Kroll Global Fraud Report 2011 2012

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Kroll Global Fraud Report 2011 2012



Junto0 con el Reporte a la Nación de la ACFE. el reporte anual de Kroll se ha convertido en una de las mayores fuentes de sistematización y producción de información empírica sobre el fraude, su ...

Junto0 con el Reporte a la Nación de la ACFE. el reporte anual de Kroll se ha convertido en una de las mayores fuentes de sistematización y producción de información empírica sobre el fraude, su control y sus costos, a nivel global.



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Kroll Global Fraud Report 2011 2012 Document Transcript

  • 1. Annual Edition 2011/12Global Fraud ReportEconomist Intelligence Unit Survey ResultsFraud concerns on the rise globallyInformation theft remains a serious threatLack of preparation for greater regulatory enforcementBusinesses struggle with anti-fraud strategies An Altegrity Company
  • 2. About the researchThe Annual Global Fraud Survey, commissioned by Kroll and carriedout by the Economist Intelligence Unit, polled 1,265 senior executivesworldwide from a broad range of industries and functions in Juneand July 2011. Where Economist Intelligence Unit analysis has beenquoted in this report, it has been headlined as such. Kroll alsoundertook its own analysis of the results. As in previous years,these represented a wide range of industries, including notableparticipation from Financial Services and Professional Services;as well as Retail and Wholesale; Technology, Media, andTelecommunications; Healthcare and Pharmaceuticals; Travel,Leisure, and Transportation; Consumer Goods; Construction,Engineering, and Infrastructure; Natural Resources andManufacturing. Respondents were senior, with 47% at C-suite level.One-half of participants represent companies with annual revenuesof over $500m. Respondents this year included 23% from NorthAmerica, 24% from Europe, 28% from the Asia-Pacific region,15% from the Middle East/Africa and 11% from Latin America.This report brings together these survey results with the experienceand expertise of Kroll and a selection of its affiliates. It includescontent written by the Economist Intelligence Unit and other thirdparties. Kroll would like to thank the Economist Intelligence Unit,Dr. Paul Kielstra and all the authors for their contributions inproducing this report.Values throughout the report are US dollars.
  • 3. ContentsGlobal Fraud ReportContents Introduction regional analysis: Asia-Pacific Tom Hartley, Global Head, Business Intelligence & Investigations............... 4 Southeast Asia overview.................................................................................................... 34 Procurement and Supply Chain Fraud in Asia........................................................ 35 Economist Intelligence Unit Overview China overview........................................................................................................................ 37 Survey Results........................................................................................................................ 5 Third Party Vendor Screening: fraud at a glance Compliance as a Route to a Better Business.......................................................... 38 Fraud Fatigue................................................................................................................................ 9 When A Watchdog May Not Be Enough: Auditors are not Fraud Investigators............................................................................ 40 A Geographical Snapshot................................................................................................... 10 India overview.......................................................................................................................... 42 The Regulatory Framework Corruption and the Indian Infrastructure Boom.................................................... 43 FCPA Reform............................................................................................................................... 12 regional analysis: emea Investing in the BRICs........................................................................................................... 14 Europe overview..................................................................................................................... 45 Special Comment The Biggest Threat to Financial Institutions: Recovering Sovereign Assets........................................................................................... 16 It Comes from Within........................................................................................................... 46 Corporate Investigations in Strict Privacy Regimes: regional analysis: Americas The Case of Italy...................................................................................................................... 48 North America overview.................................................................................................... 18 Middle East overview........................................................................................................... 50 When Fraud is an Inside Job: Five Steps to Consider.......................................... 19 Corruption and Vendor Fraud in the Gulf Inadequate Due Diligence Creates a Big Regulatory Risk............................... 21 Practical Advice........................................................................................................................ 51 Say-on-Pay in 2012: A Picture is Worth a Thousand Words........................... 23 Africa overview........................................................................................................................ 53 Canada overview.................................................................................................................... 24 Africa: Are We There Yet?................................................................................................... 54 Canada Steps Up its Anti-Corruption Efforts............................................................. 25 sector summary Latin America overview...................................................................................................... 27 Summary of Sector Fraud Profiles................................................................................. 57 Latin America’s Uneven Playing Field......................................................................... 29 Mexico overview..................................................................................................................... 30 Contacts Rooting Out Fraud After Acquisitions in the Key Regional Contacts at Kroll......................................................................................... 59 Brazilian Sugar and Ethanol Industry........................................................................... 31 Financial Statement Fraud: A Little Journal Entry Could Bring Big Trouble........................................................ 32 Economist intelligence unit Industry analysis Technology, Media & telecoms............................................................... 20 Consumer goods....................................................................................................... 22 Natural resources................................................................................................ 26 Manufacturing........................................................................................................... 33 Healthcare, Pharmaceuticals................................................................ 36 & Biotechnology Retail, Wholesale & Distribution...................................................... 39 Professional services........................................................................................ 41 Financial Services................................................................................................... 47 Construction, Engineering........................................................................ 52 & infrastructure Travel, leisure & transportation.................................................... 56 Annual Edition 2011/12  |  3
  • 4. IntroductionIntroduction Organizations operating in multiple » Corruption. Half of our respondents were geographies, legal environments and cultures moderately or very concerned about face a complex set of challenges and risks as corruption while the incidence of they develop their business. This fifth edition corruption doubled. of Kroll’s Global Fraud Report, prepared in » Preparedness. Despite the rise in cooperation with the Economist Intelligence corruption concerns, companies are still Unit, illustrates the speed at which the fraud unprepared for greater regulatory threat is evolving, and reinforces the direct enforcement. Less than 30% of financial benefit to those organizations who respondents believe their companies have actively manage their fraud risk. trained their managers, vendors and A positive finding in this years’ report is a foreign employees to be both familiar and drop in the overall prevalence of fraud - from compliant with the UK Bribery Act or US 88% of respondents having suffered an Foreign Corrupt Practices Act, and less incident in the last 12 months to 75%. than one quarter believe their pre- However, a number of specific fraud types are transactional due diligence identifies a growing more common: in particular, target’s compliance with the Acts. management conflict of interest, supply chain » Anti-Fraud measures pay. Our survey fraud, internal financial fraud and corruption suggests that any company can be the are of mounting concern. Companies must victim of fraud, but consistently and acrossAll businesses are confronted stay vigilant as today’s fraudsters are industries and geographies, the biggest increasingly sophisticated in the structuring victims of fraud invested the least in thewith the risk of fraud. of their crimes and the tactics deployed to unglamorous disciplines of training, audits,How they respond – the nature prevent detection. screening and due diligence.of their approach to prevention, There are some points of particular note that The Report presents the collective input ofdetection, investigation and emerge from this year’s survey; some of the world’s most talented anddisclosure – will separate » Awareness. Awareness and concern diligent anti-fraud practitioners. I hope it about fraud has risen markedly - even provides some useful insights and helps youthose who manage through as, or perhaps partly supporting, an identify emerging threats and opportunities overall decrease in the number of for your own business.the issues from those who suffer businesses suffering a fraud incidentsignificant loss. in the last 12 months. » Evolution. The good news is that the two biggest areas of fraud - theft of physical assets and theft of information both saw small declines this year, but fraudsters are evolving and other fraud areas, especially those linked most closely to the firms’ own employees and supply chain partners, have Tom Hartley Global Head gone up sharply. Business Intelligence & Investigations4  |  Kroll Global Fraud Report
  • 5. Economist Intelligence Unit OverviewEconomist Intelligence UnitOverview Rising Fraud may not be obviously seen to be engaging inThis report, the fifth and biggest annual Economist Intelligence Unit theft of physical assets and information asGlobal Fraud Survey, commissioned by Kroll, polled more than 1,200 they may have been previously, but that doessenior executives worldwide from a broad range of industries and not mean they are giving up. Instead, other frauds are becoming much more common, infunctions in June and July 2011. As ever, it found fraud to be particular internal financial fraud, corruption,pervasive and protean, with progress made in some areas almost and vendor or procurement fraud.inevitably matched by increasing risks in others. The data this year As a result, instead of an environment where there are two leading risks and a number ofprovides four key insights about the current fraud environment. other smaller issues, companies now face a range of more widespread dangers. In particular,1.  oncern is rising about every C Companies, however, are anything but relaxed: after the two most common frauds, the next type of fraud as businesses face instead, the level of concern has increased four—management conflict of interest, a more varied threat. sharply among respondents. For every fraud procurement fraud, internal financial fraud, and covered by the survey, the proportion ofOn the surface, the 2011 survey contains some corruption—hit roughly one in five companies respondents saying that their business isgood news. The number of companies affected last year, and financial mismanagement was highly or moderately vulnerable has risen,by the two most common types of fraud has close behind at one in six. This rapid shift in usually by between 10% and 15%. Even fordeclined. This year, 25% report experiencing the nature of the fraud threat explains the theft of information and physical assets, whichtheft of physical assets (down from 27% in the increase in a sense of vulnerability. Fraudsters declined from 2010, concern has grown.2010 survey) and 23% suffered from information have been deploying a range of tools to probetheft, loss, or attack (also down from 27%). More What can we make of this? It may take corporate defenses rather than just relying onbroadly, only 75% of companies were victims further years of survey data to demonstrate one or two, for the most part. Whether thisof a fraud in the last 12 months, a noticeable an absolutely clear trend, but this year’s shift continues, and how successfuldrop from last year’s figure of 88%, and one figures suggest the beginning of a broad companies will be in tackling it, will becomeof the lowest totals since the survey began. shift in the fraud environment. Fraudsters clear only in future surveys. Annual Edition 2011/12  |  5
  • 6. Economist Intelligence Unit Overview As a result, concern about corruption has Chart I: Proportion of companies describing themselves as highly grown to the extent that it is one of the or moderately vulnerable to the following frauds biggest fraud issues for companies: 47% now describe themselves as at least moderately 2011 2010 vulnerable to corruption, more than for every Information theft 50% 38% fraud except information theft. More Corruption and bribery 47% 38% strikingly, 24% say that they are highly vulnerable to corruption, more than triple the Theft of physical assets 46% 34% level last year and the highest figure for any Management conflict of interest 44% 27% fraud in the survey. Vendor, supplier or procurement fraud 42% 26% This is having an impact on investment decisions. As was the case last year, this Regulatory or compliance breach 41% 30% year’s survey indicates that when fraud IP theft 40% 27% dissuades companies from doing business in a country or region, corruption is by far the Financial mismanagement 39% 30% biggest specific concern: of the 46% of Internal financial fraud 38% 27% companies that were dissuaded from operating Market collusion 31% N/A somewhere by one or more types of fraud, 62% cited the presence of corruption as one Money laundering 25% 19% of the leading issues in this decision. In the three regions that saw the largest number of respondents dissuaded from operating—Africa (15%), China (10%), and India (9%)—corruption Chart II: Percentage of companies affected by listed frauds was cited as a leading cause for the decision 2011 2010 69%, 59%, and 65% of the time respectively. Theft of physical assets 25% 27% Despite such high concern, however, companies seem ill-prepared to deal with the Information theft 23% 27% issue. One-quarter admit that they are not Management conflict of interest 21% 19% very well prepared or not at all prepared to comply with regulations in this field, and Vendor, supplier or procurement fraud 20% 15% only 27% say that they are well prepared. Internal financial fraud 19% 13% A deeper look at the data surrounding compliance with the FCPA and Bribery Act Corruption and bribery 19% 10% suggests that the problem is even bigger. Financial mismanagement 16% 13% Although these laws have an extraterritorial Regulatory or compliance breach 11% 12% effect that can even have implications for non-American and non-British companies IP theft 10% 10% if they have certain links to the United Market collusion 9% 7% Kingdom or the United States, it is possible that a foreign company’s activities do not fall Money laundering 4% 7% under the scope of either. This analysis therefore looks only at those respondents based in one of the two countries, as it2.  ompanies are growing C increasingly vigorous, and extraterritorial, would be difficult to imagine scenarios where increasingly aware of their in their enforcement of the Foreign Corrupt their companies were not subject to the exposure to corruption but Practices Act (FCPA). Britain’s Bribery Act, provisions of at least one of these pieces of which entered into force this July and also legislation. Of those respondents, only 43% often still do not have structures applies extraterritorially, is in some ways have trained senior management, agents, in place to address it. even tougher than the American legislation. vendors, and foreign employees to beCorruption is a growing risk for companies It applies to bribes of individuals rather than compliant with one of these laws, and justworldwide. Its prevalence has shown the just government officials, imposes a corporate 39% have assessed the risks arising frombiggest increase of any of the frauds covered duty to prevent bribery, and forbids facilitation them. These figures are not that much higherin the survey, nearly doubling from 10% last payments. These are only the most prominent than the number of companies whichyear to 19% in the latest survey. This is examples of greater regulatory rigor. Other definitely have not done so. Often,occurring in an environment of ever greater countries, including China and India, have respondents simply do not know if theyregulatory scrutiny. The United States been toughening their legislation, although have—which suggests at the very least thatauthorities have for some years now been the effects on the ground remain to be seen. any efforts have not had a high profile.6  |  Kroll Global Fraud Report
  • 7. Economist Intelligence Unit Overview a company is likely to have. For technology, Chart III: How companies are reacting to the UK Bribery Act and US FCPA media, and telecoms companies, proprietary (British and United States-based respondents only) data is the most common target (cited by 36% of respondents), while for financial We have trained our senior managers, agents, vendors and foreign employees to be both familiar and compliant with the UK Bribery Act and/or US FCPA legislation. (1) services it is customer information (29%). Agree 43.4% Overall the ongoing investment in Disagree 31.3% Don’t know/Not applicable 25.3% information security may have yielded some positive results this year, but this is a battle We have made a thorough assessment of risks to our organization arising from the UK Bribery Act and/or US FCPA and their enforcement, and set in place a monitoring and reporting system to assess risks on an ongoing basis. (2) far from won. Agree 38.9% Disagree 31.9% 4. Those hit hardest by fraud  Don’t know/Not applicable 29.2% often have no one but We have set in place adequate procedures to prevent bribery at all levels of our operations. (3) themselves to blame. Agree 53.8% Disagree 24.3% This year’s fraud survey calculates the Don’t know/Not applicable 21.9% economic cost of fraud in a new, more direct Our internal compliance regime has become more global because of the extraterritorial reach way by asking respondents what proportion of the UK Bribery Act and/or US FCPA. (4) Agree 34.4% of revenue their company has lost in the last Disagree 31.9% year. Most companies lost something, and for Don’t know/Not applicable 33.7% the survey as a whole, fraud cost companies When entering into a joint venture, making an acquisition or providing financing, our due diligence provides us with 2.1% of earnings in the last 12 months— sufficient understanding of the target’s compliance with UK Bribery Act and/or US FCPA requirements. (5) looked at in a different way, this equates to Agree 36.6% Disagree 24.7% a whole week’s revenue over the course of Don’t know/Not applicable 38.7% a year—which varies only modestly by geography or company size. Looking just at the overall average, however,Nor have due diligence processes caught up One-half of respondents consider themselves hides a group of 18% of companies that lostwith the problem. Only 37% of respondents moderately or very vulnerable to this fraud,say that their companies provide a sufficient up from 38% in 2010. IT complexity is the more than 4% of revenues to fraud. Fifty-understanding of a potential partner’s or leading cause of increasing fraud exposure three businesses, or just under a quarterinvestment target’s compliance with these in the survey, cited by 32% of respondents, of this group, were particularly badly hit,acts. Errors here can get expensive. In 2007, up from 28% last year. It is therefore no losing more than 10% of their revenue toeLandia, a networking technology company, surprise that IT security is the most fraud. Analyzing these firms—here calledbought Latin Node, a wholesale provider of widespread anti-fraud investment planned the “most affected”—reveals certainInternet telephony. Upon discovering for the coming year (30%). common characteristics.evidence of corrupt payments at its new Part of the reason for this concern may be The first lesson is that anyone can be hurt.subsidiary, eLandia did everything right that, typically, information theft tends to Geography and industry are certainly factors,(informing authorities, firing implicated be more expensive than the other most but not dominant ones: African and Middleexecutives, terminating contracts obtained widespread fraud, physical theft. When Eastern companies are slightly over-illegally), but the costs of all these actions looking at companies that suffered only represented (19% are among the most-mounted up and took a toll on the information or physical theft—in order to affected, higher than their weight in thesubsidiary’s operations. Within a year, assess the impact of each—we can see that survey overall of 15%); and the group hadeLandia decided that the best option was to those hit by information theft lost morewind up Latin Node completely, losing its a greater proportion of financial services money. On average, victims of physical theftentire $22m investment in the process. firms (28%) than would be expected from and no other crime lost 1.5% of earnings their prevalence in the overall survey (17%).It is good that companies are aware of the to fraud, while those hit by informationproblem corruption represents. They now theft lost 1.9%, suggesting that the latter is The bigger differences are in how theseneed to do something about it. substantially more expensive. companies deal with the risk of fraud. Moreover, the nature of the information being To begin with, their defenses are weaker.3.  he battle against information T sought by fraudsters is also widespread, As the chart shows, they are much less likely theft remains a leading focus requiring potentially different defenses for to have invested in any of the anti-fraud for companies. distinct types of data. As the chart shows, measures covered in the survey.The prevalence of information theft declined proprietary data is the most frequent target,in the last year, from 27% to 23%, but that but customer and employee data are also These poorer defenses leave the mostdoes not mean that companies are confident common goals. The prevalence of these affected much more open to fraudsters, andthat they have the problem under control. targets obviously varies between industries respondents are aware of this fact. A higherInstead, their concerns have increased. depending on the value of the information proportion of those surveyed from these Annual Edition 2011/12  |  7
  • 8. Economist Intelligence Unit Overview companies reports being highly vulnerable to Chart IV: f your company has suffered information loss, theft or attack, I every fraud in the survey, with the what kind of information was targeted differences particularly large for corruption, money laundering, and regulatory breach. Personally identifying information – customers 16.7% Similarly, these companies are less likely Personally identifying information – employees 11.9% to say that they are well or reasonably well Personal health information 2.8% prepared to cope with compliance requirements relating to corruption, data, Proprietary data, including intellectual property 20.6% anti-trust rules or financial regulation, or Other 6.5% to have set effective anti-bribery safeguards Don’t know 8.3% in place throughout the company. We haven’t suffered from this kind of fraud 47.4% They may know that they have a problem, but that is not enough to galvanize these companies into action. They differ little from the survey average in terms of their intention Chart V: In which of the following anti-fraud measures does your company currently invest to invest further in anti-fraud measures. Moreover, even existing anti-fraud controls Survey Over 10% of revenue Average lost to fraud are too often not being well-maintained. Among the most affected, the leading Financial (financial controls, fraud detection, internal 72% 60% contributor to increased fraud exposure, cited audit, external audit, anti-money laundering policies) by 36% of respondents, is weakening of Information (IT security, technical countermeasures) 66% 42% internal controls. In the survey as a whole, Assets (physical security systems, stock 62% 40% only 22% reported this problem, as did just inventories, tagging, asset register) 8% of those who suffered no financial loss. Management (management controls, incentives, 52% 38% Such controls, however, are essential for external supervision such as audit committee) lowering the incidence of fraud. Last year, Employee background screening 47% 36% the survey found that more often than not fraud is an inside job. This year, if anything, Staff (training, whistleblower hotline) 44% 21% this is even more the case: for those Partners, clients and vendors (due diligence) 43% 30% companies that have experienced fraud and where the culprit is known, 28% report that Reputation (media monitoring, compliance 41% 21% controls, legal review) the fraudster was a junior employee and a further 21% say it was a senior employee Risk (risk officer and risk management system) 42% 26% (both figures were 22% last year). For a IP (intellectual property risk assessment and 34% 19% further 11%, the crime was committed by an trademark monitoring program) agent or intermediary, meaning that overall 60% of fraud this year was carried out by someone who worked for the company one way or another—up from 55% last year. Chart VI: Proportion describing themselves as highly vulnerable to the following frauds Not only do companies clearly need strong Survey Over 10% of revenue controls, those controls need to be properly Average lost to fraud implemented throughout the organization. Corruption and bribery 24% 51% Even though junior employees are most often the culprits, they are not the most expensive Theft of physical assets 13% 24% fraudsters. For the most affected, senior Management conflict of interest 13% 24% executives are to blame in 29% of cases and Vendor, supplier or procurement fraud 13% 19% junior ones in only 8%, while for those losing less than 1% to fraud, the figures are 20% and IP theft 13% 17% 35%. The more senior the potential fraudsters, Information theft 13% 17% the more rigorous a company’s controls need to be in order to prevent their schemes. Regulatory or compliance breach 11% 30% Financial mismanagement 10% 27% It is hardly surprising that those who do less to protect themselves from fraud are Market collusion 9% 24% more likely to suffer the consequences, Internal financial fraud 9% 15% but the number of companies losing a substantial portion of revenue suggests that Money laundering 8% 30% it is a point worth restating.8  |  Kroll Global Fraud Report
