Copyright Institute of Internal
Auditors, Incorporated Oct 2000
| [Headnote] |
| Aligning employee performance goals with the
organization's overall objectives is becoming more popular. However,
unless carefully monitored, programs that link personal pay to
nonfinancial measurements can prove problematic.
|
THE COMPANY'S CHIEF AUDIT executive (CAE), Richard
Painter, joined the organization three years ago with a background in public
accounting. He appeared to be a competent and professional manager. He was
personable and friendly, and, most important to his staff, he presented himself
as a change agent.
Richard's predecessor had focused solely on financial
auditing, which limited the internal audit department's scope to straight
compliance work. The experienced members on staff had always felt that they
could provide much more value to management if the department adopted a modern
approach. Consequently, the internal auditors were ready to move on to more
meaningful business process review-they eagerly welcomed Richard's progressive
ideas and agreed with his suggestions for change.
Unfortunately, it soon became apparent to the
internal audit managers and staff that Richard was all style and no substance.
Although he made grandiose promises, more often than not they were empty ones.
Richard was manipulative and prone to favoritism when dealing with his
subordinates; he was even caught in numerous outright lies. Worse, he never
bothered to learn the difference between public accounting and internal
auditing.
Not too surprisingly, staff morale and trust began to
deteriorate quite rapidly, and turnover in the department became a problem.
Under Richard's management, though, audit project results improved dramatically,
despite these personnel problems. For example, substantial cost savings and
profit improvement opportunities began to appear in the audit reports. The
reason behind this seemingly incongruous result was simple: The remaining
staff-- those who had survived both Richards and his predecessor's regimes-knew
how to provide value-added internal audit services, and they were finally able
to do so.
However, the professional successes of this
determined audit department were short-lived. Richard followed the drop-- off in
staff members with additional personnel reductions, bringing the internal audit
staff complement to a new low level. He also made severe cuts to the internal
control work performed by his shop, shifting the department's focus to the more
glamorous internal consulting projects. These types of jobs produced the large
dollar savings that Richard liked to report to the company's audit committee and
senior management. The results-and monetary savings-were so impressive that
management failed to realize few other audit projects were being completed.
Michele Able and Kevin Griffin, both of whom served
under Richard as audit managers, were becoming frustrated and concerned. Their
feelings were echoed by Senior Auditor Charlie Justice, who requested that
Michele and Kevin meet with him one evening after work.
"I know Richard is my superior, but this situation
has gone too far," began Charlie. "Now he's deliberately hiding from the audit
committee the fact that we rarely perform internal control audits anymore. Our
authorized staffing level is far too low and we're not replacing vacancies as
they occur-we've virtually disbanded the IT staff. We're not fulfilling our
department's mission, and I'm afraid that the staff may suffer any
consequences."
Michele and Kevin were nodding in agreement.
"Charlie, we think you're absolutely correct and justified in your concerns,"
said Michele. "The two of us have even attempted to discuss these same issues
with Richard on several occasions. However, nothing changes. It's clear to us
that Richard is working on his own personal agenda. The question is, what can we
do about it?"
"By comparing notes, maybe we can figure out what
he's up to and why," Charlie suggested.
The three auditors began with what they knew: Richard
was engaged in significant distortions of fact to the point that he had
manipulated internal auditing's performance statistics. He had also disrupted
the internal audit process and schedule to further his own personal interests in
attention-getting consulting projects. As they discussed and debated the
situation in detail, Charlie, Michele, and Kevin came to several conclusions.
First, they realized that Richard had manipulated the
internal risk assessment process to avoid disclosing the appropriate level of
internal audit staff. He recommended to the audit committee an authorized
complement that totaled just 65 percent of the benchmark norm. When the
committee questioned these numbers, Richard told them, "Benchmarking indicates
that for our company's size and industry, we're right where we should be with
regard to staffing levels." He also cut back the department's IT group to a
quarter of its former size and began reporting audit projects that had no IT
relevance as "systems under development" audits in his annual reports. The
falsified reports led the audit committee to believe that audit coverage with
regard to technology issues had not been compromised despite staff cuts.
