Eye on financial fraud and corruption

0

Fraud remains prevalent even in a world as advanced as today.

Certain deals come to form via under-the-table deals, added bonuses for certain individuals or even corporations in whole hiding irregularities or issues amongst technical jargons and insepid figures.

The fact of the matter still stands: How will this affect investor confidence and the ease of doing business in Malaysia?

Most businesses in Malaysia have taken upon themselves to put in place policies and controls to curb the problem, but the underlying notion that fraud, bribery and corruption is part and parcel of doing business in Malaysia remains.

In a survey conducted by the top four accounting firm; KPMG Malaysia, involving 100 listed companies on Bursa Malaysia,  64 per cent of respondents stated that businesses cannot be done in Malaysia without paying bribes.

More alarming is the fact that out of those that took part in the survey, a majority being top management, a whopping 90 per cent opined that fraud is an inevitable cost of doing business, while 71 per cent of them said the same about bribery and corruption.

Tan Sri Abu Kassim Mohamed, chief commissioner for the Malaysian Anti-Corruption Commission (MACC) previously said, “Corruption has detrimental effects on the economy.

“Corrupt practice also creates an unfavorable business environment, which promotes anti-competitive practices, unfair advantages and enables organised crime to flourish.

“Indeed, corruption is one of the most potent hindrances to the economic development of a country; it undermines the rule of law, weakens trust in public institutions and challenges democratic principles.

“With various initiatives stemming from this, we have taken steps that are in the right direction to reduce these occurrences.

“We are putting in place the relevant  laws and programmes such as MACC’s transformation programme, which also focuses on a constructive approach to curb corruption in the private sector, to instil a strong anti-corruption culture, along with the highest standards of conduct and behavior amongst our citizens starting with the top-most rung of leadership to the man in the street.

“In a rapidly changing business environment, it is vital to develop an integrated fraud and corruption strategy to address these risks.

“Implementing effective fraud and corruption measures is part of good governance and practice, but admittedly, there is still much to

be done to increase confidence in the facilities that enforcement agencies provide in Malaysia in curbing corruption.”

‘Inevitable cost’ of doing business?

KPMG in its survey noted that 52 per cent of the respondents state that fraud is  a major problem in their organisation, out of which 14 per cent strongly agreed.

It added that 90 per cent of those who stated the contrary were part of the 83 per cent of respondents who felt that fraud is a major problem for Malaysian businesses in general.

“It is interesting to note that 90 per cent of those who stated that fraud is a major problem in their organisation felt that fraud is an inevitable cost of doing business.

“This type of mindset that fraud is part and parcel of doing business is rather dangerous as it could result in the cultivation

of a somewhat lenient and tolerant attitude towards the occurrence of fraud, with organisations merely reacting to fraud instead of taking proactive steps to nip it in the bud,” it stated.

Fraud is a pervasive and persistent threat in Malaysia with an impact that is widely felt despite positive efforts being made towards enhancing fraud prevention.

Out of the total survey respondents, representing 14 industry segments, 48 per cent admitted to having encountered fraud in their organisations during the period from January 2010 to December 2012.This reflected a meager decrease of one per cent from the 2009 survey hence indicating that fraud is still regarded as a significant problem in their business.

In its report, KPMG noted that 92 per cent were able to quantify the range of financial losses due to fraud with 26 per cent able to state exactly the quantum of fraud loss experienced which amounted to RM2.407 million.

The result indicate that 42 per cent of the reported fraud incidents were within the range of RM10,001 to RM100,000.

KPMG explained that of the total reported value of fraud, which amounted to RM2.407 million, 45 per cent were attributed to customers, 32 per cent were attributed to non-management level employees while 21 per cent were attributed to service providers.

Although the incidents of fraud cases perpetrated by non-management employees appears to have increased as compared to the 2009 survey.

“We asked executives what factors may foster the occurrence of fraud in their organisations.

“Respondents cited poor internal controls (68 per cent), lack of skill sets of internal audit team to detect fraud (39 per cent) and lack of fraud awareness training which have resulted in the inability by staff to recognize glaring ‘red flags’ or early warning signals of fraud (39 per cent) as the three main factors allowing frauds to occur.

“Poor internal controls was also the leading response from this,” said KPMG.

Regional crisis

Similar fraud surveys conducted by KPMG member firms in Australia and new Zealand (28 per cent), Argentina (28 per cent), Chile (78 per cent), Mexico (25 per cent) and Uruguay (90 per cent) showed poor internal controls were a major contributor to fraud as well.

