Corporate fraud - Unusual suspects

It is said that the biggest frauds are committed through the aid of either an accountant or lawyer, or perhaps both. The value of commercial fraud, according to the latest statistics, doubled to £162.2m in 2001 from £82.2m in 2000, despite a series of new anti-fraud measures in the UK and Europe.

A second poll this year found that 90% of respondents said companies should be legally required to implement anti-fraud procedures and investigate fraud. In the same breath, the survey by PricewaterhouseCoopers highlighted the unwillingness of the British public to report fraud, raising questions about the effectiveness of the 1998 Public Interest Disclosure Act.

Work in the forensic accounting sector at most of the largest accountancy firms has doubled in the past year as a result.

Gerry Lagerberg, forensic partner at PwC, says: ‘There’s been one or two collapses as a result of fiddling the numbers. But we’ve picked up lots of acquisition disputes where people have found they don’t like what they’ve bought.’

Despite government efforts to combat fraud, it continues to rise and usually becomes more prevalent during an economic downturn or recession.

Corporate fraud through a manipulation of accounts is going on all the time, explain forensic accountants, but it is not until a slowdown occurs that it can be seen.

Raj Bairoliya, managing director of Forensic Accounting, says: ‘Everyone is happy to see profits booked but no-one is interested in where they come from. Lots of remuneration is based on performance and commissions. It doesn’t make anyone want to doubt anything.’

Last year the head of economic crime at the National Criminal Intelligence Service criticised accountants for a severe lack of disclosure of potential fraud or money laundering incidences despite accountants being one of the professions most closely involved in financial services.

Post-Enron more and more people are now asking whether the right questions are being posed to the right people? How long can crime fighters continue to blame specific professions when perhaps it is time for governments and regulators to get tough?

Perhaps, as is being increasingly suggested in the wake of Enron and the questioning of highly complex corporate structures, the solution to fraud-fighting may lie in more transparent financial reporting and tougher corporate governance.

Lagerberg says: ‘The question now is do company directors really understand what’s going on in the business? Innovative businesses are usually in risky areas. Directors need to understand and manage these risks.’

The reasons for Enron’s demise are still largely unclear, but the issues that have emerged, such as special purpose vehicles, covering up of liabilities and directors’ selling shares in bulk, are topics that need to be addressed if fraud is to be combated, say many forensic accountants.

Bairoliya explains if a public company is head and shoulders above the rest or if it has offshore vehicles, then you must ask questions. ‘Most industries don’t need to go offshore. If public companies with pensions and investments are offshore, you have to ask why,’ he says.

Pressure is not just coming from the professionals who have to pick up the pieces either. Thomas A Bowman, president and chief executive of the Association for Investment Management and Research, has this week called on all interested parties in the financial sector to participate in strengthen transparency.

‘The issues raised by the collapse of Enron cut to the heart of the standards and principles that we have advocated for more than 20 years – more corporate disclosure, greater transparency of financial information, and ethical conduct that places the interests of investors first.

‘For decades we have advocated that users of financial reports need more input into the financial-reporting system. Their information needs must always come first,’ says Bowman.

It is clear that only the minority of companies are prepared to take the lead in proactively enforcing strict internal controls, strong boards of directors and audit committees to question anomalous transactions within companies.

The Financial Services Authority is due to bring out its policy in March on whistleblowing. But Bairoliya is not confident this will alter much.

He expects FSA recommendations over strict requirements.

The markets are however already rewarding proactive companies with a lower cost of capital and higher share prices. But these pioneering companies continue to remain in the minority and fraud continues to rise year on year. Any real commitment to combating fraud by financial services organisations in the UK was recently shown for what many say is – mere lip service, as many forensic accountants have put it.

Forensic Accounting, a fraud investigation company based in London, last year launched a free confidential online service to allow employees the anonymity to report suspicions of fraud to the right authorities.

The uptake?

‘We’ve had more interest from banks in Africa than UK banks!’ says Bairoliya.

The company had hoped that the hotline would stimulate debate about why most frauds were uncovered only when it was too late.

So far, no good.

Surely a stronger, clearer commitment by regulators and governments is needed rather than the continued finger pointing that has become the norm.

One of the points to come out of the whole Enron debate is the role of the non-executive directors. Bairoliya says: ‘They need to understand that they are charged by shareholders to look after management.’

It is a topic very close to the hearts of auditors. When corporate collapses, which are generally due to ‘wrong accounting’ or outright fraud, occur shareholders tend to turn to the auditors for recompense.

Auditors argue that if there is management collusion, which there usually is with large-scale fraud, then it is virtually impossible for an auditor to detect. They are now determined to persuade regulators that they must step in to avoid future collapses and high-profile frauds.

Steve Maslin, audit partner at mid-tier firm Grant Thornton, says: ‘You could pose questions as to whether the FSA should take more responsibility. Listed companies should comply with the combined code rather than merely disclose why they don’t comply.’

Maslin also suggests that when it comes to appointing non-executive directors at large public companies, ‘genuinely independent nominating committees’ should do the selecting. He also bemoans the waning interest in the Turnbull report, hailed in its time as the way forward for corporate governance.

‘There was a flurry of activity when Turnbull came in but now not enough companies are turning it into an active process. Lots of companies have put it on the shelf,’ says Maslin.

It is here that shareholder groups and fund managers, like Hermes, can help too.

By avoiding investment in companies that lack strong corporate governance processes, companies will soon realise that the markets and shareholders dictate. Maslin’s wish list is not dissimilar to that of most auditors and forensic accountants.

‘I’d like to see written down processes rather than just talking about it; I’d like to see directors’ roles and responsibilities documented; companies should have someone who is charged to see if the same risks still apply as a company grows and ensure controls are always in place,’ he proposes.

The UK now has the opportunity to become a leader in this field. A far-reaching review of company law is underway to haul the legislation into the 21st century.

Some crucial recommendations made by the company law steering group include: the basic duties of directors to be clearly set out in the Companies Act; the present rules on directors’ conflicts of interest should be updated and clarified; and that there should be better disclosure on directors’ training, qualifications and other relevant information.

In addition to this next month the FSA’s listing authority, headed by Ken Rushton, will launch its broad review of listing rules.

The final legislation on company law due out in 2003 and the results of the FSA’s review also due in 2003 can play a major role in extracting to temptation and relieving the pressures to commit fraud.

It’s high time more than lip service was paid to fighting fraud. The Enron cloud could provide that silver lining.