Global Fraud Report 2010-2011

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The annual Global Fraud Survey, commissioned by Kroll and carried out by the Economist Intelligence Unit, polled more than 800 senior executives worldwide from a broad range of industries and functions in July and August 2010. Where Economist Intelligence Unit analysis has been quoted in this report, it has been headlined as such. Kroll also undertook its own analysis of the results. As in previous years, these represented a wide range of industries, including notable participation from Financial Services; and Professional Services; as well as Retail and Wholesale; Technology, Media and Telecoms; Healthcare and Pharmaceuticals; Travel, Leisure, and Transportation; Consumer Goods; Construction, Engineering, and Infrastructure; Natural Resources; and Manufacturing. Respondents were senior, with 47% at C-suite level. Fifty one percent of participants came from companies with annual revenues of over $500 million. Respondents this year included 29% from North America, 25% from Europe, and 24% from the Asia-Pacific region (of whom 47% – more than in previous years – were from China and India); and 11% each from Latin America and the Middle East & Africa.

This report brings together these survey results with the experienceand expertise of Kroll and a selection of its affiliates. It includes content written by the Economist Intelligence Unit and other third parties. Kroll would like to thank the Economist Intelligence Unit, Dr. Paul Kielstra and all the authors for their contributions in producing this report.

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Global Fraud Report 2010-2011

  1. 1. An Altegrity Company
  2. 2. About the researchThe annual Global Fraud Survey, commissioned by Kroll and carriedout by the Economist Intelligence Unit, polled more than 800 seniorexecutives worldwide from a broad range of industries and functionsin July and August 2010. Where Economist Intelligence Unit analysishas been quoted in this report, it has been headlined as such. Krollalso undertook 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 and Telecoms;Healthcare and Pharmaceuticals; Travel, Leisure, and Transportation;Consumer Goods; Construction, Engineering, and Infrastructure;Natural Resources; and Manufacturing. Respondents were senior,with 47% at C-suite level. Fifty one percent of participants camefrom companies with annual revenues of over $500 million.Respondents this year included 29% from North America, 25%from Europe, and 24% from the Asia-Pacific region (of whom47% – more than in previous years – were from China and India);and 11% each from Latin America and the Middle East & Africa.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.
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  4. 4. In this edition, we take a closer look at the From an industry perspective, we seeissues that Kroll is most frequently asked encouraging declines in fraud prevalence into investigate, and the variations in the three sectors: Construction, Retail and Travel.nature of the threat across different regions. The other seven sectors show an increase,Four important themes emerge: with considerable jumps in Consumer Goods Theft of information and electronic data and Technology, Media and Telecoms. overtakes physical theft for the first time You’ll notice that our report looks different as the most frequently reported fraud. this year, reflecting our transition to the Fear of fraud is dissuading 48% of Altegrity family of businesses. Altegrity is companies from operating in other a portfolio company of Providence Equity countries. China and Africa are the Partners, one of the world’s premiere private geographies most affected, with equity firms, with over $22 billion of equity corruption identified as the greatest capital under management. Our acquisition concern. by Altegrity reflects a strong belief in Companies appear unprepared for Kroll’s proven performance and growth heightened Foreign Corrupt Practices Act potential in the rapidly growing global (FCPA) enforcement and the impact of the market for investigative, compliance and UK Bribery Act. For example, only one- risk management services. third of respondents with a presence in I hope that you find our report enlightening, the United States or United Kingdom felt and that it helps you to identify emerging the laws applied to them. threats and opportunities for your own Fraud is largely an inside job across all business. geographies and industries. Some 44% of Best regards, respondents attributed fraud to employees and a further 11% identified agents or intermediaries as the key perpetrators.This year we analyze for the first time fraudlosses as a percentage of income. There iscause for concern: fraudsters’ take frombusiness increased 20% in the last 12months. Almost 90% of respondents reportbeing victims of fraud - similar to last year’ssurvey results.
