FCPA Compliance and Ethics Blog

February 6, 2013

Socio-Economic and Cultural Risk Factors That Drive Corruption: A Focus on the ‘Supply Side’ of the Equation

Ed. Note-today we conclude a three-part series by our colleague Mary Shaddock Jones on occupational fraud. 

This is the last installment of my three party series regarding Occupational Fraud.  One can never lose focus on what I consider the key question as they enter or play within the international arena:  What are the socio-economic and cultural risk factors that make companies and individuals conducting business in a particular location more vulnerable to possible corruption schemes?   We cannot adequately address corruption unless we address both the “supply side” and the “demand side”. Yesterday we considered the “Demand Side” of the equation.  Today we will focus on the “Supply Side”.  If your company has a clear policy against corruption- why would your employees risk losing their jobs or worse, going to jail by violating these laws?

A side benefit to being married to a CPA and a Certified Fraud Examiner is the ability to read not only legal and compliance magazines on a monthly basis- but also the Journal of Accountancy and the publications from the ACFE society.  I loved the August 2012 cover of the Journal of Accountancy- “Think Like a Thief”! There were three very pointed articles contained in this publication:  (1) Fraudsters Reveal Weaknesses They Exploited; (2) Detecting a Criminal Mind Before It Strikes; and (3) Antifraud Controls Can Benefit Small Businesses.   In addition to this publication, I will be examining some of the conclusions recently published in the “Report to the Nations on Occupational Fraud and Abuse- 2012 Global Fraud Study” which is recognized as the authoritative annual national report on fraud

Considering the “Supply Side” of the Equation:

The fraud triangle is a model for explaining the factors that cause someone to commit occupational fraud. It consists of three components which, together, lead to fraudulent behavior:  (1) Pressure; (2) Opportunity and (3) Rationalization.

Pressure- According to the ACFE, the first leg of the fraud triangle represents “pressure”. This is what motivates the crime in the first place.  The individual has some financial problem that he/she is unable to solve through legitimate means, so he or she begins to consider committing an illegal act, such as stealing cash or falsifying a financial problem, or entering into an improper payment (perhaps thinking of the bonus he or she will get if they land a lucrative contract for their employer) as a way to solve their problem.   The 2012 ACFE report concluded that “Most fraudsters exhibit behavioral traits that can serve as warning signs of their actions. These red flags — such as living beyond one’s means or exhibiting excessive control issues — generally will not be identified by traditional internal controls. Managers, employees and auditors should be educated on these common behavioral patterns and encouraged to consider them — particularly when noted in tandem with other anomalies — to help identify patterns that might indicate fraudulent activity.”  The report found that “More than three-quarters of the frauds in our study were committed by individuals in six departments: accounting, operations, sales, executive/upper management, customer service and purchasing.

Opportunity- The second leg in the fraud triangle is perceived as “opportunity”, which defines the method by which the crime can be committed.  The person must see some way the he or she can use (or abuse) their position of trust to solve their financial problem with a low perceived risk of getting caught.

Rationalization- The third leg of the fraud triangle is “rationalization”. According to the ACFE, the vast majority of fraudsters are first time offenders with no criminal past; they do not view themselves as criminals. They see themselves as ordinary honest people who are caught in a bad set of circumstances. Consequently, the fraudster must justify the crime to himself in a way that makes in an acceptable of justifiable act”.  Again, according to the ACFE, the most common rationalizations fraudsters use include a) I was only borrowing the money; b) I was entitled to the money; c) I had to steal to provide for my family; d) I was underpaid; my employer cheated me and e)  My employer is dishonest to others and deserved to be fleeced.

As discussed in the first part of this series, Occupational Fraud is broader than just anti-corruption as it relates to the Foreign Corrupt Practices Act or the U.K. Bribery Act.  However, the motivating factors and conclusions reached in the 2012 Global Fraud studies should be examined by companies when examining its overall anti-corruption risk profile.

