Corruption and Fraud Stunt Third-World Growth, Part Two

In the May/June issue of The White Paper, we learned how corrupt officials burden developing countries with unfinished projects and crushing debt, which can lead to economic decline and international terrorism.

Specifically, we examined the three most common and inter-related fraud schemes that afflict international projects: kickbacks and bribes to influence the award of a contract, bid rigging to assure selection of the corrupt bidder, and fraud to recover the cost of the bribes and exploit the corrupt relationship.

Here we look at red flags, countermeasures, proof of fraud and corruption in international cases, and possible remedies.

Red Flags of Corruption and Fraud
Corruption and fraud in international relief projects exhibit common telltale signs.

Bribes and Kickbacks
Local "agents" or "consultants" appear touting ill-defined, generic, or unneeded services. Many of the warning signs of corrupt agents (including loan brokers) are rather obvious:

• The agent operates in a country with a reputation for corruption.
• The agent's fee is too large for the services to be provided.
• The agent provides little or no useful services or work product.
• Payments are calculated as a percentage of the contract value rather than based on time expended or services provided.
• The agent's contract is boilerplate and only vaguely describes the services to be provided.
• The agent has no permanent business premises or staff.
• Government or project officials recommend or insist on a particular agent or consultant.
• The agent requests payment to an account in a secrecy jurisdiction.
• There are unexplained or unusual delays in the procurement process as kickback amounts are negotiated or project officials try to defeat the controls.

Other common red flags of corruption include:

• unjustified or repeat sole source awards;
• high-price awards;
• repeated selection of unqualified contractors;
• attempts to reject the low bidder on spurious grounds;
• a project official insisting on using certain local subcontractors or suppliers; and
• a project official living beyond his or her means.

Bid Rigging
Bid-rigging flags resulting from collusion among contractors and project officials include:

• reputation or history of bid rigging in the country or type of project, such as road construction or pharmaceutical purchases;
• bid specifications that are too narrow or vague;
• unreasonable pre-qualification requirements;
• unreasonably short time to submit bids;
• unqualified (local) contractors selected;
• contractor selected who isn't the low bidder;
• low bidder selected and followed by a change of order increasing the price or scope, or extension of an expired contract rather than re-bidding; and
• questionable disqualification of winning bidder and
  re-bidding.

Bid rigging red flags resulting from local cartels or collusion among bidders include:

• persistently high bid prices;
• few or same bidders;
• using bid protests or other means to exclude new bidders;
• bid prices drop when a new bidder enters; and
• apparent connections between bidders of affiliated companies shown by the same fax numbers on bidding documents, etc.

Fraud
Other signs of corruption include:

• The works projects are of poor quality and need frequent repairs; e.g., roads wash away after the first heavy rains.
• The projects repeatedly fail tests or inspections.
• The fraudsters delay tests by contractors and project officials, prohibit them from conducting tests and inspections, or choose the sites to inspect.
• Complaints from users or beneficiaries accumulate.
• Unknown or unqualified vendors are providing services.

Countermeasures to Corruption
Contractors can use these countermeasures when approached for bribes:

• Establish corporate ethics, compliance, and training programs for employees.
• Establish a strict policy controlling gifts, and entertainment and travel expenses, and then carefully scrutinize requests for these items.
• Conduct a thorough due diligence inquiry on prospective agents, consultants and subcontractors by adopting "know your business partner" policies and procedures, and train employees to recognize and look for red flags of corruption.
• Require close scrutiny and upper-level approval of contracts for local agents, consultants, or suppliers signed in the field.
• Include business integrity and broad audit clauses in all local contracts, subcontracts, and consulting agreements.
• Thoroughly inspect and test all goods and works received from suppliers. (Requiring contractors to perform to specifications before they're paid will take the profit out of corruption and make it less attractive and certainly less damaging. Only independent companies or persons whose integrity is assured must do the inspections; inspections are one of the most corrupt segments of international projects.)
• Report suspected corruption, bid rigging, or fraud to the aid organization financing the project.

Host government agencies and lenders can use these countermeasures:

• Establish independent anti-fraud and corruption investigation units.
• Install and publicize hot lines and other confidential reporting systems.
• Establish contractor compliance and voluntary disclosure programs.
• Require the disclosure of all fees and commissions by contractors and subcontractors.
• Publicize contracting and payment information, and audit and investigation results on the Web and elsewhere.
• Closely test and inspect goods, services and works received. Use outside, independent inspectors if necessary.
• Require financial disclosure by all project and government officials involved in procurement or other high-risk corruption areas, such as award of licenses, permits or inspections.
• Include anti-corruption warranties, business integrity and audit clauses in all contracts, subcontracts, and large purchase orders. Inspection rights audit clauses in contracts should extend to financial and disbursement records to reach bribes evidence, and should be effective for at least five years after the contract closes.

Proof of Fraud and Corruption in International Cases 

Internal Investigations
Contractors and lenders involved in projects at risk for corruption find it difficult to investigate because of the lack of public records, shortage of competent professionals, multitude of jurisdictions involved, and other barriers.
International corruption cases are never quick nor easy but these suggested approaches might expedite them:

