Nov 25, 2020
When it comes to limiting exposure from corporate fraud, we can learn from two philosophers, Socrates and Sun Tzu
- Socrates gave us the wise saying, “Know thyself”
- Sun Tzu followed with the equally wise saying, “Know thy enemy”
With Socrates, we’re taught the importance of introspection. When we reflect on the connection between our past decisions and our where we are today, we see relationships. The decisions we made as children opened opportunities for us. Similarly, decisions we made in early adulthood influenced the careers that we built. As we look, we can see the road ahead. Theoretically, that exercise in introspection and contemplation should influence how we think and how we act. Just as the decisions we made yesterday influence where we are today, the decisions that we’re making today will influence what we become in the months, years, and decades ahead.
Sun Tzu, author of The Art of War taught that in addition to knowing ourself, we also must know our enemy. The more we know about how our enemy thinks, the better we can prepare. Rather than defining an “enemy” as a human being, we can use the concept of an “enemy” to serve as a framework; besides being a person, an enemy may include a way of thinking, or an action, or a state of affairs that we want to avoid. If we consider “obesity” as an “enemy” of our goal to fitness, we may want to avoid actions that lead to obesity.
As business leaders, we want to avoid litigation and government investigations. That’s the enemy. Unless we’re lawyers or professionals that earn a living defending against litigation or government investigations, we want to minimize our exposure to activities that could lead to our being deposed, or standing as an “accused” inside of a courtroom. Litigation can bring excessive risks that threaten to undermine our businesses, our careers, and potentially our liberty.
For these reasons, we need to give a great deal of thought to our businesses, our careers, and how our decisions can put those businesses and careers on the pathway to success—or expose us to risks. We also need to think about how people that earn a living from either litigation or government investigations think. The more we know, the better we prepare ourselves to make good decisions, and the stronger we become at making decisions that can decimate all that we’ve worked to create.
Two political philosophers, John Locke and Thomas Hobbes, offer us more insight that we can use as we consider risk and mitigation. Thomas Hobbes, author of Leviathan, advised on how leaders should govern. At our core, Hobbes believed that as human beings we are basically beasts that fight for survival. To build a society, we need laws to keep people in order. Without strict laws, Hobbes believed that people would act in their own self-interest and to the detriment of the broader society. Enforcement of strict laws keeps people in order.
John Locke, on the other hand, believed that people are rational. We all behave in accordance with what we have learned. At conception, according to Locke, we begin with a blank slate. But every experience makes an impression upon us. Those impressions shape how we think and how we act.
- If we’re born into struggle and chaos, we may learn how to adapt in accordance with what we see.
- If we’re born in privilege, we act and believe in accordance with what we see.
As rational beings, Locke believed that just as we learned, we could also unlearn.
Unlike Hobbes, who believed that it was the threat of punishment that kept us in line, Locke held that our experiences determine who we are, and what we become. As a society, then, according to Locke, we should invest to help people learn how to behave in ways that advance our communities. Some may consider John Locke as the father of liberalism.
These philosophical understandings are all highly informative in assessing a company’s vulnerability to fraud and how to best protect against it.
Philosophy and Risk Management in the Corporate Sectors:
Whether we own a business, or we work to earn a paycheck, we all advance when we think as if we’re the CEO of our life. And as a CEO, we can rely upon some basic tenets that include:
- Tenet 1: We’ve got to start by defining success. What are we trying to achieve?
- Tenet 2: We’ve got to document the strategy that will take us from where we are to where we want to go.
- Tenet 3: We’ve got to create tools, tactics, and resources that will help us succeed, to achieve that documented strategy.
- Tenet 4: We’ve got to execute our strategy every day, and we’ve got to measure our progress.
To use lessons from Sun Tzu, we advance prospects for success when we minimize risks, or exposure to the enemy. To use lessons from Socrates, we need to introspect constantly. When Socrates said, “the unexamined life is not worth living,” he advised that we all should make connections between the decisions we’re making today, with the potential risks and rewards that we’ll experience tomorrow.
