2018 ACFE Global Study on Occupational Fraud and Abuse

Nearly 50% of all fraud cases result from internal control weaknesses, the 10th edition of the largest Global Study on Occupational Fraud and Abuse finds. The ACFE has just released its latest report, based on well over 2,500 real cases from over 20 major industries in 125 countries. Whether you call them whistleblowers, tipsters, informants or Hinweisgeber – those individuals who provided a tip were key to 50% of all fraud investigations.

The Report to the Nations is the go-to source for fraud fighters and risk professionals who look for trends, detection and mitigation tactics, numbers and qualitative insights.

Snap up a bubble

California-headquartered camera company Snap Inc.’s initial public offering (IPO), has been all the rage.  The valuation at USD 24 billion (~EUR 22.4 Milliarden), including staff stock and deal bonuses, set the IPO target at USD 17.  After its first day of trading at the New York Stock Exchange (NYSE: SNAP) markets are smiling and co-founder billionaires Evan Spiegel and Bobby Murphy, are beaming thanks to the stock closing 44% above its listing price.  Today’s performance has been no less impressive – or unsustainable – given the stock’s underlying business model and some risks I’ll look into in a minute.

Others, such as venture capital firms Benchmark Capital and Lightspeed Venture Partners,  Morgan Stanley as well as Goldman Sachs can also be reasonably expected to celebrate a nice pay-off.  Valuation and legal advice – as controversial as some of it may have been – generated USD 26 million and USD 21 million respectively for the underwriters.

Criticism hasn’t been missing, though, concerns have been raised that:

  • liberties were taken with investors’ rights, i.e. shareholders stripped of voting rights which leave them with no right to determine board members, influence merger & acquisitions or submit shareholder proposals;
  • the business model appears thin with a user base dwindling and user growth slowing, difficulty to reach over 35-year olds and securing their engagement for more than a daily couple of minutes on Snapchat they currently offer;
  • the company was founded in 2011, suffered a net loss of nearly USD 515 million in 2016, with an earlier net loss of USD 373 million in 2015 (see page 12 – Summary Consolidated Financial Data).

Snap Inc. has been aware of a range of risks, it seems.  In fact, among its financial information for investors – SEC filings, is today’s filing, a prospectus pursuant to rule 424(b)(4) which lists a whole set of – though in extra small-print- risks investors should take into consideration. The major potential areas of concern are cloud services and technical risks, competition issues within the industry, user loyalty (and over-reliance on non-Android – i.e. iOS users), sole reliance on advertising, reputational risk, intellectual property risk and in general a focus on user retention, growth, or engagement rates that are at the core of operations, which means a decrease would render Snap Inc’s products not only less attractive but also cause serious harm to the business.

What the report – a dense reading of 240 pages – does not mention at all, though, is whistleblowing or ex-employees who might engage in such act.  Litigation and lawsuits find ample discussion in the report and it seems Snap Inc. is acutely aware of the damage to reputation and drain on resources any legal action could have.

However, the (quite redacted) 31-pages lawsuit (via LA Times), filed in early January 2017 in the Superior Court in Los Angeles by former employ­ee Anthony Pompliano contains allegations regarding misrepresentation of the company’s fin­an­cial state.  Pompliano alleges that his refusal to give in to pressure and engage in cooking the books in order to inflate the company’s IPO value by means of false representations of metrics resulted in unlawful termination.

Inaccurate representations  and fake metrics are not just an ugly accusation of a disgruntled employee that is already causing reputational damage due to media coverage, but, if substantiated, carries serious penalties under the Securities Act of 1933 [amended]

UNLAWFUL REPRESENTATIONS SEC. 23. […] It shall be unlawful to make, or cause to be made, to any prospective purchaser any representation contrary to the foregoing provisions of this section. (…)
[…]
PENALTIES SEC. 24. Any person who willfully violates any of the provisions of this title, or the rules and regulations promulgated by the Commission under authority thereof, or any person who willfully, in a 75 SECURITIES ACT OF 1933 Sec. 27 registration statement filed under this title, makes any untrue statement of a material fact or omits to state any material fact required to be stated therein or necessary to make the statements therein not misleading, shall upon conviction be fined not more than $10,000 or imprisoned not more than five years, or both. [emphasis added]

Aside from all this remain two key questions:

  1. What role were analysts playing in the misrepresentation of metrics and related valuation, i.e. those individuals and teams working for the underwriters whose fees made headlines, i.e. above mentioned Morgan Stanley and Goldman Sachs?
  2. Also, the role of market data providers, such as Bloomberg who failed to raise the risks, the weak business model and other issues in their Snapchat/Snap Inc.coverage in late 2016 and seemed to contribute to what looks like another hype thanks to a price over revenue multiplied by an unsustainable valuation ratio of 60  (versus Facebook x 14.0, Twitter x 4.5).

