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Possible changes to the GAO’s Yellow Book

February 17, 2017

As of this writing, in February 2017, the Yellow Book is in flux. First the GAO will issue an ‘exposure draft’ of their government audit standards (a.k.a. the Yellow Book) to allow for public comment. After taking the public’s comments into consideration, they will issue a final version sometime in 2017.

For now, let me give you a short list of what the GAO intends to do. This is based on a presentation given by the GAO at the Association of Government Accountants Professional Development Conference in July of 2016. The GAO plans on:

Changing the format – The GAO is planning to revamp the format of the book to be similar to the AICPA’s clarified auditing standards format. This should not change the content or the meaning of the standards, but it may shed light on areas that were a little muddied or obscured in previous versions of the standards. In other words, I expect a lot of questions as users see the standards from a new perspective.

Tweaking ethics and independence – In the 2011 version, the ethics guidance in chapter 1 provided context for the independence requirements in chapter 3. In the 2017 version the two chapters will be merged.

Currently, the contents of the ethics chapter is soft. By soft, I mean the content is philosophical and conceptual and does not contain any requirements that a peer reviewer can confirm or deny. For example, the ethics chapter says “1.16 A distinguishing mark of an auditor is acceptance of responsibility to serve the public interest.” (Thankfully, this was not a requirement that auditors have to take literally – auditors do not have to got get a tattoo on their bicep that says “Public.” Get it? Distinguishing mark, tattoo?) But in chapter 3, the independence chapter, the GAO takes that soft guidance and puts teeth to it; in chapter 3 auditors are required to apply and document their application of a three step process called the ‘conceptual framework’ whenever they encounter a situation that will threaten their ability to serve the public interest.

Also, in this go round, the GAO is promising to toughen up independence requirements by asking that auditors confirm their compliance with independence standards, in writing, at least annually. And while they are at it, they are going to add in some requirements (not soft concepts) regarding ethics.

Enhancing guidance regarding SKE – When an auditor decides to take on a non-audit service, he must first ensure that the client has someone on their side who has the skills, knowledge, and experience (SKE) to evaluate the quality of the results of the non-audit service. The 2011 version of the Yellow Book introduced the concept of SKE, but didn’t spend a lot of space explaining how to document and prove a client’s SKE. The AICPA’s Government Audit Quality Center came up with a much more robust list of ways to prove SKE which, I am sure, the GAO is going to borrow from.

Defining how investigations fit into the standards – Yellow Book standards have never been a good fit for investigations. In this version, the GAO will define investigations as a non-audit service.

Requiring prophylactic CPE – The 2011 standards allow auditors to work on a Yellow Book engagement without any knowledge of government auditing. As a matter of fact, an auditor may perform government audits for a year without getting any CPE at all! The GAO is now proposing that auditors receive four hours of government audit training before they are assigned to an audit project.

Tweaking peer review requirements – Peer review teams will now need to choose a team captain and write a letter regarding the scope of the review to the audit shop undergoing peer review. Peer reviewers will also have to consider prior peer review results and include terminated engagements in their sample population.

Adding to internal control responsibilities – The GAO is promising to give auditors more guidance regarding their responsibility to gain an understanding of internal controls in order to plan the audit. Maybe they will reference the Green Book more specifically? I’ll be watching this one closely.

Stay tuned to my newsletter at Yellowbook-CPE.com to stay current on the 2017 revision.

Charging “Other Services” to the Federal Grantor

January 24, 2017

Please enjoy this chapter from “The New Uniform Guidance” self-study course by Sefton Boyars and Bill Allen.

This chapter focuses on whether grantees can charge legal and lobbying expenses to the federal government. Boyar and Allen also cover how grantees should handle donated services and assets.

Objectives:

Judge which professional service costs are allowable under a federal award
Judge which legal costs are allowable under a federal award
Distinguish between lobbying costs and normal operating costs of a program
Determine how to treat services donated in support of a federal award

Professional Services Costs

The costs of professional and consultant services rendered by persons who are members of a profession, or possess a special skill and who are not officers or employees of the nonprofit or governmental unit, are generally allowable.

For instance, a not-for-profit may engage a tax accountant to prepare its tax return or might hire an engineer to look over its plans for a facility expansion.

The costs are allowable when reasonable in relation to the services rendered and when not contingent upon recovery of the costs from the federal government.

§200.459 Professional service costs.

(a) Costs of professional and consultant services rendered by persons who are members of a particular profession or possess a special skill, and who are not officers or employees of the non-Federal entity, are allowable, subject to paragraphs (b) and (c) when reasonable in relation to the services rendered and when not contingent upon recovery of the costs from the Federal government. In addition, legal and related services are limited under §200.435 Defense and prosecution of criminal and civil proceedings, claims, appeals and patent infringements.

The cost principles offer several factors to consider when determining the allowability of costs related to professional services, including:

The nature and scope of the service rendered,
The necessity of contracting for the service,
The past pattern of such costs,
The impact of federal awards on the governmental unit’s or nonprofit organization’s business,
Whether the service can be performed more economically by direct employment,
The qualifications of the individual, and
The adequacy of the contractual agreement for the services.

§200.459 Professional service costs.

(b) In determining the allowability of costs in a particular case, no single factor or any special combination of factors is necessarily determinative. However, the following factors are relevant:
(1) The nature and scope of the service rendered in relation to the service required.
(2) The necessity of contracting for the service, considering the non-Federal entity’s capability in the particular area.
(3) The past pattern of such costs, particularly in the years prior to Federal awards.
(4) The impact of Federal awards on the non-Federal entity’s business (i.e., what new problems have arisen).
(5) Whether the proportion of Federal work to the non-Federal entity’s total business is such as to influence the non-Federal entity in favor of incurring the cost, particularly where the services rendered are not of a continuing nature and have little relationship to work under Federal awards.
(6) Whether the service can be performed more economically by direct employment rather than contracting.
(7) The qualifications of the individual or concern rendering the service and the customary fees charged, especially on non-federally funded activities.
(8) Adequacy of the contractual agreement for the service (e.g., description of the service, estimate of time required, rate of compensation, and termination provisions).

In order to be allowable, retainer fees must be evidence of bona fide services available or rendered. Note that services do not necessarily have to be rendered, so long as they are available.

§200.459 Professional service costs.
(c) In addition to the factors in paragraph (b) of this section, to be allowable, retainer fees must be supported by evidence of bona fide services available or rendered.

Legal Defense Costs

Definitions Used for Legal Defense Costs

Paragraph (a) of §200.435 provides specific definitions of “conviction,” “costs,” “fraud,” “penalty,” and “proceeding” to be used for purposes of determining the allowability of costs related to legal defense and prosecution.

§200.435 Defense and prosecution of criminal and civil proceedings, claims, appeals and patent infringements

(a) Definitions for the purposes of this section.
(1) Conviction means a judgment or conviction of a criminal offense by any court of competent jurisdiction, whether entered upon verdict or a plea, including a conviction due to a plea of nolo contendere.
(2) Costs include the services of in-house or private counsel, accountants, consultants, or others engaged to assist the non-Federal entity before, during, and after commencement of a judicial or administrative proceeding, that bear a direct relationship to the proceeding.
(3) Fraud means:
(i) Acts of fraud or corruption or attempts to defraud the Federal government or to corrupt its agents,
(ii) Acts that constitute a cause for debarment or suspension (as specified in agency regulations), and
(iii) Acts which violate the False Claims Act (31 U.S.C. 3729-3732) or the Anti-kickback Act (41 U.S.C. 1320a-7b(b)).
(4) Penalty does not include restitution, reimbursement, or compensatory damages.
(5) Proceeding includes an investigation.
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Permissible Legal Defense Costs

In general, legal expenses[1] required in the administration of federal programs by non-Federal entities are allowable. However, the federal government does impose limitations on legal expenses involved with defense of civil or criminal charges.

Under the cost principles, legal costs are a little tricky, but not if you think about things from the federal government’s perspective. For instance, you can’t use federal grant monies to fight the federal government in court. Why would they hand you the stick with which to beat them?

Section 200.435 Defense and prosecution of criminal and civil proceedings, claims, appeals and patent infringements establishes the rules applicable to the recovery of legal costs related to grant administration. Because the rules are complex and obviously written by lawyers, we strongly recommend that, if the issue arises, you confer with legal counsel before deciding which costs would be permissible in any specific case. In general, to be able to claim the costs of a legal defense, the defendant needs to be exonerated. Any determination against the defendant, or a negotiated agreement, will normally render cost incurred as unallowable.

