Case requirements 1.Imagine yourself in Nancy John's position. Recall that Nancy was openly critical of the previous
Question:
Case requirements
1.Imagine yourself in Nancy John's position. Recall that Nancy was openly critical of the previous Executive Director (ED). Using the fraud triangle as a guide, speculate on the incentives/pressures, opportunities, and attitude/rationalizations that you might contend with if you were the newly promoted ED at New Day Products. (LO2)
2.Summarize the general attributes and responsibilities of a nonprofit organization's board of directors. In what significant ways do they differ from a board of a for-profit organization? (LO1)
3.Consider the state of the organization's board of directors immediately prior to the discovery of the fraud.
a.Evaluate the board's oversight given what you now know about a board's oversight responsibilities. (LO1)
b.Identify and discuss activities that the board no longer performed or could have done differently (provide at least three specific examples) that might have prevented the fraud from occurring. In your discussion of your top three suggestions, be sure to describe what each would have accomplished. (LO3)
4.Contrast the levels of assurance provided by a financial statement audit versus a financial statement review. (LO4)
5.Assume that periodic audits rather than reviews continued for the duration of Nancy's term as Executive Director and that you were on the audit team and participating in its discussion assessing the risk of fraud.
a.Identify eight "red flags", including internal control weaknesses, that would have indicated the potential for fraud in the case (again, refer to the fraud triangle). (LO2, 3)
b.What would have been the appropriate response (i.e. changes to the audit program) to the red flags that you identified had the audit team identified them? (LO2, 3)
c.Why might a financial statement review as chosen by Nancy not have picked up on any of these "red flags"? (LO4)
6.Do you agree with the judge's ruling regarding Nancy John's culpability for the fraud?Why or why not? (LO3)
Bad Days at New Day Products
ABSTRACT:This instructional case describes an embezzlement committed by the former executive director of a Southeast Idaho nonprofit organization, New Day Products. The case examines the roles that inadequate internal controls, lax board of director's oversight, and financial statement reviews rather than financial statement audits might have played in enhancing the opportunity for the fraud. The organization, New Day Products, helps people with disabilities achieve their highest economic, social, and personal potential by providing them with vocational, social, and personal services.
Keywords: fraud; embezzlement; nonprofits; internal controls; separation of duties; board of directors; board oversight; governance; case studies.
The Case
Jamie Davis, the office administrative assistant to the Executive Director (ED) at New Day Products, stared at the letter from the IRS in shock and disbelief. The letter asserted that New Day Products owed over a million dollars in back payroll taxes, associated interest, and tax penalties. While Jamie suspected something amiss with how the ED managed the organization, she scarcely imagined that things were this bad. Jamie recalled past questionable expenditures and reflected on the ED's seemingly extravagant spending habits as well as those among the ED's family and friends. She realized that the management style at New Day Products, a small nonprofit organization focused on helping people with disabilities, had become increasingly secretive during the ED's tenure. Employees seemed discouraged, even afraid, to question authority; simple acts such as opening the mail were reserved for the ED. Jamie decided to open the IRS letter only because it appeared urgent and the ED was on vacation. Her decision would become the triggering event leading to the long unraveling of a devastating fraud and embezzlement scheme orchestrated by Nancy John, the ED of New Day Products. Jamie wondered how this could happen at an organization with a mission of helping people.
Differences between For-Profit and Nonprofit Organizations
Although for-profit and nonprofit organizations are similar in that they both comprise people working together to accomplish their organizations' missions and goals, they differ in fundamental ways. First, a primary goal of all for-profit organizations is to generate profits for their owners. In contrast, the primary goals of nonprofit organizations generally focus on providing benefits to society. Differences in the primary goals of for-profit and nonprofit organizations give rise to different funding models. For-profit organizations are generally funded by investors who expect to obtain a return on their investment. Nonprofit organizations are frequently funded by donations and government grants. Although donors and other funding sources do not usually expect to receive monetary returns from their investments of time and resources, they do expect that the nonprofit organization make measurable progress toward its mission. Although a nonprofit can generate income, it must be recycled back into the organization to achieve the organization's objectives.
Second, for-profit organizations' workforces primarily consist of competitively paid managers and staff, whereas a nonprofit's workforce often includes a large portion of volunteer efforts. As a result, employee pay is frequently higher at for-profit organizations compared to nonprofit organizations, sometimes hindering nonprofit organizations from attracting equally skilled employees. However, nonprofits can sometimes counter pay disparities by attracting employees who are strongly motivated by the organization's mission. Such differences in employee motivation between for-profit and nonprofit firms can create markedly different cultures: for-profit cultures are often typified by aggressive profit-oriented activities whereas nonprofit cultures are typified by their sense of community and the resulting intrinsic rewards. As a result, the public as well as the nonprofit organization's employees often assume that a nonprofit organization's management and staff are serving the best interests of the organization (Mann 2006).
Third, for-profit organizations pay income taxes on their taxable earnings. In contrast, organizations that are designated as nonprofit organizations by Section 501(c) of the Federal Tax Code are exempt from paying some federal and, in most cases, state income taxes. However, both types of organizations must withhold and remit any federal and state employee income, medicare, and social security taxes from employees' paychecks. Both for-profit and nonprofit organizations must also remit to tax authorities their matching contributions for employees' medicare and social security payments and any federal and state unemployment taxes.
