Manajemen | Fakultas Ekonomi Universitas Maritim Raja Ali Haji joeb.82.1.27-33
Journal of Education for Business
ISSN: 0883-2323 (Print) 1940-3356 (Online) Journal homepage: http://www.tandfonline.com/loi/vjeb20
Playing the Ponies: A $5 Million Embezzlement
Case
Martha A. Howe & Charles A. Malgwi
To cite this article: Martha A. Howe & Charles A. Malgwi (2006) Playing the Ponies: A $5
Million Embezzlement Case, Journal of Education for Business, 82:1, 27-33, DOI: 10.3200/
JOEB.82.1.27-33
To link to this article: http://dx.doi.org/10.3200/JOEB.82.1.27-33
Published online: 07 Aug 2010.
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Playing the Ponies:
A $5 Million Embezzlement Case
MARTHA A. HOWE
CHARLES A. MALGWI
BENTLEY COLLEGE
WALTHAM, MASSACHUSETTS
ABSTRACT. Fraud is a pervasive problem, and educating future business leaders,
managers, and auditors about fraud is one
way to attack the problem. This instructional fraud case chronicles the actual details
surrounding a major embezzlement at a
regional high school (RHS) that culminated
in long federal and state prison sentences
for the school’s treasurer. Names have been
changed, but otherwise the case is factual.
This case can be used in an auditing class
or a fraud examination class to help students understand the dynamics of financial
fraud, including identifying (a) the elements of the fraud triangle and the red flags
and internal control weaknesses that existed
in this situation, (b) the steps that could
have prevented the fraud, (c) the auditing
issues related to the fraud, (d) the investigation process, and (e) the resolution of fraud
through the justice system. Discussion
relating the case to these learning objectives
is included.
Keywords: auditing, embezzlement, fraud
Copyright © 2006 Heldref Publications
A
necdotal evidence of the prevalence of fraud abounds (e.g.,
Enron, WorldCom, Tyco). Rigorous statistical evidence is more difficult to
obtain, partly because of the very nature
of fraud as a hidden crime, but existing
studies do suggest that fraud is extremely costly in the American economy.
Probably the most comprehensive data
comes from the Association of Certified
Fraud Examiners (ACFE; 2002) via its
periodic survey of its members. On the
basis of the most recent survey data, the
ACFE (2004) stimates that annual losses from fraud, on average, cost 6% of
the firm’s revenues. Extrapolating from
that estimate, the ACFE further states
that the cost of fraud for the U.S. economy as a whole may approach $660 billion per year (ACFE, 2004).
The recent wave of corporate frauds
in the United States has attracted the
attention of the American public, various regulatory agencies and associations, and the government. Responses
include calls for more extensive review
and documentation of corporations’
internal controls, improved corporate
governance, and expanded training of
corporate managers and external auditors. The Sarbanes-Oxley Act of 2002
was enacted to address some of these
concerns, as was SAS 99, an auditing
statement titled “Consideration of Fraud
in a Financial Statement Audit” (American Institute of Certified Public
Accountants [AICPA], 2002). This
statement offers a list of red flags that
may signify fraudulent financial reporting (AICPA). However, one has to
understand what fraud looks like before
one can identify it and instructional
fraud cases are highly recommended as
a means of gaining that understanding
(Albrecht, Wernz, & Williams, 1995;
Wells, 2000).
Although fraud occurs in not-forprofit settings as well as corporate settings, many of the existing instructional
fraud cases relate mainly to corporations rather than to public or governmental entities (Beasley, Buckless,
Glover, & Prawitt, 2003; Boocholdt,
2000; Calderon, Conrad, & Green,
2000). In addition, many relate to fraud
in the financial statements, which tends
to be a more costly fraud that receives
more publicity, but is far less prevalent
than employee fraud, such as embezzlement (Bondy, 1998; Wells, 1997, 2000).
“Playing the Ponies” chronicles an
exceptionally large ($5 million) embezzlement involving a public school system (RHS). Despite governmental oversight of the school system through
normal regulatory processes in the state,
the fraud nevertheless continued for
many years before it was detected. The
case allows instructors to focus students’ attention on normal audit and
fraud examination issues, as well as the
issues that are unique to public entities.
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Instructional Objectives
This case (see Appendix) was initially
developed as a result of interest generated by a fraud examination course’s students and guest speakers. The case lends
itself to use in either a fraud examination
course or an auditing course. Students
are exposed to a real fraud situation,
including information about the actual
investigative and judicial processes.
Instructional objectives are to enhance
students’ ability to (a) understand and
apply the fraud triangle concept, (b)
identify red flags in a potentially fraudulent situation, (c) identify internal control weaknesses that contributed to the
fraud and identify appropriate steps to
remedy these weaknesses, (d) understand and research applicable auditing
standards and procedures, especially in
the regulated environment of a school
district, and (e) understand the investigative and judicial processes that are relevant to a fraud case.
Learning Objectives
Objective 1: Understand and Apply the
Fraud Triangle Concept
The fraud triangle concept was developed by sociologist and criminologist
Donald Cressey (Cressey, 1973). It
posits the idea that fraud is unlikely to
occur in the absence of the three elements of the fraud triangle (i.e., “perceived opportunity,” “perceived pressure,” and “rationalization”), and fraud
becomes relatively more or less likely
depending on the strength of the elements (Albrecht, 2003). Perceived pressure, such as financial or economic
need, provides the motivation for fraud.
Perceived opportunity may be the result
of poor or nonexistent internal controls
that give access to perpetrators, whereas
rationalization allows perpetrators to
adjust their perceptions of what they are
doing (Cressey).
According to Cressey (1973), fraud
can occur when individuals who are in a
position of trust perceive themselves as
having nonshareable financial pressure
and eventually come to believe that the
pressure can be resolved through the
violation of their financial trust. One of
the most fundamental observations of
Cressey’s study was that it took all three
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Journal of Education for Business
elements or conditions of the fraud triangle for the trust violation to occur. At
the base of the fraud triangle is a financial pressure or incentive to steal. This
pressure is not limited by income, net
worth, or a lack of the same. When the
pressure builds up, it isolates the affected employee, who begins to internalize
the pressure rather than sharing it with
colleagues. As a result, the employee
looks for opportunities to commit financial fraud to relieve the pressure. The
individual then goes through a process
of rationalization and learns to justify
the theft. Therefore, the bridge between
pressure and opportunity takes its shape
when one is able to rationalize the
fraudulent behavior.
In the RHS case, Philip Chartier clearly had abundant opportunity, meaning
that pressure and rationalization could
be relatively low and the likelihood of
fraud would still be reasonably high. In
addition, Chartier also had fairly high
levels of perceived pressure, which contributed to the strong likelihood of fraud.
The three elements of the fraud triangle,
as they pertain to Philip Chartier, are discussed in the next sections.
Perceived Opportunities
To be able to perpetrate a fraud as
extensive as the RHS embezzlement, a
complete knowledge of the system in
which the organization operated was
required. Chartier worked with the
school district for 26 years, sufficient
time for him to have thoroughly mastered
the operation of RHS’s financial systems.
However, Simon Dorman, the superintendent who was Chartier’s boss, was relatively new to RHS and probably was not
fully aware of the workings of the system. Although highly knowledgeable
about education, it is also possible that
neither Simon Dorman nor the members
of the school board were particularly
knowledgeable about accounting, leaving
them unable to make independent judgments about Chartier’s performance.
With his long-standing service and
dedication to RHS, Chartier had earned
the trust of his boss and the school
board and was allowed to handle virtually all aspects of RHS’s financial operations, with little or no oversight. The
lack of internal controls, as discussed
later in Objective 3, contributed to the
ease with which Chartier perpetrated
this fraud. All of these factors undoubtedly contributed to his apparent belief
that he could embezzle without detection, and, in fact, he was able to do so
for many years.
Perceived Pressure
Probably the greatest pressure that
Chartier faced was the result of his
reported addiction to gambling and his
related expenditures on horseracing and
other sports. Even aside from any gambling that might have been occurring,
the capital required to purchase and
maintain his large stable of racehorses
was certainly far beyond what his salary
at RHS would support. Chartier also
had a strong and expensive interest in
other sports. He was a season ticket
holder for a major league football team,
and he often went to the Super Bowl.
