Cleaning house

The year 2009 will be remembered primarily for the calamitous recession and the regulatory authorities’ haphazard and controversial response to it. While dealing with the fallout of the worst financial crisis in 70 years, corporate boards around the world were also quietly grappling with another kind of scourge: financial fraud.

Around one third of companies were victimized by economic crime last year, and almost half say they saw cases of business fraud increase in 2009. That’s according to a survey conducted by PricewaterhouseCoopers (PwC) between July and November 2009 that polled 3,000 companies in 54 countries. The report, entitled ‘The global economic crime survey’, is among the most comprehensive ever conducted in terms of corporate fraud activity, and provides a far-reaching map detailing geographic and demographic hotspots for financial crime during one of the most challenging business climates for decades.

The top three corporate criminal hotspots might not come as a surprise: Russia tops the list with nearly 71 percent of respondents with operations there reporting high levels of fraud. South Africa is second, with 62 percent, followed by Kenya, with 57 percent.

But you don’t often find number four on the list in the same sentence as fraud and abuse. It’s Canada, where 56 percent of respondents reported financial crimes in their companies. That’s up 10 percent since 2003. The most common fraud reported by Canadian companies is asset misappropriation, cited by 83 percent of victims. Certainly, there have been some high-profile Canadian cases of outright theft in the news this past year: Toronto fund manager Weizhen Tang is accused of running a $60 million Ponzi scheme, while Alberta’s Milowe Brost and Gary Sorenson allegedly embezzled around $100 million from investors.

Globally, asset misappropriation or theft is the most pervasive crime reported, cited by 67 percent of those reporting crimes. Only 7 percent of Canadian victims report bribery and corruption, however, compared with 27 percent of non-Canadian victims. Globally, financial statement fraud is the fastest-growing form of economic crime, hitting 27 percent of victims – more than triple the number who reported it in 2003. Other crimes include money laundering, tax fraud, insider trading, espionage and intellectual property infringement.

The numbers might not tell the whole story for the industrialized western nations near the top of the list, however. The UK also checks in with impressive – or disappointing, depending on your perspective – numbers, ranking seventh in the world with 43 percent of its companies reporting financial crimes, followed by New Zealand (42 percent) and Australia (40 percent). The US – home of Bernie Madoff, who defrauded thousands of investors to the tune of billions of dollars – is near the top with 35 percent.

Desperate times, desperate measures
So what is driving this rapid increase in the amount and scope of financial crime? Most people point to the economy, suggesting that the difficult economic situation provides employees with a powerful incentive to cut corners, turn a blind eye or actively engage in fraud. About 40 percent of respondents believe their firm faces greater risk of economic crime in the downturn. Of those, 47 percent say difficulty in achieving business targets is a motivating factor for the culprits, while 37 percent point to the fraudsters’ fear of losing their jobs. The desire to earn personal performance bonuses, or for senior management to achieve desired financial results, is cited by 27 percent and 25 percent, respectively.

Better vigilance on the part of the companies themselves definitely plays a role in the awareness of corporate crime, says Al Vondra, a veteran forensic accountant and a partner in charge of the dispute analysis and investigations practice of PwC. But he says that although the numbers at US, UK and other major-economy companies appear high, they may be misleading. While fraud is certainly occurring, these firms are simply far better at detecting it; the numbers at companies with less stringent regulators and less established compliance regimes may well be higher than the survey indicates. After all, you can’t disclose what you don’t know.

This should come as no surprise. The corporate scandals of the last decade that helped spawn regulatory watersheds, like Sarbanes-Oxley (SOX) in the US, led to massive shareholder activism and motivated companies to set up internal mechanisms to catch criminals. Across the world, only 13 percent of the crimes detected were discovered by accident; twice as many – 27 percent – were uncovered by informal tip-offs, followed by internal audits or investigations (17 percent) and risk management systems (14 percent). About 7 percent of crimes were detected via official whistleblowing channels.

In the US, in particular, fraud reporting mechanisms put in place after the passage of SOX are having a major impact on the flow of tip-offs to authorities. Companies now place risk from compliance violations right up there with risks from a negative business climate and other factors that can damage the business.

Five years ago, says Vondra, compliance at the vice president level was the exception. ‘Now you have it in almost every company,’ he notes, ‘and the companies that don’t have it are getting it.’

