Fraud on the board

Posted on 12 Aug 2008 by The Manufacturer

With fraud a £1 billion-plus annual cost to British manufacturing, Colin Chinery reports that the biggest enemy is not at the gate but on the top floor

Ask not what I can do for my company, but what can my company do for me. Nigerian scammers and identity or credit racketeers are not Britain’s biggest fraud threats, says leading fraud-buster Simon Bevan. “It’s a myth. In terms of size – the 80/20 rule – the losses come from internal management ripping manufacturers off, not bogey men from outside.”

Bevan is national head of the fraud services unit, BDO Stoy Hayward, in effect a forensic accountant and leading member of a genre described as the latest soldiers in the ‘war on terror’.

Bevan’s team specialises in investigating internal frauds for large plcs and public sector organisations. It is Britain’s biggest white collar fraud unit and business is booming. “Exploding, in fact. We are taking on as many as three new cases a week. We like to think that fraud is a dirty, sort of southern European disease which we don’t have here. But we’ve always had high levels of fraud. And fraud tends to occur in a boom and get exposed in a recession.”

Bevan works across all industries and says most frauds are committed by managing directors, finance directors, heads of marketing, and overseas managers of manufacturing entities. “It’s this internal fraud and kickbacks we see. And if it’s the financial director (FD) who is committing the fraud, the chief executive will be ringing us up. If it’s the chief executive it’s harder, in which case it’s usually the FD or maybe the audit committee who is contacting us.

“We’ve seen auto industry buyers getting new kitchens from the supplier. There are a lot of these sweeteners.” Then there are bogus factories and plants with multi hundred thousand pound annual maintenance bills where only 50 per cent of ‘work’ paid for has been done. “In the oil industry we’ve seen several million pound payments on patents on part of a rig that wasn’t patented – all because of kickbacks; management colluding with suppliers. You see management manipulating the accounts and mis-reporting figures, just to keep their jobs.”

With the control mechanisms of auditors and management at the workplace, and the backhander often unseen, detection can be difficult. “But what you do see is people with a lifestyle greater than their income, and perhaps adverse figures on the accounting side.

“In a boom, if your revenue is going up 10 per cent and you’ve got a £5 million marketing budget and this goes up 10p you don’t give it a second thought. But in a recession you say ‘hold on a second; why are we spending £5 million on marketing?’

“Then you look at it and find 80 per cent is spent with one supplier, and hey, that supplier is linked up to the brother-in-law of the marketing director. And it’s only because you start asking questions that you find something you don’t like.”

Bevan, 23 years in the fraud detection business, says there are only two ways a manufacturing company can be defrauded: over-statements of costs, and dilution of revenue. “If you dilute the revenue, if you are not getting the revenue back from the products you are sending out, that nearly always comes out as a stock loss. This is much harder to do in the manufacturing sector, where it is easier to get kick backs through paying too much for goods and services. Often it’s not the purchase of the components but the marketing of the product, in other words it tends to be on the accounts payable side.”

But there is another mega fraud, one whose sticky trail begins far beyond these shores – counterfeiting.
“The counterfeiter has now very much replaced the drug trafficker in terms of high rewards and much lower risk. Without doubt it is a humongous business,” says Gary Miller, a partner in the fraud and insolvency group at law firm Mishcon de Reya. And with the losses to British manufacturing running into billions of pounds, he says an effective anti-counterfeiting programme is an urgent priority.

“Almost everything we eat, use or sit in has got a part capable of being counterfeited and passed off as a genuine product. There are not enough resources to track down those involved. And part of the issue facing British manufacturers is establishing within their own organisations a proper understanding, and tracking down what it is that is hitting their bottom line – where are they coming from, who is distributing them, and what is the impact on their business?

“A lot of companies naively assume that because it’s not a Gucci handbag, people aren’t out there faking it and passing it on as a genuine item. The automotive and airline industries are classic examples where there are very important safety issues relating to the question of where the parts are sourced, and whether they are getting them from an approved manufacturer or vendor.”

But according to Miller, 31 years a global fraud-buster, there is a huge amount of pressure for companies not to acknowledge and investigate.
“The more you investigate the more you find.
And the more you find the greater the pressure in terms of share price and reputation issues.”

So how is counterfeiting to be combated and suppressed? “You need a robust criminal legal system, and at the moment the way our system works it’s not thought of as anywhere near as serious an offence as stealing money, even though
effectively that’s what it is.”

Manufacturing too has got to be much more focused on finding out who is really making the money out of supplying and distributing the fake products.

“If you only focus on trying to take down factories in China, Croatia, or wherever, all you are doing is simply cutting off one head of a multi headed dragon, and within months it’s going to pop up with six other little factories or sweat shops.” Miller wants a multi-pronged anti-counterfeiting strategy, with manufacturers focusing on the supply chain – and the more remote the greater the threat – and identifying who is making the most money. “And it’s normally the wholesaler – distributor. There are always going to be a few Mr Big distributors and these are the people really making hay.”

When the issue is executive hands in the company till, Simon Bevan urges an internal questionnaire approach. “Look at the positions of real risk in your organisation – the chief executive, financial director, and head of marketing – and ask yourself, ‘what sort of frauds could these people commit, and how could we mitigate against them?’”

You can’t design out fraud, says Bevan, “but you need to put tripwires into place so you know within six weeks rather than six months that you’ve been defrauded. Look at your P and L (profit and loss), look where you are spending your most money, because this is where the most fraud opportunity is.

“And the biggest defence is recruitment. It’s
a bit of a cliché, but if you recruit only honest staff and have very poor systems, you won’t suffer fraud. If you recruit dishonest staff, then no matter how good your systems, people will collude to get round them and defraud you.”

There’s no perfect system, says Gary Miller.
“No company would be able to do business if it tried completely to suppress any possibility of its employees or third parties being dishonest.

“As for statistics, you are in that difficult territory of not being able to prove or record what has not appeared on the radar screen. The bottom line is that most of us in the fraud practitioner and criminal prosecution business know that you generally pick up a fraction of the frauds going on in your company or in the country at any one time. Now this is the whole debate: is that fraction 10 per cent, 15 per cent or 20 per cent?”

Surprisingly, manufacturers attach little or no importance to fraud prevention, says Bevan. “We will do a big investigation and they will pay us a very large fee in respect of a very large fraud. But when we talk to them about fraud prevention there is very little interest. They think it won’t happen to them. It’s unbelievable, amazing.”

Gary Miller agrees that companies are less willing to pay for external advisors, but finds an increasing number of companies undertaking in-house fraud awareness and prevention campaigns. “But are you saving money and are you getting an objective analysis of what’s going on? A classic example is the writing off of bad debts. The general rule is that about 15 per cent to 20 per cent of all bad debts are mis-characterised, not bad debts but a result of fraud, a dummy invoice, the supplier intentionally supplying complete rubbish.”

Ninety five per cent or more of investigated frauds never reach the criminal courts, says Simon Bevan. What companies want is to know who took the money, how they took it, and get the executive(s) out of the door as fast as possible.

“Often the worst thing that can happen is that you lose your job. You would think, ‘OK, they’ve taken the money but they’ll never work again’. But some of them do. And while those who commit fraud may not have a criminal record, they often have a reputation, a smell around them from other organisations they’ve worked for. Which means the recruiters have not done their due diligence.”

Recession brings a closer scrutiny of business practices, says Gary Miller. “And on the other side of the fence, individuals are under huge amounts of financial and psychological pressure to maintain their jobs and salaries. And what happens in those circumstances is that their moral compass becomes completely skewered.”