Statistical Support of Forensic Auditing

A L A N D . OLINSKY

Oepartmeut of Mathematics
Bryant CoUege
Smithfield, Rhode Island 02917

PAUL M . MANGIAMELI

Department of Management Science and information

Systems
University of Rhode Island
Kingston, Rhode Island 02881

SHAW K. CHEN

Department of Management Science and Information

Systems
University of Rhode Island
Kingston, Rhode Island 02881

During a three year period, $4.38 million of gold was stolen from
the vaults of Sammartino's House of Diamonds. A civil suit between the gold's owner and its insurance company centered on
when the gold was stolen. The time of the loss was critical to the
insurer's contention that it was not liable because the gold was
missing prior to the inception date of the policy. The insurer's attorneys retained an accounting firm to conduct a forensic audit
(a financial audit to investigate fraud). The key to this investigation was reconstructing a daily gold inventory balance by sampling sales invoices. Since the audit's sampling methodology was
open to question, we were retained to use various statistical techniques to verify the process. To test the results of the forensic audit, we constructed two formal hypotheses: The first to test for
nonrandomness in the selected sample observations; the second
to test if the amount of sales dollars selected in the sample was
proportional to the amount of sales dollars in the monthly population. To accomplish this, we utilized a one-sample runs test,
time-series charts, regression analysis, and interval estimations.
We found that the sampled invoice transactions exhibited no evidence of nonrandomness or bias and appeared to be representative of the population. Hence, these results supported the inventory reconstruction obtained by the accounting firm.
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STATISTICSSAMPLING
jUDFCIAL/LEGAL

INTERFACES 26: 6 November-December 1996 (pp. 95-104)

OLINSKY, MANGIAMELI, CHEN

fter the largest gold theft in the history of the State of Rhode Island, the
gold's owner, Putnam Resources, tried to
recover its losses from its insurance company in a civil trial. Amid rumors of theft
and fraud, Sammartino's House of Diamonds, Inc., a manufacturer and retailer of
fine jewelry located in Cranston, Rhode Island, had its business seized by Shawmut
Bank of Boston on August 3, 1987 when
the bank, a major creditor, found that
Sammartino's did not have the funds to
cover its debts. One year later, a federal
grand jury indicted Walter Sammartino,
the owner, on 16 counts of defrauding
Shawmut Bank of $8 million. In addition,
an estimated $4.38 million dollars in gold
consigned to the company was missing
from the House of Diamonds' vault
IRakowsky and Howard 1988]. As the trial
began, a plea bargain was struck with Mr.
Sammartino pleading guilty to four of the
16 counts of bank fraud. As part of the
deal, the remaining 12 counts were
dropped, and Mr. Sammartino was not indicted on any counts stemming from the
gold theft [Boston Globe 19891. On May 18,
1989, Mr. Sammartino was fined $50,000
and sentenced to serve seven and one half
years; five of those years were suspended
and two and one half years were to be
served in prison. Although federal authorities have identified several people involved
in the gold theft, including members of the
Patriarca crime family, no one has been accused of the crime [UPI 19891.
All That Glitters Is Not Gold

active. Putnam owned the gold that was

missing from the Sammartino vaults. Leasing gold is a common practice in the Rhode
Island jewelry industry: The leasing company sends gold to a jewelry manufacturer
while still retaining ownership. As the raw
gold is turned into jewelry, the manufacturer becomes the owner of the metal used
and pays the leasing company for it. Periodically Putnam sent its auditors, Emst and
Whinney, to check their accounts against
the amount of gold in the vaults. Unfortunately, the auditors only counted and
weighed the gold bars; they did not assay
the gold. It was subsequently discovered
during examination at the civil trial that the
"gold" bars were actually base metal bars
electro-plated with gold by Sammartino's
production supervisor.