Fourth, for-profit organizations are owned by shareholders who have ownership claims to the organizations' assets and, through voting rights, control the composition of the organizations' governing boards. Nonprofit organizations have no owners; a nonprofit organization's earnings must be reinvested in the firm. Nonprofit organizations are generally considered accountable to the public that they serve and to the state agencies and tax authorities by which they are regulated. Much like for-profit organizations, nonprofit organizations rely on boards of directors for financial and strategic oversight. Boards also help to develop and maintain operational policies in support of the organization's mission. However, the responsibilities of nonprofit and for-profit boards of directors differ in key ways discussed in the next section.
Board Responsibilities and Differences between For-Profit and Nonprofit Boards
Except for an increased emphasis on mission, boards of directors at nonprofit organizations are much like their counterparts at for-profit firms. Boards of directors are generally responsible for the strategic and fiscal oversight of their organizations. In exchange for their time and talents, for-profit board members can be well-compensated, commonly with stock-based compensation that aligns their interests with those of shareholders. In contrast, nonprofit board members are not compensated and may be expected to directly provide or generate financial support for the organization (Epstein and McFarlan 2011).
Like the board members of for-profit organizations, board members of nonprofit organizations have a legal fiduciary duty to provide independent oversight of the organization's assets and operations. While state laws vary, in general nonprofit board members are legally responsible to provide adequate strategic, operational, and financial oversight over the organization, its mission, and its senior executives (AICPA 2017). To achieve effective board governance, a nonprofit board should meet regularly to review and approve the organization's mission, strategy, budget, compensation practices, and other key financial and operations policies. A board should comprise members having diverse ethnic, gender, and racial backgrounds to provide broad perspectives and help ensure a fair and equitable review of organization policies. Boards members should also have diverse experience and expertise to provide the organizational and financial skills necessary to advance the organization's mission and provide adequate oversight. Although boards should consist of at least five members, they can often exceed 25 members for large organizations (Independent Sector 2015).
As with for-profit boards, management oversight is among a nonprofit board's most important responsibilities. Boards are generally responsible for the hiring, evaluation, and firing, when necessary, of their organizations' EDs. A board of directors hires, oversees, and evaluates ED performance and any changes in ED compensation. A nonprofit board should also review and evaluate policies for approving expenditures to verify that they are consistent with the organization's mission. For example, the board should require that management made appropriate written policies for authorizing expenditures. Such policies should clearly establish who is authorized to approve payments, what documentation is required, and what kinds of expenditures are permitted.
Although not required, nonprofit boards may wish to form an audit committee to provide stronger assurance of the organization's financial health. Audit committees are generally formed from a small subset of the board, such as three to five members. Audit committees are not involved in day-to-day accounting functions but oversee the assurance process that includes the hiring and evaluation of the firm's independent auditors. Audit committees can also follow through on auditor recommendations to ensure that they are implemented. Although a nonprofit board may choose not to form an audit committee like what is required for publicly held companies, it should continue to protect its independent oversight of the organization's auditors by having the full board perform such audit committee functions (National Council of Nonprofits 2020).
Differences Between Board Responsibilities and Management Responsibilities
Management and boards of directors play distinctively different roles in their organizations. Whereas management is responsible for planning and executing strategy and enforcing the organization's operating procedures, boards of directors provide broader and more general oversight by reviewing and approving strategy and setting broad policy guidelines. Boards of directors are responsible for recruiting chief executives and devising their compensation contracts. They are also responsible for assessing business risk and monitoring their organizations' financial health and internal controls. In addition to monitoring financial health, boards of directors should monitor an organization's culture to assess whether it is conducive to meeting the organization's mission and goals (Grant Thornton 2016).
Organization Background
Founded in 1975, New Day Products is an Idaho nonprofit organization that provides comprehensive employment and social services to people with disabilities in cooperation with private and public community organizations and businesses. Its services include employment planning programs, employer and employee matching services, and in-house employment opportunities. Its employment planning programs assist participants with vocational decisions through standardized testing, situational assessments, and community-based job tryouts. Each individually tailored program culminates in a service report that details the participant's vocational strengths and developmental needs and helps the participant choose a vocation. New Day Products' matching services match participant's abilities to job requirements and provide additional assistance through on-site job coach training. Its in-house employment opportunities include jobs such as wood container manufacturing, pallet repair, bulk mailing operations, engraving, laundry, and janitorial services.
New Day Products' social services include a developmental disabilities program and an adult living center. The developmental disabilities program teaches life skills that not only encompass social skills but more fundamental skills such as cooking. The program is tailored to each participant's needs, goals, preferences, and interests, and the training is often provided in context, whether at home or the workplace. Residents at New Day Products' adult living center participate in the developmental disabilities program, but the adult living center also fosters greater community interaction and involvement. In addition to participating in arts, crafts, and games at the center, residents participate in field trips to local events.
When the fraud was revealed in 2009, New Day Products served seven counties in Southeast Idaho. Its funding and costs exceeded $1.3 million. Its four major funding sources were (1) the Idaho Division of Vocational Rehabilitation which helped fund its vocational training, (2) Medicaid which provided partial funding for residents of the adult living center, (3) federal and state cleaning contracts for janitorial services at local facilities including the FBI data processing center, and (4) revenues from selling goods and services like its wood pallets and trophy engravings. Profits from selling goods and services were approximately 35% of its total funding.