  • 9. Fraud at a Glance occasions corporate advisors such as us are inclined to fan the flames. The result, not surprisingly, is fraud fatigue. There needs to be a balance and some simple principles are worth keeping in mind in order to achieve it. The risk of fraud is real. The financial crisis did not make it worse; it simply made it more apparent and, perhaps, made the consequences more serious. Most of the frauds took place during the good times, when our guards were lowered. Fraud prevention is important and needs to be proportionate and relevant to fraud vulnerability. As that vulnerability evolves Fraud along with how business is conducted – from paper ledgers to computer files, from cash-in-transit to electronic fund transfer, from physical assets to intellectual property – so must prevention techniques develop. Fatigue Spotting the financial crime trends helps to anticipate where efforts need to be focused. Compliance systems and controls are a key part of the defense against fraud, but compliance should not become an end in itself, perhaps not even a means to an end. We should aspire to be compliant not because the compliance how we got here to learn some useful By Tommy Helsby departments tells us to but because that is lessons. As Warren Buffett said, “You only the best way to run our businesses. learn who has been swimming naked when Separation of duties in the accountsOur annual survey in this edition the tide goes out.” When times are good and department picks up errors far more often profits are high, a fraud might be treated asof our Fraud Report shows a than it does the occasional fraud. Contracts an “accounting correction”; but when thingssmall decline in fraud. Have we are tough, that correction may result in a won through open competition are more valuable than ones awarded thanks to bribes.turned the corner? Is fraud breach of banking covenants. When Background checks on vendors and agents businesses fail, there is a natural desire tobeginning to decline? Are fraud hold someone responsible, even to accuse will help weed out the incompetent and the inappropriate as well as the Minister’s brother-prevention measures finally that person of fraud – often with some in-law. The central mission of compliance justification, although the suspect willstarting to make inroads into probably claim desperately that it was just needs to be maintaining and developing acorporate crime? well-founded and enduring business. “market practice.” Certain “market practice” may now be recognized as, at best, improper It is simple to say but may not be so easy toThe answer is probably “no.” The survey is and, sometimes, illegal; and politicians are put into effect, particularly in an environmentan effective barometer of senior executives’ finding that what used to be “unnecessary where transgressions are being treated moreawareness of fraud as a corporate risk. It red tape” has become “essential tightening of harshly. If we don’t get it right, though, thereshows the trends in different regions and in the regulations.” Regulators are encouraged is a real possibility that the pendulum willvarious areas of fraud vulnerability. The – and empowered – to take no prisoners and, swing back to the laissez-faire past ofnumbers probably say more about what in response, the corporate compliance rule-bending and blind eyes, of regulatorybusiness people are thinking than about the department is transformed from a backwater capture and arbitrage, and the cycle willreal size of the problem. The financial crisis to a core component of business strategy. start again.of 2008-9 put a focus on fraud that pushed it Of course, I have over-simplified, but I thinkvery high on the corporate agenda for the most people would recognize the outline ofpast two years. There are, though, plenty of Tommy Helsby is Chairman of Kroll the story and many would agree that thepressing matters competing for executive Eurasia based in London. Since joining result was a good thing, long over-due. You Kroll in 1981, Tommy has helped foundattention and therefore a danger that fraud can, however, have too much of a good thing: and develop the firm’s core duerisk – generally an uncomfortable subject diligence business, and managed many no one wants regulators turning intoand an unquantifiable exposure – is of the corporate contest projects for vigilantes, the compliance police patrolling which Kroll became well known in thebecoming neglected. Bluntly put, people may company corridors, and executives seeking 1980s. Tommy plays a strategic role both for the firm andbe getting bored with fraud. for many of its major clients in complex transactions and legal advice on whether to choose a latte or a disputes. He has a particular interest in emergingBefore the pendulum swings back too far in cappuccino at Starbucks. And of course, the markets, especially Russia and India.the wrong direction, it’s worth reviewing press, conference organizers, and even on Annual Edition 2011/12  |  9
  • 10. Fraud at a GlanceA Geographical Snapshot Management Information conflict of theft 18% interest 19% Information Information theft  22% We compared the results of the theft 26% Global Fraud Survey findings with Prevalence Prevalence 71% 70% Transparency International’s Prevalence 66% Corruption Perceptions Index (CPI). Physical theft  16% Vendor/supplier fraud 14% Management Physical The CPI measures the perceived conflict 15% theft 23% Kroll findings Canada Internal financial Kroll findings 23% levels of public sector corruption as North America Canada performed very well in the fraud 16% Physical theft North America has the lowest last year relative to other regions. Kroll findings seen by business people and country average fraud loss for any region, It had the lowest loss rate than any EUROPE as well as the lowest regional other region and saw a drop in Even though the overall prevalence analysts; ranging between 10 incidence for many of the frauds 9 of the 11 frauds covered by the of fraud has decreased in Europe, covered in the survey with the survey. More than half of the the incidence of nine of the 11 (very clean) and 0 (highly corrupt). exception of information theft and Canadian respondents said they frauds has increased in this region. IP theft. Even though information have avoided operating in - or have Only 23% of European companies The comparison clearly demonstrates theft decreased slightly in the past left - a region because of fraud. said that they had suffered no 12 months, it remains the most Increased comfort levels in this financial losses from fraud, down that fraud and corruption frequently common fraud in the region. relatively benign fraud environment significantly from 47% last year. Respondents reported investment have led to companies being less Companies in Europe feel most go hand in hand. in a broad array of anti-fraud likely than average to invest in vulnerable to information theft, measures, including IT security, IP anti-fraud strategies. loss or attack. Despite these controls, financial controls, and risk growing concerns, the region is management. less likely than average to adopt most anti-fraud strategies. The panels on the map summarize: K  he percentage of respondents per region t Corruption & Management or country suffering at least one fraud in the bribery 37% conflict of interest 21% last 12 months Information K  he areas and drivers of most frequent loss t theft 27% Prevalence 69% Transparency International Vendor/supplier Corruption Perceptions Index 2009 fraud 21% Very Clean 9.0 - 10.0 Internal financial 31% Management fraud 23% Internal financial Physical theft conflict of 8.0 - 8.9 Kroll findings fraud 18% interest 21% Mexico 7.0 - 7.9 Mexico has a widespread fraud Information problem. Companies posted above theft 24% 6.0 - 6.9 average incidences for eight of the 11 frauds with the biggest problem 5.0 - 5.9 being corruption and bribery. Prevalence 74% Theft of physical assets is well 4.0 - 4.9 above average and information 3.0 - 3.9 theft, compounded by growing IT Vendor/supplier complexity, is also a significant fraud 23% 2.0 -2.9 risk. Even though they are aware of these dangers, Mexican Corruption & 1.0 - 1.9 companies are either less likely or bribery 23% 25% only about as likely as average to Kroll findings Physical theft 0.0 - 0.9 invest in every anti-fraud strategy Latin America covered in the survey. The Latin American fraud picture is Highly Corrupt No data one of transition. Although the overall number of companies suffering at least one fraud declined, there has been a striking increase in companies reporting they are at risk. Companies describing themselves as at least moderately vulnerable to theft of physical assets or vendor fraud spiked 29% while others also saw notable increases. Companies in this region are investing in a range of fraud prevention strategies, including IT security, physical asset security, and financial controls.Map image by permission Transparency International.All analysis Kroll/Economist Intelligence Unit.10  |  Kroll Global Fraud Report
  • 11. Fraud at a Glance Management conflict of interest 23% Financial mismanagement 22% Physical theft 20% Information theft 28% Prevalence 84% Vendor/supplier Internal fraud 33% financial fraud 20% Kroll findings China Eighty four percent of respondents in China fell victim to fraud in the past year, the second highest figure Internal financial after Africa. China had the highest fraud 19% prevalence figures for vendor, Information supplier, or procurement fraud and theft 26% information theft, loss, or attack among any country surveyed. The Management biggest driver of increased conflict of exposure in China is high staff interest 23% Prevalence turnover. While companies are 68% responding with above average investment in staff-related fraud prevention, these measures are not enough when China experiences a Vendor/supplier high level of fraud perpetrated by fraud 25% Corruption & senior management. bribery 21% Kroll findings middle east Financial While the number of companies mismanagement 22% that have suffered from fraud has fallen, we are seeing substantial growth of several specific types of Information theft fraud this year such as bribery & 27% corruption and supply chain fraud Physical Management conflict of theft 23% interest 31% compared to last year. Despite such worries, companies are Corruption & bribery undermining their own anti-fraud 31% Information theft efforts: one-third of respondents 28% in the Middle East said that Physical Prevalence theft 33% weaker internal controls are increasing their exposure to fraud. 84% Corruption & bribery 28% Vendor/supplier Prevalence Financial Internal fraud 22% 76% mismanagement 32% financial Kroll findings fraud 23% INDIAPhysical theft India has a higher prevalence than38% Management conflict of the overall average for 8 of the 11 Vendor/supplier Internal interest 27% frauds in the survey. Corruption fraud 33% financialCorruption and information theft, loss, or Kroll findings fraud 24%& bribery attack, are key challenges for Southeast asia37% companies in India: 78% of Respondents from the area respondents indicated that their reported the highest rates of organization is highly or moderately vendor, supplier, or procurement Prevalence 85% vulnerable to corruption & bribery. fraud and management conflict of Fewer than 50% invest in anti-fraud interest and face above average measures such as employee levels of corruption and bribery. background screening, partner or Corruption is a top concern forVendor/supplier third party due diligence, and risk companies in Southeast Asia this Internal management systems, even thoughfraud 31% year, with 70% indicating that their financial 59% of those that suffered fromKroll findings fraud 33% organization is highly or moderatelyAFRICA fraud said it was an inside job. vulnerable to this threat. DespiteAfrica reported the highest this recognition, 52% said thatincidence of fraud among any weaker internal controls haveregion, with 85% of respondents increased their organizations’falling victim to fraud in the past exposure to fraud– the highestyear. Corruption is a major level for any region.problem, with 78% of companiesin Africa indicating a high ormoderate vulnerability to bribery& corruption. Africa remains theregion where the experience orperception of fraud has dissuadedmost companies from operating.While companies in Africa widelyadopt anti-fraud strategies,weaker internal controls will makethem less effective. Annual Edition 2011/12  |  11
  • 12. The Regulatory FrameworkFCPA Reform Help Could be Coming to Those Who Help Themselves By Jeffrey CramerOn November 30, 2010 the United States Senate Judiciary Given the aggressive enforcement of the FCPA in recent years and the very smallCommittee’s Subcommittee on Crime and Drugs held a hearing to number of court cases which havediscuss potential changes to the Foreign Corrupt Practices Act clarified it, at least five potential areas are ripe for change: clarification of what(FCPA). Those testifying on behalf of reform argued that the FCPA, constitutes a “facilitating” payment;which has not been altered in 10 years, needs to be amended establishment of an affirmative defenseto allow for greater fairness in its application by the Department based upon a company’s compliance program; a better definition of “foreignof Justice (DOJ). Such sentiments were echoed on June 14, 2011 official”; limitations on successor liability;when the House of Representatives Judiciary Committee’s and a change in what a company has toSubcommittee on Crime, Terrorism, and Homeland Security also know in order for it to be liable. These potential changes could each giveexamined the issue. By the time the gavel dropped on both businesses a better chance of avoidinghearings, it was clear that Congress intended to enact FCPA reforms. FCPA problems with federal prosecutors.12  |  Kroll Global Fraud Report
  • 13. The Regulatory FrameworkClarification of“Facilitating” PaymentCompanies have justifiably been confused asto what constitutes a permissible facilitatingpayment under the FCPA. Whether somethingis a bribe, gift, or facilitating payment issubject to interpretation, often of theprosecutor assigned to the investigation.The law abhors such vagueness. Rep. JamesSensenbrenner (R-WI), the House’sSubcommittee’s Chairman stated that“everybody has a right to know what’sillegal, and there has to be much morecertainty in the law.” The DOJ does giveexamples on its website of what constitutesa bribe as opposed to a facilitating payment,but these do not provide the necessary levelof confidence as to what is proper. Statutorychanges could deliver the clarity companiesrequire to conduct their business overseaswith assurance. language makes it difficult for businesses to person who violated the FCPA was an employee determine if they are risking a violation of at the time of the crime. It makes sense for theAffirmative Defense for the law when they do transactions with individual mens rea requirement to be thea Compliance Program partially government-owned entities. same as that which would expose a companyThis reform could have the most impact as it Trying to establish what constitutes an to liability. Without this change, businesseswould afford companies a statutory “instrumentality” is nearly impossible in will continue to be subject to prosecutionopportunity to help themselves before they some parts of the world where governments even if they were unaware of the violation byget into potential trouble. Similar to the own a portion of many firms. Changes to the an employee until after the fact. This potential“adequate procedures” defense in the UK FCPA may provide clearer direction to reform is crucial when analyzing corruptBribery Act, the reform might afford a business in the form of examining the payments to foreign officials which are routedcompany potential defenses if it showed that percentage a foreign government owns through agents or other third parties. Thereit had procedures in place to prevent and of a subject firm or similar test. may be a carve-out for higher leveldetect unlawful conduct. An employee acting executives whose actions, it can be argued,independently might not subject the are more closely tied to the company’s fate. Limitation of Successor Liabilitycompany to criminal liability if he or she After the June 2011 hearing, Rep. Sensenbrennercircumvented the existing and reasonable The FCPA could be amended to eliminate informed those present that the Subcommitteecompliance program. Such a reform would or limit the liability of an acquiring company would start drafting legislation and told thelikely result in companies taking a more if a pre-purchase FCPA violation by the DOJ representative that the Departmentaggressive approach to compliance in order acquired company surfaces. Such a benefit should “get the message.” Companies lookingto ensure they have a sufficient program and might be derived only if the acquiring firm to limit their FCPA exposure should take heeddue diligence procedures in place. Congress discloses and remedies the conduct by an as well. Regardless of which reforms pass,could make the existence of adequate investigation of the acquired company, making companies that are subject to regulationarrangements a complete defense to a robust due diligence and internal audit all under the FCPA should take affirmative stepsprosecution, or it could merely codify benefits the more attractive for the acquiring business. to protect themselves. These steps shouldsuch as lesser penalties in order to encourage include appropriate levels of due diligence,companies to investigate violations on their training and monitoring. This will put Limitation of Liabilityown and self-report to the DOJ or the companies in a position to help themselves. to Willful ViolationsSecurities and Exchange Commission. For all but some minor criminal offenses, mens rea – Latin for guilty mind – is basic to Jeffrey Cramer is a managing directorClearer Definition of and head of Kroll’s Chicago office. Since establishing the guilt of a defendant in“Foreign Official” joining Kroll, he has worked with committing a crime. The FCPA requires that companies to draft their complianceIf there is one term in the FCPA that confuses individuals accused of violating the Act do so plans and lead due diligence investigations into foreign intermediariesmore than “facilitating payment,” it is “foreign “willfully.” Companies, however, could be throughout the world. He wasofficial.” Under the Act, “foreign official” is held criminally liable if they were merely previously a prosecutor in New York and Chicago and hasdefined to include any officer or employee of aware of the relevant criminal acts but failed investigated several FCPA cases during his 13 years in law enforcement. Most recently he was a Senior Litigationa foreign government or any to remedy them. Strict liability in this context Counsel for the Department of Justice in Chicago.“instrumentality” thereof. The current could result in problems for a company if the Annual Edition 2011/12  |  13
  • 14. The Regulatory Framework Investing in the BRICs Extra due diligence is vital By David Holley and Doug Frantz The high level of concern uncovered in the survey may overestimate the true degree of compliance because companies often believeThe fertile and fast-growing economies of the BRIC (Brazil, Russia, India, and they are doing better in following the lawChina) countries are calling to international corporations, investment banks, than they are actually are. Even if we acceptand investors like the Sirens sang to Jason and his shipmates in Argonautica. these self-reported estimates, however, there is cause for alarm over the exposure of manyThe haste to take advantage of these burgeoning markets can lead to corporations to the criminal sanctions andrushed decisions, shortcuts in diligence, and potentially unmeasured costs imposed by the FCPA and UKBA,business decisions. Whether a company is entering a new market, particularly in this era of aggressive enforcement by the Department of Justicecontemplating a joint venture with an overseas partner, investing in a (DOJ) and Britain’s Serious Fraud Office (SFO),foreign business, or acquiring an overseas company, an appropriate level of respectively. The question then becomesdue diligence on the foreign entity, its agents, business partners, and what steps should be taken by a corporation determined to follow the spirit and letter ofintermediaries is required to avoid problems associated with current anti- the law. Managing the anti-bribery risksbribery legislation. However, the results of the 2011 Global Fraud Survey through heightened due diligence should be a paramount focus when expanding into theindicate that fewer than one in four respondents believe that their due BRIC markets and other emerging economies.diligence is sufficient to fully understand whether the acquisition target There is little guidance in either law as tocomplies with either the United Kingdom Bribery Act (UKBA) or the United what constitutes sufficient due diligence. TheStates Foreign Corrupt Practices Act (FCPA). In addition, nearly one out of two FCPA makes no mention of the term. The DOJrespondents consider their companies to be moderately to highly vulnerable in “Opinion Procedure Release 08-01” has defined a “reasonable” due diligence file asto corruption, which is among the leading reasons why companies avoid containing the following: an independentinvesting in new regions or countries. investigative report by a reputable14  |  Kroll Global Fraud Report
  • 15. The Regulatory Framework there is so much concern around the Understanding the requirements of thorough adequacy of due diligence undertaken in due diligence is an important step, but advance of a business transaction. problems can also arise when issues turned up in a review are not managed effectively. Assuming that multi-national corporations This point was driven home by the March are doing some level of due diligence 2011 settlement involving Ball Corporation, a consistent with the guidance offered by US manufacturer of metal packaging for food, American and British regulators, the question beverages, and household products. In March as to why the level of anxiety in respondents 2006, Ball acquired an Argentine entity, over the sufficiency of their due diligence Formametal S.A. The Securities and Exchange remains high. When undertaking due Commission (SEC) found that during the diligence in contemplation of expansion into course of Ball’s pre-acquisition due diligence, the BRIC and other emerging markets, information suggested that “Formametal consider the following recommendations: officials may have previously authorized questionable payments” disguised within the 1.  he volume of publicly available information T company’s books and records. Unfortunately, varies from country to country and is Formametal executives did not do enough to generally considerably less than what is prevent further improper payments to available, for example, in the United States. Argentine customs officials, giving rise to the In addition, the information is frequently SEC’s case. The SEC noted that Ball Corporation not as well organized or as readily did not promptly terminate the responsible searchable as in many jurisdictions. This employees when company accountants highlights the importance of “feet on the learned about the improper payments in ground” and the ability to undertake February 2007. Still, Ball’s fine was a discreet source inquiries to fully relatively small $300,000 because of the understand a due diligence subject. company’s other remedial efforts, voluntary disclosure of the misconduct, and cooperation 2.  he potential for encountering a Politically T in connection with a related investigation. Exposed Person (PEP) is generally greater in Russia and China than in many other The BRIC economies are enormously parts of the world. This requires more attractive investment opportunities. extensive due diligence on officers, Estimates are that as much as 60 percent of directors, and shareholders than normal to the world’s GDP will come from them by steer clear of violations. An examination of a 2030. Participating in the world’s fastest- target’s vendors and agents to ensure growing economies carries growing risks, arm’s-length transactions with unrelated too. American, British, and multinationalinternational investigative firm; guidance by parties is also recommended. corporations need to understand thea foreign business consultant to help potential corruption dangers in the BRIC andnavigate the due diligence in the foreign 3.  edia searches may not be as thorough, M similar emerging economies and undertakejurisdiction; reports from the US Commercial complete, and reliable as in other effective due diligence to avoid running afoul jurisdictions, as the local media and press of anti-corruption laws. Certainly the DOJ,Service within the Department of Commerce; are generally less aggressive and less SEC, and Britain’s Serious Fraud Office havethe results of various databases and watch likely to present an in-depth examination recognized the risks and stepped up theirlists, DNDB, etc.; meeting notes from of issues. For instance, in countries like scrutiny of activities in these countries asdiscussions with the US Embassy in the China and Russia, both hotbeds of recent part of the overall trend in rising enforcementforeign jurisdiction; a report by outside and future M&A activity by Western of anti-corruption laws globally.counsel on the target; a report on the target companies, the simple act of checkingcompany by an independent forensic available media outlets for information David A. Holley is a senior managingaccounting firm; and an opinion by a second about a potential partner is likely to yield director and the head of Kroll’s Bostonoutside counsel who reviewed the sufficiency incomplete results at best. This is office. Since joining Kroll in 2000,of the entire due diligence process. particularly true in China, where the David has led investigations into violations of the FCPA, and mattersWhile the UKBA and SFO provide some tradition of an open press is weak and involving environmental contamination,direction on due diligence, they also provide corruption is generally regarded as high. internal fraud, and white-collar crime. Prior to joining Kroll, David worked for a mid-sizeda defense for companies that have adequate 4.  here continues to be an absence of strong T investigative firm and the Environmental Enforcementprocedures in place to prevent the type of anti-corruption laws and enforcement in Section of the US Department of Justice.conduct that would otherwise give rise to BRIC countries compared to the Unitedprosecution. The Ministry of Justice provides States, the United Kingdom, and other Doug Frantz, a Kroll managing directorsome guidance on “adequate procedures” countries. This requires a company to in Washington, is a former Pulitzerindicating that due diligence should be engage in more extensive examinations of Prize-winning investigative reporterconducted on parties performing services for, acquisition targets’ policies, procedures, and former deputy staff director and chief investigator of the U.S. Senateor on behalf of, a business and that it should and employee handbooks relating to Foreign Relations “proportionate and risk-based.” With corruption, anti-bribery, and gifts andrelatively little guidance, it is no wonder that entertainment expenditures. Annual Edition 2011/12  |  15
