Jeff Williams, managing director of AIM-quoted Telephone Maintenance Group, went for a curry in a Birmingham restaurant the other day and paid by plastic. A waiter took his details from the receipt and Williams discovered soon afterwards he was supposed to have bought a £45,000 Mercedes.
He was indemnified and able to reassure his wife there was no intended recipient of such a lavish gift. But he had become a statistic in the £500 million annual roll of card payment fraud in which Britain leads the rest of Europe.
Fraud is becoming an ever more present danger in business life. It takes numerous forms and in many cases it is highly likely the person who defrauds you is on your payroll.
Fraudsters come in all shapes and sizes. Recently convicted offenders include Dennis Alexander, David Andrews and George Steen, who took £4 million from bank loan applicants for non-existent loans, and Jamshi Hashemi, who received six-figure commissions for imaginary commodity deals with Iran.
On a more modest scale, an NHS Trust payroll manager was caught putting her family on its payroll for £125,000. Elsewhere, contracts manager John Thoroughgood lifted £400,000 by authorising false or inflated supplier invoices and ex-BBC Worldwide director Jeffrey Everard accepted £188,000 from companies keen to supply toys for children’s programmes.
The combination of speed and complexity which characterises modern commercial processes in the electronic age is giving fraudsters a field day. Directors who have not worked out systems for preventing, detecting and minimising the damage caused by fraud will almost certainly live to regret it — unless they are in on the act themselves, like Corporate Services Group’s former chief executive Geoffrey Bailey, jailed for falsifying the company’s accounts to cheat investors.
‘A bumper year for fraud’
Last year will go down in the annals of British crime as ‘a bumper year for fraud’. That is the conclusion of FraudTrack, an exhaustive study of British cases by accounting group BDO Stoy Hayward.
Andrew Durant, BDO’s fraud investigation chief, produced the report, which has found that ‘economic crimes’ – fraud, money-laundering and embezzlement – are costing UK businesses an estimated £40 billion a year. Meanwhile, the value of reported fraud alone rose 116 per cent to £435 million in the first half of 2004.
That is more than the £330 million reported for the whole of 2003 — and, of course, leaves out all those frauds which go undetected or whose victims are too embarrassed to report them, think it pointless to do so or prefer to settle scores privately. And, warns Durant, with a base level sentence for any fraud case of two years, ‘even when fraudsters are detected and successfully prosecuted, ‘they often manage to hold onto large sums of their criminal proceeds’.
Andrew Stoneman of forensic accountant Menzies, which has published ‘Top Tips on Fraud Prevention’ to alert companies on how to prevent fraud in commercial transactions, takes no less a bleak view. ‘If you go into a newsagent and steal a Mars Bar, you are likely to go to jail for six months, but, if you defraud a bank of £10 million, the case could well take two years to come to court and then the prosecution will have to make intricate mechanisms of your fraud clear and comprehensible to a jury.’
He points out that fraud is not always prompted by the lure of yachts in the Mediterranean, but often stems from attempts to keep a company afloat when business is bad. ‘Desperate times lead to desperate measures,’ he reflects, citing cases where directors took money from clients’ accounts to keep their companies going and where an administration clerk invented invoices to keep the business afloat and her job intact.
The Government is seeking to make it easier to convict fraudsters with a new Fraud Bill, but offenders are becoming more professional and specialised all the time, encouraged by the electronic tools which are now available to them. BDO’s Durant reckons ‘white collar crime is no longer the domain of directors and employees ripping off their own company — it is increasingly a means of revenue for organised criminals lured by the prospect of larger rewards, less physical danger and lower penalties’ than apply to other forms of crime.
Echoing Stoneman, Durant is sceptical about the law’s effectiveness in combating fraud. ‘Pick up a pen and a calculator rather than a pistol and a crowbar’ is his Devil’s advocacy to the intending miscreant.
Popular forms of fraud
As another accounting group Ernst & Young points out in its eighth ‘Global Fraud Survey’, there is no strict, all-embracing legal definition of fraud in Britain, though it is generally understood to involve using deception to gain an advantage to which the perpetrator is not entitled. The survey found a frequent mismatch between perceptions of risk and the reality.