His sports memorabilia business may
also have furthered his interest in sports
and possibly in sports betting.
Chartier was under the normal pressures of a family man, including raising
and educating his three sons. His salary
was probably adequate to maintain his
family responsibilities, but not sufficient to allow for many frills. Although
Chartier did not openly display an
ostentatious lifestyle to his colleagues at
RHS or to his neighbors, in his other life
as a racehorse owner and sports fan he
may have felt some financial pressure to
improve his lifestyle. In addition to his
own house, he owned a house for his
mother, a cottage on the ocean in Maine,
and a condo in Florida. He had large
amounts of cash on hand at his home,
perhaps either for gambling purposes or
to live up to the image of a big spender.
Once the fraud was under way, the
fraud itself exerted pressure on Chartier.
Over the years, Chartier was forced to
continually juggle the books and find
even larger fraudulent sources of funds,
while at the same time concealing the
increasing magnitude of the fraud.
Rationalization
Chartier made no public statements
about the case, and we can only guess at
the rationalizations he employed. It is
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possible that he felt that he had been
with the school system long enough to
deserve better treatment than his salary
and title supplied. Because he had such
extensive control over the financial systems at RHS, he perhaps thought of the
school as his own private business. He
may have felt that it was all right to take
the funds because his bosses were not
competent enough to detect the fraud.
As he juggled funds and rolled over
loans, he also may have rationalized that
no one was being hurt because he was
able to cover the shortfall and keep the
school running properly. He may even
have told himself that he would repay
his embezzled funds in the future.
Objective 2: Understand What Red Flags
Are and Be Able to Identify Them in a
Given Situation
Red flags often exist in documentation, so Chartier tried to ensure that no
one else had reason to check RHS’s
accounting books and detailed records.
Had anyone ever looked at the bank
statement or check register for various
RHS accounts, and particularly for the
student activity accounts, the number of
checks made out to and endorsed by
Philip Chartier would have been an
immediate red flag. In addition, the lack
of supporting documentation for those
checks would have raised strong suspicions. In fact, if anyone had examined
the student activities account at all, the
sheer size of the balances and the excessive volume of activity in that account
would have demanded instant attention.
A review of RHS’ loan documentation
undoubtedly would also have raised
questions, as Chartier continuously
rolled over the short-term loans. In
essence, they became permanent
sources of funding, with no real authorization from the school board.
Another clear source of red flags is
weak or missing internal controls. The
lack of effective internal controls at RHS,
as discussed in detail later in Objective 3,
contributed greatly to Chartier’s opportunity to commit the fraud.
Red flags can also be related to
lifestyle cues. Chartier was apparently
fairly successful at hiding his lifestyle
from his colleagues at RHS. They may
not have been aware of his extensive
real estate holdings and probably did
not know that he owned a stable of racehorses. Still, had his coworkers been
attuned to it, it seems likely that some
hint of his extensive interests in gambling, horseracing, and sports probably
existed.
Objective 3: Identify Internal Control
Weaknesses and Understand How They
Could Have Been Remedied
Chartier was successful in carrying
out the fraud for a long period of time
before it was detected because of the
poor control structure in place at RHS.
There are basically three elements of the
control structure that are relevant in this
case (a) the control environment, (b) the
accounting system, and (c) the control
procedures or activities. The control
environment is the atmosphere in which
individuals in the organization carry out
their various functions, and it stems
from management’s role and example.
When management begins to model
unacceptable behavior, it often leads to
an ineffective control environment
(Albrecht, 2003). As the supervisor to
whom Chartier was accountable, the
superintendent of RHS was negligent
and irresponsible. The RHS clerical
employees certainly could have shed
some light on Chartier’s activities but
did not do so, probably due to poor
communication between the superintendent and these employees. The school
board similarly failed in its responsibilities by allowing Chartier to handle all
financial matters without ever demanding clear records and appropriate documentation from him. It seems likely that
the State Department of Education
(SDOE) was also remiss in its review of
RHS’s audit and loan activities. The low
level of upper-level scrutiny, combined
with the weak internal controls, was a
clear invitation for fraud at RHS.
The accounting system at RHS was,
in theory, in accordance with the model
established by the State Board of Education. What was not in order, of course,
was the process related to the accounting system. The school board and the
superintendent both share the blame for
not ensuring the proper functioning of
the system.
The control procedures and activities
at RHS were also a problem. Chartier
performed a number of incompatible
functions of custody and record keeping, which clearly violated the basic
principles of segregation of duties. For
example, he was entrusted with exclusive control of RHS’s operating
accounts and RHS’s student activity
account. He also had custody of RHS’s
checkbooks, allowing him to make systematic transfers to himself. Chartier
also reconciled the bank statements
with RHS’s books, a function that
should have been performed by an independent person who had no authority to
write checks, make bank deposits, or
execute transfers between accounts.
There was no system of authorization
in place at RHS. Consequently, Chartier
did not have limits on his authority and
did not need approval to handle any
aspect of RHS’s finances. For example,
he was the main signatory for most of
the checks that RHS issued and was
apparently the sole signatory for the
transfers he executed. He was also in
charge of negotiating loans and had the
authority to handle all aspects of RHS’s
financing without any required
approvals or secondary signatures from
the superintendent or the board. Therefore, Chartier was able to extend and
roll over short-term revenue anticipation
loans to cover the shortfall of funds as a
result of his embezzlement.
Lack of an audit trail was also a factor in this case because Chartier
destroyed both the bank statements as
well as the returned checks for the student activities account. The absence of
these crucial documents made it unlikely that anyone in the RHS business
office would notice what was occurring.
It is not clear whether Chartier was
actually authorized to hire the auditor
for RHS’s books, or whether he simply
overstepped his authority, but it is obvious that no one else, including the
school board, took any responsibility
for the audit. There was no attempt at
communication with the auditor by anyone other than Chartier, allowing
Chartier to completely fabricate the
existence of the auditor and the audit.
Thus, the multiple functions performed by Chartier were not checked or
verified in any way—not by an auditor,
his boss, or the school board. In addition, Chartier did not take vacations,
and he made sure that he completed his
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29
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duties himself, even if it required long
hours at the office. With no effective
oversight, there was no brake on Chartier’s activities, and he was able to
embezzle increasingly larger amounts
over a period of many years.
To improve the controls and strengthen fraud prevention at RHS, Simon Dorman and the school board should have
taken steps to split up Chartier’s duties.
Other remedies that should have been
implemented include the establishing of
dollar limitations on Chartier’s checksigning authority, requiring second any
signatures on bank transfers, mandating
board approval for all loans, and specifying that auditors be selected by and
monitored by the Board—all are common sense internal controls that were
absent at RHS, but would have prevented Chartier’s embezzlement had they
been in place.
Another preventative measure is to
reduce pressures on employees. Chartier was apparently in the grip of a gambling addiction and financial problems,
both of which can be addressed by an
Employee Assistance Program. In addition, open communication between
management and employees can be
effective in allowing employees an outlet to discuss their problems, while also
alerting management to any potential
problem areas.
Management also needs to ensure that
employees will not be able to easily
rationalize committing fraud. Effective
measures include establishing a clear
ethics policy that all employees are
directed to read and discuss periodically,
stressing the responsibility that all
employees have to detect and report
fraud, and clearly specifying that all
fraud perpetrators will be subject to
criminal prosecution. Establishing a hotline can also be effective, particularly if
employees (such as those who reported
to Chartier) are able to anonymously
express their concerns about possible
fraud to a third party (Malone, 2004).
The Sarbanes-Oxley Act of 2002,
although it directly applies to corporate
entities rather than not-for-profit entities
like RHS, is still relevant in its goals for
improving internal controls. Some of
the relevant goals are to (a) upgrade
reporting disclosures, (b) strengthen
governance, (c) increase enforcement
30
Journal of Education for Business
and oversight, (d) broaden penalties,
and (e) heighten external auditor independence. Section 404 of the SarbanesOxley Act (2002) suggests that entities
should implement quarterly updates,
and monitor, evaluate, and perform corrective actions. These would require
entities to (a) assess changes in the
processes, the systems, and the business
environment and review the impact of
these changes on controls; (b) validate
continuing operational effectiveness of
controls by testing their operations; and
(c) push control consciousness and
responsibility to operating personnel.
