Internal Auditor: The casino junket - fraud investigation in casino

Convincing management to prosecute a fraudulent employee - thus acknowledging the fraud to shareholders - is sometimes more difficult and more frustrating than uncovering the fraud itself.

The casino marketing department for a major gaming company wanted to introduce a new tour and travel program. The casino had been open only a few months; and, because of its immense size, a variety of programs was needed to bring in enough gamblers to fill the hotel.

The plan was for a junket representative based in Canada to start a program that would serve the casino exclusively. The opportunity sounded promising on the surface; but as program details came to light, the auditors' suspicions were aroused.

Junket reps work as the exclusive agents of a particular casino. They rely on promotions such as free show tickets, rooms, and transportation to encourage gamblers to visit the casino. In return, junket reps are paid a commission based on the volume of gambling activity they generate.

At the time this investigation occurred, most junket reps covered their own overhead out of their commissions; however, some of the top performers received a stipend to help cover expenses. Things were very different for Danny, one of the junket reps. Danny was, first of all, an employee of the casino. As Vice President of Marketing, he earned a base salary of $75,000 per year. As a junket rep, he earned thousands of dollars more in commissions. Under the new proposal, Danny would be further compensated for operating a tour and travel program.

And guess who submitted the idea for the tour and travel program? Danny! Only the internal auditors could see that Danny was being paid three times for bringing in the same customers.

THE INVESTIGATION

A profit and loss statement (P&L) was prepared for each of the casino's 20 junket reps. The compilation allowed management to assess each rep's performance, as well as the relative strength of each market being served. Danny's P&L reflected tremendous revenue at the top line, but very little at the bottom. In fact, his gross margins were among the poorest.

Office expenses and other reimbursements represented one of his biggest revenue drains. Unlike other junket reps, Danny received more than a stipend. He was being reimbursed for all office expenses for two offices. Danny was also being reimbursed for three employees' salaries, one of which was paid to his sister. Upon further investigation, the auditors found that Danny's main office was actually a travel agency that he owned and operated.

The interrelationships among Danny, all his businesses, and the casino were starting to get cloudy. Using a flip chart, the auditor mapped the various relationships and diagrammed the flow of dollars from the casino to Danny. In looking at the relationships, the auditor developed a number of findings:

* Danny was leasing a basic minicomputer system, valued at about $5,000, for three years at $12,000 per year. The lessor was also his accountant and the landlord for his downtown travel office. All costs were passed through to the casino. Also, the computer housed proprietary information from another casino where Danny previously worked.

* Danny used one airline charter company exclusively. His "charter manager" was a former sales manager of the same airline charter company.

* An executive of the charter company was also one of the gamblers Danny brought to the casino. This individual had amassed significant gaming debts with the casino and was refusing to pay. At that time, Canadian law did not provide for enforcement of gaming debts, a fact that was well known to Danny. At the same time, the gambler's wife was working for Danny's travel agency, and her salary was being passed through to the casino.

* For gamblers traveling on commercial flights, Danny purchased tickets through his travel agency, always at full fare. He received a 10 percent commission and passed the full ticket cost through to the casino. He did not notify casino management that he was using his own travel agency.

The auditor continued to dig through several months of Danny's bills, identifying charges that appeared suspect. He noted several irregularities:

* More than $2,000 in charges incurred prior to Danny's employment with the casino was represented as current expenses.

* Personal legal costs for Danny and his sister were submitted as business expenses.

* Personal limousine and cell phone charges were billed to the casino by Danny and his employees.

* Under Danny's contract, employee taxes and medical benefits costs were capped as a percentage of base salaries; yet the casino was consistently billed for larger amounts.

* Employee salaries, which were to be paid by Danny, could not be substantiated as actually having been paid. Danny also billed for employees not included in his contracts.

* Danny held a "permanent" expense advance of $15,000 that was never reconciled or accounted for.

* Danny billed and was reimbursed for charges on his casino corporate credit card. These charges had also been paid for by the casino.

* All invoices to Danny's company were in Canadian money. Danny consistently used an inflated exchange rate, overcharging the casino by more than $14,000 in only seven months.

* Seven months of office cleaning charges billed to the casino by Danny were on consecutively numbered invoices. The auditors were unable to find any evidence of the existence of the vendor.

THE PRICE TAG

By sifting through invoices and combing Danny's P&L, the auditor concluded that revenues were accurately stated, but expenses were significantly understated - despite the fact that Danny submitted extensive monthly bills for reimbursement. All costs considered, the marginal bottom line became a loss. Excluding the fraudulent charges, it was costing the casino $1.07 for every dollar Danny generated in revenue.

When the millions in bad debt expense were added - although the debt was not yet fully realized because of the time lag allowed under the prevailing gaming regulations - the costs and fraudulent practices associated with the casino's internal junket staff became staggering.

REPORTING THE FRAUD

Armed with detailed files, the auditors met with senior management to present their findings. One by one, the instances of fraud were enumerated. Supporting documentation was reviewed, and implications to the company and its gaming license were discussed. Executive management was persuaded to sever all ties with Danny and to report the matter to regulatory authorities. Since legal counsel needed time to review the findings, a follow-up meeting was scheduled for a week later.

When the Audit Director arrived for the follow-up meeting with the CEO, no other senior manager was there. The CEO advised the Audit Director - who then advised the Audit Committee - that the internal investigation had to be halted immediately. The Audit Director was informed that gaming regulators were also investigating Danny as part of his gaming license renewal process. The CEO further advised that the company's cooperation was essential, and that the internal investigation was interfering with the regulators' investigation. As a result, no action was to be taken against Danny at that time. Some time later, the Audit Director was contacted by the regulators and asked for his assistance and for information obtained during the internal investigation.

THE REAL STORY

It wasn't until several months later - after the CEO's departure - that the real story of the abruptly halted investigation was revealed. The company had been entering bankruptcy at the time of the inquiry; and the revenue stream generated by this junket rep - no matter how unprofitable - was important to maintaining investor confidence and the casino's ability to emerge quickly from bankruptcy. Most importantly, although the regulators were investigating Danny for his license, they had never asked that the internal auditors' investigation be modified or halted.

Danny soon learned about the investigation. After a change in CEOs, management scrutinized his bills, but the casino continued to lose money to him for more than a year. Eventually, Danny became one of many targets of a Congressional investigation into organized crime ties to the gaming industry. A few years later, Danny's gaming license was not renewed.

The Audit Director did everything in his power to stop a fraud and to help remove the perpetrator from the company During the investigation the Director and some of his staff were threatened and intimidated, but they remained dedicated to their goal. Despite their efforts, not much changed, and management turned a blind eye to a serious problem.

LESSONS LEARNED

1 Things happen for a reason! Sometimes the reasons are obvious; sometimes they become obvious with time. At other times, the reasons never surface. Reasons for action or lack of action represent the underlying cause.

2 One danger associated with fraud-related work is threats. Auditors sometimes receive threats of physical violence and job loss. Such threats and intimidation should be taken seriously. Threats can also impair the scope of the work.

3 In this case study, poor reporting covered up the problems. Expenses were inadvertently omitted from the analysis of the junket rep's profitability, and bad debts were not tracked.

4 Wilful blindness was a contributing factor in Danny's story. The CEO was driven by revenue, not profitability.

5 Auditors must deal with frustration. In this case nothing happened until the CEO left. The relationship was not terminated until after the company emerged from bankruptcy.