Wednesday, 7 January 2009

Who has been swimming naked?

As celebrated financier Warren Buffett once said, "Only when the tide goes out, do you discover who has been swimming naked." Thanks to the so-called credit crunch, a handful of high-flying financiers, traders and company executives have been caught with their pants down.

There were the former Bear Stearns hedge fund managers arrested on securities fraud, the exposure of Bernard Madoff's alleged Ponzi scheme, and now the chairman of Indian IT outsourcing firm, Satyam Computer Services has admitted to "fixing the books" for the past several years.

While these frauds are not the direct result of the credit crunch; as capital has become scarcer, frauds perpetrated some years ago have become more difficult to cover up. Quoted in the Financial Times explaining how the fraud had spiraled out of control, Satyam's chairman, B. Ramalinga Raju said: "It was like riding a tiger, not knowing when to get off without being eaten."

While corporate fraud is not a new phenomenon, it is difficult to determine how endemic it is as it can go undetected for years. However, according to analyst firm Celent, internal fraud accounts for 60% of bank fraud cases involving a data breach or theft of funds. While malicious insider fraud, as opposed to accidental fraud caused through employee negligence or error, accounts for a much smaller percentage(9%)of all data breaches in financial services, Celent estimates that up to 50% of all insider fraud incidents go unreported.

With capital scarce and a high number of employee redundancies on the cards, most fraud experts anticipate the credit crunch will provide the perfect breeding ground for some employees to try and defraud the company they work for. But what is more likely to emerge is that tight availability of credit will expose those frauds that have been going on for some time. Madoff and Satyam Computers are only the tip of the iceberg.

"The general rule of thumb is that 20% of fraud companies know about, the other 40% they are aware of but don't know how to deal with and the remaining 40% they know is happening, but they are unsure where it is happening," says Bart Patrick, head of risk at business intelligence firm, SAS UK.
According to Patrick in the wake of the credit crunch, more and more companies are waking up to the threat corporate and insider fraud poses, and with capital scarcer than ever before, no company can afford to let criminal gangs or employees walk off with a few million.

More importantly perhaps, customers are likely to take an even dimmer view of those firms that do nothing to prevent internal fraud, as it is ultimately the customer that ends up paying for the higher incidence of fraud in the form of increased margins on insurance policies, for example.

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