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Corruption in procurement – can we manage it?
Eckhard Volker CA (SA), Managing Director, Thabani Zulu & Co Forensic Accounting Services
Procurement fraud and corruption are by far the most common forms of white collar crimes. In this article, I seek to demonstrate the close correlation between these two and also highlight how excessive corporate entertainment increases the risk of corruption and exposes you to procurement fraud.
Many years ago, I was involved in my first major fraud and corruption investigation. That was in 1995. The client was a municipality where the internal auditors had identified a series of suspicious transactions linked to the servicing of pumps for the municipality's sewage reticulation system. I investigated. My suspects were a senior Treasury officer - shall we call him Mr Smith – and the owner of a small company in a town nearby, purporting to be pump specialists. We’ll call her Mrs Naudé. I considered exactly 100 transactions to the value of R2 580 530.84.
The transactions did not make sense at all. It was clear that these transactions would not stand up to close scrutiny and my investigation progressed well. A few days later, I invited Smith to attend an interview to address my “audit queries” (we don’t call it interrogation). For the next few hours I chatted to him, trying to get him to admit to his (alleged) many improprieties relating to the matter at hand. I asked him at one stage whether he had received any money from Naudé (which could be construed as a corrupt relationship) to which he offered the very weak denial “No, I think not”. Eventually he admitted that he had received R5 000 from her, but claimed that his wife suffered from a foot ailment and that the medical aid had proven insufficient to cover the medical expenses. He said that Naudé had graciously offered to help him out. On further quizzing I established from him that it might be possible that there was a second R5 000 (“she suffered terribly from those feet”). He did, however, let it slip that the payment may have been a thank you “for paying the accounts so quickly” (they had a wonderful relationship where a R350 000 invoice would be settled by the municipality on the same or the next day).
Needless to say, I did not stop my investigation at this point. When I considered his bank statements I found many, many R5 000 cash deposits. In fact, there were cash deposits of questionable origin aggregating R142 240 which included no less than 18 deposits of R5 000. And those were only the amounts which were deposited into the account! Later I was granted access to Naudé’s business records, including the cash book, which gormlessly listed several of these beautifully, under the caption “gifts and donations”. She had even claimed input tax against these. I also had the deposit slips where she had deposited the cash directly into his account. It was irrefutable – she (as the service provider who had been awarded the contracts by Smith) had returned the favour generously.
I felt I had established a compelling prima facie case of corruption and testified at the trial (many years later) with confidence and conviction. We had also established very compelling charges of fraud which were included in the prosecutor’s charge-sheet.
When I testify I take the comments made by the magistrate very, very seriously. The magistrate found both Smith and Naudé guilty of fraud, but to my amazement pronounced him not guilty on the corruption charges. I was traumatised! He did explain, however, that as he had already found him guilty of fraud, the money Smith received was his share of the proceeds of the fraudulent transactions and could not be construed as corruption. If he had found him guilty of corruption as well, he said it would have been a duplication of sentencing.
This case highlighted the very close correlation between corruption and procurement abuse.
Currently, corruption is covered by the Prevention and Combating of Corrupt Activities Act, number 12 of 2004. This act supersedes the historic Corruption Act, 94 of 1992. The new act is significantly more comprehensive and seeks to close many of the loopholes of the old Act.
Section 3 of the Act contains the general offence of corruption which can be summarised as any person, who directly or indirectly accepts ... any gratification ... or gives or agrees or offers to give to any other person any gratification ... in order to act ... or by influencing another person so to act ... in a manner that amounts to the illegal, dishonest, unauthorised, incomplete, or biased ... exercise, carrying out or performance of any powers, duties or functions ... that amounts to the abuse of a position of authority, a breach of trust or the violation of a legal duty ... that amounts to any other unauthorised or improper inducement to do or not to do anything, is guilty of the offence of corruption.
This could be simplified as any person accepting, alternatively any person offering gratification, as an inducement or reward, to neglect a duty or to exceed authority, is guilty of the act of corruption.
In all the cases above, reference is made to “gratification” and to “act”. Gratification is defined in Section 1 of the Act and includes items under 11 sub-headings. These include money, cash or otherwise any donation, gift, loan, fee, reward, etc,. It also includes office, status, honour, employment, etc and finally any valuable consideration or benefit of any kind.
In the quoted sections above “to act” includes
(a) .. (not directly relevant).; (b) performing or not adequately performing any official functions: (c) expediting, delaying, hindering or preventing the performance of an official (d) aiding, assisting or favouring any particular person in the transaction of any business (e) aiding or assisting in procuring or preventing the passing of any vote or the act; business with a public body: granting of any contract or advantage in favour of any person in relation to the transaction of any business with a public body; (f) showing any favour or disfavour to any person in performing a function as a public officer; (g) ...or (h) exerting any improper influence over the decision making of any person performing functions in a public body.