A Brief Organization History
At its founding, New Day Products boasted a well-rounded board of directors consisting of 15 members with expertise in accounting, legal, financial, vocational, and social work. As some board members had relatives who were beneficiaries of the organization, the board was highly committed to the organization's success. Leading the organization, Dick Kaup, was an experienced and dedicated Executive Director. Dick believed in a highly transparent management style. He kept the board fully informed regarding all operational and financial matters. With detailed reports provided by Dick, the board monitored actual results against an annual budget and discussed significant variances. The board oversaw internal controls assuring that no one person controlled an entire financial process from beginning to end, with separation of duties enabled by the board-approved organizational structure (Figure 1). The board treasurer reviewed Dick's company credit card statement every month to ensure that all charges were reasonable and served legitimate business purposes. Regular board training, including training about financial oversight and internal controls, and annual board self-evaluation enhanced board effectiveness. Staff members were similarly well-trained and adequately supervised. A local CPA firm experienced with nonprofits performed financial statement audits every two years. Although not required by New Day's funding sources, Dick believed that a periodic independent audit provided a necessary deep dive into the processes and documentation supporting the organization's financial reporting. By all accounts, the organization operated smoothly and efficiently under Dick's leadership.
When Dick retired, Steve Clark became the new ED. One board member described the next five years under Steve's directorship as "...a period of complacency. We had been lulled into a sense of security knowing that Dick had done a wonderful job and the organization was on solid footing."While the board continued its monthly meetings and its bi-annual financial statement audits, its membership began to shrink. One member left due to health problems, another retired and moved out of the area, and two others left because their own businesses were taking up more of their time. With fewer resources, a lack of expertise, and reduced focus, the board relaxed or abandoned altogether many of the board practices from the Dick Kaup era. Rumors began circulating that Steve was not as committed or adept as his predecessor. The financial health of the organization had shown signs of deteriorating. Staff turnover, historically quite low, began to increase.
Nancy John was openly critical of Steve's leadership and some board members shared a similar sentiment. Two additional board members left the organization to pursue other service opportunities, including the board treasurer, leaving the board with no financial expertise and nine remaining members. Filling board vacancies proved difficult. A remaining board member recalled that "as folks left the board, we would make an initial attempt at replacing their area of expertise, but things would go on and we wouldn't find a replacement."In 2006, having lost confidence in Steve's ability to lead the organization, the board released Steve and appointed Nancy John as ED.
The Nancy John Years
Nancy John could have been two different people. To the board, she was a hardworking, engaged manager who was "always in control" of a situation. But to the staff, she was an intimidating micromanager who ran things "close to the vest", never asked for input, and was quick to criticize, even punish, if things went unexpectedly. Immediately after assuming the ED position, Nancy eliminated the business manager position as a "cost cutting move", combining her prior position as business manager with her new ED position. The change flattened the organization so that all managers reported directly to Nancy. The new organization chart, which was presented to and approved by the board, is presented in Figure 2.
Another of Nancy's first moves upon becoming ED was to transfer responsibilities for accounts payable from Jamie Davis to Gail Hart. Jamie Davis had managed payables for several years and remained the office administrative assistant after the change. But for Gail, the change was more meaningful. Formerly a minimum wage employee with a GED but no significant business knowledge or experience, Gail, unbeknownst to the board or other staff, became the second-highest paid staff member in the organization. Nancy made Gail responsible not only for accounts payable but accounts receivable, and she took it upon herself to personally train Gail in her new responsibilities. Gail's job was to accumulate bills and present them to Nancy for coding and approval. Gail then prepared the checks, which required two signatures including Nancy's. To simplify the check-signing and accounts payable process, Nancy instructed Gail to order signature stamps that would allow Nancy to stamp checks with both required signatures, bypassing any benefit of having the control resulting from requiring two signatures on a check.
In addition to her tendency to micromanage business processes, Nancy was known by her associates for another trait. One manager recalled that "Nancy came in with a sense of entitlement. She basically kicked out the former ED by going to the board with a number of allegations and then initiated a series of perks for herself including the construction of a private restroom, gas cards to fuel her vehicle, and an expense account to cover the cost of almost daily 'business' meals."
Nancy frequently treated friends to lunch and wine or dinner and drinks, charging them to the company credit card. She hired her husband to construct a private bathroom near her office for which the organization paid in excess of $40,000 in material and labor. When questioned about her spending habits, Nancy would attempt to placate the questioning staff member with gifts such as expensive bottles of wine for jobs well done. If the questioning continued, she replaced the staff member. Nancy followed a similar approach for any staff member who was critical of her performance or questioned her methods or policies. One staff member commented, "she didn't hesitate to fire someone if she felt that they were not loyal. She created an atmosphere where everyone was afraid of losing their job. Everyone was constantly looking over their shoulder."
To conceal her spending habits from the board, Nancy altered how New Day formatted its financial reports. Prior to Nancy becoming ED, the board received annual budgets and detailed financial statements. Nancy no longer provided detailed annual budgets and began abbreviating much of the previously provided information, including summarizing broad expense categories into a single line item. As the board no longer included financial experts, no one objected to the lack of budgets and diminished detail. Furthermore, the board no longer included a board treasurer. He departed two years earlier and had previously regularly reviewed the ED's credit card statement. Under Nancy, the board met far less regularly, only once or twice a year. After her second year as ED, Nancy explained to the board that the broader deterioration of the organization's financial picture was due to decreased funding from federal and state sources. The board gave her the go-ahead to do what she needed to trim costs.
