Corporate fraud - The revelations keep coming

As I mentioned in my previous post with the tide well and truly out as the credit crisis deepens, some unsightly corporate 'flotsam' is being washed up on our shores. But can we extrapolate from the increased disclosure of high profile corporate fraud cases in recent weeks and months that corporate fraud and the credit crunch go hand in hand?

Well the answer to that is yes and no. David Porter, head of security and risk at consultancy, Detica says corporate fraud was a major problem before the credit crisis began and that we are unlikely to see rocketing levels of fraud as a result of the crisis. "But we will see rocketing levels of discovery," he says. "When things are going well, people don't bother looking at fraud. Now that times are hard, what was previously non-pressing has become more pressing.”

In other words the scarcity of capital and renewed focus on corporate governance is helping shine the light on incidences of fraud that were less likely to be uncovered when everyone was drowning in liquidity and economic conditions were perhaps more conducive to inflating profits in financial statements.

Kroll's 2008-2009 Global Fraud Report says that 85% of companies were affected by at least one fraud in the past three years, up from 80% in its previous survey. The most common forms of corporate fraud according to Kroll's survey were theft of physical assets, which impacted 37% of companies, compared to 34% in the previous survey. Information theft also increased from 22% to 27%; and regulatory and compliance breaches from 19% to 25%.

In its 2008 Financial Risk Outlook, UK financial services regulator, the Financial Services Authority (FSA) identified financial crime as one of the key priority risks stating that “tighter economic conditions may lead to an increase in the incidence or discovery of some types of financial crime.”

Kroll anticipates that as a result of the credit crunch there is likely to be an increase in "non-malicious" corporate fraud committed by those "misguided" employers or employees who are not out for personal gain, but to save their company and employee's jobs. It also expects to see an increase in false accounting practices as companies look to inflate profits in order to maintain their core ratios or protect themselves from breaching banking covenants. We also understand that corporate bribery and corruption where business contracts are awarded on the basis of financial rewards and employees being coerced into collusion with outside gangs are also on the rise.

Below I have compiled a rough list of frauds or alleged frauds that have come to light since the credit crisis began 18 months ago. While these frauds are not necessarily the direct result of the credit crisis, the scarceness of capital has perhaps helped bring them to light or resulted in more exposure and heftier fines or closer regulatory scrutiny:

• January 2008: Trader Jerome Kerviel incurred $7 billion in losses as a result of "rogue trades" at French bank Société Générale.

• March 2008: Swiss investment bank Credit Suisse announced $2.65 billion of write downs on asset-backed securities after discovering "intentional mismarkings" by a group of traders.

• Also in March 2008, the now defunct Lehman Brothers suspended two London equity traders after "issues" were discovered on share valuations.

• May 2008: Merrill Lynch suspends a trader for "overstating the value" of some equity derivatives.

• June 2008: Morgan Stanley suspends a credit trader for "mismarking" trading positions to the tune of $120 million.

• Also in June 2008: Two former Bear Stearns hedge fund managers were arrested on charges of securities fraud pertaining to allegations of misleading investors regarding two funds they ran that were exposed to subprime mortgages.

• October 2008: The US Federal Bureau of Investigation launches an investigation into Lehman Brothers, insurer AIG and mortgage providers Fannie Mae and Freddie Mac as they fall victim to the credit crisis. The investigation is believed to be looking at whether these firms unduly influenced agencies to "inflate" their ratings and misled investors about the true state of their assets.

• December 2008: European banks reveal their exposure to ex-Nasdaq chairman Bernard Madoff's alleged $50 billion Ponzi scheme

• January 2009: B.Ramalinga Raju chairman of Indian IT outsourcing firm, Satyam Computers, admits fiddling the books to the tune of $1 billion. It has since been described as "India's Enron".

• 8, January, 2009: In the largest financial crime related fine, the FSA in the UK fines Aon Ltd, £5.25 million for failing to take reasonable care to establish and maintain effective systems and controls to counter the risks of bribery and corruption associated with making payments to overseas firms and individuals.

• Also in January of this year: Police reveal they have arrested Kabir Mulchandani, the chairman of Dynasty Zarooni, a Dubai real estate company, on allegations of fraud.

This is by no means an exhaustive list and does not take into account the myriad of fines imposed against individuals and firms for fraudulent activity such as insider trading and mortgage-related fraud.

However, the list does appear to support Kroll's view that in worsening economic conditions, employees or company executives, particularly in beleaguered industry sectors such as the financial services industry, may be tempted to falsely inflate profits, mismark the value of securities, or attempt to cover up substantial losses.

These incidences also appear to highlight a range of motivational factors ranging from personal gain in the form of seeking generous end of year bonuses by falsely inflating figures to making more money for the company concerned, or in the case of the alleged Madoff Ponzi scheme, the attainment of personal kudos through the accumulation of wealth.