Fraud and the Effects of the Recession on SMEs

In prosperous times fraud is invariably motivated by greed. In an economic downturn it is often sheer desperation that makes somebody turn to fraud. Since the middle of 2008 fraud against British business has increases substantially which in turn has exacerbated recession induced cash flow, liquidity and credit problems.

 While small businesses are already under enormous pressure it is still tempting to treat fraud as the least of your worries. But beware, while fraud can do serious damage to big companies , it can totally destroy a small one. This guide should be seen as an essential part of your recession survival strategy.

 Threats – Internal

 • Managers under pressure to perform may be tempted to falsify performance figures

• Employees with increasing debts of their own may inflate expense claims, ‘borrow ‘ from the till, steal company property, and conspire with customers, suppliers or contractors for kickbacks.

• Staff may be more open to suggestion by third parties, especially organised gangs, to sell confidential information such as credit card details for financial gain.

• As credit lines run out and changes in working practices take place existing frauds begin to surface

 Threats – External

 • If you provide credit in any shape or form you are at risk it will be fraudulently abused

• Suppliers and contractors will be tempted to defraud you with inferior goods and services or by not keeping to terms and conditions.

• You may be tempted to turn to alternative sources of finance as the traditional lines of credit become scarcer. This may leave you open to fraudsters who will take advantage of your situation.

What to do if you are a victim of fraud.

• Report the matter to the police. Regardless of whether they will do anything or not, obtain a crime number – it may be required for any subsequent criminal/civil action or insurance claim.

• Depending on the type of fraud, advise your bank, insurance company, supplier and/or customers. But only if it is relevant and applicable, and may avoid any further losses. Do not go public if it may further damage your reputation or the confidence your customers may have in your business.

• Consider seeking specialist professional advice.

• Reassess the way your organisation manages and conducts its business to ensure the risk of fraud is minimised and adequately protected.

 Do

 • Do remember that recession is the time to take fraud seriously

• Do identify areas that are most vulnerable to theft or fraud, such as stock, cash, purchasing, expenses, sales, and record keeping.

• Do monitor your bank account and credit card statements for any unusual activity or transactions.

• Do designate a senior member of staff with responsibility for managing fraud risk if you don’t have time to do it yourself. Failing that consult an fraud risk management expert.

• Do ensure that your premises have adequate physical security protection including locks, keypads and alarms. And ensure they are in full working condition.

• Do try and minimise cash transactions within your business.

• Do conduct checks on suppliers, contractors and bigger customers to ensure they are who they say they are and that you are getting the quality of product or service you expect.

• Do check invoices against original purchase orders

• Do make sure that your staff are aware of the risks from theft and fraud and how to report it

• Do make sure your staff your staff understand your expenses policies and procedures

• Do check references when hiring new staff whether full time, part time, temporary, or casual. Consider re-checking employees who may be promoted to a higher level of trust or to handling of confidential information.

• Do ensure that when sourcing alternative forms of credit or finance that it is properly authorised by the Financial Services Authority; or licensed under the Consumer Credit Act 1974 by the Office of Fair Trading.

• Do seriously consider how you will respond in the event that a fraud is

discovered in your organisation

Don’t

 • Don’t forget that severe economic pressure can cause previously honest people to become dishonest

• Don’t assume all information provided by prospective employees, suppliers, contractors or lenders is accurate

• Don’t accept that if fraud happens it is a one-off, bad luck, or just part of the cost of doing business. Even if you are lucky and the impact on your business is small this time it might not be the next.

• Don’t underestimate the impact of fraud to your bottom line, to your business reputation, or to supplier/customer confidence

• Don’t economise on protecting your business from the risk of fraud.

 

Disclaimer and Acknowledgements

While every effort has been made in composing this information, compliance with it does not guarantee that you and/or your business will not be a victim of fraud or criminality. Investitec take no responsibility for any action taken by parties as a result of any views expressed herein. You are strongly advised to seek and obtain the appropriate professional advice on the issues raised.

Investitec acknowledges the Fraud Advisory Panel and the ACFE (www.acfe.com) as a contributory sources.

 

Fraudulent Insolvancies

With the current economic climate we are seeing an increasing number of company insolvencies. Many of these are genuine hardship cases where the sales have dried up, the money has run out and there is no further finance available. However, there is a sinister element of voluntary liquidations which are of a somewhat questionable nature.

