U.S. Navy corruption on the high seas

The $35 million “Fat Leonard” corruption scandal threatens to decimate an entire generation of experienced U.S. Navy officers. What unfolds is the rise and fall of the defense contractor who bought off Navy brass with meals, liquor, women and bribes.

The $35 million “Fat Leonard” corruption scandal is so vast that it threatens to decimate an entire generation of experienced U.S. Navy officers. This story of inflated prices and bid rigging spanned decades, touched hundreds of Navy personnel, damaged the country economically and threatened national security. Here I analyze the fraud to help show the direct and indirect causes and how we might help our organizations identify and prevent similar scandals.

Leonard Glenn Francis, nicknamed “Fat Leonard” behind his back, operated the family business, Glenn Marine Defense Asia, which specialized in servicing ships in the Navy’s 7th Fleet in the Pacific. According to Rolling Stone, Francis’s firm would do almost anything to help the fleet: empty ships of sewage, provide divers who scanned harbors for explosives, drive drunken sailors into town. (See Fat Leonard’s Crimes on the High Seas, by Jesse Hyde, Rolling Stone, March 11.)

Hyde wrote that Francis took the family business to high levels of success because of his incredible ability to identify long-term strategic opportunities to sell Navy contracts and his master manipulation of personnel at any rank. Hyde describes how Francis maintained a self-proclaimed “brotherhood” in the Navy even when it was constantly rotating officers and civilian employees around the world.

Even though multiple internal whistleblowers in the 7th Fleet filed official complaints for years against Francis, the Navy would always close investigations without action. Hyde writes that Francis’s embedded informant, John Beliveau, one of the highest-ranking officers in the Naval Criminal Investigative Service (NCIS), regularly fed him classified investigative reports.

Corruption in the DNA of the 7th Fleet

My previous columns described private-sector frauds, but the Fat Leonard scandal shares many similarities. Most significant is how the Navy’s ethical culture helped set the tone for such a sweeping entity as the 7th Fleet. The fleet, headquartered in Japan, is the Navy’s largest, with more than 60 ships, 200 to 300 aircraft and “approximately 40,000 Sailors and Marines operating in the region on a typical day,” according to the U.S. 7th Fleet Commander’s website.

This scandal is unique because of the large number of Navy personnel Francis bribed with cash, prostitutes, trips and other gifts for lucrative contracts. According to The Washington Post, criminal charges as of March have been filed against 30 persons, and more than 550 — including about 60 admirals — have come under scrutiny for possible violation of military laws or ethics rules during the course of this multiyear investigation. (See Prostitutes, vacations and cash: The Navy officials ‘Fat Leonard’ took down, by Craig Whitlock and Kevin Uhrmacher, The Washington Post, March 26, 2018.)

In the ACFE’s Fraud Tree, “conflicts of interest” is a subgroup under the major group, “corruption.” According to the 2018 ACFE Fraud Examiners Manual, “a conflict of interest occurs when an employee or agent — someone who is authorized to act on behalf of a principal — has an undisclosed personal or economic interest in a matter that could influence his professional role.” An inappropriate relationship could exist between an employee of one organization negotiating with another party on terms that’d be unfavorable to their employer.

We’d assume that the U.S. government would require intense scrutinization of employees and contractors so they’d stay within ethical policies and rules, and play fair with taxpayers’ money. However, after 9/11, the Navy drastically reduced the number of independent investigators who focused on white-collar crimes. According to Hyde’s Rolling Stone article, NCIS had 140 special agents dedicated to economic crime in the early part of 2001. But in the ensuing years after 9/11, the number dwindled to just nine. None of these agents at times were investigating crimes in the Asia-Pacific region.

So, even though the Navy follows the U.S. Office of Government Ethics’ rules on gifts from outside sources, which clearly state that any gift received in excess of $50 must be reported, hundreds of employees simply weren’t following those rules. In fact, according to the Rolling Stone article, a retired captain said Navy personnel sought to work with the 7th Fleet because it “has always been the wild, wild west” where they could get anything they wanted. Navy decision-makers in the fleet saw Francis’s bribes just as requisite “perks.”

Risks investigating the top brass

Because of short staffing, the NCIS was unable initially to successfully investigate Francis and his known associates over the years. However, the Navy eventually realized that Francis’s scope of influence reached its highest ranks and even into the NCIS team itself, according to the Rolling Stone article.

Some organizations routinely perform assessments for fraud risks. However, the Fat Leonard scandal shows the importance of assessing possible physical risk for fraud examiners, witnesses and potential whistleblowers at the beginning of, and during, ongoing fraud examinations. According to the Rolling Stone article, Francis once told a water taxi inspector who gave a negative report that he shouldn’t return to Singapore, or Francis would have him killed. So, apparently, no one dared to cross Francis.

