Thoughts on Auditing: June 2013

Please refer to : Incredibly, Auditors Miss a $53 Million Fraud in Dixon, Illinois

The $53 million stolen from Dixon, Illinois was astounding when you consider Dixon’s budgeted General Fund Revenues and Transfers were $9.7 million in fiscal year 2012/13. Total property taxes were $1.4 million.[i] Yet, From May 1, 2011 to April 30, 2012, Rita Crundwell stole over $4,814,810![ii]

She did this by using fraudulent invoices purportedly from the Illinois Department of Transportation.

According to the latest indictment in this case[iii]:

50. From April 30, 2002 to April 30, 2012 the false invoices generated by Rita Crundwell purportedly from the Illinois Department of Transportation differed from the true invoices from the Illinois Department of Transportation in a number of materials respects including but not limited to:

a. None of the over 179 false invoices created by Rita Crundwell had a "Illinois Department of Transportation" emblem or logo at the top of the page;

b. The over 179 false invoices created by Rita Crundwell had the word "Section" misspelled as "Secton";

c. The over 179 false invoices created by Rita Crundwell did not have the same font or type face as the true Illinois Department of Transportation Invoices;

d. The over 179 false invoices created by Rita Crundwell omitted a contact name and phone number of an employee at the Illinois Department of Transportation if the recipient had any questions.

51. Many of the false invoices created by Rita Crundwell were made out for even amounts for hundreds of thousands of dollars which is a recognized indicia of fraud or misstatements in the field of audit1ng.

52. All of the checks made out to pay these fraudulent invoices purported to the Illinois Department of Transportation were typed by Rita Crundwell and signed only by her.

53. The custom and practice at the City of Dixon for the bill payment process was the following;

a. each invoice received at City of Dixon would be approved by the City Department head in charge and/or Commissioner;

b. a requisition would be created for each invoice;

c. the aforesaid paperwork would be sent to Clifton for entry into the City's ledger that was kept on the computer system at Clifton

d. that Clifton would print a check to pay the invoice which would then be signed by a secured signature machine with three signatures.

Here is a copy of a real invoice from the Illinois Department of Transportation:

Here is a copy of the phony invoice:

Here is the phony document with the fraud indicators identified:

So – would you have found these fraud indicators if you were doing the work?

The auditing standards actually give the auditor some wiggle room. If we focus on SAS 99 – Consideration of Fraud in a Financial Statement Audit. There are several important paragraphs. In the codification AU section 316 here are important concepts:

¶ 06 - Fraudulent financial reporting may be accomplished by the following:

— Manipulation, falsification, or alteration of accounting records or supporting documents from which financial statements are prepared

¶ 09 an audit conducted in accordance with GAAS rarely involves the authentication of such documentation, nor are auditors trained as or expected to be experts in such authentication.

¶ 11 although fraud usually is concealed and management's intent is difficult to determine, the presence of certain conditions may suggest to the auditor the possibility that fraud may exist.

Despite the transactions lacking:

a. approval by the City Department head in charge and/or Commissioner;

b. a requisition for each invoice; the CPA firm Clifton Larson did not uncover the fraud. According to the indictment, it did not:

Inspect any of the fraudulent capital projects for which Rita Crundwell submitted any false invoice.

Speak to the City Engineer or any City employee responsible for capital projects about the fraudulent capital projects for which Rita Crundwell submitted any false invoice.

Speak to anyone at the Illinois Department of Transportation regarding any of the fraudulent invoices or any of the fraudulent capital projects set forth in the fraudulent invoices.

Locate and verify the approval by the City Council by any of these specific fraudulent capital projects in the City of Dixon City council meeting minutes.

Examine any contract, bid, diagram, sketch or other contract related documents for any of the fictitious projects.[iv]

Conclusion

Again, what we are seeing here is the challenge auditors have in assessing the validity of the transactions they review. The most critical component of an audit is the need to verify the underlying substance of the transaction – did the City get what they paid for?