After further discussion Charlie, Michele, and Kevin
recognized that Richard had also distorted internal auditing's process
improvement achievements. For example, he overemphasized and exaggerated the
estimated dollar savings resulting from these consulting projects. Also, he
began to direct audit resources disproportionately to the projects with
potential for significant dollar savings so that these "process improvement"
projects began replacing internal audit assignments.
"It's just so frustrating," said Charlie. "Everyone
in our department clearly understands the distinction between internal
consulting and internal auditing. When we're acting as internal consultants, we
never address internal control considerations. But Richard refuses to
acknowledge this distinction. In all his reports to upper management and the
audit committee, he maintains the fiction that the internal consulting projects
also focus on internal controls. He's even begun to report these jobs as
`operational reviews' rather than `internal consulting projects' in our internal
audit activity reports."
"Richard is not an unintelligent person," said Kevin.
"Yet, he continues to ignore our repeated concerns and offers no reasonable
explanation for his actions. His mismanagement is so pronounced and his annual
reporting activity so distorted that I can only come to one conclusion: He must
be deriving some sort of personal financial benefit from the systematic
understaffing and overstatement of project dollar savings."
Charlie and Michele agreed, and the three auditors
formed what they called the "Trust Team" to begin a confidential fraud
investigation. As a first step, they contacted the human resources manager, John
Rivers, and found that they had an ally. John told the team that several
internal audit staff members had approached him to register official complaints
about the favoritism and personnel manipulation within their department. John
was as concerned about the dysfunctional personnel practices as the auditors
were about potential fraud.
After the Trust Team presented their hypothesis to
John, he provided them with a copy of the company's official CAE job
description, which included goals and objectives. Just as the auditors had
suspected, the CAE's goals were directly linked to incentive bonus payments and
salary raises. To make matters worse, Richards performance bonus was dependent
upon only two performance metrics: the extent to which he could cut costs from
the baseline audit budget and the annual dollar amounts that internal auditing
saved the other business units within the organization.
By manipulating the internal audit process and
schedule, as well as the internal audit department's reported savings, Richard
had achieved windfall-profit performance bonuses throughout his tenure. As a
result of the calculation and deceit evident in these practices, the auditors
considered Richard's actions to be de facto fraud.
For those involved in the investigation, the next
steps became clear. Michele, Kevin, and John met with senior management to
explain what had actually been occurring in the internal audit department.
Management determined that Richard could not continue in his current position.
Moreover, his lack of ethics and basic dishonesty effectively disqualified
Richard for any other position in the company. His employment was terminated.
LESSONS LEARNED
Every action has a reason behind it. When a
supervisor's decisions seem suspicious or unusual, consider investigating
possible ulterior motives behind those decisions. Often, rewards designed to
increase motivation, such as incentive compensation systems, provide the answer.
Poorly designed incentive plans may yield undesired
results. To mitigate the risks, ensure that care is taken in the design of the
plans so that they don't encourage dishonest or unethical behavior.
When you encounter blatant favoritism and
manipulation of staff, investigate the reasons behind these actions. Staff
manipulation in the form of pandering and "payoffs" can be a symptom of
underlying dishonest activity. In these cases, the individuals who abuse their
positions of power buy acquiescence by further manipulation of the rewards
system.
Fraud perpetrators can come in any shape, size, or
position. In this case, the person who seemed most unlikely to defraud the
company, the CAE, proved guilty.
Character and integrity are two of the most important
traits in strong, effective leaders. The executive who will sacrifice the
organization's reputation for personal gain lacks both.
Please send your fraud findings to: COURTENAY
THOMPSON & ASSOCIATES 10,000 North Central Expressway Suite 1006, Dallas, Tx
75231
+1 (214) 361-8346
Fax: +1 (214) 361-0632
E-mail: [email protected]
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