There are limited liability companies that go into liquidation, knowing they are insolvent, i.e. they can’t meet their debts when due or have insufficient assests to cover these debts. Then they start trading again in the same business, often from the same premises, with the same directors/management team, but under a different ant name, usually the very next day. These Phoenix like rising are often referred to as ‘prepacks’ and generally, they are perfectly legal and is often a way of saving skills and labour and protecting intellectual property etc. However, there are some liquidations and prepacks which warrant closer scrutiny.

The circumstances of these questionable liquidations are as follows; a company continues to place orders for goods and services maximising the use of credit lines. The directors know or would be reasonably be expected to know that the company will be unable to pay for these goods and services and so go into voluntary liquidation. An administrator and subsequently an liquidator in the form of a Insolvency Practitioner is appointed to wind up the business. However, it is the duty of the administrator/liquidator to extract maximum value for creditors from the failed business. So the first job is to see if the business and its assets can be sold. Remember this is a well stocked company having just maxed out their credit lines. But it is unlikely anybody is going to pay decent price so it open to the highest bidder to realise any value. If that bidder happens to be the old management team then they can legally buy the assets which may include any IP and simply re-hire the labour force, sign a new lease on the premises and start trading the next day.

What happens to the money owed to creditors whose stock has been sold? Unless there was a retention or a preference was secured, then any money the liquidator raises goes into the pot for the benefit of ALL creditors – with any with preference or securitised creditor, such as the bank, getting first bite, if not the whole cherry.

In these circumstances, as an unsecured creditor who will be lucky to get pence in the pound, if anything, for your debt, you have a right to feel aggrieved, even conned. But what can you do? Well, there is good news and there is bad news.

If it can be proven that a company carried on trading when the directors knew or would reasonably have expected to know, that the business was insolvent, then the directors themselves may become personally liable for the debts incurred. The DTI may also take the view that the conduct of the directors was such that they are unfit to manage a business and will be disqualified thus preventing them from being a director of another business. This on the face of it all sound like very powerful stuff. But now for the bad news.

The reality is very different. The only person who can launch an investigation into the conduct of the directors is the appointed liquidator. In theory there is no collusion between the liquidator and the owners of the business because once appointed he/she has duty to act in the best interests of the creditors, even if he/she was originally invited to act in the voluntary liquidation by the directors of the company. Remember their appointment as liquidator is made at a meeting of creditors who have an opportunity to reject the directors nomination and have the option to appointing a joint liquidator.

Although the liquidator is required to report to the DTI on the conduct of the directors an indepth investigation into the affairs of the company will be limited to those funds available for the payment of their fees in dealing with the matter. Quite simply, a liquidator may deem such a investigation not economically viable in terms of the cost of the investigation and the likelihood of recovery of funds through subsequent litigation.

So although the law appears to be on the side of the creditor, in practice rarely does it offer any protection – through disincentivising directors to act in this way in the first place, nor does it provide any satisfaction in terms of justice or recovery of financial loss. This is another example of fraud that falls through the gap of both the civil and criminal judicary system.

Are there any remedies? In certain circumstances, again providing there is a better than 60% chance of winning, and investigation and recovery can be undertaken under a Conditional Fee Arrangement with a solicitor, backed by insurance should the action fail and cost go against the claimant. There are schemes out there which means there are virtually no up front cost, not even the cost of the insurance premium. Unfortunately there seems to still be reluctance for liquidators to persue claims even with this safety net.

Invariably, there will be breaches under the Fraud Act 2006. Unfortunately again, this is a criminal prosecution and is unlikely to inspire the police nor the CPS to act unless if is of suffient size or value.

The DTI may consider the conduct of a director to justify disqualification, which while it may help any case for civil recovery a liquidator may bring, in itself does nothing to help creditors.

In conclusion there is nothing that really helps creditors who find themselves as victim of fraud in these circumstances. For anything positive to happen there needs to be  more robust application of the law, both criminal an civil to disincentivise directors acting in this way in the first place. There need to be positive incentives for both the police to act on ALL incidences of fraud and for insolvency practitioners, the legal profession and the judiciary to act in civil recovery. I personally would like to see a debate on whether such action should not be publically funded on the basis that the fund recovers its costs from a successful action.  Knowing there is nowhere to hide and that the civil penalties i.e. recovery of costs and compensation will outweigh the original gains, might be enough to stop companies and their directors acting fraudulently in the first case.

