closed Questions
Asking Follow Up Questions
Active Listening
Interview Rules
Note Taking
Interview Skills
Summary of Key Findings
By a significant margin, embezzlers are most likely to be individuals who
hold financial positions
The two broad categories that have the highest risk for a major
embezzlement are Financial Services and Government Agencies
On average, major embezzlement schemes last about 4 years
California and Florida are consistently the states that experience the
greatest losses from major embezzlements
Gambling is a clear motivating factor in driving major embezzlements
Recent cases and loss amounts:
Name
Victim Organization
Sujata Sue Sachdeva
Koss Corporation
Yolando Serrano
Southeast Petro
Distributors
JD Cash
Quest Resources
James T. Hammes
G & J Pepsi-Cola Bottlers
Nathan J. Mueller
ING Reinsurance

Amount
$ 31,000,000.
$ 12,700,000.
$ 10,000,000.
$ 8,711,000.
$ 8,500,000.

Koss Corporation Case:

Koss Corp. had $38 Million in Sales and employed 70 people
The top executive of the firm was Michael Koss, who was an outspoken
critic of Internal Controls and Corporate Governance principles
Sue Sachdeva enjoyed immense trust from Michael Voss and was the VP of
Finance
Koss has issued a public statement that their financial statements from 2006
forward should not be relied upon
Unanswered Questions:

Where was the national auditing firm that collected more than
$ 625,000 from 2004 through 2009 to audit the books of this Milwaukee
headphone manufacturer?
Richard Brown, formerly of KPMG, states The fraud is so large, in
relation to the size of the company, that I have got to believe that it is
going to be very difficult for the auditors to prove they conducted an
audit in accordance with generally accepted auditing standards.
Brian Daugherty, of UWM, states Auditors exposure could be zero
they were not engaged to issue an opinion on internal controls.

Whistleblower:
American Express, who blew the whistle on the scheme when it contact Michael
Koss and told him it suspected that Sachdeva was spending millions of company
dollars.
Facts:
The US Attorneys Office stated Sachdeva used company funds to pay down her
personal American Express bills. Among her bills: $670,000 tab at a womens
clothing store, $649,000 from a bridal salon and $255,000 in purchases from a
jeweler. The co-owner of the Mequon boutique where she spent more than $1.3
Million over slightly more than a one-year period said she never suspected
anything unusual. The total number of items she bought with company money is
currently estimated at 22,000 items valued at $31,000,000.
She told the FBI she carried out the scheme on her own, and directed two
assistants to make fraudulent transfers via wires to pay down her credit card
balances. She also falsified balances in Koss bank account to conceal the
transfers.
Questions:

Trend analysis is practically a given in doing any audit work as fraud and
errors tend to create variances over time which would go undetected if only
the single year was being analyzed. SAS 99 requires auditors to engage in
brainstorming sessions to discuss the possibility of fraud. It seems neither
happened.
Unusually large payments to a vendor in relation to the average is a sign of
error or fraud. Were payments to vendors ever subjected to statistical
analysis? Probably not.

Controls which would have prevented or detected the fraud:

Review of the trial balance and a Variance Analysis with commentary on

financial results, which is delivered to Accounting Management and senior
Officers. After the close, the Accounting Manager reviews and signs off on the
Variance Analysis.
Proper segregation of duties she was able to falsify bank balances. A monthly
reconciliation, signed and approved by an independent party, of major balance
sheet accounts, including cash would have detected this.

Lexington, Kentucky Fugitive Indicted for Allegedly Embezzling $8.7 Million from CincinnatiBased Soft Drink Bottler
CINCINNATIA federal grand jury here has returned a 75-count indictment charging James T.
Hammes, 47, Lexington, Kentucky with wire fraud and money laundering for allegedly embezzling
approximately $8,711,282.42 from G&J Pepsi-Cola Bottlers, Inc. between 1998 and February, 2009
when he was employed as the controller for the bottling companys southern division. Hammes fled
after he was initially charged by a criminal complaint in February, 2009, and is currently at large.
The indictment alleges that Hammes created an unauthorized bank account in the name of one of the
companys vendors. Hammes allegedly created an unauthorized accounts payable for the vendor from
which checks were disbursed and deposited the payments into the unauthorized bank account. From
there, he transferred the stolen money into his personal bank and brokerage accounts.
The indictment charges Hammes with 38 counts of wire fraud and 37 counts of money laundering. It
also seeks forfeiture of the contents of his bank and brokerage accounts, and his financial interest in
his house in Lexington.
The indictment specifies 38 separate transactions totaling $3,781,847.80 that occurred between
December 22, 2006 and February 18, 2009 in which he is accused of wiring money into his personal
accounts, Lockhart said, noting that wire fraud is punishable by up to 20 years imprisonment and
money laundering carries a penalty of up to ten years imprisonment.
Interestingly, Hammes was the controller for the Cincinnati-based bottling companys southern division.
Hammes was responsible for all financial accounting and internal controls.
FACTS:
He utilized a straw man vendor which required modification of the Master Vendor File.

