How Charles Ponzi Can Inform Your Compliance Program

Yesterday, I used some of the wisdom from current CIA Director General David Petraeus to suggest how senior management might move forward with a compliance program. Today I will use a very different individual to help inform your third party due diligence, Charles Ponzi.

My colleague Tracy Coenen writes an invaluable blog entitled The Fraud Files Blog. She consistently writes about detecting fraud in all its forms. In a recent post,entitled “Ponzi Scheme and Investment Fraud Red Flags”, Tracy identified many Red Flags which might come up if you performed some due diligence on a Ponzi scheme or persons promoting it. In her blog post, she listed “some red flags about the “investment” you’re considering that might indicate it is a Ponzi scheme” and they are as follows:

• Promoters are not registered to sell investments (Consider doing a background check through Financial Industry Regulatory Authority (FINRA) if the promoter is U.S. based.);
• Promoters have a history of being investigated and/or disciplined for actions related to investments (Google is your best friend for this one.);
• Promoters and/or founders of the business/investment have criminal, bankruptcy, or civil court histories that are troubling (Use PACER to search all federal court records for a nominal fee. State courts generally have their own online systems, and access to them is growing daily.);
• Difficulty in verifying whether there is a legitimate business behind the investment (Again, Google is your friend!);
• Groundbreaking “new technology” or other special (but super-secret) methods or assets, which are going to take the world by storm and be the greatest thing since sliced bread;
• Complicated alleged business model that prevents an experienced investor from understanding how money is really made;
• The alleged performance of the company is suspiciously higher than competitors or companies in related industries;
• No objective third-party information can be found about the company;
• Elaborate explanations for why the business cannot be verified;
• Unusually high rates of return offered on the investments (Note that this one is the most common across all Ponzi schemes.);
• Returns on investment are guaranteed (Not to be confused with an annuity from a reputable company with a guarantee in the contract.);
• Promoter downplays the amount of risk investors will be exposed to, often  using phrases such as “a sure thing”;
• Reluctance to provide documentation supporting claims being made about the investment and the business behind it;
• Address of the “business” is a mail drop location, virtual office, or small private office that couldn’t possibly hold a business the size that is being claimed (Google Maps is very helpful for this one.);
• Few (if any) employees in the operation other than the founder and/or promoter;
• Background of the principals of the business is mismatched with what the business does (Use Google to find out what kinds of jobs they held previously, and compare it to what they’re supposedly doing now.); and
• Company’s alleged success is related to a recent announcement of some sort, rather than historical financial results (This one is even worse if the information in the announcement can’t be verified, and it appears to just be a PR stunt for the benefit of potential investors.).

One of the things that struck me in reading Tracy’s list of Ponzi scheme Red Flags is how closely they mirror those which may appear in a Foreign Corrupt Practices Act (FCPA) or UK Bribery Act due diligence investigation. Additionally the Red Flags would seem to organize themselves into four general areas:

1. Something seems out of the ordinary.
2. Reluctance of party to supply information/difficulty of verifying information.
3. The scheme is not verifiable by data, only anecdotally.
4. Mismatch in business experience with the product or services offered.

In due diligence training, I always tell people to listen to their guts, or if the hair on the back of their neck stands up, pay attention. Not listening to your internal warning system can lead your company down a path that it may well not desire to travel. Red Flags are so called for a reason and if they are raised they must be sufficiently clear. Tracy Coenen’s list of Red Flags for Ponzi schemes is one which any corporate compliance officer should take to heart.

Tracy Coenen, CPA, CFF  has also written a useful book for helping companies and individuals detect fraud and Ponzi schemes and investment frauds entitled, “Expert Fraud Investigation: A Step-by-Step Guide.” She can be reached via email at tracy@sequenceinc.com.

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 2012

Olympus Trifecta

Richard Cassin author of the FCPA Blog, among others, consistently writes about corruption as ripping apart the fabric of many countries. This makes anti-corruption and anti-bribery legislation not only appropriate but mandatory. Over the past few weeks, I believe that we have seen another reason and that is that shareholders may have some comfort that the companies in which they invest are valued fairly and will not implode. In the US, we had the last decade brought us the trifecta of Enron, World Com and Adelphia, where accounting frauds destroyed these companies. But Japan is experiencing something different with the still unfolding Olympus matter.

