Keys to Detecting Management Fraud
Richard Steinberg 270004HRBG email@example.com | | Tags:  fraud risk_management | 0 Comments | 1,046 Visits
We know the Olympus Corp. suffered a major management fraud. Financial statements were manipulated to hide huge losses, resulting in its stock price dropping like a rock and jeopardizing the company’s listing status and indeed existence in its current form. For more on the fraud, you may want to look at my October 15, 2011 blog posting.
Those looking at this fiasco may well be asking why this fraud, which had been going on for more than a decade, wasn’t brought to light any sooner – that is, before newly appointed CEO Michael Woodford began to smell a rat. Well, now it’s come out that one critical element in detecting and possibly preventing fraud at the highest management levels – which is having an effective whisleblowing process – wasn’t in place at Olympus. Sure, they had a process, but now it’s reported that the very executives perpetrating the fraud were in charge of the hotline! It’s said that the company’s internal auditors and other employees wanted the whistleblower system to be run by outside parties, but at least one of the executives alleged to have been driving the fraud objected and won out. According to an independent panel investigating the fraud, the corporate atmosphere was such that the hotline was “significantly disabled.” Is it essential to have the hotline outsourced? No. But it is critical that company personnel feel comfortable that their communications will not come back to haunt them, which is said not to be the case at Olympus.
Much has been written about management fraud, and what internal controls are needed to prevent or detect it. But my experience is that it really comes down to four key factors. One is having a culture of integrity and ethical values, with the “right” tone at the top of the organization and open communication channels. Another is a board of directors (and audit committee) that is independent and providing effective oversight. One more is an effective internal audit function. And then there’s an effective whistleblower process. Based on what’s been reported, Olympus evidently didn’t have any of these big four – we don’t know much about the functioning of its internal audit function, but now learn that the company is suing the former internal auditor along with two other executives who an independent panel said “orchestrated the scheme.” So is it surprising that such a fraud could have existed for so long? In light of its governance, risk management and internal control processes, the answer is “not really.”
When we look at the potential of management fraud, it’s critical to look at these four elements. If even one is missing, the chance of fraud going undetected increases greatly. And no one should proceed with the odds stacked in favor of bad actors.