Section 200.435 provides the following with regard to legal costs:

§200.435 Defense and prosecution of criminal and civil proceedings, claims, appeals and patent infringements

(b) Costs.
(1) Except as otherwise described herein, costs incurred in connection with any criminal, civil or administrative proceeding (including filing of a false certification) commenced by the Federal government, a state, local government, or foreign government, or joined by the Federal government (including a proceeding under the False Claims Act), against the non‑Federal entity, (or commenced by third parties or a current or former employee of the non-Federal entity who submits a whistleblower complaint of reprisal in accordance with 10 U.S.C. 2409 or 41 U.S.C. 4712), are not allowable if the proceeding:
(i) Relates to a violation of, or failure to comply with, a Federal, state, local or foreign statute, regulation or the terms and conditions of the Federal award, by the non-Federal entity (including its agents and employees); and
(ii) Results in any of the following dispositions:
(A) In a criminal proceeding, a conviction.
(B) In a civil or administrative proceeding involving an allegation of fraud or similar misconduct, a determination of non-Federal entity liability.
(C) In the case of any civil or administrative proceeding, the disallowance of costs or the imposition of a monetary penalty, or an order issued by the Federal awarding agency head or delegate to the non-Federal entity to take corrective action under 10 U.S.C. 2409 or 41 U.S.C. 4712.
(D) A final decision by an appropriate Federal official to debar or suspend the non‑Federal entity, to rescind or void a Federal award, or to terminate a Federal award for default by reason of a violation or failure to comply with a statute, regulation, or the terms and conditions of the Federal award.
(E) A disposition by consent or compromise, if the action could have resulted in any of the dispositions described in paragraphs (b)(1)(ii)(A) through (D) of this section.
(2) If more than one proceeding involves the same alleged misconduct, the costs of all such proceedings are unallowable if any results in one of the dispositions shown in paragraph (b) of this section.
(c) If a proceeding referred to in paragraph (b) of this section is commenced by the Federal government and is resolved by consent or compromise pursuant to an agreement by the non‑Federal entity and the Federal government, then the costs incurred may be allowed to the extent specifically provided in such agreement.
(d) If a proceeding referred to in paragraph (b) of this section is commenced by a state, local or foreign government, the authorized Federal official may allow the costs incurred if such authorized official determines that the costs were incurred as a result of:
(1) A specific term or condition of the Federal award, or
(2) Specific written direction of an authorized official of the Federal awarding agency.
(e) Costs incurred in connection with proceedings described in paragraph (b) of this section, which are not made unallowable by that subsection, may be allowed but only to the extent that:
(1) The costs are reasonable and necessary in relation to the administration of the Federal award and activities required to deal with the proceeding and the underlying cause of action;
(2) Payment of the reasonable, necessary, allocable and otherwise allowable costs incurred is not prohibited by any other provision(s) of the Federal award;
(3) The costs are not recovered from the Federal Government or a third party, either directly as a result of the proceeding or otherwise; and,
(4) An authorized Federal official must determine the percentage of costs allowed considering the complexity of litigation, generally accepted principles governing the award of legal fees in civil actions involving the United States, and such other factors as may be appropriate. Such percentage must not exceed 80 percent. However, if an agreement reached under paragraph (c) of this section has explicitly considered this 80 percent limitation and permitted a higher percentage, then the full amount of costs resulting from that agreement are allowable.
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(h) Costs of legal, accounting, and consultant services, and related costs, incurred in connection with patent infringement litigation, are unallowable unless otherwise provided for in the Federal award.
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(i) Costs which may be unallowable under this section, including directly associated costs, must be segregated and accounted for separately. During the pendency of any proceeding covered by paragraphs (b) and (f) of this section, the Federal government must generally withhold payment of such costs. However, if in its best interests, the Federal government may provide for conditional payment upon provision of adequate security, or other adequate assurance, and agreement to repay all unallowable costs, plus interest, if the costs are subsequently determined to be unallowable.

Unallowable Legal Costs

When a non-Federal entity incurs legal expenses to prosecute a claim against the federal government, the related costs are unallowable. Under 2 CFR 200, some legal costs are always unallowable:

Costs of legal, accounting, and consultant services, and related costs, incurred in connection with defense against federal claims or appeals, antitrust suits, or the prosecution of claims or appeals against the federal government;
Costs for prosecution of claims against the federal government; and
Costs of legal, accounting, and consultant services, and related costs, incurred in connection with patent infringement litigation.

Legal costs include expenses incurred before, during, and after commencement of a judicial or administrative proceeding that bears a direct relationship to the proceedings. Costs include:

Administrative and clerical expenses,
The cost of legal services (in-house or private counsel),
Services of accountants, consultants, or others retained by the organization to assist it, and
Costs of employees, officers, and trustees.

§200.435 Defense and prosecution of criminal and civil proceedings, claims, appeals and patent infringements

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(f) Costs incurred by the non-Federal entity in connection with the defense of suits brought by its employees or ex-employees under section 2 of the Major Fraud Act of 1988 (18 U.S.C. 1031), including the cost of all relief necessary to make such employee whole, where the non‑Federal entity was found liable or settled, are unallowable.
(g) Costs of prosecution of claims against the Federal government, including appeals of final Federal agency decisions, are unallowable.
(h) Costs of legal, accounting, and consultant services, and related costs, incurred in connection with patent infringement litigation, are unallowable unless otherwise provided for in the Federal award.
(i) Costs which may be unallowable under this section, including directly associated costs, must be segregated and accounted for separately. During the pendency of any proceeding covered by paragraphs (b) and (f) of this section, the Federal government must generally withhold payment of such costs. However, if in its best interests, the Federal government may provide for conditional payment upon provision of adequate security, or other adequate assurance, and agreement to repay all unallowable costs, plus interest, if the costs are subsequently determined to be unallowable.

We should point out that all of these issues relate to costs incurred in criminal or civil proceedings. Researching data to refute an audit finding, for example, is perfectly acceptable, although we must remember that the general cost principles always apply. If the costs are unreasonable or unnecessary, they will be unallowable.

Lobbying Expenses

Lobbying Costs (Governmental Grantees)

Under the cost principles for governmental units, the costs of certain activities associated with obtaining grants, contracts, cooperative agreements, or loans are unallowable.

If a governmental unit incurs costs trying to implicitly or explicitly “improperly influence” an executive branch employee or officer for the purpose of considering or taking action on a “sponsored agreement or a regulatory matter,” then the costs are unallowable. What is meant by “improperly influencing” is not allowing the substance’s intrinsic value to be the basis of the decision, but instead using another means to persuade the employee or officer. The concern, of course, is with bribery, political pressure, and any other corrupting influence.

§200.450 Lobbying.
(a) The cost of certain influencing activities associated with obtaining grants, contracts, cooperative agreements, or loans is an unallowable cost. Lobbying with respect to certain grants, contracts, cooperative agreements, and loans is governed by relevant statutes, including among others, the provisions of 31 U.S.C. 1352, as well as the common rule, “New Restrictions on Lobbying” published at 55 FR 6736 (February 26, 1990), including definitions, and the Office of Management and Budget “Governmentwide Guidance for New Restrictions on Lobbying” and notices published at 54 FR 52306 (December 20, 1989), 55 FR 24540 (June 15, 1990), 57 FR 1772 (January 15, 1992), and 61 FR 1412 (January 19, 1996).
(b) Executive lobbying costs. Costs incurred in attempting to improperly influence either directly or indirectly, an employee or officer of the executive branch of the Federal government to give consideration or to act regarding a Federal award or a regulatory matter are unallowable. Improper influence means any influence that induces or tends to induce a Federal employee or officer to give consideration or to act regarding a Federal award or regulatory matter on any basis other than the merits of the matter.
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The lobbying rules for state and local governments are much less stringent than the rules for nonprofits. That is probably because state and local governments are political in their nature. We all expect that our governor, city supervisors, representatives, etc. will be trying to secure additional funding for their constituents.