With her new self-ascribed cost reduction mandate, Nancy eliminated the organization's bi-annual audits in favor of financial statement reviews. Because none of the organization's funding sources required a full audit, Nancy reasoned with the board that a financial statement review would suffice; a review was nearly as good as an audit, she explained, but would be less expensive and less administratively burdensome.
Additionally, Nancy eliminated most employees' employment benefits, while preserving her own and her family's health insurance. She also initiated certain personnel reductions, some of which were offset by questionable promotions and pay increases. For example, Nancy replaced the current community services coordinator by promoting her daughter to the position. Because Nancy's daughter was promoted from within the department, the change eliminated her previous position. Much of those cost savings, however, were offset as Nancy's daughter received a new salary that was nearly 80% higher than that of the previous coordinator. Similarly, other personnel reductions were partially offset when Nancy awarded herself an 11% pay raise.
Nancy never consulted the board with these changes, and the abbreviated financial reports combined with a lack of board member financial expertise resulted in them not inquiring further. Notably, at the time Nancy John's fraud was discovered, only five board members remained, one of whom was seriously ill leaving the board at one-third the size it had been throughout much of Dick's leadership and lacking many of the skillsets necessary to effectively oversee the organization. Fortunately, Nancy's changes caught the attention of her administrative assistant, Jamie Davis. Jamie had an "inkling that something wasn't quite right" and she began documenting what she believed represented financial irregularities.
The Discovery
One of Nancy John's rules was that she was the only one allowed to open the mail. If she was gone for a day or two, the mail was placed on her desk and she would open and route it when she returned. However, in December of 2009, Nancy had decided to take the week of December 21 off, since the office would be closed anyway on Thursday and Friday for the Christmas holiday. On Tuesday of Christmas week, a certified letter requiring a signature arrived from the IRS. Jamie Davis signed for the letter and, believing it was urgent, opened it so that she could call Nancy to report on its contents. What she saw shocked her. The letter stated that New Day Products owed the IRS in excess of one million dollars in delinquent payroll taxes along with interest and penalties that were attributable to the prior four years.[1]Jamie had no idea what to do, but she felt strongly that calling Nancy was not an option. Looking for guidance, she called Mike Williams, a manager she knew and trusted. Mike, who knew Joy Robbins, the current board chair, immediately called her and told her "You've got to get down here right now. It looks like we have a major problem!"
When Joy arrived, Jamie showed her the letter and shared her misgivings about Nancy's potential financial improprieties. After reading the letter, Joy instructed Mike and Jamie to keep everything completely confidential until she could get the board together to form an action plan. Two of the four remaining board members were travelling that week. Consequently, a meeting would have to wait until the following week. Still, Jamie called the board members that she could reach and left messages for the others. She notified them that there would be an emergency board meeting the following Monday. She also told them that they were to keep the meeting notification confidential, especially from Nancy John. Next, she called New Day Products' attorney, advising him of the situation and inviting him to the board meeting.
Nancy John returned to her office on Monday unaware of the circumstances. That evening, the board discussed the IRS letter and reviewed Jamie's notes. The attorney advised the board to engage a tax attorney and to place Nancy on paid leave. She was not to be allowed into the building until further notice. Joy made the call to Nancy that evening.
The Investigation
The next day, Jamie and other key staff members began documenting questionable transactions. On Wednesday, they contacted the local police department to report the fraud. A report was filed and the investigation commenced immediately after the Christmas holiday.
Rumors began circulating among the remaining staff and some of the organization's clients that Nancy John was being investigated for fraud and mismanagement. Concerns arose that the organization was in danger of dissolving. The local newspaper caught wind of the investigation and called Joy for a comment. Joy admitted that an investigation had begun but that no one had been charged. Moreover, she explained that she was very concerned about New Day's developmentally disabled clients and the trauma and stress that a news story might trigger. She asked the paper to hold off reporting on the story until more was known and until the organization had a plan to cope with the likely consequences. Perhaps surprisingly, the editors agreed to hold off reporting the story for the time being.
Meanwhile, rumors continued to spread. Convinced that a crime had been committed that put the organization at risk of financial collapse, staff members and clients became agitated and angry. Some repeatedly called the newspaper and police to ask why they were not reporting the crime or investigating it more aggressively. Newspaper and police department representatives contacted Joy to request that she ask her staff and organization clients to stop calling. Realizing the potential harm that might befall New Day's clients and staff if their fears continued unaddressed, Joy contacted the board and New Day Products' attorney to initiate a series of meetings with the staff, the organization's clients, and their families. The board used the meetings not only to inform the organization's stakeholders, but also to help manage the resulting anger and stress. They brought in extra counselors and social workers, but things were to remain rocky for a long time.
After the board felt that they had gathered sufficient evidence, Nancy John's employment was terminated on January 20, 2010. The financial evidence suggested that Nancy had committed substantial asset misappropriations. To better determine the types and amounts of the misappropriations, the police department added a forensic accountant to the investigation in February. Table 1 chronicles the significant events that followed the discovery of the fraud.