When the auditor does not visit the job site or seek other ways to assure the appropriateness of the transaction, they have again let the public down.

The magnitude of this fraud is so big, and occurred over a 20-year period that a good, professional, skeptical auditor should have found this fraud!

I will continue to explore other issues with this audit and the related fraud in future blogs.

http://davehancox.blogspot.com/2013/06/incredibly-auditors-miss-53-million.html

http://davehancox.blogspot.com/2013/06/auditors-miss-phony-invoices-would-you.html

http://davehancox.blogspot.com/2013/07/auditor-independence-and-competence-on.html

http://davehancox.blogspot.com/2013/08/send-these-auditors-back-to-school.html

http://davehancox.blogspot.com/2013/08/dixon-auditors-didnt-pay-attention-to.html

http://davehancox.blogspot.com/2013/09/auditors-settle-lawsuit-in-dixon.html

[i] Dixon, Illinois Ordinance No. 2888 (http://www.discoverdixon.org/index.php?option=com_docman&view=docman&Itemid=412)

[ii] ¶ 74 (Facts Common to Counts I - XIV)Fourth Amended Complaint filed in Lee County 5/23/2013 No. 12 L 12

[iii] Fourth Amended Complaint filed in Lee County 5/23/2013 No. 12 L 12

[iv] Ibid.

The story you are about to read is incredible. It is a story of betrayal. Betrayal by the person who stole $53 million from the taxpayers of the small city of Dixon, Illinois. And betrayal by the auditors who had a duty to seek out the fraud, but failed to heed the red flags that were available to them.

Dixon, Illinois is a community of 16,000 people. It’s the city where President Ronald Reagan grew up, attended school and worked as a lifeguard. Unfortunately, its taxpayers lost $53 million because its auditors did not detect a 20-year fraud committed by City Comptroller Rita Crundwell. She stole $181,000 in 1991 and stole $5,637,546 in 2008. Year after year, as the auditors issued unqualified opinions of Dixon’s financial statements, Ms. Crundwell continued to beat the auditors of a major CPA firm and of two small practitioner firms. The major firm audit partner said in court depositions, “…an audit is not designed to detect fraud.”[i] When asked, “Do you know what [internal control] means?” he said, “I can’t define it…”[ii] When asked, “Do you know what the concept of scepticism [sic] is?”, he answered, “No.”[iii]

Stunning statements by a supposed professional auditor, who should know the audit standards say auditors must be, “primarily concerned with fraud that causes a material misstatement in the financial statements.” And internal controls are essential to an auditors work and guidance has been available since at least 1992 in the Treadway Commission’s report, Internal Controls – Integrated Framework. And the audit standards “require technical training and proficiency as an auditor, independence, and the exercise of due professional care, including professional skepticism.”

This is a sad story for the auditing profession. We’ve got to begin to learn the lessons of the past, we need to sharpen our level of professional skepticism and we need to use due professional care in our daily work.

The auditors of Dixon, Illinois failed. They failed the taxpayers, and they failed the profession.

Let’s look at what happened.

What Rita Crundwell Did

Rita Crundwell is currently serving 19 years, seven months in prison. She was well-known in the international horse-breeding game. Her champion horse ranch in Beloit, WI, (one of two), produced fifty-two world champions. At the time of her arrest, Ms. Crundwell had 311 registered quarter horses. She was also the City Comptroller of Dixon, Illinois.[iv]

On December 18, 1990 Ms. Crundwell opened a bank account in the name of the City of Dixon at First Bank South (“RSCDA account”[v]) and maintained the RSCDA account at First Bank South and its successor banks, Grand National Bank, Old Kent Bank and Fifth Third Bank.[vi] This account was not authorized by the City Council and was not known to other City employees.[vii]