Although the criminal justice portion of

this episode ended in mid-1989, a civil suit
filed on August 4, 1987 by Putnam Resources of Greenwich, Connecticut was still

The court awarded judgments against

Walter Sammartino and Sammartino's
House of Diamonds to Shawmut Bank and
Putnam Resources. As neither Mr.
Sammartino nor the House of Diamonds
had assets to cover these judgments,
Shawmut sued its insurer and collected its
loss. Putnam also sued its insurer, Lloyd's
of London. Lloyd's originally paid $2 million, but then, in mid-February 1990, refused in federal court to pay the outstanding balance and demanded its original $2
million back IHarrop 1990a].
The Heart of the Case
Lloyd's of London's case hinged upon
whether the gold had been stolen before or
after the insurance pohcy went into effect
on September 11, 1986. From May 14, 1984
to September 10, 1986, Sammartino's received 40,398 fine troy ounces (FTO) of
gold of which accounting records of gold
being processed could account for only

INTERFACES 26:6

96

FORENSIC AUDITING
21,300 FTO (Figure 1). Supposedly, the remaining 19,098 FTO should have been in
inventory in Sammartino's vaults. If, in
fact, 19,098 FTO was in the vaults through
September 10, 1986, when the policy went
into effect, then Putnam's claim against
Lloyd's would be substantiated. If most of
the gold was stolen before that time, then
Lloyd's counterclaim would be correct.
It should be noted that no one physically
took most of the missing gold. The employees of Sammartino's House of Diamonds
had made jewelry out of the gold and sold
it to customers. The business kept meticulous records of these sales transactions. The
theft occurred when Mr. Sammartino, instead of paying Putnam, kept the money to

pay off debts to underworld figures.

Five witnesses who would have known
the dates of the robbery invoked the Fifth
Amendment against self-incrimination. A
sixth witness, Stephen Saccoccia, disappeared before the courts could serve a subpoena. (After the trial, he was found and
extradited from Switzerland. He was later
convicted and sentenced to 50 years for
laundering over $180 million for the
Patriarca crime family.) A seventh witness,
Charles Harrison, a Sammartino warehouseman who electroplated the fake gold
bars, although fearing for the safety of his
family, did testify but gave conflicting
dates as to when the gold was stolen.
Sometimes he said it occurred in July 1986

Beginning inventory 5/14/84

Gold received

Known
Known

Total gold available

Known

Gold out for processing

Known

Gold unaccounted for

Retail Sales

Unknown
To/a/of both is 19,098

Ending Inventory 9/10/86

Unknown

Putnam claims that Sammartino's

ending inventory should he

J 7.000

Figure 1: Gold flows in fine troy ounces al Sammartino's House of Diamonds for the period 5/14/
84 to 9/10/86 show the lotal gold available to be 40,398 ounces. The forensic audit had to determine the value of retail sales and of the ending inventory on September 10,1986, the date the
insurance policy took effect. The retail sales represent how much gold was stolen before the policy went into effect while the ending inventory on that date was the gold that Putnam claimed
under the policy.

November-December 1996

97

OLINSKY, MANGIAMELI, CHEN

and other times he testified to dates of October or November 1986 [Harrop 1990bl.
Given that Lloyd's issued the insurance on
September 11, 1986, its lawyers had to find
other means to determine the date of the
theft.
Lloyd's retained the accounting firm of
Sansiveri, Ryan, Sullivan, and Company to
determine when the gold was stolen. It
conducted a forensic audit to recreate the
inventory record. To do this, it took a san:\ple of Sammartino's House of Diamonds'
sales receipts and randomly chose one of
the jewelry items listed on each receipt. Referring to this item's manufacturing specification, it determined the amount of gold
needed to make the item. If the sample reflected overall retail sales, it could thus establish the average sales dollars needed for
one fine troy ounce (FTO) of gold. Given
that the daily sales for Sammartino's were
known, it could use this average to determine how much gold had been used in
making jewelry (and thus how much had
been stolen) and how much was actually in
the vaults and owned by Putnam.
To get a sample of the invoice records,
the accounfing firm sent several auditors to
Shawmut Bank in Boston which held the
sales invoices. These files of invoices were
stored chronologically in marked boxes.
The auditors would pick a box in a haphazard fashion and then reach into the box and
pull out a manila folder that contained all
the sales receipts from a given day. From
this folder, they would select an individual
sales receipt in an arbitrary fashion. If this
receipt had more than one item on it, they
would randomly select one of these items
and find the corresponding manufacturing