KPMG explained that organiations responded to these fraud cases in a multitude of ways, adding that response to fraud is crucial as it has the ability to help prevent future occurrences of fraud or unwittingly send the wrong signal to potential fraudsters.

Respondents were asked how their organisation responded to identify cases of fraud.

The most common response was that an internal team was mobilised/ external team was hired to investigate the fraud (71 per cent). Implementation of new/ change in existing controls (53 per cent) was the second most frequent response followed by immediate dismissal / disciplinary hearing (47 per cent).

“It is important to note that when investigations are not properly conducted, valuable evidence may be lost or unknowingly destroyed and the organisation may fail to uncover other instances of fraud.

“Our survey suggested that the most common reason why organisations fail to report incidences to the authorities are fear of negative publicity (47 per cent), inconvenience (47 per cent) and no confidence in the ability of the police or other enforcement agencies (32 per cent),” said KPMG.

“The prospects of recovering monies lost to fraud are poor. 50 per cent of respondents state that they were unlikely to recover 100 per cent of the misappropriated assets.

“For misappropriated assets which were actually recovered, 56 per cent of the value recovered was recovered from third parties whilst 11 per cent was recovered from perpetrators.”

To handle these issues, there should be a policy in place, which requires all of its employees to declare their external business interests in particular notifying any potential or actual situations that give rise to conflicts of interest with an external party with whom the organisation is doing business.

“The survey revealed that 34 per cent of respondents’ organisations required its employees to submit an annual written declaration of any potential or actual conflicts of interest whilst 18 per cent required employees to submit an annual declaration of their financial interests and those of immediate family members in relation to any activities relating to its business.

“It is also noted that only 19 per cent of respondents state that their organisation required employees to declare annually that they are in compliance with the organisation’s code of conduct.”

Poor internal controls

At the moment, there are organisations that had reviewed and improved internal controls, with 26 of them listed poor internal controls as the main contributor to fraud.

Other common steps included the conduct of pre-employment screening on staff, establish a corporate code of conduct / ethics, and establish a fraud control strategy.

Overall, there was an increase in fraud risk management strategies in place as compared to the 2009 survey.

With a majority believing that the board having a large say in risk management, bribery and corruption poses a real threat to companies as well as investor confidence.

The increasing importance of understanding and managing bribery and corruption warranted a more detailed treatment by KPMG.

As the leash of legislation tightens globally, Malaysian firms are under increasing pressure to implement more robust frameworks for detecting and managing bribery and corruption risk.

Although the last few years have seen publicised efforts by some corporations and the Government to create awareness about the ill effects of this malaise and discourage it, the industry by large remains reluctant to discuss this issue.

“We encourage organisations to consider the risk of bribery and corruption when developing fraud risk strategies.

“It is interesting to note that 71 per cent of respondents believed that bribery and corruption is an inevitable cost of doing business whilst 64 per cent believed that business can’t be done in Malaysia without paying bribes,” it said.

Corporations which operate in challenging commercial environment and in cultures where bribery and corruption is widespread, understand their responsibilities and operate to the highest ethical standards.

“Therefore, organisations need to put in place adequate policies and procedures to prevent bribery and corruption.

Ever-evolving risks inherent

Beyond the initial on-boarding due diligence on its business partners, organisations should periodically revisit the process in light of ever-changing risks.

In line with an organisation’s zero tolerance approach to bribery and corruption, its business partners must be required to strictly adhere to the organisation’s Anti-bribery and corruption Policies and code of conduct.

Companies are seeing an increased focus on managing third party relationships by including anti-bribery clauses and ‘right to audit’ clauses in new and re-negotiated agreements with third parties.

Despite the potential implications for their business, a majority of organisations have admitted of being largely unfamiliar with the Malaysia Anti-corruption commission Act 2009. This finding suggests a need for greater education and awareness in this area.

Aside from this, it is worrying to note that respondents were generally not aware if their organisation was subject to the US Foreign corrupt Practices Act 1977 (52 per cent) and the UK Bribery Act 2010 (53 per cent).

Given the broad jurisdictional reach of both Acts, this suggests that many organisations could be at a significant risk of non-compliance, potentially impacting confidence levels for foreign investors for the company.

Because of the expansive reach of its jurisdiction, any company that conducts any part of its business in the US and UK should immediately re-examine its anti-bribery policies and prevention efforts. Failure to do so can result in fines and even imprisonment.