Earlier this week we heard Warren Buffett (NY Times and Berkshire Hathaway 2016 letter) speaking angrily about [hedge fund] fee structures which he deemed “bordering on obscene”.  In the broader context of SNAP Inc.’s going public triggering similar questions about fees and performance, we may be at a point where perverse incentives coupled with fairly blatant ignorance of a whole host of risk issues enter the mainstream media and public awareness, gaining some of the urgently required attention they deserve.

Ironically, shareholders, who are supposed to have a voice and stake in such matters, have been muted.  In this bizarre tale of initial public offering marked by strange governance fascism, they have been – knowingly and with consent – robbed of their voice and potential power.

As to a potential case of IPO or valuation fraud, all hopes might be on the former employee who has been quickly dismissed as disgruntled.  We may just see this whistleblower case settled out of court, and the bubble further inflating before it eventually bursts, though.

All whistleblowers are the same. True?

“They are in for the money.” “Another disgruntled one.” “They stretch the truth for the dough.” And so it goes on. Grumpy commentary, overheard. Whistleblowers have been given a bad rep – ask by whom -, but is it true and are they really all the same?

One whistleblower withdraws his claim, and leaves everyone guessing, another one turns down a sizable award, and issues his statement of motivation for doing so. Thousands remain unmentioned, though, their cases never hit the headlines.

The US Securities and Exchange Commission boasted in a recent press release to have “awarded more than $111 million to 34 whistleblowers since [the award program’s] inception in 2011.”.  However, on the US Department of Labor’s site the Whistleblower Protection Programs’ data set spanning a ten year period between 2005 and 2015 reveals that more than 15,000 cases were dismissed, another 4,500 plus cases were withdrawn.  In total, more than 26,000 cases were considered and determined. Continue reading “All whistleblowers are the same. True?”

Risk: rogue culture killed das Fahrvergnuegen

The whistle-blower lawsuit Donovan v. Volkswagen Group of America Inc., 2016-151877-CD, Circuit Court, Oakland County, Michigan (Pontiac), filed on 8th March by a former  Volkswagen-employee, brought to light what the tone at the top can cause in terms of management of reputational and litigation risk.  Volkswagen, founded in 1937, is currently professional home to more than 600,000 employees around the globe, and a portfolio of 12 automobile brands that span the entire spectrum and include Audi, Porsche, Lamborghini and a wide range of trucks and buses.  Further, activities in engineering related to power plants, turbines, and chemical reactors and beyond make the corporation a systemically important player in Germany’s labor market and therefore a key contributor to Germany’s GDP and wider national economy.  It self-identifies as embracing an open corporate culture but has come increasingly under scrutiny for a leadership style and ownership structure (c.f. Governance issue discussion) marked by hierarchy and family dynamics.

So far, Volkswagen’s online representation only marginally touches upon the notion of whistleblowing (c.f. European Ombudsman (Draft decision on internal rules concerning whistleblowingas confined to corruption and human rights violations only, implying these are perceived as external phenomena. Following then-CEO Winterkorn’s statement in September 2015:

“We do not and will not tolerate violations of any kind of our internal rules or of the law. The trust of our customers and the public is and continues to be our most important asset.”

Volkswagen’s stance – in terms of actions – hasn’t been exactly in line with what investors and the public were hoping to see, and what should have become a governance overhaul, ideally rooted in impact assessment and supported by related relevant risk-metrics. The opposite seems to be the case, with further threatening clouds now looming large on the horizon thanks to the above-mentioned whistleblowing case which, independent of its merit, has already been making headlines and thereby increasing uncertainty for investors and stakeholders, and reputational risk.

Losses and reputational damages beyond quantifiable scars:
Increasingly it has become clear that the crisis strategy senior management at Volkswagen has been resorting to is proving inadequate and not suited to reestablish its fragile but most vital asset. Customers’ and the public’s trust have taken a severe and sustained blow as Volkswagen’s share value.  More than 6 months after the peak of emission fraud -related news, it still keeps hovering well below the 50% worth of its 52-weeks’ high Volkswagen currently faces a solid two-digit amount worth billions of Euros in fines, criminal charges, lawsuits and class actions, anticipated and resulting from filed claims in the US, Canada, the UK and beyond.  This is going to add to the losses already incurred and priced in by the market:

  1. the cost of recalling affected cars and
  2. installing the required software update.

