Case Study-QA287

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TIC Internal Control Case – DUE 10/11/16
 
On a warm, bustling August 2004 morning, outside of TIC’s Jacksonville, Florida, building, it felt like the stillness after a storm. Hannah Lewer sat at her desk, reflecting on the events that occurred at TIC in the past six weeks. How many hundreds of thousands of dollars worth of computers were stolen because an employee in a managerial role was able to override the company’s system of internal controls?
 
She looked out her door at her former supervisor, Kevin Kennia’s, empty office. A few months ago, no one would believe that this man would be fired for selling TIC’s computers to non-approved resellers and pocketing the proceeds. However, looking back, Lewer realized that red flags were there all along. She was glad that she uncovered the fraud, but worried that she waited too long to report her discoveries. She thought about the month she spent gathering information before she felt confident notifying upper management of her suspicions. How many assets were lost during this delay? More importantly, how could this go unnoticed for so long in a large, sophisticated company like TIC?
 
TIC Group, Inc. was a Fortune 500 global commercial finance company that provided financing and leasing products to many industries worldwide. With 2004 net income of $754 million, its Equipment Leasing division made up 16 percent of the company’s total assets. This division specialized in leasing computers, copiers, and fax machines to companies, schools, and universities. At the end of the lease, customers could buy the equipment or return it to TIC.
 
TIC hired Lower in March 2000 as a Vendor Account Specialist, after obtaining a B.A. in Business Administration from Flagler College. Within two years, she was promoted to Senior Vendor Account Specialist to manage TIC’s relationships with its used computer resellers. Lewer also interacted with the Credit Department, reviewed credit reports from Equifax, and recommended appropriate action. In April 2004, she was promoted to Remarketing Inventory Manager. In that position, she oversaw off-lease equipment that was returned to TIC’s Jacksonville office, and managed the warehouses to which TIC would resell (or “remarket”) this off-lease equipment. If a customer wished to return equipment at the end of a lease, her team would send a return authorization to the lessee, instructing them to send the equipment for resale to an approved warehouse/computer reseller.
 
Konia supervised Lewer. He was born in Iran and attended college in London. He was an outspoken opponent of the current Iranian regime. Several members of his family settled in the United States, and Kennia helped support them. Kennia was generous to his family and coworkers. His subordinates viewed him as a great boss. He was married with two young children. Lewer remembered Kennia mentioning that he and his wife went through several rounds of expensive in vitro fertilization before they had their twins.
 
TIC hired him in January 2000. In October 2001, his supervisor, Senior Vice President Denise Thompson, promoted him to Director of Asset Management. In addition to her professional relationship with Kennia, Thompson also had a social relationship with him. They saw each other outside of work and occasionally had dinners with each other’s families. However, their friendly relationship did not prevent Thompson from criticizing his performance when it fell below expectations. In his 2002 Annual Review, Thompson warned Kennia that his team needed to improve end of lease sales and inventory returns. As a publicly traded company, TIC placed much pressure on Kennia to meet monthly budgets. As Director of Asset Management, Kennia was responsible for the Remarketing Department that Lewer managed and the End of Lease Department, making him in charge of all returning off-lease assets at the Jacksonville branch.
 
Lewer thought back to the biggest red flag that alerted her that something was amiss. On July 14, 2004, when Kennia was out of the office for a few days on business, a customer—PGT Industries—called to inform TIC that it had returned its leased equipment as instructed. Lewer replied that she did not authorize PGT to return any equipment. She checked her files and found no record in the Inventory Tracking System, letters database, or Infolease system of anyone sending PGT authorization to return their equipment to a remarketer.
 
PGT said it received faxed instructions, but Lewer was confused. The return authorization referenced a warehouse name and address that she did not recognize as an approved TIC remarketer. The equipment was directed to go to Venture c/o Tim Williamson. That name sounded familiar and Lewer remembered hearing Kennia mentioning a friend named Tim Williamson. She was baffled. She could not understand why the customer would receive a return authorization listing a non-approved remarketer and thought to herself, “I will discuss this with Kennia when he gets back.”
 
