Ken Springer: Seven Steps To Prevent Fraud

Taylor Bean & Whitaker Mortgage Corp., Carter’s Inc., Kmart, DHB Industries. What do these four companies have in common? An executive from each of these companies was charged with fraud within the last few years. And these are just a few examples. Whether it is securities fraud, corruption or tax evasion, C-suite executives are often the ones who have the access to take advantage of investors and directors. It is a constant challenge to identify executives who are trustworthy.

Executives and upper management are responsible for about 13.5% of corporate fraud, according to the Association of Certified Fraud Examiners (ACFE) and its 2010 “Report to the Nation.” Other notable groups include accounting (22%) and operations (18%). The ACFE also concluded that when executives commit fraud they cause the greatest damage to the firm and often, because of the complicated nature of the fraud and the control these executives have over companies, the fraud takes longer to discover than other types of corporate malfeasance.

So, as a director, you know that management is your key asset and must take all precautionary measures to ensure your executives meet your ethical standards so that your company will not become susceptible to fraud when the wrong executive is at the wheel.

Having witnessed businesses and investors become victims to every form of investment fraud over the last 30 years, I have found the following seven steps to be critical for any director who hopes to secure their interests and avoid vulnerability to fraud:

1. Conduct background checks: The importance of this step cannot be underestimated. More often than not, the perpetrators of investment fraud have something in their backgrounds that would have predicted the crime (or, at the least, alerted investors to a troubling pattern). The issues we most often see when conducting background checks on management teams are resume fraud/exaggeration of credentials; lawsuits by former employers; and, controversial media attention regarding previous positions in management.

2. Routine Monitoring: We have often seen problems arise after monies have been extended. Update the background checks. Don’t assume that if someone has no controversial issues or conflicts of interest in his/her background that the individual is then free and clear in perpetuity.

3. Dig Deeper: If potentially problematic issues are uncovered in the background check, they can often be resolved. Talk to the executive, get his/her statement about what transpired and then confirm the statement by reaching out to other parties, regulators or obtaining documents filed in related lawsuits. When we employ these methods, we gain clarity on an issue and assist in determining whether it is a problem that will impact an executive’s ability to manage successfully.

4. Ethics Hotline: Implementing an anonymous ethics hotline at portfolio companies is a resource for employees, vendors and others to report any internal wrongdoing and is an ideal investor tool that gives you a set of eyes on the inside. Should a problem surface, the hotline allows you to act proactively and not as a reaction.

5. Know Your Overseas Partners: Learning more about your business partners, investors and others involved in the success of your business is crucial. If you operate overseas as well, then understanding the ins-and-outs of how business is executed in these countries is not only important, it is mandatory to ensure compliance with the Foreign Corrupt Practices Act.

6. Education & Training: Making sure your employees and vendors understand and comply with your Code of Ethics policies and appropriate government rules and regulations (FCPA, SarbOx, Dodd-Frank, etc) will mitigate your exposure to complications or problems.

7. Rumors of Wrongdoing: It is critical to know the appropriate response when you receive information (anonymous or otherwise) that threatens the success of your company: from allegations of fraud to sexual harassment to violence in the workplace. Contact outside counsel; hire an independent skilled investigative team; conduct the investigation discreetly; and, based on the findings of the inquiry, decide whether the rumors were legitimate and, if so, how to resolve the problem before it becomes systemic at your firm. [Ed Note: We have a saying in this business: it almost always is precisely what it looks like.]

Ken Springer is President and Founder of Corporate Resolutions Inc., a business investigations firm that conducts background checks and business intelligence globally.

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