In addition Future Losses encompassing:

  • long-term profit decline resulting from reputational damage to the corporate brand, the wider industry and the nation’s quality standard “Made in Germany”,
  • a weighing down of Germany’s share performance index DAX,
  • staff retention issues, hiring and related costs, and
  • further expansion of internal controls and compliance efforts,
  • less apparent knock-on effects such as not yet known potential further revelations which may need to be added in and will most likely be revised upward.

Risk resulting from ineffective crisis management:
The lack of clear, firm, concise and concerted, as well as forthcoming and truthful communication, by top management, has been particularly painful and adding scorn to the scandal.

  1. Senior leaders chose to provide piecemeal allocations of blame and engaged in accountability rhetoric of very limited substantiation.
  2. They focused initially on blaming a single-digit figure of “rogue engineers”.
  3. In addition, they had very little to say about the lack of decisive action upon notification in the past,
  4. and failed to provide clarity on missing or dysfunctional internal controls, thereby only further damaging the demolished brand.

Volkswagen’s social media engagement continued to be highly selective: VW Group’s Twitter channel follows less than a mere 10% of its followers and engages predominantly in glossy self-promotion. An advanced search demonstrates Volkswagen’s complete absence of engagement with critical consumers, clients, and the wider public.

This silence on the particular matter has proven counterproductive to the restoration of trust and confidence.  Even if the default tone at the top in such moments of public and widespread embarrassment may have been silencing critical voices, waiting it out and hoping that time will encourage regulators and the public to forget, might not be a reasonable strategy, in particular as Volkswagen had committed similar fraud in the past (discussed and referenced further below in more detail).

Volkswagen Financial Services AG (VW FS, and Volkswagen Bank GmbH) 2015 report strikes a tone that appears overly confident, given the ongoing debacle, the audience is assured of the Group’s strength to “master the impact of the emissions issue and to emerge stronger in the future”.  The report was compiled at a time when the full scale of what Volkswagen calls euphemistically the “emission issue” was neither clear nor the internal investigation, commenced in October 2015, concluded.

With no consideration or reference to factual data and underpinning evidence, the bold promise made to the audience represents an assessment that is potentially misleading shareholders and the public alike:  VW FS’ credit rating downgrade in November 2015, to long-term investment grade BBB+ (S&P via Reuters; downgraded also by Moody’s with negative outlook by either rating agency, also applied to Volkswagen Group which maintains a higher credit rating though) reflects this  view.

Volkswagen, however, argues that the rating agencies focused mainly on the emissions fraud and resorts to a defensive tone in respect to their communication with the agencies. Overall, the report remains very tight-lipped on the tone at the top, in fact leadership issues are mentioned only a handful of times within the 184-pages strong report, with a brief and vague note on one training opportunity which was held to “promote the corporate and management culture”, leaving the reader guessing as to whether the problematic existing culture was indeed further promoted or if any rethinking and remodeling was considered.

Communication as to the consideration of adoption of best practice from outside the firm, industry or nation has not been provided at all so far.

Internal controls – wherefore art thou?
At the time of writing, neither Volkswagen’s online staff magazine nor its corporate website offers much transparency as to recently implemented hotlines (via external Ombudsmen). Questions which arise are for instance:

  • what protection and/or incentives are offered other than (discouraged) anonymity,
  • whether whistle-blowing is valued or perceived as the operation of last resort.
  • in the case of the latter, what alternative routes exist in order to tackle misconduct, fraud, corruption, or other ethical concern.
  • How many, if any, instances have been handled so far and
  • how long it took to investigate them and/or
  • what losses and damage have subsequently or potentially been prevented.

Clarity and insight into soundness, effectiveness and acceptance rate of the mechanism would benefit investor relations but also impact positively on retention rates. It could prevent whistleblowers from going public.  It could in the wider sense positively shape the restoration of trust and support behavioral change if Volkswagen’s leadership committed to more transparency of their whistleblowing policies and related procedures.

A progress report of 2010 (dated 2008) can be found that summarizes progress on whistle-blowing protection but only in the narrowly defined context of conflicts of interest and corruption:

“Der Volkswagen-Konzern zeichnet sich durch eine offene und transparente Unternehmenskultur aus.

Das Ombudsmann-System garantiert allen Mitarbeitern bei Verdacht auf Verstöße das Whistle-Blowing, ohne dass sich jemand vor Repressalien fürchten müsste. “

Volkswagen prides itself on an “open and transparent corporate culture” and guarantees employees [the right] to whistle-blow with subsequent protection from retaliation. Further details cannot be found, this hasn’t changed post-scandal.