I will end this series by listed two of the conclusions and recommendations contained within the 2012 Global Fraud Report which I believe are excellent advice:

Targeted fraud awareness training for employees and managers is a critical component of a well-rounded program for preventing and detecting fraud. Not only are employee tips the most common way occupational fraud is detected, but our research shows organizations that have anti-fraud training programs for employees, managers and executives experience lower losses and shorter frauds than organizations without such programs in place. At a minimum, staff members should be educated regarding what actions constitute fraud, how fraud harms everyone in the organization and how to report questionable activity.”

“Our research continues to show that small businesses are particularly vulnerable to fraud. These organizations typically have fewer resources than their larger counterparts, which often translates to fewer and less-effective anti-fraud controls. In addition, because they have fewer resources, the losses experienced by small businesses tend to have a greater impact than they would in larger organizations. Managers and owners of small businesses should focus their anti-fraud efforts on the most cost-effective control mechanisms, such as hotlines, employee education and setting a proper ethical tone within the organization. Additionally, assessing the specific fraud schemes that pose the greatest threat to the business can help identify those areas that merit additional investment in targeted anti-fraud controls.”

What is your company’s risk for corruption?  When is the last time that you conducted a risk assessment for corruption? As yourself these questions:

  1. Do you have a Code of Conduct?
  2. Do you have a policy which clearly addresses the company’s position on anti-corruption? If so, is the policy easily accessible to your employees in their native language?
  3. Do you have an anonymous reporting system or other method in which employees can elevate concerns relating to occupational fraud to the appropriate person within the company?
  4. Do you provide any type of meaningful training on fraud and corruption to your employees?
  5. Do you have internal controls to prevent and detect fraud or corruption within your organization?

________

Mary Shaddock Jones has practiced law for 25 years in Texas and Louisiana primarily in the international marine and oil service industries. She was the first woman to earn TRACE Anti-bribery Specialist Accreditation. Mrs. Jones has extensive experience in creating and designing compliance programs to reduce the risks of such violations, including policies and procedures, educational and training materials and programs, contract provisions and due diligence protocols. She implements and works with in-house counsel and compliance vendors to execute compliance policies and training programs tailored to the client’s business structure and the market conditions in the client’s target countries.  She can be reached at 337-513-0897 or via e-mail at msjones@msjllc.com. Her associate, Miller M. Flynt, assisted in the preparation of this series.  He can be reached at mmflynt@msjllc.com.

February 5, 2013

Socio-Economic and Cultural Risk Factors That Drive Corruption”: A Focus on the ‘Demand Side’ of the Equation

Ed. Note- today we continue with Part II of our three part series by out colleague, Mary Shaddock Jones. 

Yesterday we discussed Occupational Fraud and how, according to the ACFE, survey participants estimated that the typical organization loses 5% of its revenues to fraud each year. Applied to the 2011 Gloss World Product, the ACFE estimates that this translates into a potential projected annual fraud loss of more than $3.5 trillion dollars.

One can never lose focus on what I consider the key question as they enter or play within the international arena:  What are the socio-economic and cultural risk factors that make companies and individuals conducting business in a particular location more vulnerable to possible corruption schemes?   We cannot adequately address corruption unless we address both the “supply side” and the “demand side”.

Considering the “Demand Side” of the Equation:

I recently ran across an article that was published in the 2010 World Policy Journal[i] entitled “THE BIG QUESTION: How Can Nations Break the Cycle of Crime and Corruption”? The World Policy Journal asked a panel of experts to weigh in on the challenges of crime and corruption.  Two of the quotes contained in the article are as follows:

“Corruption thrives where civil liberties, free press, transparency, and contestable politics are absent. A functioning rule of law matters for controlling both crime and corruption, but again differences emerge: an independent judiciary is crucial for combating political corruption; an effective police is important for fighting petty corruption as well as common crime. There are also differences between the determinants of common crime and organized crime, since the latter does relate to corruption.”  Daniel Kaufmann (at the time of the article was a senior fellow in the Global Economy and Development Program at the Brookings Institute)