  • 16. Special Comment With each new uprising across North Africa Recovering and the Middle East comes the inevitable challenge of recovering hidden assets that rightfully belong to the people. Like Gadhafi, Tunisia’s deposed leader Zine al-Abedine Ben Ali and Egypt’s ex-president Hosni Mubarak Sovereign Assets are also alleged to have accumulated massive fortunes concealed in bank accounts and other financial and real assets around the world. The situation is not without precedent. In 1986, the Reagan administration evicted Ferdinand and Imelda Marcos from the Philippines after a sham election and the assassination of their chief political opponent. The same year, the US and French governments sent Haiti’s Jean Claude Duvalier and his wife into exile in France. Duvalier and the Marcoses had acquired great wealth for themselves and their families while in power; assets which they secreted outside their countries in the face of widespread poverty and unemployment at home. Similar allegations were made against other dictators and political leaders, such as Asif Ali Zardari, the current president of Pakistan and husband of former prime minister Benazir Bhutto, Indonesian president Suharto and his clan during his 30-year reign, and Liberian president Charles Taylor, among others. The notion that a sovereign has ownership rights to a country and its treasury is not a new one. The vast “crown estates” taken in the Norman conquests, much of which are still owned by the Queen of England, attest to that. But a republican form of government accords no such privilege to a head of state. And yet despots like the Marcoses, the Duvaliers and, allegedly, the Gadhafis were able to control commerce and divert state funds through a combination of raw political power, terror, and, in some cases, the support of other nations. Of course, ill-gotten gains carry their own risks. Chief among these is that a successor By Daniel E. Karson government can seize assets within its borders. For this reason, heads of state must park their fortunes outside their home countries.As the search for Colonel Moammar Gadhafi intensified after How do politicians export their assets?Tripoli fell to rebel forces in late August, so too did the discussion For a head of state, it’s easy to do. When theof how to determine whether Gadhafi and his family diverted depositor is a national leader or a topLibyan assets to personal use and, as with other former heads government official, represented by a prominent local law firm or investment advisor, and theof state, held moneys in secret overseas bank accounts. The US, amounts are in the seven and eight digits orUK and other governments had already frozen billions of dollars more, the money does its own bank and real estate assets tied to the Gadhafi regime, most Governments and banks have cracked down on “no-questions-asked” accounts in manyof which will be released to Libya’s new government. But what traditional flight capital havens, such asof the other assets Gadhafi may have converted? Switzerland. However, the “Know Your16  |  Kroll Global Fraud Report
  • 17. Special CommentCustomer” policies ostensibly in effect in The Duvaliers simply wrote checks to themselves the world is slowly catching up. More andmajor banking centers are not airtight and off bank accounts in their own names. Charles more information can be identified throughthey postdate the establishment of many Taylor’s (Liberia) family held title to deeds to databases, making it harder to concealsuspect accounts. This was certainly so in properties in Florida in their own names. beneficial ownership, among other assetthe case of Jean Claude Duvalier, where a indicators. The next key to unlocking assets is toyear ago the Swiss Federal Supreme Court interview the people in the know. When Third, as with Switzerland, the tide of publicupheld his claim to a $4.8 million account. dictators depart, they leave behind cadres of and political sentiment has turned against(The account is still frozen.) aides and functionaries, who did the drudge offering safe havens to deposed dictators.Over the last 25 years, successor work of keeping records and running Former heads of state may find refuge outsidegovernments and opposition political parties errands. Many of those who did not get a their country or safe passage to internal exilehave tried to track down the assets of ticket out face jail sentences for complicity in within, but they are almost certain to losepoliticians and their families, who skimmed the larceny. They have an incentive to “work any court battle over excessive wealth thatmoney off government contracts or, as the off” their time by disgorging intelligence on can be tied to them.Duvaliers did, simply wrote checks to assets and asset locations. It is important However, serious challenges remain. MLATsthemselves out of the national treasury. to get to these people early in the process. with The Cayman Islands and other They may have records which become road Caribbean nations do not automaticallyThe plunder goes on today and, not maps to the assets. ensure that governments will open theirsurprisingly, it is poor nations that are beingransacked. The good news is that the Where are the assets of the most recently books if the alleged crime is not recognizedTunisians, Egyptians and Libyans will have in their countries. This includes tax deposed heads of state? It is a fair guess thatan easier time tracing and recovering assets violations, a customary leverage point for anyone who came to power before it becamethan did the Philippine and Haitian asset investigations. unpopular to be a flight capital haven parkedgovernments, if they can prove their cases their cash in Switzerland, The Channel Also, political relationships may influence aagainst their former rulers. Mutual assistance Islands and Liechtenstein. These were country’s decision to cooperate with an assettreaties and the worldwide media attention rock-solid, secure places with official “no-tell” investigation. A former head of state – Gadhafifocused on the excesses of deposed rulers policies. Gadhafi and Mubarak would fall into is a good example – may have cultivatedhave unlocked the vaults, if not the hearts, this category. warm relations with other oppressiveof the Swiss and other governments. regimes that might serve him in exile, as a However, beginning with the Marcos and haven for both himself and his cash. Hugo Duvalier cases, Swiss banks and the SwissThe Trappings of Wealth Chavez, who is very much still in power in government found themselves burdened with Venezuela, is in the process of movingHeads of state and their spouses spend their endless litigation and terrible press. They Venezuelan gold bullion from the Unitedcountries’ wealth not unlike the “ordinary” went from being seen as a secure and States to Russia, China and Brazil. He is beingvery rich. They buy real estate (the Marcoses) discreet banker to the wealthy to a protector treated for cancer; his country is rife withand jewelry (the Duvaliers). They support of tyrants and murderers. As a result, the violent crime, power shortages and otherentourages (Charles Taylor). And, of course, Swiss began to cooperate with successor problems. If Chavez is defeated at the polls,they open foreign bank accounts (all of them.) governments. Apparently without prompting, his relations with these countries may serve they froze the bank accounts of Tunisia’s Ben as a down payment for his retirement home.There are two keys to unlocking the secrets: Ali on their own initiative. Separately, therecords and human sources. The first is simple Central banks and regulators can and should agreement by UBS to turn over to the USenough, and falls into two categories – prohibit their member institutions from government the names of American accountpersonal records and public records. establishing bank accounts for heads of holders also evidenced a transparency neverInvestigators can usually make a quick score governments outside their homeland without before seen in that country.and identify assets by getting their hands establishing legitimate prior title to theon the records all heads of state leave behind As the customary flight capital havens have assets and legal authority to transfer some form or another. In addition, since crumbled or at least thinned their shrouds, times Banks also can step up the level of dueegomaniacs rarely contemplated being out of have gotten tougher for larcenous dictators. diligence checks on their depositors.power, they often have acquired assets First, many countries have pledged support By adopting such policies, in addition tolocated in countries where business to one another through Mutual Legal implementing tough anti-bribery statutes,registrations and property records are public Assistance Treaties. Under these treaties, the world community can make it harderand reveal personal holdings. Within 90 days, governments will provide assistance (in for tyrants to turn a nations assets intodepending on what records have been left varying degrees and with many exceptions) personal plunder.behind, investigators usually are able to find to law enforcement and tax collectionsome bank accounts, businesses, properties, agencies of other governments. A search for aairplanes and yachts. These findings often lead Daniel E. Karson is Chairman of Kroll former head of state’s assets can fall within Americas based in New other assets as well. The Marcoses owned the scope of a MLAT. He conducted the asset searchoffice buildings in Manhattan, thinly disguised investigations of the Marcoses forbehind a corporation in Curacao. Iraq’s former Second, every day we become more record- the US House of Representatives;president Saddam Hussein controlled intensive societies. While the accumulation the Duvaliers for the Republic of Haiti; Saddam Hussein, for the Kingdomcorporations in the US and the UK, nominally and storage of business and personal data is of Kuwait; and many similar cases around the world.headed by former government ministers. greatest in the developed world, the rest of Annual Edition 2011/12  |  17
  • 18. Regional Analysis: Americas North America OvervieWAs in previous years, North America fares well on many fraud-related issues. There are, however, two particular weak spots forIt registered the lowest average fraud loss for any region, as well as the lowest North American respondents. The first comes asregional incidence for five of the frauds covered in the survey: management no surprise: information theft, loss, or attackconflict of interest with 15% of companies reporting they were affected; internal remains the most common fraud in the region, affecting 26% of companies this year. This is alsofinancial fraud (13%); vendor, supplier, or procurement fraud (12%); corruption the area where respondents perceive the greatestand bribery (7%); and market collusion (6%). In addition, unlike elsewhere in the risk. A full 15% see themselves as highlyworld, North America did not post dramatic increases in other types of fraud. vulnerable – nearly double last year’s figure – and an additional 36% say that they are at least 2011-2010 2010-2009 moderately vulnerable. Similarly, 35% of North Prevalence: American respondents point to IT complexity as 66% 87% Companies affected by fraud the leading driver of increased exposure to risk, Information theft, loss, or attack (26%) Information theft, loss, or attack (32%) well up from last year’s number (26%), and one Areas of Frequent Loss: of the reasons why so many more companies Percentage of firms reporting loss to this Theft of physical assets or stock (23%) Theft of physical assets or stock (27%) type of fraud see their exposure to fraud growing. Management conflict of interest (15%) Management conflict of interest (14%) Less recognized is the difficulty that companies Areas of Vulnerability: Information theft, loss, or attack (51%) Financial mismanagement (36%) in North America are facing with the theft of Percentage of firms considering themselves moderately or highly IP theft (39%) Information theft, loss, or attack (34%) intellectual property. With 14% of companies vulnerable Theft of physical assets or stock (36%) Theft of physical assets or stock (31%) affected – up from 10% last year – North America has the highest regional incidence of IP theft in Increase in Exposure: this year’s survey. Local respondents, however, Companies where exposure to fraud has 79% 66% increased have been slow to adjust to the shift. Although 39% see themselves as moderately to highly Biggest Drivers of Increased vulnerable, this figure is slightly less than the Exposure: Most widespread factor IT complexity (35%) IT complexity (26%) survey average (40%). leading to greater fraud exposure and percentage of firms affected Despite noteworthy decreases in several types Loss: of fraud, North American companies will need Average percentage of revenue lost 1.7% Not available to fraud to remain vigilant in their efforts to prevent information theft and IP theft.18  |  Kroll Global Fraud Report
  • 19. Regional Analysis: AmericasWhen Fraudis an Inside JobFiveStepstoConsider By Richard PlanskyFraud remains a large and growing concern for virtually everytype of company in every part of the world. This is one of theconclusions of Kroll’s 2011/2012 Global Fraud Survey. Anotheris that a large majority of frauds are committed by insiders.To be precise, 60% of frauds, in which the perpetrator isknown, are committed by senior managers, junior employees,or third party agents or intermediaries – up from 55% in the2010/2011 survey. The phenomenon of fraud as an inside jobis not only prevalent but on the rise. The question is, “why?”While there is no simple answer, it appears In light of these trends, it is increasingly unfettered access to the materials that provethat the increasing fraud risk posed by likely that companies will at some point their fraud. At the earliest opportunity, stepsinsiders is, at least partially, a reflection of encounter the need to investigate a fraud should be taken to lock down electronicour information-based economy. More and allegation against an insider. When that day evidence that is easily destroyed. Themore, the value of a company is not comes, critical choices must be made that company should be prepared to discreetlymeasured in tangible property – rather, it is can have significant impact on the company’s acquire forensic images of computers,measured in ideas. Those ideas – a reputation, business continuity, and even taking “snapshots” of relevant accountscompany’s intellectual property – tend to employee morale. To that end, there are five from e-mail servers and shared drives,reside on computers and servers in the form basic steps that should be considered: preserving logs that show access to theof digital data. As a result, insiders have » Lock down evidence. When an investigation Internet and internal IT systems, andaccess to a far greater range of valuable involves insiders, the need to preserve removing relevant back-up tapes fromassets – and can acquire them with far potentially relevant evidence is particularly rotation. In some cases, it may also begreater ease – than ever before. acute. Inside fraudsters will likely have necessary to secure company landline Annual Edition 2011/12  |  19
  • 20. Regional Analysis: Americas and cell phone records, access card logs, and surveillance videos.» Get smart discreetly. Investigative steps can be taken at the outset to shed light on insider allegations without alerting the perpetrator. In virtually any case, a review of company e-mails and Internet browsing history will shed significant light on an insider’s activities and associations, both in and outside of the office. In a case involving kickbacks or conflict of interest, a review of records showing purchases from vendors may reveal patterns and recent changes indicative of corruption. A review of corporate filings might show an ownership interest in one or more vendors, whose share of business has been increased by the insider.» Look for personal events that may trigger the ‘need’ to commit fraud. Fraud is often sparked and/or evidenced by specific events. When an insider is suspected, it is always advisable to mine publicly-available sources for signs of financial distress like bankruptcies, recently filed litigation, divorces, judgments, liens, and large purchases that are inconsistent with the insider’s known income. Economist Intelligence Unit Report Card Technology, media & telecoms» Monitor key activities. Consistent with The technology, media, and telecommunications sector had a mixed fraud picture over the last year. Although corporate policy and applicable law, an it experienced a noticeable decline in fraud prevalence overall, particularly for information theft (dropping insider suspected of wrongdoing should be from 37% to 29%) and IP theft (from 27% to 22%), it still had the highest prevalence of these two frauds of any monitored in order to develop evidence of industry. For IP theft, this was the second year in a row it held this dubious distinction. Sector companies wrongdoing and mitigate ongoing harm. understand that this is a problem: they are the most likely of any industry to consider themselves highly Examples of potentially fruitful activities to or moderately vulnerable to information theft (59%) and IP theft (49%). Moreover, certain other frauds are monitor include e-mail communication on increasingly common in the sector: procurement fraud hit 21% of firms (up from 15% last year), financial the company domain, hiring decisions, and mismanagement 16% (up from 10%), and corruption 11% (up from 7%). payment authorizations made by the insider, as well as postings on social Loss: Average percentage of revenue lost to fraud: 2.1% networking sites. Prevalence: Companies affected by fraud: 74%» Have a succession plan. As an Areas of Frequent Loss: Percentage of firms reporting loss to this type of fraud investigation progresses and it appears Information theft, loss or attack (29%) • Theft of physical assets or stock (24%) that insider allegations are substantiated, Management conflict of interest (23%) • IP theft, piracy or counterfeiting (22%) it is important to plan for what will happen Vendor, supplier or procurement fraud (21%) • Internal financial fraud or theft (18%) “the day after.” Failure to have a succession Financial mismanagement (16%) plan can lead to delay in terminating a Increase in Exposure: Companies where exposure to fraud has increased: 78% corrupt employee and possibly create Biggest Drivers of Increased Exposure: Most widespread factor leading to greater fraud exposure and significant business disruptions. percentage of firms affected: IT complexity (43%)While every case is different, thinking 0 10 20 30 40 50 60 70 80 90 % 100 through the basic steps outlined above can Corruption and briberyhelp companies respond ethically and Theft of physical assets or stock Money launderingeffectively to the rising threat of insider fraud. Financial mismanagement Regulatory or compliance breach Internal financial fraud or theft Richard Plansky is a senior managing Information theft, loss or attack director and head of Kroll’s New York IP theft, piracy or counterfeiting office. With 19 years of investigative Vendor, supplier or procurement fraud and law enforcement experience, Management conflict of interest Richard manages a wide variety of Market collusion complex assignments with a special emphasis on corporate investigations. Moderately or Highly vulnerable Slightly vulnerable20  |  Kroll Global Fraud Report
  • 21. Regional Analysis: AmericasInadequate Due DiligenceCreates a Big Regulatory Risk By Peter J. Turecek Companies globally are facing a huge liability pitfall in failing to identify and mitigate Foreign Corrupt Practices Act (FCPA) risks in transactions. Fewer than 40 percent of respondents to this year’s Global Fraud Survey say that their due diligence in advance of an acquisition, creation of a joint vehicle, or provision of financing gives them a sufficient understanding of an investment target’s compliance with the FCPA and the UK Bribery Act 2010 (UKBA). » Annual Edition 2011/12  |  21
  • 22. Regional Analysis: AmericasThe cost of insufficient due diligence can be Such settlements reflect only a part of the Recognition that current due diligence effortsvery high. In just the last year and a half, the true costs of an FCPA violation. Investigation may not provide sufficient comfort is the firstfines and other payments associated with and litigation expenses, public relations step toward taking action. Companies needsome FCPA settlements to end regulatory consultations, and the opportunity cost of to significantly enhance these efforts,action have exceeded $200 million each, taking senior executives away from their particularly in jurisdictions where transparencyincluding those of BAE Systems ($400 is lacking and a certain measure of focus on running the business couldmillion), Snamprogetti Netherlands BV ($365 corruption is considered a normal part of collectively add millions of dollars to themillion), and Technip SA ($338 million). doing business. This is not the place for false financial impact.Smaller settlements still involve significant economy. Due diligence limited to runningexpense. For example, Alliance One – a With regulators globally devoting increased media, litigation, and criminal checks maytobacco company formed by the merger in attention towards rooting out corruption, be low-cost, but it is simply insufficient in2005 of DIMON Incorporated and Standard it is only a matter of time before more many global jurisdictions and may proveCommercial – was sued last year by the companies find themselves responding to fatal in the long run. Outside of the UnitedSecurities and Exchange Commission over inquiries from authorities about suspect States, the scope and availability of publicbribes DIMON was alleged to have paid records shrinks precipitously. Reliance upon business transactions around the globe.between 2000 and 2004 to Thai government such sparse – and, in certain countries, Even investment vehicles, previously deemedofficials. To settle that civil case, Alliance safe, now contain risks. For example, private questionable – data may actually increaseconsented to a permanent injunction against equity firms providing active management risk rather than mitigating it.future violations of the FCPA, disgorgement of$10 million in profits, and retention of an of portfolio companies are more likely to Enhanced due diligence efforts thereforeindependent monitor. To resolve the see regulators closely examining the require a combination of varied techniques.associated Department of Justice criminal chain of ownership and management At a minimum, they should include: decision-making in order to hold morecase, Alliance agreed to pay an additional » A thorough review of available public$9.45 million as a criminal fine. parties liable when corruption is identified. records. » A comprehensive series of human Economist Intelligence Unit Report Card Consumer goods intelligence/source inquiries of people who understand the specifics of a target The news for the consumer goods industry is generally good this year after worrying data in 2010. The prevalence of fraud has dropped markedly from 98% of companies being hit by at least one fraud to 73%. Certain frauds company’s operations and reputation. in particular have seen marked reductions in prevalence: theft of physical assets dropped from 43% to 27%, » A thorough review of the target company’s information theft from 25% to 15%, and financial mismanagement from 21% to 8%—the lowest figure for any books and records, particularly with sector. Not all the news was good, however. Procurement fraud, corruption, and internal financial fraud was more widespread across the sector. The big challenge for consumer goods companies remains staff. In cases regards to cash flows and how certain where a company has identified a member of staff who has committed a fraud, 45% of the time in this industry the expenses are recorded. culprit is a junior employee, which is 11% higher than in any other sector. Similarly, the leading driver of increased fraud exposure is high staff turnover (27%). The industry is taking up the challenge: it has a higher proportion of » A careful analysis of the findings in the companies planning to invest in staff training (39%) than in any other sector, and also has the second highest context of the local business environment, number, after financial services, putting new money into background screening (27%). Continued success will players, and activities. depend to a great extent on the effectiveness of such efforts. As many of the companies reaching legal Loss: Average percentage of revenue lost to fraud: 1.8% settlements have found, ignorance of ongoing Prevalence: Companies affected by fraud: 73% behavior at an acquisition target is not a Areas of Frequent Loss: Percentage of firms reporting loss to this type of fraud valid excuse when regulators start looking at Theft of physical assets or stock (27%) • Internal financial fraud or theft (23%) potential issues involving corruption. Vendor, supplier or procurement fraud (23%) • Corruption and bribery (19%) Thorough due diligence at the outset of a Information theft, loss or attack (15%) transaction can ultimately save significant Increase in Exposure: Companies where exposure to fraud has increased: 69% money in the long run – sometimes to the Biggest Drivers of Increased Exposure: Most widespread factor leading to greater fraud exposure and tune of tens or hundreds of millions of dollars percentage of firms affected: High staff turnover (27%) – and in certain cases can even secure the 0 10 20 30 40 50 60 70 80 90 % 100 very survival of the company. The alternative Corruption and bribery is an unnecessarily risky roll of the dice with Theft of physical assets or stock the future of the firm. Money laundering Financial mismanagement Regulatory or compliance breach Peter Turecek is a senior managing Internal financial fraud or theft director in Kroll’s New York office. Information theft, loss or attack He is an authority in due diligence, IP theft, piracy or counterfeiting multinational investigations, and hedge Vendor, supplier or procurement fraud fund related business intelligence Management conflict of interest services. He also conducts a variety of Market collusion other investigations related to asset searches, corporate contests, employee integrity, securities Moderately or Highly vulnerable Slightly vulnerable fraud, business intelligence, and crisis management.22  |  Kroll Global Fraud Report