  5. 5. Such growth is never uniform across the economy. As Chart 2 indicates, information- rich industries such as Financial Services, Professional Services, and Technology, Media and Telecoms itself are the most likely to be hit. The chart also indicates, however, that the problem is far from isolated. The survey suggests that things may get worse before they get better. Information theft or attack is the type of fraud to which respondents are most likely to describe their companies as vulnerable (37%). Again, their concerns are not isolated. This type of crime is regarded as the greatest weak spot for three of the 10 industries covered in the survey – Financial Services, Professional Services, and Natural Resources – and the second- Fraud, then, is only rarely an acute disease greatest for three more – Construction, threatening the whole body. It is frequently, Technology, Media and Telecoms, and Retail. however, a widespread virus that, while usually draining limited resources from the Corporate information host, is always ready to flare up when the technology systems are opportunity arises. And like a virus, fraud increasingly under threat is constantly mutating, and can, if left unchecked, become life-threatening. This Criminals have always targeted physicalIf fraud were a virus, almost assets because they are present in almost year’s Global Fraud Survey digs deepereveryone would be slightly ill all companies, are frequently simple to steal, than previous years to offer an insight intoOf the respondents, 88% report that they had the sources and impact of fraud and the and have a tangible value which makesbeen hit by at least one type of fraud in the perceptions of senior business executives them easy to convert to financial gain.past year, a figure broadly similar in every around the world. The findings highlight The increasing prevalence of informationregion and consistent with those of previous several key trends: technology has made the same attributesyears. Record-setting, headline-grabbing increasingly true of data. The rise inscams, such as the Madoff or Satyam frauds, Theft of information and information theft and attack is bestcan give a false impression of fraud’s electronic data surpass all other understood as part of a more general problemfinancial impact on business. The most of the exploitation of information systems by frauds for the first timesuccessful pathogens do not kill the host, but criminals. Poorly defended technology islive off them. Of course, huge, company- Information theft has become the most common increasingly easy to exploit for fraudstersdestroying losses do occur, but they are very form of fraud. In previous Global Fraud with ever more advanced tools of their own,rare. More typical are smaller losses over Surveys, the theft of physical assets or stock ranging from sophisticated hacking to amonths or years. has always been the most widespread fraud simple memory stick that can let a by a considerable margin. In 2009, for example,In isolation, this appears to be good news. disgruntled employee walk into the office 28% of companies surveyed reported sufferingThe frequent repetition of small losses, however, and walk out with details of the company’scan create a significant problem in aggregate. physical theft, while the next most common most valuable intellectual property. Of course,In the past, this report has presented the fraud – management conflict of interest – not all information theft is digital.figures for an average overall fraud loss, but affected only 20%. This year, however, as Mishandled paper can reveal as much assuch a figure is less instructive than it might Chart 1 (overeaf) shows, information theft, mishandled data files. Nevertheless, theseem: levels of loss are closely associated loss or attack has become, by a small margin, pervasiveness of information systems shapeswith the size of companies. Instead, it is more the most commonly reported fraud. It is not the context of the theft.meaningful to report losses as a proportion of that fraudsters are switching away fromincome. By this measure, the take of other methods: the increases and decreases This year’s survey shows how far technologyfraudsters from business rose by more than in other categories are of the sort that could has become an issue for those fighting fraud.20% in the last 12 months, from $1.4 million be expected in this type of survey. Rather, Respondents report that the complexity ofper billion dollars of sales to $1.7 million. information theft grew significantly. information infrastructure is the single most
  6. 6. widespread factor in raising exposure tofraud, cited by 28%. Moreover, whenrespondents were asked which of a series of10 elements were involved in frauds they hadsuffered in the last year, the two mostcommon elements were technology-related:phishing attacks (20%) and the increased useof technology (18%). As elsewhere, this is across-industry issue – these two responseswere the top answers in five of the 10 sectorssurveyed. Anonymous email allegation,another increasingly common fraud element,will be closely observed as a result of thenew US Dodd Frank Act, which requires theSecurities and Exchange Commission (SEC) toreward whistleblowers.This growing technological challenge,however, is not eliciting as large a responseas might be expected. In the coming 12months, 48% of companies expect to spendmore on information security. Although thatfigure makes this the most common field ofanti-fraud investment, it is actually downfrom 51% from last year.Fear of fraud is dissuading asignificant number of companiesfrom going globalIn the survey, 48% of respondents indicatethat fraud has deterred them from engagingin business in at least one foreign country.Nearly two-fifths (39%) of respondents list atleast one type of fraud that had dissuadedthem from doing business in a foreignmarket, and 36% name a country or regionwhere their experience or perception of fraudhad deterred them from operating. The issueaffects small and large companies alike.The breakdown of respondents by revenuefor those companies which fraud haddissuaded from investing was the same as listed for developing regions than for North North America list corruption as a leadingthat for the survey as a whole. America and Western Europe. Globally, the reason. In most geographies information theftThis is not merely a developing world leading worry is corruption. It has dissuaded is the second biggest deterrent to investment,problem: 7% of those surveyed say that fraud 17% of all businesses – and 37% of those but that varies widely, from 7% in Westernhas dissuaded them from operating in North who have in fact been deterred – from Europe to 31% in neighboring Central andAmerica. Nevertheless, its biggest impact is investing somewhere. Consistent with the Eastern Europe. China, where fraud deterredon emerging economies. Fraud has deterred other findings in the survey, information theft the most respondents, faces a range of11% of those surveyed from doing business is also an important concern, ranking second challenges rather