Controls which would have prevented or detected the fraud:

i.

A daily check payment log documenting all vendor payments reviewed on a regular basis

ii.

A system which prevents the same person from initiating and releasing the same wire
transaction

iii.

During AP input a matching of the vendor name and remittance address to the vendorsupplied information

iv.

Access to the Master Vendor File restricted to the Sr. Cash Management Specialist

Nathan J Mueller, lone architect of a $8.5MM embezzlement fraud that last four years, was
sentenced to eight years in prison
FACTS:

According to the mail fraud charge against him, Mueller, routinely requisitioned
and cashed checks from ING accounts that he kept for himself from 2003 until
2007.

ING employees eventually caught Mueller after he had request 99 checks for straw
men companies who had names similar to those of actual ING clients

Mueller personally cashed the checks (all for under $250,000 each) allowing no
manual review of the issued checks

Mueller personally authorized the checks using his electronic password to request
them; then using the passwords of others (which he had obtained) to approve
the checks

His attorney says his crime was driven by helplessness & hopelessness. He received
the low end of the advisory sentencing range at the urging of federal prosecutors, who
said he helped locate assets that could be seized for restitution.
Mueller knew his was not a foolproof plan. His attorney: He was in such a state at the
time that not only did he not care if he was caught, he was in fact simply waiting for it. In
the meantime, though, Mueller lived so lavishly that people he befriended believed him
when he told them he had won a $93 million lottery prize.
According to prosecutors, Most of the ill-gotten funds were spent on extravagant or
corrupt behaviors, including substantial gambling losses, gifts to friends and
acquaintances and entertainment.
The extent of Mr. Muellers deceit is substantial and tragic, Assistant US Attorney John
Marti wrote in court papers. Given the turmoil that our countrys financial services sector
currently faces, there is a substantial need for substantial punishment to afford adequate
deterrence to criminal conduct.
Under the advisory sentencing guidelines, Mueller could have received up to 121 months
in prison rather than the 87 months he got. Marti said Muellers cooperation with his
former employer and the government warranted a sentence at the lower end of the range.

Controls which would have prevented or detected the fraud:

AP Invoices require an approval signature on a valid invoice
Check signors review supporting documentation before signing checks.
Authority limits exist.
Checks require two authorized signatures.

Yolando Serrano embezzles $ 12,700,000 from the Shah familys Southeast Petro
Distributors in Melbourne, FL

BREVARD COUNTY, Fla. -- Yolanda Serrano worked for the Shah family's Southeast
Petro Distributors for 17 years, earning enough trust that she had access to all company
accounts and was regarded as a family member. As comptroller, it was Serrano's job to
deposit checks from customers and to transfer funds among money market funds and
other accounts.
Mike Shah, the Cocoa-based company's president, found evidence that his trust may have
been misplaced when he discovered several checks had not been deposited. Instead, the
money -- about $12 million -- went into Serrano's own company bank accounts, Shah
testified at a bail hearing for Serrano on Wednesday morning.
Serrano, 44, is being held at the Brevard County jail on a $12.5 million bond, the amount
she is accused of embezzling over five years from Southeast Petro, which distributes oil
and gasoline throughout Florida, Georgia, Alabama and Tennessee. Brevard County
sheriff's agents arrested her at her riverside house in Rockledge April 7, a week after she
returned from a trip to Japan. She is charged with grand theft of more than $100,000 and
scheming to defraud. She has pleaded not guilty.
Serrano's lawyer, Kenneth Weaver, asked that her bail be reduced so she could help with
her own defense. But after about an hour of testimony from prosecution witnesses, Judge
Lisa Davidson denied the reduction. Serrano has too many contacts outside the United
States -- in Colombia, where she was born and still has relatives, in India, where her
husband is from, and in Dubai, where her son lives.
"We are deeply hurt by the violation of trust by someone we treated as a family member,"
said Summit Shah, vice president of operations for Southeast Petro. He said the theft
won't affect the company's finances, however. His father, Mike Shah, started the company
with one gas station in 1980. It has grown to a major distributor with reported revenues of
$209 million annually.
Serrano had been its comptroller for the last five years, Shah testified. He wasn't aware of
any problems until March 12, when his accountant told him that several checks he signed