There are two distinct parties in corruption i.e. the corruptor (the person who pays) and the corruptee (the person who receives). Corruption could, however, be initiated by either party through offer by the corruptor or by demand of the corruptee.
In my experience, I categorise motives for corruption into different objectives i.e.:
· To obtain an unfair advantage · To pave the way for procurement fraud · To protect against any penalty.
I will explore only the first two.
I find that the procurement function will always be targeted by fraudsters. There is just too much money in procurement. In procurement we have two parties - the buyer and the seller. The buyer has access to (or influence over) the entity's buying power and the seller has a product or a service on offer. In an arm's length transaction the buyer would act in the best interest of the organisation to find the best possible product or service required for operational reasons from a suitable supplier, for the most competitive price, but considering the procurement regulations or policies applicable to the organisation. The seller, on the other hand, wishes to get the best price for minimum effort and cost. In arm's length transactions both parties can emerge relatively happily.
The problem arises when people get greedy. The buyer (remember this is not his/her personal money) might seek a personal benefit in return for giving the seller a contract. The seller, on the other hand, might wish to have a better profit margin and may offer the buyer a personal benefit in return for "relaxing the rules a bit".
Back to my example of Smith and Naudé. In that case I could satisfy all of the legal requirements of proving corruption. I demonstrated how Smith had obtained a personal benefit (gratification) which he was not entitled to and which was not disclosed, nor authorised. I could also quantify and demonstrate how he had neglected his duties when he engaged with Naudé's company. In fact he significantly exceeded his authority and neglected his official duties when he awarded high value contracts to Naudé where the procurement policy (and governing legislation) required a more onerous tender process. I could also link payments to him to specific examples of excess or neglect. Had the magistrate not found the parties guilty of fraud, I am confident that the elements of corruption would have been satisfied and that he would have made the appropriate ruling.
Although strictly only applicable to the public sector, the Constitution of South Africa requires procurement to be fair, equitable, competitive, cost effective and transparent. These are very sensible objectives, relevant universally. If these principles were to be applied to all procurement there would be little opportunity for corruption.
Most people are inherently honest and would not respond to a blatant corrupt approach by a service provider. Imagine how you would respond if somebody were to suggest to you that you should award a contract or pass an invoice for payment in return for R100 000 cash. Is that worth it? Granted, an additional 100K is nice, very nice, but consider the downside.
Immediately you will realise that you are now a criminal. Even if nobody ever finds out, you will still know. That implies your self esteem takes a dip. There is also the stress of possibly being caught. The stress will not go away, but will increase. You will now start to fear these "tedious auditors", whom you will perceive to be a real threat to your financial future and general wellbeing. There are also very severe implications to being caught and prosecuted for fraud. On a financial side, you will lose your job and find it very difficult to get another one of the same status. You will probably have to repay the money the company lost - there goes your pension. It is also worth your while to pay for the best attorney you can (or cannot) afford. This may require a second bond which you repay over the next twenty years. Emotionally you suffer. Imagine your shame if your children no longer respect you, and the "disappointment" of your parents, spouse and siblings. You will also discover quickly how many of your friends are less sincere than you previously thought. I haven't even mentioned the risk of going to jail and what that entails.
Although I have seen many rich fraudsters, I have not found a happy one.
Considering this, why is fraud so prevalent?
I believe that most fraudsters are "weaned" into it by a carefully calculated ploy to gradually draw them in. They are set up in a way that they do not realise it until they believe that it is too late to stop. It starts slowly with the dreaded entertainment. I see this happening in eight stages:
· A thank you gift · A reward for favoured service · A reward for information · A reward for favourable consideration · A reward to process false claims · A threat to expose · Participation in the scheme · An incentive to recruit
Imagine these from a procurement perspective. A creditors lady may call a supplier to advise that a cheque is ready for collection. He arrives with a thank you gift. A small inconsequential thank you gift of say a bunch of flowers and a box of chocolates. He hands these over with a compliment saying how efficient she is and what a pleasure it was to work with her. He lets it drop that he is sure the organisation must really appreciate her and he wishes that all of them were just as effective. In truth, she has done nothing special. In fact, she is demoralised and feels unappreciated (this was carefully researched before hand). The compliment and the gift, although harmless enough, make a huge impression on her and contact has been made. From a corruption perspective there is no problem. She did not neglect her duties nor exceed her authority and the gifts are considered inconsequential.