Control self assessment (CSA) is particularly required as an ongoing process
in all entities (for profit and not-forprofit). CSA is a process by which every
department of an entity, with assistance
from internal audit, assesses the adequacy of their internal controls and identifies opportunities for improvement. Had
these steps been taken by RHS, the
weakness of the internal controls would
undoubtedly have been recognized and
corrected, and Chartier’s embezzlement
would not have been possible.
Objective 4: Understand and Research
Applicable Auditing Standards and Procedures, Especially in the Regulated
Environment of a School District
As governmental units, school districts are audited under Generally
Accepted Government Auditing Standards (GAGAS; Comptroller General of
the United States, 1972). Several similarities exist between GAGAS and SAS
99 (AICPA, 2002) as they pertain to
fraudulent activities. Although reference to specific state laws and regulations for various governmental entity
audits is recommended, GAGAS generally contains standards for audits of
government organizations, programs,
activities, and functions. GAGAS
requires that the audit be designed to
provide reasonable assurance of detecting material misstatements resulting
from noncompliance. Also of significance, GAGAS provides internal control evaluation standards that call for the
following: (a) established of internal
controls to ensure compliance with
applicable laws and regulations; (b)
mandated tests of controls to evaluate
the effectiveness of the design and operation of the controls in preventing or
detecting material noncompliance; and
(c) formal written reports regarding the
internal controls and the assessment of
control risks.
Going beyond GAGAS, SAS 99
(AICPA, 2002), Consideration of Fraud
in a Financial Statement Audit, not only
requires auditors to be reasonably sure
that financial statements are free of
material misstatements, whether caused
by error or fraud, but it also gives them
focused and clarified guidance on meeting their responsibilities to uncover
fraud (Brickner & Pearson, 2003).
Reminiscent of the three sides of the
renowned fraud triangle (perceived
opportunity, pressure, and rationalization), SAS 99 typically refers to incentive or pressures, opportunities, and attitudes or rationalizations. Like GAGAS,
SAS 99 specifies procedures the auditor
should perform, including making
inquiry of management and others
about risks of fraud. Management
should be questioned about their awareness of fraud or allegations of fraud;
their understanding of the entity’s fraud
risks, including any specific risks identified; their programs and controls that
they have implemented to prevent,
deter, and detect fraud, including how
they monitor the performance of these
programs and controls; their monitoring
of multiple locations or business segments; and their communications to
employees about business practices and
ethical behavior.
Different states further regulate
school districts in different ways, but
most states have some form of regulation that may be similar to that governing RHS. In terms of the specific regulations that applied in this case, in
which the RHS fraud occurred has an
Audit and Compliance Unit (ACU) that
manages and coordinates all financial
and compliance audit functions for the
SDOE. This unit also serves as liaison
for the department with state, federal,
and independent auditors. The SDOE
requires every school, as part of a general audit, to have the financial statements independently audited by a public accounting firm. The audit is to be
based on the compliance requirements,
audit objectives, and suggested audit
procedures contained in the compliance
supplement for the state school districts.
Further, the auditor is directed to comply with the professional standards
included in Standards for Audit of Governmental Organizations, Programs,
Activities and Functions Adopted by the
Comptroller General of the United
States in the Conduct of the Audit
(Comptroller General of the United
States, 1972).
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Objective 5: Understand the Relevant
Judicial and Investigative Processes
Criminal law involves a wrong
against society. It is based on statutes
and the remedies include incarceration
as well as fines. Because the sentence
can include prison time, guilt must be
agreed upon unanimously at trial, and
the standard is beyond a reasonable
doubt. By contrast, guilt in a civil law
case is based on the more easily met
standard of preponderance of evidence. Chartier was prosecuted criminally because his crime went far
beyond a civil offense against one individual or organization. Although it is
harder to prove guilt in a criminal trial
than in a civil trial, there was ample
evidence in this case, and the egregious nature of the fraud made criminal prosecution and a prison sentence
the appropriate alternative.
Prosecution for fraud is often pursued
through state-level courts because most
of the statutes dealing with fraud reside
at the state level. However, larger frauds
may end up in federal court, either
because they cross state lines or because
they run afoul of federal statutes, such
as tax or money laundering statutes
(Albrecht, 2003). In Chartier’s case,
prosecution proceeded at both the state
and the federal level, because statutes
that were applicable to the fraud existed
at both levels.
Federal law enforcement authorities
(i.e., the Internal Revenue Service [IRS]
and the Federal Bureau of Investigation
[FBI]) and state law enforcement
authorities (state police and state auditor’s office) worked together in their
investigation of Chartier’s fraud. This is
an efficient and effective way to quickly
marshal strong evidence against a fraud
perpetrator. In this case, investigators
probably primarily relied on documentary evidence, buttressed by testimonial
evidence retrieved via interviews of
Chartier’s colleagues at RHS and in the
racing business.
A federal search warrant is issued by
a federal judge or magistrate on the
basis of evidence of probable cause presented in an affidavit (IRS, 1998). Using
this warrant, the federal agents were
able to search Chartier’s house for evidence of the embezzlement, including
evidence of assets and expenditures that
may have been related to the embezzled
funds. Within the limits of the search
warrant, they were able to confiscate
pertinent evidence. Most of the evidence recovered in the search of Chartier’s residence was probably documentary in nature, although physical
evidence may also have been obtained.
Based on the evidence amassed, the
next step is an indictment, which is a
finding that probable cause exists to
arrest and charge the suspect. In the RHS
fraud, federal prosecutors received an
indictment in the fall of 2000 on one
count of embezzlement and five counts
of federal tax evasion. The state indictment was for 123 counts of larceny in
excess of $250, and three counts of filing
false state tax returns. Chartier probably
knew that the evidence was overwhelming, and he pleaded guilty to the federal
charges in January of 2001, about a year
after the fraud was first detected.
Sentencing for federal crimes is based
on relatively strict sentencing guidelines
and prisoners generally serve their entire
sentences. Sentencing at the state level is
more variable, and prisoners can be
released early based on good behavior.
Sentences on various charges can run
consecutively, meaning that the sentence
for one crime has to be served in full
before starting the sentence for another.
Alternatively, the sentences can run concurrently, meaning that sentences for all
offenses are satisfied at the same time, as
was true in Chartier’s case.
Conclusion
Use of instructional fraud cases in
business courses can better prepare
future managers and auditors for situations that they are likely to face at some
point in their careers. The RHS case
provides students with factual details
from a large fraud that occurred in a
not-for-profit setting, thus highlighting
issues unique to public entities. The
case allows students to gain experience
in identifying red flags and internal control weaknesses, and to improve their
understanding of investigative methods
and the processes of the justice system.
NOTES
The authors gratefully acknowledge many helpful comments by workshop participants at Bentley
College, two anonymous reviewers, and participants at the annual American Accounting Association, Northeast Region meeting as well as Ron
Huefner, Jim Hunton, Jay Thibodeau, David
Schwarzkopf, Priscilla Burnaby, and Mahendra
Gujarathi. They are grateful to their students for
their assistance with this case. They are also
indebted to several professionals who spoke to the
class and whose enthusiasm prompted their interest in developing this instructional case.
Correspondence concerning this article should
be addressed to Dr. Martha Howe, Senior Lecturer, Bentley College, 175 Forest Street, Waltham,
MA 02452-4705.
E-mail: mhowe@Bentley.edu
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Cressey, D. R. (1973). Other people’s money.
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Malone, T. (2004). Best practices for ethics hotlines. The White Paper, 18, 38–41.
Sarbanes-Oxley Act of 2002. Pub. L. No.
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Wells, J. T. (1997). Occupational fraud and abuse.
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APPENDIX
Case Study
Setting the Stage
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The regional high school (hereinafter RHS), located at the summit of a hill, offers
breath-taking views of the surrounding towns that it serves. In this seemingly unlikely
setting, a major fraud was perpetrated, starting prior to 1995 and ending with its detection in January of 2000.
