Business Risk November 2011

Fishing for Fraud in the Supply Line

While the triple disaster in March this year severely threatened—and even crippled—some supply chains in Japan, it is all too often that international firms remain unaware of a greater and more consistent threat to their supply chains, namely, fraud.

In extreme cases this has led to the damage of brand equity, a decline in investor confidence, loss of market share, and severe civil and criminal penalties.

For any global business today, the supply chain represents the greatest risk for fraud and corruption. Fraud can be found across the length and breadth of an organisation: in the areas of raw materials, finished goods, as well as monies and services. Moreover, it is often more internal than external.

The types of supply-chain fraud are numerous and the deceit can be carried out by customers, suppliers, distributors, employees or management. In my experience, fraud most often involves collusion between two or more employees, or between employees and external vendors—which is, perhaps, the most dangerous complicity.

Unfortunately, while fraud should be detected by internal controls, it is often uncovered by accident, through anonymous notes or unexpected crises. Firms often ignore, at their peril, key fraud-risk indicators, including:

• Anonymous letters
• Key finance staff unwilling to take scheduled holidays
• Customers’ complaints about the accuracy of invoices
• Receivables problems

In the case of firms with offshore subsidiaries and affiliates, it can be difficult for corporate headquarters to detect fraud, particularly when different languages and cultures are involved, and when no individual is tasked with fraud prevention, or with conducting local, proactive measures related to country-specific codes of conduct on the ground in all countries.

Firms can become vulnerable to the threat of supply chain fraud if they fail to implement sufficient business controls or undertake sufficient due diligence and vetting of employees and third-party vendors.

Businesses should consider introducing:

• Strong internal controls
• Tough, visible deterrents
• Clear management responsibility
• Unambiguous reporting lines
• Suitable whistleblower programmes

Further, the absence of a systematic vendor-verification programme exposes firms to considerable risk, and it is critical that supply-chain vendors are brought into a firm’s overall compliance programme under both the Foreign Corrupt Practices Act of the US and the UK Bribery Act.

Once fraud is alleged or suspected, prompt action is necessary in order to get the facts. Corporate fraud investigation is not something that should be conducted in-house, except in large organisations that have experts. Moreover, using specialist consultants avoids accusations of conflict of interest among members of staff who may have worked together for many years.

If fraud is discovered, the dismissal of offenders or the termination of certain vendor agreements is only a short-term solution. Firms must change their systems, or increase the monitoring and supervision of employees and vendors, in order to reduce the risk of fraud.

Case Study

A Japanese retail conglomerate engaged FTI Consulting following anonymous allegations that: (1) the purchasing division was receiving kickbacks for buying products; (2) team members were penalised if they did not deal with key vendors; and (3) possibly there were ties with local organised crime groups.

It was also suggested that the vice-president of the suspect division personally had benefitted from his business relationship with vendors.

In a bid to change the way it operated vis-à-vis vendors, the firm hired some new staff for the division to review vendor management. However, some of the new hires soon resigned, and one received a letter threatening him if he continued to investigate vendor relationships or in any way changed the structure of the division.

We undertook comprehensive research, checked public records, and discreetly inquired into key personnel and vendors to identify potential issues. Initial investigations showed that alleged kickbacks were associated with certain product lines, and focused on two individuals and six vendors.

Before conducting interviews with these individuals, we undertook discreet forensic imaging of data on the hard drives used by the two suspect individuals. We were then able to undertake a forensic analysis that provided evidence (mainly e-mails) for our investigation. This clearly indicated a conflict of interest between individuals and vendors.

Our investigation confirmed that close relationships existed between the purchasing division and certain vendors. One member of staff had personal ties to a vendor and was receiving kickbacks. Another was residing in a property registered to a vendor and had links to individuals connected to organised crime.

Fundamental issues were identified in the process of vendor approval. In particular, many of the first-tier vendors appeared to be small low-profile firms with no specific function beyond being intermediary traders.

As a result, several staff contracts were terminated. We continue to help the client implement a vendor-screening programme to help mitigate the risk of fraud in its supply-chain processes.