had not been deposited, he said. Shah asked what happened to the checks. The accountant
asked Serrano, and she said she'd get back to him. Twenty-four hours later, she reported
that "someone made a mistake" and she'd fix it, Shah said.
A subsequent investigation by the Brevard County Sheriff's Office, begun the Monday
after Easter, found she had deposited those checks and about $1 million during the past
six months into accounts of two companies she owned, Blue Consulting and Sunshine
Food Marts, sheriff's Agent Tim Anliker testified.
He reviewed another 18 months and found another $3 million transferred to those
companies. Next, he reviewed the previous five years and discovered that more than $12
million had been transferred. Authorities seized $455,000 from Serrano's bank accounts.
Prosecutors said more than $11 million was still unaccounted for.
Defense attorney Weaver said Serrano has cooperated with the investigation and that she
had come back from Japan and had turned over more than $8 million worth of property
and other assets over to the Shahs. County records confirm three properties in Rockledge
and Titusville were deeded over from Serrano and her husband to East Coast Petro, which
is owned by the Shahs, earlier this month. But Shah testified that Serrano only returned
when her access to the Southeast Petro accounts was cut off. And he placed the value of
the property much lower.
Controls which would have prevented or detected the fraud:
The Funding Customer Service Representative receives and restrictively endorses

checks (using an appropriate stamp)

Checks are scanned via Remote Deposit Capture. The bank provides a daily

statement that summarizes the days deposit and provides detail listings of the
individual checks received in each batch. The Check Log is reconciled to the total
credit amount reported by the bank. Any discrepancies or exceptions are
addressed.
JD CASH & Quest Resources - $10MM
Between 2005 and August 2008, Cash embezzled $10,000,000. from Quest by transferring funds
between Quest-related entities and companies he owned and controlled. Cash concealed his
scheme by, among other things, ostensibly transferring the funds back to Quest each quarter.
Quest Energy Partners is a Delaware limited partnership with its principal place of business in
Oklahoma City, OK. Quest Energy acquires, exploits and develops oil and gas properties. Quest
Energys common units representing limited partnership interests are registered with the SEC
under Section 12(b) of the Exchange Act and trade on the Nasdaq Global Market.

As CEO of the company, Cash authorized over various periods a total of $10,000,000 of transfers
to a related entity that he controlled, and then utilized the funds, among other items to spend over
$5 Million on his Oklahoma City home, including $2.3 Million to general contractors, $1.3 Million
for landscaping and $180,000 for the sound system. He also had luxury cars, a Malibu vacation
home, and a full time gardener. He charged over $1.4 Million on credit cards during this period.
During the March 2006 fieldwork for the 2005 year end audit, the auditors raised questions about
the $2 Million (at that time) transaction with Rockport Energy. JD said that Rockport was used to
scout oil and gas leases for Quests benefit. In March 2008, Quests auditors again questioned
the transfers, which had grown to $10 Million. Gross met with them and reiterated the story that
the money was for stealth projects for Quest, and told the auditor that the transactions were
approved by the Quest board of directors and that the money was in an escrow account.
During the same years he signed management representation letters that were provided to
Quests auditor as part of its annual audits and quarterly reviews. These letters failed to disclose
the loans to Cash through related party transactions between Rockport Energy and Quest. The
letters also affirmatively represented that there was no fraud involving Quest management, which
was false.
An accomplice of Cash was David Grose, the chief financial officer of Quest. Cash compensated
him through allowing an unusual transaction to occur. Grose wired $1 Million to a pipe supplier in
2008, and then canceled the order. But instead of having the money returned to Quest, Grose
directed the supplier to send it to a hydrogen fuel technology company, which was a start-up
controlled by Grose.
In late July 2008, a Quest VP discovered the transfers between Quest and Rock Energy and
alerted Quests recently hired COO, David Lawler, that Rockport Energy had $10 Million of
Quests cash. Lawler immediately question Grose, who assured him that: (a) Cash had provided
documentation from Quests board approving the transfers; and (b) Quests auditors were aware
of the arrangement. Lawler later questioned Cash, who explained that Rockport Energy was
acting as an undisclosed agent for Quest in scouting possible oil and gas deals.
As a result of this questioning of the transfers, the auditors contacted Grose, who again told them
that the money was used to scout deals for Quest. For the first time, however, Grose expressed
concern that neither Rockport Energy nor Cash could repay the money. The auditors concluded
that the quarterly transfers were nothing more than a series of kited checks. On Monday, August
11, 2008, Cash gave Grose a Rockport Energy check for $ 10 Million. Grose did not deposit the
check that day and told another Quest employee that Cash had instructed him to hang on to the

check for a little bit. A few days later, the payor bank informed him that the check would not clear.
He deposited it and on August 22, 2008, the company learned that the check had bounced.

Controls which would have prevented or detected the fraud:

I/A review and confirmation always requires copies of correspondence and statements.

Cash in suspense accounts is reviewed and resolved on a timely basis.

Check signors are required to review supporting documentation before signing checks.

All checks require two authorized signatures

Why Interview for Fraud?