RHS is a vocational high school that serves seven towns and enrolls about 1,000 students. Calvin Lucette was the superintendent during the late 80s and early 90s, followed
by Simon Dorman, who is the current superintendent. Philip Chartier was hired in the
mid-70s as the assistant superintendent for business, and was promoted to treasurer and
business manager in 1990. The remaining business staff consisted of several clerical
workers, supervised by Philip Chartier.
At some point in the late 80s, Chartier became very involved in a sports memorabilia business that he owned with a friend, Eugene Youmans. The business quickly grew
and was apparently lucrative. The staff at RHS was fully aware of the existence of this
side business. In fact, Calvin Lucette, Chartier’s boss at the time, complained about the
amount of time that Chartier was spending on the sports memorabilia business to the
detriment of his RHS responsibilities. By the time Lucette left the superintendent job
and was replaced by Simon Dorman in 1992, Chartier and Youmans had cut back significantly on their sports memorabilia business because of the increased level of competition that made the business less profitable.
Without the distraction of the sports business, Chartier worked hard at RHS. He put in
long hours and took vacations only when the entire office was shut down. He is variously
described as being well liked by the staff, and alternatively, as being disliked and difficult
to work for. In the 1990s, Chartier was handling virtually all aspects of the business end of
the high school, including overseeing the expenditures from RHS’ general funds, making
deposits, reconciling bank statements, authorizing payments to suppliers, acting as a signatory for all checks issued by RHS, making funds transfers, arranging and signing for
short-term loans, preparing the school budgets, maintaining student activities accounts,
arranging for regulatory reports and audits, and receiving federal and state funds. Simon
Dorman, Chartier’s boss, depended heavily on him and trusted him completely.
By January 2000, when everything fell apart for him, Chartier was 47 years old, married, and had three sons. He appeared to live modestly, drove an old car, and splurged
on tickets to his favorite team’s professional football games. He owned his house and
another one nearby in which his mother resided. Active in his community, at various
times Chartier coached Little League, chaired the School Board Committee, and
worked as a volunteer firefighter. He earned about $75,000 a year in his RHS position,
and he also ran a tax preparation business in his spare time.
These were the facts as colleagues at RHS and neighbors in Chartier’s hometown
knew them, but by 1997, there was another side to Chartier. At racetracks up and down
the East Coast, he was known as a partner in a large and very successful stable of racehorses. However, those who knew Chartier from horseracing were not familiar with his
modest lifestyle and his job at RHS. The rumors among the racing set were that he had
won the lottery or had inherited a great deal of money.
The Fraud Is Detected
In January 2000, Chartier drove to a local bank branch and attempted to cash an RHS
check drawn on the student activity account and made payable to himself. Unfortunately for him, the teller had worked in another branch of the bank and remembered
Chartier cashing similar checks at that branch. The teller brought the situation to the
attention of the branch manager and a quick review showed that Chartier had cashed
other RHS checks at other branches over the past few days. Chartier’s boss at RHS,
Simon Dorman, was notified that same day. By the end of January, Chartier had
resigned from his job at RHS.
The Investigation and Its Results
A forensic accounting firm was contacted and the firm quickly began its efforts to
uncover the true status of RHS’ financial situation. As it became apparent that a major fraud
had occurred, authorities from the state police, the state auditor’s office, the Federal Bureau
of Investigation, and the Internal Revenue Service joined the investigation. In June of 2000,
a federal search warrant was executed at Chartier’s residence and at his mother’s house.
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Journal of Education for Business
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APPENDIX—Continued
The investigation found that the embezzlement probably began in about 1993, and
final tallies of the amounts taken came to $5,465,000. It was the largest embezzlement
of school funds ever in the entire state. Chartier wrote more than 1,900 checks to himself during the 5-year period preceding the detection of the fraud. All were drawn on the
student activity fund, over which he had complete control. Chartier also maintained the
bank statements; he destroyed those as well as the returned checks for the student activities account so that his cashed checks would not be discovered by anyone in the RHS
business office.
Although the student activities account would not normally have maintained large
cash balances, between 1993 and January 2000 Chartier continuously and systematically moved funds totaling $6,435,494 from the school’s operating accounts into the
student activity fund. He then covered the shortfalls in the operating accounts by rolling
over or taking out new short-term revenue anticipation loans. These loans were meant
only to cover short-term needs, but they became a permanent and growing source of
funds for Chartier’s increasing involvement in his horseracing stable.
The investigation also found that Chartier prepared fictitious audits of RHS’ financial
statements from 1993 on, using samples from other school districts and from prior
years. He forged the name of a Certified Public Accountant (CPA) who had done legitimate work for RHS in previous years, and submitted the phony audits and other regulatory paperwork to the State Department of Education and the Department of Revenue.
It is interesting that the CPA whose name Chartier forged was the daughter of Chartier’s old friend and former business partner in the sports memorabilia business, Eugene
Youmans.
The investigators were able to document a lifestyle that Chartier had kept quiet from
his colleagues and his community. In addition to the two houses that he owned in his
town, Chartier also owned a cottage on the ocean and a condo near a Florida racetrack.
He had season tickets to a professional football team’s games, and he often attended
Super Bowl games, but his largest investment was C & P Stables, which he owned with
a partner. At the time the fraud was detected, C & P owned at least 40 racehorses. From
about 1997 on, the stable was a major player at several second-tier racetracks on the
East Coast, with 1999 winnings totaling more than $400,000 from two of those racetracks. Chartier also gambled on horses and sports, and his attorney would later claim
that he suffered from an addiction to gambling.
The Resolution
Both state and federal officials were involved in the investigation, and both brought
charges against Chartier. In August and September of 2000, Chartier was indicted in
state court on 123 counts of larceny in excess of $250, and three counts of filing false
state tax returns. Later that fall, he was indicted in federal court on one count of embezzlement and five counts of tax evasion. Over the period of 1994–1998, he allegedly
omitted $3,976,328 from his reported gross income.
On January 9, 2001, Chartier pleaded guilty to the federal charges of embezzlement
and tax evasion. On September 10, 2001, he was sentenced to 4 years and 9 months in
federal prison, and ordered to pay restitution of $5.4 million to RHS. On February 9,
2002, he pleaded guilty to the state charges, and was sentenced to 7–10 years, to run
concurrently with the federal sentence. Chartier negotiated to serve the bulk of his sentence in federal prison. Thus, only the last 27 months of his state sentence would be
served in state prison, after he served his federal sentence of 57 months in federal
prison. Chartier is currently at Fort Dix federal prison in New Jersey.
Chartier forfeited his condo in Florida and his seaside cottage in Maine, which were
sold by authorities and netted $492,000. Also forfeited were his pickup truck, $15,500 in
cash that was found during the search of his property, and the proceeds (about $250,000)
from the sale of 11 horses belonging to C & P Stables. What remained of his portion of
the sports memorabilia business was also claimed and sold off by federal officials.
In all, $918,612 was recouped and returned to RHS by authorities. Once out of
prison, Chartier will remain responsible for repayment of his debt to RHS. On the brink
of bankruptcy because of the fraud, RHS has survived because of a special clearance
passed by the state legislature allowing the district to borrow up to $5 million.
September/October 2006
33
ISSN: 0883-2323 (Print) 1940-3356 (Online) Journal homepage: http://www.tandfonline.com/loi/vjeb20
Playing the Ponies: A $5 Million Embezzlement
Case
Martha A. Howe & Charles A. Malgwi
To cite this article: Martha A. Howe & Charles A. Malgwi (2006) Playing the Ponies: A $5
Million Embezzlement Case, Journal of Education for Business, 82:1, 27-33, DOI: 10.3200/
JOEB.82.1.27-33
To link to this article: http://dx.doi.org/10.3200/JOEB.82.1.27-33
Published online: 07 Aug 2010.
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Playing the Ponies:
A $5 Million Embezzlement Case
MARTHA A. HOWE
CHARLES A. MALGWI
BENTLEY COLLEGE
WALTHAM, MASSACHUSETTS
ABSTRACT. Fraud is a pervasive problem, and educating future business leaders,
managers, and auditors about fraud is one
way to attack the problem. This instructional fraud case chronicles the actual details
surrounding a major embezzlement at a
regional high school (RHS) that culminated
in long federal and state prison sentences
for the school’s treasurer. Names have been
changed, but otherwise the case is factual.