  • 23. Regional Analysis: Americas is also part of Dodd-Frank, and may require graphic representation of the information. In the 2011 proxy season, certain companies got a jump start on this requirement and for the first time included charts in their proxy statements depicting five year total shareholder return compared to total executive compensation. For already-disgruntled shareholders, these pictures will be worth a thousand words. However, compensation consultants and governance attorneys warn the new pay-for-performance disclosures may not accurately reflect all relevant information, such as the company’s financial performance as compared to a relevant peer group, and compensation that is actually paid versus potentially earned. For companies receiving negative say-on-pay votes, the first step is to reach out to institutional shareholders in order to explain executive pay practices and changes, if any, Say-on-Pay in 2012 to the compensation plan. The second step is to get a better understanding of the background and track record of those investors. Important A Picture is Worth a Thousand Words information includes whether a shareholder, institutional or individual, has a history of investor activism or of working together with By Marcia Berss others as activists in a disclosed or undisclosed group – a so-called “wolf pack.” Also, what are the shareholder’s usualThe 2011 US proxy season has concluded, and for the first time it included tactics? Does he, for example, have a history“say-on-pay” – a shareholder advisory vote on executive compensation of launching proxy fights?mandated by the 2010 Dodd-Frank Wall Street Reform Act. Some governance observers believe that a negative say-on-pay vote in 2011 is notAt most companies, shareholders voted annual meeting under the threat of a worrisome, given that it was the first year inoverwhelmingly to endorse executive rejection. Still others have revised their which the advisory vote was mandated.compensation and approved pay plans with compensation plans after shareholders They add, though, that a second consecutivean average 90 percent support. However, at expressed disapproval in the 2011 vote, or are negative vote in 2012 will make the companyabout three dozen companies, the considering changing executive compensation a target for activists. It could be worse.remuneration packages were rejected, due before the 2012 shareholder meeting. This summer Australia revised its say-on-paylargely to pay-for-performance concerns as law, and now requires the board to resign Nor have shareholders been inactive. Severalreflected in weak stock prices. At more than if a company gets two consecutive negative companies face shareholder lawsuits afterthree dozen companies, the vote passed, but votes on compensation. Simply put: two failed say-on-pay votes and, in some cases,with significant shareholder opposition. strikes and you’re out. stock owners displeased with executiveThe fallout has been varied. Some companies compensation have targeted directors who sit The Dodd Frank Act has given shareholders a on the compensation committee by voting voice, and ammunition, to influence executivetook the unprecedented step of challenging against their re-election. compensation. Companies are listening andproxy advisors which advised “no” votes on need to be prepared to respond.executive compensation plans. One such In this charged environment, the 2012 proxyadvisor, Institutional Shareholder Services, statements will include potent newrecommended negative votes at information for shareholders: disclosures Marcia Berss is an associate managingapproximately 300 companies in 2011, about which compare executive compensation to director in Kroll’s Chicago office specializing in public securities filings,11 percent of the corporations it reviewed. A the financial performance of the company, corporate finance and corporatedifferent strategy has been to fight critics by including dividends and changes in the stock governance issues. She began herlobbying institutional investors to support price. The Securities and Exchange career as a corporate finance associate with Warburg Paribas Becker and wasproposed pay plans. Other companies altered Commission is issuing rules to implement vice president in M&A for Dean Witter Reynolds.their compensation practices before the 2011 this pay-for-performance requirement, which Annual Edition 2011/12  |  23
  • 24. Regional Analysis: Americas Canada OvervieW In the last 12 months, Canada did very well relative to other countries in terms of fraud. Most striking was the very low loss rate (0.9%), which was by far the best of any country or region. Canada also saw a drop in nine of the 11 frauds covered by the survey from record highs reported last year. In another positive development, the number of companies hit by at least one fraud (70%) declined to 2008-2009 levels, when the figure was 71%. On the whole, Canadian companies are also more 2011-2010 2010-2009 careful than their regional counterparts. Over half Prevalence: (51%) have avoided operating in – or have left – a 70% 86% Companies affected by fraud country or region because of fraud. This is much higher than the survey average of 37%. Although Theft of physical assets or stock (44%) corruption is the main concern for Canadian Areas of Frequent Loss: Information theft, loss, or attack (28%) respondents, (35%), they are also nearly twice as Information theft, loss, or attack (22%) Percentage of firms reporting loss to this Management conflict of interest (19%) likely as the survey average to cite information type of fraud Theft of physical assets or stock (16%) theft (21%). Vendor, supplier, or procurement fraud (16%) The only real danger in such an environment is Information theft, loss, or attack (48%) complacency closer to home. In particular, the Areas of Vulnerability: Information theft, loss, or attack (47%) prevalence of information theft, loss, or attack in Percentage of firms considering Regulatory or compliance breach (44%) the country is about the same as the global survey IP theft (35%) themselves moderately or highly vulnerable Theft of physical assets or stock (34%) Vendor, supplier, average (22% compared to 23%) and IT or procurement fraud (37%) complexity is the leading cause of increased risk exposure. Moreover, 47% of Canadian respondents Increase in Exposure: Companies where exposure to fraud has 78% 72% indicated that they are at least moderately increased vulnerable to this fraud, again close to the survey average of 50%. Although they see the problem Biggest Drivers of Increased as well as anyone else, Canadians are noticeably Exposure: Most widespread factor IT complexity (33%) IT complexity (35%) less likely to take steps against it. Only 17% intend leading to greater fraud exposure and percentage of firms affected to invest in new IT security measures in the coming 12 months, compared to 30% overall. This Loss: disconnect suggests that the relatively benign Average percentage of revenue lost 0.9% Not available to fraud fraud environment in Canada may lead some companies to get too comfortable.24  |  Kroll Global Fraud Report
  • 25. Regional Analysis: AmericasCanada Steps Up itsAnti-Corruption Efforts For many years, Canadian multinationals By Jennie Chan, Deborah Gold, Peter McFarlane caught up in corruption – whether intentionally or inadvertently – could take some comfort inWith one of the world’s largest economies, Canada has many knowing that the risk of prosecution bysuccessful multinational companies, particularly in the resource Canadian authorities under the Corruption of Foreign Public Officials Act (CFPOA) – Canada’ssector. Major players in this industry have long used expertise equivalent of the Foreign Corrupt Practices Actgained domestically in order to develop operations overseas. – was minimal. That assumption, however, is looking increasingly tenuous.Often geology dictates that these will be in difficult operatingenvironments and in jurisdictions, which Transparency Canada enacted its legislation against foreign corruption in the 1990s along with severalInternational’s Corruption Perception Index suggests have other OECD countries. Few or no resources,some of the world’s worst corruption environments. however, were allocated to enforcement. As a result, no convictions took place underTransparency International, however, in its most recent the legislation until 2005 when an energyprogress report on anti-corruption activity, castigated Canada service company, Hydro-Kleen, pled guiltyfor being the only G7 country that exhibited “little or no to bribing an American public official, a conviction which came about more throughenforcement” against this fraud. Worse still, it has been in this the efforts of one of the company’s competitorscategory since the report was first published in 2005. than those of the Canadian authorities. Annual Edition 2011/12  |  25
  • 26. Regional Analysis: Americas investigation concerning the activities of a Canadian Senator acting for Niko on a consulting basis is currently taking place. James Klotz, President of Transparency International Canada, hailed the result as “Canada’s first major conviction and fine under our international anti-corruption legislation.” He hopes for further action: “The new RCMP task force has been working hard at investigating Canadian companies suspected of bribery abroad… [T]here are at least 22 active files, so we expect more charges against companies or individuals.” The Niko proceedings certainly do indicate that the authorities are taking a pragmaticOnly in 2008 did the Royal Canadian Cruiser worth $191,000 and a $5,000 approach to investigations and prosecutionsMounted Police (RCMP) establish its non-business trip to New York and Chicago. so that these occur in a timely way.International Anti-Corruption Unit with the In addition to suffering reputational damage, Moreover, the OECD and other bodies such asspecific mandate to investigate allegations of the company had to pay fines totaling $9.5 Transparency International are pressing theforeign bribery by Canadian individuals and million and was placed under a three-year Canadian government to bring the CFPOA in line with legislation in other OECD countriescompanies. In June 2011, after a multi-year Probation Order. The latter required Niko, and to increase the resources dedicated toinvestigation, Niko Resources Ltd., a among other things, to complete ongoing enforcement. Such pressure also will likelyCanadian natural gas company, pled guilty to compliance audits to ensure its compliance mean more prosecutions under the CFPOA inbribing the former Bangladeshi State Minister with the CFPOA. The imposition of sanctions the future.for Energy with gifts including a Toyota Land may not even be the end of this story; a new Due to enhanced FCPA enforcement efforts by Economist Intelligence Unit Report Card Natural resources American authorities over the last few years, as well as the resulting significant fines for Although the natural resources sector saw an overall decline in fraud prevalence, the industry still had the violations and transgressions concerning highest proportion of companies hit by fraud in the last year. It was also tied with manufacturing for the second bribery of foreign officials, many US highest increase in fraud exposure of any industry (84%). Although the prevalence of certain crimes dropped multinationals have implemented from the previous survey—notably management conflict of interest, which declined from 27% to 18%—for comprehensive programs to ensure FCPA seven of the 11 frauds covered in the survey the number of companies affected has risen. The industry even compliance. If they have not done so already, bucked two positive trends seen in the survey as a whole. Unlike most other sectors, which saw declines, the Canadian multinationals, particularly those prevalence of the theft of physical assets increased (from 28% to 33%) and that of information theft held steady operating in high risk jurisdictions, should with last year’s figures (22%). The sector’s biggest problem is corruption, which is perhaps predictable, given also ensure that senior management is that its ability to choose where to extract resources is more affected by nature than by local governance. It had committed to complying with the CFPOA by the highest prevalence of any industry last year (29%), and also the highest number of companies saying that they are highly or moderately vulnerable to this fraud, a remarkably high 62%. putting in place appropriate policies and procedures designed to detect and deter such Loss: Average percentage of revenue lost to fraud: 1.9% activity. Prosecutions that may potentially Prevalence: Companies affected by fraud: 82% result in substantial penalties are now a real Areas of Frequent Loss: Percentage of firms reporting loss to this type of fraud risk for Canadian businesses. Theft of physical assets or stock (33%) • Corruption and bribery (29%) Vendor, supplier or procurement fraud (26%) • Information theft, loss or attack (22%) Internal financial fraud or theft (21%) • Management conflict of interest (18%) • Financial mismanagement (17%) Jennie Chan is a managing director in Kroll’s Toronto office, specializing in complex financial investigations. Regulatory or compliance breach (16%) Jennie has led and participated in a wide range of Increase in Exposure: Companies where exposure to fraud has increased: 84% assignments, including internal fraud investigations, Biggest Drivers of Increased Exposure: Most widespread factor leading to greater fraud exposure and financial reviews and litigation support matters. percentage of firms affected: IT complexity (34%) 0 10 20 30 40 50 60 70 80 90 % 100 Deborah Gold is a managing director with Kroll Risk and Corruption and bribery Compliance Solutions, heading up its Toronto practice. Theft of physical assets or stock She provides due diligence solutions to support clients’ Money laundering commercial transactions, investments, and regulatory compliance requirements, and helps them manage legal, Financial mismanagement regulatory, financial, and reputational risk concerns. Regulatory or compliance breach Internal financial fraud or theft Information theft, loss or attack Peter McFarlane is a managing director and head of the IP theft, piracy or counterfeiting financial investigations team in Toronto. Vendor, supplier or procurement fraud With more than 20 years of forensic accounting and Management conflict of interest investigative experience, Peter manages a wide range of Market collusion complex financial investigations, litigation consulting, asset recovery and financial due diligence assignments Moderately or Highly vulnerable Slightly vulnerable for corporate and government clients around the world.26  |  Kroll Global Fraud Report
  • 27. Regional Analysis: Americas Latin America OvervieW As with some other parts of the world, the Latin American fraud picture is one of transition. This year saw a drop in the overall number of companies suffering at least one fraud to 74%, a little under the global average. At the same time, there has been a striking increase in the percentage of companies reporting that they are at risk. The proportion of respondents saying that they are at least moderately vulnerable to every fraud covered in the survey grew substantially, and in five of 11 cases at least doubled. For example, those companies describing themselves as vulnerable to the theft of physical assets jumped from 29% to 58% and those vulnerable to management conflict of interest ballooned from 26% to 53%. 2011-2010 2010-2009Prevalence: This unexpected combination of lower incidence 74% 90%Companies affected by fraud and higher perceived vulnerability probably arises from shifts in the types of fraud that companies Theft of physical assets or stock (25%) Information theft, loss, or attack (35%) are seeing. Although the incidence of information Information theft, loss, or attack (24%) theft and management conflict of interest dropped Management conflict of interest (27%) Vendor, supplier, (from 35% to 24% and 27% to 21% respectively),Areas of Frequent Loss: or procurement fraud (23%) Theft of physical assets or stock (26%) both remain troublingly common. At the same time,Percentage of firms reporting loss to thistype of fraud Corruption and bribery (23%) Vendor, supplier, other frauds saw notable increases, such as internal or procurement fraud (22%) financial fraud, which affected 18% of companies Management conflict of interest (21%) Regulatory or compliance fraud (21%) in this survey, up from just 13% last year. Internal financial fraud or theft (18%) Corruption, however, is the fastest growingAreas of Vulnerability: Corruption and bribery (70%) Information theft, loss, or attack (34%) problem. Nearly one in four companies in LatinPercentage of firms considering America (23%) was affected by this crime in the Theft of physical assets or stock (58%) Theft of physical assets or stock (29%)themselves moderately or highly last 12 months, up from 13% in last year’s survey.vulnerable Management conflict of interest (53%) Management conflict of interest (26%) Moreover, 70% admit to being moderately to highly vulnerable, up from just 20% last year.Increase in Exposure:Companies where exposure to fraud has 79% 85% These numbers may have a silver lining. Expertsincreased and residents have always known that corruption is an issue in much of the region: only three of itsBiggest Drivers of Increased countries finish in the best third of TransparencyExposure: Most widespread factor High staff turnover (34%) IT complexity (30%) International’s Corruption Perception Index. Theleading to greater fraud exposure and IT complexity (33%)percentage of firms affected results, therefore, may indicate not just a growth in corruption – although other data sourcesLoss: indicate that this is happening – but also a growingAverage percentage of revenue lost 1.9% Not availableto fraud recognition that bribery should not be a part of normal business. Annual Edition 2011/12  |  27
  • 28. Regional Analysis: Americas Latin America’s Uneven For many decades, investors stood on the hazardous – playing fields. Any litigation may By Andrés Otero sidelines in Latin America because of take years to resolve, will be costly, and could corruption, political turmoil, lack of potentially impact the company’s globalAt a time when the global competitiveness, poverty and inequality, reputation and financial stability. kidnapping and insecurity, terrorism, and aeconomy is wracked by general lack of trust. This is no longer the The main issue is the highly politicizeduncertainty and volatility, case. Many foreign companies, attracted by justice system in these countries. Many high courts are composed of political appointees.Latin America – led by Brazil high commodity prices and expanding local Magistrates start wearing their robes markets, are looking to the region for the first– continues to present time and liking what they see. International owing political favors. This leads to intervention by other branches of governmentsignificant opportunities for rating agencies have granted investment- in judicial affairs and judgments that can grade ratings to several countries in theinvestment and growth. The region, leading to a change of perception and favor politically connected local interests. Some judges can find themselves beingarbitrariness of its legal a larger appetite for Latin American risk. Local investment funds, as well as Latin pressured by interested parties or negotiatingsystems, however, and the America-based multinational companies, their next political assignment based on thelack of independence of the often referred to as multilatinas, have also outcome of certain cases. Transparency is increased their bets by investing and often non-existent. In others, court rulingsjudiciary in several countries may be made in closed chambers. Under such expanding in neighboring markets.continue to be of concern to circumstances, those with fewer connections In addition to producing many of the world’s and less knowledge of how the systemmany investors and highly valued food and mineral commodities, operates will be at a distinct disadvantage.corporations operating in the Latin American countries are updating and Although this is especially the case in ALBA 2 expanding their aging infrastructure, andregion1. Whether it be a governments in the region are awarding countries and in most Central Americangovernment expropriation of multi-million dollar contracts and long-term nations, not all countries should be tarred concessions. These opportunities have with the same brush. Chile, Colombia, andassets of an energy company, prompted many international companies to Brazil, for example, have made strides ina rigged public bidding invest at a fast pace, often leaving them strengthening the independence of their exposed to potentially costly disputes and judicial systems and higher courts, allowingprocess, an environmental very limited intervention from their legal actions. While Latin America is undeniablydispute with an indigenous a more attractive business opportunity than governments. However, given the caudillo3 mentality of most rulers in Latin America,community, or the alleged it has been in a long time, investors need to be aware of the potential pitfalls. there remains a constant threat to the ordercorruption of a high-level of justice and democracy. What many fail to understand fully is that thegovernment official, Latin rule of law in some Latin American countries While none of the above will be new toAmerica continues to raise is a far cry from the international standards of seasoned investors who have been doing justice that they may be used to in developed business in Latin America for many years, somedoubts about transparency, markets. In Latin America, they will often be recent developments have added even morelegality, and fairness. operating on uneven – and potentially elements of risk for unsuspecting companies.28  |  Kroll Global Fraud Report
  • 29. Regional Analysis: AmericasPlaying Field One example is class action lawsuits against people without means to obtain legal redress far from becoming the standard way of doing multinational companies, funded by private and compensation for their losses. But lost in business in the region. The results of this equity firms. Some lawyers and investors are the outwardly benign purposes of contingent year’s Global Fraud Survey make this point seeking to replicate the success obtained by fees, are those cases where indigenous and loud and clear: 70% of companies in Latin the classic “strike suit” law firms in the community groups who may barely America acknowledge that they are United States that made billions in product understand the cause of action brought on vulnerable to corruption and bribery. liability litigation. They have targeted large their behalf, and ultimately may come away Despite the new allure of Latin America as a multinational corporations with operations in with a small fractional share of an award. land of opportunity, in many countries little the less developed world, bringing lawsuits Multinational companies face similar has been done to address the lack of an on behalf of local citizens claiming personal challenges with government projects impartial system of civil justice. International environmental injuries, allegedly inflicted by involving public bidding contracts. All too investors must assess the risks associated with the defendants. In some cases the causes of often in several Latin American countries, the economic opportunities of a country before action have been based on the alleged player with the closest connections to the jumping in. They must also conduct thorough conduct of predecessor companies acquired project wins. Frequently, the contract award reputational due diligence investigations of by the defendants decades earlier. is not based entirely on the lowest bid, the their partners and third party agents with Class action fervor in the United States has quality of services offered or price. The whom they plan to do business. Businesses been quieted to some extent by criminal selection is often made behind closed doors and investors today are excited about Latin convictions of lawyers and professional without little if any transparency. This has America, and there are compelling reasons plaintiffs who turned fraudulent schemes into led to unfinished infrastructure projects, that support this enthusiasm. Still, they lawsuits against large corporations. However, litigation disputes and investigations of should be aware that structural changes in the concept of piggybacking a contingency corruption. If a frustrated foreign bidder sues these attractive markets are long overdue, award on the backs of alleged mass tort a government, the odds of succeeding or and that political stability and impartial victims has found a new life. In the last few even getting a fair hearing in court are justice in the region are works in progress. years private equity firms have been created uncertain at best. After years of civil whose main investment specialty has been litigation a foreign plaintiff may end up Andres Otero is a managing director the funding of such actions. In many cases seeking recourse in an international and head of Kroll’s Miami office. the founders of these firms have been former arbitration tribunal claiming that it was In addition, Andres oversees Kroll’s litigators themselves. denied equal justice under bilateral treaty. offices in Argentina, Colombia, Mexico and Grenada and manages The firms operate by buying investment There are exceptions to this generalized client relationships in the Andean region, Southern Cone, Central America stakes in lawsuits. Like the class action law description. To root out corruption, for and the Caribbean. He’s an expert in a variety of example, Brazil and Chile have enacted investigative and intelligence areas, including fraud and firms, they put up millions of dollars for legal legislation similar to the United States anti-corruption services, money laundering investigations expenses, experts and the other costs of Foreign Corrupt Practices Act and Britain’s and conflict resolution matters. litigation. The contracts they write vary, but Bribery Act. Other countries, such as essentially the longer the lawsuit goes on, 1  isk areas highlighted by the World Bank’s annual Doing R Colombia and Peru, are making strong efforts Business report. and the more money they put up, the higher 2  LBA is the Spanish-language acronym for the Bolivarian A to fight corruption in the public sector and to their return will be on an eventual judgment. Association of Nations, an international cooperation provide a sound environment for investors. organization currently led by Venezuelan president Hugo Chavez, members of which include Venezuela, Ecuador, There is certainly a public benefit to Having said this, the battle against Bolivia, and Nicaragua. 3  Spanish term for a charismatic, egocentric leader who A contingency lawsuits. They enable injured corruption is just beginning and fair play is believes that his country cannot survive without him. Annual Edition 2011/12  |  29
  • 30. Regional Analysis: Americas Mexico OvervieWThis year’s survey indicates that Mexico has a widespread fraud problem. The country’s biggest fraud problem is corruptionRespondents posted above average incidences for eight of the 11 frauds and bribery. After Africa, Mexico has the second highest percentage of respondents of any regiontracked in the survey. The country also reported a slightly above average or country reporting losses in this area (withpercentage of revenue lost (2.2%), which compares badly with those of its rounding, both geographies show a figure of 37%).North American (1.7%) and Latin American (1.9%) neighbors. The danger is even more widespread than the incidence: 45% report being highly vulnerable 2010-2011* to this risk – nearly twice the survey average (24%) – with a further 36% moderately vulnerable. Prevalence: 69% Companies affected by fraud The incidence of theft of physical assets (31%) is Corruption and bribery (37%) also well above the survey average (25%), and the number of those considering themselves at Theft of physical assets or stock (31%) least moderately vulnerable (65%) is substantially Areas of Frequent Loss: Information theft, loss, or attack (27%) Percentage of firms reporting loss to this higher than the figure for the survey as a whole type of fraud Internal financial fraud or theft (23%) (46%). Finally, information theft is a significant Vendor, supplier or procurement fraud (21%) risk, compounded by the growing IT complexity. Management conflict of interest (21%) Although Mexicans are aware of these dangers, Corruption and bribery (81%) more aggressive anti-fraud tactics than currently Areas of Vulnerability: Percentage of firms considering being adopted are probably in order. Respondents Theft of physical assets or stock (65%) themselves moderately or highly from the country were either less likely or only vulnerable Information theft, loss, or attack (58%) about as likely as average to have invested in every anti-fraud strategy covered in the survey. Increase in Exposure: Companies where exposure to fraud has 82% More striking still, except for protection of physical increased assets – in which 34% plan to invest in the coming year – they are also only about as likely as the Biggest Drivers of Increased Exposure: Most widespread factor average to spend more on these strategies. IT Complexity (35%) For information security, for example, just 26% leading to greater fraud exposure and percentage of firms affected planned to make such investments compared to 30% for the survey as a whole. Loss: Average percentage of revenue lost to 2.2% Mexicans recognize that they are vulnerable to fraud fraud. Now they need to do something more *Insufficient respondents in 2010 to provide comparative data. about it.30  |  Kroll Global Fraud Report