The UK Bribery Act specifically provides that companies can be held liable if they failed to implement adequate bribery and corruption preventive measures.

Touching on the foreign impact (specifically US), Ernst and Young’s global leader for fraud investigation and dispute services, David Stulb noted, “The US Securities and Exchange Commission (SEC) and the US Department of Justice (DoJ) have continued to lead the way in robust domestic and extraterritorial proceedings relating to a wide range of offenses, including financial statement fraud and bribery.

“The SEC’s Financial Reporting and Audit Task Force is starting to deploy cutting-edge forensic data analytics tools to mine corporate big data for fraud and is engaging whistleblowers in unprecedented numbers to uncover financial reporting and disclosure problems.”

Stulb added that it is not just US authorities that are engaged in this fight. Regulators in the UK, Germany, Italy and France, among others, have been involved in major enforcement actions, including those relating to financial services mis-selling, reference rate manipulation and bribery.

The European Commission and Japan regulators have teamed with their US counterparts on cartel investigations.

Cross-border cooperation among prosecutors is strong and growing stronger. With a number of countries adopting stronger legislation, including India, Brazil and China, the number of parallel investigations is likely to rise further still.

“Our research suggests that there may be a persistent or residual level of inappropriate conduct that cannot be eradicated.

“That is not to say that companies and their stakeholders should simply accept such behavior — rather, companies need to uncover such conduct faster and to focus on minimizing its impact on the business as much as possible.

“Companies also need to address the emerging external threats — such as cybercrime — which have the potential to cause significant reputational and financial damage,” said Stulb.

Enforcing good corporate conduct

Following the financial downturn, consumers and investors have become more aware and increasingly intolerant of corporate conduct they perceive as unethical. As a result, regulators are expected to broaden their remit to enforce good corporate conduct.

Businesses appear more likely now to be challenged on any activities that are considered to have been detrimental to consumers or the effective operation of the financial markets.

Recent examples include the large number of mis-selling reviews in the financial services sector.

Additionally, regulators can be expected to increase their focus on financial statement fraud as the risk of such behavior is perceived to increase as businesses struggle to fulfill the resurgent growth expectations placed on them by the markets.

With the creation of the Financial Reporting and Audit Task Force in the US, it should be expected that an increase in enforcement action will follow in the near future.

With the evolving nature of businesses today, having the basic compliance elements in place is not enough. organisations need to improve the effectiveness of their risk assessments — responding quickly to new and changing risks.

They need to ensure limited resources are focused effectively — including the use of forensic data analytics.

They need to tackle the significant bribery and corruption risks associated with transactions and do more to promote and incentivize ethical business conduct.

At the end of the day, businesses need to do more than implement a whistleblower hotline to promote and incentivize ethics. But nearly half of the businesses in Malaysia do not have a hotline in place, so this is an essential starting point.

Boards should be asking the business how else they are promoting and incentivizing ethical behavior.

Many businesses will find it very easy to describe how they are rewarding growth — but can they also articulate how they are rewarding an ethical culture? What is the role of the remuneration committee, for example, in monitoring how performance against this metric is encouraged?

With Malaysia jumping in ranking is well received by the investment community and economists laud the significantly stronger investor sentiment as an achievement, especially in view of the rising cost of doing business in Malaysia.

Arguably, it is a sign that Malaysia is moving very fast up the value chain.

It was noted in the 2014 Foreign Direct Investment Confidence Index by AT Kearny that any improvement in global ranking is always a step in the right direction and serves to highlight Malaysia’s competitiveness and attractiveness as an FDI destination with policy, rather than ranking, is the main FDI pull factor.

Ranking is more a marketing point; but it is a very convincing one. Malaysia is undergoing subsidy rationalisation. The hikes in electricity tariffs and petrol prices, and the implementation of minimum wages have increased labour cost and the cost of doing business in the country.

Malaysia’s attractiveness, hence, would depend on the policies supporting its goal in becoming a high-income nation and how fast it can move up the value chain, especially in terms of building a pool of quality human capital.

The Malaysian Anti-Corruption Commission has said it was looking at the survey findings and wanted to come up with better programmes to fight corruption in organisations, placing emphasis on detection, prevention and education. But don’t expect immediate results, as educating people can take time.

However, if nothing is done, it will just get worse. And as the basic tenet of corruption is that it has two sides – a giver and a taker – someone has to stop before it can be tackled, potentially impacting not only credibility of businesses locally but also affecting business confidence towards the country.