Corruption is all too frequent in small businesses — especially involving government contracts. In 2016, the Association of Certified Fraud Examiners reported that it takes 18 months for companies to uncover fraud schemes — and corruption in particular (for example, conflicts of interest or bribery) produces a median loss of $200,000. Left undetected, corruption has the potential to threaten a company’s ability to continue as a going concern.
What to look for
Here are some red flags that might signal corrupt activities:
- The goods or services the borrower provides fall far short of quality expectations and cost more than competitors’ products; yet little is done to remedy the issue.
- Payments made to vendors lack support, appear excessive or don’t correspond to services provided.
- There’s a lack of segregation of duties within the company, and the management team often overrides internal controls.
- The company suddenly receives far more work than in the past for no apparent reason.
- The borrower’s documents show signs of alteration, and important documents routinely go missing.
- Check memo lines seem cryptic.
- Travel and entertainment expenses are excessive and unrelated to normal business activities.
Any one of these signs may be cause for further investigation — more than two may signal a serious problem. While as lender you may not be privy to all of this information, you can assign a field auditor to investigate further when obvious red flags appear.
How to prevent it
It’s important to help your borrowers understand how to prevent corruption and other fraud. Common-sense examples include:
Segregating duties. An employee shouldn’t exert control over multiple elements of an important process, such as the awarding of supplier contracts.
Training employees in fraud awareness. Training helps enhance the “perception of detection.” This means employees will know the company is aware of fraud risk and able to detect violations quickly.
Circulating a code of conduct. This document should include the company’s stance on, and the repercussions for, fraud. To specifically target corruption, borrowers might add a formal policy that limits the size and frequency of gifts employees can give to or receive from supply chain partners.
Mandating that employees use vacation time. When a dishonest employee is out of the office, anomalies may be unearthed by management or the employee’s temporary replacement. Similarly, borrowers might consider a job rotation program that periodically reassigns employees within the organization.
Monitoring employee communications. Emails and Internet history may provide evidence of wrongdoing.
Additionally, borrowers at risk for collusion between employees and vendors might include a “right to audit” clause in their contracts. Periodically exercising that right helps enhance the perception of detection.
Checks and balances are key
Corruption is often difficult to detect. Preventing the payment of illicit funds requires a layered approach that includes many checks and balances designed to prevent and detect corruption early.