On Monday, the Wall Street Journal (WSJ), in an article entitled “Olympus Admits to Hiding Losses” reporters Kana Inagaki and Phred Dvorak, wrote about the scheme by which the Olympus Corp. hid years of investment losses by making wildly overpriced acquisitions and then writing off the investments losses by writing down the value of the acquisitions. Such a business strategy  is so well known in Japan that it even has a name, “tobashi.”

To recap this story, on October 14, 2011 the now-resigned Olympus Chairman, Tsuyoshi Kikukawa, dismissed the former head of the company, the Briton Michael C. Woodford, citing cultural differences in management styles. Mr. Woodford contended that he had been fired after raising questions about a series of acquisitions made by Olympus, that, he said, were inexplicably high prices paid for the acquired companies or involved exorbitant advisory fees paid to tiny entities which acted as agents of Olympus for the transactions in question. Indeed one of these commissions was a payment of $687 million, almost one-third of the amount of a transaction of just less than $2 billion. Of course the company claimed he was fired for the catch-all usual suspect reason, that being he was ‘not a team player.’

Later the WSJ reported that the three companies purchased by Olympus, whose purchases led to the unusually high commissions, had the following characteristics: “two of the acquired companies, medical-waste disposal company Altis Co. and food-container maker News Chef Inc., were founded in the early 1990s under different names, public company records show. The companies conducted no business for years.” The third company was founded “less than a year before Olympus bought a stake”. Olympus eventually acquired control of all three companies.  Within a year of acquiring control of these three companies, “Olympus wrote off three-fourths of its investments in the companies.”

In an article in Wednesday’s New York Times, entitled “Shares Dive as Olympus Scrambles for Answers”, Christine Hauer reported that “The developments cast a harsh light on Olympus’s auditors, KPMG until 2009, which have signed off on financial statements that may now be suspect.” While auditor negligence may well have been a factor, I will leave this area of comment to Francine McKenna and her blog site, retheauditors.com. If you do not read Francine of a regular basis, you should take this opportunity to begin doing so.

So what makes this new revelation so stunning? First, much like Harry Markopolis, who could not have predicted that Bernie Madoff was running a decades long Ponzi scheme, I could not have predicted that Olympus was defrauding its shareholders by hiding investment losses through acquisitions. And while fraud may well be a part of this story, I will leave that discussion to Tracy Coenen and her blog site, sequenceinc.com. As with Francine, if you do not read Tracy’s site on a regular basis now might be a propitious to start.

Remember the $687 million commission paid to an agent of Olympus? It is this part of the story that relates to Richard Cassin and all the others who tirelessly campaign against bribery and corruption in the corporate world. One of the bases for jurisdiction of the Foreign Corrupt Practices Act (FCPA) applies if a company with a US presence engages in bribery or corruption and the US banking system is involved. While at this point it is unknown if any of the monies paid for the companies acquired by Olympus to hide its investment losses came through the US banking system, if it did, the FCPA might well be invoked. To this end the New York Times reported that the US Securities and Exchange Commission (SEC) and FBI are investigating the matter.

Admittedly the FCPA is a supplier side law, which only punishes the bribe-payer. However, the same is not true of the UK Bribery Act, which makes illegal the payment or receipt of bribes. Clearly Olympus does business in the UK so the Bribery Act may also be invoked. Further, while the FCPA applies to ‘foreign governmental officials’, the UK Bribery Act applies to bribery between foreign officials and private citizens. If any of the monies paid as commissions was made to purchase the silence of the putative agents, then jurisdiction may lie. Lastly, the Board of Olympus should also note that the Bribery Act has a strict liability component for those who are actively involved in conduct which violates the Bribery Act.

So just who on Olympus could have been involved in any untoward conduct? Perhaps any person involved in properly not recording the company’s transactions so as to provide a fair and accurate representation of the financial health of the company? Any person involved in the transactions of purchasing the companies bought for the purposes of writing down their values? Maybe the agents who received the high commissions and, by the way, where did those exorbitant commissions go after they went into those Cayman Island bank accounts? How about any persons from the company’s purchased? Was this conduct systemic, as it engaged in for 15-20 years?