As Francis’s threat against the inspector illustrates, retaliation in some parts of the world might not be just professional derailment but physical threats and violence, especially when they involve politicians or those who are politically well-connected.

Government security services in some countries can target those investigating politicians, said independent journalist and ACFE Sentinel Award recipient, Clare Rewcastle Brown, during her keynote address at the 29th Annual ACFE Global Fraud Conference in June. Of course, those countries can deport, imprison and even kill nosy investigators. (See Brown’s address.)

At the same conference, Tom Golden, CFE, explained during his breakout session, “Techniques That Work: Advanced Interview Methods That Produce Results,” that government officials can retaliate against fraud examiners for their investigations by taking them hostage at gunpoint — as Ecuadoran security did to him and his team when they were conducting a large fraud examination.

Planning the fraud examination from top to bottom

Bribery and corruption fraud examinations often are longer, deeper and broader than most internal fraud examinations. Informants on the inside of the corruption network, who are probably disgusted with the crimes, often provide many of the examination’s leads. (Obviously, any potential leaks of confidential information pose risks to informants, their families and investigators.)

However, it’s often more difficult to obtain required documentation such as kickback agreements and bank records than in other fraud cases because it has to come from outside an organization. Also, international corruption scandals include sources from many countries and jurisdictions, so we must consider the risk of conspirators destroying documents because of geographical distances and difficulties in apprehending suspects because of extradition laws. Therefore, we often have to conduct this type of examination covertly, which could culminate in a sting-type operation.

Whether you’re in a law enforcement role or working jointly with law enforcement personnel, you must conduct rigorous risk assessments before you begin corruption fraud examinations.

Light at the end of the tunnel?

As of publication, the location and fate of Francis is anything but clear. Since his 2013 arrest in San Diego, the U.S. Marshals Service has held him in custody. According to an article in The Washington Post, recent court proceedings in Virginia indicate that Francis is no longer in prison but is living under 24-hour watch at a private apartment (for which he is paying) in San Diego.

According to the article, the court released him based on his apparently failing health. The 53-year-old maritime tycoon has reportedly turned state’s witness and provided more than 7 million documents to the prosecution. (See ‘Fat Leonard’ is ailing and the feds are keeping his whereabouts a secret, by Craig Whitlock, The Washington Post, May 22, 2018.)

As prosecutors continue to process through the Fat Leonard network, the names of those involved have shocked the Navy and the entire U.S. armed forces, which saw the 7th Fleet as a training ground for future naval leaders. However, with more than 30 admirals under investigation or facing disciplinary actions, the military and U.S. allies are concerned about the Navy’s wartime capabilities.

The military has blamed a high incidence of ship and submarine collisions in the 7th Fleet during the past 18 months, to a large extent, on human error in leadership positions. (See 7th Fleet collisions raise questions about U.S. military readiness in the Pacific, by Daniel Arkin and Daniel Hurst, NBC News, Jan. 17, 2018.)

As we saw to a lesser degree in the wake of the Toshiba accounting scandal, an organization must be aware not only of the risks and liabilities associated with the fraud itself, but also any risks created through the eventual housecleaning that takes place afterwards. (See the May/June 2017, “Big Frauds” column, In Toshiba’s scandal, blame samurai code.)

Also, businesses should conduct periodic fraud risk assessments as required under the Committee of Sponsoring Organizations of the Treadway Commission (COSO) requirements. In 2013, COSO updated its framework to include 17 principles in addition to the already established five internal control components. The issuance of this framework update included the explicit fraud-related Principle No. 8: “The organization considers the potential for fraud in assessing risks to the achievement of objectives.” After focusing primarily on unintentional errors and misstatements for more than 20 years, COSO was now telling users to also focus on intentional misstatements and the deliberate misappropriation of assets — fraud. (See the Fraud Risk Management Guide , a joint publication of COSO and the ACFE.)

Fraud risk assessments are especially important when organizations reduce or otherwise change those departments or groups they charge with oversight of fraud, waste and abuse risks. Don’t make the mistake of understanding your risk exposure after your organization descends into corruption.

According to Hyde’s Rolling Stone article, the Navy cited a faulty contracting process as a root cause of the scandal as it led to systematic problems in the administration and oversight of the contracting process. “NCIS also determined they needed more agents trained to spot and investigate white collar crimes,” Hyde reported.

I stopped by the NCIS booth in the exhibit hall at the 29th Annual ACFE Global Fraud Conference and learned the agency is actively recruiting CFEs to join its team. After I witnessed the dedication and bravery of those who took down the largest organized fraud ring in the Navy’s history, working for the NCIS seems like an exciting opportunity for the right CFEs.

Steve C. Morang, CFE, CCEP, CIA, is a senior manager at a Northern California-based CPA firm and president of the ACFE San Francisco Chapter. Reach him at steve.morang@yahoo.com.