- False accounting – Dressing up a company’s figures to attract investors, win corporate contracts or hide losses (or conceal profits) has played a part in some of the biggest and best-publicised frauds of recent years, such as Enron and Parmalat — scandals which brought about the demise respectively of accountant Arthur Andersen and Grant Thornton’s Italian business. However, only 21 per cent of respondents to the Ernst & Young survey said this was the form of fraud which most worried them.
- Asset misappropriation – Employees, perhaps including management and directors, or third parties or employees and third parties acting together can collude to steal assets from a business. They can do this by stock ‘shrinkage’, stealing intellectual property, price lists or lists of clients, putting fictitious employees on the payroll or cheating on their expenses. Accepting kickbacks or commissions from a supplier not in the best interests of the company or agreeing or initiating a similarly disadvantageous transaction because of an undisclosed financial interest in the other company are other instances of this type of fraud. ‘Procurement fraud is rife in most companies,’ declares Durant. ‘Long firm fraud’, where the fraudster purports to be a valid customer, takes goods on credit and then vanishes, is another hardy annual. This is a practice to which start-up and fast-growing companies are particularly vulnerable.
- Trade fraud – Deception in trade, involving false export or import documents and letters of credit, is a perennial problem. Recently, trader Milton Kounnou was imprisoned for two years after taking §200 million (£105 million) from ten Middle East banks with false documents for fictitious metals shipments. Some years ago, issues of this type contributed to the collapse of Johnson Matthey Bankers in London.
- Investment fraud – Another venerable branch of fraud, with a pedigree stretching back to the South Sea Bubble and beyond, this practice usually sees investors persuaded to put up money for ventures which are either not as described to them or are non-existent. Examples range from the Barlow Clowes scam, whereby individual investors were promised literally impossible returns on Government securities, to the 1990s Bre-Ex mining scandal, where drilling samples were blatantly falsified to ‘prove’ a multi-billion gold prospect in Indonesia. This achieved a huge but brief share boom and was followed by the disappearance from a private plane of the geologist in question and a five-year blight on mining shares.
- Insurance fraud – Factories burning down over a public holiday with caretakers and security staff miraculously unharmed are a classic example of this brand of fraud, but it has many applications. Lord Brocket, now known as a ‘reality’ TV star, first hit the headlines when he was convicted of fraud after claiming £4.5 million for allegedly stolen classic cars which he was then found to have dismantled and disposed of himself. Insurers find that questionable insurance claims become more frequent during an economic downturn, when companies are often strapped for cash and the unscrupulous are not too fussy how they seek to obtain it. Resulting higher premiums can punish the innocent as well as the guilty.
- Computer and e-fraud – Fraudsters use computers and the internet to facilitate their ploys, from diverting funds from one bank account to another after ‘hacking’ in to the first one, posing as a legitimate business and receiving payments or diverting intellectual property. The methods employed in ‘computer fraud’ and ‘internet fraud’ may be new, but the frauds themselves are centuries old.
- Card payment fraud – This involves not only lost and stolen cards, but copied data skimmed from the magnetic tapes of cards whose owners are unaware this has happened. Banks are transferring liability for many of these frauds from themselves to retailers, who are being forced to adopt newer technology to fight it.
Spoils of fraud
Some companies think of fraud as a ‘cost of business’, odious but essentially an expense to be factored in to overall cost projections. In fact, the cost to companies of different types of fraud varies considerably and can be ruinous.
BDO’s FraudTrack survey found that each reported fraud involving wilful violation of laws or Government regulations caused the company targeted an average £4.3 million in 2003. Employee fraud cost an average £2.2 million and frauds by financial mis-statement cost an average £1.3 million, the same as third-party fraud. Unauthorised use of assets, physical, financial or information, cost companies an average £1 million and fraud on individuals cost an alarming average of £786,000.
These figures understate the full costs significantly, since they represent simply the amounts of money taken. But frauds have other costs, which in some cases can exceed the direct fraud hit, such as legal and investigative expenses and the diversion of management time.
A company involved, however innocently, in fraud can suffer a loss of reputation and customers and a hike in insurance premiums. Its key staff may leave, while banks and other lenders may refuse to advance money or could raise the rates they charge for it.
Who commits fraud?
As with murder, victims of fraud are more likely than not to know the perpetrators. Ernst & Young’s Global Survey found that employees were responsible for 30 per cent and management for 55 per cent of serious frauds, making 85 per cent of them inside jobs, a percentage which does not change much over the years.
