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Corruption

Chapter 10

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What are the two principle schemes involving bribery?

 

Pop Quiz

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Learning Objectives

• Define corruption.• Identify the four categories of corruption.• Define bribery.• Compare and contrast bribery, extortion, and illegal

gratuities.• Identify the two categories of bribery schemes.• Understand kickback schemes and how they are

committed.• Understand bid-rigging schemes and explain how they are

categorized.

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Learning Objectives• Describe the types of abuses that are committed at each

stage of the competitive bidding process.• Be familiar with the controls and techniques that can be

used to prevent and detect bribery.• Define conflicts of interest.• Differentiate conflicts of interest from bribery schemes

and billing schemes.• List and understand the two major categories of conflicts

of interest.• Be familiar with proactive audit tests that can be used to

detect corruption schemes.

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CorruptionCorruption

Conflicts ofInterest

Conflicts ofInterest

PurchaseSchemesPurchaseSchemes

BriberyBriberyIllegal

GratuitiesIllegal

GratuitiesEconomicExtortionEconomicExtortion

SalesSchemes

SalesSchemes

OtherOther

InvoiceKickbacks

InvoiceKickbacks

Bid RiggingBid Rigging

OtherOther

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85.7%92.7%

12.8%

30.1%

5.1%

7.9%

0.0% 20.0% 40.0% 60.0% 80.0% 100.0%

AssetMisappropriation

Corruption

FraudulentStatements

2002 2004

Frequency of Types of Occupational Fraud and Abuse

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Median Loss of Types of Occupational Fraud and Abuse

$80,000 $93,000

$530,000

$250,000

$4,250,000

$1,000,000

$- $500,000 $1,000,000 $1,500,000 $2,000,000 $2,500,000 $3,000,000 $3,500,000 $4,000,000 $4,500,000

AssetMisappropriation

Corruption

FraudulentStatements

2002 2004

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Dollar Loss Range from Corruption Schemes

14.6%30.1%

6.8%7.5%

29.2%35.6%

12.9%11.0%

22.8%11.0%

12.3%3.4%

1.4%1.4%

0% 5% 10% 15% 20% 25% 30% 35% 40%

1,000,000 and up

500,000 - 999,999

100,000 - 499,999

50,000 - 99,999

10,000 - 49,999

1,000 - 9,999

1-999

All Cases Corruption

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Frequency of Corruption Schemes

17.6%

24.8%

40.5%

56.9%

0% 10% 20% 30% 40% 50% 60%

Extortion

Gratuities

Bribery

Conflicts

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Median Loss Corruption Schemes

$275,000

$275,000

$300,000

$285,000

$0 $50,000 $100,000 $150,000 $200,000 $250,000 $300,000

Extortion

Gratuities

Bribery

Conflicts

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0.9%2.8%

5.1%9.0%

6.2%9.0%

7.8%9.7%

10.9%11.8%

18.4%13.2%

21.3%13.2% 23.6%

29.2%23.8%

26.4%

0% 5% 10% 15% 20% 25% 30%

Law Enforcement

Anonymous Tip

Tip from Vendor

Tip from Customer

External Audit

Internal Control

By Accident

Tip from Employee

Internal Audit

All Cases Corruption

Detection of Corruption Schemes

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Perpetrators of Corruption Schemes

12.4%21.2%

34.0%47.3%

67.8%56.2%

0% 10% 20% 30% 40% 50% 60% 70%

Owner

Manager

Employee

All Cases Corruption

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Median Loss by Perpetrator

$900,000$1,500,000

$140,000

$225,000

$62,000$200,000

$0 $300,000 $600,000 $900,000 $1,200,000 $1,500,000

Owner

Manager

Employee

All Cases Corruption

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Size of Victim in Corruption Schemes

13.6%19.7%20.3%

23.8%21.5%

18.4%44.6%38.1%

0% 5% 10% 15% 20% 25% 30% 35% 40% 45%

10,000+

1,000 - 9,999

100 - 999

1 - 99

Nu

mb

er o

f E

mp

loye

es

All Cases Corruption

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$105,500$300,000

$87,500$173,500

$78,500$200,000

$98,000$342,500

$0 $50,000 $100,000 $150,000 $200,000 $250,000 $300,000 $350,000

10,000+

1,000 - 9,999

100 - 999

1 - 99

All Cases Corruption

Median Loss by Number of Employees in Corruption Schemes

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Bribery

• Offering, giving, receiving or soliciting any thing of value to influence an official act

• Buys influence of the recipient

• Commercial bribery

• Kickbacks

• Bid-rigging schemes

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Kickback Schemes

• Involve submission of invoices for goods and services that are either overpriced or completely fictitious

• Involve collusion between employees and vendors• Almost always attack the purchasing function of

the victim company

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Kickback Schemes

• Diverting business to venders– Vendor pays the kickbacks to ensure a steady

stream of business from the purchasing company

– No incentive to provide quality merchandise or low price

– Almost always leads to overpaying of goods or services

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Overbilling Schemes

• Employees with approval authority– Vendor submits inflated invoices to the victim

company– Overstates the cost of actual goods or services

or reflect fictitious sales– Ability to authorize purchases is key to the

scheme

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Overbilling Schemes

• Employees lacking approval authority– Circumvents purchasing controls– May prepare false vouchers to make it appear

that the invoice is legitimate– May forge an approval signature or have access

to a restricted password in a computerized system

– Difficult to detect since the victim company is being attacked from two directions