Lobbying Costs (Non-Governmental Grantees)

Unallowable Lobbying Costs

Under the cost principles for nonprofit organizations, far more lobbying activities associated with obtaining grants, contracts, cooperative agreements, or loans are unallowable[2]:

Costs incurred in trying to implicitly or explicitly “improperly influence”[3] an executive branch employee or officer for the purpose of considering or taking action on a “sponsored agreement or a regulatory matter”;
Costs incurred in trying to influence, through in-kind or cash contributions, endorsements, or publicity, the outcomes of any federal, state, or local election, referendum, initiative, or similar procedure;
Costs incurred for the purpose of forming, running, contributing to, or paying the costs of a political party, campaign, political action committee (PAC), or other organization established with the intention of influencing the outcomes of elections;
Costs incurred to lobby or influence the introduction of federal or state legislation;
Costs incurred to influence the enactment or modification of any pending federal or state legislation; and
Costs for distributing or using publicity or propaganda, or urging members of the general public or any segment thereof to contribute to or participate in any mass demonstration, march, rally, fundraising drive, lobbying campaign or letter writing or telephone campaign.

§200.450 Lobbying.
(c) In addition to the above, the following restrictions are applicable to nonprofit organizations and IHEs:
(1) Costs associated with the following activities are unallowable:
(i) Attempts to influence the outcomes of any Federal, state, or local election, referendum, initiative, or similar procedure, through in-kind or cash contributions, endorsements, publicity, or similar activity;
(ii) Establishing, administering, contributing to, or paying the expenses of a political party, campaign, political action committee, or other organization established for the purpose of influencing the outcomes of elections in the United States;
(iii) Any attempt to influence:
(A) The introduction of Federal or state legislation;
(B) The enactment or modification of any pending Federal or state legislation through communication with any member or employee of the Congress or state legislature (including efforts to influence state or local officials to engage in similar lobbying activity);
(C) The enactment or modification of any pending Federal or state legislation by preparing, distributing, or using publicity or propaganda, or by urging members of the general public, or any segment thereof, to contribute to or participate in any mass demonstration, march, rally, fund raising drive, lobbying campaign or letter writing or telephone campaign; or
(D) Any government official or employee in connection with a decision to sign or veto enrolled legislation;
(iv) Legislative liaison activities, including attendance at legislative sessions or committee hearings, gathering information regarding legislation, and analyzing the effect of legislation, when such activities are carried on in support of or in knowing preparation for an effort to engage in unallowable lobbying.
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Permissible Lobbying Costs

Under the cost principles for nonprofit organizations, some costs related to influencing the decisions of federal and other officials of governmental units are allowable. Costs are allowable when grantees:

Present, in response to a documented appeal, technical and factual data on an issue directly related to a grant’s, contract’s or other agreement’s performance through hearing testimony, statements, or letters to the Congress or a state legislature, or subdivision, member, or cognizant staff member thereof;
Lobby or attempt to influence state legislation in order to directly reduce the cost, or to avoid material impairment of the organization’s authority to perform the grant, contract, or other agreement; or
Conduct an activity specifically authorized by law to be carried out using funds from the grant, contract, or other agreement.

§200.450 Lobbying.
(c)(2) The following activities are excepted from the coverage of paragraph (c)(1) of this section:
(i) Technical and factual presentations on topics directly related to the performance of a grant, contract, or other agreement (through hearing testimony, statements, or letters to the Congress or a state legislature, or subdivision, member, or cognizant staff member thereof), in response to a documented request (including a Congressional Record notice requesting testimony or statements for the record at a regularly scheduled hearing) made by the non-Federal entity’s member of congress, legislative body or a subdivision, or a cognizant staff member thereof, provided such information is readily obtainable and can be readily put in deliverable form, and further provided that costs under this section for travel, lodging or meals are unallowable unless incurred to offer testimony at a regularly scheduled Congressional hearing pursuant to a written request for such presentation made by the Chairman or Ranking Minority Member of the Committee or Subcommittee conducting such hearings;
(ii) Any lobbying made unallowable by paragraph (c)(1)(iii) of this section to influence state legislation in order to directly reduce the cost, or to avoid material impairment of the non-Federal entity’s authority to perform the grant, contract, or other agreement; or
(iii) Any activity specifically authorized by statute to be undertaken with funds from the Federal award.
(iv) Any activity excepted from the definitions of “lobbying” or “influencing legislation” by the Internal Revenue Code provisions that require nonprofit organizations to limit their participation in direct and “grass roots” lobbying activities in order to retain their charitable deduction status and avoid punitive excise taxes, I.R.C. §§501(c)(3), 501(h), 4911(a), including:
(A) Nonpartisan analysis, study, or research reports;
(B) Examinations and discussions of broad social, economic, and similar problems; and
(C) Information provided upon request by a legislator for technical advice and assistance, as defined by I.R.C. §4911(d)(2) and 26 CFR 56.4911-2(c)(1)-(c)(3).
(v) When a non-Federal entity seeks reimbursement for indirect (F&A) costs, total lobbying costs must be separately identified in the indirect (F&A) cost rate proposal, and thereafter treated as other unallowable activity costs in accordance with the procedures of §200.413 Direct costs.
(vi) The non-Federal entity must submit as part of its annual indirect (F&A) cost rate proposal a certification that the requirements and standards of this section have been complied with. (See also §200.415 Required certifications.)
(vii) (A) Time logs, calendars, or similar records are not required to be created for purposes of complying with the record keeping requirements in §200.302 Financial management with respect to lobbying costs during any particular calendar month when:
(1) The employee engages in lobbying (as defined in paragraphs (c)(1) and (c)(2) of this section) 25 percent or less of the employee’s compensated hours of employment during that calendar month; and
(2) Within the preceding five-year period, the non-Federal entity has not materially misstated allowable or unallowable costs of any nature, including legislative lobbying costs.
(B) When conditions in paragraph (c)(2)(vii)(A)(1) and (2) of this section are met, non‑Federal entities are not required to establish records to support the allowability of claimed costs in addition to records already required or maintained. Also, when conditions in paragraphs (c)(2)(vii)(A)(1) and (2) of this section are met, the absence of time logs, calendars, or similar records will not serve as a basis for disallowing costs by contesting estimates of lobbying time spent by employees during a calendar month.
(viii) The Federal awarding agency must establish procedures for resolving in advance, in consultation with OMB, any significant questions or disagreements concerning the interpretation or application of this section. Any such advance resolutions must be binding in any subsequent settlements, audits, or investigations with respect to that grant or contract for purposes of interpretation of this part, provided, however, that this must not be construed to prevent a contractor or non-Federal entity from contesting the lawfulness of such a determination.

Donated Services

Donated or volunteer services (professional and technical personnel, consultants, and other skilled and unskilled labor) are not reimbursable either as a direct or indirect cost. However, the value of donated services may be used to meet cost sharing or matching requirements in accordance with the provisions of the administrative rules.

If significant, the value of donated services should be considered in the determination of the governmental unit’s indirect costs or rate(s) and, accordingly, shall be allocated a proportionate share of applicable indirect costs. However, our experience indicates that this occurs very infrequently.

§200.434 Contributions and donations.
(a) Costs of contributions and donations, including cash, property, and services, from the non-Federal entity to other entities, are unallowable.
(b) The value of services … donated to the non-Federal entity may not be charged to the Federal award either as direct or indirect (F&A) cost. The value of donated services … may be used to meet cost sharing or matching requirements (see §200.306 Cost sharing or matching)….
(c) Services donated or volunteered to the non-Federal entity may be furnished to a non‑Federal entity by professional and technical personnel, consultants, and other skilled and unskilled labor. The value of these services is not allowable either as a direct or indirect cost. However, the value of donated services may be used to meet cost sharing or matching requirements in accordance with the provisions of §200.306 Cost sharing or matching.
(d) To the extent feasible, services donated to the non-Federal entity will be supported by the same methods used to support the allocability of regular personnel services.
(e) The following provisions apply to nonprofit organizations. The value of services donated to the nonprofit organization utilized in the performance of a direct cost activity must be considered in the determination of the non-Federal entity’s indirect cost rate(s) and, accordingly, must be allocated a proportionate share of applicable indirect costs when the following circumstances exist:
(1) The aggregate value of the services is material;
(2) The services are supported by a significant amount of the indirect costs incurred by the non-Federal entity;
(i) In those instances where there is no basis for determining the fair market value of the services rendered, the non-Federal entity and the cognizant agency for indirect costs must negotiate an appropriate allocation of indirect cost to the services.
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(f) Fair market value of donated services must be computed as described in §200.306 Cost sharing or matching.
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The following addresses the treatment of the indirect costs related to donated services:

§200.434 Contributions and donations.
(e)(2)(ii) Where donated services directly benefit a project supported by the Federal award, the indirect costs allocated to the services will be considered as a part of the total costs of the project. Such indirect costs may be reimbursed under the Federal award or used to meet cost sharing or matching requirements.
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Donated Property

Like donated services, the value of property contributed to a grant program cannot be claimed as either direct costs or indirect costs. However, it can be claimed as cost sharing. Generally, the amount that can be claimed as cost sharing is the fair market value of the items at the time of the contribution. However, the new rules contain a limitation on value that had not existed previously.