Organised crime syndicates account for no more than six per cent of the total of reported fraud, says Ernst & Young. Other observers suggest they could soon feature more prominently in the internet age.
Opportunity plays an important part here. Menzies’ Stoneman reflects ‘bookkeepers, who often get in to the office first, leave last and are frequently the most trusted people in their firms, are the most likely to commit employee fraud.’
Similarly, at the more elevated level of full-scale corporate fraud, he argues, ‘top directors and management are the most likely perpetrators. They can set up the systems and controls which they want to subvert.’
As well as being known to their victims, those who defraud them are overwhelmingly likely to be male. According to BDO’s FraudTrack survey, 84 per cent of frauds reported in 2003 were by men.
Moreover, the men went for richer pickings. Joyti De-Laurey, convicted last April for stealing £4 million from her bosses at investment bank Goldman Sachs by forging cheques and wire transfers, is not — yet — typical.
During 2003, 24 men were convicted for frauds of more than £5 million and 108 for frauds of more than £1 million. In the same year, no woman was found guilty of a fraud worth more than £4 million and only a handful committed frauds of more than £1 million.
Regional variations are strong. FraudTrack showed London, Liverpool, Glasgow and Birmingham as Britain’s top fraud cities, with the cost of fraud per head approaching £10 in the north-west of England, followed by the midlands, the north-east and London and the south-east (with nearer £7 a head).
How to fight fraud
Combating and, preferably, preventing fraud is a battle on two fronts, inside your company and externally. Durant says that, although companies are more willing than they used to be to report fraud to the police, ‘fraud still comes low down in police priorities’, while insurance cover these days tends to be costly and carries a high level of self-insurance.
Need to know – The warning signs of company fraud
- No management accounts and uncompleted chequebook stubs
- Slow collection of debtors
- Reluctance to meet clients on the premises
- Lumpy turnover
- Unduly high stock levels (typically it should turn over four times a year)
- Increasing debt turn (fraudsters paying fictitious invoices with new fictitious invoices)
- Lavish entertaining and high living
- A dominant boss with a docile board
- High turnover of auditors and legal advisers
- Excessive hours worked and poor delegation
- Reluctance to take holiday
- Inadequate credit checks on customers
- Inadequate checks on new staff
- Poor response to queries from management, suppliers, auditors and others
- Poor checks over access to IT systems
- General poor disclosure
- Profits affected significantly by unusual deals
- Excessive payments for consultancy
- Secrecy about key client
- Management unduly focused on share price
- Aggressive accounting policies
Need to know – Six steps to fraud protection
1. Screen employees
Investigate staff and maybe key customers and suppliers. Make background checks and follow up references.
2. Train staff and maintain ‘whistle-blowing’ procedures
New staff should be fully versed in your company’s procedures and longstanding staff updated. Whistle-blowing should be encouraged, not punished, but it must not be misused to pursue vendettas or damage the company.
3. Use the courts
Once you realise your company has been defrauded and you want redress, first a civil action should precede triggering the criminal process provided you take action within days. If you think the fraudster has traceable assets, you can sue him or her in the courts and obtain court orders to trace and freeze assets both in the UK and worldwide.
Using the courts can, however, be expensive and even now banks, for example, can be reluctant for reasons of reputation to take part. Andrew Stoneman of forensic accountant Menzies recalls an alternative strategy used last year by a lending company, which wanted to pursue a fraudster but was advised that, if the company reported him to the police, he would hide his loot and declare himself bankrupt, waiting till the fuss had died down to purge his bankruptcy and enjoy his ill-gotten gains. Instead, the lender communicated with the fraudster and told him it would report him to the police unless he repaid the company. This he did, reimbursing the lender but leaving him still at liberty, with no criminal record, and ready to plot his next adventure.
5. Deploy technology
New technology is opening more opportunities for fraud, but also for combating it. Investigators now have tools, such as imaging of electronic documents to recover deleted information and data mining tools to identify suspicious transactions. Alan Moss of card technology specialist Thales paints a similar picture with card payment fraud. New technology being introduced by retailers and other potential victims, coupled with the move to chip and pin, will present fraudsters with tough new challenges.
6. Stay alert
Remember, fraud is cyclical. It fluctuates with the economy, but concern about fraud beyond its immediate victims tends to be triggered by big spectacular cases every four or five years.