than a single, overwhelmingin China and Africa, and 10%, in Latin with 9% of all respondents and 19% of those issue. Corruption and information theft areAmerica. These respondents manage risk by deterred citing it as the reason not to invest. the two most widespread issues (34% andsimply staying out of these three regions, 33% respectively), but concerns about Although corruption is the most importanteven though they may present a large intellectual property, a long-standing worry deterrent to investment in every region, theinvestment opportunity. for those operating in the country, were a impact is far from universal. Corruption was leading factor for 23% of businessesMoreover, developing countries appear to named by 63% of respondents as the main dissuaded from doing business there.have more issues to clear up. In our survey, reason for not doing business in Africa andrespondents were asked to rank the types of by 59% for avoiding Central Asia. By Clearly, many companies are willing to gofraud that had dissuaded them from entering comparison, only 21% of those who were into emerging markets knowing the risks:certain markets. Twice as many types were dissuaded by fraud from doing business in 21% believe that their exposure to fraud has
  7. 7. increased because of entry into new, riskiermarkets in the last year. The survey alsofound, however, that fraud is exacting aneconomic price by causing companies to passon potential opportunities, especially inunderdeveloped and emerging economies.Companies are unprepared forincreasing regulatory effortsagainst corruptionThe Foreign Corrupt Practices Act (FCPA) usedto be a quiet backwater for United States lawenforcement officials. Those days are nowlong gone. Between 2005 and 2009, the USDepartment of Justice brought more than 60FCPA cases – more than during the entireperiod from 1977 to 2005. Every sign points might have more excuse, but the figures for Fraud is most often an inside jobto continued acceleration of this trend: early the largest firms are not much better. Forin 2010, 130 open cases were under Employees are the people who have the best those with annual sales of over $10 billion,investigation, their targets ranging from large knowledge of a company. Unfortunately, this 43% understood that they were covered bycorporations to small private concerns. also means that dishonest employees know one of the acts, and 30% were uncertain.American authorities have even begun using what there is of value, how it is protected,sting operations as an FCPA enforcement tool. Not surprisingly, then, only a minority of and the best way to circumvent that companies are addressing the regulatory protection. In our survey, for those companiesThis development has global consequences. Not risks that accompany more vigorous FCPA that have been affected by fraud in the lastonly does the Act cover foreign activity by US enforcement and the advent of the Bribery year and the culprits identified, the mostpersons and companies, it defines the latter Act. Among respondents with operations or a common fraudsters are equally juniorcategory very broadly. Of the 47 fines handed presence in the United States or UK, only employees (22%) and senior ones (22%).out in 2008 and 2009, 19 hit non-US one-third believe that their senior managers When agents and intermediaries (11%) arecompanies. Operations, share listings, American are thoroughly familiar with the legislation. added in, the proportion of fraud carried outDepository Receipts (ADRs), and even having Just 42% say that they have assessed the by those who work for the company in oneUnited States nationals as board members can risks and set in place the necessary way or another goes well above half.potentially open companies up to liability for monitoring and reporting procedures.actions anywhere in the world. Siemens, for Most of the rest are uncertain, but about The finding is remarkably consistent acrossexample, reached a settlement for activities in one-quarter (24%) say that they have not. geographies, with the proportion of fraudsSouth America with the Department of Justice Finally, fewer than one-half (47%) are carried out by agents, junior or senior confident that they have the controls in employees falling between 50% and 60% in(DOJ) and BAE Systems for behavior in Africa. place to prevent bribery at all levels of the North America, Europe, and Asia-Pacific. ItMeanwhile, the reach of the UK’s new operation, and 16% of respondents are hits its highest figure at 71% in the MiddleBribery Act is in theory longer and wider sure that this is not the case. East and Africa, and the lowest it goes isthan that of the FCPA, covering the global only 42% in Latin America, where customers Just because a company knows that it isactivities of every person or company doing are the single biggest fraudsters. Similarly, subject to the FCPA or Bribery Act, it does notany business in the UK. It not only prohibits automatically follow that it is fully-equipped that proportion also falls within the 50% to 60%bribery, but covers failure to prevent bribery to comply with them. Of the respondents who range for most industries, the only exceptionsby persons associated with the company believe that one or both of these laws being consumer goods (45%), constructionanywhere in the world in both the private definitely applies to their firms, only 40% say (46%), and professional services (72%).and public sectors. UK authorities are that their senior management understandsunlikely to be any less vigorous than Some differences between industries do them, and 32% believe the opposite. WhileAmerican ones in enforcement of their laws. exist. In financial services, for example, a 46% say that their company has done a detailed assessment of their exposure to risks notably high proportion of customers are keyThe survey indicates that too few companies perpetrators of fraud (28% compared to a associated with non-compliance to the acts,fully understand the current regulatory survey average of 10%). Consumer goods 29% report that they have not. The only realsituation. Businesses with a link to the United companies, meanwhile, suffer 40% of their difference between those who know they areStates or United Kingdom are very likely to subject to the legislation and the rest of the frauds at the hands of vendors and suppliers,fall under one of these acts. However, of survey seems to be a greater tendency to more than twice the survey average of 18%.respondents whose firms had operations or a steer clear of the problem. Companies with The broader message of the survey here,presence in one of these countries, only 36% links to either the United States or the United however, is an unpleasant one. Whatever thebelieve that these laws applied to them; more Kingdom need to review their legal position sector, if a fraud occurs the culprit is morethan one-quarter believe that they would not, and controls in order not to fall afoul of more often than not likely to be one of the peopleand 37% were not sure. Smaller companies aggressive anti-corruption enforcement. working with you.