The Forensic Accountant's Report
New Day hired a forensic accountant to determine what amount had been misappropriated, who benefited from the misappropriation, and how it was committed. Appendix A reproduces and summarizes portions of the report. Concerned about the financial costs of a broader forensic audit coupled with New Day's current financial situation, New Day asked the forensic accountant to stop research once he had identified asset misappropriations in excess of $100 thousand dollars. The forensic accountant completed his report over one year later. The report classifies Nancy's misappropriations into three schemes: an authorized maker scheme, a falsified salary scheme, and a falsified payroll withholding scheme.
An authorized maker scheme is a type of misappropriation where an employee having signature authority uses that authority to disburse funds for her own benefit, signing her own name. For New Day Products, Nancy carried out the authorized maker scheme by misappropriating $16,340 using checks written against the company's bank accounts and $89,250 in charges against the company's credit card. In one example, Nancy submitted invoices for new windows and a deck on her home, coding them for reimbursement purposes as leasehold improvements. In another example, Nancy was reimbursed for personal purchases of wine, filet mignon, and salmon coded as office supplies. In a third example, Nancy charged the company credit card for airline tickets to San Diego and for a Caribbean Cruise for herself, her husband, and another couple. Following up with the other couple, the forensic accountant discovered that they had reimbursed Nancy for both trips. The couple provided cancelled checks as proof of their reimbursement. However, Nancy kept the reimbursement funds.
The falsified salary scheme involved unauthorized raises. On June 28, 2006, the board authorized raises for New Day Products employees who had been with the company for at least twelve months at 1.5% for a cost of living increase. This was to continue each year unless otherwise changed by the board. Nancy John, however, authorized herself yearly raises of 9.8%, 32.6%, and 33.1%, in addition to the 1.5% increase authorized by the board. The total for "falsified salary" amounted to $58,657.
In the falsified payroll withholding scheme, Nancy falsely reported her payroll withholdings to the IRS and the Idaho State Tax Commission, so that she received as pay what should have been withheld and forwarded to the taxing authorities. The amount totaled $7,757. Additionally, pay that was withheld from New Day employees' paychecks was not remitted to the IRS, resulting in the overdue taxes, interest, and penalties described earlier.
In all, the forensic audit report indicated that Nancy's direct misappropriations totaled at least $172,004.
The Court's Ruling
On September 20, 2013, the court issues its final restitution order. The order states:
At the outset the Court notes that the evidence in this case certainly supports the conclusion that John was a poor financial manager and the New Day has suffered significant financial loses and problems as a result of Defendant's mismanagement during her term as the Executive Director. However, it can also be said, and was said by those witnesses for the State that evaluated the records in this case, that New Day had inadequate controls and oversight in place to correct mismanagement or to discover and respond to criminal conduct. Certainly the evidence supports the conclusion that New Day has now instituted better oversight procedures to prevent such mismanagement and/or criminal conduct in the future. This being said, the Court's challenge is to, consistent with the standards listed above, determine which losses or claims by New Day were 'caused,' both actually and proximately, by the criminal conduct of Defendant to which she pled guilty. While the court does not doubt that New Day has suffered substantial financial losses resulting from the overall management and criminal conduct of Defendant, the only restitution that can be ordered is that which is attributable to criminal conduct, not to mismanagement. (Bannock County District Court 2011)
In summary, New Day Products' was denied full restitution for Nancy's actions because some actions were indistinguishable from, or could be construed as, ineffective but purposeful management decisions.
The order continues indicating that the board's lack of oversight, including lack of internal controls, might have provided opportunity for the "unauthorized expenses", and the board did not question the salary increases even though they were presented in periodic reports. The Court again reiterated that New Day Products did not "prove" that many of the alleged misappropriations were not business expenses. Rather, New Day Products opined that the amounts would not be expenses incurred in the conduct of New Day Products company business. In conclusion, the order set restitution at only $50,403.03, reflecting amounts that Nancy John either admitted to or that were undoubtedly for personal use. The costs of the private restroom, her daughter's promotion, and many of the meals costs were among the many items not included in the restitution settlement amount. Upon further assessment, the court agreed that, because Nancy was unable to make any larger payment, she would make monthly restitution payments to New Day Products of $100/month.
The Aftermath
Misappropriations, reckless spending, mismanagement and litigation costs left the organization with less than $2,500 in cash, a traumatized staff and clients, and a liability to the IRS in excess of $1 million. In the year leading up to Nancy John's termination, the organization lost federal and state contracts, and funding from the United Way and the local Civitan's group. Each was integral to New Day Products' ability to serve its clients.
In 2010, the board hired a consultant to handle bookkeeping duties and establish a system of financial controls. It also hired a new ED, Terry Fredrickson, who came with a strong background in management and counseling. His skills were vital to managing the company's recovery, including over the next several months assisting the forensic accountant and others with the investigation. With his counseling skills, Terry was able to help employees, clients, customers, and members of the community cope with the trauma that they had experienced in the aftermath of Nancy's leadership. Terry actively recruited additional board members with appropriate areas of expertise, and he assessed and redesigned New Day Products' organizational structure and operating policies, with the board's approval.
With the help of New Day Products' tax attorney, Terry negotiated a settlement with the IRS for the payroll tax liability. The settlement burdened New Products' with considerable debt but satisfied the entire tax liability by 2016. Under Terry's leadership and with strong community support, the organization has again begun to prosper and fulfill its mission.
References
American Institute of Certified Public Accountants (AICPA). n.d. "Not-for-Profit Governance & Management Resources." Accessed October 4, 2017. https://www.aicpa.org/interestareasotforprofit/resources/governancemanagement.html.