In my last post on Olympus (Olympus Redux) I wrote about the need to perform due diligence on transactional agents. While this need still exists, the use of transactions and transactional agents to hide investment losses may explain why it does not appear that such due diligence was done on the agents. Moreover, if such transactional agents are going to be used for fraudulent purposes, it really doesn’t matter what quality of due diligence is performed. Further, if the amount of the commission is exorbitant, as in one-third the value of a multi-billion dollar transaction, this in and of itself may be a Red Flag. This is the initial Red Flag that the now fired UK whistle blowing President reported to UK authorities. So now we have hit the trifecta for Olympus in the arena of corruption: (1) termination of the UK subsidiary President for reporting Red Flag conduct; (2) use of small agents who were paid huge commissions which were not deserved; and (3) failure to actively report years of investment losses by fraudulent transactions. I can only wonder what might be the next bombshell. I guess it will have to be called the quadruple.

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 2011

Inbound Corruption and the UK Bribery Act

The UK Bribery Act, as hopefully everyone is aware by now, became effective last Friday, July 1. Most compliance practitioners are keenly aware of its application to UK based companies or subsidiaries for bribery of governmental officials and private parties. Many companies have understood that these types of activities are illegal under the Foreign Corrupt Practices Act (FCPA) in connection with foreign governments and foreign governmental officials and some companies focused on these types of schemes when they involve private, non-governmental actors. However, the Bribery Act prohibitions apply to inbound schemes that involve bribery as well. These include bribery of a UK company or subsidiary’s employees. Most companies focus on the outbound schemes so we thought it might be a propitious time to review the different types of fraud schemes that that might be covered by the Bribery Act for inbound actions.

In her book “Expert Fraud Investigation: A Step-By-Step Guide” Tracy Coenen details several types of fraud investigations. In addition to the book as a useful tool for the fraud examiner, Coenen also provides the lay person with a general discussion of the types of corruption schemes a company may face and how best to prevent them. As well as outright bribery there are several types of inbound corruption; including kickbacks, extortion, conflict of interests, and related party transactions as examples of corruption which can involve a payment to obtain an advantage, receive preferential treatment, or force certain preferential actions.

Kickbacks

 Kickbacks occur when a company overpays for goods or services and then remits all or part of the overpaid amount back to the perpetrator. This can be affected by the person in charge of the overall bidding process. However, it can extend down into any other employees involved in the approval process such as employees in production, engineering or quality control. So, similar to bribery, there can be more subtle forms of kickbacks and such forms can include the substitution of inferior components into an overall product while charging the higher price to the end-user/purchaser. Kickbacks can also include irregularities in pricing and quality throughout a project. Even if inferior quality goods are not substituted, an irregular price can inflate the cost of goods paid for by a company.

Extortion

 Extortion is in many ways the mirror image of bribery. Whereas with a bribe, something of value is given to obtain a benefit, with extortion, a payment is demanded. While such demand can be made to obtain a benefit, such as to allow a company to go forward in a bidding process; extortion can also be made to prevent injuries to persons and damage to physical facilities. While not nearly as common as bribes, there are cases where extortions have been made and money paid based upon the threats.

Conflict of Interest

 Many people do not think of conflicts of interest when considering a corruption scheme. Nevertheless, if an employee, executive, or owner of a company has an undisclosed interest in an entity with which his company is doing business, the situation can present a conflict of interest. In the conflict of interest scheme, the employee, executive, or owner may be able to influence the company decision making process in order to send business to the other entity. This conflict of interest may be broader than simply directly involving an employee, executive or owner; it can extend to wives, children and other family members who stand to benefit from any such undisclosed interest.

Related Third Party Transactions

 Many compliance practitioners do not consider transactions with third parties as part of an overall fraud scheme. However, if the third party transactions are not conducted in an arms-length manner, this may well be indicia of an overall fraud scheme. Problems can arise when the related parties have a special advantage in doing business with a company and when that special advantage harms the company through increased costs, decreased revenue or other concessions.