  8. 8. Kroll findings Information theft 19% Prevalence Kroll findings 83% Information Vendor/supplier Physical theft 32% fraud 14% theft 23% EUROPE Prevalence Europe performed relatively well in the last year with emphasis on 87% relative with still more than eight in 10 companies hit by a fraud. Management Europe also had a below average conflict 14% Physical theft 27% incidence of every fraud covered in NORTH AMERICA the survey, though the number of North America enjoys low levels of companies seeing an increased fraud compared to the other fraud exposure is the same as the regions, ranking below the survey average. There are some signs of average in every type of fraud complacency – for example the except information theft or loss. region is less likely than average to While fraud in this area spiked have adopted most anti-fraud during the last 12 months, strategies in the survey. companies generally believe they are less vulnerable to fraud than in previous years. Respondents reported investment in a broad array of anti-fraud measures, including financial and management controls, IT security, due diligence and background screening. Kroll findings Information Regulatory / theft 21% compliance 15% Kroll findings Money Prevalence Information laundering 94% theft 43% 17% Vendor/supplier Management 9.0 - 10.0 fraud 24% conflict of Kroll findings Management interest 18% conflict of Prevalence 8.0 - 8.9 COLOMBIA Information interest 27% 90% theft 35% 7.0 - 7.9 A startling 94% of Colombian companies say they have been defrauded in the past year, a figure Vendor/supplier 6.0 - 6.9 fraud 27% well above the survey average 5.0 - 5.9 of 88%. The areas of greatest Prevalence Regulatory / concern include vendor or 90% compliance 20% 30% 4.0 - 4.9 procurement fraud, information theft Physical theft or loss, management conflict and Management 3.0 - 3.9 regulatory or compliance fraud. Vendor/supplier conflict of interest While Colombians have been slow fraud 22% BRAZIL 2.0 -2.9 to adopt fraud prevention measures, Fraud levels in Brazil hit record Regulatory / levels, surpassing the global 1.0 - 1.9 planned investment over the next compliance 21% 26% 12 months in these strategies is Physical theft average in all 11 categories of fraud 0.0 - 0.9 25 – 40% higher than elsewhere. covered in the survey. Information LATIN AMERICA theft and theft of physical assets Companies in Latin America report No data being defrauded at rates second were the most commonly reported frauds. Brazilian companies also only to Asia. The region suffers the posted above average results for highest incidence of regulatory fraud vendor or procurement fraud and and ranked second in five other money laundering. Despite these areas: information theft or loss, alarming results, investment in management conflict of interest, anti-fraud measures is low vendor or procurement fraud, IP compared to other countries in all theft and money laundering. but two areas: financial controls Companies in the region are and physical asset security. investing heavily in a range of fraud prevention strategies, including financial controls, physical asset and IT security, IP and trademark monitoring and due diligence.Map image by permission Transparency International.All analysis Kroll/Economist Intelligence Unit.