This case can be used in an auditing class
or a fraud examination class to help students understand the dynamics of financial
fraud, including identifying (a) the elements of the fraud triangle and the red flags
and internal control weaknesses that existed
in this situation, (b) the steps that could
have prevented the fraud, (c) the auditing
issues related to the fraud, (d) the investigation process, and (e) the resolution of fraud
through the justice system. Discussion
relating the case to these learning objectives
is included.
Keywords: auditing, embezzlement, fraud
Copyright © 2006 Heldref Publications
A
necdotal evidence of the prevalence of fraud abounds (e.g.,
Enron, WorldCom, Tyco). Rigorous statistical evidence is more difficult to
obtain, partly because of the very nature
of fraud as a hidden crime, but existing
studies do suggest that fraud is extremely costly in the American economy.
Probably the most comprehensive data
comes from the Association of Certified
Fraud Examiners (ACFE; 2002) via its
periodic survey of its members. On the
basis of the most recent survey data, the
ACFE (2004) stimates that annual losses from fraud, on average, cost 6% of
the firm’s revenues. Extrapolating from
that estimate, the ACFE further states
that the cost of fraud for the U.S. economy as a whole may approach $660 billion per year (ACFE, 2004).
The recent wave of corporate frauds
in the United States has attracted the
attention of the American public, various regulatory agencies and associations, and the government. Responses
include calls for more extensive review
and documentation of corporations’
internal controls, improved corporate
governance, and expanded training of
corporate managers and external auditors. The Sarbanes-Oxley Act of 2002
was enacted to address some of these
concerns, as was SAS 99, an auditing
statement titled “Consideration of Fraud
in a Financial Statement Audit” (American Institute of Certified Public
Accountants [AICPA], 2002). This
statement offers a list of red flags that
may signify fraudulent financial reporting (AICPA). However, one has to
understand what fraud looks like before
one can identify it and instructional
fraud cases are highly recommended as
a means of gaining that understanding
(Albrecht, Wernz, & Williams, 1995;
Wells, 2000).
Although fraud occurs in not-forprofit settings as well as corporate settings, many of the existing instructional
fraud cases relate mainly to corporations rather than to public or governmental entities (Beasley, Buckless,
Glover, & Prawitt, 2003; Boocholdt,
2000; Calderon, Conrad, & Green,
2000). In addition, many relate to fraud
in the financial statements, which tends
to be a more costly fraud that receives
more publicity, but is far less prevalent
than employee fraud, such as embezzlement (Bondy, 1998; Wells, 1997, 2000).
“Playing the Ponies” chronicles an
exceptionally large ($5 million) embezzlement involving a public school system (RHS). Despite governmental oversight of the school system through
normal regulatory processes in the state,
the fraud nevertheless continued for
many years before it was detected. The
case allows instructors to focus students’ attention on normal audit and
fraud examination issues, as well as the
issues that are unique to public entities.
September/October 2006
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Instructional Objectives
This case (see Appendix) was initially
developed as a result of interest generated by a fraud examination course’s students and guest speakers. The case lends
itself to use in either a fraud examination
course or an auditing course. Students
are exposed to a real fraud situation,
including information about the actual
investigative and judicial processes.
Instructional objectives are to enhance
students’ ability to (a) understand and
apply the fraud triangle concept, (b)
identify red flags in a potentially fraudulent situation, (c) identify internal control weaknesses that contributed to the
fraud and identify appropriate steps to
remedy these weaknesses, (d) understand and research applicable auditing
standards and procedures, especially in
the regulated environment of a school
district, and (e) understand the investigative and judicial processes that are relevant to a fraud case.
Learning Objectives
Objective 1: Understand and Apply the
Fraud Triangle Concept
The fraud triangle concept was developed by sociologist and criminologist
Donald Cressey (Cressey, 1973). It
posits the idea that fraud is unlikely to
occur in the absence of the three elements of the fraud triangle (i.e., “perceived opportunity,” “perceived pressure,” and “rationalization”), and fraud
becomes relatively more or less likely
depending on the strength of the elements (Albrecht, 2003). Perceived pressure, such as financial or economic
need, provides the motivation for fraud.
Perceived opportunity may be the result
of poor or nonexistent internal controls
that give access to perpetrators, whereas
rationalization allows perpetrators to
adjust their perceptions of what they are
doing (Cressey).
According to Cressey (1973), fraud
can occur when individuals who are in a
position of trust perceive themselves as
having nonshareable financial pressure
and eventually come to believe that the
pressure can be resolved through the
violation of their financial trust. One of
the most fundamental observations of
Cressey’s study was that it took all three
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Journal of Education for Business
elements or conditions of the fraud triangle for the trust violation to occur. At
the base of the fraud triangle is a financial pressure or incentive to steal. This
pressure is not limited by income, net
worth, or a lack of the same. When the
pressure builds up, it isolates the affected employee, who begins to internalize
the pressure rather than sharing it with
colleagues. As a result, the employee
looks for opportunities to commit financial fraud to relieve the pressure. The
individual then goes through a process
of rationalization and learns to justify
the theft. Therefore, the bridge between
pressure and opportunity takes its shape
when one is able to rationalize the
fraudulent behavior.
In the RHS case, Philip Chartier clearly had abundant opportunity, meaning
that pressure and rationalization could
be relatively low and the likelihood of
fraud would still be reasonably high. In
addition, Chartier also had fairly high
levels of perceived pressure, which contributed to the strong likelihood of fraud.
The three elements of the fraud triangle,
as they pertain to Philip Chartier, are discussed in the next sections.
Perceived Opportunities
To be able to perpetrate a fraud as
extensive as the RHS embezzlement, a
complete knowledge of the system in
which the organization operated was
required. Chartier worked with the
school district for 26 years, sufficient
time for him to have thoroughly mastered
the operation of RHS’s financial systems.
However, Simon Dorman, the superintendent who was Chartier’s boss, was relatively new to RHS and probably was not
fully aware of the workings of the system. Although highly knowledgeable
about education, it is also possible that
neither Simon Dorman nor the members
of the school board were particularly
knowledgeable about accounting, leaving
them unable to make independent judgments about Chartier’s performance.
With his long-standing service and
dedication to RHS, Chartier had earned
the trust of his boss and the school
board and was allowed to handle virtually all aspects of RHS’s financial operations, with little or no oversight. The
lack of internal controls, as discussed
later in Objective 3, contributed to the
ease with which Chartier perpetrated
this fraud. All of these factors undoubtedly contributed to his apparent belief
that he could embezzle without detection, and, in fact, he was able to do so
for many years.
Perceived Pressure
Probably the greatest pressure that
Chartier faced was the result of his
reported addiction to gambling and his
related expenditures on horseracing and
other sports. Even aside from any gambling that might have been occurring,
the capital required to purchase and
maintain his large stable of racehorses
was certainly far beyond what his salary
at RHS would support. Chartier also
had a strong and expensive interest in
other sports. He was a season ticket
holder for a major league football team,
and he often went to the Super Bowl.
His sports memorabilia business may
also have furthered his interest in sports
and possibly in sports betting.
Chartier was under the normal pressures of a family man, including raising
and educating his three sons. His salary
was probably adequate to maintain his
family responsibilities, but not sufficient to allow for many frills. Although
Chartier did not openly display an
ostentatious lifestyle to his colleagues at
RHS or to his neighbors, in his other life
as a racehorse owner and sports fan he
may have felt some financial pressure to
improve his lifestyle. In addition to his
own house, he owned a house for his
mother, a cottage on the ocean in Maine,
and a condo in Florida. He had large
amounts of cash on hand at his home,
perhaps either for gambling purposes or
to live up to the image of a big spender.
Once the fraud was under way, the
fraud itself exerted pressure on Chartier.
Over the years, Chartier was forced to
continually juggle the books and find
even larger fraudulent sources of funds,
while at the same time concealing the
increasing magnitude of the fraud.
