Do some MNCs have a Fraud Problem?

A key aspiration of any leading Company is to maintain a high customer base, be profitable, have a sustainable business and importantly, to build trust with all Stakeholders.

Further, in order to secure an enviable Employer of Choice reputation and to achieve maximum profits, a specific strategic goal is to eliminate fraud and to create a collegiate, productive work place. This is easier said than done, if one considers the alarming incidence of internal / external investigations as well as the uptake in Management Fraud enforcement actions. 

Quite simply, the best way to minimize fraud is to prevent it from occurring in the first place.

Fast Facts which impact Business:

• Organisations lose about 5% of their revenue to fraud.
• With the advent of computers, the internet, and complex accounting systems, perpetrators now need only to make a telephone call, misdirect purchase invoices, bride a supplier, manipulate a computer program, or “hide” an asset to misdirect company property.
• In addition, because Companies make promises to Wall Street with regard to earning’s expectations, and succumb to pressures to “meet the numbers”, their often is a wilful blindness operating at senior levels when financial statements are “sanitised”. Hundreds of millions- and event billion-dollar frauds are not unusual, which in turn impact the Company’s stock price.
• Since fraud reduces net income, it takes significantly more revenue to recover the effect of the fraud on net income.

Ref: ACFE Study, “Report to the Nations on Occupational Fraud & Abuse”, 2012.

What is Fraud?

Essentially, fraud can be seen as either a theft or robbery of assets (overt), or a mechanism to secure an advantage over another by false representations (covert). It may include perfidy, surprise, trickery, deceit or financial chicanery. The only boundaries defining fraud those that limit human ingenuity.

In terms of defining “fraud”, the following criteria typically apply:

1. There is a representation;
2. About a “material” fact;
3. Which is false;
4. And intentionally or recklessly so,
5. Which is believed or relied upon,
6. And acted by the victim,
7. To cause damage to the victim.

Fraud is wholly different from mistake or unintentional error, as “bad intent” is absent in these instances.

Fraud Prevention:

The most obvious approach in preventing fraud is to tackle one of three (the easiest) elements of the “fraud triangle”, namely opportunity. As it is generally understood that “internal controls” are designed to eliminate “opportunity”, Risk Managers spend the majority of their time focusing on implementing good internal controls (policies, approval procedures, authority levels) and ensuring adherence to them. To a lesser degree do Risk Managers actually focus on the other elements of the fraud triangle, namely “rationalisation” and / or “pressures” (or motivation).

In the corporate world, it is pretty clear that “pressure” to achieve short-term (and long term) gains may often seduce an honest person to break the rules. Most fraud experts consider that “fraud triggers” or pressures can fall into 1 of 4 categories:-

1. Financial pressures;
2. Vices;
3. Work-related pressure, and
4. Reputational anxiety or a desire to compete with another.

When Management Fraud occurs, Company Executives may inflate income or overstate assets on the balance sheet to create a better financial scorecard. This may be due to the organisation’s poor cash flow position, declining sales or market share, or an inability to collect receivables. The major pressure is to keep the Company’s stock price high, in order to (falsely) assure Investors of the firm’s “financial health” and to also reap significant personal rewards through stock option earnings and eye watering bonuses.

What is Management's Ethical Barometer?

In terms of Psychology, the “honesty or ethical barometer” (or lever) when assessing individual proclivities to fraud can sometimes be described as follows:

• Individuals with high integrity and discernible transparency traits, yet with low opportunity, need extreme pressure to be dishonest.
• On the other hand, people with low integrity and high “control”, need low levels of pressure to be dishonest.

In the corporate world, if someone purposely enters incorrect numbers in a Financial Statement to trick or deceive Investors or Shareholders, then that clearly amounts to fraud or trickery. There is real intent, to gain an advantage over another, through false pretence.

In essence, this type of fraud involves greed by the perpetrator and – dare I say – greed or foolhardiness by Investors who insist upon consistently high returns (but fail to question when revenue returns continue to flow, when economic tumult impacts the majority of others).

Furthermore, in circumstances where prolonged financial misstatement takes place, there is a high degree of “confidence” at play. [Notably, the word “con” - which means to deceive - is derived from the word confidence). It is difficult to con many people, unless the Deceived implicitly trusts (or has unfaltering confidence) in the Deceiver. Where the latter is a large organisation, with oft stated high “Values & Behaviours” which emphasize Trust, Honesty and Integrity - the more unlikely is it that Investors will suspect that anything nefarious or inappropriate might be at play. At the heart of this, is Management Fraud or deception. It has no “face”, but it does have corporate conspirators to actively maintain the illusion (and hide the evidence).

In the case of financial misstatement, Executives usually commit fraud “on behalf of an organisation”, yet they also have “skin in the game” when the reported financial results look better than they are (i.e. which lead to promotions, generous bonuses and other lucrative incentives). This cabal of typically senior individuals particularly benefit because the misstatements will inevitably increase the Company’s stock price or cause it to remain artificially high in periods when they are in charge of the financial performance of the enterprise.  

In this scenario – see Enron, WorldCom, Parmalat, Adelphia – top executives deliberately engaged in a prolonged period of financial chicanery with the organisation’s financial statements with a clear intent to deceive absolutely everyone else. Such deception takes place when revenues are artificially inflated OR known liabilities are under-reported. The aim is to create the illusion that the Company is in good financial health, or far from insolvent. Moreover, it is virtually impossible for these high profile scams to be attributed to any single individual in a large organisation, as they require multiple levels of coordination, financial analysis and consolidation, as well as external vetting. In which case, the question is often: Why didn’t anyone raise concerns early on? And if they did, were those concerns taken seriously and acted upon in a timely manner? If not, why not? Importantly, who had the most to gain from a less-than-timely disclosure?

These are questions which seasoned investigators frequently ask as well Judicial Officers.

Comment:

What is clear is that the US economy was significantly hurt by the fraudulent acts which took place at Enron, WorldCom and Madoff Investment Securities. There were few heroes, as much of it could have been avoided by early intervention (by multiple Parties).

With a toolkit of sophisticated internal controls at one’s disposal today, do MNCs really have a fraud problem? Probably not – it is more likely that they have a “business problem”. They can either work towards honest, sustainable and organic growth OR they can stop pursuing questionable business models, which fly very close to the legal wire, and hope that the fraud is never uncovered – which is highly unlikely to today’s age of technological advancement and savvy human intuition.

If a fraud is prevented early on, then significant $$$ can be saved and resources can be reinvested in building up a healthy, viable business.

Moreover, should a major fraud be belatedly discovered (and / or exposed by an honest observer), this has a huge detrimental impact on the trust factor which Investors, Shareholders and Employees alike have in the organisation. In turn, this leads to investment decisions being made by Stakeholders and / or Governments as to whether they are willing to keep “backing” an integrity-challenged corporate player. Investors lose confidence in the Board and the Company, whilst Governments will very quickly look to more “honest brokers” to place their public funds, in providing public benefits.

It seems like such a simple equation:

• High Integrity + Honest Brokerage = Unquantifiable Success / Iconic Leader

OR

• Low Integrity + Deception = Failure / Demise / Felon