  9. 9. Kroll findings Management conflict of IP theft/ interest 30% counterfeiting 26% Prevalence 98% Information theft 16% 20% Vendor/supplier fraud Money laundering 22% Physical theft Financial mismanagement Market collusion Regulatory / compliance Kroll findings Internal financial fraud 21% CHINA Information Ninety eight percent of respondents theft 30% in China fell victim to fraud in the last 12 months. The types of fraud are Kroll findings highly varied, with at least one in Management Regulatory / five companies hit by nine of the conflict of compliance 16% Prevalence 11 frauds covered in the survey. interest 25% 86% Businesses are doing little to protect Information themselves: only 54% will invest in theft 22% staff training and 42% in employee Financial Physical background checks. mismanagement 19% theft 30% Kroll findings MIDDLE EAST The Middle East picture is mixed. Physical theft 21% Prevalence Below average incidences of fraud Information 92% in seven of the 11 frauds surveyed theft 19% is positive, including the lowest Management Vendor/supplier levels of vendor fraud, IP theft and Kroll findings Physical conflict of fraud 16% conflicts of interest. There are interest 26% theft 28% concerning trends emerging Prevalence IP theft 16% however, including higher than 88% Information average levels of employee theft, theft 25% ASIA-PACIFIC the second highest figure for INDIA Asia-Pacific has the highest number companies suffering at least some Respondents feel mainly vulnerable of companies being hit by at least one financial loss and the highest to regulatory or compliance breach fraud in the last year, with the percentage of respondents that and information theft, loss, or Prevalence majority feeling vulnerable to vendor, said fraud had grown worse at attack, which is not surprising since 90% supplier or procurement fraud or their companies in the past year. complexity of IT infrastructure was information theft, loss or attack. cited as one of the leading factors More worrying is how many contributing to increased exposure Vendor/supplier companies are looking to cut costs fraud 17% Physical by weakening controls: 33% of firmsKroll findings to fraud. For those that experienced theft 32% Financial fraud, 48% reported that the key reported that this practice had mismanagement 35% perpetrators had been their IP theft 16% increased fraud exposure, up from employees. Anonymous email just 19% last year. High staff turnover SOUTHEAST ASIA Information theft allegations and collusion within the was another factor. Physical theft Respondents from the area 41% Management supply chain were involved in 26% reported one of the highest rates of conflict of and 19% of frauds experienced. theft of physical assets or stock interest 39% (32%) and face above averageRegulatory / levels of management conflict ofcompliance interest and vendor fraud. While20% more firms than average are making investments in anti-fraud Prevalence measures, 35% are weakening 87% controls in order to save money – the highest level for any region.Vendor/supplier Internalfraud 26% financial fraud 30%AFRICADespite a 1% decline in companiesaffected by at least one fraud,Africa paints a generallyworrying picture. The continenthas the highest incidence of fraudin eight of the 11 categoriesreported and came a closesecond to Latin America forregulatory and compliance fraud.Africa also saw leaps in theoccurrence of fraud throughinformation theft and conflicts ofinterest. While companies inAfrica widely adopt anti-fraudstrategies, they do not appear tobe working particularly well.
  10. 10. By Tommy Helsby The new regulatory environment Regulation has caught up with globalization in other ways as well. Prosecutors and The bite is as likely to come from regulatory regulators are actively cooperating acrossOne result from the latest EIU Global Fraud enforcement at home as in the place whereSurvey—that the greatest fraud risk to borders as never before. In our work, we may the offense occurs. Stung by criticism that find the victim of a fraud in one country, thecompanies lies with employees and their laxity contributed to the financial crisis, crime scene in a second, the perpetrator in aagents—reinforces a truth well-known to regulators are acting with renewed vigor, third, and the money stashed in a fourth.practitioners: it’s usually an inside job. authority, and political backing – and in Putting together effective enforcement acrossThe prominence of theft of information and some cases new legal powers. Certainelectronic data in our survey makes the multiple borders used to be a nightmare for longstanding prosecutorial backwaters haveproblem worse: insiders generally have legal authorities. The fight against the funding bubbled into life. The most obvious isfreer access to the valued information. of international terrorism, however, has corruption: as the Economist IntelligenceBut there is a double risk from employees fostered much better communication between Unit’s introduction highlights, there havecommitting crimes that seek perceived the appropriate institutions in countries,easy routes to business success, such as been more prosecutions under the United which has in turn permitted dialogue onpaying bribes, colluding with competitors States Foreign Corrupt Practices Act (FCPA) in fraud and corruption investigations.and cutting corners on compliance: the past five years than in the previous 30not only does the company suffer the and the UK has passed a new Bribery Act. The embracing of technology by businesseconomic consequences of their behavior Corruption is not the only area of increased has also given investigators some powerfulbut it also opens itself to increasingly regulatory activity: last year fines – in one tools. Copies of documents, drafts, comments,robust treatment from regulators. These case of more than half a billion dollars – and circulation lists often remain forgotten onrisks have been heightened by the current were levied against several major banks for servers; emails may seem to have been killedeconomic climate. financial sanctions compliance failures that but their digital ghosts linger on; telephone might once have been seen as little more records and voice mails are stored longerMany companies operating in the currently than clerical errors.1 Meanwhile, European than many realize. The ability to reconstructflat markets of the developed world are Union competition investigators have an electronic record of a supposed conspiracyseeking growth elsewhere, sometimes simply