“Corruption should not be approached as a moral problem, as too often happens, but as a symptom of serious political and economic problems that need correcting. Petty corruption, such as low-ranking civil servants demanding payment for services they should provide for free, is a problem that requires restructuring the civil service, reducing the number of public employees within a government, and providing those who remain with decent wages. Attempts to curb petty corruption are unlikely to have an impact when extracting payments from the public is the only way a government employee can feed his family. Grand corruption, such as large payments to high-ranking officials to secure lucrative public contracts, requires political solutions. If there is no renewal of the government and the political class, grand corruption inevitably becomes a problem. Frequent turnover of government officials make it more difficult for corrupt networks to consolidate power. Democracy is the best anti-corruption measure…Donor countries worried about corruption should focus on two tasks: putting in place good control mechanisms over the funds they provide; and promoting fundamental political, economic, and administrative reform.” Marina Ottaway (at the time of the article was director of the Middle East Program at the Carnegie Endowment for International Peace)

In March of 2012, Compliance Week 2012 had an online program entitled “Targeting the Demand for Facilitating Payment- Compliance Week (Online).  The Article discussed the efforts undertaken by a consortium of compliance executives primarily from the energy industry is taking aim at one of the most vexing headaches businesses face today: facilitation payments.  While “facilitating payments” are permitted under the U.S. Foreign Corrupt Practices Act, they are not allowed under the U.K. Bribery Act or the local laws of most foreign countries.  In addition, the line between a true “facilitating payment” and a “bribe” is indeed a fine one.  With this in mind, the group formed the new Committee to Address Facilitating Payments (“CAFP”).  According to the article, the committee’s strategy is to convince governments to crack down on requests for facilitation payments by their officials, thus reducing the demand. It wants governments to review the documentation that certain transactions require, how the required fees are paid (cash or wire transfer, for example), and whether the processes can be automated to reduce risk. CAFP is also working on a country-by-country basis to convince governments to provide more training to officials that facilitation payments are improper and to make sure that those officials are fairly compensated.

Multiple Kudos need to go out to this group of executives.   The fight against corruption must target both the “demand side” as well as the ‘supply side”.   Tomorrow we will discuss the “Supply Side”.

________

Mary Shaddock Jones has practiced law for 25 years in Texas and Louisiana primarily in the international marine and oil service industries. She was the first woman to earn TRACE Anti-bribery Specialist Accreditation. Mrs. Jones has extensive experience in creating and designing compliance programs to reduce the risks of such violations, including policies and procedures, educational and training materials and programs, contract provisions and due diligence protocols. She implements and works with in-house counsel and compliance vendors to execute compliance policies and training programs tailored to the client’s business structure and the market conditions in the client’s target countries.  She can be reached at 337-513-0897 or via e-mail at msjones@msjllc.com. Her associate, Miller M. Flynt, assisted in the preparation of this series.  He can be reached at mmflynt@msjllc.com.

[i] The World Policy Journal is the property of MIT Press.  See www.worldpolicy.org

February 4, 2013

Occupational fraud involves a personal breach of trust

Ed. Note-today we are pleased to begin a three part guest series from our colleague Mary Shaddock Jones. 

My husband, Brian R. Jones, is a CPA, a Certified Fraud Examiner and a member of the Association of Certified Fraud Examiners. He recently received the annual publication entitled “Report to the Nations on Occupational Fraud and Abuse- 2012 Global Fraud Study” which is recognized as the authoritative annual national report on fraud.  One of the introductory statements contained in the report was as follows: “For businesses to operate and commerce to flow, companies must entrust their employees with resources and responsibilities, so when an employee defrauds his or her employer, the fallout is often especially harsh.” This statement rings true- whether the employer is a public or a private entity. Occupational fraud involves a personal breach of trust. The unfortunate fact is however, that organizations of all sizes invariably are losing some percentage of their annual revenues to occupational fraud conducted by employees.  So what can be done to minimize the risk of fraud occurring in the first place, then  detect the fraud once it has been perpetrated?

In order to answer this question, it is important for us first to discuss how occupational fraud is committed.  According to the ACFE, occupational fraud schemes fall into three primary categories:

  • Asset Misappropriation – schemes in which an employee steals or misuses the organization’s resources, such as cash, inventory or other assets.
  • Corruption- schemes in which an employee misuses his or her influence in a business transaction in a way that violates his or her duty to the employer in order to gain a direct or indirect benefit, such as through conflicts of interest, kickbacks, bribery, illegal gratuities or economic extortion.
  • Financial Statement Fraud- schemes in which an employee intentionally causes a misstatement or omission of material information in the organization’s financial reports, such as through asset/revenue overstatements via recording fictitious revenues or asset/revenue understatements  by understating reported expenses.