In addition to the types of schemes listed in the categories above, Coenen lists several different types of such transactions. They include:

Extending credit to a company which would not otherwise be so entitled;

• Writing off accounts receivables with no legitimate business reason;
• Doing business with a small or one-man shop with no physical assets or simply a post office box for an office;
• Engaging in consulting agreements where no substantive work is done for payments received;
• A consultant who engages in extensive ‘market research’ in foreign countries with little to no tangible work product; and
• Concealing the existence of direct or indirect ownership in entities with which a company is doing business.

So what can a company to do combat inbound bribery and corruption? The techniques will be familiar to the compliance practitioner; they include ongoing monitoring programs of both accounts and transactions, through robust internal controls. It is also recommended that there be an anonymous reporting hotline through which employees can alert management of such activities without fear of supervisor retaliation. However, the most important form is that management set the correct ‘Tone at the Top” that such fraudulent activity within the company will not be tolerated.

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

 © Thomas R. Fox, 2011

Jonathan Marks Tweets and Why You Should Be On Twitter

Yesterday my Fraud Examiner colleague Tracy Coenen posted a blog entitled, “Why I’m quitting Twitter (and you should too)”. My blog today will set forth the reasons why the compliance practitioner should refrain from quitting Twitter, actively participate and why the greater compliance world benefits from participation from experts like Tracy Coenen. So Tracy, do not quit!

Twitter is an excellent resource for anyone in the compliance community. It provides real time reporting and more importantly excellent resources for the compliance practitioner. AND BEST OF ALL IT IS FREE!

Why should you participate on Twitter? My experience is that it is one of the most efficient ways to get your name out in the field you practice. Whether it is law, forensic accounting, finance or selling flowers, it does not matter. The key is to stay focused on your area of specialty. If you tweet about where you are or that you are the Mayor of some such place it will not assist you professionally.

What did I do? I began my social media journey focusing on Twitter. Beginning in January, 2010, I reposted every tweet I could find on the Foreign Corrupt Practices Act (FCPA). I did not post original content because I was learning the Twitter ropes and was not sure what to do. I stayed focused on the area of the FCPA which led to me being named in February as one of the Top 15 “Must Follows” in the area of Securities Law (FCPA) by Bruce Carton, author of the Securities Docket Blog and his list was posted in Compliance Week.

I then decided to see if I could begin to send articles to different blogs and websites for posting. I always send an email introducing myself and they all come back with something along the lines of the following, “We know who are and thanks for re-tweeting our tweets.” To date they have all said yes to me sending in a contribution for consideration. So I was able to make a name for myself through Twitter. Of course I had to follow up with substantive content and perhaps I could have sent blind submissions but Twitter was the tool which introduced me to the wider compliance world.

How else can one use Twitter to meet and develop substantive business? In December 2010, I noticed a tweet by Jonathan Marks where he mentioned that he had developed a 13-step action plan for FCPA compliance programs. I thought that this was an interesting item but there was no link to the document or information, so I took the direct approach and Direct Messaged Jonathan, on Twitter, to ask if he would be willing to share with us the 13-step action plan, which he was willing to do.

I met Jonathan (virtually) through LinkedIn and his hosting of the LinkedIn group ‘Fraud Pentagon.’ Through his profile I was able to discover Jonathan’s interesting professional journey, he is the Partner In-Charge of the Fraud, Ethics and Anti-Corruption practice at Crowe Horwath and has worked with the US Attorney’s office, the FBI, the IRS Criminal Investigation Division and US Customs officials during his career. Jonathan has also served as the Chief Audit Executive at several public companies and is a Certified Public Accountant, Certified Fraud Examiner and is certified in financial forensics.

I spoke to Jonathan to find out how he developed this plan and he told me that from his meetings with clients, on the issue of compliance over the years, he wanted to develop a non-legalistic approach that he could easily convey to clients. After the interview and his sharing of his 13-step program I wrote a blog about the program by which a company could review its FCPA compliance program, assess where the program is in terms of best practices, and then use the same action plan as a guide for implementing some or all of the best practices.

The response to the blog posting was so great that Jonathan wrote a White Paper on his 13-step program which I assisted him with some of the drafting. All of this happened because he tweeted about his 13-step program. In other words, one little tweet led to all of the above.