VW Group Sustainability Report 2014 further demonstrates very limited progress on group-wide compliance efforts: less than 1/3 of all staff had received class-based or online Compliance training. Whistle-blowing is not mentioned anywhere in the report. Further questions arise:

  • No explanation is provided as to the newly introduced – quite airy and generic – Code of Conduct (PDF, 24p), mandatory per online training for all new employees has been introduced.  However, with respect to those who have been with the firm for years or decades, no clarity is offered as to training records.

While the variable bonus pay (performance-based element of compensation) has now been linked to compliance with the Code of Conduct:

  • Yet, it remains entirely unclear how/to what degree compliance with the Code is measured and taken into account;
  • how the Code is enforced,
  • what measures are taken when breaches occur and
  • what consequences, in particular with respect to those employees who haven’t been recently recruited, can be expected, and
  • what metrics and qualitative data underpin the wider implementation and monitoring of compliance with the Code and when communication to shareholders and stakeholders about progress or lack of such can be expected.

The Group’s online subsite on Compliance and Governance is boldly talking of “successful Governance”, not clarifying, though, how it measures the success, what parameters feed the model and not permitting the audience to reverse-engineer that statement.

Trust assumed, when trust has just been severely damaged does not underpin the notion of an introspective, reflective, open and learning corporate culture.

The notion of a flat, open and dynamic corporate culture, capable of incorporating critique for the wider good and at an early stage as means of effective (preventive) risk management appears like a nostalgic advertisement of the glorious past.

The glorious past – and the history of breaches:
Volkswagen had come under intense scrutiny by US EPA (Environmental Protection Agency) back in 1973 for a not dissimilar issue: emission-defeat devices had been installed in more than 20,000 cars and also buses.  This consequently resulted in fines and a costly recall for removal imposed by the US authority, c.f. VW DefeatDevice EPA Prosecution 7-23-73 (PDF, 6p).

The failure to disclose the inbuilt switches and seek prior permission and certification was paralleled by a lack of swift and forthcoming correspondence with the US Agency.  The settlement meant that Volkswagen did not admit any wrongdoing, but committed shortly after, in 1974, yet another breach WSJ, 1974 [PDF].

Switching heads:
Various individuals have stepped down or have been suspended, most prominently CEO Winterkorn who was offered a much criticized golden handshake. Furthermore, heads of development and research respectively at Audi and Porsche as well as Volkswagen U.S. CEO Horn were dismissed.

While the internal probe, launched on 1st October 2015, continues, the reshuffle brought various new heads in.  Previously ordinary board member Poetsch (since 2003) is now heading a newly set up 20-member controlling panel and is chairman of the Supervisory Board.

As mentioned at the onset, Volkswagen is systemically important to the Germany national economy and a look at the newly placed Board members and their affiliations raises further questions as to independent decision-making and conflicts of interest at the helm of the giant:

  • While the federal state Lower Saxony holds 12.4% of subscribed capital and 20% of voting rights, 2 of the Supervisory Board members are ministers of Lower Saxony,
  • 3 hold professorships at German universities,
  • 5 of the Supervisory Board Members received basic compensation of nearly EUR 6.5 mn p.a. in the past fiscal year, with the lowest of the 32 receiving only around 6% Supervisory Board’s Chairman’s compensation, amounting to EUR 398,500.

Switching gears – or not:
In total 5 key Committees of the Supervisory Board are headed by 2 individuals who act as chairmen, i.e.:

  • Chairman of the Supervisory Board Poetsch – heads 3 committees, including ExCo and Nomination, and
  • 2 family members of the Porsche family (uncle and nephew) are heading the Audit Committee and a Special Committee of Diesel Engines.

The lack of independent decision-making at the top level and related impressions of conflict of interest are unfortunately not being dispersed by the newly set-up Ombudsmen system. Neither is specialized in whistleblowing protection, but both have extensive expertise in employer interest representation and their legal defense.

The segregation of functions, independent examination of internal controls and compliance with regulatory requirements remain a major challenge for Volkswagen Group.  Also, perhaps most importantly, mechanisms that offer effective means in the prevention and early detection of compliance breaches continue to present a pressing issue to the organisation.