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Other Kickback Schemes

• Discounts are given in exchange for bribes

• Slush funds– Other side of the transaction– Funds can be paid from other accounts or paid

as “consulting fees”

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Detecting Kickbacks

• Normal controls may not detect kickbacks schemes

• Look for price inflation• Monitor trends in cost of goods sold and services

purchased– Often starts small but increases over time

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Detecting Kickbacks

• Look for excessive quantities purchased• Investigate inventory shortages• Look for inferior goods purchased • Compare actual to budgeted amounts

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Preventing Kickbacks• Assign an employee independent of the purchasing

department to routinely review buying patterns• Make sure that all contracts have a “right to audit” clause• Establish written policies prohibiting employees from

soliciting or accepting any gift or favor form a customer or supplier

• Expressly forbid any employee from engaging in any transaction on behalf of the company who has an undisclosed personal interest in the transaction

• Implement an ethics policy that clearly explains what improper behavior is and provides grounds for termination if an employee accepts a bribe or kickback

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Bid-Rigging Schemes• All bidders are expected to be on an even playing

field – bidding on the same specifications• The more power a person has over the bidding

process, the more influence he can exert over the selection of the winning bid

• Potential targets include:– Buyers– Contracting officials– Engineers and technical representatives– Quality or produce assurance representatives– Subcontractor liaison employees

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Pre-Solicitation Phase• Need recognition schemes

– Employee of the purchasing company convinces the company that a particular project is necessary

– Has the specifications tailored to the strengths of a particular supplier

• Trends indicating a need recognition scheme is occurring– Higher requirements for stock and inventory levels– Writing off large numbers of surplus items to scrap– Defining a need that can only be met by a certain

supplier– Failure to develop a satisfactory list of backup suppliers

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Specification Schemes• Specifications include a list of the elements, materials,

dimensions, and other relevant requirements• Set the specifications to a particular vendor’s capabilities• Use“prequalification” procedures to eliminate certain

vendors• Sole-source or noncompetitive procurement justifications• Deliberately writes vague specifications requiring

amendments at a later date• Bid splitting• Gives a vendor the right to see the specifications before his

competitors get the specs

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The Solicitation Phase

• Restricting the pool of vendors to choose from• Bid pooling• Fictitious suppliers• Restricting the time for submitting bids• Soliciting bids in obscure publications• Publicizing the bid during holiday periods

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The Submission Phase

• Fraud in the sealed bid process– Last bid submitted is the one that is awarded the

contract

– Winning bidder finds out what the other competitors are bidding

– Winning bidder may see the other competitors bids before submitting his bid

• Gets help on preparing the bid

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Detecting Bid-Rigging Schemes• Look for:

– Unusual bidding patterns– Low bids followed by change orders– Very large unexplained price difference among bidders– Contractors who bid last repeatedly receive the

contract– Predictable rotation of bidders– Losing bidders who become subcontractors– Vendors with the same address and phone number– Few bidders for the project– Projects that have been split into smaller ones

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Something of Value• Cash

• Promises of future employment

• Promise of ownership in the supplier’s firm

• Gifts– Liquor and meals

– Free travel and accommodations

– Cars and other merchandise

– Sexual favors

• Payment of credit card bills

• Loans on very favorable terms

• Transfers of property

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Something of Value

• Illegal gratuities– Given to reward a decision rather than influence it

– Decision made to benefit a person or company but is not influenced by any sort of payment

– May influence future decisions

• Economic extortion– “Pay up or else”

– Employee demands payment from a vendor in order to make a decision in the vendor’s favor

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Conflicts of Interest• Employee, manager or executive has an

undisclosed economic or personal interest in a transaction that adversely affects the company

• Victim organization is unaware of the employee’s divided loyalties

• Distinguished from bribery in that conflict of interest the fraudster approves the invoice because of his own hidden interest in the vendor

• Purchasing schemes• Sales schemes

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Purchasing Schemes• Overbilling schemes

– Bill originates from a real company that the fraudster has an economic or personal interest in the company and is undisclosed to the victim company

– Fraudster uses influence to ensure the victim company does business with a particular vendor

– Does not negotiate in good faith for the employer nor attempts to get the best price

• Turnaround sales– The employee knows that the company is seeking to

purchase a particular asset and purchases it himself– Turns around and sells it to the company at an inflated

price

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Sales Schemes

• Underbillings– Goods are sold below fair market value to a

vendor in which the perpetrator has a hidden interest

• Writing off sales– Purchases are made from the victim company

and credit memos are then issued later

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Other Conflict of Interest Schemes

• Business diversions– Siphoning off clients of the victim company to the

employee’s own business

• Resource diversions– Diverting funds and other resources for the

development of the employee’s own company

• Financial disclosures– Inadequate disclosures of related-party transactions to

the company

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Preventing and Detecting Conflicts of Interest

• Implement, communicate, and enforce an ethics policy that addresses conflicts of interest offenses

• Require employees to complete an annual disclosure statement

• Establish an anonymous reporting mechanism to receive tips and complaints

• Compare vendor address and telephone files to employee address and telephone files for matches