• Exercise audit clause rights. Absent the subpoena and treaty power of government agencies, private sector investigators must depend on the exercise of audit clause rights to access contractor and subcontractor records and financial accounts. Look for anomalous fees and commissions, payments to agents, large or unusual cash transactions, and excessive expenditures for entertainment and business development. Watch for unusual transfers or charges involving subsidiaries or affiliates because bribes can be paid from these entities.
• Conduct local financial investigations of suspect employees.
  Fraud examiners can unravel locally a global fraud and corruption scheme. For example, public records might show that a suspected bribe recipient spent a lot of money improving his home - a prime expenditure for bribe money. Building permits will show which home contractor did the work. After finding the name of the building contractor on the building permit, ask him how he was paid (cash? check? traveler's checks?) and try to trace the funds back to the source. This isn't an easy task but it can be done.
• Insist that the suspect employee cooperate in the investigation. In most organizations, employees are required to cooperate in internal investigations. The fraud examiner can insist that the employee produce personal financial records or execute consents to obtain such records from banks or other institutions. (Even if the organization's rules don't specifically require an employee's cooperation, most jurisdictions impose it by law on directors, officers, and key employees.) The investigating organization must be willing to take strong steps - up to and including termination - to enforce its demands if the employee refuses to comply.
• Use international investigative consultants, who are usually former law enforcement officials. It's difficult to find international investigative consultants because, until recently, bribery of foreign officials hasn't been a criminal or civil offense in most parts of the world. Be sure the consultant is experienced in corruption cases, which are much more difficult than other types of fraud cases.

Possible Remedies  

U.S. Foreign Corrupt Practices Act
The U.S. Foreign Corrupt Practices Act (FCPA), adopted in 1977, prohibits the bribery of a foreign public official by U.S. nationals, businesses, and persons who commit acts in the United States. The FCPA's books and records provision requires SEC-reporting companies to keep accurate accounting records to make it more difficult to hide bribes.

Recent amendments added a provision prohibiting the bribery of an official of an international aid organization, such as the World Bank.

More than 60 countries in Europe, Latin America, Asia and elsewhere have committed to outlaw foreign bribery through a variety of international agreements. The treaties also commit the signatories to cooperate in the gathering of evidence (including agreeing not to raise bank secrecy laws as an objection), extradition of witnesses, and seizure of assets. Following are some of the international agreements.

OECD Anti-bribery Convention
Thirty-three of 34 signatories have now ratified the Organization for Economic Cooperation and Development (OECD) Convention (www.oecd.org) and most of the countries have passed implementing legislation similar to the provisions of the U.S. FCPA., which makes the bribing of a foreign public official a criminal offense.

The OECD Convention also requires that the parties penalize companies for omission and falsification of records. Auditors are now required to audit for compliance with these provisions.

OAS Inter-American Convention against Corruption
Twenty-eight of 30 member countries have signed the Organization of American States (OAS) Convention (www.oas.org) established in 1996, which requires the parties to criminalize domestic as well as foreign bribery.

The convention also requires that each state, which is permitted to do so under its constitution, establish the offense of "illicit enrichment." The OAS defines illicit enrichment as:
... a significant increase in the assets of a government official that he cannot reasonably explain in relation to his lawful earnings during the performance of his functions.  

CE Criminal Law Convention on Corruption
Forty-two states have signed and 16 have ratified the Council of Europe (CE) Convention, (www.coe.int) which was opened for signature in January 1999. This is the first convention requiring the signatories to introduce legislation making private sector (commercial) bribery and the bribery of foreign public officials criminal offenses.

Also, the CE Convention is the first to prohibit what it terms "trading in influence," which requires each state to outlaw payments to anyone who uses his or her influence over a public official. This language seems to refer to the local, ubiquitous "agents," loan brokers, and information brokers in international projects.
The CE also:

• makes it a criminal offense to create or use false invoices or accounting records or to unlawfully omit the recording of a payment; and
• imposes criminal liability on corporations as well as their employees for making illegal payments and for failing to exercise adequate supervision or control, which would lead to a corrupt practice.

Private Civil Actions
A victim of fraud or corruption can file a civil action for damages in the United States or other country in which corrupt acts occurred or the parties are located. Such an action would provide the opportunity to issue subpoenas or other requests for documents and to compel testimony under oath.

Civil actions can be expensive, time-consuming, and ultimately futile exercises. Do the following before deciding whether and where to file suit:

• Evaluate the probabilities that assets or accounts can be located and seized to satisfy a judgment. If you can't reach the actual stolen funds, look for domestic assets of the defendant that can be used to collect a judgment.
• Look for alternative remedies or defendants that might be easier to reach. For example, if a domestic bank might be liable if it facilitated the fraud through its negligence. Also consider a referral for criminal investigation and prosecution. A follow-up civil action based on evidence collected in the criminal case might be possible.
• If international legal action appears feasible:
  • Trace the illicit funds or assets as far as possible from available records. These might show a wire transfer to an account used by the subject that can start the tracing process in court.
  • Promptly determine if ex-parte orders are available in the foreign jurisdiction to freeze accounts and assets, seize evidence (including bank account and business records), or to search persons and premises and take statements from witnesses.
    For example, in the U.K. and other British Commonwealth jurisdictions court orders to freeze assets and accounts (formerly known as "Mareva" injunctions) and to seize evidence and obtain information from wit-
    nesses (formerly known as "Anton Pillar" orders) are available to fraud victims. Applicants must show substantial evidence of wrongdoing and a need for quick action to prevent the dissipation of assets or removal of evidence. The applicant usually must post a bond or otherwise indemnify the subject or third parties against loss if the legal action doesn't succeed.
   

Administrative Actions
The World Bank (www.worldbank.gov), the U.S. Agency for International Development (USAID) (www.usaid.gov), the Asia Development Bank (www.adb.org) and other international lenders and aid organizations have rules that provide for the debarment of contractors and the sanctioning of employees who engage in fraudulent or corrupt practices. More details on how to report suspected corruption are available on the organizations' Web sites.
The severe problem of fraud and corruption in the developing world far outstrips the resources being applied against it, with frightening potential consequences. The challenge of the next decade will be to bring fraud examination principles, knowledge, and techniques where they're needed most - the third world.

W. Michael Kramer, J.D., CFE, has investigated corruption and fraud cases throughout the world. He is an advisory member of the Association's Board of Regents.

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