Meanwhile, she looked up Venture on the Florida Secretary of State website to discover its full name was Venture Fitness. This made no sense. Why was TIC’s office equipment being sent to a fitness company in Jacksonville? Lewer had never heard of them. She drove by Venture after work on July 15th to check it out for herself. Venture sold fitness equipment. It had a few bays, but no docks or loading ramps that were typical of TIC’s contracted warehouses.
 
For the next few days, Lewer examined her records to see if other non-approved warehouses had received shipments. She found E-Remarketing, owned by Nasser Kadkhodaie. Becoming suspicious, Lewer distinctly remembered Kennia mentioning Nasser as a close friend. Two unapproved computer resellers, who happened to be Kennia’s good friends, had received TIC assets. Lewer decided to investigate E-Remarketing in person. Driving by the company, she saw it was in a little office with no sign on the door. It did not look like an appropriate location capable of receive large equipment deliveries. Why would Kennia violate company policy by overriding internal controls and selling computers to an unapproved remarketer—a related party who was a personal friend?
 
Lewer then recalled other previously dismissed red flags. She remembered how Kennia would ask his End of Lease team and Lewer’s Remarketing team to always notify him when large amounts of computer equipment were slated for return. He told her it was because he could make good deals for TIC. Lewer thought back to a July 13th event, just one day before the PGT phone call. Lewer received notice of a large computer shipment that was being returned by Regis High School. Since Kennia was out of the office, Lewer decided to research some TIC-approved remarketers. Kennia called Lewer at the office later that day to check in:
 

Kennia: So, how is everything going back at the office? Any news?
Lewer: Things are going great. Actually, we expect a shipment of computers back from Regis High School. I have started looking into a few remarketers that might sell these for us.
Kennia: A new shipment? How big?
Lewer: It’s pretty big—about 50 computers.
Kennia: Ok, listen. I will handle this contract when I get back, ok?
Lewer: I do not mind doing this one. I know you are busy. I can handle this.
Kennia: No. Do not do anything with these contracts. I will personally take care of them, ok?
Lewer: Ok …
 
Lewer remembered feeling dissatisfied with this conversation, believing she could handle this account. Why was Kennia so reluctant to let her deal with it? She continued to research remarketers. The next morning, just hours before the PGT phone call, Lewer found a sticky note on her desk from Kennia and a copy of the Regis High School lease. Attached to the top of the lease was an E-Remarketing business card that said, “Nasser has the better deal now.” But Lewer did not believe that Kennia had sought bids from anyone other than his friend Nasser. Kennia was out of the office. How could he have negotiated with multiple companies in such a short time?
 
Continuing her research to find other laptop purchasers, on July 16th, she decided to offer the computers to Dauer Business Services, based in Chicago. They had contacted Lewer previously, looking for off-lease equipment to resell. Lewer sent them an email pricing offer request for the described equipment. Dauer offered her $240 per laptop. When Kennia returned to the office on July 19th, Lewer asked what Nasser was offering. She remembered this conversation vividly:
 
Lewer: You left a note on my desk saying that Nasser has the best deal for the Regis High computers. I was wondering, just how much is he willing to pay?
Kennia: He is willing to pay more than any of our other remarketers. That’s why I am letting E-Remarketing have this deal.
Lewer: But how much will he pay per laptop?
Kennia: Oh, I do not have the exact figure off the top of my head.
Lewer: How about an estimate?
Kennia: Um, let’s see … it was … Nasser will pay us $225 per laptop.
Lewer: $225? Well, I contacted Dauer, and they gave me a better offer—$240 per laptop. That’s $15 more than Nasser’s offer. I am going to give them the deal instead of E-Remarketing.
 
Kennia looked surprised, but did not protest. Dauer was not an authorized remarketer either, but Lewer did not think this would be a problem. She would occasionally see computers sold to remarketers not on the TIC approved reseller list. Previously, she did not think to question this deviation from company policy. Kennia ran the office, so Lewer assumed that this was normal. Lewer sighed. Why had she not asked more questions while she was training? Why have a pre-approved reseller policy if no one checked to verify that it was followed?
 
After visiting Venture Fitness and E-Remarketing, Lewer realized that those locations could not be appropriate resellers to receive TIC equipment. Lewer wanted an explanation of why Kennia sent computers there, so later that day she went back to see him. She took the faxed copy of the return authorization from PGT to Kennia’s office. She placed the fax on his desk.
 