(g) Personal Property and Use of Space.
(1) Donated personal property and use of space may be furnished to a non-Federal entity. The value of the personal property and space is not reimbursable either as a direct or indirect cost.
(2) The value of the donations may be used to meet cost sharing or matching share requirements under the conditions described in §§200.300 Statutory and national policy requirements through 200.309 Period of performance of subpart D of this part. The value of the donations must be determined in accordance with §§200.300 Statutory and national policy requirements through 200.309 Period of performance. Where donations are treated as indirect costs, indirect cost rates will separate the value of the donations so that reimbursement will not be made.

For contributions of buildings or land, the value of the property for cost sharing purposes is the lesser of:

The book value in the contributor’s accounting records at the time of the donation; or
The fair market value of the item at the time of donation.

Because most real property has significantly increased in value over the years, any real property that is contributed to meet cost sharing requirements might be valued at far less than the current fair market value. My house would constitute a graphic example. My wife and I purchased it over 40 years ago. Its current market value is close to 20 times what I paid for it all those decades ago. However, its book value would be almost zero. It would be considered almost fully depreciated, so the book value would be miniscule.

The rules do permit the federal agency, with sufficient justification, to use the fair market value at the time of donation even if that value exceeds book value. This text is being written before the new rules become effective, so we do not know at this point how the federal agencies will handle such contributions. Although, if they do limit the amount of cost sharing to book value, real property contributions may decline substantially.

The regulations make it clear that if the contributed real property is not to be used as cost sharing, but rather is included in general inventory and depreciated, then this limitation will not apply. In such a case, the value would be the fair market value at the time of donation.

§200.306 Cost sharing or matching
(d) Values for non-Federal entity contributions of services and property must be established in accordance with §200.434 Contributions and donations. If a Federal awarding agency authorizes the non-Federal entity to donate buildings or land for construction/ facilities acquisition projects or long-term use, the value of the donated property for cost sharing or matching must be the lesser of paragraphs (d)(1) or (2) of this section.
(1) The value of the remaining life of the property recorded in the non-Federal entity’s accounting records at the time of donation.
(2) The current fair market value. However, when there is sufficient justification, the Federal awarding agency may approve the use of the current fair market value of the donated property, even if it exceeds the value described in (1) above at the time of donation.
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Chapter 6 Summary

Grantee organizations may require services that are not available within the organization itself. Thus, the costs of professional services are generally permissible. The costs are allowable when reasonable in relation to the services rendered and when not contingent upon recovery of the costs from the federal government.

In general, legal expenses required in the administration of federal programs are permissible. However, legal expenses for prosecution of claims against the federal government are unallowable. Legal expenses involving the defense of criminal or civil prosecution are unallowable when a proceeding is settled by consent or compromise, unless specifically provided for in the settlement agreement.

Lobbying costs incurred by either a governmental unit or nonprofit in an attempt to improperly influence an employee or officer of the executive branch of the federal government are unallowable. Under the cost principles for nonprofit organizations, far more lobbying activities associated with obtaining grants, contracts, cooperative agreements, or loans are unallowable. In addition to the above restriction, costs for the following activities are unallowable:

Attempting to influence the outcomes of election, referendum, initiative, or similar procedure;
Establishing, administering, contributing to, or paying the expenses of a political party, campaign, or political action committee;
Lobbying or influencing the introduction of federal or state legislation; and
Influencing the enactment or modification of any pending federal or state legislation.

Under the cost principles for nonprofit organizations, costs are allowable to:

Provide a technical and factual presentation of information on a topic directly related to the performance of an award;
Lobby or attempt to influence state legislation in order to directly reduce the cost, or to avoid material impairment of the organization’s authority to perform the grant, contract, or other agreement; or
Conduct an activity specifically authorized by statute to be undertaken with funds from the grant, contract, or other agreement.

Donated goods or services may not be claimed as either direct costs or indirect costs. However, they may be allowable as cost sharing or matching requirements in accordance with the provisions of the administrative rules.

[1] Costs include all costs related to the proceedings.

[2] When an organization seeks reimbursement for indirect costs, total lobbying costs shall be separately identified in the indirect cost rate proposal, and thereafter treated as other unallowable activity costs.

[3] Improper influence is defined the same for both governmental units and nonprofit organizations.

Expense Reimbursement Fraud Schemes

December 28, 2016

We are still working through the cash disbursement schemes mentioned in the fraud tree. For a picture of the fraud tree, see this link: http://www.acfe.com/fraud-tree.aspx. Last time we discussed the categories of fraudulent disbursements, we covered payroll schemes and billing schemes. This time we will cover the third out of five schemes classified by the Certified Fraud Examiners as cash disbursement schemes and expense reimbursement schemes.

Go tell that long tongue liar,
Go and tell that midnight rider,
Tell the rambler, the gambler, the back biter,
Tell ’em that God’s gonna cut ’em down.
Run on for a long time
You can run, Lord, for a long time.
You can run, Lord, for a long time
But let me tell you God Almighty’s gonna cut you down.
Traditional folk song

Expense Reimbursement Schemes

Another way to falsely extract money from your employer is to make up fake or inflated business expenses. Under this section of the tree, the Association of Certified Fraud Examiners lists four components:

Mischaracterized expenses
Overstated expenses
Fictitious expenses
Multiple reimbursements for expenses

Mischaracterized Expenses

When I was in college, I worked as an accounts payable clerk at a high tech company for a summer. One of my jobs was to review travel expense reports for compliance with corporate policy.

The company did not pay for movies in the hotel room – especially not adult movies. Adult movies are more expensive, so I knew that one executive was being – shall we say ‘creative’ – with his entertainment charges. The phone call was a little tense, “Your film is not allowable, sir…”

Robert Half International, a professional recruiting firm, asked 150 senior executives with some of the nation’s largest companies, “What is the most outrageous thing that an employee has tried to pass off as a work-related expense?” It turns out creative employees have tried to expense tropical fish, traffic tickets, the cost of transporting a pet gerbil overseas, ‘lodging’ at a storage facility, expensive silk sheets and silverware, excursions to Europe and the Masters, health care coverage for a pet, and my personal favorite, divorce costs. I can see the reasoning there: employers expect so much nowadays, they probably trigger most divorces in the US.[1]

Overstated Expenses

I enjoyed working with a Medicare audit group in 2008. They were responsible for finding fraud, waste, and abuse in the Medicaid program. That is quite an undertaking since so many people and so many systems are involved, and so many folks are in need. Doctors, hospitals, nurses, pharmacies, suppliers, patients, and families can be mighty creative in getting just that little extra from the federal government by overstating expenses. Here is another executive summary from a GAO audit.

Medicare Fraud, Waste, and Abuse: Challenges and Strategies for Preventing Improper Payments[2]

Summary

GAO has designated Medicare as a high-risk program since 1990, in part because the program’s size and complexity make it vulnerable to fraud, waste, and abuse. Fraud represents intentional acts of deception with knowledge that the action or representation could result in an inappropriate gain, while abuse represents actions inconsistent with acceptable business or medical practices. Waste, which includes inaccurate payments for services, also occurs in the Medicare program. Fraud, waste, and abuse all can lead to improper payments, overpayments and underpayments that should not have been made or that were made in an incorrect amount. In 2009, the Centers for Medicare & Medicaid Services (CMS) – the agency that administers Medicare – estimated billions of dollars in improper payments in the Medicare program. This statement will focus on challenges facing CMS and selected key strategies that are particularly important to helping prevent fraud, waste, and abuse, and ultimately to reducing improper payments, including challenges that CMS continues to face. It is based on nine GAO products issued from September 2005 through March 2010 using a variety of methodologies, including analysis of claims, review of relevant policies and procedures, stakeholder interviews, and site visits. GAO received updated information from CMS in June 2010.