Now she makes a special effort. To return the kindness she uses her influence to process the next transaction for payment in only seven days as opposed to the thirty days as before. Once again this is not irregular. She does, however, get recognition by means of a reward for favoured service. This is a "nice" gift which could include a pen set, a bottle of wine, maybe even invitations to dinner or to sports outings. As this is so common, no one notices or cares. The values are, after all, insignificant and everyone else does it anyway. Once again, there is no corruption.
But then the rules change. Because contact has been made and a relationship has developed with the service provider, the latter suggests it may be time to squeeze in a favour in return. All he wants is a little harmless information, perhaps to give him a clue what his competitors have quoted. How can that hurt? The procurement officer (she has been promoted) rationalises it to herself that there is no prejudice - he will have to be the cheapest to get the job. In return, however, she accepts a gift as reward for information. Now for the first time there is an element of secrecy. The gift is more substantial and valuable but is delivered to the home and not the office. The bearer says "don't worry about it, the boss also got his. We just don't talk about it". Very relevantly, no cash changes hands. Technically, however, the offense of corruption has been committed. Gratification (in the Act) includes all forms of gifts. The procurement officer has "acted" as defined, by passing on confidential and privileged information. The seller has obtained an unfair advantage which makes this transaction less transparent and unfair.
Offer a finger and he takes the whole hand. Information is never enough. Now he asks you to help out a bit more, and is prepared to offer a reward for favourable consideration. The rules say you need three quotes. The supplier gives all three. The price is no longer market related; there is no more competition. In return, he lavishes ever larger gifts and special attention. It is important to note that there will be no suggestion of a cash payment at this time because everyone knows that a cash gift is a bribe. Although, the procurement officer argues or rationalises to the contrary, she is now involved in a fully fledged corrupt relationship. The next stage introduces the fraud.
The rules have clearly changed. The supplier will now chance his hand by submitting an invoice, but he made a little mistake with the unit of measure. The invoice value is therefore significantly higher than what it should be. For example, assuming a stationery supplier previously charged a R100 for a pack of ten pens, he now "accidentally" charges R100 per pen. The procurement officer notices, but because of the special relationship chooses to ignore it. Everyone can make a mistake, not so? A few days later, the service provider phones and says "did you see the little gift I put into your bank account"? In fact, he has made a moderate deposit of R200. The procurement officer is excited yet apprehensive and rushes out to check her bank account. She sees only R200. This disappoints, yet pleases. Disappointment because she had expected something more substantial - pleased because it is so insignificant that her integrity seems intact. Little does she know that she has now crossed the line by accepting a reward to process a false claim.
More "bad invoices" come in. The procurement officer panics and phones the supplier asking desperately what this is all about. She says she cannot process these transactions. "You can and you will" is the reply. The service provider reminds her that she was paid to do exactly the same thing last time, not to mention all those gifts. In fact, he threatens to expose her if she does not process these transactions. Panic prevails. The procurement officer feels she has no choice but to comply. She can't afford to plead for mercy with her boss and she doesn't want to resign and run, nor does she have the presence of mind to call his bluff. She realises the predicament she is in and blames everyone else. She was "set up".
Now that the integrity hurdle is out of the way, she expects to be rewarded for participation in the scheme. Although she has effectively "crossed to the other side" she is still very junior in the syndicate and only earns about 10% of the value of the false invoices. There are no more gifts and very little visible contact between her as procurement officer and the supplier. Secrecy becomes paramount. Communication is restricted to the personal cell phone. There is no more official office contact.
Big league syndicated procurement fraud requires more accomplices. Our friend is now given an incentive to recruit. The first useful service is to gather information about other (still honest) employees who could be useful to the syndicate and to identify their weaknesses. Through this process she gets promoted in the ranks and is rewarded accordingly. Arguably, she is no longer a corruptee but a fraudster.
What seemed to be such an innocent compliment and gift was in fact the first approach to test and to corrupt. Once one has reached the eighth level he or she will never fully restore his/her integrity or be truly happy again. Although you might have more money, you blow it on things which you think will make you happy again. It just does not work.
This is why I call it the "dreaded entertainment". That is where the trouble starts. Corporate entertainment has become an integral part of everyday business and it becomes difficult to differentiate between the "honest" entertainment and the type of entertainment which creates a sense of obligation. Technically, all forms of entertainment qualify as a form of gratification. It only becomes corruption if the recipients "act inappropriately" in response. Section 10 of the Corruption Act (12 of 2004) uses the concept of "unauthorized gratification".