conducted dawn raids to gather documents has become all too apparent in many highto survive. That is likely to require developing and the resultant suits have led to fines of profile investigations in recent years.new product lines or entering new hundreds of millions of euros.geographical markets – which generallymeans operating outside existing comfort Another feature of the new regulatory Addressing the riskszones. The quick route is to use acquisitions, landscape is the rise of extraterritoriality: the This is how a perfect storm builds.joint ventures, or distribution agreements application of laws from one country to Companies need to expand beyond wherebut, as with all short cuts, these can be risky. actions in another. The FCPA always applied they have experience and effective controls,Acquisitions or partnerships can infect a to overseas actions, as does the new UK but the best opportunities are often preciselybusiness if they have questionable business Bribery Act. So, typically, do competition in places where these are most needed.practices or lax standards. These may even legislation and trade sanction-related laws. Meanwhile, penalties for regulatory failure,be perceived to be tolerated in the target’s or The exposure is not only to the actions of a and the chances of getting caught, arepartner’s sector or country of operation, but company’s own employees: regulators have growing quickly. It is no surprise that almostthey can leave the unaware open to gotten wise to the practice of “outsourcing”economic damage and increasingly harsh half of the respondents in the Global Fraud wrong-doing to a local partner or agent. Survey indicate that they have beentreatment from regulators. The UK Bribery Act makes quite explicit a dissuaded from operating in one or moreThis risk is heightened when the move is into corporation’s liability to third party acts that countries because of fraud risk.an emerging market, where growth rates are benefit the company, but it has been implicithigher but governance, compliance and in most such national legislation already. If just staying at home is not an option, though,transparency are often less mature than in The onus is now clearly on the company to you can take useful precautions. First, reassessdeveloped countries and where regulation is police the actions of affiliates, partners, and the range of your regulatory exposure. Thissporadic and inconsistent, even arbitrary. agents, and to have a clear record of doing involves managerial as much as legal analysis:Too often, corporate attention focuses on so, in order to protect its own integrity. carefully review all of your business processesmarket and credit risk in emerging markets: This applies not just to the prevention of – including in the finance, IT, marketing, andoperational risk is neglected until it turns corruption but to many other aspects of even the legal and compliance departments –around and bites you. international trade and business regulation. against a list of regulated actions – such as
  11. 11. hiring an agent, making a payment, recordingan individual’s name, or negotiating with acompetitor – and a list of countries whereyou have any activity. The latter should not I agree with the following statementbe restricted to where you have a physicalpresence: sales agents, or critical suppliers, 47.2%for example, may create regulatory exposure.From this matrix, you can begin to develop We have set in place adequate procedures to prevent bribery at all levels of our operationsyour global compliance footprint. 32.9%When Kroll facilitates these exercises for clients, Our senior managers are thoroughly familiar with the new UK Bribery Act and the FCPAthe results can be alarming. Even if you havejust a de minimis presence in Ulan Bator and 26.2%your contact there says that Mongoliananti-competition regulation is lax, you may We do not have sufficient links with the UK or US for these laws to apply to usstill be at risk at home. The analysis needs tobe dynamic and intelligent: the process Perhaps the most surprising set of responses FCPA enforcement and the advent of the UKdriven exercise that many Sarbanes-Oxley in the survey related to the potential lack Bribery Act. Fewer than one-half (47%) of thosecompliance reviews became may not suffice. of awareness of the extraterritorial nature of surveyed are confident that they have theThe point of this exercise is not to develop international corruption regulation, given controls in place to prevent bribery at all levelscompliance programs that prevent any of the the publicity surrounding both high profile of the operation, and 16% of respondents aremultitude of identified vulnerabilities from US Department of Justice prosecutions under sure that this is not the case. But just becauseever becoming a problem. Apart from being the FCPA and the introduction of the UK Bribery a company knows that it is subject to the FCPAcost-prohibitive, this would prevent you from Act. Close to 70% of respondents have or UK Bribery Act, it does not automatically followdoing almost any useful business anywhere.What you do need is effective contingency operations or a presence in the UK or US, that it is fully equipped to comply with them.planning, having identified the types of potentially exposing them to one or both sets of regulations. The responses to three In Kroll’s experience, the impact of anti-responses that may be necessary. Who willmake the decisions? Do you have the questions in particular stood out: corruption legislation is being considerednecessary resources in-house? If not, have How familiar are senior management with within compliance and legal functions of mostyou identified and pre-qualified outside the regulations? organizations, but anti-corruption programsassistance in case you need help in a hurry? have not generally been fully implemented. Have you set in place adequate procedures?Do your outside resources match the needs Organizations should ensure that a corruptionyou have now identified, particularly Do you have a sufficient link to the UK/US to be impacted? risk assessment has been carried out acrossregarding global coverage and relevant their businesses considering both the inherentexperience? Can your team – in-house and As the survey indicates, too few companiesexternal – help you find specialized expertise and residual risk of corruption. A corporate fully understand the impact and implications ofsuch Ulan Bator’s top anti-trust lawyer? anti-corruption policy and code of ethics should these laws. Among