GAO has identified challenges and strategies in five key areas important in preventing fraud, waste, and abuse, and ultimately to reducing improper payments. GAO has made recommendations in these areas. CMS has made progress in some of these areas, and recent legislation may provide the agency with enhanced authority. However, CMS faces continuing challenges. 1. Strengthening provider enrollment process and standards. Checking the background of providers at the time they apply to become Medicare providers is a crucial step to reduce the risk of enrolling providers intent on defrauding or abusing the program. In particular, GAO has recommended stricter scrutiny of providers identified as particularly vulnerable to improper payments to ensure they are legitimate businesses. 2. Improving pre-payment review of claims. Pre-payment reviews of claims are essential to helping ensure that Medicare pays correctly the first time. GAO has recommended that CMS further enhance its ability to identify improper claims through additional automated pre-payment claim review before they are paid. 3. Focusing post-payment claims review on most vulnerable areas. Post-payment reviews are critical to identifying payment errors and recouping overpayments. GAO has recommended that CMS better target claims for post payment review on the most vulnerable areas. 4. Improving oversight of contractors. Because Medicare is administered by contractors, overseeing their activities to address fraud, waste, and abuse is critical. GAO found that CMS’s oversight of prescription drug plan sponsors’ compliance programs has been limited. However, partly in response to GAO’s recommendation, CMS oversight of these programs is expanding. 5. Developing a robust process for addressing identified vulnerabilities. Having mechanisms in place to resolve vulnerabilities that lead to improper payment is vital to program management, but CMS has not developed a robust process to specifically address these. GAO has recommended that CMS establish an adequate process to ensure prompt resolution of identified improper payment vulnerabilities.

Here in Austin, the directors of an electric co-op, the Pedernales Electric Cooperative (of which I am a member), paid themselves ten times the salary of the nation’s second largest co-op! Board members were reimbursed for about $700,000 in expenses between 2002 and 2006 for everything from first-class airfare to top-tier hotel stays to costly purchases of meals, furniture and concert tickets, according to court records. All of these board members were, thankfully removed in shame, but not before they lived the high life for a good long while.[3]

Fictitious Expenses

Yes, another Medicaid story! The plethora of Medicaid stories shouldn’t be too surprising since over 20% of our federal budget is spent on Medicaid.[4]

The number one crime in Miami isn’t drug trafficking; it is Medicare fraud. A 60 Minutes investigation uncovered hundreds of tiny pharmacies and doctors’ offices in South Florida that weren’t staffed or open; some were really just storage facilities!

One fraudster shared with 60 Minutes how easy it is to set up a fake supplier or pharmacy and bill the feds using names and social security numbers of real patients. Hackers steal the names and social security numbers from legitimate doctors’ offices and pharmacies and sell them for up to $10 a name to these illegitimate ‘suppliers.’ One retired judge’s social security number was used to charge for a prosthetic right and left arm. Only problem is, he still has both arms and they work just fine!

Medicaid auditors are understaffed and overwhelmed. And most scammers are able to operate without any trouble – quietly ripping off $20-40 thousand a day.[5]

An aversion to IT Cost a New Zealand Company $1.7 million!

A simple fraud, using Microsoft Excel templates to create the 350 bogus invoices, lasted six years and made Trevor Uialatea Esera richer by $1,758,193. As the company’s IT manager, he was responsible for signing off expenditures, preparing the IT budget, and ordering equipment and computer software.

He created fake invoices from three companies. Two of the companies – Intergra Images and Software Plus – were bogus, and the third had no idea what he was doing. Court documents described the fake firms as “companies of his own invention.”

Esera’s bosses were oblivious to his fake invoicing because senior staff at Rinnai, a water heater manufacturer, had little or no experience in IT.[6]

Multiple Reimbursements for Expenses

Have you seen the website that lets you create fake receipts? Just Google ‘fake receipts,’ and Google lists pages and pages of sites. One of the sites is generic, but for a small fee you can upgrade to get better logos for well-known companies. Here is an image of what you can create using one of these sites:

Looks pretty good, doesn’t it?

If you think you can get away with it, why not submit the same expense more than once! You’d score extra points for commiting two frauds at once – a fake receipt and double payment on the same receipt. You over-acheiver you!

I receive ridiculous proposals and promises of riches every day via email. “Please let me introduce myself. I am blah blah from X, Africa seeking to transfer funds to the United States. I will share the proceeds with you, blah blah.” A CPA in my class confessed that one of his elderly clients fell for this scam and lost $50,000 because he gave the scammers his bank account number.

I have heard of (but can’t tie down with a news story) scammers creating hundreds of fake invoices and sending them to every corporation they can find. Even if only 2 out of a hundred pay, they still have something with which to buy that coveted wide-screen TV!

I can easily see this happening, because when I worked as an accounts payable clerk the summer of my junior year in college, one of my horribly boring tasks was to match up the vendors’ monthly statements to their invoices. It was hard to reconcile the two because the vendors would call complaining that we weren’t paying them in a timely manner and the accounts payable supervisor would often pay whatever was in front of her… It was a mess. Several times, we decided to pay whatever the came in through the mail because we were getting so backed up. We wrote a check, crossed our fingers and hoped for the best.

[1] Robert Half International. Can You Expense a Tropical Fish? What Workers Try to Put on the Company Dime. September 24, 2009.

[2] United States. Govt. Accountability Office. Medicare Fraud, Waste, and Abuse: Challenges and Strategies for Preventing Improper Payments. June 15, 2010. GAO-10-844T.

[3] Claudia Grisales. “Settlement Reached In Pedernales Co-Op Lawsuit.” Austin American Stateman. March 11, 2008.

[4] Policy Basics: Where Do Our Federal Tax Dollars Go? Center for Budget and Policy Priorities. April 14, 2010.

[5] Ira Rosen and Joel Bach. “Medicare Fraud: A $60 Billion Crime A.G. Holder Tells 60 Minutes More Oversight Is Needed; Scammer Explains How Easy It Is To Steal Millions.” Sixty Minutes. WCBS. October 25, 2009. Television.

[6] Kerry Williamson. “Bogus invoices got IT chief $1.75 million.” The Dominion Post [New Zealand]. December 12, 2009.

Completing the risk assessment

December 2, 2016

Risk assessment per the Green Book is a complicated, multiple-step process. First, you have to break the universe into small enough pieces to be able to confidently assess risk on each piece. (Remember, if your subject matter is too broad, you will have a hard time moving on to later steps.) Next, you have to imagine the bad things that could happen with each piece and rank those bad things for magnitude and likelihood. After that, you have to decide what to do with the risks you have identified.

In earlier chapters we broke our subject matter into pieces, imagined the risks, and rated the risks for magnitude and likelihood. Now, in this chapter, I’d like to go back and add a little more useful information to help ensure that our thinking about the risks was thorough. We will also decide what to do with the risks that we have uncovered.

Was our thinking thorough?
Over time I have compiled a list of risks. Notice that I said that “I” compiled the list. It is not grounded in any standard because the standards are pretty vague about this sort of thing. In other words, don’t look for these in the GAO’s Green Book because they aren’t there.

Generic Risk
• Death
• Injury
• Shame
• Loss of Money
Fraud Risk
• Corruption
• Misstatements
• Misappropriation
Flip Risk

Why have this list of risks? Because we need a benchmark against which to measure the risks we identified to make sure that our thinking was robust. But before we do that, let’s take a closer look at the components of the list.

More on generic risk

Thankfully, nothing I do in my job can cause death. I mean, if someone doesn’t get their CPE, they aren’t going to keel over dead! As I talk to my kids about future careers, I remind them that doctors hold people’s lives in their hands; and therefore, they have to go through an enormous amount of training and rigorous vetting in order to earn the right to practice medicine.

There are plenty of government activities that could involve death and injury. States take care of foster children, cities and counties run and regulate hospitals, and the federal government provides health care for veterans and the elderly. Citizens can die if a bridge collapses because of decay and neglect or if a shady restaurant goes unregulated and serves contaminated food.

But with most government activities the worst risk they can generate is shame and loss of money. Scandals, waste and abuse are, unfortunately, very common in government.

