© Grant Thornton LLP. All rights reserved.

STEERING CLEAR OF INTERNATIONAL FRAUD, MONEY LAUNDERING AND CORRUPTION

KNOWING WHO AND WHAT YOU’RE DEALING WITHGENE CAHILL, DIRECTORGRANT THORNTONNovember 17, 2014

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LEARNINGOBJECTIVES• Introduction to Anti-Corruption and

Anti-Money Laundering

• Financial Statement Ratio and Related Fraud Risks

• Evaluating Fraud in the Manufacturing Industry

• Q&A

INTRODUCTION TO

ANTI-CORRUPTION

AND ANTI-MONEY LAUNDERING

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FCPA PROVISIONSAND APPLICABILITY• Anti-Bribery Provisions

o Prohibits U.S. companies and citizens, foreign companies listed on a U.S. stock exchange, or any persons acting while in the U.S. from paying or offering to pay, directly or indirectly, money or anything of value to a foreign official to obtain or retain business

• Books and Records and Internal Controls Provisionso Requires "issuers" (any company including foreign

companies) with securities traded on a U.S. exchange, or otherwise required to file periodic reports with the Securities and Exchange Commission (SEC) to keep books and records that accurately reflect business transactions and to maintain effective internal controls.

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REACH OFTHE FCPA• The source of the alleged bribe does not

have to be in the U.S.o The actions of an agent, consultant and

distributors acting "on behalf" of the company will be attributed to the company.

o The actions of the foreign subsidiary will be attributed to the U.S. parent

• FCPA is jointly enforced by SEC and Department of Justice (DOJ)o SEC generally enforces record-keeping and

accounting provisions while the DOJ enforces anti-bribery provisions.

o The SEC and DOJ may conduct joint or parallel investigations.

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CORRUPTION RED FLAGSThe U.S. DOJ and SEC have identified corruption “red flag” scenarios which serve as a guide for companies engaged in international business with foreign agents, partners, and joint ventures. These include but are not limited to:

• Off-the-book accounts whereby a payment is made to an individual who then diverts part of the proceeds to a separate account for unexplainable reasons

• An unusually large credit line for a new customer, unusually large bonus or similar payment, or substantial and unorthodox upfront payment is requested

• A vendor has family or business ties with local government officials; or has a bad reputation in the business community

• A potential government customer or authorizing agency recommends a vendor

• Payments to charitable organizations affiliated with foreign government officials

• Gifts, hospitality and entertainment of foreign government officials or relatives

Source: AICPA's Dealing with International JV Partners: FCPA Issues

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CORRUPTIONON THE MAP• According to the Transparency

International 2013 Corruption Perception Index (CPI):

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COUNTRY SPECIFICCORRUPTION• Brazil• Russia• India• China

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CORRUPTION IN BRAZIL

Typical Schemes/Crimes• Tax evasions by high-ranking

officials, politicians and other powerful individuals.

Whistle Blowing• Public officers and private

employees who report corruption are not legally protected.

Anti-Corruption Agency• Controladoria Geral da União

(Office of the Inspector General)

Risk of Corruption• Wide range of regulatory

agencies due to the federal structure of the political system; may increase the likelihood of demands for bribes by public officials.

• The Brazilian tax system is complex and reportedly prone to corruption.

Business Corruption• Tax regulations can be

extremely burdensome and complicated.

• Tax collectors frequently ask for bribes to relax assessments and inspections, to cease threatening the company, to refrain from pursuing acts of tax fraud and to give advice on the legal possibilities of reducing tax obligations.

2013 CPI Score: 42

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BRAZILSCENARIO• U.S. expatriate is assigned to the São

Paulo subsidiary to integrate headquarters accounting system.o The expatriate is required to assist with

resolving tax discrepancies with multiple Brazilian tax authorities

o The expatriate works with the local law firm to understand the differences and broker a settlement with the tax authority

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CORRUPTION IN RUSSIA

Whistle Blowing• Measures are 'very weak.' No laws

exists for protection of whistleblowers.

Anti-Corruption Agency• No specific anticorruption agency

able to investigation and prosecute corruption

Risk of Corruption• Large companies cite

corruption as a major obstacle to doing business – inconsistent application of laws/regulations on a non-transparent basis, weak enforcement of laws.

Business Corruption• Tax regulations are identified

as among the most problematic factors for doing business; not enforced uniformly and without discrimination; arbitrary environment.

Typical Schemes/Crimes• Widespread tax evasion

2013 CPI Score: 28

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RUSSIASCENARIO• After the U.S. company purchases a

strategic partner located in St. Petersburg, U.S. expatriate relocates to Russiao The expatriate learns that in order for

shipments to leave Russia, custom agents request cash payments to be made after-hours

o The expatriate learns that Russian in-house counsel is very close to the local judge who has been providing favorable judgments to the company

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CORRUPTION IN INDIA

• Corporate integrity is very low• Scandals increasingly involve high

level officials• Federal structure of government

means the level of corruption and responses to it vary a lot from state to state.

Risk of Corruption• Bodies charged with

combating corruption have conflicting mandates and lack of qualified staff and funding.