We can lessen our risk levels, or our exposure to litigation and government investigations, when we understand the thinking patterns and motivations of regulators—or our opposition. Like Thomas Hobbes, government regulators believe that if we’ve come under their purview, we’re beasts by nature—out to deceive and defraud consumers, as we prioritize our self-interest. Regulators will define success with injunctions, fines, disgorgement, corporate shutdowns, and decimation of businesses.
To lessen risks of litigation and government investigations, we’re going to help people understand the various types of corporate fraud; people should have a clear understanding of the exposure that accompanies fraud. Through this lesson, people will learn why a personal investment in compliance and risk-mitigation goes a long way toward advancing prospects for success.
Various Type of Corporate Fraud:
Fraud charges may begin with either civil or criminal investigations; those investigations may stem from any number of alleged activities. An inexhaustive list of those activities may include:
- bribery,
- forgery,
- copyright and trademark infringement,
- overbilling,
- price fixing,
- embezzlement,
- insider trading,
- data theft,
- unscrupulous telemarketing,
- money laundering,
- wire fraud,
- mail fraud,
With more than 4,000 criminal statutes, and millions of pages of government regulations, investigators have many more charges at their disposal. Any of those laws or regulations can prompt a government investigation. For such reasons, business owners do well when they invest time and energy to learn about what happens when investigators bring allegations of fraud. Since the acts of employees can launch an investigation, it makes a lot of sense to include such training for all new hires.
Any decision made during the course of business can threaten to undermine the enterprise.
When business leaders help all members of the company’s team understand these concepts, they are better situated to avoid problems that can lead to government investigations or criminal prosecutions. Authorities can charge executives for decisions they made while on the job, and they can also bring charges if people under their control engage in any type of act that they deem nefarious. Those charges can destroy careers, decimate shareholder value, and lead to the loss of liberty.
Even if an individual did not carry out the act, authorities may bring conspiracy charges. With a conspiracy charge, authorities will look to “overt acts” that they believe would further a conspiracy. Conspiracy charges prove to be very useful for prosecutors because they require a lower threshold of proof; further, conspiracy may not require intent, yet they could bring penalties that are identical to those that would exist if the fraud had been consummated.
One of the numerous cases brought during this past decade against healthcare providers may be instructive. A director of physical therapy regularly performed services for patients and supervised the services of other therapists; the director signed off on to approve the work of others.
To further the enterprise, a marketing company orchestrated media campaigns to spread awareness of the business’s services. Rather than charging a set fee for its services, the healthcare provider paid the marketing company on a per-patient basis. If the marketing company’s efforts resulted in a new patient, the healthcare provider would compensate the marketer.
The government launched an investigation for “patient brokering.” Although the marketing company thought its billing approach would reward it for success, legislators deemed the practice illegal.
Patient brokering represents a hot-button topic for regulators. Prosecutors filed charges against many people within the organization. According to prosecutors, the CEO “should have been” better supervising the marketing department. The director of physical therapy “should have known” that the company engaged in patient brokering and that patient brokering was against the law. The marketing company should not have participated. Each person in the conspiracy bore liability. The director of physical therapy chose to fight the charges at trial. After a jury returned a guilty verdict, the judge sentenced him to 12 years in prison.
For these reasons, stakeholders should understand the nature of corporate fraud and the allegations that may follow from a government investigation. By learning how regulators attach risk and learning more about the risk-exposure to corporate fraud, we help people make better decisions.
Knowledge can prove an effective first line of defense against any potential exposure.