Rationalization
Chartier made no public statements
about the case, and we can only guess at
the rationalizations he employed. It is
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possible that he felt that he had been
with the school system long enough to
deserve better treatment than his salary
and title supplied. Because he had such
extensive control over the financial systems at RHS, he perhaps thought of the
school as his own private business. He
may have felt that it was all right to take
the funds because his bosses were not
competent enough to detect the fraud.
As he juggled funds and rolled over
loans, he also may have rationalized that
no one was being hurt because he was
able to cover the shortfall and keep the
school running properly. He may even
have told himself that he would repay
his embezzled funds in the future.
Objective 2: Understand What Red Flags
Are and Be Able to Identify Them in a
Given Situation
Red flags often exist in documentation, so Chartier tried to ensure that no
one else had reason to check RHS’s
accounting books and detailed records.
Had anyone ever looked at the bank
statement or check register for various
RHS accounts, and particularly for the
student activity accounts, the number of
checks made out to and endorsed by
Philip Chartier would have been an
immediate red flag. In addition, the lack
of supporting documentation for those
checks would have raised strong suspicions. In fact, if anyone had examined
the student activities account at all, the
sheer size of the balances and the excessive volume of activity in that account
would have demanded instant attention.
A review of RHS’ loan documentation
undoubtedly would also have raised
questions, as Chartier continuously
rolled over the short-term loans. In
essence, they became permanent
sources of funding, with no real authorization from the school board.
Another clear source of red flags is
weak or missing internal controls. The
lack of effective internal controls at RHS,
as discussed in detail later in Objective 3,
contributed greatly to Chartier’s opportunity to commit the fraud.
Red flags can also be related to
lifestyle cues. Chartier was apparently
fairly successful at hiding his lifestyle
from his colleagues at RHS. They may
not have been aware of his extensive
real estate holdings and probably did
not know that he owned a stable of racehorses. Still, had his coworkers been
attuned to it, it seems likely that some
hint of his extensive interests in gambling, horseracing, and sports probably
existed.
Objective 3: Identify Internal Control
Weaknesses and Understand How They
Could Have Been Remedied
Chartier was successful in carrying
out the fraud for a long period of time
before it was detected because of the
poor control structure in place at RHS.
There are basically three elements of the
control structure that are relevant in this
case (a) the control environment, (b) the
accounting system, and (c) the control
procedures or activities. The control
environment is the atmosphere in which
individuals in the organization carry out
their various functions, and it stems
from management’s role and example.
When management begins to model
unacceptable behavior, it often leads to
an ineffective control environment
(Albrecht, 2003). As the supervisor to
whom Chartier was accountable, the
superintendent of RHS was negligent
and irresponsible. The RHS clerical
employees certainly could have shed
some light on Chartier’s activities but
did not do so, probably due to poor
communication between the superintendent and these employees. The school
board similarly failed in its responsibilities by allowing Chartier to handle all
financial matters without ever demanding clear records and appropriate documentation from him. It seems likely that
the State Department of Education
(SDOE) was also remiss in its review of
RHS’s audit and loan activities. The low
level of upper-level scrutiny, combined
with the weak internal controls, was a
clear invitation for fraud at RHS.
The accounting system at RHS was,
in theory, in accordance with the model
established by the State Board of Education. What was not in order, of course,
was the process related to the accounting system. The school board and the
superintendent both share the blame for
not ensuring the proper functioning of
the system.
The control procedures and activities
at RHS were also a problem. Chartier
performed a number of incompatible
functions of custody and record keeping, which clearly violated the basic
principles of segregation of duties. For
example, he was entrusted with exclusive control of RHS’s operating
accounts and RHS’s student activity
account. He also had custody of RHS’s
checkbooks, allowing him to make systematic transfers to himself. Chartier
also reconciled the bank statements
with RHS’s books, a function that
should have been performed by an independent person who had no authority to
write checks, make bank deposits, or
execute transfers between accounts.
There was no system of authorization
in place at RHS. Consequently, Chartier
did not have limits on his authority and
did not need approval to handle any
aspect of RHS’s finances. For example,
he was the main signatory for most of
the checks that RHS issued and was
apparently the sole signatory for the
transfers he executed. He was also in
charge of negotiating loans and had the
authority to handle all aspects of RHS’s
financing without any required
approvals or secondary signatures from
the superintendent or the board. Therefore, Chartier was able to extend and
roll over short-term revenue anticipation
loans to cover the shortfall of funds as a
result of his embezzlement.
Lack of an audit trail was also a factor in this case because Chartier
destroyed both the bank statements as
well as the returned checks for the student activities account. The absence of
these crucial documents made it unlikely that anyone in the RHS business
office would notice what was occurring.
It is not clear whether Chartier was
actually authorized to hire the auditor
for RHS’s books, or whether he simply
overstepped his authority, but it is obvious that no one else, including the
school board, took any responsibility
for the audit. There was no attempt at
communication with the auditor by anyone other than Chartier, allowing
Chartier to completely fabricate the
existence of the auditor and the audit.
Thus, the multiple functions performed by Chartier were not checked or
verified in any way—not by an auditor,
his boss, or the school board. In addition, Chartier did not take vacations,
and he made sure that he completed his
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duties himself, even if it required long
hours at the office. With no effective
oversight, there was no brake on Chartier’s activities, and he was able to
embezzle increasingly larger amounts
over a period of many years.
To improve the controls and strengthen fraud prevention at RHS, Simon Dorman and the school board should have
taken steps to split up Chartier’s duties.
Other remedies that should have been
implemented include the establishing of
dollar limitations on Chartier’s checksigning authority, requiring second any
signatures on bank transfers, mandating
board approval for all loans, and specifying that auditors be selected by and
monitored by the Board—all are common sense internal controls that were
absent at RHS, but would have prevented Chartier’s embezzlement had they
been in place.
Another preventative measure is to
reduce pressures on employees. Chartier was apparently in the grip of a gambling addiction and financial problems,
both of which can be addressed by an
Employee Assistance Program. In addition, open communication between
management and employees can be
effective in allowing employees an outlet to discuss their problems, while also
alerting management to any potential
problem areas.
Management also needs to ensure that
employees will not be able to easily
rationalize committing fraud. Effective
measures include establishing a clear
ethics policy that all employees are
directed to read and discuss periodically,
stressing the responsibility that all
employees have to detect and report
fraud, and clearly specifying that all
fraud perpetrators will be subject to
criminal prosecution. Establishing a hotline can also be effective, particularly if
employees (such as those who reported
to Chartier) are able to anonymously
express their concerns about possible
fraud to a third party (Malone, 2004).
The Sarbanes-Oxley Act of 2002,
although it directly applies to corporate
entities rather than not-for-profit entities
like RHS, is still relevant in its goals for
improving internal controls. Some of
the relevant goals are to (a) upgrade
reporting disclosures, (b) strengthen
governance, (c) increase enforcement
30
Journal of Education for Business
and oversight, (d) broaden penalties,
and (e) heighten external auditor independence. Section 404 of the SarbanesOxley Act (2002) suggests that entities
should implement quarterly updates,
and monitor, evaluate, and perform corrective actions. These would require
entities to (a) assess changes in the
processes, the systems, and the business
environment and review the impact of
these changes on controls; (b) validate
continuing operational effectiveness of
controls by testing their operations; and
(c) push control consciousness and
responsibility to operating personnel.
Control self assessment (CSA) is particularly required as an ongoing process
in all entities (for profit and not-forprofit). CSA is a process by which every
department of an entity, with assistance
from internal audit, assesses the adequacy of their internal controls and identifies opportunities for improvement. Had
these steps been taken by RHS, the
weakness of the internal controls would
undoubtedly have been recognized and
corrected, and Chartier’s embezzlement
would not have been possible.