She immediately began to transfer money from authorized City accounts into the RSCDA account and used those funds to pay her own personal expenses and private business expenses.[viii] She did this by writing checks on the Capital Development Fund account (an authorized account) made payable to “Treasurer,” signed those checks as “Treasurer,” and had those checks deposited into the RSCDA account.[ix]

Finally, she created fictitious invoices purported to be from the State of Illinois to show the auditors for the City of Dixon that the funds she was fraudulently depositing into the RSCDA account were being used for a legitimate purpose.[x]

In the fall of 2011, while Ms. Crundwell was on vacation, a city employee discovered the account and the checks written from it. On November 14, 2012, Ms. Crundwell pled guilty to allegations that she embezzled more than $50 million. On February 14, 2013, Ms. Crundwell was sentenced to 19 years and 7 months in prison, just under the maximum 20-year sentence.

Ms. Crundwell used the money to buy:

The single family residence located at 1679 U.S. Route 52, Dixon, Illinois;
The horse farm property located at 1556 Red Brick Road, Dixon, Illinois;
A single family residence located at 1403 Dutch Road, Dixon, Illinois;
Approximately 80 acres of vacant land located in Lee County, Illinois with Lee County property identification number 14-09-07-100-014;
A single family residence located at 821 East Fifth Street, Englewood, Florida;
A 2009 Liberty Coach Motor Home, Model H-345, D/S, VIN 2PCV334988C711148;
And various other trucks and boats.

The Liberty Motor Coach cost over $2 million. Here is a picture of the inside and outside of the bus:

What the Auditors Did

There were three audit firms involved with the city of Dixon - Clifton, Larson, Allen, LLP formerly known as Clifton Gunderson, LLP, Janis Card Company and Samuel S. Card, PC. Clifton, Larson, Allen did the audit of Dixon from 1993 to 2005. In 2005, Clifton asked Janis Card to do the audit, and Clifton said they would do the compilation work.

In its lawsuit, Dixon alleges that Clifton continued to do the audit work and Janis Card & Associates, and subsequently Sam Card & Associates, a small local accounting firm simply signed the report. In his deposition, Sam Card was asked, “Clifton is coming to you and saying, ‘Look, we have an independence problem. We want you to come in and sign the report. We will do all the work,’ true?” Mr. Card responded, “True.”[xi]

Clifton denies this and claims they only performed the compilation, which they claim lessens the responsibility that Clifton owed to the City to find fraud or misstatement.[xii]

While it might lessen it, Omnibus Statement on Standards for Accounting and Review Services—2005, amended SSARS no. 1, making specific changes regarding the practitioner’s consideration of fraud and illegal acts in compilation and review engagements. Although compilation and review performance standards don’t require CPAs to assess the risk of fraud, they still must inform the client of incorrect, incomplete or otherwise unsatisfactory information discovered during an engagement.[xiii]

In all of the audits I reviewed, the auditors gave an unqualified opinion on the financial statements. They said, “We noted no matters involving the internal control over financial reporting and its operation that we consider to be material weaknesses." "In our opinion the financial statements referred to above present fairly, in all material respects, the respective financial position of the governmental activities…” ''No instances of noncompliance material to the financial statements of the City of Dixon, Illinois which would be required to be reported in accordance with Government Auditing Standards, were disclosed during the audit."

These statements were made despite the following:

A bank confirmation that showed the unauthorized account.
Fictitious invoices that had several red flags that should have alerted a skeptical auditor to pursue the transaction further.
The Dixon procedures required a purchase requisition and approval by an appropriate employee to support an invoice. None of the fictitious invoices had this purchase requisition.
Capital assets purchased were not verified to see that they existed. In fact, they did not exist.[xiv]

In subsequent blogs, I will explore these issues in greater detail. I'm trying to gather more information on the audits. I'm trying to find out who had the working papers for the audits done after 2005. Did Sam Card maintain the working papers to support the audit or was it Clifton Larson? Who initialed the work done on the working papers and who approved the papers as a supervisor?