  • 31. Regional Analysis: AmericasRooting Out Fraud After 2. The next step is a complete review of all major agricultural and industrial processes with particular emphasis on the role ofAcquisitions in the Brazilian each employee. A thorough review and crosscheck – using a company’s Enterprise Resource Planning systems – of purchaseSugar and Ethanol Industry orders, payrolls and work hours, and price curves of key inputs will provide a detailed picture of the plant’s operations and the reliability of the numbers in its financial statements and other reports. The directors of the agriculture and industrial divisions will have a key role in assuring the success of this review. 3. It is recommended that the internal transformation process be accompanied by a renewed commitment to security. In the first year of the new ownership, literature and political imagery – is slowly it is crucial to undertake a thorough By Vander Giordano being replaced by faceless executives. assessment of the corporate security International investors face other issues as structure and technical staff, followed byThe Brazilian sugar and ethanol well. Kroll has seen a high incidence of the implementation of state-of-the-artindustry has become an important unethical behavior in the pre-sale phase of security systems to ensure the highestoption for investors seeking to transactions, especially in the cases of level of asset protection at the plants.increase their holdings in the energy heavily indebted sellers. These practices, 4. To raise awareness of new businesssector. Several factors, notably the including fraud and other questionable practices, management may want to behavior by employees and suppliers may conduct an internal campaign bycountry’s large sugarcane production, continue even after the arrival of new owners. distributing manuals, explaining ethicalthe instability of global oil prices, and conduct and encouraging employeegrowing worldwide concern over the Once the acquisition is complete, those buying engagement based on a clearly defined a Brazilian sugar and ethanol producer wouldenvironmental impact of energy set of goals set by the new owners. be well advised to undertake a comprehensiveproduction, have combined to make internal review, with special attention to 5. To reinforce best practices, trainingthe sector particularly attractive. budget execution, late payment of vendors, modules, aimed at group leaders, help expenses for supplies, contract enforcement reinforce the new rules of conduct andBrazilian government support adds to this and outstanding debts. Particular attention the need for commitment from allappeal. The National Economic Development should be paid to activities involving employees to the implementation of newBank has approved some $35 billion in loans industrial and agricultural warehousing; practices. The human resourcesto private companies in the sector over the cutting, loading and transportation of sugar department would be responsible fornext four years. These will support the cane; delivery of farm supplies; provision of coordinating this phase of the program.growth of sugarcane plantations, spur contracted services; and company fuel The above efforts will be necessary to helptechnological development in the industry, supplies. The most important step of all is to effect an ideal transformation in the newlyand finance the expansion of ethanol implement a new system of internal controls. purchased company. The participation of topdistilleries, pipelines, and other The following may help to minimize risks in management and its willingness to followtransportation networks for the industry. the period after the purchase is completed: through in implementing these five steps willIt is not surprising that an increased go a long way towards bolstering the 1. A good way to start the process ofparticipation of foreign capital has accelerated understanding of – and the support for – any transforming internal procedures is to setconsolidation within the sector in recent new processes that the incoming up an effective channel for internalyears. The transformation has been dramatic. administration needs to impose. If this does communication to funnel the ideas,What was once an industry of primarily not happen, however, the possible losses suggestions, and complaints of employeesfamily-owned businesses is now dominated during the transition could potentially that impending changes inevitably professionally run companies. This trend undermine the entire investment. It is important to give this channelis expected to continue as large firms credibility by providing prompt and fullincrease their market share and the number Vander Giordano is a managing director responses to employees’ concerns. Theof small enterprises further diminishes. in Kroll’s São Paulo office. He is a member change of personnel in key positions at of the Brazilian and International BarThis transformation brings a variety of this early stage will help ensure that the Associations and holds an MBA. Vanderchallenges, including a culture shock for company’s answers are clear and objective. has extensive experience working with companies in the energy, retail,Brazilians as the archetypical powerful local The human resources department will play banking and airline owner – a staple of the country’s a central role in this process. Annual Edition 2011/12  |  31
  • 32. Regional Analysis: Americas Financial Statement Fraud A Little Journal Entry Could Bring Big Trouble By Glen Harloff It’s time to renew the line of credit with the bank, but the company is offside on its loan covenants. If the current period’s loan interest payment of $2 million were put on the balance sheet though instead of the income statement and $1 million of next year’s sales included in this one, net income would grow by $3 million. The company would no longer be offside. It’s only a few journal entries that can be reversed in the next fiscal period. No harm, no foul, right?32  |  Kroll Global Fraud Report
  • 33. Regional Analysis: AmericasThe proper response, of course, is “wrong.” This » Unreasonable assumptions or an example of financial statement fraud – the » Management dominated by a single person Some common forms ofdeliberate inclusion of misleading amounts or or small group. financial statement frauddisclosures, or the omission of pertinent ones,in order to deceive financial statement users, When financial statement fraud occurs, Revenue recognition or timing schemesespecially investors or creditors. It is one of investors, bankers, and others cannot properly K Recording future sales in the current periodthe most costly of all frauds in terms of size assess the financial health of the company K Recording fictitious or phantom salesand damage created, but also one that tends and make informed decisions. As those relying K Recording gross rather than net revenueto get the least attention. on the last financial statements of Enron and K Recording revenues of other companies WorldCom before they went bankrupt canA company’s financial statements may be the when acting as a middleman or sales of attest, the result can be substantial losses. products on consignmentonly window into the company’s financial Companies where executives engage inaffairs for the average investor and sometimes fraudulent activity also run a high risk of Understating expensesfor banks and other institutional investors. their own demise – something management K Deferring the recording of expenses toAt the same time, the high stakes business should remember when tempted to make “just another period or not recording themenvironment in which companies operate a few journal entries that won’t hurt anyone.” altogethercreates a tremendous pressure on management K Reporting cost of sales as a non-operatingto portray the company in the best possible expense to improve gross marginslight and, as a consequence, may cause the Glen E. Harloff (cga cfi) is a managing K Capitalizing operating expensesmanagement of some companies to create director in the Caribbean and Latinfraudulent financial statements. America, specializing in forensic accounting and complex financial Improper asset valuationsThe forms this fraud can take are many and investigations, litigation consulting, and K Manipulating the value of reserves financial due diligence. He has beenvarious [see sidebar]. Typically, it involves involved in numerous forensic K Failing to write-down the value of an assetmultiple journal entries which use different investigations relating to publicly traded and privately held when required or changing its useful lifetypes of falsehood, making the crime more companies, and domestic and offshore financial institutions. K Manipulating estimates of fair market value Prior to joining Kroll, he was a member of the Royaldifficult to detect. A common misconception is Canadian Mounted Police where he conducted complexthat financial statements prepared by national and international white-collar crime investigations. Inadequate disclosureauditors are an insurance policy against suchmisconduct. Detecting fraud, though, is not aprimary objective of financial statement Economist Intelligence Unit Report Card manufacturingaudits. Standard sampling techniques do not Despite some positive news, the overall outlook for the manufacturing industry is a cause for concern. On the– and cannot – examine every transaction. plus side, the relative cost of fraud (1.8% of revenue) is lower than the survey average (21%). The prevalence of fraud has also dropped to 74%, mirroring the decline in this year’s survey average. One worry is that forThe perpetrator of financial statement fraud eight of the 11 frauds tracked by the survey, the proportion of companies hit has risen, most notably for theft ofis not necessarily the company itself but physical assets (from 25% to 34%), procurement fraud (from 23% to 30%), and management conflict of interestmore commonly a group of people within it, (from 13% to 24%), for each of which the sector now has the highest prevalence of any industry. Manufacturingincluding senior executives at the very top of companies, however, are not responding aggressively. A lower proportion than average will be investing in all but two of the anti-fraud strategies covered in the survey. In particular, staff training will see the leastleadership who have the ability to override widespread investment of any industry, even though high staff turnover is now the leading driver of increasedinternal controls. The motivation may be the fraud exposure in the sector (cited by 31%).ostensible good of the company and itsstakeholders which can allow the fraudsters Loss: Average percentage of revenue lost to fraud: 1.8%to rationalize their actions. For example, a Prevalence: Companies affected by fraud: 74%fraudster could convince himself that a few Areas of Frequent Loss: Percentage of firms reporting loss to this type of fraud Theft of physical assets or stock (34%) • Vendor, supplier or procurement fraud (30%)‘white lies’ may seem essential in order to Management conflict of interest (24%) • Corruption and bribery (21%)save the company and the jobs of its Information theft, loss or attack (19%) • Financial mismanagement (17%)employees. Alternatively, those involved may Increase in Exposure: Companies where exposure to fraud has increased: 84%simply be seeking their own private benefit Biggest Drivers of Increased Exposure: Most widespread factor leading to greater fraud exposure andby inflating the stock price before sale, percentage of firms affected: High staff turnover (31%)securing performance bonuses, or even 0 10 20 30 40 50 60 70 80 90 % 100 concealing other illegal acts. Corruption and briberySo what are some of the red flags of financial Theft of physical assets or stockstatement fraud? Money laundering Financial mismanagement» Unusual or large transactions recorded at Regulatory or compliance breach the end of an accounting period or Internal financial fraud or theft occurring with related parties. Information theft, loss or attack» Unusually rapid growth or unusual IP theft, piracy or counterfeiting Vendor, supplier or procurement fraud profitability compared to other periods or Management conflict of interest peer companies. Market collusion» Restrictions placed on auditors or bankers Moderately or Highly vulnerable Slightly vulnerable in reviewing company accounting records. Annual Edition 2011/12  |  33
  • 34. Regional Analysis: Asia-Pacific Southeast Asia OvervieWLast year’s survey showed that the developing countries of While the overall incidence of fraud has declined broadly in line with the survey as a whole, theSoutheast Asia had a significant fraud problem. This year number of companies affected by nine of the 11the results indicate that in many ways it has grown worse. frauds covered has increased, with corruption and bribery, internal financial fraud, and vendor, supplier, 2011-2010 2010-2009 or procurement fraud seeing the biggest jumps Prevalence: over last year. Southeast Asia also saw the highest 76% 90% Companies affected by fraud incidence of any region or country for: vendor, supplier, or procurement fraud (33%); management Theft of physical assets or stock (33%) Theft of physical assets or stock (32%) conflict of interest (31%); regulatory or compliance Vendor, supplier breach (19%); and market collusion (14%). or procurement fraud (33%) Management conflict of interest (26%) Management conflict of interest (31%) Information theft, loss, or attack (25%) Corruption is a leading concern for companies in Areas of Frequent Loss: Southeast Asia this year, with 70% indicating that Corruption and bribery (28%) Vendor, supplier Percentage of firms reporting loss to this their organization is highly or moderately or procurement fraud (17%) type of fraud Information theft, loss, or attack (28%) IP theft (16%) vulnerable to this threat. This comes as no Internal financial fraud or theft (24%) surprise given that only 14% say that their Corruption & bribery (13.6%) Financial mismanagement (21%) organization is well prepared to comply with Internal financial fraud or theft (9.9%) anti-corruption legislation. Regulatory or compliance breach (19%) Despite this recognition, companies are Areas of Vulnerability: Corruption and bribery (70%) Theft of physical assets or stock (46%) economizing in ways that encourage fraud. Over Percentage of firms considering Theft of physical assets or stock (60%) Internal financial fraud or theft (43%) half (52%) indicated that weakened internal themselves moderately or highly vulnerable Management conflict of interest (57%) Corruption and bribery (40%) controls, typically due to cost cutting, have increased their exposure to fraud in the last year – Increase in Exposure: by far the highest response to this question Companies where exposure to fraud has 83% 74% increased across any region or country. Southeast Asia also had the highest number of respondents reporting Biggest Drivers of Increased that cost restraint over pay (38%) and reduced Exposure: Most widespread factor Weaker internal controls (52%) Weaker internal controls (35%) revenues (33%) had increased their organization’s leading to greater fraud exposure and percentage of firms affected exposure to fraud. Loss: If businesses in the region want to stop the spread Average percentage of revenue lost 2.5% Not available to fraud of fraud, they need to think carefully about where they are cutting corners.34  |  Kroll Global Fraud Report
  • 35. Regional Analysis: Asia-Pacific Procurement and Supply Chain Fraud in Asia By Tadashi Kageyama and Charlie Villasenor Kroll has investigated a large number of cases where the local senior manager has taken bribes from suppliers. TheseVendor, supplier and procurement fraud is an increasing individuals are aware that it is against theproblem in Asia. In the recent Global Fraud Survey, a third of rules – they have read the compliance manuals and signed the various documentsthe respondents in both China and Southeast Asia said that – but they say, “Hey this goes on in thethey had suffered from this type of fraud in the past year. world, so why can’t I do it?” In one case, an American company brought in a new generalThis is roughly a 50 percent increase over last year’s survey. manager for its China operation. Telling the head office that it was necessary in order toThis increase is partly due to greater challenged to drive efficiencies and eliminate obtain the best prices, the new managerawareness of existing fraud, as well as to gaps in compliance. Increased spending can called in the company’s suppliers one by onechanges in the global environment which potentially lead to a higher risk of bribery and threatened to change vendors if they didhave led to higher domestic consumption in and fraud. As a result, the need for effective, not meet his requirements. In fact, he wasAsia. In the past, goods were often made in efficient, and ethical procurement and supply really keeping on board those vendors whoChina and quickly shipped out to places like management will be of greater importance. were willing to give him a kickback andJapan or the United States. The supply chain firing the ones that refused to do now much more sophisticated. A good Kickbacks Corrupt practices are often revealed throughexample is one Kroll client, a materials Supply chain fraud can take many forms, whistle-blowing by an honest supplier, butcompany which used to manufacture low-end but in Kroll’s experience, the most common managers can also look out for some tell-talechemical solutions in China and export them manifestation in Asia involves kickbacks warning signs. One sign is a lack of thoroughto other countries. It is now making more and bribery, with conflicts of interest and vendor background checks as part of the duecomplex items in China for local consumption collusion coming second, and tender rigging diligence process. Some companies fall intoand hence procuring more high-end items. being the least common. It is perhaps the trap of only conducting a quick internetThe Procurement and Sourcing Institute of surprising, given the growing awareness search on their vendors, without ever visitingAsia (PASIA) believes that this shift in strategy of the far-reaching and hard-hitting United their factories; often when investigators showis also focusing more attention on ethical States Foreign Corrupt Practices Act, that up the vendor is not even there. Another redsupply management. As Asian economies Asian operations of well-known multinational flag is to see one or two vendors getting allgrow, traditional tactical procurement and corporations are by no means immune to the contracts, or if the same purchaser issupply management processes will be this kind of fraud. managing a vendor for one or two years. Annual Edition 2011/12  |  35
  • 36. Regional Analysis: Asia-PacificConflicts of interest What the future holds what is ethical, and they should use global standards. Ethical practices make anThe second most common type of supply chain PASIA expects that, as business competition organization sustainable. Ethical business isfraud in Asia involves conflicts of interest and accelerates, supply chains are going to be competitive. Ethical procurement and supplycollusion. In one Kroll case, a Japanese under tremendous pressure to perform. This management is good for business.machinery company had a large operation in will also hold true for sales and businessnorthern China overseen by a trusted Chinese development professionals who are chargedgeneral manager. It was only when a newly- with delivering top line revenues. For both to Tadashi Kageyama is a senior managing director and head of Kroll’sappointed CFO carried out a management keep themselves sustainable in the global Asia operations including Japan. Tadashireview that problems were revealed, including marketplace, adherence to the highest ethical specializes in business intelligence,a significant payment to one supplier which standards when buying and selling is critical. investigations, and risk consultingwas owned by the general manager’s wife. services for corporate, financial clients An obvious challenge facing all countries is and government agencies. He helpsWhen confronted, the manager saw nothing the absence of a global standard on ethics in clients respond to and mitigate the risk of fraud, disputewrong with his actions: in his view, he had procurement. This is why PASIA is offering and litigation, regulatory and compliance violations, intellectual property theft, and the theft of assets andbeen making money for the company and the Global Procurement and Supply information.there was no real financial damage done. All Management Ethics Certification Program,the items had been delivered at fair market which will be rolled out in the fourth quarterprices. The manager was, however, receiving of 2011. It will focus on identifying gaps in Charlie Villasenor is the Chairman ofa salary and dividends from his wife’s company, how organizations carry out their business, the Procurement and Sourcing Instituteand was clearly in breach of his employment providing enterprise-wide education, and of Asia (PASIA) and President and CEOagreement and code of conduct. In such certifying individuals and companies in of TransProcure Corp. Charlie has over 20 years of experience in procurement,cases, the damage is to reputation and relation to sustainable ethical practices. manufacturing and supply chainmorale. If left untended, the problem can lead management and is on the Board for In PASIA’s view, when you have twoto a lot more costly problems down the line. the International Federation of Purchasing & Supply professionals from different countries doing Management ( the procurement and supply management business, they should establish baselines ofsector, fraud typically involves high-valueitems and is often committed by senior-level Economist Intelligence Unit Report Card Healthcare, Pharmaceuticals & Biotechnologyexecutives who are authorized to sign off onhigh-value invoices. In one case which PASIA This was a challenging year for the healthcare, pharmaceuticals, and biotechnology sector. The good news was that, as for every other industry, the overall prevalence of fraud dropped (from 88% to 73%). The sector also sawstudied, involving a foreign multinational a decline in the theft of physical assets (from 34% to 26%). The bad news, however, was that the average losscompany, a problem was only uncovered for the industry, at 2.6% of revenue, was the second highest figure for any sector, trailing only financial services,when a third-party procurement consultant and a higher proportion of companies saw an increase in exposure (89%) than in any other industry. The problemwas brought in to find opportunities for was widespread. Eight of the 11 frauds covered in the survey saw an increase in prevalence in the last year, mostsavings and efficiencies. He found not only notably information theft, which bucked the trend in other sectors and grew from 19% to 26%. Other substantialopportunities but also anomalous increases include procurement fraud (up from 11% to 23%), internal financial fraud (up from 13% to 24%), andtransactions, notably a contract which had financial mismanagement (up from 11% to 20%), which was more common in healthcare than anywhere else.been in place for several years under terms Moreover, eight of the 11 frauds tracked by the survey hit more than 15% of sector companies—the sector tiedwhere, although real market prices were with financial services for the highest number of frauds this widespread. In the past, healthcare companies haveexpected to go down, the contract prices needed to focus in particular on the common threats to knowledge industries—information theft and IP theft—butwere pegged at an old, high rate without any now the risks are much more diverse.clause to allow price redetermination. Loss: Average percentage of revenue lost to fraud: 2.6%The good news is that, due to its nature, Prevalence: Companies affected by fraud: 73%many employees are aware of supply chain Areas of Frequent Loss: Percentage of firms reporting loss to this type of fraud: Theft of physical assets or stock (26%)fraud. Problems can be picked up through Information theft, loss or attack (26%) • Internal financial fraud or theft (24%)careful vendor screening which should Vendor, supplier or procurement fraud (23%) • Management conflict of interest (23%)consist of more than a standard web search: Financial mismanagement (20%) • Corruption and bribery (16%) • Regulatory or compliance breach (15%)Kroll recommends the cross-referencing of Increase in Exposure: Companies where exposure to fraud has increased: 89%vendor information with the phone numbers Biggest Drivers of Increased Exposure: Most widespread factor leading to greater fraud exposure andand addresses of employees and their families. percentage of firms affected: IT complexity (30%)As well as screening, companies need to 0 10 20 30 40 50 60 70 80 90 % 100 conduct regular fraud checks at various Corruption and briberypoints in the procurement cycle. This should Theft of physical assets or stock Money launderinginclude looking at financial data to see if Financial mismanagementthere are any anomalies, such as contracts Regulatory or compliance breachwith specifications which highly favor one Internal financial fraud or theftparticular supplier. A third party procurement Information theft, loss or attackand supply management specialist can help IP theft, piracy or counterfeitingidentify and correct weaknesses in four areas: Vendor, supplier or procurement fraudpeople, process, procurement, and governance. Management conflict of interestSuch a project and its outcome must be Market collusionpublicly endorsed by the board and the audit Moderately or Highly vulnerable Slightly vulnerablecommittee in order to prove successful.36  |  Kroll Global Fraud Report