Bannock County District Court. 2011. State of Idaho vs. Nancy K John, CR-2011-12639.
Epstein, Marc J., and F. Warren McFarlan. 2011. "Nonprofit vs. For-Profit Boards: Critical Differences." Strategic Finance 92 (9): 28.
Grant Thornton. 2016. "Not-for-Profit Board Guidebook."
Independent Sector. 2015. Principles for Good Governance and Ethical Practice. Independent Sector. Washington, DC: Independent Sector. https://www.independentsector.org/wp-content/uploads/2016/11/Principles2015-Web-1.pdf.
Mann, Gregory A. 2006. "A Motive to Serve: Public Service Motivation in Human Resource Management and the Role of PSM in the Nonprofit Sector." Public Personnel Management 35 (1): 33-47. https://doi.org/10.1177/009102600603500103.
National Council of Nonprofits. 2020. "Nonprofit Audit Guide." https://www.councilofnonprofits.orgonprofit-audit-guide.
Figure 1
New Day Products Organization Chart Pre-2006
(In the Picture)
Figure 2
New Day Products Organization Chart 2006
(In the Picture)
Table 1
Timeline of Significant Events that Followed Discovery of the Fraud
12/22/2009
Jamie Davis opens IRS letter notifying New Day Products of past due payroll taxes and penalties in excess of $1 million.
Jamie notifies Joy, the board chair, who takes control of the organization.
12/28/2009
The board places Nancy on paid leave.
12/29/2009
The staff begin reviewing internal records and documenting questionable transactions.
12/30/2009
The staff initiate a police investigation.
01/20/2010
Nancy's employment is terminated.
02/01/2010
A forensic accountant begins investigating the misappropriation.
03/26/2010
Jamie receives anonymous phone threat to reveal unflattering personal information if it doesn't cease "[expletive] with my friend Nancy."
07/14/2010
A police investigator meets with Jamie to discuss her history with the organization and its bookkeeping practices and controls. They also discuss Gail Hart's responsibilities as accounts receivable and payable clerk.
10/04/2010
New Day Products hires a new ED, Terry Fredrickson.
05/03/2011
The forensic audit report is completed. It indicates that Nancy misappropriated at least $172,004. Terry provides a copy of the report to the police.
08/01/2011
The police charge Nancy with grand theft by embezzlement.
12/12/2011
Nancy pleads not guilty.
03/12/2012
Nancy pleads guilty during a plea bargain.
Nancy is sentenced to a fixed prison term of five years with a subsequent indeterminate term of three years.
The sentence is suspended in exchange for Nancy spending ten days in Bannock County Jail, paying $20,000 in restitution to New Day Products, and receiving a supervised probation with the Idaho Department of Correction for a period of ten years.
09/20/2013
The court issues its final restitution order.
Appendix
The following pages are excerpts reproduced from the forensic audit report. Names and other identifying information have been changed or removed to protect them from harm and to protect their privacy. Portions of the report, especially Table 4A, were summarized to focus on key details.
Personal and Confidential
April 29, 2011
Mrs. Joy Robbins
Board of Directors Chair
New Day Products, Inc.
1704 N. Main
Pocatello, ID 83204
RE: Nancy Johns, Executive Director
Dear Mrs. Robbins:
We have conducted a fraud examination concerning a possible misappropriation of assets of New Day Products, Inc. This examination was predicated upon a police report alleging improprieties on the part of Nancy John, New Day Products Inc.'s executive director.
Our examination was conducted in accordance with lawful fraud examination techniques, which include, but are not limited to, examination of books and records, voluntary interviews with appropriate personnel, and other such evidence gathering procedures as necessary under the circumstances.
During our examination we validated at least $172,005 was misappropriated for the personal benefit of Nancy John and/or her close friends and family members.
Based upon the results of our examination, these actions, if proved in a court of law, could constitute a violation of criminal and/or civil law.
Very truly yours,
Smith & Company, Chartered
TO:Joy Robbins
Board of Directors, Chair
FROM: McKay Robertson, CFE, CPA
Certified Fraud Examiner
RE: EXAMINATION OF POTENTIAL ASSET MISAPPROPRIATION
DATE:April 29, 2011
I. Background
On January 1, 2010, an administrative assistant from New Day Products Inc. in Pocatello, Idaho reported to the Pocatello Police Department that the CEO of New Day Products had been taking and using business funds for her own personal benefit and gain. On October 19, 2010, New Day Products engaged Smith & Company to perform a fraud examination as a result of the above allegations.
Based upon the above events, a fraud examination was conducted, which included reviews of relevant records and interviews of appropriate personnel.
II. Executive Summary
The fraud examination commenced when Smith & Company was engaged by New Day Products' Board of Director's chair person, Joy Robbins.
III. Scope
The objective of the Fraud Examination was as follows:
Determine the amount of asset misappropriation.
Who benefited from the misappropriation and
How the misappropriation was committed.
During the engagement, on March 31, 2011 the client requested the Fraud Examination Team from Smith & Company minimized time and resources once misappropriation of assets found exceeded $100,001. The request was to minimize cost to the company.
IV.Approach
Fraud Examination Team Members (the Team)
Jonathan Simmons, CPA and McKay K. Robertson, CFE, CPA, from Smith & Company, Chartered;
Procedures
New Day Products hired Suzanne (Phillips) Baker with Bookminders Consulting to gather pertinent documentation and file copies of such documentation in report form for the Team.
