How Much Fraud is in Your Supply Chain or Sales Channel?
This article is part 1 of 2, by Jack P. Healey, CPA/CFF, CFE, Firestorm Expert Council Member and Partner Genesis Management.
Mr. Healey is an expert in supply chain financial and operational performance, fraud education and prevention. He is a Member of the Business Advisory Board of Syracuse University Lubin School of Accounting, a guest lecturer on Procurement Fraud and Merger and Acquisition Fraud for the Whitman School of Management, and has been asked to present to Kennesaw State University Michael J Coles School of Business in Merger and Acquisition Fraud. He is quoted in CFO Magazine, Industrial Distribution Magazine and Modern Distribution Magazine.
How Much Fraud is in Your Supply Chain or Sales Channel? (part 1 of 2)
As the title of this article suggests, there is fraud in your supply chain; the question is how much? We all see the headlines- – “Amid Bribe Probe, China Bars Glaxo Official from Leaving” (WSJ July 18, 2013), followed seven days later by “Glaxo Cites Possible China Violations” (WSJ July 23, 2013).
Unethical or illegal actions in one organization’s sales channel may affect another’s supply chain.
You may have read the articles mentioned with interest, but not with a feeling that this could cause a threat to your company. After all, your company has an ethics policy, and your auditors have found no fraud in the company in the past. Although you may not be facing the lengthy FCPA and UK Bribery Act investigations Glaxo is facing, you may find the similarities between your supply chain and theirs alarming; and with near certainty, I can tell you that if you have any substantial business enterprise there are elements of fraud and collusion in your supply chain.
GlaxoSmithKline PLC, (GSK) is under investigation for alleged bribery by some of its senior executives who bribed hospitals, doctors and health officials to prescribe GSK’s drugs. GSK officials said in a statement- “certain senior executives of GSK China who know our systems well, appear to have acted outside of our processes and controls which breach Chinese law”.
The Company had been alerted by a tipster a few months back to the possibility of improper behavior and conducted ‘an extensive’ four month investigation and found no evidence of fraud.
These allegations by the Chinese authorities involve payments to a travel agency by company officials. The travel agency would then funnel the funds to the doctors either as trips or cash. It was also disclosed that many of the other major pharmaceutical companies used the same travel agency – in other words, this was common practice. The Chinese Ministry of Public Security said that this practice resulted in pushing up prices and ‘seriously disrupting the market’. GSK announced on July 24, 2013 that it had ‘commissioned an independent review to investigate the root cause of the fraudulent behavior”.
The Association of Certified Fraud Examiners in their biennial Report to the Nation found that about 5% of companies’ revenue is lost to Fraud each year. This includes your company!
The three classifications of occupation fraud and abuse are: Corruption, Asset Misappropriation and Financial Statement Fraud. Fraud in the supply chain is an example of corruption. Corruption includes: Conflict of Interests, Illegal Gratuities, Bribes/Kickbacks and Economic Extortion.
Corruption is defined as ‘the wrongful use of influence in a business dealing to procure a benefit for the actor or another person, contrary to the duty or rights of others’. Corruption can be found anywhere in an organization, but is most commonly found in the purchasing and sales organization.
Bribes and Kickbacks are defined as giving or receiving a “thing of value” to influence an official act or a business decision. Bribes and kickbacks are classified as corruption schemes because they involve collusion between employees and vendors.
In 2012, 25.1% of all frauds related to corruption, up from 21.9% in 2010 of reported frauds and the median loss was $250,000. There are 24 common supply chain frauds, and each of these frauds leaves clues – or indicators – that a trained associate or fraud examiner can detect.
Ten examples of fraud indicators are:
- Award to a last minute new bidder
- Failed Product Tests or Inspections
- Failure of employees to Accept Promotions
- Favoritism of a Particular Supplier
- Large Difference on Bid Prices
- Low Bid Award Followed by Changer Orders
- Missing Inventory
- Multiple Purchases Just under Bid Limit
- Payment without an Invoice, Purchase w/o Purchase Order
- Poor Quality
Most of these frauds require collusion between a company official and an outsider. You need a company employee because you need someone on ‘the inside’ to initiate the payment, or process a fake invoice or approve/manipulate a flawed bid and accept the substandard part. It requires someone to know your company’s internal controls so that they can subvert those controls.
We heard the officials at GSK admit that “senior executives who know our system well, acted outside our procedures and controls”. In this case, payments to a travel agency- which would appear a normal business activity were actually a bribe. The review and approval for travel expenses were less stringent than payments made to physicians. The executives took advantage of this gap to perpetrate the fraud, after all a payment made directly to the physician entitled ‘bribe’ may have aroused suspicion!
There are many ways to make an illegal payment, not all of them are in cash, they include:
- Inappropriate and excessive gifts, travel and entertainment
- Loans, whether or not repaid
- Use of Credit cards (or purchasing/ P-Cards)
- Sexual favors (hiring prostitutes etc.)
- Overpaying for a purchases (e.g. paying $20,000 for a $5,000 part)
- Fees and commissions- even if recipient performed some sort of service
- Hidden interests in business transactions
A simple gratuity becomes a bribe or illegal when it is offered in exchange for an official act by that employee. A round of golf may not be a bribe, but a round of golf at Augusta National or Pebble Beach could be a bribe. The expense report of the employee will say ‘entertainment’- when in fact there is an inducement to buy more product than necessary or award a pending contract. Participants will often say that this was a necessary business trip that ‘just happened’ to take place in a nice location. There are no coincidences in fraudulent behavior.
So how do you detect collusion, in your supply chain, and how can you measure the potential impact on your company? We recommend an independent review conducted by a supply chain and fraud specialist, a Certified Fraud Examiner with knowledge of supply chain activities. In Part II of this article, we will review the latest fraud detection techniques, including using predictive analytics utilizing ‘big data’ to uncover fraud. We will discuss what to do when you discover fraud (hint: you do not confront the fraudster), and we will give you 5 steps that you can take today to deter fraud in your organization.
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