Business Corruption• Companies report that

inspection visits are often arbitrary and excessive, at times serving as avenues for demanding bribes.

• Majority of companies surveyed report that in order to avoid disruptions, they give gifts in meetings with tax inspectors.

Anti-Corruption Agency• Institutions at federal and state

level with authority to deal with allegations of corruption.

2013 CPI Score: 36

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INDIASCENARIO• U.S. expatriate relocates to New

Dehli for 18 months to perform quality control for the manufacturing planto The expatriate is involved with the

expansion of the plant; however, the company is required to make cash payments to code enforcement agencies and building inspectors in order to obtain permits and pass building inspections.

o The expatriate pays "extra" to keep electricity running

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CORRUPTION IN CHINA

Business Corruption• Tax laws are not always

enforced uniformly or without discrimination

Typical Schemes/Crimes• Well-connected businessmen

are able to evade taxes

Whistle Blowing• Article 41 of the Chinese

Constitution ensures whistleblower protection.

Anti-Corruption Agency• China does not have any

independent anti-corruption agencies; the Central Committee of Discipline Inspection (CCDI) of the CCP is responsible for combating corruption and ensuring integrity amount CCP cadres.

Risk of Corruption• Companies have difficulties

with authorities because of corrupt behavior by their agents/intermediaries; important to thoroughly vet agents.

• Restrictions to the freedom of speech and press deprive China of an effective long-term instruments in the fight against corruption.

2013 CPI Score: 40

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CHINASCENARIO• U.S expatriate relocates to Guangzhou to

train employees at the subsidiary in China on the U.S. "go to market" strategies

o The expatriate is involved with multiple business development dinners and entertainment events with state-owned entities officials, company wins major projects as a result of wining and dining.

o The expatriate pays for vacations for prospective buyers and their families

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RISKS FOR ALLCOUNTRIES• Cash transactions (including petty cash)• Government contracts at all levels of

government• Necessary contact with government

agents and foreign regulators during the normal course of business

• Third-party contracts that are vague or lack details

• Extravagant entertainment expenses including meals, tickets to events and travel

• Gifts outside of the normal course of business an customs

• Operations in countries with complex and varying tax regulations

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What is Money Laundering? "The conversion or transfer of property, knowing it is derived from a criminal offense, for the purpose of concealing or disguising its illicit origin or of assisting any person who is involved in the commission of the crime to evade the legal consequences of his actions" United Nations 20000 Convention Against Transnational Organized Crime

ANTI-MONEYLAUNDERING

What is Money Laundering used for?1. Money must be laundered to disguise its true origin. 2. Proceeds are from illegal and criminal activities:- Illegal arms sales- Drug trafficking- Smuggling

Why Money Laundering?1. Makes illegitimate money appear legally earned2. Attempts to hide beneficial owners3. Attempts to avoid reporting requirements: - Currency Transaction Reports (CTRs) - Suspicious Activity Reports (SARs) - Monetary Instrument Exchange Logs (MIELs)

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A TYPICAL MONEY LAUNDERING SCHEME

TARGETED FOCUS: MONEY LAUNDERING

Grant Thornton LLP | 32

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MONEY LAUNDERING EXAMPLES AND RED FLAGS

• China - Electronics• Brazil - Commodities • India - Manufactured Goods

FINANCIAL STATEMENT

REVIEW

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KEY RATIOS• Compare year-to-year

performance to determine company’s financial status

• Compare companies in an industry to see which is performing best given common constraints

• Benchmarks– History– Competition– Industry

5 Groups of Key Ratios1. Liquidity ratios2. Efficiency ratios3. Solvency ratios4. Profitability ratios

5. Cash flow ratios

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Current Assets

Current Liabilities

Interpretation: The ability of the business to meet its current obligations, while maintaining a margin of safety to allow for possible shrinkage in the value in its various current assets such as inventories and receivables.

Current Ratio 2.813 x 1.197 x

20142013

CURRENT RATIO

Current Assets - Inventory

Current Liabilities

QUICK RATIO

Interpretation: Inventories are typically the least liquid of a company’s current assets, hence they are the assets on which losses are most likely to occur in the event of a liquidation. The quick ratio is a measurement of the firm’s ability to pay off short-term obligations without relying on the sale of inventories.

Quick Ratio 1.2668 x .8931 x

2013 2014

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Interpretation: The inventory turnover ratio measures the number of times the inventory is turned over in a year. This ratio is important, as profit is generated when inventory is sold.

Inventory Turnover Ratio 3.208 x 2.913 x

20142013

Cost of Goods Sold

Average Inventory

INVENTORY TURNOVER RATIO

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Interpretation: Days sales outstanding is also commonly referred to as the “average collection period”. This ratio represents the average length of time that a company must wait to receive payment on its sales.

Days Sales Outstanding 43.94 x 53.25 x

20142013

Receivables

Sales/365

Analysis of Financial StatementsDays Sales OutstandingDAYS SALES OUTSTANDING

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Interpretation: The total assets turnover ratio measures the turnover of all the company’s assets.