respondents whose firms be developed and implemented and mustThere is a hierarchy in crisis management: have operations or a presence in one of these contain a clear statement of an anti-corruptionan issue becomes a problem; the problem countries, only 36% believed that the lawsdevelops into a drama; and the drama turns culture fully and visibly supported at the highest applied to them while more than 25% believedinto a crisis. It need not be that way, despite levels in the business. that they did not and 37% were not sure.the fraud risks of entering new sectors and Companies with operations in regions more It is important that individual accountabilitymarkets. Identifying these risks and planning prone to corruption need to take particular care: is established for anti-corruption efforts andfor the consequences eliminates or reduces the Securities and Exchange Commission (SEC) that training has been implemented andmany surprises, and without surprise, thereis no drama. Without drama, an issue is just recently announced its intention to focus on monitored to ensure dissemination of thea problem, not a crisis, and problems are business in Asia-Pacific, and companies around anti-corruption policies, rules and culture towhat companies deal with every day. the world will soon begin to grapple with the staff at all levels. limitations imposed by the UK Bribery Act. The1 http://www.guardian.co.uk/business/2010/aug/18/ Proactive implementation of an effective anti- survey findings highlight the need for a proactive barclays-sanctions-us-court response to combat potential violations: less corruption program is a minimum requirement than half of those surveyed believe they have in mounting a defense against corruption Tommy Helsby is Chairman of Kroll allegations from regulators and it is imperative adequate bribery prevention procedures in Eurasia based in London. Since joining Kroll in 1981, Tommy has helped found place; 17% say they do not and 25% believe that that due consideration be given to the reach, and develop the firm’s core due their companies are not impacted by either law. financial penalties and reputational impact of diligence business, and managed many anti-corruption regulation. of the corporate contest projects for Given the survey findings concerning which Kroll became well known in the Penalties imposed by regulators for breaches awareness levels, it is less surprising that only 1980s. Tommy plays a strategic role both for the firm and for many of its major clients in complex transactions and a minority of companies are addressing the frequently have a larger financial or reputational disputes. He has a particular interest in emerging regulatory risks that accompany more vigorous impact than the bribe or fraud itself. markets, especially Russia and India.
  12. 12. By Melvin GlapionIt is surprising to Kroll that nearly half of Of course every investment involves some the leading markets of the future. Is there afirms surveyed think that the best way to level of risk and reward. The perceived levels way to enter these dynamic but challengingmitigate fraud risks in some key growth of corruption within the BRIC countries, economies yet mitigate the obvious risks?markets, given the potential opportunities which have drawn much of the world’s FDI inavailable and Foreign Direct Investments (FDI) the last ten years, have actually grown Due diligence in challenging marketsforecasts, is to avoid them altogether. Indeed, worse. Moreover, those developing countriesthe markets expected to exhibit the highest Those considering the plunge could begin by in the next tier of interest for investors, suchlevels of growth over the next five years are as Angola, Ukraine, and Egypt, have even accepting that conducting due diligence inthose where fraud is causing the most poorer CPI scores. this environment needs to be done differently.companies to steer clear. Average compound Whether entering a new market throughannual real GDP growth rates in the G7 over This growing risk is compounded by acquisition or joint venture, or contractingthe next five years are expected to be below increased regulatory oversight of activities in with a distributor or supplier, financial and2%. In comparison, the figure for the BRICs developing and emerging markets. The legal due diligence remains essential but on(Brazil, Russia, India, China) over the same United States Department of Justice is its own will be insufficient, picking up onlyperiod is predicted to exceed 7%. aggressively enforcing the Foreign Corrupt documented instances of fraud. Practices Act (FCPA), and the UK’s newTo examine the link between fraud and Bribery Act has extra-territorial reach, strict A more effective approach is to combineinvestment in emerging markets further, liability, third party responsibility, and a ban commercial and integrity due diligencewe compared, for a range of countries, the on facilitation payments. A serious concern into a unified whole which also takesforecast five year growth in stocks of is how few companies seem to realize that account of the difficulties created by severalinward FDI – a measure of total investment in they may come under greater scrutiny or face fundamental differences between emerginglocal businesses by foreign investors – with higher penalties. As page 11 highlights, and developed markets:the Transparency International Corruption the Global Fraud Survey found that only The quality of the secondaryPerception Index (CPI) scores for 2009. 36% of respondents who had operations or information: In emerging countries,We used the latter rather than Global Fraud a presence in the UK or the US thought that industry reports, brokers’ notes, orSurvey data both because it contains more they could be prosecuted under the FCPA or guidance from chambers of commerce ordetailed country level data and because the Bribery Act. trade associations are often inaccuratecorruption is the leading fraud impeding The dilemma is difficult: going into many or nonexistent. Assessing the size,investment. As the figure opposite emerging markets leads to significant fraud structure, and segmentation of thesedemonstrates, across our entire sample, only risk exposure but staying out means requires a balance of desktop researchthe United Arab Emirates combined a greatergrowth in FDI than the G7 states with a sacrificing growth prospects that are absent and intelligence gathering in the field.comparable CPI score to the G7 average. in developed countries. The latter could also The political/regulatory environment:All other countries with higher than average mean being left behind as competitors seek Commerce and politics are interconnectedFDI growth did significantly worse in the CPI. to establish positions in what will be among and investigating potential conflicts