  • 37. Regional Analysis: Asia-Pacific China OvervieW China’s fraud picture has improved slightly over last year, but the country still faces a tremendous challenge. Even with overall incidence declining from 98% to 84%, China still has the second-highest proportion of companies affected by fraud of any country or region, just falling below Africa’s 85%. Although a number of fraud types did see marked declines, especially money laundering which dropped from last year’s extraordinary figure of 20% to 1%, this may merely reflect that fraudsters are now employing 2011-2010 2010-2009 different techniques.Prevalence: 84% 98%Companies affected by fraud Despite the positive news, this year’s top two Management conflict of interest (30%) fraud types in China – vendor, supplier, or IP theft, piracy, or counterfeiting (26%) procurement fraud and information theft, loss, or Vendor, supplier or procurement fraud (33%) Theft of physical assets or stock (22%) attack – had the highest prevalence out of any country or region surveyed. The incidence of the Information theft, loss, or attack (28%) Regulatory or compliance fraud (22%) former rose from 20% last year to 33% this year;Areas of Frequent Loss: Management conflict of interest (23%) Financial mismanagement (22%) the latter from 16% to 28%.Percentage of firms reporting loss to this Market collusion (22%) Financial mismanagement (22%)type of fraud Eighty-four percent of respondents also report Internal financial fraud or theft (20%) Corruption and bribery (20%) higher exposure to fraud this year – again one of Theft of physical assets or stock (20%) Vendor, supplier the highest figures in the survey. The biggest or procurement fraud (20%) driver is high staff turnover, one of the traditional Corruption and bribery (19%) Money laundering (20%) problems of operating in China. While companies are responding with above-average investment in Information theft, loss, or attack (16%) the coming year in staff-related fraud prevention, Corruption and bribery (30%) such as training and whistleblower hotlines (38%), Corruption and bribery (64%)Areas of Vulnerability: these measures are not sufficient given thatPercentage of firms considering Information theft, loss, or attack (56%) Information theft, loss, or attack (27%) China had the second-highest level of fraud ofthemselves moderately or highly Theft of physical assets or stock (26%) any country or region perpetrated by seniorvulnerable Vendor, supplier or procurement fraud (55%) Financial mismanagement (26%) management. Frauds committed by high level executives typically cost a company significantlyIncrease in Exposure: more than those committed by junior employees,Companies where exposure to fraud has 84% 72% and require stronger preventative solutions.increased Despite the overall drop in incidence, the sense ofBiggest Drivers of Increased vulnerability to fraud in China is rising significantly.Exposure: Most widespread factor High staff turnover (34%) High staff turnover (43%) In most cases the proportion of companies whereleading to greater fraud exposure and Weaker internal controls (34%)percentage of firms affected respondents reported moderate or high vulnerability has more than doubled. The top perceived risksLoss: include corruption and bribery (64% over lastAverage percentage of revenue lost 2.3% Not availableto fraud year’s 30%), information theft (56%), and vendor, supplier or procurement fraud (55%). Annual Edition 2011/12  |  37
  • 38. Regional Analysis: Asia-PacificThird Party Vendor ScreeningCompliance as a Routeto a Better Business By David Wildman Collusion, fraud, and corruption often flourish where victims are at an information disadvantage. Due diligence may involve checking voluminous records in foreign languages and jurisdictions, so companies which rely on partners, intermediaries and agents dispersed along global supply chains face numerous vulnerabilities. Effective third party vendor screening can identify past involvement in fraud and corruption by external parties and the benefits may go further, in identifying improvements to a company’s value chain. These can include culling dormant suppliers, reconciling related or affiliated companies and identifying partners whose business capacities or competencies may not actually be in line with your company’s needs.38  |  Kroll Global Fraud Report
  • 39. Regional Analysis: Asia-PacificWhile a wide ranging forensic analysis of also however, suggest the possibility of bid did hold a trading permit for medical equipment,every business partner is obviously rigging, price fixing, inflated supplier costs or it remained an obvious question whether it hadimpractical, a failure to make reasonable and other opaque, non-competitive behavior. the requisite expertise, customer networks andprudent inquiries about third party vendors capacity to service the medical equipment Comparison of other data such as financialmay leave a company vulnerable to the client’s business needs effectively. and accounting records should also be areasallegations of negligence and potentially for concern. Kroll has identified instances Prudent and reasonable vendor screeningliable under American, British and other where the balance sheets and income can reveal not only past instances of fraudcountries’ anti-corruption legislation. As statements from some companies have beensuch, a company needs a systemic program but also that partners may not have first inconsistent with the respective figures filedthat can segment the various risks that may point access to markets, superior products, with the corporate registration records;be inherent with various vendors, suppliers technology, or networks. As such, a robust whilst tax and financial reporting conventionsand/or partners and importantly, provide an program can both address anti-corruption, in certain jurisdictions may result in variances,auditable defense should a regulatory action fraud and collusion risks while also identifying some of the discrepancies noted have beenregarding one of the vendors ever arise. key areas where business partnerships and significant and would indicate that at least one set of records may require further clarification. synergies may be improved.The screening needs to start with a baselevel review and diligence to identify red In addition to revealing red flags, vendor David Wildman M.A. is a managingflags. Furthermore it may include consultation screening may provide sound business director based in Kroll’s Singaporealong a wide spectrum of multi-lingual grounds to revisit supplier relationships or office. Prior to Kroll, David was amedia, Internet-based data and official Superintendent with the Australian renegotiate service level, delivery times,records. Such information ideally should be Federal Police and has worked in payment schedule or warranties. In one case, Australia and Asia. In 2006 David wascomplemented with inquiries in and Kroll identified a situation where the client’s invited to participate on the Hong Kongknowledge of the relevant local areas, third party vendor – a supplier of medical Independent Commission Against Corruption’s Seniorbusiness environment, and industry circles. Investigator Command Course and travelled across equipment, was actually a railway industryFor example, a Kroll client recently requested Northeast Asia studying anti-corruption efforts with company, which was a subsidiary of another Chinese Procuratorate counterparts.checks on a Chinese company and its three railway operator. Although its parent companyprincipals. Research into one of the principal’suncovered two media references pertaining Economist Intelligence Unit Report Card Retail, Wholesale & distributionto bribery, committed in the same city, yetwith another company. Research in court In many ways, the fraud environment of the retail, wholesale, and distribution sector mirrors that of the surveydatabases yielded no relevant information, as a whole. The overall prevalence of fraud has dropped in line with the survey average to 74%, and there hasbut often in many jurisdictions such records been progress on the number of companies suffering from theft of physical assets (down from 41% to 28%)are incomplete or not publicly available. Local and information theft (down from 26% to 14%). This, however, has been partly counterbalanced by growth ininquiries subsequently confirmed that the all but one of the other frauds tracked in the survey. The most notable of these are internal financial fraud,principal in question had indeed been found which doubled in prevalence within the sector from 13% to 26%; market collusion, which rose from 2% to 15%;guilty in the earlier bribery case. and even corruption, which, despite being less widespread here than in any other industry, affected 9% of companies, up from 4%. Just as last year, the industry’s big Achilles heel is a lack of attention to staff issues.Comparison and reconciliation of information It has the highest percentage of firms of any industry reporting high staff turnover (33%) and cost restraintsprovided by vendors and business partners is over pay (31%) are increasing exposure to fraud. Add to that the highest number reporting weakened internalanother important way to identify possible controls (29%) and it becomes clear that the sector is running a high risk.trouble. In addition to requesting copies ofrecords such as company registrations or Loss: Average percentage of revenue lost to fraud: 1.9%relevant licenses, compliance questionnaires Prevalence: Companies affected by fraud: 74%should ask prospective partners and suppliers Areas of Frequent Loss: Percentage of firms reporting loss to this type of fraudto disclose other company and business Theft of physical assets or stock (28%) • Internal financial fraud or theft (26%)interests. Missing documents and unanswered Vendor, supplier or procurement fraud (22%) • Management conflict of interest (22%)questions are potential red flags. The checks Market collusion (15%)and research can be sequenced based on key Increase in Exposure: Companies where exposure to fraud has increased: 77%risk variables, and a more in-depth diligencecan be conducted when there is a higher Biggest Drivers of Increased Exposure: Most widespread factor leading to greater fraud exposure andlikelihood of exposure. In one case, Kroll percentage of firms affected: High staff turnover (33%)established through records analysis that a 0 10 20 30 40 50 60 70 80 90 % 100 person, described to our client as the legal Corruption and briberyrepresentative and 1% shareholder of the Theft of physical assets or stockvendor company, was in fact a 90% Money launderingshareholder and legal representative of Financial mismanagementanother, similar business in the same Regulatory or compliance breachindustry. Further research revealed that the Internal financial fraud or theftcompanies had jointly participated in a Information theft, loss or attack IP theft, piracy or counterfeitingbidding project a year earlier. Vendor, supplier or procurement fraudA failure to reveal interests in multiple Management conflict of interestcompanies that are vendors, distribution Market collusionagents, suppliers, or third party agents for Moderately or Highly vulnerable Slightly vulnerablethe same firm could be innocuous. It could Annual Edition 2011/12  |  39
  • 40. Regional Analysis: Asia-Pacific per staff ratio between 2008 and 2010 remained stable at around $40,000. Was this a potential red flag? One should question a constant ratio such as this, especially when economies of scale, improvements in work efficiency, and hence increased output per head might be anticipated as a business grows. A further review of the Longtop staff details reveal that about three quarters of its employees had been sourced from third- party human resources companies in return for monthly service fees. Longtop claimed that an un-related company, called XiamenWhen A Watchdog Longtop Human Resources Services Company Limited, had been involved in hiring the majority of these individuals.May Not Be Enough The similar names of the two companies and the unusual staff arrangement are highly suggestive of fraudulent activity and, in early 2011, research reports certainly speculatedAuditors are not Fraud Investigators that an undisclosed relationship existed between the two. Without access to the company’s books and records, one can only By Colum Bancroft speculate about the details of the fraud scheme employed by Longtop’s management.On May 22, 2011, Deloitte Touche Tohmatsu CPA Ltd announced its Two possibilities are that Xiamen Longtopresignation as the auditor of Longtop Financial Technologies Limited, a overstated the staff numbers in order to support its own inflated revenue figures, or itsoftware developer headquartered in China and listed on the New York may have understated the staff costs in orderStock Exchange. The trigger for Deloitte’s resignation was their discovery to boost the apparent net margin of Longtop.that certain statements and confirmations received from one of The industry recognizes that revenue is oftenLongtop’s banks were false. Longtop is one of several Chinese overseas considered susceptible to manipulation, solisted companies under investigation for fraud, and these various were the red flags described above missed or not given due attention by the auditors?scandals have resulted in falling stock prices, delistings, and lawsuits. It is true that extra attention should be paid to the nature and quality of the auditFor years, Longtop misled its bankers, clients, called the auditor and confessed that “there evidence obtained in this area but what areinvestors, and auditors. Although many were was fake revenue in the past so there was auditors expected to do?quick to blame the auditors for missing the fake cash recorded on the books [sic].” Hewarning signs, investors need to understand also admitted that “senior management” was International Standard of Audit (ISA) 240that auditors are not as experienced as fraud responsible for the fraud. states that the “primary responsibility for theinvestigators in being able to spot and Fraud is not intended to be easy to detect, prevention and detection of fraud rests withquestion potential red flags. A more detailed and schemes committed by management are both those charged with governance of theexamination of the Longtop scandal shows particularly difficult to uncover. Senior entity and management.” The auditor’s role insome of the limitations of traditional audit executives are in a position to devise fraud prevention when conducting an audit ispractice for fraud prevention. sophisticated arrangements to conceal their to obtain “reasonable assurance that the wrongdoing by forgery of supporting financial statements taken as a whole areDeloitte’s resignation letter released in the documents, deliberate failure to record free from material misstatement, whetherpublic domain states that, during a round of certain transactions, collusion to compromise caused by fraud or error.”bank confirmations on May 17, 2011, officials and override existing internal controls, orfrom Longtop appeared at the bank and To obtain reasonable assurance, auditors are intentional misrepresentations to auditors.prevented the auditors from leaving until required to maintain “professionalthey surrendered the bank confirmation Taking Longtop as an example, and how the skepticism” throughout the engagement.documentation and their working papers. fraud was perpetrated, a look at reported This is a fairly abstract, subjective term, andThree days later, the company’s chairman staff numbers shows that Longtop’s sales the degree to which professional skepticism40  |  Kroll Global Fraud Report
  • 41. Regional Analysis: Asia-Pacificshould be applied depends on various factors, being related to Longtop, but the auditors’ and borrowing costs increase whenincluding auditors’ experience in relation knowledge of a conflict of interest often stakeholders lose confidence in a the integrity of a company’s leadership depends on information made available to Auditors are likely to resign when theyand their knowledge and experience of the them by management and those charged believe that their previous trust in seniorindustry. with governance. They are not trained to management was misplaced and that the conduct detailed background investigations engagement may have a negative impact onSo audit work may include a combination of to ascertain whether management, or people their reputation. The results could becompliance (controls) and substantive connected with management, may be behind disastrous: Longtop was delisted by NYSE(transactional) testing. One would also expect particular companies; nor are they required two months after Deloitte’s resignation.auditors to carry out analytical procedures in to do so. IAS 550 “Related Parties” requiresorder to gather more evidence and provide In order to effectively prevent and detect auditors to obtain written representationsfurther audit assurance and comfort, fraud before it becomes front page news, in from management and, where appropriate,especially if “professional skepticism” led addition to the external audit, management those charged with governance, to confirmthem to have concern. Such procedures may and Audit Committees should arrange for an that all the related party relationships ofinclude studying the relationship between independent fraud risk assessment and the which they are aware have been disclosed toreported sales revenue and various related implementation of a comprehensive fraud the auditor.parameters – including, among others, prevention program.purchases and direct expenses, sales outlets, The recent accounting scandals in Chinaand number of staff – in order to reveal any should serve as a collective wake-up call for Colum Bancroft is a managing director auditors to strengthen oversight and based in Hong Kong and leads Kroll’sunusual or undisclosed relationships and Financial Investigations practice acrossseek explanations for the apparent anomalies. implement more rigorous procedures in Greater China. Colum has extensive certain areas. Disclosure of poor corporate experience assisting clients on local andHowever, auditors are not specifically required multijurisdictional issues in areas such governance and malfeasance are definitely a as asset tracing and recovery; family,to conduct an in-depth fraud risk assessment blow to a company’s reputation, affecting its partnership, shareholder, and other business disputes;as part of their audit process. The Audit insider dealing and share price manipulation; money ability to raise funds from investors or secureCommittee should consider appointing laundering; and fraud and misappropriation of assets. bank financing. Creditors may recall debtsindependent risk consultants to conduct suchan exercise, which would assist the external Economist Intelligence Unit Report Card Professional servicesauditors during the initial planning stage oftheir work when they decide upon the specific As in the past, professional services companies had relatively good fraud numbers compared to other industries. The number of companies hit by fraud dropped markedly, and was the second lowest of any sector.nature and scope of audit tests to be followed. Moreover, the industry had the fewest businesses hit by theft of physical assets (15%), procurement fraudIn the absence of an independent fraud risk (12%), or financial mismanagement (6%). Difficulties remain, however. Even with the smaller number hurt byassessment, auditors may incorrectly perceive fraud, the industry’s average loss of revenue (2.0%) is only slightly less than the survey norm (2.1%). Moreover, a higher number of companies this year are experiencing an increase in exposure. The two areas requiring mosta relatively low fraud risk, and claim attention are information theft and IP theft. For both—despite a noticeable drop in the prevalence of informationjustification for accepting the information theft—professional services companies performed about the same as the survey average. Moreover, they wereprovided by management as sufficient audit more likely to feel highly or moderately vulnerable in these areas than other businesses, and IT complexity wasevidence, on the basis that ISA 240 also the biggest—and a growing—cause of increased fraud exposure in the last 12 months.states that “unless the auditor has reason tobelieve the contrary, the auditor may accept Prevalence: Average percentage of revenue lost to fraud: 2.0%records and documents as genuine.” Prevalence: Companies affected by fraud: 67% Areas of Frequent Loss: Percentage of firms reporting loss to this type of fraud:This may present management with an Information theft, loss or attack (23%) • Theft of physical assets or stock (15%)opportunity to deceive auditors. For example, Increase in Exposure: Companies where exposure to fraud has increased: 81%if senior executives establish vendor Biggest Drivers of Increased Exposure: Most widespread factor leading to greater fraud exposure andcompanies to record purchases that can be percentage of firms affected: IT complexity (37%)matched against fictitious sales, auditors may 0 10 20 30 40 50 60 70 80 90 % 100 request from the company the addresses of Corruption and briberysuch vendors in order to send out Theft of physical assets or stockconfirmation letters. Trusting in the “good Money launderingfaith” of management, the auditors might not Financial mismanagementhave considered it necessary to review Regulatory or compliance breach Internal financial fraud or theftfurther or verify the mailing details, meaning Information theft, loss or attackthat senior executives or people connected IP theft, piracy or counterfeitingwith them could simply receive letters from Vendor, supplier or procurement fraudthe auditors and reply with false information. Management conflict of interest Market collusionBack to Longtop, Deloitte may have Moderately or Highly vulnerable Slightly vulnerableconsidered the possibility of Xiamen Longtop Annual Edition 2011/12  |  41
  • 42. Regional Analysis: Asia-Pacific India OvervieW India has a number of significant fraud problems. Its prevalence there (84%) is among the highest in the survey, behind Africa but in line with China. Respondents in India said that corruption and bribery is the most common fraud type they experienced in the past year. Moreover, 78% indicated that their organization is very or moderately vulnerable to the problem, higher than the overall Asian average of 63%. Despite these concerns, only 25% of respondents in India say their organization is well prepared to comply with anti-corruption legislation. Corruption is only part of the problem. India has a higher prevalence than the overall average for eight of the 11 frauds covered in the survey. In particular, India has one of the highest rates of information theft, loss, or attack (27%), 2010-2011* which is of particular relevance in a country that Prevalence: 84% relies so much on its IT sector for growth and Companies affected by fraud development. Corruption and bribery (31%) Fraud concerns are on the rise. The number of Information theft, loss, or attack (27%) companies in India with growing exposure to Internal financial fraud or theft (23%) fraud (85%) is the highest for any country or Areas of Frequent Loss: Percentage of firms reporting loss to this Theft of physical assets or stock (23%) region. The country also has one of the largest type of fraud proportions of respondents (41%) saying that Vendor, supplier or procurement fraud (22%) Financial mismanagement (22%) high staff turnover is driving this growth, and the highest percentage saying the same about Management conflict of interest (19%) increased collaboration between firms (27%). Areas of Vulnerability: Corruption and bribery (78%) Percentage of firms considering Companies in India do not appear to be Vendor, supplier or procurement fraud (59%) themselves moderately or highly investing in the right anti-fraud measures. vulnerable Information theft, loss, or attack (58%) Results indicate that less than 50% of Increase in Exposure: respondents in India invest in employee Companies where exposure to fraud has 85% background screening, partner or third party increased due diligence, and risk management systems Biggest Drivers of Increased – a surprising finding given that 59% of those Exposure: Most widespread factor that suffered from fraud and knew the culprit High staff turnover (41%) leading to greater fraud exposure and said it was an inside job. Measures such as third percentage of firms affected party due diligence, effective and well Loss: understood whistle blower systems, and Average percentage of revenue lost to 2.2% well-tested internal risk management systems fraud would help companies in India reduce losses to *Insufficient respondents in 2010 to provide comparative data. fraud and corruption.42  |  Kroll Global Fraud Report
  • 43. Regional Analysis: Asia-PacificCorruption and the IndianInfrastructure BoomBy Ramon GhoshAny visitor to India will see an array of rickshaws, carts, The government has initiated a number of projects as part of its drive to improve India’smotorcycles, cars, buses, and livestock squeezed on to infrastructure. These include plans to spend more than $1 trillion over the next 10 yearspotholed, badly maintained roads. While this may to build new roads, bridges, and ports, as well as modernize India’s aged railway lines.provide a good photo opportunity for passing tourists, Despite these promising plans, these initiatives have been met with manyit is a continuing source of frustration to residents and obstacles along the way. For example, thehas severe consequences for the Indian economy. Golden Quadrilateral – a $13 billion highway project to connect India’s four metro citiesEvery train derailment, bridge collapse, or gridlocked (Mumbai, Chennai, Kolkata, and Delhi) due to be completed this year – was at the center ofhighway means a loss for the country’s finances. corruption allegations. Annual Edition 2011/12  |  43
  • 44. Regional Analysis: Asia-PacificThis comes as little surprise. Bribery,together with poor infrastructure, have longbeen significant problems for the country.Corruption in India has also recently come tothe forefront as a high profile issue. ActivistAnna Hazare staged a series of hungerstrikes in an attempt to force the governmentto accept proposals for an independentanti-corruption ombudsman laid out in aversion of the Lokpal Bill advocated byactivists. While the government has engagedon the issue, it remains to be seen whetherthe anti-corruption movement’s demandswill ultimately be met. If they are, there willbe increased transparency for all governmententities, and this will affect how contractsare awarded and serviced in theinfrastructure sector.This year’s Global Fraud Survey shows howpervasive the problem of corruption is inIndia: 78% of respondents in India say thattheir organizations are highly or moderatelyvulnerable to corruption and bribery,compared with 47% of global respondentsand 63% of those in Asia. Kroll haswitnessed first-hand how this affects India’sinfrastructure industry. The frequent lack ofmanagerial accountability in the sector can the extraterritorial UKBA prohibition on making assurance of complete confidentiality forcreate an environment conducive to cash facilitation payments are (i) payments being those who use it.kickbacks between contractors and sub- made to village heads and local landlords whocontractors, who are frequently engaged in On top of such practical measures, it is vital may, in turn, use their influence to help acquireregional areas. Pressure can also occur to that foreign companies fully understand the land from farmers at below market price and culture of business in India. The use ofmake facilitation payments to local (ii) making payments to land owners when facilitation payments is widespread acrosslandowners – if payments are not made, then they demand a premium on the market value of many sectors, particularly those that involvecommunities can act to stop construction their property to ensure ownership. Kroll has negotiations or approvals from governmenttaking place and works can be disrupted and seen instances where farmers and local land agencies. Investors unaware of such practicesdelayed. In states such as Jharkhand, for owners have been paid up to 50% of the might incur serious legal and reputational harm.example, it is common to encounter physical value of the land in cash or “black money”security threats to people and property when The events surrounding the Lokpal Bill show as an incentive for the seller so that it doesacquiring land and requests for payment for the increasing appetite for change in India. not have to be disclosed as income. Theprotection against the disruption of A culture of corporate compliance is now exchange of black money, though, would beoperations by Maoist guerillas. in clear contravention of the UKBA, under likely to become more important when doing which ignorance is not a valid legal defense. business in the country. Companies must,The growing number of anti-corruption laws therefore, be aware of the need for forwardwith extraterritorial reach – such as the United While chasing the potentially lucrative thinking when reviewing their existingStates Foreign Corrupt Practices Act (FCPA) and returns available in the Indian infrastructure systems. In the infrastructure sector, thethe UK’s recently enacted Bribery Act (UKBA) sector, businesses must have adequate potential returns are vast but these must be– means that the regulatory risks involved with procedures in place to prevent corruption, realized in an ethical way and always withcorruption are not just restricted to overseas including facilitation payments. At the very an eye to compliance.investors: many Indian entities will also be least, companies should carry out a thoroughsubject to the multi-jurisdictional obligations audit of their internal procedures to make Ramon Ghosh is a senior director withof these pieces of legislation. In particular, the sure that they comply with the FCPA and the Kroll’s operations in India. Ramon is aUKBA expands the scope of regulatory risk UKBA, and that their employees are not qualified solicitor (England & Wales)into the area of facilitation payments. This has and spent a number of years working adopting dubious local practices. Putting in as a commercial litigation lawyer forparticular relevance for India’s infrastructure place an effective whistle-blowing system international law firms. Ramon hassector, where land acquisition has long been a can also help, but in order to get proper been involved in in-depth investigations,compliance grey area. Two examples that Kroll evidential analysis, witness proofing and mitigation buy-in from employees it needs endorsement strategy discussions on a number of cases.has seen of how companies could fall foul of from the top of the company and the44  |  Kroll Global Fraud Report
