At the end of the third business quarter, Sten Lepp, the chief audit executive at NorthStar Energy Corp., received an email from the head of sales, Henry Klassen:
“For your information, on the 8th of July, we discovered that a salesperson, Andy Pine, used standard consumption graphs for certain customers instead of the customers’ actual consumption history. Thus, sales to those clients were made with wrong assumptions. As soon as we discovered the manipulation, I had Pine write an explanatory letter and sent him home. We are processing termination documents, and I intend to deduct sales bonuses from his last paycheck to recoup monies. I am truly sorry for the incident. As a manager, it is difficult when a team member breaches trust.”
After reading the email, Lepp wanted to better understand exactly how the salesperson manipulated sales. How had such a standardized business process become so trust-based? The email looked like an attempt to sweep the matter under the rug as quickly as possible, so Lepp initiated an internal investigation.
- Don’t jump to conclusions. Just because the prime suspect was no longer with the company and Klassen assured everyone that the incident had been taken care of doesn’t mean there isn’t much to investigate. When beginning an investigation, avoid assessments and conclusions early on and keep an open mind.
- Use professional skepticism, instead of falling victim to truth bias, which is people wanting to believe what they see or hear. The investigators first interviewed Klassen, who was cooperative and ready to explain the sales process and fraud scheme. While the chief investigator then compiled a summary of Pine’s deeds, the effective resolution, and the incident’s low impact, the other investigation team member decided to talk to the portfolio analyst. By talking to the analyst, the investigator learned that Klassen was not telling the truth and that the loss from those contracts was more substantial than a single person’s bonuses. The analyst also revealed that Pine and Klassen were close friends.
- Have a thorough investigation plan. List all employees to be interviewed and in what order. Never start with those who could potentially be main suspects. Had the auditor not decided on her own to talk to the portfolio analyst, he never would have discovered that Klassen was less than truthful. Make sure investigation steps and responsibilities are listed, as well as what evidence is most likely needed. Agree ahead of time on communication channels and frequency, where evidence is stored and how it is indexed, and set and monitor deadlines for each step of the investigation.
- Understand business context. Klassen succeeded in undermining the impact of the fraud because he focused everybody’s attention on bonuses overpaid to a single salesperson rather than the lack of controls withinin the sales system. If you are not familiar with the business, step back to read through manuals and related procedures, and interview employees.
- Conduct due diligence by preserving evidence. The decision to turn the case over to law enforcement may be reached several months later, but the evidence should still be available and the chain of custody must be clear.
The pricing strategy for each customer was based on the customer’s profile. One of the inputs that shaped the profile was the customer’s historical energy consumption data, which was used to project future consumption patterns. The pricing model then calculated the minimum selling price, allowing the salesperson to add a margin to that price while maintaining customer relations. This margin was shared between the salesperson and the company, and the salesperson’s bonus was a percentage of the added margin.
In the previous year, energy market prices increased, resulting in a higher precalculated base selling price. Most of the sales team was struggling to add every cent to the sales margin without customers complaining about the cost increases. Pine, however, completed contracts and bragged about his bonuses. His colleagues grew curious, but no one dared to ask Klassen because of his close friendship with Pine. Their chance came when Klassen left for a scheduled vacation and Helina Saar, a recent hire, came in as his temporary replacement.
When the other salespeople approached Saar about the discrepancies in bonuses, she accessed Pine’s portfolio in the sales system and found that he used creative solutions to ensure his bonuses while his co-workers struggled. Specifically, he changed the presumably unchangeable — the customer’s profile. He manually changed inputs to the pricing model in the sales system. Instead of using the customer’s real historic consumption data, Pine entered the customer’s consumption as a single value, so the system disregarded real consumption patterns and distributed consumption equally, calculating lower base prices. Lower base prices allowed Pine to add the desired margin and receive a larger bonus from each sale.
Saar talked about her findings with the portfolio analyst responsible for monthly sales results reporting, who then approached her supervisor to confirm the findings. The supervisor waited until Klassen returned from his vacation and informed him about Pine’s contracts. Klassen had no choice but to fire Pine.
The investigation unveiled several key findings:
- The sales process manual had not been reviewed for more than five years, and actual practices deviated substantially. There were no controls or monitoring from the head of sales or anyone else.
- No attention was paid to the development of the sales information system. As a result, IT controls were not performing as intended and could be easily overridden with no one noticing.
- Bonuses were paid out immediately based on forecasted revenues, and actual execution of sales contracts were not monitored, which invited fraudulent behavior from sales personnel.
- Klassen and Pine owned and ran an online retail business together. Though it was in an unrelated business sector and did not breach NorthStar’s code of conduct, the investigation found that they took care of their affairs during business hours. Therefore, Klassen was paying little attention to what was going on in the sales unit.
NorthStar, of course, suffered losses from such deals as it will have to cover energy costs from the customers’ real consumption patterns.
As a result, the company completely restructured the sales process, supporting information system, and bonus principles; contacted law enforcement; reviewed whistleblowing channel effectiveness; and fired Klassen.