Ripe for the pickingInternal fraud in a changing oil and gas landscape

Volatility in the oil and gas market, geopolitical instability, slow energy demand growth and economic sanctions have brought new challenges for oil and gas companies, including testing companies’ ability to preserve capital, reduce spending and withstand sustained pressure on balance sheets.

1 Ripe for the picking A changing oil and gas landscape

The main driversDriven by anemic economic growth in Europe and North America, oil and gas companies continue to invest in emerging markets, often perceived to be of higher risk for bribery and corruption. While it is good practice for companies to build or strengthen compliance programs in higher-risk markets, one must ask how much attention has been given to perceived low-risk local markets such as the UK?

For example, mergers and acquisitions in the North Sea have created a global marketplace for professionals from various regions of the world who have brought in their own culture and work practices. This raises new challenges in establishing a standard in corporate culture.

The current volatility has triggered budget cuts and increased pressure on the cost of doing business across this industry. Finance, production, sales and operations managers are all under pressure to continue to deliver results. In some cases, this may provide a strong incentive to do whatever it takes to make the numbers look good. In fact, In our 2016 Global Fraud Survey,

almost half of respondents felt that potentially unethical behavior was justified in order to meet financial targets.

These factors can heighten a company’s exposure to internal fraud and misconduct risks in the form of corruption, asset misappropriation or financial misstatement. Corruption and mis-selling have increasingly become the focus of enforcement and regulatory action. However, it is vital that while responding to these developments, oil and gas companies do not neglect their internal fraud controls.

This was made evident in our recent 2016 Global Fraud Survey, where a third of extractive respondents said they were willing to act unethically in order to survive an economic downturn, while a fifth of respondents said that loyalty to their company would prevent them from reporting an incident of fraud. This environment of increased pressure and market instability exposes oil and gas companies to a greater risk of internal fraud and misconduct.

The favorite forms of internal fraudManipulation of expenses continues to be a high-risk area for internal fraud and we will likely see this exacerbated by the instability in the market. The pressure that companies face to increase profits with fewer assets and manpower may have unintended effects on this type of fraud. There may be a greater risk of employees seeking to replace lost pay increases or bonuses by embezzling funds through manipulation of expenses, gifts and hospitality. One recent case saw a former finance executive charged for allegedly defrauding a North Sea company of £1 million.

In another case, one international oil exploration company has notified the UK Serious Fraud Office (SFO) of dubious expenses and unauthorized bonuses after being alerted by a whistle-blower. Initial investigations have led to the firing of a number of senior personnel and compounded the collapse in the company’s oil price and subsequent de-listing.

An issue we often observe is billing and procurement fraud. A payroll officer at an energy company recently defrauded her employer of £1.3 million over four years by fabricating demands for payment from HMRC and funneling the proceeds into her personal account.

Financial misstatement can also be a high risk area: a North American exploration and production company oil producer was accused by the SEC of overstating the value of oil and gas properties by more than $400m following acquisition. The company subsequently agreed to pay the SEC $5m to settle the matter with the company’s former CFO and former COO being charged with accounting fraud.

2Ripe for the picking A changing oil and gas landscape

Some insights from our 2016 Global Fraud Survey(Oil, gas and mining)

35% of respondents said they were willing to act unethically to help a business survive an economic downturn

43% felt that potentially unethical action could be justified to meet financial targets

21% said that loyalty to their company would prevent them from reporting an incident of fraud

24% said that loyalty to colleagues would prevent them from reporting an incident of fraud

3 Ripe for the picking A changing oil and gas landscape

Fraud model originally developed by Donald R Cressey1

Ratio

naliz

atio

n Opportunity

Pressure

Disrupting internal fraudUsing the fraud triangle to explain the factors that cause someone to commit fraud, one sees a pattern. In most of these cases, red flags such as the perpetrator living beyond his means, falling into acute financial difficulties or having unusually close relationships with customers and vendors were clearly discernible.

Ultimately, the risk of fraud can be reduced by taking steps to disrupt any one or more of these three attributes: rationalization, opportunity; or pressure. EY regularly supports companies operating in the Oil & Gas sector in developing these counter-fraud mechanisms.

Internal

► “I need the money”

► “ It is such a small amount anyway”

► “No one will ever know”

► Loopholes in internal systems and controls

► Keeping up with the lifestyle of peers

► Debts/addiction

► Malice/revenge

Culture

4Ripe for the picking A changing oil and gas landscape

1Donald R. Cressey, Other People’s Money (Montclair: Patterson Smith, 1973) p. 30.

Practical steps for combatting internal fraudEY can provide companies with practical support in developing successful anti-fraud frameworks.

Employee due diligenceAs well as conducting due diligence on key members of staff, corporate integrity methodologies can be utilized to profile employees’ decision-making processes, allowing organizations to detect weak links and be alert to any potential breaches.

Internal controlsProcess workflow can be examined, modeled and set up to utilize known fraud-deterrents such as bank reconciliations, IT security audits and process audits.

