Bruce Dorris, head of the Association of Certified Fraud Examiners (ACFE), the world’s largest anti-fraud organisation, recently stated that the effects of COVID-19 look like “a perfect storm for fraud”.
These unprecedented times have pushed numerous businesses to switch to remote and restricted working environments. Management of fraud risks during this time presents unique challenges that may not have been envisaged during the designing of existing fraud prevention protocols and controls. It is equally concerning that the existing fraud prevention measures may no longer continue to be followed due to disruption of standard operating procedures.
Losses from external frauds are usually harder to quantify and when revealed, their scale can be relatively low. Internal or occupational frauds perpetrated by employees or managements, go beyond the financial damages with repercussions on an organisation’s reputation and brand. According to a global study published by ACFE in 2020 on Occupational Fraud and Abuse, organisations worldwide lose 5% of their annual revenues to fraud. Based on the global GDP, this translates to a potential total global fraud loss of nearly USD 4.5tn. While this estimate itself is an eye-opener for most organisations, this figure is only expected to escalate further.
The impact of COVID-19 could push organisations to cut back on compliance, risk and internal controls, which could be counterproductive as a lack of these measures will make the operating environment vulnerable to fraud and misconduct, especially in emerging economies like India. It is noteworthy that corruption, bribery & corporate fraud emerged as top risks in the India Risk Survey 2019 conducted by FICCI.
Vulnerabilities may arise on multiple fronts across the fraud triangle, a commonly used framework that highlights reasons for committing fraud. The COVID-19 situation stimulates all three dimensions and can open a Pandora’s box of issues for organisations to deal with.
Fraud and related vulnerabilities experienced by an organisation during the COVID-19 crisis are spread across the three branches of the Occupational Fraud Tree - Bribery & Corruption, Asset Misappropriation and Financial Statement Frauds.
Bribery & Corruption
Organisations are at a greater risk of facing bribery and corruption due to intense commercial pressure and shrinking business opportunities. Many organisations have an unclear approach towards bribery which does not specify “zero tolerance”, others may not have enough controls in place during the current crisis to ensure adherence to the policies in place. In fact, many employees may believe it is necessary to pay bribes (or to use agents who have the right contacts to get the job done) to compete in this challenging time.
Illicit payments in cash or kind could be provided by third parties of an organisation to statutory authorities, to ensure smooth clearance and transition of goods or services. Moreover, new third parties may be onboarded to deal with immediate operational challenges, wherein adequate due diligence may not have been conducted.
A remote working environment may lead sales personnel to believe that there is limited oversight over their activities, which could result in payment of bribes to win new contracts. Additionally, desperation to identify alternate procurement channels due to restrictions on imports and domestic transportation could increase the risk of collusion between vendors and employees leading to kickbacks and undue favours.
The above scenarios could not only lead to increased ethics and integrity risks but may also lead to the violation of the applicable Anti-Bribery and Corruption (‘ABC’) laws and regulations.
It is interesting to note that as per the 2020 Global Study on Occupational Fraud and Abuse by ACFE, a whopping 86% of all occupational fraud cases are of asset misappropriation. Select assets, especially cash, become vulnerable during such crises and become prone to abuse by employees. Employees may take undue advantage of the COVID-19 situation and skip through the relaxed controls’ environment during such times. Some of the most vulnerable assets/areas are:
CSR spending – Many organisations are stepping forward to increase or focus their CSR spending towards COVID-19. This may leave room for collusion of employees with shell or fictitious entities posing as NPO / NGOs. Employees could also resort to receiving kickbacks from spends related to charities and donations.
Hygiene supply spending – Organisations would need to comply with government/regulatory guidelines on sanitisation and protection of their employees post the lockdown, resulting in a higher than usual need of healthcare equipment and hygiene supplies. This will trigger vulnerability for employee collusion with third parties to fix prices, receiving sub-optimal product quality and/or overbilling quantity.
Fictitious payments - Due to remote working and operational pressures, unauthorised alterations could be made to master databases in the accounting systems to make fictitious payments to siphon off funds.
Expense frauds – Given that there is a much-needed push to go digital, this opens lucrative channels, especially in countries like India, to provide fake or forged expense proofs for reimbursement.
Inventory – Stocks piled up at factories and warehouses with limited remote oversight and physical monitoring are exposed to various kinds of leakages and employee thefts.
Movable assets – Relaxed controls with rotational or limited staff presence in premises may provide an opportunity for abuse or unauthorised use of movable assets and equipment by staff.
Digital assets – As organisations work towards enhancing their online working platforms and increase the use of digital data, damages on account of unauthorised access and data theft especially by existing employees can be unparalleled.
Financial Statement Fraud
There is likely to be excessive pressure on employees including senior management personnel to achieve performance targets, especially in the period immediately after the lockdown which is expected to be surrounded by mass layoffs, collapsing markets, and reluctant buyers. When coupled with a weak control environment, such pressures can trigger fraudulent behaviour and the crisis may act as a rationalisation for such actions. Accounting treatment and practices that would be most vulnerable are:
Overstatement of sales - To make up for decreased consumer spending, personnel may endeavour to deliberately inflate the sales/revenue and demonstrate how they were able to perform in a challenging environment.
Capitalisation of expenses – COVID-19 related costs and damages may be substantial, personnel may be inclined to spread these costs over a few years, rather than expensing them in that very year.
Deferment of expense accruals – To improve the bottom line, personnel may defer accruals of select expenses and account for them at the time of payments.
Manipulation with net realisable value - Disruptions to supply chains and the volatility in financial markets may result in challenges in recording select assets at their net realisable or fair values. Personnel may take advantage of this and consider intentionally delaying the recording of such losses or may attempt to overvalue these assets.
Understatement of provisions and reserves - Provisions and reserves having underlined estimates or assumptions may be manipulated by personnel to avoid additional charges to profitability.
Disclosure fraud - Personnel may avoid fully disclosing the actual impact of COVID-19 on their overall financial results, especially related to off-balance sheet items including contingencies.
Going Concern – Assessment of going concern for select organisations could be a tricky task during these times and personnel may make favourable assumptions for evaluating their business as a going concern.
While financial statement fraud and schemes are the least common, they are the costliest, having an average median estimated loss of USD 954,000 as per the 2020 Global Study on Occupation Fraud and Abuse by ACFE.
Interestingly, while the COVID-19 crisis is expected to trigger new frauds and malpractices, historically financial and economic crisis have been a hotbed for discovery of existing frauds in an organisation. Deficient cash flows in an organisation puts fraudsters in a difficult position as they are no longer able to cover up the stolen money. Various book-cooking scandals of the recent decades emerged in such downturns. For instance, some of the biggest corporate frauds occurred during the economic crisis of 2008, including uncovering of the largest Ponzi scheme in history, which defrauded its investors of more than USD 50 bn.
Thus, be it new or existing, the bottom line is that organisations would need to stay more vigilant than before and cannot afford to let their guard down while battling the impact of the COVID-19 crisis.
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