Total Assets Turnover 1.67 x 1.44 x20142013

Sales

Total assets

TOTAL ASSETS TURNOVER

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Interpretation: This ratio provides some insight into the relative size of the “cushion” of ownership funds

that creditors can rely upon to absorb possible losses from operations. The debt to equity ratio is frequently referred to as the leverage ratio, since it

shows the relative use of borrowed funds as compared to resources invested by owners.

Debt to Equity %390.83% 610.14%

20142013

Total Liabilities

Stockholders’ Equity

DEBT TO EQUITY %

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Interpretation: This ratio measures the ability of a company to meet its annual interest payments. An

alternate interpretation may be that the ratio measures the extent to which operating income can

decline before the company is unable to meet its annual interests costs.

Interest Coverage -1.26 x .41 x

20142013

EBIT

Interest Expense

Analysis of Financial StatementsInterest CoverageINTEREST COVERAGE

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Interpretation: This key ratio measures the profit margin achieved from selling the company’s products. The gross profit percentage assists in understanding the company’s pricing structure, overhead structure and its ultimate profit level.

Gross Profit% 31.90 % 32.09 %

20142013

Sales – Cost of Goods Sold

Sales

GROSS PROFIT %

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RED FLAGS & FRAUD

EXAMPLE

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ASSET MISAPPROPRIATION RATIOS RED FLAGS

• Organization has a weak internal control environment• Decreasing ratio of cash to total current assets• Decreasing ratio of cash to credit card sales• Flat or declining sales with increasing cost of sales• Increasing accounts receivable compared to cash• Increasing “soft” expenses (like “temporary labor”,

“consulting”, “advertising”) • Excessive numbers of credit memos issued to clients of

one sales representative• Key customer / vendors address is post office box

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FINANCIAL STATEMENT MANIPULATION RED FLAGS• Management has engaged regularly in disputes with

auditors with respect to the aggressive application of accounting principles

• A substantial portion of management compensation depends on meeting quantified targets

• Organization tends to be dominated by one person or a small close knit circle who act in unison

• Organization is in a period of rapid growth (including numerous mergers)

• Consistently increasing "deposits in transit" amounts on bank reconciliations

• Organization often reports financial results “at the last minute” or late

• Multiple related party relationships exist between organization and vendors, suppliers or customers

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INTERNATIONAL ENERGY TRADING COMPANY• Company sells coal and petroleum coke to Asia• Chinese subsidiary provided freight shipping

discounts to "freight forwarding company" based in China

• "Freight forwarding company" partially owned by GM of the Chinese subsidiary of the parent company– No employees in the sales department

(California) of the parent company knew the "freight forwarding company" existed

• Settlement in excess of $20 million with Chinese "freight forwarding company"

EVALUATING FRAUD IN

THEMANUFACTURING INDUSTRY

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Manufacturing is in a particularly vulnerable state…

THE NATURE OF THE THREAT IN MANUFACTURING

• 50% of companies suffer theft of physical assets

• Only sector to see an increase in the average loss per event from the year prior

• Manufacturing suffers the highest average loss at 1.9% of revenue

• 9 out of 10 companies surveyed by Kroll believe their exposure to fraud has increased over the last 12 months…

2012-13 Global Fraud Report, Kroll, pg. 27

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THE NATURE OF THE THREAT IN MANUFACTURING

2012-13 Global Fraud Report, Kroll, pg. 27

Manufacturing Industry Vulnerabilities

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Cash Thefts

• Larceny of cash or cash equivalents

• Ghost employees

• Inflation of hours worked

• Inappropriate approval of loans or bonuses

What to Look For

• Increased write-offs• Cash collections far below

reported revenues• Poor controls in the

collection process• Increases in "soft" expenses

(e.g. advertising, consulting)• Employees with no benefits

selected, P.O. box addresses, or multiple employees at same address

RED FLAGS IN THE MANUFACTURING INDUSTRY

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Noncash Misappropriation

• Theft of inventory• Manipulation of warehouse

management• Defeating cycle counts• Misuse of company assets

(e.g. vehicles)

What to Look For

• Inventory stored in unsecured, unusual, or secluded locations

• Unusual off-hours or holiday access

• Unsecured, rarely used entrances & exits

• No scrap v. High scrap • Rarely sold or used

product that is not physically verified on a regular basis

• Unusual expenses related to travel or maintenance of company assets

RED FLAGS IN THE MANUFACTURING INDUSTRY

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Overstating Value or Quantity of Inventory

• Schemes which overvalue assets could also apply to receivables or other current assets.

• Aimed at fraudulently obtaining financing or to indicate personal success.

• Example: A manufacturer moved inventory between plants during non-simultaneous audits, obtained $130 million in loans secured by the inventory.

What to Look For• Unclear cut-off procedures

or inclusion of product already sold in inventory

• Increases in bad debts expenses

• Unusual relationships between average inventory value and COGS

• Inventory that is difficult to physically verify

• Increases in inventory as a percentage of total assets

RED FLAGS IN THE MANUFACTURING INDUSTRY

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QUESTIONS