Objective 4: Understand and Research
Applicable Auditing Standards and Procedures, Especially in the Regulated
Environment of a School District
As governmental units, school districts are audited under Generally
Accepted Government Auditing Standards (GAGAS; Comptroller General of
the United States, 1972). Several similarities exist between GAGAS and SAS
99 (AICPA, 2002) as they pertain to
fraudulent activities. Although reference to specific state laws and regulations for various governmental entity
audits is recommended, GAGAS generally contains standards for audits of
government organizations, programs,
activities, and functions. GAGAS
requires that the audit be designed to
provide reasonable assurance of detecting material misstatements resulting
from noncompliance. Also of significance, GAGAS provides internal control evaluation standards that call for the
following: (a) established of internal
controls to ensure compliance with
applicable laws and regulations; (b)
mandated tests of controls to evaluate
the effectiveness of the design and operation of the controls in preventing or
detecting material noncompliance; and
(c) formal written reports regarding the
internal controls and the assessment of
control risks.
Going beyond GAGAS, SAS 99
(AICPA, 2002), Consideration of Fraud
in a Financial Statement Audit, not only
requires auditors to be reasonably sure
that financial statements are free of
material misstatements, whether caused
by error or fraud, but it also gives them
focused and clarified guidance on meeting their responsibilities to uncover
fraud (Brickner & Pearson, 2003).
Reminiscent of the three sides of the
renowned fraud triangle (perceived
opportunity, pressure, and rationalization), SAS 99 typically refers to incentive or pressures, opportunities, and attitudes or rationalizations. Like GAGAS,
SAS 99 specifies procedures the auditor
should perform, including making
inquiry of management and others
about risks of fraud. Management
should be questioned about their awareness of fraud or allegations of fraud;
their understanding of the entity’s fraud
risks, including any specific risks identified; their programs and controls that
they have implemented to prevent,
deter, and detect fraud, including how
they monitor the performance of these
programs and controls; their monitoring
of multiple locations or business segments; and their communications to
employees about business practices and
ethical behavior.
Different states further regulate
school districts in different ways, but
most states have some form of regulation that may be similar to that governing RHS. In terms of the specific regulations that applied in this case, in
which the RHS fraud occurred has an
Audit and Compliance Unit (ACU) that
manages and coordinates all financial
and compliance audit functions for the
SDOE. This unit also serves as liaison
for the department with state, federal,
and independent auditors. The SDOE
requires every school, as part of a general audit, to have the financial statements independently audited by a public accounting firm. The audit is to be
based on the compliance requirements,
audit objectives, and suggested audit
procedures contained in the compliance
supplement for the state school districts.
Further, the auditor is directed to comply with the professional standards
included in Standards for Audit of Governmental Organizations, Programs,
Activities and Functions Adopted by the
Comptroller General of the United
States in the Conduct of the Audit
(Comptroller General of the United
States, 1972).
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Objective 5: Understand the Relevant
Judicial and Investigative Processes
Criminal law involves a wrong
against society. It is based on statutes
and the remedies include incarceration
as well as fines. Because the sentence
can include prison time, guilt must be
agreed upon unanimously at trial, and
the standard is beyond a reasonable
doubt. By contrast, guilt in a civil law
case is based on the more easily met
standard of preponderance of evidence. Chartier was prosecuted criminally because his crime went far
beyond a civil offense against one individual or organization. Although it is
harder to prove guilt in a criminal trial
than in a civil trial, there was ample
evidence in this case, and the egregious nature of the fraud made criminal prosecution and a prison sentence
the appropriate alternative.
Prosecution for fraud is often pursued
through state-level courts because most
of the statutes dealing with fraud reside
at the state level. However, larger frauds
may end up in federal court, either
because they cross state lines or because
they run afoul of federal statutes, such
as tax or money laundering statutes
(Albrecht, 2003). In Chartier’s case,
prosecution proceeded at both the state
and the federal level, because statutes
that were applicable to the fraud existed
at both levels.
Federal law enforcement authorities
(i.e., the Internal Revenue Service [IRS]
and the Federal Bureau of Investigation
[FBI]) and state law enforcement
authorities (state police and state auditor’s office) worked together in their
investigation of Chartier’s fraud. This is
an efficient and effective way to quickly
marshal strong evidence against a fraud
perpetrator. In this case, investigators
probably primarily relied on documentary evidence, buttressed by testimonial
evidence retrieved via interviews of
Chartier’s colleagues at RHS and in the
racing business.
A federal search warrant is issued by
a federal judge or magistrate on the
basis of evidence of probable cause presented in an affidavit (IRS, 1998). Using
this warrant, the federal agents were
able to search Chartier’s house for evidence of the embezzlement, including
evidence of assets and expenditures that
may have been related to the embezzled
funds. Within the limits of the search
warrant, they were able to confiscate
pertinent evidence. Most of the evidence recovered in the search of Chartier’s residence was probably documentary in nature, although physical
evidence may also have been obtained.
Based on the evidence amassed, the
next step is an indictment, which is a
finding that probable cause exists to
arrest and charge the suspect. In the RHS
fraud, federal prosecutors received an
indictment in the fall of 2000 on one
count of embezzlement and five counts
of federal tax evasion. The state indictment was for 123 counts of larceny in
excess of $250, and three counts of filing
false state tax returns. Chartier probably
knew that the evidence was overwhelming, and he pleaded guilty to the federal
charges in January of 2001, about a year
after the fraud was first detected.
Sentencing for federal crimes is based
on relatively strict sentencing guidelines
and prisoners generally serve their entire
sentences. Sentencing at the state level is
more variable, and prisoners can be
released early based on good behavior.
Sentences on various charges can run
consecutively, meaning that the sentence
for one crime has to be served in full
before starting the sentence for another.
Alternatively, the sentences can run concurrently, meaning that sentences for all
offenses are satisfied at the same time, as
was true in Chartier’s case.
Conclusion
Use of instructional fraud cases in
business courses can better prepare
future managers and auditors for situations that they are likely to face at some
point in their careers. The RHS case
provides students with factual details
from a large fraud that occurred in a
not-for-profit setting, thus highlighting
issues unique to public entities. The
case allows students to gain experience
in identifying red flags and internal control weaknesses, and to improve their
understanding of investigative methods
and the processes of the justice system.
NOTES
The authors gratefully acknowledge many helpful comments by workshop participants at Bentley
College, two anonymous reviewers, and participants at the annual American Accounting Association, Northeast Region meeting as well as Ron
Huefner, Jim Hunton, Jay Thibodeau, David
Schwarzkopf, Priscilla Burnaby, and Mahendra
Gujarathi. They are grateful to their students for
their assistance with this case. They are also
indebted to several professionals who spoke to the
class and whose enthusiasm prompted their interest in developing this instructional case.
Correspondence concerning this article should
be addressed to Dr. Martha Howe, Senior Lecturer, Bentley College, 175 Forest Street, Waltham,
MA 02452-4705.
E-mail: mhowe@Bentley.edu
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York: Southwestern.
Albrecht, W., Wernz, G., & Williams, T. (1995).
Fraud: Bringing light to the dark side of business. Burr Ridge, IL: Richard D. Irwin.
American Institute of Certified Public Accountants. (2002). Consideration of fraud in a financial statement audit. Statement on auditing
standards no. 99. New York: Author.
Association of Certified Fraud Examiners. (2002).
Report to the nation on occupational fraud and
abuse. Austin, TX: Author.
Association of Certified Fraud Examiners. (2004).
2004 report to the nation on occupational fraud
and abuse. Austin, TX: Author.
Beasley, M., Buckless, F., Glover, S., & Prawitt,
D. (2003). Auditing cases: An active learning
approach (2nd ed.). Upper Saddle River, NJ:
Prentice-Hall.
Boocholdt, J. (2000). Comptronix, Inc.: An audit
case involving fraud. Issues in Accounting Education, 15, 105–128.
Bondy, C. (1998). Fraud’s changing dynamic: Is
SAS 82 the protection against fraud that auditors have been waiting for, an added burden of
responsibility, or both? Outlook, 65, 11–16.
Brickner, D., & Pearson, M. (2003). SAS 99:
Another implement for the fraud examiner’s
toolbox. The White Paper, 17, 31–33, 41–42.
Calderon, T., Conrad, E., & Green, B. (2000).
Qualitative analytical procedures and management fraud: The case of the Regina Company.
The Journal of Accounting Case Research, 5,
163–174.
Comptroller General of the United States. (1972).
Standards for audit of government organizations, programs, activities and functions. Washington, DC: U.S. General Accounting Office.
