INTERNAL CONTROLS AND RED FLAGS OF FRAUD IN INFORMATION SYSTEMS AT LIBERTY BELL HOSPITAL (LBH)

When Downs interviewed Matt Harris, she found him to be personable, curious, and very eager to work at the hospital. Immediately, she hired him as a temporary accounts payable clerk without interviewing any other candidates. Since Harris was being hired as a temporary employee, he wasn't required to go through a background investigation; which was one of LBH's standard operating procedures for employees in sensitive positions (i.e. IT, Finance etc.). During a routine audit of the finance division, Alan Walters, Internal Audit Manager casually introduced himself to Matt Harris. When he discovered that Matt was Sharon Harris's son, he immediately researched the company's policies regarding nepotism. His research found that LBH's general administrative policies prohibited members of the same family from working in a sensitive department that would potentially impact the integrity or safekeeping of corporate assets or documents. The situation in the accounts payable department appeared to conflict with LBH's policies and was considered a red flag, indicating a situational environment which is conducive to a potential fraudulent act. Mr. Walters, therefore, decided to call this important issue to the attention of LBH's senior management.

Mr. Walters requested a meeting with James Smith, CFO to discuss the apparent nepotism issue in the accounts payable department. While Smith indicated that he was aware of the company's policy; he explained why he thought it was in the best interest of the hospital to keep Matt in this job. Walters explained this potential fraud environment to Smith who agreed that the situation was not ideal, but disagreed that Matt Harris be re-assigned to another department. Mr. Smith also felt this would not be acceptable since Sharon Harris, Matt's mother, had long been one of the most dedicated members of the accounts payable department, and had even won numerous Employee of the Month awards during her fifteen years of employment. LBH treated Matt Harris like it did any other independent contractor. LBH paid all of its contractors and suppliers through the accounts payable module of its financial information system. When a new vendor was identified it was set-up by either Tracy Downs, accounts payable manager, or Elinor Linz, assistant accounts payable manager, by updating the accounts payable master file with the necessary data to ensure timely and accurate processing. Tracy Downs was responsible for reviewing this data file each month for obsolete and inactive vendors, as well as overall data integrity issues (i.e. accuracy, completeness etc.)

During September 2002, within two months of working as an independent contractor, a vacancy developed in the department and Matt Harris was given the opportunity to apply for this permanent, full-time position. Although Matt was no longer an independent contractor, his accounts payable vendor file was not deleted by Tracy Downs or Elinor Linz. With the support of Steven Jones, Controller who commented about Matt's pleasant demeanor and cooperative attitude, Tracy Downs hired Matt again without interviewing anyone else or requesting a background investigation. At this time, Matt began to receive all fringe benefits (e.g. health insurance, vacation pay, disability insurance, etc.) and regular weekly pay checks; which were processed with all other employees using the PeopleSoft system.

FRAUD DISCOVERY

In January 2003, Tracy Downs returned from her annual Christmas holiday in Jamaica to discover some very unsettling information. As part of catching up on her work, Downs scanned the system generated Check Register Reports for the three weeks that she was on vacation. This review identified six cash disbursements totalling $80,000 that had been made to Matt Harris. Ms. Downs thought that these disbursements looked suspicious and immediately contacted Alan Walters, the company's Internal Audit Manager. At a meeting later that same day, Downs detailed the primary job responsibilities of Mr. Harris and his employment relationship.

Alan Walters began planning an information systems fraud investigation. Copies of relevant information system reports, cancelled checks from the hospital's bank, supporting cash disbursement authorization forms were analysed, and a thorough review of the accounts payable department's operating. procedures were initiated. Consistent with LBH's policies, members of the information systems, human resources and security departments were notified by the Internal Audit Manager that a possible fraud had occurred. This was to inform all management personnel about the potential disciplinary and legal ramifications.

Walters discovered that Matt Harris appeared to have forged six cash disbursement authorization forms which contained vendor invoice data (e.g. vendor name, vendor address, invoice number, and invoice amount). Harris then input the data contained on the fraudulent accounting forms into the accounts payable accounting module under his own vendor account. Furthermore, while Harris's supervisor was away on vacation, he was assigned responsibility for performing the semi[1]weekly cash disbursement run. Another key aspect of this fraud involved the printing and mailing of the physical checks to LBH's vendors. In order to accomplish this task, Matt was allowed access to the main safe where pre-signed checks were stored. It was LBH's standard operating procedure to require a second signature on all checks over $15,000. Matt was very savvy. In order to avoid creating suspicion by management, each of the individual checks he processed was for less than $15,000. At the conclusion of the fraud investigation, the preliminary results were discussed with the accounts payable manager, security director, vice-president for human resources and chief executive officer.

Matt Harris was now to be interrogated. Although all facts seemed clear, LBH desired to obtain a confession from Mr. Harris in addition to identifying a motive for the fraud. Mr. Harris was called at his desk and requested to go to a conference room for a meeting to discuss his employee benefits. Alan Walters, internal audit manager, and Theodore Block, security director, conducted the interrogation and presented Matt with the specific facts uncovered during the fraud investigation. Matt was visibly nervous when he entered the conference room. The following is an excerpt of this discussion:

Walters: Matt we called you to this meeting to discuss a very serious matter. I have conducted a fraud investigation surrounding six cash disbursements in your name.

Harris: I don't know what you mean.

Walters: It seems that when your supervisor, Ms. Downs was away on vacation you forged six accounting documents that generated checks to yourself.

Block: This is a serious matter and a fraudulent act like this is considered a felony crime in the State of Pennsylvania.

Walters: Our goal here is to confirm the facts and understand your reasons for perpetrating this fraud.

Harris: I want you to know.....I did this by myself......I am very ill and have over $50,000 in credit card bills that I incurred to pay for experimental drugs that may possibly cure me.

After a short period of silence Harris began to cry, and later confessed to the crime and explained that he was forced to steal from LBH because he was diagnosed with a terminal illness and had no personal assets or health insurance with which to pay for the treatments. Standard medical treatments had not been successful and experimental treatments, which were not Food and Drug Administration approved, were not available in the United States. Matt had to obtain treatments and medications in Mexico.

When questioned, once again, about the involvement of any other parties, and, in particular, his mother, Mr. Harris reiterated this fraud was solely his doing. He explained to Mr. Walter and Mr. Block how he had already spent the funds he had stolen and did not have a means to make repayment. Matt then signed a written confession, and was immediately suspended without pay.

Questions:

a. Briefly outline 4 factors that contributed to this opportunity to commit fraud.[5 marks]

b. Describe 3 breakdowns in internal control that could have been improved to prevent this fraud. [7 marks]

c. Other than Matt Harris, explain who else bears some responsibility for this fraud. [3 marks]

d. Briefly outline whether Alan Walters, the Internal Audit Manager did the right thing [2 marks]

e. Explain how general computer controls and application level controls could have helped prevent and detect this fraud