How does all of this relate to Ms. Coenen and her pronouncement? I say to Tracy, do not stop tweeting – WE NEED YOU. One other reason to continue to participate in Twitter is the absolute wealth of information that is available to any chosen profession. However, I can speak only to the compliance world and in that world there is significant information available to all AT NO COST. If you are in a company on a budget, and who is not, you can obtain the best practices of FCPA compliance, Bribery Act compliance, fraud and forensic accounting compliance by participating on Twitter. Tracy’s tweets are substantive and if she retweets someone else’s tweets, I am confident that it is substantive as well.

Twitter is but one tool and to any professionals a quiver of tools it is a significant and useful tool (did I mention that it is FREE?) for both marketing and research. I do agree with Tracy that I cannot point to one client I have obtained exclusively from Twitter. It is always some combination of Twitter/LinkedIn/Blogging/Speaking/White Papers and word of mouth. But it is a significant tool and, in my opinion, a tool that you should not forsake.

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 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

Bring Out the Big Guns?

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

When companies have big problems, they usually bring out the big guns. The benefits of using large law firms, audit firms, and other professional service firms are undeniable. These firms offer a depth of experience that is invaluable, and they have seemingly unlimited resources in terms of manpower. A large firm often has the ability to mobilize an engagement team quickly, and can bring in experts from around the world. 

Does bigger mean better? Certainly the perception exists that larger firms provide better services. No one can fault an executive who chooses a big firm when trouble is brewing. There is an undeniable comfort level that comes with the big firms because they have established reputations and many resources. Even if the project goes poorly, no one can fault the executive who chose the large firm. 

Contrast this with the risk of using a small law firm or forensic accounting firm. Most board members and shareholders have never heard of the small firm. Is it competent? Does it have the resources to handle an investigation of this size? What if something goes wrong? The executive who chose the small firm is going to feel the heat.

Gradually, companies are becoming more willing to use smaller professional services firms. The first clear benefit of a small firm is the ability to get significant expertise focused on your project.  A small firm lawyer or accountant can have just as much knowledge as a big firm professional. The key is finding the right professional with a wealth of knowledge. 

A small firm professional is often more accessible to the client. In addition, she or he is likely to be doing the bulk of the work on the engagement, making it easy to get timely updates from the front lines of the project. 

Most important is the level of experience on a project.  With a small firm, the client is less likely to have young, inexperienced staff members cutting their teeth on the client’s project. Who wants to pay for on-the-job training for young personnel, when they could instead pay a highly experienced professional to do the bulk of the work? 

In addition, small firms can often control budgets better than large firms.  Smaller firms are more likely to use non-traditional billing arrangements, such as fixed fees, and are often more cost-conscious.  Larger teams can tend toward runaway fees, and the client doesn’t necessarily receive commensurate value. 

Choosing between small and large firms is not an all or nothing type of thing. Large firms are well suited to many engagements, but on highly specialized assignments, it might make sense for management to seek out a solo practitioner or small firm with the right expertise.  By focusing on getting highly-qualified professionals on a project, the company can often get greater value for its money. 

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 Securities Docket.

 

Fraud Investigation and the UK Bribery Act

We were recently introduced to Fraud Examiner Expert Tracy Coenen, in her book “Expert Fraud Investigation: A Step-By-Step Guide” she details the steps a company should go through in performing a fraud investigation. Coenen provides the ‘nuts and bolts’ on how conducting an investigation can be a powerful tool to help corporations ferret out fraudulent practices within their organization. Her book gives the examiner the specific steps to take when fraud is suspected and how to proceed forward throughout the investigation to conclusion. In addition to the book as a useful tool for the fraud examiner, Coenen also provides the lay person with a general discussion of the types of corruption schemes a company may face and how best to prevent them. Coenen lists bribery; kickbacks; extortion; conflict of interests; and related party transactions as examples of corruption which can involve a payment to obtain an advantage, receive preferential treatment, or force certain preferential actions.