Cressey, D. R. (1973). Other people’s money.
Montclair, NJ: Patterson Smith.
Internal Revenue Service Criminal Investigation
Division. (1998). Financial investigations: A
financial approach to detecting and resolving
crimes. Washington, DC: U.S. Government
Printing Office.
September/October 2006
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Malone, T. (2004). Best practices for ethics hotlines. The White Paper, 18, 38–41.
Sarbanes-Oxley Act of 2002. Pub. L. No.
107–204, §404 (2002).
Wells, J. T. (1997). Occupational fraud and abuse.
Austin, TX: Obsidian.
Wells, J. T. (2000). So that’s why it’s called a
pyramid scheme. Journal of Accountancy, 190,
91–95.
APPENDIX
Case Study
Setting the Stage
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The regional high school (hereinafter RHS), located at the summit of a hill, offers
breath-taking views of the surrounding towns that it serves. In this seemingly unlikely
setting, a major fraud was perpetrated, starting prior to 1995 and ending with its detection in January of 2000.
RHS is a vocational high school that serves seven towns and enrolls about 1,000 students. Calvin Lucette was the superintendent during the late 80s and early 90s, followed
by Simon Dorman, who is the current superintendent. Philip Chartier was hired in the
mid-70s as the assistant superintendent for business, and was promoted to treasurer and
business manager in 1990. The remaining business staff consisted of several clerical
workers, supervised by Philip Chartier.
At some point in the late 80s, Chartier became very involved in a sports memorabilia business that he owned with a friend, Eugene Youmans. The business quickly grew
and was apparently lucrative. The staff at RHS was fully aware of the existence of this
side business. In fact, Calvin Lucette, Chartier’s boss at the time, complained about the
amount of time that Chartier was spending on the sports memorabilia business to the
detriment of his RHS responsibilities. By the time Lucette left the superintendent job
and was replaced by Simon Dorman in 1992, Chartier and Youmans had cut back significantly on their sports memorabilia business because of the increased level of competition that made the business less profitable.
Without the distraction of the sports business, Chartier worked hard at RHS. He put in
long hours and took vacations only when the entire office was shut down. He is variously
described as being well liked by the staff, and alternatively, as being disliked and difficult
to work for. In the 1990s, Chartier was handling virtually all aspects of the business end of
the high school, including overseeing the expenditures from RHS’ general funds, making
deposits, reconciling bank statements, authorizing payments to suppliers, acting as a signatory for all checks issued by RHS, making funds transfers, arranging and signing for
short-term loans, preparing the school budgets, maintaining student activities accounts,
arranging for regulatory reports and audits, and receiving federal and state funds. Simon
Dorman, Chartier’s boss, depended heavily on him and trusted him completely.
By January 2000, when everything fell apart for him, Chartier was 47 years old, married, and had three sons. He appeared to live modestly, drove an old car, and splurged
on tickets to his favorite team’s professional football games. He owned his house and
another one nearby in which his mother resided. Active in his community, at various
times Chartier coached Little League, chaired the School Board Committee, and
worked as a volunteer firefighter. He earned about $75,000 a year in his RHS position,
and he also ran a tax preparation business in his spare time.
These were the facts as colleagues at RHS and neighbors in Chartier’s hometown
knew them, but by 1997, there was another side to Chartier. At racetracks up and down
the East Coast, he was known as a partner in a large and very successful stable of racehorses. However, those who knew Chartier from horseracing were not familiar with his
modest lifestyle and his job at RHS. The rumors among the racing set were that he had
won the lottery or had inherited a great deal of money.
The Fraud Is Detected
In January 2000, Chartier drove to a local bank branch and attempted to cash an RHS
check drawn on the student activity account and made payable to himself. Unfortunately for him, the teller had worked in another branch of the bank and remembered
Chartier cashing similar checks at that branch. The teller brought the situation to the
attention of the branch manager and a quick review showed that Chartier had cashed
other RHS checks at other branches over the past few days. Chartier’s boss at RHS,
Simon Dorman, was notified that same day. By the end of January, Chartier had
resigned from his job at RHS.
The Investigation and Its Results
A forensic accounting firm was contacted and the firm quickly began its efforts to
uncover the true status of RHS’ financial situation. As it became apparent that a major fraud
had occurred, authorities from the state police, the state auditor’s office, the Federal Bureau
of Investigation, and the Internal Revenue Service joined the investigation. In June of 2000,
a federal search warrant was executed at Chartier’s residence and at his mother’s house.
32
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APPENDIX—Continued
The investigation found that the embezzlement probably began in about 1993, and
final tallies of the amounts taken came to $5,465,000. It was the largest embezzlement
of school funds ever in the entire state. Chartier wrote more than 1,900 checks to himself during the 5-year period preceding the detection of the fraud. All were drawn on the
student activity fund, over which he had complete control. Chartier also maintained the
bank statements; he destroyed those as well as the returned checks for the student activities account so that his cashed checks would not be discovered by anyone in the RHS
business office.
Although the student activities account would not normally have maintained large
cash balances, between 1993 and January 2000 Chartier continuously and systematically moved funds totaling $6,435,494 from the school’s operating accounts into the
student activity fund. He then covered the shortfalls in the operating accounts by rolling
over or taking out new short-term revenue anticipation loans. These loans were meant
only to cover short-term needs, but they became a permanent and growing source of
funds for Chartier’s increasing involvement in his horseracing stable.
The investigation also found that Chartier prepared fictitious audits of RHS’ financial
statements from 1993 on, using samples from other school districts and from prior
years. He forged the name of a Certified Public Accountant (CPA) who had done legitimate work for RHS in previous years, and submitted the phony audits and other regulatory paperwork to the State Department of Education and the Department of Revenue.
It is interesting that the CPA whose name Chartier forged was the daughter of Chartier’s old friend and former business partner in the sports memorabilia business, Eugene
Youmans.
The investigators were able to document a lifestyle that Chartier had kept quiet from
his colleagues and his community. In addition to the two houses that he owned in his
town, Chartier also owned a cottage on the ocean and a condo near a Florida racetrack.
He had season tickets to a professional football team’s games, and he often attended
Super Bowl games, but his largest investment was C & P Stables, which he owned with
a partner. At the time the fraud was detected, C & P owned at least 40 racehorses. From
about 1997 on, the stable was a major player at several second-tier racetracks on the
East Coast, with 1999 winnings totaling more than $400,000 from two of those racetracks. Chartier also gambled on horses and sports, and his attorney would later claim
that he suffered from an addiction to gambling.
The Resolution
Both state and federal officials were involved in the investigation, and both brought
charges against Chartier. In August and September of 2000, Chartier was indicted in
state court on 123 counts of larceny in excess of $250, and three counts of filing false
state tax returns. Later that fall, he was indicted in federal court on one count of embezzlement and five counts of tax evasion. Over the period of 1994–1998, he allegedly
omitted $3,976,328 from his reported gross income.
On January 9, 2001, Chartier pleaded guilty to the federal charges of embezzlement
and tax evasion. On September 10, 2001, he was sentenced to 4 years and 9 months in
federal prison, and ordered to pay restitution of $5.4 million to RHS. On February 9,
2002, he pleaded guilty to the state charges, and was sentenced to 7–10 years, to run
concurrently with the federal sentence. Chartier negotiated to serve the bulk of his sentence in federal prison. Thus, only the last 27 months of his state sentence would be
served in state prison, after he served his federal sentence of 57 months in federal
prison. Chartier is currently at Fort Dix federal prison in New Jersey.
Chartier forfeited his condo in Florida and his seaside cottage in Maine, which were
sold by authorities and netted $492,000. Also forfeited were his pickup truck, $15,500 in
cash that was found during the search of his property, and the proceeds (about $250,000)
from the sale of 11 horses belonging to C & P Stables. What remained of his portion of
the sports memorabilia business was also claimed and sold off by federal officials.
In all, $918,612 was recouped and returned to RHS by authorities. Once out of
prison, Chartier will remain responsible for repayment of his debt to RHS. On the brink
of bankruptcy because of the fraud, RHS has survived because of a special clearance
passed by the state legislature allowing the district to borrow up to $5 million.
September/October 2006
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