Once a company understands the typical method of committing occupational fraud, it can then devise internal controls to minimize the risk of loss in the first place, and/or to detect the fraud early enough to minimize the loss.

The Association of Certified Fraud Examiners has broken down corruption into four schemes, namely: conflict of interest, bribery, illegal gratuities, and economic extortion.  Attorney’s and compliance professionals continue to write articles and blogs on a daily basis.  The reason for this is simple- according to the ACFE, survey participants estimated that the typical organization loses 5% of its revenues to fraud each year. Applied to the 2011 Gloss World Product, the ACFE estimates that this translates into a potential projected annual fraud loss of more than $3.5 trillion dollars.  Unfortunately, it does not appear that Occupational Fraud and Corruption are going away anytime soon.

One can never lose focus on what I consider the key question as they enter or play within the international arena:  What are the socio-economic and cultural risk factors that make companies and individuals conducting business in a particular location more vulnerable to possible corruption schemes? Tomorrow I will discuss how a company can examine the “big picture” to try and predict and minimize these risk factors.

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Mary Shaddock Jones has practiced law for 25 years in Texas and Louisiana primarily in the international marine and oil service industries. She was the first woman to earn TRACE Anti-bribery Specialist Accreditation. Mrs. Jones has extensive experience in creating and designing compliance programs to reduce the risks of such violations, including policies and procedures, educational and training materials and programs, contract provisions and due diligence protocols. She implements and works with in-house counsel and compliance vendors to execute compliance policies and training programs tailored to the client’s business structure and the market conditions in the client’s target countries.  She can be reached at 337-513-0897 or via e-mail at msjones@msjllc.com. Her associate, Miller M. Flynt, assisted in the preparation of this series.  He can be reached at mmflynt@msjllc.com.

February 24, 2011

Five Myths About Fraud

Ed. Note-today we host a Guest Post from our Fraud Examiner Expert colleague – Tracy Coenen

We’ve all heard so much in the news about fraud over the last several years. Not a day goes by that we don’t hear about an executive caught with his hand in the cookie jar, a company that failed to follow proper accounting rules, or a compensation structure that led someone to cheat with the numbers.

In some ways, I think people are becoming immune to fraud. The cases don’t seem as significant as they would have been five years ago. They’re not as shocking as they used to be. It is sad that fraud is becoming more commonplace. And the more we hear about fraud, the more I think companies run the risk of not taking it seriously.

Most importantly, I think people are running around with some big misconceptions about employee fraud. If they mistakenly believe their company is not at risk, they are probably not actively preventing fraud. Companies must know the truth about fraud and its perpetrators in order to actively protect themselves.

The following are five of the fraud myths that I regularly run into in my fraud investigation practice. Whether owners and executives actually utter these out loud or not, merely buying into these myths mentally can be a recipe for disaster.

1. Our company does not have an internal fraud problem.

While companies would like to believe they have good employees and adequate controls to prevent fraud, the fact of the matter is that 45 percent of companies will be significantly affected by fraud, according to one international study. A separate study estimates that the average internal fraud will cost $159,000, and that almost one-fourth of fraud cases will cost companies over $1 million each.

Companies cannot afford to ignore the risk of fraud and the likelihood that fraud is occurring internally. It is too expensive, particularly when one considers the fact that there are many indirect costs of fraud, including investigation and legal costs, employee attrition, and decreased employee morale.

Actively fighting fraud means implementing policies and procedures that prevent and detect fraud. Anti-fraud professionals who are experienced with the common methods of fraud can be invaluable to this process. Whether a company gets there with employees or outside consultants, it is important to secure company information and assets to prevent internal fraud.

2. Most people are honest and won’t commit fraud.

This is a dangerous approach to take to the business of fraud. It is true that most people are generally honest. But to rely on this instead of putting controls in place to prevent fraud is a big mistake.