As part of the examination of this matter, the Team took the following actions:
Obtained, reviewed, and analyzed New Day Products' financial documentation, including purchase records, invoices, and canceled checks and verified information provided by Suzanne (Phillips) Baker.
Obtained, reviewed, and analyzed copies of bank and credit card statements of Marshall and Nancy John provided by the Pocatello Police Department.
Obtained, reviewed, and analyzed New Day Products' payroll records and reports provided by Suzanne (Phillips) Baker.
Review and analyze interviews provided by the Pocatello Police Department.
Additional Interviews
Jamie Davis, Assistant to the Executive Director, New Day Products.
Terry Fredrickson, Executive Director, New Day Products.
Pamela Luis, Board member, New Day Products.
V. Findings
We reviewed the policies and internal controls from January 1, 2006 to February 28, 2010. We found the Organization had minimal written policies and procedures governing the recording of the Organization's accounting transactions. We found that some polices were not enforced or were by-passed by management. These detours in controls allowed one individual with control over assets the ability to record and authorize disbursements.
If a single individual has these abilities mentioned above, then based on the COSO model for appropriate controls, created by the Treadway Commission, there is a loss of sufficient separation of duties and, therefore, does not allow management or employees, in the normal course of performing their assigned functions, to prevent, or detect and correct misstatements on a timely basis.
Due to the lack of sufficient separation of duties within New Day Products, we found Nancy John performed various types of fraudulent schemes. The below list includes the schemes verified by the Team:
Authorized maker schemes
Falsified Salaries and Falsified payroll withholding reports
Based upon the documents reviewed, and information collected, during the course of the fraud examination, the Team finds as follows:
Authorized maker schemes occur when an employee with signature authority on a company account writes fraudulent checks, or authorizes electronic payments for his/her own benefit and signs his/her own name as the maker (person who signs the check). Using fear of job security as a weapon, the authorized maker can maintain a work environment in which employees are afraid to question these transactions.
The Team verified a minimum of $14,928.34, $14,764.42, $36,117.14$, $39,181.48, and $599.74 of personal expenses were identified for the use of Nancy Johns, or close family relatives in 2006, 2007, 2008, 2009 and 2010, respectively. The above amounts include payments of credit card balances where personal purchases were made using a credit card owned by New Day Products, and assigned to Nancy John. The above amounts also included direct transfers from bank accounts owned by New Day Products Inc. to personal bank or credit card accounts owned by Nancy Johns and her husband Marshall Johns. (See addendum A.1 for detail of procedure performed and explanations of these transactions).
We also found that Nancy John used her position as Executive Director of New Day Products Inc. to increase salaries without the approval of the board. She also used her position to change the reported amounts withheld from paychecks for federal and Idaho State tax withholding reports.
The policy manual provided to the Team by New Day Products states, (see page 50 of New Day Products policies and procedures manual) "The Board of Directors has authority to grant salary adjl15tmcnts ... The Board of Directors has final authority regarding salary adjustments."
The Team found actual salary paid to Nancy John exceeded the board approved salary by $5,425.22, $18,396.71, $15,617.47 and $19,218.19 in 2006, 2007, 2008 and 2009, respectively. The Team found actual salary paid to Rhonda Hinman exceeded the approved salary on the "PERSONNEL ACTION REPORT" by $1,936.69, and 2,642.05 in 2006, and 2007, respectively. The Team found actual salary paid to Jamie Davis exceeded the approved salary on the "PERSONNEL ACTION REPORT" by $5.60, $1,656.49, $617.07 and $2,829.6 in 2006, 2007, 2008, and 2009, respectively.
The difference in reported withholding to the IRS and Idaho State Tax Commission for Nancy John was overstated in the amount of $3,129.28, $65.89, and 4,561.92 for the years 2006, 2007, and 2008. The reported withholding to the IRS and Idaho State Tax Commission for the other employees' reports examined differed in the amount of $66.86 in 2006 for Jamie Davis.
The combined total of verified misappropriation of assets is summed up on Table - A1.
VI. Limitations
On March 31, 2011 it was decided by Joy Robbins, Board of Directors Chair of New Day Products Inc. to limit the Teams time and resources once misappropriation of assets verified exceeded $100,001. No limitations were set by the board as to which transactions or accounts could be examined by the Team. Due to the limitation, however, the Team did not provided procedures for asset misappropriations within the General Wells Fargo bank account for the periods January 1, 2006 through July 1, 2008 and October 1, 2009 through February 28, 2010. All cleared checks from the General Wells Fargo bank account were also not examined. Only electronic payments/withdrawals from the General Wells Fargo bank from July 1, 2008 to September 30, 2009 were analyzed and misappropriations verified.
Checks written from the General Citizens Community bank account were also not examined. Only electronic transfers from the General Citizens Community bank account were analyzed, examined-and misappropriations verified.
The Team assessed the above accounts and their transaction as very high risk of asset misappropriation, but had reached the asset misappropriation limit set by the board.
Also, only individuals' payroll with high risk assessed by the Team or the ability to change payroll were tested for reporting errors or misappropriations.
VII. Summary
This report reflects that $172,005.80 were verified as misappropriated from New Day Products Inc. between January 1, 2006 and February 28, 2010, for the personal benefit or the benefit of friends and relatives of the Executive Director of New Day Products, Nancy John.