  13. 13. 10 Perceived to have Figure 1: CPI vs FDI Note: Kroll analysis based upon low levels of corruption information as provided by the IMF and UNCTAD; Kroll compared 9 countries in the EMEA regions with FDI stock greater than $10 billion to Public Sector Corruption Perceptions Index 2009 8 G-7 and BRIC countries. Size of circle represents projected 7 FDI. Sources: Transparency G7 Country Average International, IMF, UNCTAD United Arab Emirates 6 5 Turkey 4 Italy Brazil Romania China 3 Egypt India Azerbaijan Nigeria Algeria 2 Ukraine Russia 1 Angola Perceived to be 0 highly corrupt 0% 5% 10% 15% 20% 25% Stock of inward FDI CAGR 2009 to 2014 should be a high priority before investing Involve internal or external counsel in a Kroll was recently approached to review significant time and resource in a country. review of all key strategic options in order a potential partner for a global energy Our investigations in emerging markets, to ensure that commercial opportunities company seeking to enter the Chinese for example, often uncover opaque are assessed against fraud risks; market. The call came one month before relationships between customers, Safeguard against unforeseen risks. an agreement was to be signed. Through suppliers, and local officials. Also vital in Companies should seek to include deal painstaking research and discreet human this sphere is gaining an understanding terms that are even more defensive than source inquiries, Kroll concluded that the of the robustness of the local government usual when dealing with partners or proposed partner had significant issues with and regulatory bodies, as well as of what purchases in riskier jurisdictions; respect to its financial, operational, political, changes might occur after an investment and environmental performance. The energy Ensure that anti-fraud programs are takes place. There are several unfortunate company, which had initially expected a embedded within your organization and examples of companies investing millions clean bill of health, was in the unwelcome extend to the company’s intermediaries of dollars only to have licenses revoked by position – after several months of staff time, and partners. Significant investment will a new regime months later. be required in communicating these policies travel expenses, and advisors’ fees – of trying The need for physical searches and as emerging market countries typically do to find a more suitable partner. An integrated human intelligence: In many of these not have a culture of “whistleblowing”. due diligence exercise that had begun countries, certain key information is held earlier would have saved time and money. Although this advice applies to all types of locally and in physical form. Moreover, fraud, companies should, given the particular Due diligence, however, should never end members of the business and financial risks at present, pay special attention to with the acquisition. In the following communities are more likely to express implementing them with respect to anti- article Glen Harloff and John Price discuss true opinions or give advice only in bribery and anti-corruption efforts. options when the acquisition raises concern person and to someone they know. Perhaps the most difficult advice for post-competition.Once companies appreciate the challenges companies to adopt, given the speed atof doing due diligence in these markets, which transactions now take place, is towhat specific steps should they take before Melvin Glapion leads Kroll’s business allow enough time for this commercial and intelligence practice in London. He hasmarket entry? Despite the inevitable limits integrity due diligence. Early planning can over 16 years of experience of M&A,on what can be done pre-deal or pre- avoid the significant costs on potential corporate strategy and financialpartnership, some sensible steps include: analysis experience, leading multi- transactions that, in the end, prove disciplinary and multi-jurisdictional Ensure that your board shows commitment inappropriate. Initial due diligence work teams in conducting cross-border and leadership in order both to drive should: analyze the size of the opportunity; market entry, due diligence and competitive intelligence home the importance of anti-fraud identify the touch-points for potential fraud; engagements. Previously he advised on corporate strategy initiatives at KPMG, and has held several other programs and to avoid potential liability and, what is often forgotten, be broad enough strategy roles within the private sector. for negligently failing to prevent fraud; to consider alternative options.
  14. 14. By Glen Harloff & John PriceOnly so much can be investigated by lawyersand accountants during a typical due diligenceperiod. A truer picture, including questionablelinks between management and a company’svendors or customers, often only comes tolight post-transaction when the newmanagement team is in full possession ofthe facts, accounts and records. The changesbrought about by a purchase may eveninduce fraud. Occasionally, financial investorsor a foreign strategic buyer acquiring aprivately held business will use carrots, suchas bonuses tied to aggressive profit goals,or sticks, such as terminations in the eventof poor results. These can place managersunder unaccustomed, intense pressure toperform which may tempt certain sub-parstaff to adopt fraudulent practices.For example, a publicly traded retail companyrecently acquired a well-established retailoperation in a foreign jurisdiction. One of thelatter’s main attractions was the CEO, whohad a stellar reputation. The buyer providedadditional incentives, tied to certain revenueand profit goals, to the CEO and his seniormanagement team. After the second quarter,the CEO realized that these targets would notbe met. Perhaps, as we see frequently insuch cases, pride and greed took over, butinstead of reporting the true financial results,the CEO, in collusion with the CFO and othersenior managers, “cooked the books.” Saleswere overstated, expenses understated orinappropriately capitalized. Two years later,an anonymous e-mail resulted in aninvestigation which uncovered the fraud, butby then the damage was done – and thebonuses distributed.

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