The risks of fraud during an economic downturn

When economies go south, not only are companies more likely to be the victims of fraud, but crimes committed in the past are more likely to be uncovered. Tadashi Kageyama, Kroll's Asia head of investigations, spoke about these risks at the annual Global Economic Crime Summit held in Hong Kong this week.

"Fraud is increasing and I think it is increasing because people are seeing more, detecting more, so it is surfacing more," said Kageyama.

It is not until growth dries up, and companies become more diligent with regard to the costs of doing business, that acts of fraud become uncovered, he said.

The example he gives is of a Japanese bank where one employee in a small office managed to steal nearly $4 million over a seven-year period. At the beginning of the investigation, Kageyama asked to see the audit report and discovered blatantly false invoices, such as monthly bills of about $20,000 for stationery.

"An office with less than 10 staff ordering $20,000 worth of stationery? I know that banks have nice offices, but those guys must have been using Mont Blanc pens," said Kageyama.

Simple things like stationery can fall under the radar of routine accounting checks. And since the office was growing and meeting its targets, head office had little to offer apart from encouragement. The main culprit was aware of the overall company situation and diligently read company reports, therefore the false claims did not appear out of synch with company performance.

Companies might be more conscious of costs, and therefore more aware of the risks of fraud in a downturn. At the same time, there are extra threats, said Kageyama. As companies are forced to lay off staff, they could be the target of revenge attacks by former employees; and as the downturn affects the personal finances of its employees, desperate individuals are more likely to do desperate things.

After his presentation, Kageyama spoke to FinanceAsia about how financial companies fit into the picture. He is currently conducting several post-transaction investigations for investors who have run into trouble with their investments. Some of these deals are a couple of years old, from the boom years of 2006 and 2007, but some are just less than a year old.

"By mid-2008, the banks had so much money and fewer opportunities for investment, we were seeing four or five institutional investors competing for deals. So many were spending less time on due diligence," said Kageyama. "We have [investors] who have found out that a large part of the company is fictitious or that the founders took out personal loans using part of the company as security." 

Kageyama said that while many bankers involved in these transactions had very little information, others had enough information to make them aware that everything was not above board. He cites the case of a Japanese ponzi scheme that had attracted money from a number of international banks, which came to light last year.

"We did an investigation for a certain client to see who did it, how it happened, and where the money went. Our assessment is that a large number of institutions that invested in that product had a certain understanding that the financial product was suspicious," said Kageyama. The investment scheme's contract and the parties involved were so shoddy that it should have raised alarm bells -- it was written in an unprofessional manner and the company chop didn't look right. The fact that it was guaranteeing returns way above the market trend at a time when the markets were already weak was also implausible.

He discovered that several bankers were putting their own money in before their employer invested: the banker might get a kickback in the form of cash or shares, or a waiver of the management fees. This kind of insider trading is common. In another case, he found more than 20 bankers had invested into the scheme.

But perhaps the main risk for financial companies is the future, says Kageyama: "I think it is easier to commit fraud when the market is growing fast: people will be hired quickly and told to invest. That's the time we will see lots of fraud that might never get discovered."