Lewer: I have a question. I received this fax from PGT indicating that you wanted them to ship their computers to Venture. Why would you instruct them to ship to this reseller?
Kennia: PGT? Oh, I took care of that already. It’s done. Do not worry about it.
Lewer: Well, Venture is not on the list of approved remarketers.
Kennia: So? We do not only sell to resellers on that list. How many times have you seen me use a different reseller? I go with whoever has the best deal.
Lewer: But Venture is not even a remarketer. It sells fitness equipment. And I have not seen any checks coming in from Venture for any sold computers.
Kennia: Oh, well, they … uh … I will look into that and see why that is.
Lewer: What is going on?
Kennia: You do not want to know about it.
Lewer: What do you mean by that?
Kennia: I mean do not worry. We will get our money by month end.
Lewer: This month or next month?
Kennia: Umm … it should be here by next month …
 

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Listen, I made a bad deal, ok? I already called the guy at Venture and I threatened to cut his arms off if he did not pay. So he will pay. Listen, you do not want to know what I do sometimes, but you will reap the benefits because I bring in a lot of money. So do not worry about what I do. Shannon did not worry about it. She just let me do my job. I think you are taking on too much. You need to ease up on your work load a bit. Just pass on all of the large computer transactions to me and I will take care of them. They take too much time and you have enough to do. I can get the good deals on them. I am a good salesman. I am a hustler, you know, I can make things happen. So do not worry about it, ok?
 
Lewer remembered leaving Kennia’s office feeling unsettled. She recalled that Shannon Geiser was the Remarketing Inventory Manager prior to her. Why did she not question Kennia’s actions? She also did not understand why Kennia wanted her to pass on more work to him. He often complained about his responsibilities and how he had no time to manage his other team.
 
A few days later, Lewer saw that Kennia entered notes into the Infolease system for the PGT contract stating that he took care of this account. Notes like this would cause those working on this account to refer all questions directly to him. Two weeks later, on August 3, Kennia was out of the office again when mail for the End of Lease Department arrived on his desk. As the manager in charge while he was away, Lewer would go to his desk and distribute the mail accordingly. One item on his desk that day was an invoice from Tantara, a freight company TIC recommends to their customers. TIC also used Tantara for repossessions. When Kennia was training Lewer, he informed her that he would take care of all Tantara invoices.
 
Because she knew how invoices were paid, Lewer decided to turn this one into the accounting department for payment. She wanted Kennia to have one less item to deal with when he returned to the office. The invoice was for the pickup and delivery of equipment from the University of North Dakota to the same suspicious Venture Jacksonville location. It appeared to be a large amount of computer equipment. Lewer called Tantara to identify the Venture invoice, and Tantara asked her to clarify which Venture invoice she was referring to, since they had multiple deals regarding deliveries of computer equipment to Venture. Lewer became alarmed. Not only were large amounts of equipment going to this unauthorized company, but TIC was getting billed for the shipping. Lewer had then rarely seen equipment sent to non-contracted remarketers, and even less frequently would TIC pay for the shipping.
 
Lewer could not ignore this. On August 16th, one month after that initial suspicious phone call and fax from PGT, Lewer asked Thompson, Kennia’s supervisor, to talk to her privately. They went into a conference room and Lewer told Thompson about her suspicions that Kennia was using his authority to override the system of internal controls and conducting shady transactions. She mentioned that Kennia directed PGT’s off-lease computer equipment to his friend Tim Williamson at Venture Fitness, and that he gave the Regis High School account to his friend Nasser. Further, he had TIC pay to ship the equipment from the University of North Dakota to Venture, even though this was against company policy. Thompson decided to conduct an internal audit.
 
During the two-week audit, TIC discovered that Kennia had diverted part or all of the proceeds from several shipments of computers from April 4, 2003–August 2004. Also, several companies, including Venture Fitness and E-Remarketing, never remitted payment to TIC for this equipment. They also discovered invoices for the shipment of equipment to Venture that Kennia had signed off on and turned in to Accounts Payable for payment, even though it was not TIC’s policy to cover shipping costs. Finally, there was evidence that, although computers that were placed with unauthorized remarketers were entered into the Infolease system, they were being sold for below-market prices to those remarketers. There was no doubt in anyone’s mind that fraud was occurring at TIC.
 