  • 45. Regional Analysis: EMEA Europe OvervieW European companies continue to do well relative to the rest of the world when it comes to fraud. They have a lower than average incidence of every fraud covered in the survey except market collusion (9%), which is only slightly above the global norm. A comparison with last year however yields a 2011-2010 2010-2009 picture of a growing fraud problem. Unlike muchPrevalence: of the rest of the world, compared to last year the 71% 83%Companies affected by fraud region saw no decline in the prevalence of the theft of physical assets (23%), and only a small Theft of physical assets or stock (23%) Theft of physical assets or stock (23%) drop in information theft (from 19% to 18%). Management conflict of interest (19%) Moreover, out of the 11 fraud types covered inAreas of Frequent Loss: Information theft, loss, or attack (19%) Information theft, loss, or attack (18%) the survey, the incidence of six has significantlyPercentage of firms reporting loss to this Vendor, supplier or procurement fraudtype of fraud increased over the last year and moderate Internal financial fraud (16%) (14%) increases were seen with three. Management Vendor, supplier Management conflict of interest (13%) conflict of interest (19% up from 13%), corruption or procurement fraud (14%) (14% up from 8%), and financial mismanagement (19% up from 12%) in particular saw strikingAreas of Vulnerability: Information theft, loss, or attack (47%) Information theft, loss, or attack (37%) growth. Furthermore, in last year’s survey 47%Percentage of firms considering Theft of physical assets or stock (41%) Theft of physical assets or stock (32%) of European companies said that they hadthemselves moderately or highlyvulnerable Management conflict of interest (39%) Regulatory or compliance breach (28%) suffered no financial losses from fraud; this year that figure dropped to 23%.Increase in Exposure:Companies where exposure to fraud has 74% 73% Meanwhile, anti-fraud measures are not beingincreased implemented proportionate to the growing prevalence. European companies are currently lessBiggest Drivers of Increased likely than average to deploy every such strategyExposure: Most widespread factor IT complexity (33%) IT complexity (29%) covered in the survey. In particular, employeeleading to greater fraud exposure andpercentage of firms affected background checks (34%) are much less widespread than the global average (47%), despite respondentsLoss: indicating that, when fraud occurred and the culpritAverage percentage of revenue lost 2.0% Not availableto fraud was known, it was frequently committed by a junior employee (25%) or senior manager (23%). Annual Edition 2011/12  |  45
  • 46. Regional Analysis: EMEA The Biggest Threat to Financial Institutions: It Comes from Within By Richard Abbey However, alongside these external threats is reasons, depending on circumstances: when an even bigger risk: greed, in the shape of times were good, the business generated the eternal yearning inside these companies significant profits; as the credit squeeze tookThe statistics from the 2011 for increased profits. effect and the economy turned, past excessesGlobal Fraud Survey show that, needed to be covered up. Either way, the History has shown that, in a large number of behavior demonstrated that controls workonce again, financial institutions cases, employees themselves have caused only if they are actively implemented, and the greatest damage to individual financialare a prime target. The greatest even the most stringent ones will be institutions. Substantial losses have been ineffective when collusion is used to workthreats which they face are incurred – and in several instances entire around them. companies have collapsed – as a result of theoften thought to come from actions of a group of individuals, or even a The auditors, too, were often not withoutoutside the institution and single person, within the business. blame. In several of these investigations, serious questions arose about their role ininvolve crimes such as data Since the ongoing financial turmoil first identifying the issues that ultimately began over four years ago, Kroll has been contributed to the collapse of the financialtheft, credit card fraud, asked to investigate the circumstances institution in question. In many instancesidentity theft, bank fraud, and surrounding the collapse of major financial the auditors failed to look in the right places: institutions in at least four different the audit procedures undertaken were tooattempts at fraudulent transfers: jurisdictions in Europe and the Middle East. standardized or they did not consider theA significant amount is lost to A recurring theme of each investigation has fundamental substance of what was been that individuals in powerful positions at happening over its form. On other occasions,these frauds so it is no surprise the companies in question were, or at least the relationship between auditor and clientthat financial institutions should have been, aware of activities that was unhealthily close. This was often true inspend substantial amounts were exposing the institution to significant emerging markets where only a small risk. Policies and procedures designed to number of qualified professionals wereof money on dedicated teams safeguard the organization were either not available to deal with a large number of highand sophisticated technology followed or “creative” transaction structures growth businesses. were used to bypass monitor and prevent such What can a financial institution do to protect Senior executives typically allowed such itself? First, it should ensure that itavoidable losses. activity to go unchecked for one of two implements a rigorous risk management policy46  |  Kroll Global Fraud Report
  • 47. Regional Analysis: EMEAand internal reporting structures which are Economist Intelligence Unit Report Card Financial Servicesactively monitored and tested for adherence. Despite some notable progress against information theft and theft of physical assets, this was another difficultSecond, it should make certain that the board fraud year for the financial services industry. It had the highest rate of loss of any sector (2.7% of revenue) andand any internal risk committees adequately the highest prevalence of information theft (29%), internal financial fraud (29%), regulatory and complianceunderstand how and where the institution is breaches (19%), and money laundering (10%). It is therefore understandable that respondents from this sector are more likely than average to feel very or moderately vulnerable to every fraud covered in the survey, exceptmaking its profits, the risks associated with IP theft, where they feel only slightly less vulnerable than average. On the positive side, financial servicesthose transactions, and how they are being companies are more active than most in addressing fraud. They are more likely on average to invest in themanaged. Finally, the board should see to it coming year in every anti-fraud strategy covered in the survey, and are the most frequent investors in six outthat independent risk assessments are of 10: risk systems (35%), IP protection (34%), management controls (34%), financial security measures (33%), employee background screening (30%), and asset security measures (29%).routinely carried out on the company’s mostprofitable divisions to ensure that the controls Loss: Average percentage of revenue lost to fraud: 2.7%in place are adequate and that the Prevalence: Companies affected by fraud: 80%transactions it is undertaking make sense in Areas of Frequent Loss: Percentage of firms reporting loss to this type of fraud: Information theft, loss or attack (29%) • Internal financial fraud or theft (29%) • Financial mismanagement (18%)terms of the profits derived and true potential Management conflict of interest (24%) • Theft of physical assets or stock (23%) • Corruption and bribery (22%)exposure. Such work is not the stuff of normal Vendor, supplier or procurement fraud (21%) Regulatory or compliance breach (19%)audits, and should be conducted by expert Increase in Exposure: Companies where exposure to fraud has increased: 82%financial investigation firms as opposed to a Biggest Drivers of Increased Exposure: Most widespread factor leading to greater fraud exposure andcompany’s usual auditors. percentage of firms affected: IT complexity (43%) 0 10 20 30 40 50 60 70 80 90 % 100 Corruption and bribery Richard Abbey is head of Kroll’s London Theft of physical assets or stock financial investigations practice. He has Money laundering 16 years’ experience in forensic and Financial mismanagement financial investigations. He has Regulatory or compliance breach managed complex international frauds, Internal financial fraud or theft multi-jurisdiction asset-tracing and large accounting investigations, Information theft, loss or attack including a number of alleged breaches of the Foreign IP theft, piracy or counterfeiting Corrupt Practices Act. Richard’s investigations have Vendor, supplier or procurement fraud covered many industries, and he has appeared as an Management conflict of interest expert witness in both civil and criminal matters. Market collusion He has also commented on white collar crime for Moderately or Highly vulnerable Slightly vulnerable numerous media outlets. Annual Edition 2011/12  |  47
  • 48. Regional Analysis: EMEACorporate Investigationsin Strict Privacy RegimesThe Case of Italy By Marianna Vintiadis Over the past couple of decades, European countries have adopted legislation which has increasingly strict privacy-related rules and regulations. Italy’s regime in this regard is complex and, in many respects, draconian.48  |  Kroll Global Fraud Report
  • 49. Regional Analysis: EMEAWhat often worries corporate executives the employers to be aware that they have tools at even corporate email accounts. Moreover,most about Italy’s privacy laws is the their disposal that do not violate Italy’s tough many individuals labor under the falseattribution of criminal liability to company privacy laws when trying to detect and assumption described above that Italian lawdirectors when the rules are breached. In one collect evidence of internal fraud. prevents the employer from accessing theirwidely publicized case, three Google directors devices no matter what the circumstances. The first thing to understand is thatwere convicted in 2010 of breach of privacy. Many believe that the rules prohibiting investigations do not have to invade personalThe New York Times reported on February 24 Italian employers from monitoring employee privacy. Many involve desktop analysis of2010, “In Milan, Judge Oscar Magi sentenced activity mean that no type of enquiry or publicly available information. Take thethe Google executives in absentia to scenario of a manager having a conflict of investigation is allowed at all.six-month suspended sentences for violation interest because he, or a member of his As a result, in many cases, cheatingof privacy. Prosecutors said Google did not act family, owns a company supplier. In such employees pay very little attention tofast enough to remove from the site a widely cases, an analysis of corporate records andviewed video posted in 2006 showing a covering their tracks. Often, therefore, the information on immediate relatives availablegroup of teenage boys harassing an autistic evidence recovered through computer through the general registry may beboy.” Those convicted included Google’s forensics is very strong and sufficient either sufficient to obtain the required proof ofPrivacy Director and the former Chairman of to make a case or to extend investigators’Google in Italy who, at the time of the conflict of interest. understanding of the so-called circle ofconviction, was Senior Vice-President and Another important tool is the use of computer knowledge. This latter outcome can be asChief Legal Officer for the company. forensics to recover and analyze data present important as a smoking gun, because primaIf privacy law is a worry at the best of times, on the computers of employees. Accurate facie evidence of involvement in the criminala case of fraud or other white collar crime information on the subject for those outside activity under investigation can be sufficientrequiring an internal investigation is likely the legal profession is hard to come by and to extend the scope of the investigation produce shudders in boardrooms. Such a relatively few Italian law firms have this expertise in-house. Many executives Another helpful tool in investigations isreaction can result in a propensity to turn a believe that the accessing of an employee’s surveillance. Once again, this very widelyblind eye or in the temptation to settle the corporate email account is always a violation used instrument in Italian investigations isproblem through a termination of employment, of “private correspondence.” However, the often misunderstood. There is a general beliefwithout a full investigation of the facts which Italian Supreme Court has, in fact, made a that it represents an automatic breach ofmay in itself create further liability for thecompany. When combined with the fear of clear distinction between open and closed privacy for those being watched. This is notupsetting the country’s powerful labor correspondence, placing corporate email in necessarily correct: surveillance is veryunions or breaching provisions of the law the former category which indicates that, highly regulated and subject to significantprotecting employees, the Statuto dei in certain circumstances an employer may limitations, but in certain circumstances itsLavoratori, the result can be paralysis. be entitled to access an employee’s corporate use is legal and evidence collected through email account providing, of course, such its deployment can in some cases beActing without a proper investigation of the access is in accordance with applicable submitted in court.facts, however, can lead to mistakes and can laws and regulations and with themean that a problem is only partially solved. These are not the only investigative tools and company’s own policies.Complex corporate frauds can require the techniques available to employers. Forparticipation of many employees in different Many factors, including a company’s internal example, many internal investigations alsodepartments. The failure to carry out a policies and regulations play a part in rely heavily on forensic accounting andthorough investigation of all facts and shaping what can and cannot be done in interviews. Typically, an enquiry will requirepersons involved, can lead to the dismissal of each case. As the rules are so complex and the combination of a number of differenta single person which may leave the illicit turn on the facts of each particular case, tools. It is therefore important to have theactivity unimpeded and allow its revival after legal advice should be sought in each case right legal advice, proper investigativethe dust has settled. Moreover, terminating before deciding on the recovery process, backup, and the unions on board beforeemployment without carrying out a thorough the investigation plan, and the relevant deciding how to tackle an internal problem.investigation can often mean foregoing exclusions in order to ensure that the The message, though, is clear: strict privacydamage recovery and may even prove a very actions of investigators and technicians laws need not obstruct the carrying out ofcostly option in the absence of evidence. An will not undermine the validity of the internal investigations.even bleaker prospect is that an Italian court evidence gathered.can order a company to reinstate unlawfully When the rules are followed, however,dismissed employees. Marianna Vintiadis is Kroll’s computer forensics can constitute an country manager for Italy and Greece.Strict privacy regimes should not, however, extremely powerful instrument. In Italy, A trained economist with experiencebe an impediment to internal investigations where Internet usage still lags behind the in policy making and analysis, she works on business intelligence andwhich are in some cases compulsory, for European average and many families do not complex investigations in theseexample, in certain whistle-blowing cases own a computer, Kroll has found that countries. Her areas of expertise– the employer is required to carry out an unscrupulous employees will often conduct include market entry, shipping, piercing the corporate veil, and internet investigations.investigation. It is therefore important for their business using company computers and Annual Edition 2011/12  |  49
  • 50. Regional Analysis: EMEA Middle East OvervieWWhile the number of companies that suffered from fraud last year fell to This year, the region has seen the number of respondents facing increased exposure to fraud68% from 86% the year before, it is still a concern in the Middle East. grow to 77% from 70% last year. More worrying, there has been substantial growth in several 2011-2010 2010-2009 specific types of fraud: vendor, supplier, or procurement fraud hit 25%, up from 9% last year; Prevalence: 68% 86% corruption and bribery affected 21% of companies, Companies affected by fraud also up from 9%; and management conflict of Information theft, loss, or attack (26%) interest was present in 23%, nearly double last Information theft, loss, or attack (30%) year’s 12%. Vendor, supplier Areas of Frequent Loss: or procurement fraud (25%) Theft of physical assets or stock (30%) As a result, concern over these frauds is growing Percentage of firms reporting loss to this Management conflict of interest (23%) Internal financial fraud or theft (21%) markedly: 42% of respondents rank themselves type of fraud Corruption and bribery (21%) as at least moderately vulnerable to procurement Financial mismanagement (19%) fraud (up from 26% last year) and 48% to Internal financial fraud or theft (19%) management conflict of interest (up from 40%). Areas of Vulnerability: Corruption and bribery (62%) Information theft, loss, or attack (49%) Concern about corruption and bribery is even Percentage of firms considering themselves moderately or highly Information theft, loss, or attack (54%) Regulatory or compliance breach (47%) greater: 62% say their organizations are highly or vulnerable Management conflict of interest (48%) Financial mismanagement (47%) moderately vulnerable (up from 30% last year) and 37% admit that they are not prepared to Increase in Exposure: comply with anti-corruption regulations – the Companies where exposure to fraud has 77% 70% highest figure for any region. increased Despite such worries, companies are undermining Biggest Drivers of Increased their own anti-fraud efforts: 32% of respondents in Exposure: Most widespread factor IT complexity (35%) IT complexity (33%) the Middle East said that weaker internal controls leading to greater fraud exposure and Entry into new, riskier markets (35%) percentage of firms affected are increasing their exposure to fraud, up from 14% last year and much higher than this year’s Loss: survey average of 22%. If businesses are to face Average percentage of revenue lost 2.6% Not available to fraud the growing exposure to fraud, they must strengthen such controls.50  |  Kroll Global Fraud Report
  • 51. Regional Analysis: EMEACorruption and Vendor Fraud in the GulfPractical Advice assuming active positions in companies, but By Yaser Dajani the rules are not always well defined. This lack of clarity can leave companies exposedThe last few years have shown that the Gulf economies are not insulated to regulatory risk. Although rare, corruptionfrom global trends. In particular, the financial crisis and its fallout investigations in the country do take fraud in the region like never before, showing it to be In 2010, the government established a Saudi Commission to investigate the infrastructure’sremarkably similar to fraud elsewhere. With several key financial hubs in inability to withstand a flood which resultedthe region exhibiting limited signs of recovery, a number of markets – in a major collapse in the Jeddah Governorate.including Saudi Arabia, Kuwait, Qatar, and the United Arab Emirates – In looking for the right business partner inhave seen a surge of activity. What do companies based in the region and this environment, one should focus on:those seeking to enter it need to do to mitigate their exposure to fraud? » The management of family-owned businesses: In Saudi Arabia, control ofAccording to the Global Fraud Survey, government. The Kingdom is using this companies is typically “generational,” withcorruption and vendor or procurement fraud money to develop six economic cities, 27 management passed on from fathers toare the fastest growing types of fraudulent airports, and various train networks and sons. Understanding the management ofactivity observed in the region. The latter highways. The Kingdom is also pursuing recent transition and whether or notaffected 25% of respondents last year, up major development projects in key areas corporate controls have been introducedfrom 9% in 2010, while corruption hit 21%, including Riyadh, Jeddah, and the oil-rich are crucial; a robust governance systemalso up from 9%. Whether these figures Eastern Province. The majority of large provides comfort to potential partnersreflect a true increase or a greater recognition contracts are awarded by the Saudi regarding a company’s code of conduct. government-related enterprises. To penetrateof these frauds by executives, companies » The company’s classification by Saudineed to deal with them. The following this market, regional and international ministries: Most businesses in thespecific examples will provide some insight. construction companies are forming joint industry have a grade between one, the ventures or partnerships with local Saudi highest, and four, the lowest, whichGovernment contracts in businesses, most of which are family-owned. regulates the scope and value of thethe Saudi construction market The Saudi construction market is complex projects on which local companiesSaudi Arabia has a booming construction and operating under an evolving regulatory permitted to work. This officialmarket with an annual budget exceeding framework. Anti-bribery laws exist and classification can serve as an important$80 billion earmarked by the Saudi government officials are prohibited from indicator of a company’s strengths and Annual Edition 2011/12  |  51
  • 52. Regional Analysis: EMEA weaknesses in the market, as well as a thereby obscuring the supply chain and interact with disreputable organizations or tool to gauge the extent of potential raising the potential for “diversion risk” to sanctioned entities, such as trading with exposure to corrupt practices. restricted markets. Iran in prohibited items such as dual-use» The place of company principals within » Related-party transactions: Review and equipment. Regulatory action against the the Kingdom’s elite: In some cases, ensure full disclosure of related-party agent will have implications on the parent contracts are awarded to companies based transactions to understand their objectives company and might disrupt the provision not only on the owning family’s position in and relevance. Some sister companies of royalties and other payments. the Saudi social and political fabric but provide each other with services—which Despite increases in certain types of fraud in also on the proximity of shareholders to can be valuable at times—however in some the Middle East, including bribery and the ruling family, the Al Saud. Knowledge cases there is over-invoicing for no actual procurement fraud, the data shows that some of how relationships are structured is often services rendered. companies have successfully reduced their the key to understanding how businesses » Offshore Incorporation: Local agents fraud incidence in the Gulf. Knowledge and operate in the country. One of the key often establish representation in free zone understanding of local red flags can help complications of doing business in Saudi jurisdictions, which are not subject to companies go a long way towards protecting Arabia is that this commercial strength can international standards of disclosure or themselves. potentially carry FCPA/UK Bribery Act risk. regulatory oversight, thereby hindering We can help distinguish between strong transparency. Agents should disclose their Yaser Dajani is an associate managing relationships without such risk, and strong director with Kroll’s Middle East practice corporate information and constituents based in Dubai. Yaser focuses on relationships with risk. before being selected. complex business intelligence and due» Reasons for previous success: How a » Multiple businesses: Agents frequently diligence investigations. His core areas of expertise include market entry, company has won past tenders, especially control or own multiple businesses but do corruption risk assessments, anti- large contracts may reveal important not disclose their existence or nature. counterfeit support and litigation support and asset recoveries. He works across a wide range of sectors information. If a potential joint venture or These undisclosed relationships carry and geographies in the MENA region. partnership moves forward, it is important particular ramifications if such companies to exercise joint control over the bidding process and financial expenditures. Economist Intelligence Unit Report Card Construction, Engineering & InfrastructureIn looking into these areas, companies should Despite another noticeable improvement in overall incidence this year, the construction industry still has aavoid over-reliance on the public record, problem with several of its traditional fraud issues. Theft of physical assets increased, affecting 32% of companies,which is undependable. In Saudi Arabia it is the third highest industry figure. Corruption—a particular temptation for still-struggling companies in thetypically people, not documents, which hold developed world that may need government contracts in order to prosper—hurt 24% of construction businesses,information. the second highest industry level. Finally, the sector has an above-average incidence of market collusion (11%). Unlike last year, this year’s survey indicates that construction companies are less focused on fraud prevention.Distribution agents in the Gulf Construction firms are less likely to invest in eight of the 10 anti-fraud strategies covered in the survey. MoreVendor or procurement fraud in the Gulf worrying, this sector is least likely to put extra money into employee background checks, even though high staffregion often involves local agents, who turnover remains the biggest driver of increased fraud exposure.commonly represent companies in theconsumer goods, information technology, Loss: Companies affected by fraud: 1.9%retail, insurance, and professional services Prevalence: Companies affected by fraud: 69%sector. In most cases, agents divert business Areas of Frequent Loss: Percentage of firms reporting loss to this type of fraudor products away from the company they are Theft of physical assets or stock (32%) • Corruption and bribery (24%)representing by setting up parallel corporate Management conflict of interest (21%) • Vendor, supplier or procurement fraud (19%)entities, and in other cases agents become Financial mismanagement (17%) • Information theft, loss or attack (15%)involved in counterfeit activities. This helps Increase in Exposure: Companies where exposure to fraud has increased: 75%explain why the reported prevalence of Biggest Drivers of Increased Exposure: Most widespread factor leading to greater fraud exposure and percentagemanagement conflict of interest in the of firms affected: High staff turnover (28%)region has also increased from affecting 0 10 20 30 40 50 60 70 80 90 % 100 12% of companies in 2010 to 23% in 2011. Corruption and briberyThis particular conflict is amongst the most Theft of physical assets or stockpernicious, damaging and widespread. Money laundering Financial mismanagementWhen appointing an agent in the Gulf, Regulatory or compliance breachcompanies should consider several factors: Internal financial fraud or theft» Relationships with third parties: Information theft, loss or attack IP theft, piracy or counterfeiting Companies in the consumer goods sector Vendor, supplier or procurement fraud should examine their local partners’ Management conflict of interest distribution channels and ensure that they Market collusion maintain effective access to key markets. Moderately or Highly vulnerable Slightly vulnerable Local agents often use multiple re-sellers52  |  Kroll Global Fraud Report