More on fraud risk

In the last two chapters, we focused on the Green Book’s directives regarding fraud risk. The original COSO model and the original Green Book did not mention the Certified Fraud Examiner’s Fraud Tree. The GAO’s Green Book mentions the three main branches of this tree in section 8.02:

8.02 Management considers the types of fraud that can occur within the entity to provide a basis for identifying fraud risks. Types of fraud are as follows:
• Fraudulent financial reporting – intentional misstatements or omissions of amounts or disclosures in financial statements to deceive financial statement users. This could include intentional alteration of accounting records, misrepresentation of transactions, or intentional misapplication of accounting principles
• Misappropriation of assets – theft of an entity’s assets. This could include theft of property, embezzlement of receipts, or fraudulent payments
• Corruption – bribery and other illegal acts

Flip risk

A flip risk is when an entity experiences results contrary to its mission and goals. For instance, a school cafeteria has a program to feed low income children breakfast and lunch, but instead, they use the money to feed wealthy children. The cafeteria has experienced flip risk.

For our case study the purpose of issuing credit cards to all the staff is to make purchasing small items easier. But sometimes in government, we can make what should be easy extremely hard and burdensome. I am friends with a professor who says he dreads using his university purchasing card because it involves twice as much paper work and justification than if he used the university’s purchase order system. But occasionally, he absolutely must use it because he can’t wait for the purchasing process system to make a purchase. Is the extra hassle intentional on the part of the university to discourage use of the card, or have they lost a sense of what they are ultimately trying to achieve (convenience and speed) by issuing purchasing cards?

Back to the case study

When we last visited our case study, we ended up with this result:

Now I want to go back and ask whether we thought of everything. Did we think of all the risks? Yes, I could have covered this a few chapters back… but I wanted to cover fraud risk and magnitude and likelihood first.

So let’s remove the magnitude and likelihood columns and instead name each “what could go wrong?” as either generic, fraud, or flip risk and make sure that we covered all of our bases.

We considered all three types of risk in our analysis – so I am pretty satisfied. But I could add flip risk to the use of the card and fraud risk to the “getting stuff” phase. Let me go ahead and do that and rank our two new ideas for magnitude and likelihood while I am at it.

I am sure you can think of more risks in these three categories for these three steps of the process, but we have enough to work with for purposes of this book. Again, the reason we apply the three types of risk to our ideas is to help us think of other relevant risks.

Here is an applicable quote from the Green Book:

7.06 Management estimates the significance of the identified risks to assess their effect on achieving the defined objectives at both the entity and transaction levels. Management estimates the significance of a risk by considering the magnitude of impact, likelihood of occurrence, and nature of the risk. Magnitude of impact refers to the likely magnitude of deficiency that could result from the risk and is affected by factors such as the size, pace, and duration of the risk’s impact. Likelihood of occurrence refers to the level of possibility that a risk will occur. The nature of the risk involves factors such as the degree of subjectivity involved with the risk and whether the risk arises from fraud or from complex or unusual transactions. The oversight body may oversee management’s estimates of significance so that risk tolerances have been properly defined.

Use the top of the cube if you prefer

If my approach and my list of risks seems a little to rogue to you and you prefer to tie everything you do to the standards, you could use the categories at the top of the COSO cube as your benchmark.

You could ask, did I consider the risk as it affects operations, reporting, and compliance. You could also use the evolved version of the COSO – the COSO ERM Model – and add strategy as part of your analysis.

Now what are you going to do about these risks?

Now that we have identified several high magnitude and high likelihood risks that deserve our attention, it is time to choose what we are going to do about them.

Per the Green Book, management has four choices for each risk they care about. They can accept the risk, avoid the risk, reduce the risk, or share the risk.

7.08 Management designs responses to the analyzed risks so that risks are within the defined risk tolerance for the defined objective. Management designs overall risk responses for the analyzed risks based on the significance of the risk and defined risk tolerance. These risk responses may include the following:
• Acceptance – No action is taken to respond to the risk based on the insignificance of the risk.
• Avoidance – Action is taken to stop the operational process or the part of the operational process causing the risk.
• Reduction – Action is taken to reduce the likelihood or magnitude of the risk.
• Sharing – Action is taken to transfer or share risks across the entity or with external parties, such as insuring against losses.

Why would an organization accept a risk? Well, maybe mitigating the risk would be too costly. Maybe they simply don’t have the resources or the desire to change. I watched the Dustin Hoffman “dramedy” Little Big Man again recently. One of the characters was a charlatan who traveled the old west selling snake oil. Along the way he had been tarred and feathered, brutalized, and maimed by townspeople who had become violently ill after drinking his snake oil. Early in the movie the charlatan was missing his hand. By the end of the movie he also had a peg leg and only one eye! Dustin Hoffman’s character told the snake oil salesman he’d better choose another profession because his angry customers were whittling him down to a nub. And the snake oil salesman replied, “Every business has a degree of risk…” and hobbled off.

Or maybe after doing a risk assessment, the organization looks at the bad things that could happen and decides not to engage in that activity any longer. In our case study the school district could decide to cancel everyone’s purchasing cards to avoid the risks they pose. In other words, they choose to avoid the risk.

We are going to pluck a few of the risks off of our matrix and reduce the risk by designing controls. Another word that I hear in regards to this choice is ‘mitigate.’ Controls mitigate or reduce the severity of a risk.

And sharing occurs when an organization decides to partner with other organizations to take some of the responsibility for the risk. For instance, the state of Texas decided to privatize many of their correctional facilities. The state hired a professional prison management company to be responsible for running dozens of Texas prisons. This does not mean that the state of Texas is not ultimately responsible for the care of prisoners, but it does mean that if anything goes wrong, the state will not take the full brunt of criticism. The state can fire the management company and appear proactive and responsive to the public.

Lots of steps to risk assessment

Now that we have seen all of the steps of risk assessment, let’s review.

1. Choose a subject matter
2. Break the subject matter down into activities
3. Imagine what could go wrong – the risk – of each activity
4. Ensure that you thought of everything by comparing the risks against the list of generic, fraud, and flip risks
5. Rate each risk for magnitude and likelihood
6. Decide what you are going to do with high magnitude and high likelihood risks: accept the risk, avoid the risk, reduce the risk, or share the risk

Only if you do reduce or share the risk, you need to go further in applying the other elements of the COSO model to the risk (control activities, information and communication, monitoring and control environment).

Here is the matrix, one more time!

Notice that I blacked out management’s response for risks that did not rank high as far as magnitude and likelihood. In our next chapter we will start applying controls to the risks that we want to reduce

Fraudulent Disbursements – Billing Schemes and Payroll Schemes

November 15, 2016

More in the series on getting to know the fraud tree better. To get a better sense of where we are on the fraud tree and which branch we are talking about in this newsletter, please see the entire fraud tree at http://www.acfe.com/fraud-tree.aspx.

Learn to do good;
seek justice, correct oppression;
bring justice to the fatherless,
plead the widow’s cause.
Isaiah 1:17

Misappropriating cash through fraudulent disbursements is a sizable portion of the fraud tree because there is a lot of room for creativity. See an illustration of the fraud tree here: http://www.acfe.com/fraud-tree.aspx In this newsletter, we will cover billing schemes & payroll schemes. In future newsletters we will cover expense reimbursement schemes, check tampering, and register disbursements. Five creative categories under fraudulent disbursements in all!

With fraudulent disbursements, the fraudster causes an organization to disburse funds through some trick or device such as submitting false invoices or forging checks. The disbursement is often disguised as a legitimate business activity so that it can slide through the accounting system undetected by controls.

And with these sorts of schemes, the fraudster is usually caught when they get too bold or too greedy. If they would just keep it small, they could supplement their income for decades!

Billing Schemes

Here the fraudster creates a valid looking bill and causes the organization to issue payment for the fraudster’s personal benefit. The Association of Certified Fraud Examiners classifies billing schemes into three categories:

Shell companies
Non-accomplice vendors
Personal purchases

Shell Companies

In this creative scenario, the fraudster creates a fake company that has a valid sounding name and then sends checks from the victim company to their fake, or shell, company.

In my hometown, LouAnne Aponte stole over $800,000 from a large not-for-profit, Family Connections, for which she was the executive director. For six years she forged a well-known local CPA firm’s name on audit reports to avoid questioning by auditors and to satisfy federal grant requirements.

In March 1993, Aponte formed a business named Excite and Challenge, and then paid Excite and Challenge from Family Connections funds. She used the money to pay her mortgage for a home in a tony Austin neighborhood and bought herself a convertible Mercedes.

For a decade LouAnne Aponte also volunteered as the treasurer for the Texas Association of Child Care Resources and Referral Agencies. Aponte was accused of stealing over $100,000 from that organization.