Let the punishment fit the crime
Failure to remain vigilant is becoming increasingly costly. The Enron, Adelphi and WorldCom scandals and the options backdating fiascos that followed didn’t just increase regulation; they also dramatically hiked the cost to companies that failed to respond. The average settlement amounts for accounting-related class-action suits in the US rose from about $19.4 million between 1996 and 2002 to $52 million in 2008. With three companies forced to shell out nearly $2 billion in 2008, is it any wonder other companies are increasingly eager to detect and prevent crimes before they happen?

The latest trend in enforcement and government action may be helping to make the North American obsession with compliance even more global, says Vondra. US federal regulators have begun targeting companies for their actions abroad and recently served notice that corporate officers can be held responsible for the actions of their foreign partners – even if the officers themselves don’t directly participate.

The Foreign Corrupt Practices Act (FCPA) makes it illegal for individuals or companies to bribe foreign government officials to secure business. The number of FCPA cases brought against companies and individuals by the Department of Justice (DoJ) and the SEC nearly doubled between 2006 and 2007, and nearly quadrupled from 2002. The average size of settlements rose from $3.2 million in 2002 to $1.7 billion in 2009.

In December 2008 Siemens of Germany agreed to pay $800 million in fines and penalties to settle DoJ charges that it had engaged in a pattern of bribery the DoJ called ‘unprecedented in scale and geographic scope’, doling out money for contracts in countries including China, Mexico, Russia and Venezuela. It was the largest and most high-profile FCPA case in decades.

Last July, Frederic Bourke, co-founder of the Dooney & Bourke handbags and accessories company, was found guilty of conspiracy to violate the FCPA as part of a scheme to buy the state oil company of the Azerbaijan Republic. Bourke did not make the bribes himself; instead, prosecutors accused him of looking the other way while a Czech financier and partner in a consortium attempted to bribe officials. Bourke, the prosecutors argued, was guilty of knowingly investing in an offshore venture he knew had violated the FCPA.

The heat stays on
The US government has made it clear that such hardnosed prosecutions will continue. Last year, the DoJ publicly stated it has 120 investigations open. Many companies are now ramping up their due diligence, since even doing business with an entity that violates the FCPA can lead to criminal charges. This, in turn, is helping to ramp up financial controls around the world.

‘Companies are encouraged to do due diligence even on their suppliers and the people they do business with,’ says Vondra, ‘because if you have some knowledge that your trading partners are committing fraud and engaging in criminal activities, it could now affect you and your culpability. I’m seeing companies where officers realize they have some responsibility for this, so they go around the company preaching that bribing to get business in places where it’s the norm won’t be tolerated.

‘When the chief executive is out there spreading the word, things start popping through the whistleblower hotlines, people get nervous – and you start investigating. And once you start to investigate, you find more and more.’

This will only add to a push that has prosecutors increasingly sharing information across government agencies and borders, adds Vondra. ‘Overall, what you’re seeing now is a step up in enforcement internationally,’ he concludes. ‘The world is getting smaller by the day.’

Corporate fraud highlights

The PricewaterhouseCoopers corporate crime survey shows that companies across the world are taking complaints seriously: once internal fraud was discovered, 85 percent of fraudsters were dismissed. Civil or criminal charges were brought against 48 percent of internal fraudsters and 59 percent of outsiders.

• No industry is immune to the spike in financial crime, but those hardest hit are communications (46 percent), hospitality and leisure (42 percent), financial services (44 percent) and insurance (45 percent).
• Large companies – those with 1,000-plus employees – are the most vulnerable, with 46 percent reporting incidents. Nearly a third of those affected say they were hit more than 10 times in the last year.
• More than half (53 percent) of those committing economic crime work inside the organization they victimize. Internal fraud was highest in the aerospace, chemicals, manufacturing and pharmaceuticals industries. External fraud was most common in the insurance, technology, communication and financial services sectors.
• Economic crimes committed by middle managers accounted for 42 percent of all internal frauds, up from 26 percent in 2007. The number of frauds involving senior management declined over the same period from 26 percent to 14 percent.    
• The cleanest country is Japan, where just 10 percent of respondents experienced fraud in the 12 months prior to being surveyed. Hong Kong/China is next at 13 percent, followed by the Netherlands and Turkey, at 15 percent each.