Forensic reviewsAnalyzing data to examine compliance, deviations and red flags is an important tool to detect fraud. The results can be used to detect fraud retrospectively, as well as to protect against these specific fraud patterns in future.

Whistle-blowing

Companies need to have clearly defined whistle-blower policies and processes, which ensure that allegations are investigated and resolved in a timely manner.

Despite this, our recent EMEIA Fraud Survey 2015 has shown that 14% of extractive companies did not have a whistle-blower hotline, and out of those who do have this in place, less than half said a report would always be followed up on by senior management.

InvestigationsShould fraud occur, companies must have the tools and training necessary to quickly investigate, and if necessary, evidence wrongdoing.

Data analyticsProactive monitoring through forensic data analytics can be used to detect fraudulent activity early on and discourage future misconduct.

Cultural integrity

Underpinning an effective anti-fraud framework is a culture that encourages and nurtures a strong, sustainable organization, which serves wider society, through cultivating a working environment guided by values that are shared by everyone.

Our 2015 EMEIA Fraud Survey showed that the extractive sector still has a long way to go in addressing cultural integrity. Less than a quarter of respondents rated their companies’ ethical standards when doing business as very good, while two-thirds felt that unethical practices may often go unnoticed by the head office. Only 36% of respondents, felt that their company had improved ethical standards in the past year.

5 Ripe for the picking A changing oil and gas landscape

Are companies sufficiently aware of the risks?Almost half the companies surveyed in the National Fraud Authority report in 2013 said they had been victims of Insider Fraud. While the ACFE’s 2016 Report to the Nations found that oil and gas companies had a similar likelihood of being victims of fraud, their financial losses were some of the heaviest. Out of 23 industries, oil and gas companies suffered the fifth largest financial losses at an average of $275,000.

Across each of the sectors, the report found that losses were estimated to be 5% of company revenue. These losses are usually not recovered and the eventual cost to the company can be up to four times higher, taking in the cost of the investigation, disciplinary action, and replacements (CIFAS, April 2014).

The collateral damage to reputation, political and social capital, loss of productivity, and drop in employee morale amplify these losses even further.

There is also a risk that internal fraud is heavily underreported due to low whistle-blower activity, tolerance of minor infractions and a desire to keep the firm’s reputation untarnished. Companies need to re-examine key messages and tolerance levels for unethical behavior and misconduct. They then need to adopt a robust corporate integrity framework and actively engage in fraud management programs if they want to limit their exposure to this risk.

The final wordThe current instability in the oil and gas market and subsequent pressures on headcount and budget reductions, means that firms need to think strategically when identifying efficiencies in their counter-fraud programs. Companies operating in this sector should not view investing in their counter-fraud framework as a burden to profitability. An effective counter-fraud program must be seen as a requirement to securing a sustainable success take over in the current marketplace.

Successfully combating internal fraud will require firms to take a multi-faceted approach, integrating the expertise of their business, compliance, internal audit and risk functions. It means developing the tools, processes and systems to allow firms to monitor, detect

and investigate promptly when something appears out of place. Firms that exploit new developments in forensic data analytics, may be able to create greater efficiencies in the long run.

However, countering fraud is a wider question than merely early detection. It begins with organizational culture, continues through internal processes and culminates in the way that breaches are investigated and resolved.

Given the volatility currently faced by oil and gas firms, it is now more important than ever for firms to prioritize implementing effective internal fraud controls.

6Ripe for the picking A changing oil and gas landscape

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About EY’s Fraud Investigation & Dispute ServicesDealing with complex issues of fraud, regulatory compliance and business disputes can detract from efforts to succeed. Better management of fraud risk and compliance exposure is a critical business priority — no matter the size or industry sector. With over 4,500 fraud investigation and dispute professionals around the world, we will assemble the right multidisciplinary and culturally aligned team to work with you and your legal advisors. We work to give you the benefit of our broad sector experience, our deep subject matter knowledge and the latest insights from our work worldwide.

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This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice.

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EY Fraud Investigation & Dispute Service contacts

Find out how we can help you protect the financial and reputational value of your business. We will react quickly and efficiently to prevent, detect and resolve any threats you face, however complex.

Jim McCurry EMEIA and Northern Europe leader Tel: + 44 20 7951 5386 Email: jmccurry@uk.ey.com

Sharon Van Rooyen Africa Tel: + 27 11 772 3150 Email: sharon.vanrooyen@za.ey.com

Stefan Heissner Central and Eastern Europe Tel: + 49 211 9352 11397 Email: stefan.heissner@de.ey.com

Ricardo Norena Western Europe Tel: + 34 91 572 5097 Email: ricardo.norenaharrera@es.ey.com

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Michael Adlem Middle East Tel: + 971 4701 0524 Email: michael.adlem@ae.ey.com

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Ken Arahari Japan Tel: +81 3 3503 2510 Email: arahari-kn@shinnihon.or.jp