Most Common Types of Corporate Fraud
Every company faces unique challenges with respect to fraud, depending on the specific type of business. For example, a chain of pharmacies may not have the same level of exposure to the Foreign Corrupt Protection Act as a steel manufacturer that sells its products around the world. Nevertheless, in our era of big government, professionals that value their liberty should learn about the various types of fraud, and the risk exposure that accompanies allegations of wrongdoing. Such knowledge, theoretically, will help people make better decisions:
- Corporate Account Abuse – All companyies maintain corporate accounts to track transactions. Those corporate accounts may allow employees to order shipments on credit from a supplier; or the company may issue corporate credit cards so that employees don’t need to come out of pocket for travel expenses. Managers are often too overwhelmed to extensively review details, so long as the dollar amounts and types of expenses listed seem reasonable.
Corporate executives may use their corporate accounts to order car services, stay at nice hotels, take first-class flights, and enjoy other perks while on a business trip. Many think nothing of keeping the frequent flyer miles and hotel points, even though they technically belong to the company. Some credit-card benefits may include cash-back programs for expenses paid by an employee and reimbursed by the company.
What policies exist to track these transactions? Investigators with the IRS may want to know.
Members of our team served time with an executive that got wrapped up in a government investigation that stemmed from an alleged abuse of expenses. After a prosecution, a judge sentenced him to 17 years in prison.
If business owners or professionals blur the line with regard to how they account for expenses, they expose the company and their lives to potential civil or criminal liability.
- Overbilling – Overbilling practices can also lead to charges of fraud. For example, we knew the owner of a plumbing supply company that used some of the products in inventory to repair rental properties. He then wrote off the items as business expenses, declaring he lost toilets as being lost due to damage. When a disgruntled employee turned him in to authorities, a government investigation ensued. He went to prison for tax fraud.
- Vendor Systems – Managers should be aware of one of the more common variations of fraud: setting up phantom vendors and creating fraudulent invoices for non-existent goods and services.
This type of fraud requires planning and plotting by the perpetrators, but all managers can get wrapped up in the problem. Investigations that reveal this type of fraud can bring both civil and criminal liability.
- Bribery – Either giving or receiving something in exchange for a purchase order or project can lead to liability.
Regardless of where the bribe takes place, criminal charges can follow. In fact, Oderbrecht, a large Brazilian company paid a $3.5 billion fine in 2016 for bribery; the CEO went to prison.
Smaller independent contractors sometimes feel pressured to offer bribes just to get their foot in the door and keep it there. For example, we knew a former military contractor and West Point graduate that paid a bribe in the form of a “no-show” job to someone instrumental in helping him get a sizable military contract. The contractor, in turn, billed the Army $422,704 for the purported work. After a government investigation, a six-year sentence followed.
- Payroll – A company owner or manager has hiring discretion. Abusing that discretion, however, can lead to charges of corporate fraud. For example, if a company provides employment to a person that does not perform any duties for the business, investigators may allege a fraudulent transaction. The allegation may be that the company took an unfair business expense by providing employment to somone that did not provide any service.
- Sales – If companies try to push revenues into a specific time frame in order to manipulate accounting, investigators may allege fraud. Remember, although we can control what we do, we cannot control what other people do. Accounting scandals can result when people turn their employers in to authorities.
Consider the case of an executive we knew that worked with one of the world’s largest software companies. In the years 1998 through 2000, the company began prematurely reporting $3.3 billion in revenues from 363 software contracts, creating what the SEC later facetiously referenced as 35-day months. Wanting to exceed Wall Street expectations to support the company’s rising stock price, the company used accounting trickery. The investigation resulted in the company paying a $225 million settlement; eight people went to prison.
- Forward and Backdating of Documents –Dozens of companies faced option-backdating scandals, which led to government investigations, fines, huge disruptions within their organizations, and imprisonment for some. Although companies have the right to issue option grants, their accounting practices must comply with regulations to order to withstand the scrutiny of investigations.
- Evading Management Supervision –Telemarketing employees may increase their compensation levels by increasing sales. If not trained properly, however, they may go off-script. When anyone deceives consumers to strike a deal, that person may put the employer, and his or her liberty at risk.