Aponte had a history of theft dating back to the 1980s when she stole about $60,000 from two employers. In 1987, she served only four months of a four-year prison sentence for her crimes. Unaware of Aponte’s past, the nonprofit Austin Families hired Aponte in 1990 when she was still on parole.

Having served only two and a half years of her 25-year sentence for the crimes against Family Connections, Aponte was up for parole in May 2013.[1]

Straw students are like shell companies, aren’t they?

Creating fake students has always been a popular scam when it comes to milking money out of student financial aid programs. When you actually see students in a classroom in college environments, it is hard to keep a scammer from succeeding – but how do you verify online students?

Between 2006 and 2009, Trenda Halton defrauded Rio Salada College in Arizona for over a half a million dollars. Having discovered how to defraud the registration system of Rio Salado College, Halton worked with four accomplices to create 136 “straw” students.

In her scheme, she recruited “straw” students who prepared and filed bogus admissions applications, financial aid applications, and Pell Grant applications in the students’ names. The financial-aid recipients received aid money after Rio Salada deducted tuition.

Halton’s cover was blown when a Rio Salado employee noticed that the applications all had the same handwriting and the students were enrolled in the same classes. In 2009, Halton was indicted with 64 other defendants and charged with offenses such as conspiracy, mail fraud, financial aid fraud, and making false statements in connection with financial aid.

Rio Salada’s small distance learning college was a prime digital target for Halton. Other colleges that have been victimized by online financial-aid fraudsters include the University of Phoenix’s Axia College, Michigan’s Lansing Community College, and Texas’ Dallas County Community College.[2]

Non-Accomplice Vendors

My small business has several names, and I have been married 15 times. OK, OK, I have wed only twice. But I have three last names! And the bank will take any check from me using any of my last names or business names.

A banker in one of my classes told me that the bank doesn’t check endorsements or names on the check if the amount is under $10,000. The volume of checks is just too high for them to watch. Banks also put on the back of your bank statement that you have 60 days from the date of the statement to resolve any discrepancy, otherwise the bank is not responsible.

So imagine taking a valid vendor name – say ABC Pest Control – that your organization would spend money on and changing the address on the payment to your own PO Box. And if you have already succeeded depositing checks under ABC Enterprises, the bank will take it. You will enjoy the money, and your organization probably won’t know the difference.

Personal Purchases

Whether personal purchases are considered fraud by an organization depends on the type of organization. In the corporate environment, use of the company credit card to buy golf equipment while entertaining clients could be perfectly valid.

In government, we never entertain! OK, we seldom entertain, but governments would seldom find the purchase of golf equipment valid. Remember our discussion about what fraud is, what abuse is, and whether something is worthy of the attention of those in charge of governance? That applies to personal purchases, big time.

But HP wasn’t as lenient with their money as some other corporations. They ousted their CEO, Mark Hurd, in 2010 for expense report irregularities and for hiring a model/actress that he had a personal relationship with to represent HP at trade shows for $5000 to $10,000 a pop.[3]

Payroll Schemes

Another way employees can extract money from their employers using a false disbursement scheme is to make false claims for compensation. The fraud tree is divided into four parts under payroll schemes:

Ghost employees
Commission schemes
Workers compensation
Falsified wages

Ghost Employees

In this scheme, the government is charged for employee wages for fake employees or, if you prefer, “phantom” employees.

Do you remember Paul Bremer? He was the administrator of the Coalition Provisional Authority (CPA), the transitional Iraqi government. In 2007, Bremer acknowledged to the House Committee on Oversight and Government Reform that during the 2003 to 2004 rebuilding of Iraq, for which he was responsible, America had paid nonexistent “ghost employees.”

Bremer suggested that the organization feared the consequences of stopping payments to determine who were truly employed. Those who were employed supplied the Iraqi ministries with security, and Bremer did not want to anger these 74,000 armed men.

The problem of the “ghost” employees was just one piece of the puzzle of the missing $8.8 billion that the CPA distributed to Iraqi ministries. Stuart Bowen, the Special Inspector General for Iraq Reconstruction stated that the problem was not a major reason that so much money was unaccounted for. He blamed the lack of transparency for the missing funds.[4]

Commission Schemes

The Pyramid

Although I can’t imagine this happening in government, or that a commission/pyramid would be relevant in government, you may have personally been the victim of a pyramid scheme in your past. In a pyramid scheme, the fraudster promises consumers or investors large profits if they can recruit others to join the program. Some schemes purport to sell a product, but the product is really just a cover for the pyramid.

Victims of a pyramid scheme are often asked to inventory load – or buy stock inventory of a product in order to sell. In this way, the company does make profit, and the folks on the top of the pyramid profit, but the front-line salesmen are stuck with a bunch of inventory they can’t sell!

Also beware of claims that the product is selling like hotcakes! Who is buying the hotcakes: actual customers or just players in the pyramid?[5]

A few cautions about marketing ‘spin’!

I remember my mother buying a horrible car – a Ford Taurus – in the 90s because the dealer told her it was the best selling car in America. Yes, it was, but only because Ford made incredible deals to get the rental car industry to buy beaucoup of them. Consumers hated the car and for good reason. Ah, marketing spin wins again!

A well known vitamin company in the US is advertising that they are the first vitamin company to get clearance from an organization they say is an independent evaluator of vitamin quality. Only problem is that the vitamin company founded, funds, and shares staff with this independent evaluator.

And it isn’t just creative Americans: Customer complaints against four of the United Kingdom’s largest energy firms led to an investigation of nPower, Scottish Power, Scottish and Southern Energy, and EDF Energy by the energy regulator Ofgem.

Many of the complaints were against door-to-door salespeople and telemarketers who were persuading customers to switch suppliers. Customers were given misleading information and quotes, which resulted in the customers being in worse positions than before switching suppliers.

Confirming the customer complaints, Ofgem’s 2008 investigation showed that changing firms at the persuasion of pushy door salespeople left almost half of gas customers and electricity customers worse off.

As of September 2010, energy regulators were considering fining suppliers a portion of their annual revenue if customer complaints proved true.[6]

A bit about the the Ponzi

Although a Ponzi scheme is not specifically mentioned on the fraud tree, it is definitely worth talking about! A Ponzi scheme is similar to a pyramid scheme, except there is no product to sell, and the schemer doesn’t pay a commission to salespeople to find new recruits. A Ponzi schemer uses the money from new recruits to pay existing members.

The most notorious Ponzi schemer of our day is Bernie Madoff who defrauded investors out of $60 billion. Madoff paid investors significant returns using money he collected from new investors, which he never truly invested.

Enticing new investors by paying his investors more money allowed Madoff to keep the scheme rolling for about two, maybe three, decades. Madoff told investors that their investments were earning high returns and would give them large payouts to keep them onboard.

While he probably believed that his venture could last forever, it couldn’t withstand the decline of the stock market. In 2008, he could no longer keep up his lie. Investors weren’t paid on time because of his inability to yield sufficient cash out of his holdings.

On March 10, 2009, Bernie Madoff was charged with eleven felony charges including securities fraud, investment adviser fraud, mail fraud, wire fraud, three counts of money laundering, false statements, perjury, false filings with the United States Securities and Exchange Commission (“SEC”), and theft from an employee benefit plan. On June 29, 2009, Madoff was sentenced to 150 years in prison.[7]

Workers Compensation

I like to work, don’t you? I like to get something done and create new things. But not everyone is motivated to create – some people think the world owes them a living, and false workers comp claims are an easy route to income without exertion.

It makes me very sad to see a video on 60 minutes of a guy moving a piano who has been claiming workers comp for three years. Can you imagine being related to that guy? How could he, and you, stand it?

Here is an executive summary from a report by the GAO on fraudulent benefits:

Social Security Administration: Cases of Federal Employees and Transportation Drivers and Owners Who Fraudulently and/or Improperly Received SSA Benefits[8]

Summary

This testimony discusses the results of our investigation of the disability programs managed by the Social Security Administration (SSA). SSA administers two of the nation’s largest cash benefit programs for people with disabilities: the Disability Insurance (DI) program, which provides benefits to workers with disabilities and their family members, and the Supplemental Security Income (SSI) program, which provides income for aged, blind, or disabled people with limited income and resources.

In 2008, the DI program provided about $104 billion to some 9 million beneficiaries, and the SSI program provided about $38 billion in financial benefits to some 7.5 million recipients. Given the magnitude of these cash benefit payments, it is important for SSA to have effective fraud prevention controls in place to minimize fraudulent and improper payments.