Does the Expenses “Scandal” Mean Our Politicians are Corrupt?

While this may be what the British media is alluding, or at least trying to imply, technically and in the fraudulent sense the answer is no. And certainly when seen against the behaviour of Third World Governments and even some of our European cousins this scandal is nothing. However, you might be justified in accusing them of being morally corrupt.

You may be able to justify letting them off the hook because ‘technically’ they have not breached the rules on MPs expenses. That may be true, and the reason this is true is that quite simply the rules, policies and procedures are so badly written. This is a lesson that anybody in business should heed whether they are a CEO or in Human Resources. If you write a missive, a policy or a rule that says ‘you can do this, but you can’t do that’ there is very little room for ambiguity. If you use words like ‘discretion’ or ‘reasonable’ it I is obvious that you will get a wide interpretation of what that actually means – one man’s reasonable expenditure is another’s excess.

Unfortunately our politicians are renown for wishy washy rules, just look at some the Acts of Parliament we have, especially ones like the Hunting Act which is virtually unenforceable because the judiciary are having so many problems interpreting it. It is also the nature of the beast. Ask any politician a question and you expect anything but a straight answer in return. Listen to Radio 4 any day of the week for evidence of that.

However, there are more important issues at stake here, ones from which corporate Britain definitely should take notice of. What this scandal has exposed is a culture of greed. Greed that is justified because ‘it is within the rules’. There are also commentators who are justifying it because MPs aren’t that well paid and that maximising the use of expenses should be seen as a ‘perk’ in compensation. While there may be some validity in the argument about MPs remuneration there has to be a debate as to what expenses are for and why they exist at all.

Many of us have the benefit of expenses to cover costs incurred on our employer’s or company’s behalf, from which the company ultimately benefits. This can take the form of mileage to visit a client or entertainment to ease the discussions of new business – although the latter is straying into the area of corruption – especially if excessive. I have always viewed expenses as an aid to doing my job, no more and no less. If I travel to visit a client and claim mileage then the company may benefit from an increase in business as a result, and I may even benefit from a higher bonus cheque as my recompense. In this scenario expenses are an investment that provides a mutually beneficial return.

But what happens when expense accounts are abused. Potentially this means a higher and disproportionate cost to the business which ultimately leads to lower profit margins and affects the people who own the business, the share holders. So here is the moral issue. By abusing the tool that expenses provides and claiming more that necessary to carry out your job you are taking benefit from those that would otherwise be entitled to it. But this is still not the big issue. That is what happens when expense abuse happens at the highest level in an organisation? What message does that send?

In an organisation where expense abuse is tolerated it is usually because it starts at the top and become enshrined – at least while the organisation can still afford it, in the culture. Everybody knows it wrong but its OK because if its good enough for the bosses its OK for everybody else. This is a culture that is on a slippery slope. A great example of this is, once again the Metropolitan Police. DAC John MacDowell is the national co-ordinator of terrorist investigations, and is due to be questioned about his expenditure on the Met’s American Express card. It is looks likely that any transgression will be minor or a ‘technical’ oversight on MacDowells’ part. That is until you look at the wider picture of credit card abuse in the Met. Last year a DS serving under MacDowell was sentenced to 10 months in prison for misspending £70,000 on his credit card, and another Met sergeant was given a suspended sentence for misusing £9,622 on his card. Currently, in all, the IPCC is handing 33 cases involving Met Amex cards, and since 2006 when expenditure checks started 1400 cards have been cancelled (Latest arrests Daily Mail Online – http://tinyurl.com/qatx96).  What does this tell you or at least imply about the culture surrounding expenses in the Met?

Potentially a culture where expenses abuse is tolerated is also the breeding ground in which fraud, corruption and malpractice may also thrive. So this then is also potentially the big issue with the MPs expenses scandal. The media have revealed a culture that is not morally sound and that sends a message to the rest of us that its OK to be greedy and take what you want in your own interest, providing somebody else is picking up the bill. In this case it is the tax payer. But where will it go next? Is this the thin edge of the wedge towards a banana republic style government? I hope not.

So think about it the next time you fill in your tax return or pay your corporation tax, you are financing a culture that is morally questionable, could possibly be corrupt and may even be fraudulent! Again, I hope not for everybody’s sake. But its a damn good reason to make sure that your voice is heard when it comes to election time.