specificafions. The auditors confinued in

this fashion until they had reviewed 7,750
invoices totaling approximately $2 million
(23.34 percent of population dollar sales
over the period May 14,1984 to June 25,
1987).
They thus reconstructed the inventory
(Figure 2). The accounting firm's forensic
audit showed a large discrepancy between
what it found should have been left and
the gold that Putnam had shipped and
thought was in Sammartino's vault. The forensic audit showed that over 8 thousand
FTO of the total of 11.2 thousand FTO of
gold had been stolen before the policy took
effect on September 11, 1986 (Figure 3).
The auditors presented the results to
James Campise, the attorney representing
Lloyd's in early 1990. Although he had no
objection to the method used to measure
the amount of the gold theft, he questioned
the sampling methodology. He thought the
sampling procedure was not truly random
but biased in some way. If it were, the average sales dollars to FTO of gold might be
wrong, thus leaving the forensic audit's inventory reconstruction open to question. In
essence, Mr. Campise felt that the forensic
audit contained a sampling error. What
was needed was independent statistical
verification that the results of the forensic
audit were in fact based on random sampling and representafive of total sales. The
accounting firm asked us to do this work.
Because he might have to present the statisHcal support to the jury, Mr. Campise
asked us to make our report visually compelling by using charts and graphs that the
jury members could easily understand.
With this request in mind, we set about developing our statistical analysis.

INTERFACES 26:6

98

The Forensic Audit

FORENSIC AUDITING

18.0 -

0.0
05/14/84

12/31/84

12/31/85
09/10/86
Date of Policy

12/31 /86

07/03/87

Jewelry Firm m Gold Leasing Company

Figure 2: This graph compares, at key dates, the amount of gold that should have been on hand
according to the leasing company's records with the amount of gold on hand as evidenced by the
forensic audit's inventory reconstruction. This chart was presented as evidence during the trial.
Statistical Support
We had about one month before the trial
started. If the sampling method were biased, Lloyd's case would be badly damaged. We constructed two formal hypotheses to test the results of the forensic audit.
The first hypothesis was designed to test
for nonrandomness in the selected sample
observations.
Hypothesis 1: There is no pattern of bias in
the sample taken by the forensic auditors.
Specifically, the sequence of ratios of sales

dollars to FTO of gold for each transaction

in the forensic audit's sample was random.
Since we would ultimately make inferences in the form of confidence-interval estimates, we had to first test the sample for
evidence of nonrandomness or bias. We
subjected the sequence of ratios of sales
dollars to FTO of gold to a Wald-Wolfowitz
one-sample runs test. This is a nonparametric test for runs above and below the median of a sequence of values (in this case,
our ratios) that are arranged in temporal

November-December 1996

99

OLINSKY, MANGIAMELI, CHEN

12.0

05/14/84

12/31/84

12/31/85

09/10/86

12/31/86

07/03/87

Date of Policy
Figure 3; Based upon Figure 2, this chart shows the cumulative loss of gold when comparing the
amount of gold on hand according lo the leasing company's records with the amount of gold on
hand according to the forensic audit. If this forensic audit is correct, most of the missing gold was
stolen before the policy was issued.
order. Too many runs or too few runs
would indicate nonrandomness in the selection of the sample. Eor example, if the
auditors had selected invoices with large
dollar amounts early in the selection process (a distinct possibility if they wanted to
speed up the sampling process), this would
have caused a pattern of ratios that the
runs test would detect.
Eor this test, we needed the total number
of runs, the number of individual values

below the median, and the number of individual values above the median. As long as
the number of values below the median
and the number above both equal or exceed 10, it is appropriate to use a z score
for testing fWatson et al. 1994]. The onesample runs test was not significant
(2 = -0.5687 and p = 0.5696), and therefore, our first major hypothesis was not rejected. There was no evidence of a pattern
of nonrandomness.