While it’s wise to hire those with a track record of honesty, past behavior doesn’t necessarily predict future behavior. Almost 88 percent of employees and executives who commit fraud against their employer have never before been charged or convicted of a fraud-related offense. This means it’s nearly impossible for companies to predict who is going to commit fraud and when they are going to do it.

It is a fact that honest people can and do commit fraud. Outside pressures can cause people to behave in ways they normally would not. Things that could push someone toward fraud include addictions, divorce, overwhelming debt, and gambling problems. When pressures like this are present, it’s difficult to predict who will commit fraud.

In the end, those who commit fraud come from all walks and ways of life. From clerks to executives, no one is immune. Thieves come from all social classes and all economic backgrounds. If given a strong motivation and ample opportunity, anyone can commit fraud against her or his employer.

3. If our company follows government regulations, we will be protected against fraud.

Unfortunately, the current accounting rules and regulations do not really provide protection against fraud. Sarbanes-Oxley is probably the most widely-recognized regulation dealing with fraud. It has had some positive effects because it has forced companies to review and document their policies and procedures.

Companies have spent enormous amounts of money on implementing Sarbanes-Oxley, and it’s probably discouraging to admit that even such an extensive project isn’t really preventing fraud. The regulation forces management and the board of directors to accept responsibility for issuing accurate financial statements, however, it doesn’t really ensure that companies have fraud prevention procedures in place.

In order to effectively prevent fraud, companies must create and implement policies and procedures specifically designed to deter and detect fraud. Again, this should be accomplished with the help of an anti-fraud professional who is experienced in the methods used by corporate fraudsters. A good fraud prevention program will actively prevent and detect fraud while still complying with the applicable regulations.

4. Small frauds aren’t important enough for management to worry about.

Virtually every big fraud started out as a small fraud at one point. Whether it is a minor theft of cash or a financial statement manipulation intended to cover up a substandard quarter, what starts out as a small fraud can quickly grow into a major fraud scheme. A theft of $500 may not seem significant enough for management to devote time and effort to the problem. But what if an employee was stealing $500 a week for three years? Suddenly, there is a theft of over $75,000, which could be very material to the company.

It’s important for companies to take small frauds and ethical lapses seriously. Not only does management want to cut off frauds while they are in their early stages, they also should be sending a message to employees that dishonesty is not tolerated. A zero tolerance policy is a necessary part of any good fraud prevention program.

It may be expensive to monitor and investigate smaller thefts from the company. However, in the long run, the cost will be worthwhile because the company will have stopped frauds from growing into the hundreds of thousands and millions of dollars. Therefore, an effective fraud prevention program will contain components that help the company discover fraud early.

5. Fraud will be detected by our auditors.

History has shown us that a company’s independent auditors cannot be relied upon to find fraud. This is true primarily because audits are not designed to detect fraud. They are designed to give “reasonable assurance” that the numbers shown on the financial statements are materially accurate.

Because fraud involves the active concealment of the truth, it makes it difficult for auditors to discover. Further, auditors have a tendency to become complacent with their clients. They see the same things year after year in the audit, and they may stop paying close attention. Employees who are concealing a fraud may also be comfortable with the auditors and know what procedures are coming. If that’s the case, count on the employees to be very careful with the fraud as it relates to those expected procedures.

Auditing rules have attempted to address how auditors approach the potential for fraud within companies. While the current rules are somewhat better than those of several years ago, a traditional independent audit still cannot be relied upon to detect fraud. Executives who believe differently are setting their companies up for disaster.

The Solution
Preventing fraud in companies all comes back to active prevention techniques and educating employees about fraud. First, owners and executives must be aware that they are very much at risk of experiencing internal fraud, and that the statistics show that the losses can be expensive. Then they need to take decisive action in formulating a fraud prevention program.

Education of everyone is still a very important part of fraud prevention. No company is immune to the problem, and no employee is completely free from the possibility of committing a fraud one day. After owners and executives appreciate the true magnitude of the problem, it will be through action that fraud will be prevented at their companies.