People actually admit theyve committed fraud, abuse, or other
illegal acts when confronted.
People who have knowledge of wrongdoing but arent involved in
fraud often wont come forth with information unless asked.
Quickly identifies control weaknesses an interview can save a lot
of time.
Standards require it:
Auditing Standards
Government Auditing Standards
SAS 99
Sometimes people with knowledge of actual or potential fraud are
just waiting to be asked

Elements of Conversation
Expression

Persuasion
Therapy
Ritual
Information Exchange
Remember An interview is just a structured conversation.

Facilitators of Communication
Fulfilling Expectations
Recognition
Altruistic Appeals
Sympathetic Understanding
Inhibitors of Communication
Competing Demand
Demands for Time
Ego Threat

Establish Baseline
It is critical that we establish a baseline or calibrate the subject of the
interview.
How do we calibrate a subject?

Attempt to relax the subject

Establish rapport early baseline reactions are then compared against
later reactions

Inquire of management about:

Knowledge of any fraud or suspected fraud

Any allegations about fraud
Risks of fraud in the entity
Programs and controls that mitigate these risks
Monitoring of operating locations and business segments; and any
locations or segments that might have higher fraud risk
Any fraud-related reports it has made to the audit committee
Making routine inquiries about fraud
Inquire directly to the audit committee about:
The committees views on fraud risk
Any knowledge of fraud or suspected fraud
Mitigating controls
How the committee exercises oversight in this area
Making routine inquiries about fraud
Inquire of internal audit personnel about:
Their views about fraud risks
Any knowledge of fraud or suspected fraud
Any fraud-related work they have done
The adequacy of managements responses to any fraud-related
findings
Making routine inquiries about fraud
Inquire of other personnel about the existence of fraud or suspicion
about fraud:
To learn more about or corroborate what others have said about fraud risk
To allow individuals an opportunity to convey information that might not
otherwise be communicated

Question Types
Open or Indirect

Closed or Direct

Probing or follow-up

Open Questions
Cant be answered with yes/no response.

Pros: Useful when youre not sure of what information you need or if
you want to know how someone feels about an issue.

Cons: Can take a lot of time and requires more note taking, more
difficult to control, and interviewee may not be sure of what you want.

Closed Questions
Answered restricted to a few choices (yes/no)

Pros: Useful when answers require little or no explanation, saves time,

and makes it easy to tabulate results.

Cons: Limits information that can be obtained

Probing/follow-up Questions
Asking another question to clarify or obtain further information about
an interviewees response.

Pros: Useful when the interviewee provides inadequate answers,

stimulates discussion, and can be used to resolve inconsistencies.

Cons: Can make interviewee become defensive

Questioning the Subject

If something is not clear, keep asking
Use follow-up questions as needed to clarify issues
Drill-down on an issue
Dont let your question go unanswered
Active Listening
When the listener provides feedback (verbal and/or non-verbal) to
the speaker on the extent to which the speakers message has been
understood and will be retained.
Restating in your own words what the person said.
Repeating exactly what the person said
Reflecting to show you understand how they feel (You were pretty upset

by this)
Summarizing (These seem to be the main ideas you stated.)

Active Listening
Non-verbal techniques
Maintain appropriate eye contact
Occasionally nod and display understanding and interest
Pause occasionally to let interviewee know to continue
Voice inflections
Body Language
Interview Donts
Dont ask more than one question at a time.
Dont jump to conclusions
Dont assume you know the response
Dont interrupt or debate with the interviewee
Dont monopolize the conversation (70/30 rule)
Dont think about the next question
Dont read documents
Dont be annoying (finger tapping, clock watching)
Building Relationship
To establish a balanced relationship between the interviewee and
yourself

Your voice should be calm

Show interest in what the person is saying
Dont indict the person during the interview

Building Relationship
If the subject perceives you as a professional and someone that is
honest, they are more likely to be helpful during the interview.

If individual is reluctant:
Keep calm, dont become frustrated
Use positive language
Use gentle persistence in asking questions
If need to, reschedule the interview

Note Taking
Note taking tips:
Dont tape record the interviews
Take accurate and complete notes, but dont distract the interviewee
Try to avoid taking notes when the interviewee is talking about a
sensitive subject
Begin each interview on a clean page.
Note Taking

Takes minimal notes

Does not interrupt the interviewee

Asks open-ended questions

Follows a logical usually chronological question sequence

Advanced Interviewing Skills

More experienced auditors, not new staff, should do these interviews

Be prepared, but dont follow a checklist

Put the subject at ease
Be conversational
Make good eye contact
Get the subject talkinglet subject talk

Interview versus Interrogation

Interview
Purpose: gather information
Nonaccusatory
Free-flowing
Interviewer speaks 30%
Stay within social zone
Note taking O.K.
No Miranda warning required
30-60 minutes