Unfashionable: intellectual property risk

Listen to the think piece

Ethics are and remain rather unfashionable, it seems. Keen to compete and keen to impress, fashion firm KTZ – les enfants terribles behind UK fashion label Kokon to Zai – committed something much more serious than a fashion faux pas.  The global fashion market is approaching USD 2 trillion (Factsheet Feb2015) with severe income inequality knitted into many garment pieces consumers pick and wear.  The UK (Figures 2014) being a key player in this race for fashion hegemony and design dominance.  From a risk perspective, KTZ probably did weigh their chances but failed to consider the role of social media, or maybe they just hoped globalized media sharing wouldn’t really reach that far.  Now litigation and reputational risk are looming large, and subsequent losses have been stamped on the brand. Any press is good press? Not so fast with the marketing myths.

Fashion brands, in fact, the fashion and clothing industry itself, have been plagued for years by its unethical stance and practices. Whether

  • human rights violations and child labor,
  • the range of body image controversies due to anorexic underage models in advertisements and on runways,
  • environmental issues, or in fact,
  • cultural appropriation,

have made the headlines.  Blood diamonds, fur, sweat shops and the rampant – euphemistically framed “borrowing” from indigenous cultures, but also from sub-cultures and powerless individual artists, represent a persistent and severe problem.

As long as celebrities, royals and even the nouveau riche de la politique across the nations, don’t seem to mind, these unethical products find their followers.  They promise that brief moment of fame, the glamor shot, the much desired high, resulting from flattering Likes on traditional and social media, and that little bit of attention in a world that spins around short attention spans.  Short-lived, just like the fashion, handed over to to the charity shop down the road, label still intact, when it’s deemed so last season.

Avoiding plagiarism and being aware of ethical production and consumption standards should by now belong to every consumer’s and citizen’s (or student’s) basic knowledge. The risk to be branded an intellectual property thief, ignorant capitalist or quite generally, belonging to the exploiting (rather than inspiring) brand of entrepreneurs, is simply too high and too expensive to be neglected.  The fashion industry is not entirely unaware of these issues, and in fact, has been attempting to tackle the issues and improve the business and its image for a while (c.f. Ethical Fashion Forum). Sustainability is high on the agenda, governance policies have been drafted – but their enforcement remains unclear.  Counter-plagiarism and ethics enforcement, in particular with respect to intellectual property rights, are not embedded.

KTZ faced a storm of criticism and were fairly quick in issuing what felt like a lukewarm apology. Copying Inuit sacred symbols surely caused an icy blast – apparently relying on a notion that those remote few, discovered only by anthropologists long before the label was even founded, would not find out.

But will it last, or is the brand going to hunt down the next indigenous piece of design, hoping this time to get away with it?  Or worse, will they resort to appropriating symbols whose meaning they may not even grasp but, deciphered by insiders, may stir much worse than a painful offense and hurt to the peaceful Inuit? Copying someone else’s intellectual property and representing it as your own work counts as plagiarism, depending on your perspective you could argue forgery. Luckily, social media sharing facilities mean such kind of attempted fraud incidents stands a good chance of becoming widely visible.

Whether avantgarde fashion or budget micro label, it’s vital to address the lack of speed regarding the legal options in such moments, gaining redress takes time and resources.  Either tend to be scarce goods. However, with increasing technological facilities on social media and image recognition softwar,  the future is promising to hold more power for those whose rights have been infringed.

In the meanwhile, socially and environmentally educated and aware consumers, are making more demands and hope is growing that these crowds will step up and express their critical thinking when making purchases based on informed decisions.

As to KTZ, it remains to be hoped, that their “raw energy and contemporary urban edge” which they are so proud of, finds less disturbing channels.  Perhaps they could bring these characteristics to their much needed reputation and litigation risk management and toy with the idea of going beyond monetary compensation?

This idea is by no means as far-fetched as it may sound.  Up near the Arctic Circle the Alaskan Native people, a group of about 13,500 Inuit have been living for many thousands of years across a vast territory.  Seeing their traditional lifestyle severely threatened by the increasing impacts of climate change, the Alaskan Iñupiat collaborated with video game designers and developed  Never Alone. Their educational video game features documentary-style videos and inter-generational storytelling, making it part of a growing number of indigenous video games that feature atmospheric, story rich and beautiful ways of conveying the narratives, habits, practices and beliefs.  First released in late 2014, KTZ remained unaware of this though, while the Inuit reached out to the wider world to share, KTZ seemed to deem the Inuits in their case too far away to be taken seriously and consult with.

Here is the story of the Shaman whose daughter received KTZ’s apology.

Ethics training doesn’t have to be uncool and it certainly does not have to be boring. Creatively linking the requirement for respect of human rights, the environment and property rights on a global scale is what can set the ethically sound and successful leaders in any sector truly and sustainably apart from the rest of the short-term goal-chasers.

Forensic Accounting and Fraud Examination: Case Study – Online Pharmacy