Tracy L. Coenen, CPA, CFF is a forensic accountant and fraud investigator with Sequence Inc. in Milwaukee and Chicago. She has conducted hundreds of high-stakes investigations involving financial statement fraud, securities fraud, investment fraud, bankruptcy and receivership, and criminal defense. Tracy is the author of Expert Fraud Investigation: A Step-by-Step Guide and Essentials of Corporate Fraud, and has been qualified as an expert witness in both state and federal courts. She can be reached at tracy@sequenceinc.com or 312.498.3661.

Ed.Note-this article initially appeared in the Fraud Files Blog.

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FCPA Compliance and Ethics Blog on the Road

Next week, together with Stephen Martin, General Counsel of Corpedia, we will be having an FCPA ‘road trip’ next week in Miami on Tuesday, Atlanta on Wednesday and Cleveland in Thursday.  We will present the most current best practices for an FCPA and Bribery Act compliance program. If you reside in or near one of the venues, I hope you can join us. I would love to meet you.

All events are complimentary and both CLE and breakfast are provided. Our presentation is hosted by World Check.

Tuesday, March 1 in Miami-http://members.ethisphere.com/events/event_details.asp?id=143046

Tuesday, March 2 inAtlanta-http://members.ethisphere.com/events/event_details.asp?id=143049

Wednesday, March 3 inCleveland-http://members.ethisphere.com/events/event_details.asp?id=143052


November 24, 2010

5 Important Fraud Investigation Interview Tips

Ed. Note-today we host a guest post by our Canadian colleague, Lindsay Khan of I-Sight

To conduct an investigation interview, you don’t need to be Sherlock Holmes- but it wouldn’t hurt to channel your inner detective. Fraud investigation interviews are a lot of work, but can take your investigation from ho hum to awesome. A successful investigation interview isn’t just a question and answer period. Asking good questions is just a small piece of a very big puzzle. To get the most out of your fraud investigation interviews, remember these 5 important steps:

1. Set Goals

First and foremost, set a list of goals. Identifying goals helps shape investigation interviews and allows you to put things in perspective. Goals will vary with each interview, but should be based on these primary objectives:

  • Gathering the facts- how long the fraud has been going on for, who was involved, what are their roles in the company, etc.
  • Determining the merits of the complaint- is the complaint valid?
  • Complying with legal obligations.
  • Maintaining confidentiality to the greatest extent possible.
  • Preserving the reputations of individuals and company.

2. Do Your Research

During a fraud investigation, you’ll want to do some digging to find out more about the people you’re interviewing. Reviewing personnel history of the potential interviewees will help clarify relationships and potential biases. This might also help you piece together multiple person involvement in the fraud scheme.

3. Bring Evidence Into the Interview

Documents, electronic files, expense reports and other evidence should be brought into the interview for reference. In the article “Anatomy of an Interview,” by Jim Marasco of StoneBridge Business Partners, Marasco writes:

“The most efficient and productive interviews are accomplished by advanced preparation. Questions should be prepared ahead of time along with evidential material that will be introduced during the interview. Having documents at your fingertips will move things along more quickly and offer the impression that your case is organized and solid.”

4. Background Questions

When interviewing someone about suspected fraud, kick off the interview with some basic background questions to gauge the individual’s reactions. The person you are interviewing is probably going to be uncomfortable regardless of how “welcome” you try to make the interview environment. By asking them questions related to their history at the company and the responsibilities of their position, you’ll get a better idea of their reactions and natural demeanor. Some background questions worth asking in a fraud investigation interview:

  • How long have you worked for the company?
  • What is your job title?
  • What is a typical day like for you in the office? What are your responsibilities?

*Probe deeper and ask specifics about how certain tasks are carried out- you should have gone over this information yourself before the interview, but hearing it from them adds to the investigation.

5. Double Check

Sometimes the facts involved in a fraud investigation can be a bit complicated. Always ask for clarification. Repeating statements and clarifying the facts are useful tips for making sure you’ve understood the interviewee’s story. You can’t afford to misinterpret or misunderstand what an interviewee is trying to say- it’ll ruin your investigation. Re-confirm their statements throughout the investigation interview, and at the end, have them sign your notes, stating that the statements are true and understood.

Ed. Note-Lindsay Khan regularly blogs on a wide variety of issues related to the compliance and ethics arena. You can follow her at http://www.customerexpressions.com/.

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