To gauge possible motives, consider the intended purpose. It might be for market penetration (get your name and product known), appreciation (for providing a professional opportunity), enhancing communication channels (required for operational fluidity), to enhance the relationship, or the more sinister motives of having an advantage over your competitors, or as elaborated on above, to corrupt. Also consider who is the intended beneficiary and the role the person would serve in the professional relationship. I differentiate between operational level, management and the executive. If a disproportionate amount of entertainment is spent on the operational level staff, it seems more likely that there are ulterior motives. If, for example, an employee who earns R10 000 per month receives a benefit of R20 000 it would create a profound sense of obligation to return the favour, compared to an executive earning R300 000 per month who might even forget to say thank you and forget about it altogether. It must therefore be viewed in context.
Entertainment must be governed, policed, and most importantly, restricted by policy and practice. In government circles there are rules that the value of the entertainment may not exceed R350 and it must be disclosed and approved. One client of ours has a pragmatic rule: if you cannot eat it, drink it or consume it in one day, do not take it. This implies that an invitation to a golf day is acceptable but a hunting weekend is not. Accepting a bottle of whisky is okay but don't accept a case.
There are many forms of entertainment, some legitimate and others less so. I differentiate between:
· Corporate gifts · Meals and other · An invitation to sporting events · Travel related entertainment · Non-branded gifts
A corporate gift is usually acceptable because there is full disclosure. These gifts clearly identify the sponsor as they bear a corporate logo. Although the gifts could be very expensive, transparency is assured. Corporate gifts vary from and might include a desk pad, calendar, business card holders, pens, leather folders or branded clothing.
How much does a meal cost? A meeting at a coffee shop hardly counts as entertainment but a dinner with drinks does. Business lunches are very common. A notable difference between a lunch and a dinner is that a lunch happens during office hours whereas dinner infringes on a person's private time. In the latter, the beneficiary would expect something special for giving up family time and would probably be offended if offered pizza. A dinner at a fancy restaurant with drinks is more acceptable. If there are too many drinks there is the added risk of being invited to engage in some inapt, lewd or unsavoury behaviour. Where this occurs there is a risk of blackmail should something inappropriate happen.
We all love our sports. What better way to spend a Saturday afternoon than watching your favourite sports team from the comfort of an executive suite where you are treated like someone special. It is difficult, however, to remain completely objective towards a service provider if you know that you will never have to pay for sports outings as long as you continue to use that particular service provider.
How long or how extensive is a trip in travel related entertainment? An invitation to a golf event means you are going to be back on the same day after an enjoyable outing. If invited to participate in a hunting weekend that takes much longer and costs the host so much more. You might even be invited to an international conference or, more blatantly, you and your spouse, on a sponsored international holiday. It seems clear that, for the latter, there must be some expectation in return.
Most inappropriate forms of entertainment come in the form of unbranded gifts. These could take the form of expensive pens, clothing, a case of drinks, a watch or other forms of jewellery, maybe some furniture or appliances or other gifts of greater value like a painting. Usually these are just given "in gratitude" but stating that they would be offended if the gift was not accepted. Imagine coming home to hugs and kisses from your wife, thanking you for this new double door fridge which fits in so beautifully in the kitchen and which you had no idea about. How do you tell her that it must be returned? Gift givers can be very sneaky in this regard.
Where do we draw the line and how do we know that the line has been crossed? I submit that the line has been crossed if any of the following conditions prevail:
· When gifts and entertainment become secretive and you no longer disclose these as required; · When you realise that you are no longer objective in choosing your prospective service providers and you tend to favour those who entertain you more than others; · When you start ordering substandard (or more expensive) goods and services than those that are freely available, once again favouring those who entertain you better; · When procurement procedures are violated ; · When the relationship becomes possessive in that you insist that you may interact with the supplier; · When you believe that entertainment is a perk you are entitled to; · When cash changes hands, and finally · When gifts are demanded.
Most corporate entertainment remains transparent and honest. The problem is identifying which entertainment comes with a sting.
Companies are well advised to have a well communicated policy on what is acceptable and what is not. I believe that the key to such a policy would be to limit the amount of entertainment a person may accept, it may not exceed a certain value, it must be approved by someone in authority beforehand and it must be formally recorded. Auditors are well advised to consider the risks of excessive entertainment and how this could lay the foundation for corrupt relationships.
We cannot eliminate procurement fraud and corruption from our organisations. We can, however, be aware of the risk and manage it accordingly. First objective is to recognise the symptoms in time and to respond decisively. I trust this article will help you recognise some of those early red flags.
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Phishing in China
