Regulators on red alert: a tough year ahead

February 2021  |  SPECIAL REPORT: CORPORATE FRAUD & CORRUPTION

Financier Worldwide Magazine

February 2021 Issue

2020 has seen businesses in Asia struggling to survive an economic crisis. Businesses already exposed to a trade war between global economic powers and further aggravated by a global pandemic, are striving to regain normal, pre-coronavirus (COVID-19) levels of revenue and profitability. Among business leaders surveyed by the Association of Chartered Certified Accountants (ACCA) in its ‘COVID-19 Global Survey’, released in April 2020, 80 percent expected year-on-year (YOY) revenue and profit to be significantly below forecasts.

In such challenging times, combating compliance risks is an additional distraction and burden that is sometimes overlooked. But responding to the challenging economic situation will not provide an excuse, since it is clear from 2020 that regulators globally are not minded to let businesses off the hook and, if anything, are introducing stronger enforcement measures in response to the perceived risks. Businesses may therefore be underprepared for a tougher year of regulatory enforcement than anticipated.

During difficult economic times, such as the 2008 global financial crisis, we have historically witnessed a rise in fraud exposure, and this time around businesses are anticipating a considerable surge in fraud. In a benchmarking 2020 report – ‘Fraud in the Wake of COVID-19’ – by the Association of Certified Fraud Examiners (ACFE), 79 percent of respondents observed an overall increase in fraud, an uptick that looks set to continue with 90 percent of respondents expecting fraud to continue rising well into 2021.

This year we will see the first full year of financial reporting and audit since the pandemic began. It is to be expected that there will be some difficult discussions between management and auditors in some cases, and this reporting season may expose many cases of financial statement fraud.

Such financial statement fraud often starts out with just a few fake invoices or a modest inflation of turnover to make the company’s financials look rosier. Management may have rationalised these actions as being temporary in the hope that the economic conditions will soon improve and the transactions can be reversed. But too often one falsehood leads to another and things can very quickly spiral out of control if the company’s performance does not bounce back to ‘normal’ profitability in line with stakeholder expectations. This chimes with the ACFE’s benchmarking report, in which 68 percent of those surveyed anticipated an increase in financial statement fraud over the next 12 months.

2020 was a record year for large fines and penalties by global regulators. The Hong Kong Securities and Futures Commission (SFC) fined Goldman Sachs $350m for serious regulatory failures over 1MDB – the biggest fine ever imposed by the SFC. Wells Fargo was fined $3bn by the US Department of Justice (DOJ) and the Securities and Exchange Commission (SEC) for its fake-accounts scandal. Foreign bribery fines also reached a record-breaking high as regulators imposed $7.76bn in penalties globally in 2020, compared with only $2.83bn in 2019. In Australia, Westpac was handed a record $1.3bn fine by AUSTRAC for AML breaches. These recent sizeable breaches have made regulators hypervigilant, subjecting all businesses to tighter scrutiny.

In China, regulators were also seen to impose large penalties and fines. Bank of China was fined the equivalent of $7.7m by the China Banking and Insurance Regulatory Commission (CBIRC) for risk management transgressions. The CBIRC also imposed over RMB290m in fines on Zheshang Bank, Minsheng Bank and Guangfa Bank for various misconduct.

Regulatory fines will only continue to get bigger, alongside an increase in criminal charges as regulators implement stronger enforcement measures and impose exemplary penalties to drive the message home. Regulatory frameworks have increasingly shifted responsibility toward individual accountability in a drive to reduce misconduct and improve ethical culture in organisations. A recent example of this spotlight on personal liability is the false accounts scandal at Wells Fargo, where the US Office of the Comptroller of the Currency (OCC) fined eight former Wells Fargo senior executives a total of $59m and banned Wells Fargo’s former chief executive John Stumpf from the industry for life.

US law enforcement and regulators continue to put China under the spotlight, increasing the number of investigations of Chinese companies, particularly since the US Holding Foreign Companies Accountable Act came into force on 18 December 2020. This law requires US-listed Chinese companies to comply with US audit rules and open up their books for inspection, or risk being delisted.

At the same time, preventing, detecting and investigating fraud are now more difficult in the wake of COVID-19 – 74 percent of respondents in the ACFE report found investigating fraud more difficult, while 68 percent found detecting fraud more difficult. The most cited challenges to combating fraud in the current environment were the inability to travel, difficulties with remote interviews, and lack of access to evidence. These challenges have significantly hindered normal compliance functions, weakening organisations already vulnerable to heightened risks of fraud and misconduct.

Businesses that manage to weather the pandemic will need to refocus their efforts on compliance measures and investigating historical misconduct. Most large-scale fraud schemes are perpetrated by long-time, trusted employees. Despite the first signs of fraud appearing, management and stakeholders are likely to give these trusted employees the benefit of the doubt, thus prolonging the detection process. According to the ACFE’s 2020 ‘Report to the Nations’, the average time taken to discover a fraud is 14 months, while several fraud types take two years to discover, and the longer a fraud remains undetected, the greater the financial losses. This could mean that a fraud which began in 2020 will only be detected and investigated within the next two to three years or more.

At a time when many businesses may feel that their survival depends on returning revenues and profitability to pre-COVID levels, rather than complying with regulatory demands, such thinking will be too one-dimensional. Tackling fraud investigations will in fact divert much of management’s valuable operational time into having to deal instead with stakeholders, auditors and regulators, whereas ensuring proper compliance in the first place would take up much less time. Businesses would be wise to adopt a more multidimensional approach to success and prioritise compliance if they are to weather a tough regulatory environment and difficult economic year.

 

Chris Fordham is a managing director in the disputes and investigations team at Alvarez & Marsal. He can be contacted on +852 3102 2637 or by email: cfordham@alvarezandmarsal.com.

© Financier Worldwide

BY

Chris Fordham

Alvarez & Marsal

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