Article by the Forensic and Investigation Services Department
A Chinese perspective
Despite the Chinese government's efforts to combat fraud and corruption, statistics emanating from Tsinghua University would suggest that fraud and kickbacks have totalled approximately 15% of China's GDP in the past decade.
Multinational companies are often more exposed to frauds in China. Unfamiliar with the local language, culture or business environment, expatriate management usually relies heavily on "trusted" local management. Relationships ("Guanxi") open the door to the Chinese market for these companies, but these relationships may subsequently lead to real problems, as "normal business practices" result in significant losses through fraudulent transactions and bribes.
When we have been called in by US and European parented groups to investigate their operations in China, it is not uncommon for us to find bogus transactions used to cover up cash and expensive gifts made by the companies' sales executives to certain third parties as "facilitation fees" for helping to secure business. Expensive gifts in many cases were also considered part of staff remuneration. Our investigations have often been triggered by whistleblowers or are issues identified through staff compliance training.
A further dimension is added where payments have been made that potentially are in violation of the US Foreign Corrupt Practices Act or local bribery laws, and in such situations the company may be liable to pay substantial financial penalties and may suffer serious reputational loss as a consequence.
So, our top recommendations to help multinational companies manage fraud risks in their Chinese operations are:
- Be professionally sceptical – "trust but verify".
- "Know who you are dealing with" – know your customers, suppliers, distributors and your other business partners well. Have formalised vetting procedures.
- Set up and monitor a formal internal control system.
- Look out for red flags, items that are abnormal, such as significant cash transactions.
- Put in place an ethical corporate culture and a fraud averse environment.
An Irish perspective
The announcement by the Irish quoted Greencore plc that it had uncovered a significant and deliberate concealment of costs in its mineral water business will raise concerns with senior management in many companies around Ireland who will be asking themselves "Could this happen to us?".
This is not the first time that a high profile company has suffered unexpected financial losses as a result of accounting irregularities that have arisen in the main from a breakdown in fundamental internal control procedures. But, in addition to the financial cost of such an event, the loss of reputation and shareholder and market confidence can also have a significant impact on the organisation. In most cases, the issues in question appear to have slipped under the radar of senior management, and the internal and external auditors.
So what controls and risk management procedures can organisations implement to minimise their exposure to such losses? As a starting point, the following fundamental controls should be in place:
- A lead-by-example culture of compliance should be established with best practice that filters down throughout the organisation.
- A clear fraud risk management strategy should be in place, devised following a comprehensive review of the organisation's risk environment.
- The internal control environment should be stringent and not easy to manipulate or override. All key accounting processes should be subject to regular review and challenge by senior financial management. There must be sufficient segregation of duties in all core accounting processes throughout the organisation.
- It is important that there is a culture of regular and active involvement from head office at remote business locations, particularly where local management may be heavily incentivised by performance related bonus arrangements or previous owners are still involved in the business and subject to earn out arrangements.
- A recognition of the importance of the internal audit process to risk management. Afford it a direct reporting line to the board of directors. Of course, many businesses will not have the luxury of a dedicated internal audit team but such businesses should consider outsourcing this function to a third party or extending the scope of the external audit process to cover a review of areas of perceived risk or concern.
- An embracing of the external audit process as an important component of the risk management process. It is important that the audit methodology is a risk based approach, agreed between the auditors and the management team, or audit committee where existing, and focuses on the key business risks. The auditors should meet with management and the internal audit team on a regular basis.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.