This statement summarizes our most recent report, describing cases of federal workers, commercial drivers, and commercial vehicle company owners who fraudulently or improperly received disability benefits. The objectives of the investigation were to (1) determine whether federal employees and commercial vehicle drivers and company owners may be improperly receiving disability benefits and (2) develop case study examples of individuals who fraudulently and/or improperly received these benefits. In conducting this investigation, we compared DI and SSI benefit data to civilian payroll records of certain federal agencies and carrier/driver records from the Department of Transportation (DOT) and 12 selected states.

We found the following:

1) Thousands of federal employees, commercial drivers, and owners of commercial vehicle companies received Social Security disability benefits during fiscal year 2008, though we could not determine the extent to which beneficiaries improperly or fraudulently received payments. Because further investigation is required to determine whether these individuals are entitled to receive payments, our analysis provides only an indicator of potentially improper or fraudulent activity. Federal salary data from selected agencies for October 2006 through December 2008 show that about 1,500 federal employees may be improperly receiving payments. These employees were (1) DI beneficiaries who received federal salary above the earnings threshold for more than 12 months after the start date of their disabilities or (2) SSI recipients who received more than 2 months of federal salary above the maximum SSA earnings threshold for the SSI program after the start date of their disabilities. Based on their SSA benefit amounts, we estimate that these federal employees received about $1.7 million in benefits a month.

2) Based on our overall analysis above, we selected 20 nonrepresentative examples of federal employees, commercial drivers, and registrants of commercial vehicle companies who received disability payments fraudulently and/or improperly. The 20 cases were primarily selected based on our analysis of SSA electronic and paper files for the higher overpayment amounts, the types of employment, and the locations of employment, and thus they cannot be projected to other federal employees, commercial drivers, or commercial vehicle owners who received SSA disability payments. In each case, SSA’s internal controls did not prevent improper and fraudulent payments, and as a result, tens of thousands of dollars of overpayments were made to individuals for 18 of these 20 cases. For the 20 cases, our investigations found the following: (1) For five cases, we believe that there is sufficient evidence that the beneficiaries committed fraud to obtain or continue receiving Social Security disability payments by withholding employment information. (2) For 10 cases, SSA improperly increased the benefit amounts of the disability payments because the individuals had increases in the reported wages on which the disability benefit payments are based.

(3) Several individuals from our cases were placed in long-term, interest-free repayment plans for improperly accepting disability overpayments, even though SSA can charge interest. One individual’s $33,000 repayment plan was in $20 monthly installments–resulting in a repayment period of 130 years. For 10 cases, the individuals were continuing to receive disability benefits as of October 2009. For 18 of these 20 cases, the individuals also received $250 stimulus checks as part of the American Recovery and Reinvestment Act of 2009 (Recovery Act) while they were improperly receiving SSA disability payments. According to SSA officials, most of these individuals were entitled to and would have received the $250 stimulus checks even if SSA had properly suspended the disability payments to them. Specifically, SSA officials stated that beneficiaries covered under the DI program would have been covered under an extended period of eligibility (EPE), which is a 36-month period in which SSA does not pay any benefit amounts (i.e., payments are suspended) if the beneficiary has earnings above the substantial gainful activity (SGA) threshold. According to SSA officials, all working DI beneficiaries covered by an EPE received the $250 stimulus check.

Falsified Wages

Here is a report from the NY Attorney General regarding contractors who falsified employee wages:

Three Contractors Arrested For Underpaying Employees And Falsifying Business Records In Connection With New York City Housing Authority Construction Projects[9]

State Attorney General Spitzer and New York City Department of Investigation Commissioner Rose Gill Hearn today announced that three construction contractors were arraigned on felony and misdemeanor charges arising out of their falsification of records that made it appear that $367,000 in legally required prevailing wages were paid to 19 workers on New York City Housing Authority projects, when, in fact, such wages were not paid.

Mohammed Abdur Rashid, and his company Columbus General Construction Inc., and Tarcisio Ferreira and Harrison Jarvis, whose construction companies are now defunct, were charged with failure to pay wages, falsification of business records, false filings and perjury in connection with Housing Authority contracts at the Edgemere and Arverne Houses (Ocean Bay) located in Far Rockaway.

The defendants entered “not guilty” pleas in Queens County Criminal Court, and were ordered to return to court on October 15, 2003.

“The message is clear: falsifying records and failing to pay the prevailing wages on a public work project are serious violations of the law. Contractors who engage in such tactics can expect criminal sanctions,” Spitzer said.

“These contractors unjustly chose to enrich themselves rather than pay employees their rightful wages. DOI will not tolerate this type of fraud or other acts of dishonesty and will investigate them with vigor. Upon recovering any improprieties, DOI will seek to prevent the company in question from obtaining future contracts with the City,” said Commissioner Gill Hearn.

The joint investigation by the Attorney General’s office and the Department of Investigation’s Office of the Inspector General for the Housing Authority revealed that between July 2, 2001 and December 31, 2002, Rashid, Ferreira, Jarvis, and their respective companies employed nineteen workers at the Edgemere and Arverne Houses. The work was subject to federal and state prevailing wage laws, which dictate the hourly rates that must be paid to employees working on public projects. In each case, the defendants are alleged to have failed to pay workers prevailing wages, and attempted to conceal their wrongdoing by filing false payroll showing that their employees were paid properly. The workers received between $70 to (sic) $110 per day instead of up to $48.53 per hour, which they were entitled to by law.

The Attorney General is also seeking restitution for the underpayment of wages to employees, which totals more than $367,000.

As a result of the continuing cooperation between the OAG and DOI, over one million dollars in wage restitution orders have already been obtained this year.

…

Next time… more on fraudulent disbursement schemes including expense reimbursement schemes.

[1] Andrea Ball. “Woman who stole from nonprofit up for parole two years into 25-year sentence.” Austin American Statesman. May 14, 2013.

[2] Marc Parry. “Online Scheme Highlights Fears About Distance-Education Fraud.” The Chronicle of Higher Education. January 13, 2010.

[3] Ben Worthen and Joann S. Lublin. “Mark Hurd Neglected to Follow H-P Code.” Wall Street Journal. August 8, 2010.

[4] Melinda Henneberger. “Bremer paid ‘Ghost Employees’ to avoid ‘Real Trouble.’” Huffington Post. February 6, 2007.

[5] Debra A. Valentine. Prepared statement. “What is a Pyramid Scheme and What is Legitimate Marketing?” International Monetary Fund’s Seminar On Current Legal Issues Affecting Central Banks. Washington, D.C. May 13, 1998.

[6] Tim Webb. “Ofgem investigates doorstep gas and electricity sales agents.” The Guardian [UK]. Web. September 2, 2010.

[7] New York State. Department of Justice. United States v. Bernard L. Madoff and Related Cases. FBI, August 5, 2009.

[8] United States. Govt. Accountability Office. Social Security Administration: Cases of Federal Employees and Transportation Drivers and Owners Who Fraudulently and/or Improperly Received SSA Benefits. August 4, 2010.

[9] New York. Office of the Attorney General. Three Contractors Arrested For Underpaying Employees And Falsifying Business Records In Connection With New York City Housing Authority Construction Projects. Media Center. September 2003.

Possible changes to the GAO’s Yellow Book

Charging “Other Services” to the Federal Grantor

Professional Services Costs

Permissible Legal Defense Costs

Unallowable Legal Costs

Lobbying Expenses

Lobbying Costs (Non-Governmental Grantees)

Permissible Lobbying Costs

Donated Services

Donated Property

Chapter 6 Summary

Expense Reimbursement Fraud Schemes

Completing the risk assessment

Fraudulent Disbursements – Billing Schemes and Payroll Schemes

Billing Schemes

Shell Companies

Non-Accomplice Vendors

Personal Purchases

Payroll Schemes

Ghost Employees

Commission Schemes

The Pyramid

A bit about the the Ponzi

Workers Compensation

Falsified Wages

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Professional Services Costs

Permissible Legal Defense Costs

Unallowable Legal Costs

Lobbying Expenses

Lobbying Costs (Non-Governmental Grantees)

Permissible Lobbying Costs

Donated Services

Donated Property

Chapter 6 Summary

Billing Schemes

Shell Companies

Non-Accomplice Vendors

Personal Purchases

Payroll Schemes

Ghost Employees

Commission Schemes

The Pyramid

A bit about the the Ponzi

Workers Compensation

Falsified Wages

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