Specific Concerns for Senior Management
Business owners and managers want to increase value with job performance. Similarly, investigators will want to distinguish themselves on the job by building cases that lead to findings of culpability or guilt. With that in mind, leaders should develop an understanding of the following charges that investigators or prosecutors may bring:
- Conspiracy – the company and management can be held liable for conspiracy, regardless of whether the perpetrators carried out the fraud. To prove a conspiracy existed, prosecutors must identify the elements of the offense—like a conversation to deceive consumers. Then, they must show that the participants engaged in an overt act, like designing a marketing brochure. The deception does not have to take place—only the effort to deceive. Those actions can lead to a conviction for conspiracy on any fraud charge, as many people in prison have learned.
- Aiding and Abetting – Sadly, a well-intentioned effort at damage control can lead to charges of a cover-up. We know one person who enjoyed fishing and regularly caught fish without checking or worrying about the limits. The Coast Guard stopped him for a random check. An officer spotted the captain throwing fish overboard in an attempt to cover up a catch of under-sized fish. The Coast Guard pressured the captain to provide evidence against the owner, or face charges for aiding and abetting.
Investigators may bring charges for aiding and abetting for any number of reasons, including shredding or destroying corporate documents. A good compliance program can shield a leader from such charges, especially if they train regularly on the importance of compliance.
- Obstruction of Justice – When investigators or prosecutors believe that a witness has willfully tried to block the investigation, they may bring charges for obstruction of justice. For example, by providing false statements, tampering with or destroying evidence—even before an investigation begins—can lead to criminal charges.
We got a chance to know a media mogul who once controlled the world's third-largest English-language newspaper empire, which published more than 300 newspapers including The Daily Telegraph (UK), Chicago Sun-Times (U.S.), The Jerusalem Post (Israel), National Post (Canada). He was world renowned and even anointed a Lord by the Queen of England. That, however, didn’t keep him from getting charged with 8 counts of fraud for a payment of $5.5 million that allegedly unjustly enriched him. While fighting those charges, he removed 13 boxes of documents from his office, which were merely copies of documents he’d already handed over to the SEC. That action led to additional charges for obstruction of justice. The media mogul appealed and beat the original charges; yet he still had to serve 37 months of the original 78-month sentence because of the obstruction of justice charges.
- Responsible Corporate Officer Doctrine - in some instances management and the company can even be held liable for failure to prevent a wrongful action, such as in instances of “public welfare” and certain regulatory offenses.
One such instance involved the sale and distribution of tainted eggs and salmonella, leading to criminal liability for the father and son in charge of the company, even though they were not directly involved with day-to-day quality control procedures.
- Avoiding Fiduciary Duties – Honest Services fraud has led many people into the crosshairs of an investigation, and to prison. Politicians and corporate executives perform duties that can be interpreted as favors on any given day. Voting for a particular bit of legislation, for example, or developing a corporate complex in a specific area. Certain people stand to benefit from these decisions and if any of them can be reverse engineered back to a vote or decision, that can spell potential trouble.
- Control Person Liability – a person who legally controls another person or entity (and it need not be complete control) can be held jointly and severally liable (i.e. responsible for the actions of) for the wrongful acts of the controlled person/entity.
We know a former executive of a publicly traded corporation. His company made an acquisition and he delegated material aspects of the merger to several other high-level executives to deal with the details. When the CEO signed and attested to documents filed with the SEC, he exposed himself to criminal liability. Later, prosecutors charged the CEO and other executives for not recognizing possible warning flags and relying on assurances by subordinates. The government claimed the CEO signed off on financial statements in "reckless disregard" of the truth of their contents. The conviction resulted in a fine of $1 million and a 10-year sentence.
The examples above show the risk exposure for corporate fraud. To minimize exposure to such risks, we encourage regular training on best-practices for compliance at every level of the organization.