Many compliance and ethics practitioners have long understood that these types of schemes are illegal under the Foreign Corrupt Practices Act (FCPA) in connection with foreign governments and foreign governmental officials, but many FCPA compliance practitioners in the US may not have focused on these types of schemes when they involve private, non-governmental actors, outside the US. However, with the upcoming April 1, 2011 effective date of the UK Bribery Act, such practitioners may well be served to revise their company policies to take into account that the UK Bribery Act prohibitions apply to private actors equally as well as governmental officials. Based upon this difference in the pubic actor v. private actor distinction between the FCPA and UK Bribery Act, this post will review the different types of corruption schemes that Coenen outlines in her book.

Bribery

While most FCPA practitioners understand that a payment to confer a benefit may be enough to be classified as a bribe, such practitioners may not focus on other, more subtle, forms of bribery than simply bags of cash. These can include bid-rigging where inside information is passed to a vendor to allow said vendor to unfairly win an allegedly open bid, or where the bid winner has been secretly pre-determined in what is advertised as an open and fair bidding process. Bid-rigging can extend to the collusion between certain employees of a purchaser-company and vendor, where such employees purchase more goods or services than the company would need. Bid-rigging can also be found where alleged non-winners, in an apparently open bidding process, later appear as subcontractors on a project.

Kickbacks

Kickbacks occur when a company overpays for goods or services and then remits all or part of the overpaid amount back to the perpetrator. This can be affected by the person in charge of the overall bidding process. However it can extend down into any other employees involved in the approval process such as employees in production, engineering or quality control. So, similar to bribery, there can be more subtle forms of kickbacks and such forms can include the substitution of inferior components into an overall product while charging the higher price to the end-user purchaser. Kickbacks can also include irregularities in pricing and quality throughout a project. Even if inferior quality goods are not substituted, an irregular price can inflate the cost of goods paid for by a company.

Extortion

Extortion is in many ways the mirror image of bribery. Whereas with a bribe, something of value is given to obtain a benefit, with extortion, a payment is demanded. While such demand can be made to obtain a benefit, such as to allow a company to go forward in a bidding process; extortion can also be made to prevent injuries to persons and damage to physical facilities. While not nearly as common as bribes, there are cases where extortions have been made and money paid based upon the threats.

Conflict of Interest

Many people do not think of conflicts-of-interest when considering a corruption scheme. Nevertheless if an employee, executive, or owner of a company has an undisclosed interest in an entity with which his company is doing business, the situation can present a conflict of interest. In the conflict of interest scheme, the employee, executive, or owner may be able to influence the company decision making process to send business to the other entity. This conflict of interest may be broader than simply directly involving an employee, executive or owner. It can extend to wives, children or other family members who stand to benefit from any such undisclosed interest.

Related Party Transactions

Coenen points out that many people do not consider transactions with third parties as part of an overall fraud scheme. However if the third party transactions are not conducted in an arms-length manner, this may well be indicia of an overall fraud scheme. Problems can arise when the related parties have a special advantage in doing business with a company and when that special advantage harms the company through increased costs, decreased revenue or other concessions. In addition to the types of schemes listed in the categories above, Coenen lists several different types of such transactions. They include:

• Extending credit to a company which would not otherwise be so entitled;
• Writing off accounts receivables with no legitimate business reason;
• Doing business with a small or one-man shop with no physical assets or simply a post office box for an office;
• Engaging in consulting agreements where no substantive work is done for payments received;
• A consultant who engages in extensive ‘market research’ in foreign countries with little to no tangible work product; and
• Concealing the existence of direct or indirect ownership in entities with which a company is doing business.

Although the focus of Coenen’s book is the investigation of fraud, in all of its forms and permutations, she does give several pointers to assist in the prevention of fraud. These will be familiar to the FCPA practitioner and include ongoing monitoring program of both accounts and transactions, through robust internal controls. Coenen recommends an anonymous reporting hotline through which employees can alert management of such activities without fear of supervisor retaliation. But Coenen ends by noting the most important form is that management set the correct ‘Tone at the Top” that such fraudulent activity within the company will not be tolerated.

Any US company operating internationally will be subject to the UK Bribery Act. Therefore the time has come to consider the changes required to its overall compliance program to meet the UK Bribery’s Act proscription against bribery and corruption of private actors. Tracy Coenen’s book is an excellent starting point for the FCPA practitioner to begin to enlarge a FCPA compliance based program to meet this challenge. We commend it to you for your consideration.

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 2010