Wed, Sep 26, 2018

China: Developing a Strategy to Combat Fraud

China stood out in Kroll’s 2016 Global Fraud and Risk survey, but not in a good way. A quarter of survey respondents indicated that they were dissuaded from operating in China due to concerns over fraud and corruption. This result is consistent with what we see on the frontline of fighting fraud in China.

Over the past decade, fraud in China has become increasingly complex and challenging. While its fraud trends share some common traits with other developing countries, fraud in China also has some unique characteristics.

For example, fraud is often committed by senior executives, resulting in losses that are potentially more significant. It also often involves cross-departmental and multiple-party collusions, rendering traditional internal control measures ineffective. To complicate the problem, the rapid expansion and quick staff turnover of many organizations means that there is a lack of continuity in corporate governance and fraud detection. Fraudsters in China are also becoming more systematic and enterprising, posing significant threats to their victims.

While some survey respondents suggested that they were prepared to walk away from China because of their fear of fraud, this may not be the easiest (or necessarily the smartest) move.

China has firmly established itself as the second-largest economy in the world. As such, it is becoming increasingly difficult for global organizations to avoid doing business there altogether. It is also the dominant trading partner of many countries, and Chinese consumers represent attractive revenue streams that are not easily ignored.

Managing the risk of fraud in China is never easy, but it is achievable with a clear and consistent strategy. While no single solution will work in isolation, in our experience, there are a number of fraud mitigation measures that can be adopted by organizations of any size, in any industry. Companies must be vigilant and dynamic in their approach. It is essential to treat the fight against fraud as a long-term game, and not to look for shortcuts or overnight miracles.

1. Get the most out of your whistle-blowing system
Fraud is most commonly perpetrated by company insiders – and is most commonly discovered by company insiders. Whistle-blower complaints and senior management oversight are the most effective channels for detecting fraud in China. Many companies now have whistle-blower hotlines or reporting systems, but are not necessarily making the best use of them.

For example, Kroll worked with a multinational company to modify and domesticate its whistle-blowing system. To ensure that sufficient and relevant information is extracted from each whistle-blower and presented in a manner that can be easily accessed and analyzed, we designed questions and fields for whistle-blowers to complete during the anonymous reporting process. We also advised the client to implement a protocol to document the nature of the specific allegations in each report, including the department and seniority of the personnel implicated, the types of fraud alleged, and the duration of the alleged scheme.

Over a period of 2–3 years, a clear and auditable trail was maintained. More importantly, the accumulated data was reviewed and analyzed, which revealed internal control vulnerabilities and fraud risks in particular functions. Subsequent investigations were much more effective as a result.

2. Focus on the human factor
Regardless of the type and scale, all fraud is committed by people. In my experience, many companies do not do enough to ensure that they are hiring individuals with proven track records and strong integrity. During an investigation, we often discover that wrong-doers have committed fraud against their employers before. This could have been flagged through employee background checks. Robust employee due diligence carried out in conjunction with third-party vendor due diligence often reveal signs of potential conflicts of interest and kickback arrangements.

3. Ensure independence of investigations
Given the high prevalence of fraud in China, it may not be practical or feasible for a company to investigate all allegations. It is therefore important not to give employees the perception that investigations were initiated to further someone’s personal agenda. Using professional advisers can enhance senior management’s credibility and ensure confidentiality and independence. External advisers can also deter fraudsters who hope to influence the investigations by playing office politics.

4. Build a strong compliance culture with tone from the top and clear accountability
One of the best tools for preventing, detecting, and responding to fraud is to build and maintain a corporate culture with zero tolerance for fraud and corruption. This takes time, and support from the C-Suite is crucial. When setting key performance indicators for employees, financial goals should not be the only objectives considered. Senior executives should also be responsible for setting the tone and embedding a robust compliance culture in their teams.