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?

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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 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”.

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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.

[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.

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