INTERFACES 26:6

100

FORENSIC AUDITING
The second hypothesis we introduced
was as follows:
Hypothesis 2: For all the months involved
in the sampling process, the amounts of
sales selected in the sample were propor*
tional to the amounts of sales in the populafion on a monthly basis.
If we were to develop inferences based
upon the ratio of sales dollars to FTO of
gold, it was critical that the sampled sales
be truly representative of the population
sales. We used two different statistical
methods to test this hypothesis. Since we
had available the actual population dollar
sales figures for each day of the period, we
first developed a time-series chart to compare the total sales population with the
sampled sales for each month of the two
years under consideration.
We carefully examined the time-series
chart (Figure 4) and found that the amount
of sales in the sample for the various
months increased and decreased along with
the amount of total sales. We also divided
each month's sales by the total sales for the
two-year time period to find the percent of
sales attributable to each month (Figure 5)
and found that the sample mimics the population very well. These results supported
our second major hypothesis.
In addition to testing these two hypotheses, we also tested the accounfing firm's estimate of the ratio of sales dollars to FTO.
We first created a scatterplot of sales dollars to FTO of gold which showed a linear
relationship between the two variables. We
therefore deemed it appropriate to run a
hnear regression with sales dollars as the
dependent variable and FTO of gold as the
independent variable. We forced the resulting regression line through the origin so

that its slope would be a ratio estimate. As

this procedure is independent of the
method used in the forensic audit, our ratio
would not necessarily be the same as determined in the forensic audit.
The regression line, forced through the
origin, fit the data quite well: R", that is the
number of FTO of gold (independent variable), explaining 80.55 percent of the variability in sales dollars (dependent variable).
In other words, only t9.45 percent of the
variability in sales dollars was due to other
factors. The slope of this line was found to
be $844.30, which is our independent estimate of the rafio of sales dollars to FTO of
gold. In other words, $844.30 received from
customers was due to the sale of one fine
troy ounce of gold. Since we used a different stafistical technique, we did not expect
this estimate to be identical to the point estimate of $882.80 determined by the forensic audit. The auditors calculated their ratio
by dividing the total sales dollars in the
sample by the total number of FTO of gold.
Using a regression approach, we found the
ratio by determining the slope of the line
based on all 7,750 transactions in the sample. Because we used all the values, rather
than just two numbers, we probably obtained a more accurate ratio than the forensic auditors did.
Next, we used the estimated slope of the
regression model to construct a 95 percent
confidence interval for our ratio. We compared this confidence interval with the confidence interval based upon the approach
the auditors used. If the two confidence intervals failed to overlap, we would beheve
the sample was biased.
Using our regression estimate of $844.30,
we constructed a 95 percent confidence in-

November-Deceniber 1996

101

OLINSKY, MANGIAMELI, CHEN

Sales ($ Thousands)

700

600
500

9 10 1 1 1 2

84

Month
^ Population + Sample
Figure 4: In Ihis comparison of the recorded total sales ($ thousands) with the sampled sales ($
thousands) over the period from June 1984 to June 1986, the two lines seem to parallel each other,
indicating that the sample represents the total sales accurately.
terval for the ratio, yielding a range from
$802.12 to $886.48. Our range includes the
forensic audit's ratio estimate of $882.80. In
addition, a 95 percent confidence interval,
based on the methods of Scheaffer,
Mendenhall, and Ott 11979] for the forensic
audit's ratio ranged from $812.27 to
$953.33. This confidence interval has a
much wider range than the confidence interval from the fitted regression model.
However, the point estimate of the regression slope, $844.30, is within the confidence
interval of the forensic audit. Given that the

INTERFACES 26:6

forensic auditor's ratio fell within the regression model's confidence interval and
that the regression model's ratio fell within
the auditor's confidence interval, we concluded that the forensic audit estimate of
$882.80 represents the population ratio.
The results of the time-series analysis
and the overlapping confidence intervals
supported our second hypothesis. The sample does indeed represent the entire population.
In that they supported both hypotheses,
our findings supported the forensic audi-

FORENSIC AUDITING

0.12
0.1

9 10 1112 1

84

Month
"^Population + Sample
Figure 5: This comparison of the percent of sales in the population with the percent of sales in
the sample from June 1984 to June 1986 shows that they Irack together very well, again indicating
that the sample accurately represents the population.
tor's inventory reconstruction. This meant
that over 70 percent of the gold had been
stolen before the policy took effect on September 11, 1986.
Conclusions
Armed with the forensic auditor's results
and our statistical support, Mr. Campise
went to court and successfully defended
Lloyd's of London. On March 2,1990, the
jury ruled that Lloyd's was not liable as
most of the gold had been stolen before the
policy date. Putnam was ordered to repay
the $2 million advance plus interest to

Lloyd's [UPI 1990].

