The incidence of financial fraud has increased of late, probably as a consequence of the increased pressures on the police after a recent disclosure in MaltaToday regarding alleged kickbacks paid in the oil procurement division of national electricity supplier Enemalta Corporation.
Last month, well known businessman Tancred Tabone resigned as president of the Malta Chamber of Commerce, after having been called in for questioning by the police regarding his previous role as chairman of Enemalta. Seven other individuals are currently under investigation regarding alleged kickbacks on oil purchases for Enemalta and their assets have been frozen pending the outcome of the investigation.
Another person under the spotlight is Frank Sammut. He was the former chief executive of Enemalta’s bunkering arm and a prominent member of the corporation’s fuel procurement committee when the international oil broker Trafigura was first awarded a contract for low sulphur fuel oil. The story of sleaze continues when one learns that Tancred Tabone is facing charges of corruption over kickbacks Trafigura paid to Frank Sammut in 2004 on oil supplies, when he was employed as a consultant to Tabone.
Yes, the Swiss economy did benefit from the blossoming of kickbacks in Malta according to Court testimony by Assistant Commissioner Michael Cassar. He referred to a Swiss bank account specifically opened to receive payments from Trafigura, and it is shocking to hear that a trusted entrepreneur who has been politically appointed as chairman and overseer of the national utility company was himself siphoning off the cream of commissions.
Perhaps it could be argued that such spectacular revelations coming days before a national election are not representative of the fraud environment in the country. It could perhaps also be argued that a purge on public financial administration cannot arrive a moment too soon, given that it appears to have been going on undetected for over a decade. It is not the purpose of this article to repeat in any detail the daily tales of woe describing how the mighty and trustworthy barons of power (all political appointees or their interlocutors) have, over the years, been milking the country dry while building up their overseas Swiss bank accounts.
Can we blame the pressures of the political bickering during the over-stretched electoral campaign as being the harbinger of such revelations? The answer is that it is somehow connected to some extent. This has exacerbated the pressure on regulators and naturally the company auditors of Enemalta (one of the ‘big four’ auditors) who, over the past years, were appointed by the government to review the company’s internal controls and to confirm that the financial statements are accurate.
This is statutorily required by International Standards of Auditing which mandates that, if their checking results in suspicions of financial fraud that lead to material misstatements arising out of intentional fraud and sometimes out of unintentional errors, then they have to report this. We see how the string of accounting scandals in the last decade exploded with a bang: Enron, and the revelations following the dot-com collapse in 2002/3 that dwarfed the gravity of scandals of late connected with the sub-prime banking crisis, the Madoff Ponzi scheme and now the unaccounted sovereign debt discovered by the Brussels mandarins in cooked Greece accounts.
Other examples come to mind. Earlier this week, the Times of Malta reported how Island Oil Bunkers Ltd, a local company has been revealing massive losses in spite of its staggering turnover of $1,300 million between 2003 and 2011. No eyelids were raised by the taxman that this relative behemoth did not pay any tax during these years. It reminds one of the shocking story of nil tax being paid by large international companies in the UK. All the audit reports on Island Oil Bunkers Ltd, signed by Deloitte, are clean and unqualified. The company enjoyed very good relations with local banks, which issued it with loans and overdrafts in the region of $46 million and MaltaStar.com revealed that after it examined the records at MFSA, its bankers took no tangible security, no special hypothecs, no pledges, no ship’s mortgage, no personal guarantees from shareholders, whether registered or hidden, or from directors – whether those appearing in the MFSA files, or those in the shadows.
It is unbelievable how, with such a negative equity and with a recurrent loss posited in its audited accounts, the bank only requested a general hypothec on the company’s assets. MaltaStar asks some pertinent question about this company, the ownership of which is connected to Tancred Tabone. Has any legal action been taken by the banks for the recovery of the credit? Have any provisions been made by the directors to cater for the negative equity of the company?
Readers may well ask why fraud permeates even solid company structures that are regularly monitored by the MFSA and FIAU after they conduct regular inspections and, of course, pay for statutory audits by one of the big four.
Before examining the most common types of fraud and how to detect them, it is worth reviewing what fraud is, why it happens and how it manifests itself in various scenarios. By definition, fraud can be better described as deception or misrepresentation on the part of an individual or entity knowing that such misrepresentation could result in some unauthorised benefit to the individual or to the entity or some other third party.
This definition therefore excludes errors or misconceptions on accounting estimates. Corruption is a cousin to fraud but takes a broader perspective and includes conflict of interest, bribery, kickbacks, the trading in influence and bid–rigging. From an audit theory perspective, any fraud scheme is generally not detectable by traditional sampling and audit procedures, because frequently the transaction is not recorded.
Therefore, auditors must understand that not all fraud schemes are detectable by traditional tests of controls. Fraud analytics may be more successful in detecting the probability of cash skimming but investigative procedures will be required to track the theft to its roots. At this stage one can quote the famous fraud triangle depicted by the late criminologist Donald R. Cressey who specialised in this type of fraud detection.
Dr Cressey said three factors are typically present when a fraud occurs: rationalisation, pressure and opportunity. To start with rationalisation, this is an intention to cover one’s abusive attitudes by wilful justification. Secondly we have “pressure”, something that is closely tied to today’s deep recessionary environment and that can easily influence management. And the finally there is “opportunity”, which – in simple terms – means a situation where fraud can be perpetrated due to a lack of organisational controls and security. Therefore one expects more “pressure” on management when, say, the commercial environment places undue stress on meeting operating targets in a downward spiral due to recession.
In this culture of “opportunity” we see how auditors have been advised to take a sceptical approach when examining a client’s accounts, although they are not responsible directly for the detection of fraud. Looking for red flags is a practical way of deciphering the existence of fraud, whether it arises due to error or an intentional misappropriation of assets. Typically, auditors will question why there are reports of increased revenue without a corresponding increase in cash flow or why there are highly complex transactions, particularly those that are closed near the year end. It is standard practice for auditors to examine any unusual growth in the number of days’ sales in debtor lists which may possibly account for fake sales invoices. These can be intended to jack up revenue.
Overstating or improperly recognising revenues is a common form of fraud. The majority of cases of fraudulent financial reporting in listed companies involve making a company’s financial health appear better than it really is. Then there are the clever schemes that include understating the cost of sales as a non-operating expense so it does not negatively affect gross margin. Another ploy is to improve profits by capitalising operating expenses, and recording them as assets on the balance sheet instead of as expenses on the income statement.
All this is usually associated with domineering management that over-rides internal controls and manipulates inventory balances at year-end simply by allowing a lax control over those responsible in conducting physical counts. Rationalisation means that the common attitude is that no one will miss the embezzled funds, particularly in larger retail environments. A strong tool in the arsenal of the examiner is the use of analytical procedures.
To conclude: fraud is contagious and the implications for management to detect and eradicate it are paramount.
Every organisation is vulnerable to fraud, and managers must know how to detect it or at least when to suspect it. It is not surprising that management has to be vigilant, as fraud and corruption in financial circles is a threat to a company’s very existence. At this stage one can fight using superior analytical tools which are recommended for directors and government inspectors who are responsible for the reporting of opinions over assets held by clients or the state. The fight against fraud continues – it never ends
The writer is a partner in PKF an audit and business advisory firm
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