Meantime, Kennia continued to divert company assets. At one point during those two weeks, he handed Lewer a copy of an $82,125 check from Asset Recovery Specialists and told her to close out a University of North Dakota contract for 565 laptops. But Kennia did not know that Lewer had already spoken to the Asset Recovery Specialists representative and found out that the check was for the purchase of only 365 laptops. Kennia had diverted the other 200 laptops to Venture.
 
At the end of the audit, Thompson arranged a meeting with Kennia and several corporate executives who flew in from New York. Lewer did not attend the meeting, but Thompson told her what occurred. Kennia’s demeanor changed significantly from the start to the end of the interview. He first answered questions easily and confidently. As the questions turned to his relationship with E-Remarketing and Venture Fitness, Kennia became increasingly flustered. He explained that Venture was a drop-off site for Karl Griner, with whom he had a one-time deal to sell computers. He could not explain why some Venture accounts were closed with no payment and why some assets were never entered into the Inventory Tracking System. He slumped down lower and lower in his chair. Finally, he said, “I am not going to incriminate myself further. Make whatever decisions you are going to make.” He was asked to leave the office.
 
After some deliberation, TIC called Kennia to inform him that he was fired. TIC’s Corporate Office also contacted the Florida Department of Law Enforcement (FDLE) to begin a criminal investigation. Three days after Kennia was fired, Karl Griner called Lewer at her office. He informed her that he had a weird conversation with Kennia the night before. He said Kennia told him he had been fired from TIC. Griner told Lewer that he had purchased computers from Kennia. He had some ready to be shipped to his buyers, but after the conversation with Kennia he was not sure if he was getting them “legit.” He wanted to know if he should send the money to TIC.
 
Lewer wanted to find out more about how Griner and Kennia conducted business. She asked Griner how these computer sales would occur. He explained that Kennia would call him when he would have 15 to 75 computers available. Griner would then pick up the computers from Kennia’s home or from a drop-off point called Venture. He would buy the computers from Kennia for $220 to $250 apiece, paying Kennia by check, and would put Kennia’s name, not TIC, as the payee. He said he was made to believe that the money he paid Kennia was given to TIC. Griner started buying the computers from Kennia about a year ago.
 
He would sell them to a distributor in Lakeland, Florida, paying $20,000–$25,000 for the computers. Griner said that after talking to his wife, he was unsure about Kennia and would rather deal with TIC directly. He told Lewer that Kennia gave him her number and told him to call. He also told Lewer that he was an officer with the Jacksonville Sheriff’s Office. Lewer thought it was odd that an officer would deal with computers without knowing whether they were received legitimately. Also, Griner’s figures did not add up. Paying $20,000 to $25,000 for 200 to 300 units equals about $100 per computer, less than half of the $220 apiece that he claimed to pay, and far less than the computers were worth. At the end of the conversation, Griner gave Lewer his cell phone number and she said she would get back to him about these computers. Lewer notified FDLE and they seized the stolen TIC assets from Griner’s residence.
 
Lewer then thought back to other red flags. When Kennia trained her, he told her to record only a set amount of inventory each month to “smooth” earnings, as all public companies managed earnings. He even had certain remarketers hold inventory in a separate file and pay separately, so the inventory would not appear in TIC’s system.
 
Lewer remembered when Kennia prepared a monthly aging report for Thompson. Lewer asked to see this report, but Kennia did not want to show it to her. She persisted and then he sent it to her, warning her that the figures would not match what was in her system. He told her that he took out some accounts to keep Thompson off his back. Reconciliations were never performed to make these numbers match because there were too many exceptions going back too far. Thompson never checked that Kennia completed the monthly reconciliation of remarketers. Kennia also directed employees to send contracts with large amounts of computer equipment directly to him, so he could control the disposition process for accounts to close unpaid accounts without raising suspicion. Lewer also recalled Kennia mentioning how expensive it was for his wife to try and have children through in vitro fertilization. Kennia had financial pressure at home coupled with earnings targets at work. How did she not spot these issues earlier?
 