  • 53. Regional Analysis: EMEA Africa OvervieW Africa continues to struggle with one of the worst fraud environments in the world. It has the highest overall incidence (85%) of any region. Although information theft, loss, or attack saw a marked decline – from 41% last year to 22% this year – fraudsters seem only to have changed their methods rather than to have been thwarted. For five of the 11 frauds tracked in the survey, Africa had the highest incidence of any region: theft of physical assets (38%); corruption and bribery (37%); internal financial fraud (33%); financial mismanagement (32%); and money laundering (13%). 2011-2010 2010-2009 Corruption is a particular problem: 37% of African companies said that they were affectedPrevalence: 85% 87% in the last year, more than twice the figure inCompanies affected by fraud the 2010 survey (17%). More alarming still, 78% of Information theft, loss, or attack (41%) respondents said their company is highly or Theft of physical assets or stock (38%) Theft of physical assets or stock (41%) moderately vulnerable to this fraud, up from Corruption and bribery (37%) Management conflict of interest (39%) 44% last year. Internal financial fraud or theft (33%) Financial mismanagement (35%) Financial mismanagement (32%) Fraud continues to deter companies fromAreas of Frequent Loss: Internal financial fraud or theft (30%) working in Africa. This year, it remains thePercentage of firms reporting loss to this Vendor, suppliertype of fraud or procurement fraud (31%) Vendor, supplier region where the experience or perception of or procurement fraud (26%) Management conflict of interest (27%) fraud has dissuaded the most companies from Regulatory or compliance fraud (20%) operating (15% of global respondents). Of those Information theft, loss, or attack (22%) Corruption and bribery (17%) dissuaded, 69% cited corruption as one of the Market collusion (14%) Market collusion (15%) leading causes for the decision, although theft of physical assets (26%) and information theft Vendor, supplier or procurement fraudAreas of Vulnerability: Corruption and bribery (78%) (59%) (24%) were also common factors.Percentage of firms considering Theft of physical assets or stock (68%)themselves moderately or highly Information theft, loss, or attack (58%) As ever, companies in Africa are trying tovulnerable Internal financial fraud (67%) Management conflict of interest (54%) stem the tide of fraud. Most anti-fraud strategies are already more widespread thereIncrease in Exposure:Companies where exposure to fraud has 84% 70% than elsewhere, and more Africa-basedincreased companies plan to invest further in several areas – such as staff training, employeeBiggest Drivers of IncreasedExposure: Most widespread factor background screening, and third party due Weaker internal controls (35%) IT complexity (39%)leading to greater fraud exposure and diligence – compared to the global average,percentage of firms affected At the same time, however, over a third ofLoss: companies are also seeing weaker internalAverage percentage of revenue lost 3.1% Not availableto fraud controls due to cost-cutting, which will negate some of the anti-fraud investment. Annual Edition 2011/12  |  53
  • 54. Regional Analysis: EMEAAfricaAre We There Yet? investment opportunities. The results show, this year has been the $1.3 billion sale of By Melvin Glapion and Béchir Mana for example, that average fraud losses on the Cape Town’s Victoria and Albert Waterfront continent are higher than in any other region Mall. Even private equity is getting into theFor years, forecasters have been proclaiming and that fraud worries are a bigger act, with its sub-Saharan investmentthat Africa’s hour has arrived. Several impediment to attracting companies to Africa growing 60% last year.unprecedented trends are making that hope than anywhere else.especially strong at the dawn of this new Africa is definitely providing new hope for One might therefore assume that investment investors. In spite of the varied anddecade. Africa is among the fastest in Africa is on the wane, but this could not sometimes significant risks in Africa, thedeveloping regions in the world, with be further from the truth. The value of opportunities cannot be easily overlooked,continental GDP growth expected to reach mergers and acquisitions (M&A) deals particularly given the lower price of assets5.5 percent in 2011 and 5.9 percent in 2012. completed in sub-Saharan Africa for 2011 is than in North America and Europe. InMoreover, the region’s countries are not just expected to top the $44 billion recorded in business, though, the more tantalizing asupplying commodities to China and the 2010, which was itself double the 2009 market seems, the more investors should beWest. A virtuous circle is expanding the figure. This activity goes well beyond cautious. Foreign investors are oftenAfrican middle class and boosting domestic extractive industries: of the 10 largest M&A unfamiliar with the potential risks ofdemand: higher education is becoming much deals in Africa last year, only four involved investing and operating a business in Africamore common, leading to numerous that sector. Similarly, the largest deal thus far and could lose money because of it.well-paid jobs in booming sectors, which arein turn raising standards of living, leading to Current Focus in African Risk Managementthe opportunity to pay for better education.Unlike struggling developed economies,emerging markets such as those in Africa Prevent Detect Recoverhave shown a capacity for continued growth. Partner/Target Screening Financial Controls External InvestigationsBusiness leaders working there may have Employee Screening Inventory Management Internal Investigationsthought that they faced high levels of risk Senior Hire Screening Physical Security External Forensicsbefore 2008, but after the financial crisis, Risk Assessment IT Security Internal ForensicsAfrican investments can seem less risky thanthose in many developed countries. So, has Risk Management IT Counter Measures External LegalAfrica’s time come? Are we there yet? Employee Training/Whistleblower Audit Committee Internal LegalBased on this year’s Global Fraud Survey, onemight be inclined, erroneously, to think that Future Trends in African Risk Managementthe news is grim for those pondering African54  |  Kroll Global Fraud Report
  • 55. Regional Analysis: EMEAOver the years, we have found that thoseinvestors who successfully manage and mitigate Issue Vulnerability or Challengerisks in Africa share three key attributes: M Market, industry, and country statistical data is K How do I benchmark levels and degree of fraud?1. They understand the nuances: Treating K How do I coordinate an industry-led response to fraud? scarce, unreliable, orAfrica as a monolithic whole obscures local inconsistent. K How do I understand the context of the financials of a potential partner or acquisition target?understanding. Consistently successfulinvestors in Africa make rigorous assessmentsof the nuances of each investment O Opaque corporate structures and a lack of K How do I gain an understanding of the ownership structures or financial provenance of partners or acquisition targets?opportunity from a country, regional, and clear corporate governance K Is the beneficial ownership of a competitor or partner a government entity?industry perspective. Such an assessment are common.need not be long and arduous, or expensive,in order to give a clear indication of where R Restrictions are placed on access to the public record, K Have previous controversies around my potential senior-level hire been reported or erased from the public record?vulnerabilities may exist. This in turn can especially the press. K How much faith can I put in articles from certain media?help businesses in deciding how to structure,partner, manage, and monitor investments. T Ties to government determine the level of K How can I be sure my competitor is not unfairly benefitting from a government relationship?One useful approach for gaining a better commercial success. K How can I be sure that my employees are not running afoul of the law?understanding of the local situation is to applywhat we call a M-O-R-T-A-R analysis to thecountry and market environment of the A Absence of a judiciary is compounded by lack of a K What remedies are available to me if I am a victim of a fraud? K What level of enforcement support am I likely to receive?investment. We have created the concept of clear legal framework.MORTAR as a reaction to the ‘BRIC opportunities’way of thinking, currently in existence. R Regulatory environment is constantly changing or hard K How does this affect the incentives for my competitors to engage in corrupt practices?MORTAR is a risk assessment paradigm used to assess. K How do I ensure my employees are not encouraged to violate the law?to address a series of possible red flags.Consideration of an investment’s country and 3. They develop a reputation for compliance programs, integrity policies, andsector in the light of each of these issues can combating fraud aggressively: Regardless above all thorough investigations whereprovide some guidance on where to focus of the specific anti-fraud measures upon necessary are crucial means to strengthen amitigation efforts. For example, a lack of which a company relies, long-term success in company’s reputation and thereby to securemarket and industry data should prompt this battle depends on its reputation among its business. This is not wasted cost; with theinvestors to spend additional time in in-country stakeholders for combating fraud. right preventative measures in place, Africa’sconducting more “on the ground” human return on investment becomes unmatched.intelligence research, which will likely be This local reputation will affect the types ofmore reliable than government statistics; in partnerships a business is offered, the integrity The attributes of those investors who are longthose countries where corporate governance of the employees it is likely to attract, and established in Africa show that lasting businessis wanting, it would be wise to make certain the manner in which customers will engage success is possible with the appropriate levelthat there is a strong culture of anti- with it. In Kroll’s experience with firms that of fraud risk mitigation and compliance.corruption and anti-bribery, as well as have successfully addressed fraud risk in In the years ahead, such an approach willrigorous processes to ensure that employees Africa while thriving financially, a principled allow investors to thrive in this challenging,and agents are compliant with local and presence in-country, combined with a strong but increasingly promising, law as well as with company culture of business integrity – supported bypolicies and procedures; or, in circumstances the necessary policies, procedures, and Melvin Glapion leads Kroll’s Businesswhere there is a weak or absent judiciary, structures – is instrumental in not only Intelligence practice in London. He hasinvestors need to consider how they might deterring fraud but also in greatly minimizing over 16 years of M&A, corporatebe able to recover in the event of fraud or the impact should it occur. Contrary to popular strategy and financial analysisto use the limited remedies available to belief, fraud prevention is not solely a regulatory experience, leading multidisciplinary and multi-jurisdictional teams inthem to maximum advantage if necessary. function; it is a critical strategic function. conducting cross-border market entry, Never is this more accurate than when due diligence and competitive intelligence engagements.2. They use the full spectrum of risk considering an investment in a region with Previously he advised on corporate strategy initiatives atmitigation strategies: This year’s Global Fraud so much potential for reward, and yes, risk. KPMG, and has held several other strategy roles withinSurvey results indicate that African companies the private sector.are more likely than Western ones to be To manage the complexity of African markets,planning to invest in due diligence, employee some business leaders could still be tempted to believe that success depends mostly on political Béchir Mana is a senior managingscreening, and staff training. This represents director. Béchir leads Kroll’s operationsa shift – a good one – in the allocation of connections, but such shortcuts leave companies in France, Africa, Switzerland, Belgium,resources [see figure 1]. Too many businesses in greatly exposed to political volatility and Netherlands and Luxembourg. He is expertthe region focus narrowly on one type of fraud reputational risk. On the continent, a in business intelligence and investigativeprevention strategy. Experienced investors in compliance-driven approach is the wisest due diligence, asset-tracing and litigation support, with particular emphasis onAfrica have learned that they need to use every and safest way to take advantage of new French, African and North African assignments. He alsorisk mitigation strategy available. Moreover, a opportunities. Such a risk mitigation strategy advises corporate and government clients on risk,focus on preventative measures is likely to cost also brings with it effective accounting, legal strategy, crisis management, hostile takeovers andless time and money that might otherwise and financial management, cultural, and corporate affairs. Bechir has managed complex, sensitive policy issues with senior government officials. He hasneed to be spent on long and complex economic insight. Moreover, in Africa, where strong expertise in influence, policymaking and lobbying.recovery efforts after a fraud has occurred. facts are complex and often hard to ascertain, Annual Edition 2011/12  |  55
  • 56. Regional Analysis: EMEA Sailing Safe?For a second successive year, the travel, leisure, and transportation sectorregistered better fraud figures than those of the other sectors.It had the lowest prevalence of fraud of any Economist Intelligence Unit Report Card Travel, Leisure & Transportationindustry overall, although a majority ofcompanies (59%) were still hit at least once. Loss: Average percentage of revenue lost to fraud: 1.9%Moreover, these companies saw the lowest Prevalence: Companies affected by fraud: 59%level of information theft (12%) and market Areas of Frequent Loss: Percentage of firms reporting loss to this type of fraudcollusion (4%), as well as a notable decline Theft of physical assets or stock (21%) • Vendor, supplier or procurement fraud (17%)in the prevalence of several individual Internal financial fraud or theft (16%) • Management conflict of interest (16%)frauds, primarily procurement fraud, which Increase in Exposure: Companies where exposure to fraud has increased: 71%dropped from 27% to 17%. Amid thegenerally positive news, however, are a few Biggest Drivers of Increased Exposure: Most widespread factor leading to greater fraud exposure and percentage of firms affected: IT complexity (32%)worrying trends. The number of companiesexperiencing an increase in fraud exposurelast year has risen from 58% to 71%, and 0 10 20 30 40 50 60 70 80 90 % 100 the proportion of companies hit by five of Corruption and briberythe 11 frauds covered in the survey also Theft of physical assets or stockrose. In the case of internal financial fraud, Money launderingthis involved a rise from 7% to 16%. Financial mismanagementMoreover, with success comes the danger of Regulatory or compliance breach Internal financial fraud or theftcomplacency. The industry has the smallest Information theft, loss or attackpercentage of companies expecting to invest IP theft, piracy or counterfeitingin information security (23%), financial Vendor, supplier or procurement fraudcontrols (17%), and physical asset security Management conflict of interest(17%), the last of which was an area with Market collusionthe biggest fraud prevalence in the sector Moderately or Highly vulnerable Slightly vulnerablethis year.56  |  Kroll Global Fraud Report
  • 57. Sector SummarySummary Prevalence vs response High Prevalence Natural Resources Financial Servicesof Sector Retail, Wholesale and Consumer Goods Distribution Moderate Manufacturing Healthcare, Pharmaceuticals Technology, Media and and Biotechnology Telecoms Professional ServicesFraud Profiles Travel, Leisure and Transportation Construction, Engineering and Infrastructure Low response Low Moderate HighSector Prevalence Response Comment (degree to which (degree to which sector is exposed sector has adopted to fraud) or plans to further invest in fraud countermeasures) The natural resources sector reported the highest percentage of companies hit by fraud in the last year, with theft of physical assets and corruption cited as the biggest problems. To combat these concerns, companies are heavily investing inNatural Resources High High a broad range of anti-fraud measures: management and financial controls, information security and physical asset security. The sector recognizes its vulnerability to corruption and plans to increase investment in due diligence, staff training and whistle-blower hotlines over the next 12 months. Companies in the financial services sector experienced the highest rate of loss of any sector (2.7% of revenue) and had the highest prevalence of information theft, internal financial fraud, regulatory breaches, and money laundering. Investment inFinancial Services High High fraud prevention mirror these concerns: the sector is more likely on average to invest in risk systems, IP protection, management controls, financial security measures, employee background screening, and asset security measures. However for a high risk sector these measures should be regularly tested and reviewed. Manufacturing companies posted the highest incidence of theft of physical assets, procurement fraud, and management conflictManufacturing Moderate Low of interest of all sectors, with high staff turnover cited as the leading reason for the increase in fraud exposure. Unfortunately, the sector’s response to these concerns is poor. Companies plan below average investment in most anti-fraud measures. Despite a noticeable drop in the overall prevalence of fraud, construction, engineering & infrastructure companies continueConstruction, to struggle with theft of physical assets, corruption and procurement fraud. On average, the sector is less focused on fraudEngineering & Low Low prevention compared to other industries. More worrying, this sector is least likely to put extra money into employeeInfrastructure background checks, even though high staff turnover remains the biggest driver of increased fraud exposure. While the retail, wholesale and distribution sector has experienced a drop in theft of physical assets and information theft, itRetail, Wholesale is seeing a growth in internal financial fraud, market collusion, and even corruption. The sector logs the highest percentage of Moderate Moderate& Distribution companies reporting high staff turnover, cost restraints over pay and weakened internal controls as the reasons for increased fraud exposure. Even so, the sector has modest plans to invest in staff training and due diligence over the next 12 months. While the TMT sector continues to feel highly vulnerable to IP theft and information theft, loss or attack, there are a newTechnology, Media and growing set of frauds that the industry needs to address: procurement fraud, financial mismanagement and corruption. Moderate Moderateand Telecoms Despite these increasing threats, investment in anti-fraud measures is only average compared to other sectors, and is primarily concentrated on IT security. This year, consumer goods companies saw a decline in the traditional risks areas associated with the sector – theft of physical assets, information theft, loss or attack and financial mismanagement. At the same time, it experienced a rise in vendor, supplier and procurement fraud, corruption, and internal financial fraud. The sector is aware of the challengesConsumer Goods Moderate High brought on by high staff turnover and is handling it appropriately. More consumer goods companies plan to invest in staff training than any other sector. The industry also has the second highest percentage, after financial services, putting new money into background screening. This was a challenging year for the healthcare, pharmaceuticals, and biotechnology sector. On average, companies lostHealthcare, 2.6% of revenue to fraud, the second highest figure for any sector. The sector faces much more diverse risks than previousPharmaceuticals Moderate High years, with more companies now having to deal with procurement fraud, internal financial fraud and financial mismanagement.and Biotechnology Companies in the sector are dealing with their challenges and currently adopt a variety of anti-fraud measures. Professional services companies report the second lowest percentage of companies hit by fraud (after travel, leisure andProfessional transportation). Even so, the sector continues to struggle with persistent issues around IP theft and information theft, loss Low LowServices or attack, and are more likely to cite IT complexity as the leading cause of increased fraud exposure. Still, investment in anti-fraud strategies is low compared to other sectors, with a focus on reputation monitoring and IP/trademark protections. Despite the lowest recorded level of prevalence of any sector, travel, leisure, and transportation companies this yearTravel, Leisure and reported a marked increase in fraud exposure and saw a rise in five of the 11 frauds covered in the survey. However, lower Low LowTransportation incidence levels may be leading to complacency when it comes to investment in anti-fraud measures. The industry has the smallest percentage of companies planning to invest in information security, financial controls and physical asset security. Annual Edition 2011/12  |  57
  • 58. The information contained herein is based on currently available sources and analysis and should be understood tobe information of a general nature only. The information is not intended to be taken as advice with respect to anyindividual situation and cannot be relied upon as such. Statements concerning financial, regulatory or legal mattersshould be understood to be general observations based solely on our experience as risk consultants and may not berelied upon as financial, regulatory or legal advice, which we are not authorized to provide. All such matters shouldbe reviewed with appropriately qualified advisors in these areas. This document is owned by Kroll and theEconomist Intelligence Unit Ltd, and its contents, or any portion thereof, may not be copied or reproduced in anyform without the permission of Kroll. Clients may distribute for their own internal purposes only. Kroll is a businessunit of the Altegrity family of companies.58  |  Kroll Global Fraud Report
  • 59. Europe, Middle East and Africa ContactsKey regional contacts at KrollFor information about any of Kroll’s services, please contact a representative in one of our offices below.Business Intelligence Latin America Asia Europe, Middle Eastand Investigations & Africa Andrés Otero Violet HoTom Hartley Miami Beijing Tommy HelsbyGlobal Head 1 305 789 7100 86 10 5964 7600 LondonLondon 44 207 029 500044 207 029 5000 Matías Nahón Colum Buenos Aires Hong Kong Brian Stapleton 54 11 4706 6000 852 2884 7788 LondonAmericas 44 207 029 5126 bstapleton@kroll.comRobert Brenner Andrés Otero Richard DaillyVice President Bogota Mumbai Richard Abbey1 212 593 1000 57 1 742 5556 91 22 6724 0500 44 207 029 5153 Glen Harloff Feng LuNorth America Grenada Shanghai Omer Erginsoy 1 473 439 7999 86 21 6156 1700 LondonDavid Holley 44 207 029 5226Boston oerginsoy@kroll.com1 617 350 7878 Ernesto Carrasco Abigail Mexico City Singapore Ben Hamilton 52 55 5279 7250 65 6645 4942 LondonJeff Cramer 44 207 029 5071Chicago bhamilton@kroll.com1 312 345 2750 Frederico Gebauer Penelope São Paulo Singapore Zoe Newman 55 11 3897 0900 65 6645 4941 LondonJack Weiss 44 207 029 5154Los Angeles znewman@kroll.com1 213 443 6090 David Singapore Melvin Glapion 65 6645 4520 LondonRichard Plansky 44 207 029 5313New York mglapion@kroll.com1 212 593 1000 Tadashi Tokyo Brendan Hawthorne 81 3 3509 7100 LondonBill Nugent 44 207 029 5482Philadelphia bhawthorne@kroll.com1 215 568 Tom Everett-Heath DubaiBetsy Blumenthal 971 4 4496701San Francisco teverettheath@kroll.com1 415 743 Béchir Mana ParisPeter McFarlane 33 1 42 67 81 46Toronto bmana@kroll.com1 416 682 2784ext. 3516 Marianna Milan 39 02 8699 8088Douglas Franz mvintiadis@kroll.comWashington1 202 999 9382 Alfonso Barandiará Madrid 34 91 310 67 20 Annual Edition 2011/12  |  59
  • 60. © 2011Certain Altegrity companies provide investigative services. State licensing information can be found at An Altegrity Company