“Fraud in times of crisis” by Roderick M. Vega (September 28, 2009)

SUITS THE C-SUITE By Roderick M. Vega
Business World (09/28/2009)

FRAUD OCCURS during good times and bad times, but more so during times of crisis.

In these interesting times, with the world in financial turmoil, many com-panies are busy fighting fires on several fronts.

Senior manage-ment has to deal with decreasing revenues, disappearing or falling market demand, precarious cash position, demanding credit-ors, and many other unpleasant conse-quences brought about by the global financial crisis.

Members of the C-suite, led by the CEO, will naturally want to prioritize restoring sales and preserving market demand for the company’s products or services, while at the same time reducing the cash burn of the business.

It may come as a surprise to some, but it is in times of crisis that incidence of corporate fraud is shown to increase. It is one of the unintended effects of the crisis which C-suite members should very well consider lest they be blindsided by it.

And fraud, when it does occur, always has adverse consequences in varying degrees and, in some cases can cause the downfall of companies.

Why is fraud an imposing presence in these times? In fact, fraud can happen in both boom and bust times, except that it is easier to conceal in good times. Many of these “fraud sins” tend to be hidden when com-panies ride the wave of success, i.e. when sales are increasing exponentially, stock prices are rising, and cash and credit are aplenty.

But when those successes are gone or when they subside, what surfaces are those companies with poor governance, weak internal controls, and highly leveraged positions.

Management should also be conscious that the current financial crisis brings about different aspects of the so-called Fraud Triangle. According to the Association of Certified Fraud Examiners, the Fraud Triangle consists of three elements — Opportunity, Pressure and Rationalization.

Here are some examples of how these three elements relate to times of crisis.

First, the fraud opportunity may result from cost reductions that companies use to minimize their cash burn.
When companies resort to Reduction in Force (RIF), some of the critical functions are merged, and the remaining employees are assigned more responsibilities. If management is not careful, some of these responsibilities may entail potential conflict of duties that, when left unchecked, may allow employees to commit Occupational Fraud. These are typical fraudulent actions like skimming, kiting, lapping, and pilferage by those handling cash and other assets; as well as bribery and check tampering by those with purchasing or cash disbursement functions, respectively.

Second, fraud pressure arises when there is need, for example, to increase or preserve sales that may cause a company’s sales force to resort to unethical or unlawful practices just so they can meet their numbers and keep their jobs.

Management is well-advised not to overlook unethical or illegal sales or market-ing practices. There can be severe conse-quences for companies that are found to resort to these, in particular if those companies are bound in some way with US regulatory requirements like the Foreign Corrupt Practices Act (FCPA). And, indeed, over the past few years, the US Securities and Exchange Commission and US Justice Department have been increasing their investigation of companies suspected of violating the FCPA.

Third, in fraud rationalization, employ-ees of companies under financial stress and with looming RIF may feel the need to “invest in their future,” avenge for perceived injustice in being laid off, or simply to preserve their lifestyle when large bonuses and paychecks were still the norm. Whatever the rationalization, these can be powerful motivations for employees to commit fraud in stressful times. Besides the theft of company assets, terminated employees may also resort to theft of company information which can range from those covered by intellectual property rights, customer files, marketing strategy and plans, and any other information that terminated employees intend to profit from.

What, then, can the C-suite do? As in any situation, acceptance is the first step in the process. Those in senior management should acknowledge that fraud can happen in their business. And rather than wait for the fraud to happen, or to be discovered, senior management can take a proactive stance when dealing with the risk of fraud.

For one, senior management can make a conscious effort to establish and imple-ment the Anti-Fraud Program. The prog-ram, developed by Ernst & Young, covers three important elements — Tone at the Top, Proactive, and Reactive.

Examples of the Tone at the Top element are levels of authority and responsibility, code of ethics, and fraud awareness training. Examples of the Proactive element of the program are fraud risk assessment, fraud controls monitoring and whistle blower reporting. Finally, the Reactive element of the program deals with how to respond to fraud allegations within a company, such as who should be investigating the fraud, how to preserve evidence, disciplinary actions to those persons found to have committed the fraud, and remediation of internal controls to prevent the fraud from recurring.

Most likely, many of these key elements that comprise a company’s Anti-Fraud Program are already present in a well-established company, but these elements may not be linked effectively or may need some improvement to really be effective in managing the company’s fraud risks. Any Anti-Fraud Program has to also continually adapt to the changing landscape because people who commit fraud are very creative.
Fraud risks, while they appear to be daunting at the onset, can be managed proactively. But, as mentioned previously, acceptance that fraud can happen in your company is the first step to managing the risk. The next step is not to get blindsided and to actually do something about it.

Roderick M. Vega is a partner of SGV & Co. and a Certified Fraud Examiner.

This article was originally published in the BusinessWorld newspaper. It is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.