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BW Businessworld

A Timely Check Needed To Curb Frauds

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An organisation faces numerous threats such as adverse market conditions, obsolete technology, risks related to human capital, finance, fraud, reputation and regulatory compliance. To mitigate these, companies may need to invest a substantial amount in terms of time and effort to protect their business. However, it is often observed that such an approach is either neglected or companies have inadequate budgets to address such challenges. Many industries have been victims of fraud — even suffering from enormous losses. In extreme cases, the severity of the situations has even forced companies to file for bankruptcy.

Global reports bear true testimony to this scenario, for instance, ACFE’s ‘Report to the Nations on Occupational Fraud and Abuse, 2014’ estimated that a typical organisation loses 5 per cent of their revenues each year to fraud. Though a small number, it will have a significant impact on the bottomline. The new Companies Act 2013, a game changer for corporate India, defines fraud, penalties for delinquency and establishing a vigil mechanism. It also highlights extensive responsibilities of board of directors, independent directors, audit committee and auditors — focusing on establishing, evaluating and mitigating risk of fraud and reporting of fraud in case of auditors. Thus, it is imperative for organisations to institutionalise a fraud risk management framework, which would not only help them in adhering to the Act, but also lead to cost savings for the company.

If You Think You’re Safe, Think Again!
With the fraudsters innovating every day, no organisation today is immune to its risks. In a positive economy, a company may be doing well and witnessing an increase in profit margins. But such a scenario could see frauds being undetected. However, with diminishing margins and pressure on liquidity, the likelihood of fraud detection, which may typically go under the radar, increases. Today, organisations may face different fraud risks such as:

• Financial statement fraud: Inflating revenues or assets and understatement of expenses or liabilities

• Bribery and corruption: Conflict of interest, kickbacks and bid rigging

• Asset misappropriation: Fictitious expenses, personal expenses charged as official, assets misutilisation, thefts

While any department in a company may see a fraud incident; procurement, sales, accounting and finance departments are more susceptible. Cases of data theft and cybercrime are also increasing with fraudsters becoming extremely tech savvy. It has been observed that in many cases, frauds comprising significant amounts have seen management involvement. However, perpetrators could range from employees, external parties such as vendor, customer etc., or collusion between them.

Numbers Don’t Lie
ACFE’s ‘Report to the Nations on Occupational Fraud and Abuse, 2014’ pegged the median loss caused by frauds at $1,45,000. If unnoticed, frauds can even lead to high cost of purchases. This is because kickbacks paid by vendors would be charged back to the company either by supplying inferior quality material, overpricing, or by short supplying them. Depending on the nature and magnitude, situations may lead to investigations by statutory authorities. This would result in high legal costs, fines and penalties. The impact would also be seen on the reputation and brand, leading to lowered investor confidence.

A Framework To Rescue
The responsibility to detect fraud risks lies with all stakeholders in the organisation — Board of Directors, audit committee, management, employees as well as internal and external auditors. It is also important to demonstrate the organisation’s preparedness and response toward fraud risks in an efficient and cost-effective way. This can be done by establishing a strong anti-fraud framework, which can identify, prevent or detect fraud risks through reactive steps such as investigations and corrective action. A company that implements a zero-tolerance policy is less likely to incur financial losses due to employee fraud than companies that have less stringent policies.

To illustrate the benefits and cost savings by implementing fraud risk management, let’s take the example of a large construction company with a decentralised procurement team comprising two-five employees. They handle the complete process in their respective regions. A fraud risk review was initiated in two large regions of the company and significant lapses were observed in the procurement process. These remained unidentified through regular internal audits. However, an investigation revealed that on an average, 3 per cent of the procurement costs were paid as kickbacks by several vendors to the procurement team. These kickbacks were primarily given to get the contract and also used to inflate the rate at which materials were supplied. This way, vendors gained more out of each supply. The company’s major raw material cost for a year was approximately Rs 5,000 million — considering an average of 3 per cent as kickback, the amount resulted in approximately Rs 150 million. So the amount of kickbacks paid by vendors (which they added up to the material cost) was enormous (30 per cent of net profit), considering that the net profit of the company for the year was Rs 500 million.

In a manufacturing company, fraud risk review was undertaken, which identified significant lapses in the payment process. These included a lack of segregation of duty, misuse of authority matrix and management override of the existing control in the vendor payments, which led to several suspicious payments of Rs 1,000 million over a period of six years. These expenses were incurred on the request of the senior management to shell companies, consultancy vendors and other related parties (undisclosed). They were identified as unwanted and suspicious in nature and also the benefits derived from incurring these expenses could not be substantiated.

Frauds do exist in a modern-day business environment and the potential impact of a sizeable fraud could be commercially disastrous for an organisation. It would also require systematic and continuous efforts to curb them. Historically, it has been seen that every fraud starts small, but if unnoticed, it could lead to bigger frauds over a longer period of time. So it is important now for organisations to comply with the Companies Act 2013 and have a robust fraud risk management systems in place. This way, companies can boost their profits; unearth fraud risks and safeguard corporate wealth and reputation.
The author is partner and national Leader, Fraud  Investigation & Dispute Services, Ernst & Young India
(This story was published in BW | Businessworld Issue Dated 06-04-2015)

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