TIC had several controls in place to handle off-lease inventory appropriately. Once the decision was made by the lessee to return the equipment, the lessee would be sent return authorizations indicating where to ship them. When the remarketer received the equipment from the lessee, they forwarded a report to the TIC inventory manager to notify them of the equipment’s receipt. The inventory manager then updated the Inventory Tracking System and inventoried the asset in the Infolease system. When selling the asset, the remarketer forwarded a check to TIC with the sale proceeds. The inventory manager then forwarded the information to the cash operations department to apply the proceeds and close the contract. If funds were received after an inventoried contract was closed, the funds were applied to the contract. This allowed TIC to have an audit trail and record the funds to the inventory valuation account. Unfortunately, no one reconciled the significant differences between expected Infolease balances and actual balances.
 
Kennia circumvented the controls by stepping into the middle of the process to set up a separate system that he controlled. He would review the Financial Reporting group’s report that showed contracts with large residuals that had lease dates expiring within the next six months. The report was generated as a forecasting tool to help negotiate equipment prices with remarketers. Kennia used this report to determine the assets that could easily be sold outside of the normal process. Rather than let an inventory specialist be involved in the process, he spoke directly with the lessee and had the assets sent to an unauthorized remarketer. The remarketer did not forward information to the Inventory manager to notify her that the assets were returned. Without this information, it was very difficult to determine if the assets were delivered.
 
When computers would come off-lease, Kennia would often sell them to both unauthorized and authorized vendors. This strategy was particularly effective with large quantities, such as shipments from the University of North Dakota. In these cases, he would have the computers delivered to two separate locations—one authorized remarketer (e.g., Asset Recovery Specialists, Inc.—ARS) and one unauthorized (e.g., Venture)—the authorized entity would remit payment to TIC and the unauthorized entity would remit payment directly to Kennia. Thus, if 500 computers came off-lease and 300 went to ARS for $250 each and 200 went to an unauthorized dealer who paid Kennia directly, the system would show 500 computers being shipped out and $75,000 (i.e., 300 × $250) being received in exchange. This process was further flawed in that the lease agreements all required the lessee to send the computers to whatever location they were instructed to by TIC.
 
During the audit process, TIC and FDLE identified 36 different diversions of TIC off-lease equipment, with a conservative total loss to the company of $637,000. A financial analysis revealed that checks were written to Kennia personally to purchase TIC off-lease computers. The related investigation also revealed multiple cash transfers between Kennia, Griner, and Nasser. Griner and Nasser paid far less than the fair value of the computers they received.
 
Your Task
 

Write a professional memo (see memo guidance below) to the owner of TIC analyzing how the five components of the COSO framework could have helped to prevent the fraud that occurred at TIC. Explain the difference between preventive and detective controls and give an example of how each could have been used by TIC with respect to this fraud. Discuss whether necessary controls were missing or merely ineffective. Also, be sure to discuss how Kennia’s role at TIC violated the concept of segregation of duties.
 
Memo guidance
 

Formatting: use times new roman, 12 point font, single space, and most importantly, there is a two page maximum not including exhibits or appendices. Use the following header information:
 
Memorandum
 

To: Client Name, Client Title, Client Company Name
 

From:
Date:
Re: Topic
 
The introductory paragraph should clearly state the purpose of the memo. You should then list the major topics that you will cover over the next couple of paragraphs. Accordingly, the structure of the body of the memo (i.e., all the paragraphs between the introductory paragraph and the concluding paragraph) should follow the order you laid out for the reader.
 
For example: “The purpose of this memorandum is to give students as much guidance as possible related to the research projects. In order to provide such guidance I will define the purpose of the projects, provide you with examples of what I am looking for, and outline some of the most common mistakes I see when grading.”
 
The body of the memo should contain an overview of the questions at hand and include any relevant technical guidance which should be appropriately referenced. However, the body of the memo should be integrated and cohesive. That is, don’t just answer the questions in the order presented. Organize your memo with all of the information needed to address the case questions.
 
Once you have addressed the question of interest in the body of your paper, you will want to construct an appropriate concluding paragraph. This paragraph should provide a brief review of the topics covered. Then, based on that review, provide some type of conclusion. Finally, the last sentence of your last paragraph should contain some language along the lines of the following: “If you have any additional questions regarding the contents of this memorandum, or would like any additional information, please don’t hesitate to contact me.”
 
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