VIII. Impact to New Day Products Inc.
During the period of January 1, 2006 and February 28, 2010 a minimum of $172,005.80 was misappropriated from New Day Products Inc.
IX. Recommendations
It is recommended that a full review, either internal or external, of internal controls should be conducted to determine how such incidents can be detected in the future.
Addendum A.1
New Day Products Inc
Authorized maker schemes
The Team was provided with a list of transactions that were confirmed as personal expenditures by the Chairman of the Board of Directors, Jolene Barnett-Stephens of New Day Products Inc. and Terry Fredrickson, the CEO of New Day.
This report was reviewed by the Team and verified that the type of transactions were indeed of a personal nature and not for the benefit of New Day Products Inc. When available, invoices were provided to verify the person nature of the transaction.
Due to the lack of invoices available for examination for various transactions, additional analysis was performed to verify the purchases were not for the benefit of the company. These additional analyses included analyzing the personal bank account of Nancy John. Total authorized maker scheme verified can be found on Table - A2
During additional analysis, it was found that electronic payments from New Day Products Inc.'s bank statements were for the personal benefit of Nancy John or friends and close relatives of Nancy John. While reviewing expenditures from Nancy John's person bank account the Team found that Mrs. John would make payments to the same entities as New Day Products Inc. This would not be against company policy if the payments from New Day Products Inc. were for business purposes. However, the month that New Day Products Inc. made payments to the vendor, there were no payments recorded on Nancy Johns bank account. An example of this includes the electronic payment to Nissan Motor from Nancy Johns personal Wells Fargo account for the amount of $703.60 on December 29, 2008. When reviewing the electronic payments of New Day Products Inc.'s Wells Fargo checking account, the Team also found electronic payments for the same amount to Nissan Motor on 10/31/2008 but found no payments to Nissan Motors from Nancy John's Wells Fargo account for her personal vehicle. The team also noted that New Day Products was not purchasing a vehicle for New Day Products Inc. The Team also found that these payments form New Day Products Inc. were not include in Nancy John's payroll.
The above example of analytical procedures was mirrored for each transaction for the "Wells Fargo General Checking" electronic payments listed in Table - A3.
These accounts, (New Day Products Wells Fargo General Checking account) were only reviewed from July 2008 to September 2009 due to the finding limitations set by New Day Products. The Team believes these additional transaction not reviewed are at high risk of asset misappropriation.
The transaction listed in Table - A3, as "Citizens Community Bank" are direct transfers traced from New Day Products Inc.'s Citizen Community Bank to the personal Citizens Community bank account of Nancy John. These transfers were not included in Nancy John's W-2.
These transactions reported in Table - A3 were electronic payments or transfers and were used to pay personal debts including car payments, credit card payments and personal insurance payments.
New Day Products maintained three (3) separate Wells Fargo credit cards. These cards were assigned to three individual as follows:
1 - Rhonda Hinman, Director of Human Resources
2 - Nancy John, Executive Director
3 - Suzanne Richards, Production Manager
All three accounts were reviewed by pulling 3-4 statements throughout the period of the exam. We found suspicious transaction in the second account.
Due to the lack of suspicious transaction in the other accounts, the Team focused on the transaction reports for the second credit card account provided by New Day Products Inc.
Table - A4 represents personal transactions with the use of New Day Products Inc.'s second credit card.
All credit card statements for the second credit card from January 1, 2006 to February 28, 2010 were reviewed by Terry Fredrickson, new Day Products Inc.'s Executive Director as of March 2011. A list of personal transactions found on the business credit card was made based on the knowledge of Terry Fredrickson as to the type of transactions that would have been business appropriate and those which were for the personal reasons. This list was compiled by Suzanne Baker and provided to the Team.
The Team reviewed the list of items and matched up the personal transaction with the credit card statement. Where possible, invoices were traced to the credit card statement to verify the detail of the transaction was of a personal nature and not for the benefit of New Day Products, Inc.
One example of a personal credit card transaction that is included in table A2 includes two (2) Home Depot charges to the New Day Products, Inc. in the amount of $48.2l and $300.98 on 6/6/09 and 6/7/09. These receipts were found with the invoice provided by Marshall John (Nancy John's husband) for his labor and "materials" totaling $1,823.12. New Day Products, Inc. paid this invoices in full on 06/12/09 with check #G0195801. This resulted in New Day Products, Inc. paying twice for the same materials.
The Team questioned personal transactions which appeared to. be for gas or travel. The response was given that New Day Products, Inc. has gas cards which were provided to Nancy John to be used for business purposes. They also stated that some of the gas purchases were for diesel fuel and that they do not own any vehicles or machinery which require diesel fuel. The team reviewed the list of vehicles and owned by New Day Products Inc. and concurred that New Day Products Inc.'s vehicles did not require diesel. Additional travel expenses included airfare for other individuals not on New Day Products Inc.' s payroll. Various meals were purchased while in the Pocatello, Idaho and were, therefore, not for business travel purposes.
The transactions for "Cable One" bills were an additional bill not for the services of New Day Product. The Cable One invoices, for New Day Products, Inc. services received, were paid using the Citizens Community Bank general checking account. Therefore, all Cable One bills paid on the credit card were not for services provided to New Day Products Inc.
Other miscellaneous transactions were verified by vendor typ and information provided by the credit card statement.
Expert Answer:
