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Exploiting a Position of Trust

A trusted vendor, a longtime business associate, or a close friend; we all have them and rely on them.  When a close friend or business associate does the unexpected and violates a trust, the hurt cuts to the heart. Seemingly, there is no real way to stop the pain as it stays with you, at least in the back of your mind. You may even call yourself into question –“I should have known better” or “How did I miss this?” No one likes getting burned, but the impact is far greater when the opportunist is a trusted individual who you depend on in business.

Vendors hold a unique position in our business lives. They provide necessary services to our companies, deliver goods, and depending on the length of their relationships, sometimes become part of the family. This, at times, leads us into a false sense of security not only regarding the quality and pricing of those goods and services, but also the integrity of the vendor.

How can this false sense of security be prevented? Is there anything we can do to avoid or prevent a violation of trust? One way is to ensure transparency in our business relationships. Do you really know who you are doing business with or have you fallen asleep at the wheel because the particular vendor “assists at all hours of the day or night” or “employs the go to people that get the job done?”

According to the Association of Certified Fraud Examiners’ 2014 Report to the Nations, approximately 5% of a company’s gross revenues are lost to fraud annually.  While clearly this does not only encompass vendor related fraud, decision making may be impacted by identifying undisclosed relationships of vendors. Employing preventative measures to uncover “what you don’t know” may mitigate the hurt associated with an exploitation of trust.

This was the case with Valeant Pharmaceuticals International and its initially undisclosed captive pharmacy Philidor. Valeant was a darling of Wall Street. Hedge funds and “smart money”, piled into the stock as the company’s revenue skyrocketed. It was seemingly all based on a new business model. The company developed a strategy to create a drug giant that focused on distribution and let someone else do the research. The plan was, of course, controversial and required rapid acquisitions to make it work. Valeant became one of the hottest healthcare stocks in recent years by buying other firms’ medicines and then swiftly hiking their prices by as much as 500%.

However, allegations began to surface that Valeant’s true success may have been built on not only price gouging, but a secret network of specialty pharmacies, and fraud. In fact, the Southern Investigative Reporting Foundation was the first to detail the odd ties between Valeant and a rapidly growing specialty pharmacy that appeared to be controlled by Valeant, Philidor.  Interestingly, the relationship had never been disclosed to Valeant shareholders An investigation by the Wall Street Journal further discovered that Valeant employees were frequently involved with the operations at Philidor and used fake aliases including those of comic book characters, like Peter Parker, to hide their identities.

In fact, it wasn’t until later, on one of Valeant’s conference calls, that the company first disclosed it had purchased Philidor for $100 million. It later acted to cut its ties to Philidor and subsequently disclosed that the pharmacy would shut down immediately. However, by this point the stock had fallen from a high of $260 per share to about $90! Highlighting yet another example of how what you don’t know can and will hurt you.

So what do you do to protect your company and the reputation of its directors and officers? Knowing all you can about who you are doing business with is a great place to start. Do they have undisclosed relationships with any other company, other vendors already existing in your company’s vendor master file, your employees, or other key stakeholders? Do your vendors’ officers have criminal records, are their business licenses active and in good standing, have you checked them against sanctioned listings such as Office of Inspector General (OIG) or Excluded Parties Listing (EPLS)? Are there pending lawsuits or liens against them?

A robust on-boarding process coupled with proper training of line staff in both payroll and accounts payable departments is essential. Things to consider include:

  • Avoid potential conflicts of interest and identify undisclosed relationships through a thorough vendor credentialing process. This will ensure that your company is comfortable with the vendors they are doing business with. This can be accomplished through a system such as VETTED®. As part of this credentialing process vendors should be required to disclose any and all ownership interest they have in other organizations. All such disclosures should be thoroughly investigated. Note: Vendors could be charged a nominal fee to offset incremental costs of credentialing vendors or pay directly to the third party provider, effectively, resulting in a zero cost solution.
  • Require all employees, especially those in key decision making positions, to sign a conflict of interest statement requiring them to disclose any and all relationships they may have with businesses and/or individuals; including any relevant investments.
  • Validate all new and existing vendors to the IRS website. Ensure that all vendors are legitimate, have valid FEIN’s. No vendor should be approved/added without a properly completed W9 and valid FEIN.
  •  Identify and remove all duplicate vendors.
  • Have one department assigned the responsibility to on-board vendors. A single point of entry for on-boarding of vendors is not only a best practice it also affords you a systematic review of the vendor master file in order to minimize duplicates and/or errors.
  • Develop a standard naming convention to be used in the vendor setup process as a means of avoiding duplicate vendors.
  • Limit access to the vendor master file to the same department assigned the responsibility of on-boarding vendors.
  • Develop appropriate segregation of duties between vendor setup in the system and the review and approval of that setup.
  • Only a limited group of approved individuals should be allowed to add, modify, or in any other way change or adjust vendor data. A log should be maintained of all modifications and reviewed by an independent manager.
  • A complete review should be made of all vendors in the accounts payable database with specific attention to vendor address. Duplicates and those with different names but sharing the same address should be investigated thoroughly.
  • If a vendor has multiple remit to addresses, setup one vendor (as opposed to multiple vendors) with multiple remittance addresses.
  • Remove all employees from the accounts payable master file and process expense reimbursements through payroll as an Employee Expense Reimbursement (EER).
  • Any vendor with no activity for the preceding 15 months should be de-activated.
  • Periodically and systematically review and compare vendor, employee, and other related data (i.e. physicians, professors, students, dependents, beneficiaries, etc.) in an effort to identify duplicates, errors, irregularities, and anomalies. Note: This can be accomplished via a service like that offered by Database Queries®. Findings should be communicated to the appropriate level of management and a corrective action plan should be developed, implemented, and reviewed.
  • Require all vendors to do regular background checks of all their employees and subcontractors that have access your data and/or facilities.

Vendors are trusted business partners. They are often familiar with confidential and strategic plans for your company. In many cases, they have access to personal identifiable information (yours and/or your client’s) and/or key operating systems.

Once a fraudulent vendor gets into your system, it is like a Trojan horse or computer virus that upon release could cause havoc. Losses due to misappropriations may cost companies hundreds of thousands if not millions of dollars; not to mention loss of reputation, future revenue, and/or career potential for those at the helm.

Our experience shows that well intentioned and highly educated managers, even in effective and excellently controlled environments, can often leave themselves and their organizations vulnerable to fraudulent vendors. They simply don’t know what they don’t know; a blind spot that can really hurt you and your organization!

Written by Joseph M. Palmar, CPA, CFE, CFF. Palmar is a Partner at Goldstein Schechter Koch and provides forensic accounting and litigation services for emerging businesses to Fortune 500 companies. For assistance in this service area, Palmar can be reached at joseph.palmar@gskadvisors.com.


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Stealing in Plain Sight: Know Thy Vendors…

Miami is known for many things — natural beauty, beautiful people, great weather and South Beach. That aside, it is also the fraud capital, not only in terms of Medicare and Medicaid, but in mortgage fraud, identity theft, and potentially in the area of vendor fraud.

Often I have found that fraud discussions and seminars seem to relate to the aforementioned. I have attended many seminars and no one focuses on what I believe is the most crucial potential for fraud that exists — approved vendors sitting in vendor master files.  These are vendors you use every day, many who are legitimate and provide excellent and timely services. However, when I ask financial or supply chain managers about the number of active vendors they have or what they know about their vendors’ potential undisclosed relationships and related conflicts, I typically get the “deer in the headlights” stare or an off the cuff D&B response.

Once a fraudulent vendor gets into the accounts payable system, it is like a Trojan horse or computer virus that upon release could cause havoc. Losses due to misappropriations may cost companies hundreds of thousands if not millions of dollars, not to mention loss of reputation and or career for those executives who allowed this to occur.  Even worse, it often occurs in plain sight, no back alley deals or brown paper bag brush bys.  Everyone knows the vendor and often uses them as the “people who come to our aid at all hours of the day or night. They are the go to people that get the job done”. 

While they may be a trustworthy loyal vendor, do you really know who they are?  Do you know if they have relationships with your other vendors or employees?  Do they have related companies? Have you even looked to see if the 3 bidders (in a 3 bid process you obtained to protect your company) are related and the bid is rigged? Proper and thorough up front vetting can be used to detect and prevent these problems.

Accordingly, organizations need a robust, vendor on-boarding process which thoroughly and completely requires vendors to submit to an in-depth review in order to identify potential conflicts with existing employees and management of the organization with whom the vendor is trying to do business.

Pertinent data is entered by the vendor and then is sent out through various public databases; concurrently, information is obtained allowing management to make an intelligent decision regarding whether to engage the vendor.

Not only does this improve internal controls, but also identifies conflicts before a vendor is on-boarded while highlighting other anomaly data and improper relationship issues. In some systems, the vendor pays a fee to do business with the organization; in essence, it is a zero cost proposition to the entity choosing to use it!

Our experience shows what well intentioned and highly educated managers, in an effective if not excellent control environment, can often leave themselves and their organization vulnerable to fraudulent vendors if they don’t know what they don’t know.  In this case what you don’t know can really hurt you and your organization!

Vendors beware! Companies know thy vendors…

Written by Joseph M. Palmar, CPA, CFE, CFF. Palmar is a Director at Goldstein Schechter Koch and provides forensic accounting and litigation services for emerging businesses to Fortune 500 companies. For assistance in this service area, Palmar can be reached at joseph.palmar@gskadvisors.com.

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Popular Tax Savings Strategy May be under Attack again – Proposed Changes to Section 2704

At GSK, we make sure to keep you abreast of current legislative updates and what implications they could have for you. We want you to always be in the know, and we have our advisors ready to answer any questions and plan tax saving strategies. In our newest video blog, Howard Lucas, CPA/ABV – Partner  explains the proposed changes to Section 2704 and what this may mean for you.

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Affordable Care Act (Obamacare) Beats Challenges

We are living in interesting times. Most of us do not ordinarily follow the day to day rulings of the Supreme Court. Last month, however, the Supreme Court made two controversial back to back rulings that got the attention of many Americans who do not normally follow the Court. These included the June 26, 2015, 5-4 decision granting same-sex couples the right to marry and the June 25, 2015, 6-3 ruling, where the Court rejected the Affordable Care Act’s challengers. These were historic cases and both will impact the delivery of healthcare in the US.

The same-sex ruling, known as the Obergefell v. Hodges decision made it legal for same-sex couples to marry. This will no doubt affect the way employers offer health insurance to employees. The exact impact is yet to be seen, but some employers may, for example, drop domestic partnership benefits instead requiring same-sex to marry before being eligible for group health. Time will tell how the logistics and technical compliance of this ruling will play out with employers. At a minimum, this ruling eases the burden on many large employers allowing them to treat their employees uniformly regardless of where they live and their sexual orientation.

The Affordable Care Act Ruling, better known as the King v. Burwell ruling may be slightly less controversial than the Obergefell ruling but this ruling has an overreaching effect on the delivery of US healthcare. Readers may recall that this is the second Supreme Court ruling favoring the Affordable Care Act. On March 23, 2010, President Obama signed the Affordable Care Act (“ACA”). The law put in place comprehensive health insurance reforms that rolled out over several years beginning in 2010. The most significant of the rules included requiring that 85% of premiums collected by insurance companies be spent on health care services, providing tax credits to make it easier for certain individuals to pay for health insurance, establishing the health insurance marketplace (or insurance exchanges), requiring large employers to provide health insurance to employees and requiring individuals to purchase health insurance (or pay a tax).

Soon after the ACA was passed, twenty six states filed lawsuits challenging the ACA’s requirement that individuals purchase health insurance or pay a penalty tax. In 2011, the individual mandate portion of the law was declared unconstitutional but the rest of the law remained intact. The Supreme Court agreed to hear the case and in 2012 declared that the “penalty” imposed for not having health insurance was a valid exercise of Congressional power to tax and the individual mandate prevailed.

The next major challenge to the ACA was the King v. Burwell case. In this case, it was argued that premium tax credits under the ACA were only available in states that operated their own insurance exchanges. The ACA required each state to set up an Exchange (or marketplace) where insurance would be sold. For the most part, this meant that web sites would be set up so citizens could “easily” compare the costs and benefits offered by competing health insurance plans. States had several options in complying with this requirement. They could create their own exchange or use the exchange created by the federal government (i.e., www.healthcare.gov – the well-known website that was initially marred by serious technological problems which were eventually resolved).

In general, in the King v. Burwell case, it was argued that the ACA language required states to establish their own exchanges in order for tax credits to be issued. The language in the law said that tax credits “shall be allowed“ only if the taxpayer has enrolled in an insurance plan through “an Exchange established by the State”. The King position was one of semantics arguing that since the Federal Exchange was not established by the States, individuals residing in a state using the Federal Exchange would not be eligible to receive federal tax credits (or subsidies) to help pay for their health insurance. Since only 16 states (and the District of Columbia) had set up their own Exchanges and the other 34 states were using the Federal Exchange, this case could have severely impacted the ACA if the Court was to rule that individuals residing in states using the Federal Exchange did not qualify for government insurance subsidies. Fortunately for many, the opinion authored by Chief Justice Roberts, held that tax credits are available to individuals in states that utilize both state run and federally-facilitated insurance Exchanges. According to Roberts, because the phrase “an Exchange established by the State” is ambiguous as it relates to tax credits, the Court must look to the broader text and structure of the Act to determine the meaning of that phrase. The Court ruled that, when the text of the ACA is considered as a whole, tax credits must be available to all qualifying citizens in every state.

In the opinion, Justice Roberts wrote that “Congress passed the Affordable Care Act to improve health insurance markets, not destroy them”. This ruling and the 2012 Supreme Court ruling have dealt blows to Obamacare foes and show that our current Supreme Court, which tends to lean slightly to the right of moderate, has not been willing to change the ACA law.

Had the Supreme Court ruled against the ACA, an estimated 6.4 million Americans in at least 34 states would have lost their subsidies most certainly making coverage unaffordable for them. Like it or not, it appears that the ACA is here to stay unless congressional Republicans muster the capital to change the law through legislation or figure out how to beat it in the Courts.

Written by Jeffrey Kramer, CPA, CGMA. Kramer is a partner at Goldstein Schechter Koch and provides audit, tax and consulting services to clients in healthcare, manufacturing and other industries. Kramer can be reached at jeff.kramer@gskadvisors.com.