The Greatest Unmanaged Risk
12 February 2007 Martin Samociuk
Are management taking fraud and corruption seriously enough by making prevention integral to their business strategies? In an extract from their book, 'Fraud and Corruption: Prevention and Detection', Nigel Iyer and Martin Samociuk explain how to tackle what is arguably the greatest unmanaged commercial risk of the day.
Many executives would argue that they do take fraud and corruption seriously, having spent the last couple of decades implementing extensive corporate governance and control frameworks. However, in spite of tougher legislation and vociferous corporate rhetoric in recent years, not that much has changed in the world of fraud and corruption. Reports of major frauds and bribery scandals are just as prevalent now as they were 20 years ago.
OVERKILL IN BUREAUCRACY AND LEGISLATION
In recent years there have been improvements in reporting requirements and a greater level of awareness, but a lot still has to be done to prevent the recurrence of fraud and corruption. Rather than making the prevention of fraud and corruption central to their management style, many executives still tend to rely on the belief that people are honest.
Employees in both large and small organisations often believe that despite all the focus on controls, they can easily spot ways to defraud the organisation. The reason they haven't done it is because they are honest. Sadly, the spate of recent corporate collapses and the fact that investigators around the world continue to prosper shows that there are plenty of dishonest people around.
So much time and effort has gone into creating corporate responsibility agendas, defining corporate governance and internal controls frameworks, and implementing risk management strategies that very little time has been left to get to grips with the actual risks of fraud and corruption, the way criminals think and the methods that they use.
Fraud and corruption differ from many other risks in that they are aggressively perpetrated against the company by intelligent people who are continuously looking, covertly, to identify and target new loopholes for new opportunities. That is why it comes as a distressing shock to management and employees alike when a fraudster or corrupt individual is uncovered; the honest staff find it very difficult to believe that dishonest people would affect their organisation.
Extensive efforts have been made around the world to improve laws and definitions to ensure that legal processes are capable of adequately punishing fraudsters, corrupt employees and corporate psychopaths. Up until now we have not seen the same effort made by organisations in detecting attempts and preventing them from succeeding in the first place.
THE TRUE COST OF FRAUD AND CORRUPTION
There is a wealth of academic and empirical research that demonstrates the extent and effect of corporate fraud and corruption. However, the mounting piles of research, surveys and statistics are of little value in organisations if board executives and senior managers are reluctant to take fraud and corruption seriously.
Many senior executives believe either that their organisation is so much better than others that the likelihood of fraud and corruption is low, or alternatively that since there have not been many problems in the past then there cannot be any. They wait for a tip-off, and as a result, they are often waiting while the damage is being done.
However, once executives have experienced the effects of a major fraud or corruption scandal there is very little need to convince them to invest in preventing a reoccurrence. They also realise that their past inaction has led to significant losses.
Because these losses eventually come off the bottom line, every dollar lost reduces net income by the same amount. If the profit margin of the organisation is 10%, then to recover the lost income requires ten times that revenue to be generated. Hence to recover a $10m loss requires $100m of extra revenue.
In most cases the hidden indirect costs such as constraints on expansion and development, damage to reputation and employee morale greatly outweigh the direct costs.
Also the costs of investigation are not to be taken lightly. If a case is complicated and involves the international movement of funds, then the investigation costs can be very complex. It is not unusual to spend $1m investigating a $10m fraud. If it involves international money movement and offshore tax havens, this can cost from 30% to 100% of the amount lost.
Probably the single largest, and most ignored, cost element of fraud and corruption is the cost of all the on-going cases which have not been discovered and which are being carried by the organisation.
COULD THIS BE YOUR ORGANISATION?
An email arrives at head office alleging that certain directors have been buying personal items on the company's account and that some of the marketing expenses are not genuine. Furthermore, people who have spoken up are being quietly dismissed.
It's not the first email of this kind and rumours to this effect have been circulating for a while. However financial results in the region are strong and local management resents interference. The tone of the emails is becoming increasingly angry and some of the claims about fraud and corruption are hard to believe.
You are one of seven recipients of this email. You are not directly responsible for the division concerned and it is easier to close your eyes to unsubstantiated claims by assuming that they cannot be true. What you are unaware of is that if enough resources were actually dedicated to uncovering the whole truth then you would find that many of the allegations are in fact true and just the tip of the iceberg.
In reality profits are declining, losses are being systematically hidden in the books, some managers have covert ownership in business partners via offshore companies, property frauds are taking place and bribes are being paid in violation of the code of conduct.
ARE YOU SURE?
You may think that this sort of thing would never occur in your organisation, but are you sure? At first glance, any organisation may appear to have procedures and controls in place to prevent fraud and corruption, but when examined through the sharp eyes of a criminal, it quickly becomes evident that many different methods of fraud and corruption could easily succeed. And when you are in business, fraudsters, corrupt employees and corporate psychopaths are always looking to find a way round your controls if they can.
If you would like to find out if your organisation's defences are in fact a paper tiger, and understand the fraud and corruption risks to which your organisation is exposed, you need to ask what could be achieved by a dishonest, motivated person, or fraudster, whether internal or external.
A WAY OF MAKING MONEY IS TO STOP LOSING IT
Once the opportunity to stop losing huge sums of money is recognised at board level, there are effective measures which can be put in place to prevent fraud and corruption. Even for multinational organisations, the solution to the problem has to come from within because there is little help from governments or regulators on an international level.
Tackling fraud and corruption on an international level is always difficult as it takes so long to get agreement as to how to go about it.
Even agreeing on the definition of fraud and corruption is nowhere near an international standard. There are dozens of definitions of fraud and corruption in use around the world.
Rather than waiting for precise international definitions to materialise, organisations should start tackling the problems by gaining a better understanding of the fraud and corruption risks that they face and then developing a much greater level of resistance to them.
As a senior manager or executive director, it makes sense to pay more attention to the behavioural aspects of fraudsters, corrupt employees or corporate psychopaths, rather than being blinded by accounting, legal or procedural issues.
CEO readers can find further information about Nigel and Martin's new book Fraud and Corruption: Prevention and Detection and a free chapter download here. Readers can also receive a 20% discount by quoting ITL/SW207 when placing an order.