The accounting firm of Sansiveri, Ryan,
Sullivan, and Company, which conducted
the forensic audit, had been far too haphazard in sampling methods. Although no one
can ever establish whether the case would
have been determined in Lloyd's favor
without our statistical support, Mr.
Campise clearly had far firmer ground
upon which to build his case because of
our work. Even though we were brought in
after Sansiveri, Ryan, Sullivan, and Company conducted the forensic audit, we used

November-December 1996

103

OLINSKY, MANGIAMELI, CHEN

statistical techniques to verify that its results were, in fact, random and representative of total sales.
In retrospect, we should have conducted
additional statistical tests, such as a Chisquare test. Two factors stopped us from
performing more formal tests. Because Mr.
Campise wanted visually compelling support, we used approaches that provided
charts and graphs that the jury could easily
understand and appreciate (a Chi-square
test would not have done this). Also, we
had very little time in which to conduct our
studies. With this rush we honestly did not
think of using any statistical tests that were
not visual in nature, even though they are
more powerful. Clearly, had the accounting
firm employed trained statisticians from
the beginning instead of bringing them in
at the last minute to "bail them out," they
would have used correct sampling methods. This would have saved them time,
money, and anxiety. In such critical areas
of litigation as tax fraud and forensic auditing, proper statistical methodology plays a
crucial role.

United Press International 1989, "Judge sentences

ex-jeweler for bilking bank," May 18, Regional
News.
United Press International 1990, "Lloyd's earns $2
million judgment," March 4, Financial News.
Watson, C; Billingsley, P.; Croft, D.; and

Huntsberger, D. 1994, Statistics for Management

and Economics, fifth edition, AUyn and Bacon,
Boston, Massachusetts.

Daniel J. Ryan, CPA, Partner, Sansiveri,

Ryan, Sullivan, and Company, Certified
Public Accountants, 55 Dorrance Street,
Providence, Rhode Island 02903, writes,
"Our court testimony, as to when the gold
was missing, depended heavily on our inventory reconstruction which in turn depended to a great degree on our sample of
invoice transactions. Although we took
great care in obtaining a very large sample
of invoice transactions in a random fashion,
our attorneys were concerned about this
randomness issue being challenged in court.
"Therefore, it was important for us to
have supporting documentation that our
sample of invoice transactions showed no
evidence of nonrandomness or bias. We
turned to Dr. Alan Olinsky, professor of
mathematics at Bryant College, for his proReferences
fessional expertise.
Boston Globe 1989, "Jeweler pleads guilty,"
March 16, Thursday, City Edition, Economy,
"The efforts documented in Dr. Olinsky's
pp. 68.
paper submitted to your journal resulted in
Harrop, Froma 1990a, "Lloyd's reneged in gold
the required supporting documentation.
loss, court told," The Providence Journal-BulleWe felt confident of the legal standing of
tin, Eebruary 7, Vol. 18, No. 33, Sec. B, pp. 1.
Harrop, Froma 1990b, "Witness testifies he
our inventory reconstruction by virtue of
faked gold," The Providence journal-Bulletin.
his work as summarized in his paper.
February 16, Vol. 18, No. 41, Sec. B, pp. ].
Lloyd's of London was also most pleased
Rakowsky, Judy and Howard, Peter E. 1988,
with
the resulting court decision in their
"Jewelry dealer Sammartino is indicted by
US," The Providence journal-Bulletin. September favor."
23, Vol. 159, No. 186, Sec. A, pp. I.
Scheaffer, R. L.; Mendenhall, W.; and Ott, L.
1979, Elementary Survey Sampling, second edition, Duxbury Press, North Scituate,
Massachusetts.

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104