Case Studies

The Fraud:

A US-owned agency with offices worldwide.  The Hong Kong branch was previously independent and had been sold to the international agency in the 2000s.  A wholly owned subsidiary dealing with all the agency’s business in the Far East, reporting directly to the US head office.

The dishonest employee was the Director of Finance and Administration who had been recruited 25 years earlier, when the business was owned and managed by the founder.  As the Hong Kong branch grew, she developed from a junior administrative role to a senior management position in charge of 12 finance and administrative staff.  She was also a cheque signatory (with sole authority up to the equivalent of US$20,000 but with joint signatures required above that), and was responsible for financial reporting to head office.  Made redundant due to a global restructuring, and the perceived need for fresh new personnel.  Discovery of the fraud came very soon afterwards.

For 14 years the employee had fraudulently issued around 1,000 cheques totalling about US$6,000,000 for her own benefit.  Transactions were recorded as if relating to the cash requirements of the branch or the payment of supplier invoices.  They were supported by false invoices in the names of bogus suppliers and legitimate companies.  The invoices would typically relate to travel costs, a category with substantial genuine expenditure.  Also to toner cartridges, printing costs, and translation services.

The employee would write a manual cheque for her own benefit, but would keep a doctored photocopy showing that it had instead been written in favour of the supposed supplier.  Most but not all were within her sole signing authority. The fraud started at a modest level but then escalated to between US$600,000 and US$700,000 in each of the three years before discovery.

Risk Features:

• No introduction of new management when the subsidiary was acquired.

• Payments would normally be made only to approved suppliers via SAP but a manual cheque book was retained for emergency and one-off payments.

• The subsidiary remained extremely profitable, even allowing for the fraud.

• Annual budgets were based on prior year figures.  The continuation of the fraud became incorporated within them.

• The nature of the Far Eastern business was sufficiently different to operations in other parts of the world for there to be no direct comparisons for profit margins and costs.  Also, costs were not attributed to specific sales or contracts.

• The US-installed head of the Hong Kong office had responsibility for monitoring office expenditure, but he focused on sales and client relationships rather than costs and underlying profitability.

• The US Worldwide Financial Controller could monitor expenditure via SAP and from the reports sent to him by the implicated employee.  So too would various divisional directors.  But their questions were referred to and dealt with by the dishonest employee herself.

• There were no internal audits during the 14 year period of the fraud.

• Much of the proceeds funded a lavish lifestyle.  Some assets in Hong Kong but civil action hampered there by criminal proceedings.  Some of the proceeds were channelled overseas.

• Difficulties in holding the bank or external auditors liable.

Solutions:

• Introduction of new management when a subsidiary is acquired.

• Focus not just on sales and developing the business, but also on the financial results and underlying profitability.

• Focus on profit and loss account – many frauds have a direct impact on this rather than leaving a “hole” in the balance sheet.

• Effective internal audit function and divisional / regional financial review.

• Appreciation of nature of the acquired business, and how it differs from other subsidiaries in other regions.