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2014-03-11 05:18:10
Fraud within companies is a risk that can never be eliminated, just managed
BUSINESS has always been plagued by fraud: witness the South Sea Company in the
1710s (which enveloped the British economy in a giant bubble) or Charles Ponzi
s Securities Exchange Company in 1920 (which gave the world the Ponzi scheme)
or the Enron and WorldCom scandals in the early 2000s. Ambitious fraudsters are
attracted to businesses for the same reason that Willie Sutton, a contemporary
of Ponzi, reportedly said he robbed banks: Because that s where the money is.
Some frauds are committed by people at the top such as Bernard Madoff or Allen
Stanford. Others are committed by hired-hands lower down the organisation. But
all frauds involve abusing people s trust and diverting corporate resources for
personal ends. Fraud by wayward employees, be they high or low, can never be
eliminated. Directors and executives can, however, treat it like any other
unavoidable risk, and manage it professionally.
The risk is particularly acute at the moment. Companies are straining the bonds
of loyalty. They are making ever more use of contractors and temporary workers.
They are putting more pressure on employees to hit targets; they are also
holding down the wages of the majority of workers while increasing the boss s
pay. This is all happening at a time when economic activity is shifting to the
emerging world (where corporate fraud is rife) and to the internet (where
fraudsters are having a field day). Kroll, a security consultant, found that
70% of the companies that it studied were affected by fraud in 2013, up from
61% in the previous year.
At the same time the punishment is harsher than ever. Companies nowadays run
the risk of being held liable for their employees misbehaviour unless they can
show they had done their best to prevent it. Directors who play even the
smallest role in frauds can now go to prison. America s Foreign Corrupt
Practices Act and its European imitators have made a serious crime of something
once seen as normal business practice: bribing foreigners. Companies infected
by fraud can incur all sorts of other costs. Their licences to trade may be
withdrawn, they may be barred from bidding for government work and they may be
subjected to online campaigns urging customers to boycott them.
What can companies do to uncover internal scams? A new book, Corporate Fraud:
the Human Factor , by Maryam Hussain, an investigator at EY, an accounting
firm, provides a timely guide. One answer is to look for the telltale signs.
Some of the biggest corporate tricksters were people whose flamboyant
personalities often raised suspicions: think of Robert Maxwell, or Augustus
Melmotte in Anthony Trollope s The Way We Live Now , perhaps the best novel
about corporate fraud. Boards have a duty to pluck up the courage to challenge
such larger-than-life bosses.
However, most corporate fraudsters do not have swishing reptilian tails as a
giveaway sign. In many instances they are not borderline psychopaths, just
ordinary people gone wrong. Frequently, they start with small crimes and then
engage in ever bigger misdemeanours to conceal their wrongdoing. Nick Leeson,
who destroyed Barings Bank by losing 862m in bad bets on derivatives, said,
It all started when I tried to cover for a junior colleague who had lost
20,000. Ramalinga Raju, the chairman of Satyam, who admitted to inflating the
computer-services company s revenues by $1 billion, said, It was like riding a
tiger, not knowing how to get off without being eaten.
A second answer is to put procedures in place to detect frauds. The
Sarbanes-Oxley law passed in America after the Enron and WorldCom frauds
requires the boards of public companies to commission independent audits of
their internal financial controls. But rigorous procedures can easily lure
companies into a false sense of security. The employees most affected by those
rules may be precisely the ones most capable of finding ways around them, as
was the case with Mr Leeson and J r me Kerviel, a renegade trader at Soci t G
n rale.
Many companies seek reassurance that all is well by installing cyber-security
tools to monitor employees e-mails and internal accounting systems for
suspicious activity. But fraudsters are often quicker at harnessing technology
to disguise what they are up to (for instance, using instant messaging on their
smartphones as a back-channel to communicate with accomplices) than companies
are at using it to spot them. Those running scams may also be skilled at
tricking colleagues into giving them passwords a technique Edward Snowden may
have exploited to devastating effect.
Praising the bearers of bad news
The most powerful weapon against fraud is not an algorithm or a checklist but a
whistleblower. The Association of Certified Fraud Examiners calculates that
three times as many frauds are discovered by tip-offs than by any other method.
It also notes that firms with fraud hotlines, which staff can call anonymously,
suffer smaller losses from fraud, and cut by seven months the exposure gap
between the start of an illicit scheme and its discovery. Governments are
increasingly providing whistleblowers with legal protection and financial
incentives: America s Securities and Exchange Commission has created a $450m
fund to reward them.
Companies that dither, blather or launch half-hearted inquiries when presented
with evidence of employee misconduct often end up regretting it. JPMorgan Chase
lost billions in its London Whale rogue-trader scandal, initially dismissed
by the bank s boss, Jamie Dimon, as a tempest in a teapot . Besides doing more
to encourage whistleblowers, businesses must take decisive action to close the
exposure gap. A botched investigation can tip off a fraudster and make it easy
for him to cover his tracks. A suspicion of deliberate foot-dragging can render
an entire company vulnerable. The damage done by corporate fraud can last long
after the culprits have been identified.