Muhammad Ali Bhojani Research Report On Fraud, Corruption & Money Laundering

Challenges in dealing with Fraud, Corruption and Money Laundering. by

Muhammad Ali Bhojani The Institute of Cost & Management Accountants of Pakistan [email protected] 1

Contents

1.

Fraud, corruption and the society

3.

Economic Development and poverty alleviation

5.

Economics, terrorism and security

7.

National and international agenda

9.

Level of common understanding and the responsibility the accounting profession

of

11. Governance and corruption 13. Corporate governance: challenges 15. Fraud detection and audit procedures 17. Anti-money laundering : Regulations and implementation and challenges 19. The future course of action. 21. Conclusion

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Fraud ,Corruption and Society (1) Chances of frauds and corruption in any society curtails the knowledge (technological) and human resource development. This leads to ‘Brain drain’ and a perpetual vicious circle of hopelessness and chaos. Societies able to keep these curses in manageable proportions remain vibrant and provide environment for sustainable growth and knowledge economy that attracts talent. Prevalence of corruption hinders institution building, stability, technological growth and competitiveness in the medium and long term. 3

Fraud, Corruption and Society (2) 2. In such societies there could be individuals with ‘excellence’ but knowledge economy (technological development ) and institutions being essential for stability do not emerge. 4. In essence it a national problem, however, in the post WTO, 9/11 world it is also a challenge for the whole world.

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Fraud, Corruption and Society (3) 2. In the past when societies were ‘isolated’, corruption in one country or society only had local effects. This is not the situation now. In the new global village, there has to be level playing field for ‘all’ residents. If not, then problems (though different in character) will arise for everyone.

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Economic Development & Poverty Alleviation (1) Recent history of economic development has revealed that ‘Economic Development’ and ‘Poverty Alleviation’ are not always concurrent. There could distortions in theoretical ‘Trickle Down Effect’. There had been instances where the results are different. One of reason for this distortion is ‘corruption’ in the system that leads to disproportion or inequitable flow of the results of economic development . This is the phase where ‘corruption’ pervades into some form of ‘extortion’. 6

Economic Development & Poverty Alleviation (2) Primary reason for distortion is the lack of institutional development in the sectors of banking, taxation, corporate regulations, including governance and others allied fields that leads to the growth of environment conducive for the promotion of ‘corruption’ resulting in improper (inequitable) dissemination of the results of growth. If this situation persists for a long duration then it would ultimately result in curtailment of the pace of economic growth that enhances poverty level or slows the pace of poverty alleviation. 7

Economics, terrorism and security In post 9/11 scenario issues of ‘terrorism’ and ‘security’ have been intermingled. Terrorism is an international phenomenon that may not relate to level of economic development or the security state of society. Nevertheless, it has a direct relation with fraud, corruption and moneylaundering activities. This provides a breeding ground both for money and human resources required for such activities. 8

National and International Agenda (1) Anti-corruption and anti-money laundering require actions both on national and international levels. There are empirical evidences that, at times corruption in the developing societies arise on account of economic interest of the persons and entities in the developed world. There are supply and demand sides of the transaction. Commissions and gifts usually emanate from the developed world. There is a view that big ticket corruption issues only arise where a deep pocketed client exists in the developed world.

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National and International Agenda (2) In the current international scenario, as emerging in post 9/11, continuation of such practices could have very serious consequences. This requires an international strategy for ‘anti-corruption’. There had been development in the field. However, the pace is not encouraging. Identifying the ‘challenges’ is the theme here.

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National and International Agenda (3) On our part, accounting bodies on national, regional and international levels have by and large been proactive in their role in this field. Appropriate guidelines, standards and study materials on the subject including code of ethics, auditing standards on fraud etc. have been released. However there is a need for wider involvement of other professions and stakeholders in this movement. 11

National and International Agenda (4) Unfortunately till now only 30 country’s ratification has been received for the ‘UN Convention Against Corruption’ signed in Mexico in December 2003. The report prepared in New Zealand has provided astonishing low level of awareness on the convention among the business community. 12

National and International Agenda (5) The international approach for anti-corruption requires concurrent strong national strategies with conviction. In the developing world the issue of corruption is directly related to institutional development and capability and capacity of governance. This requires necessary support from international development institutions and appropriate ‘support’ and ‘audience’ in the WTO deliberations. 13

National and International Approach (6) There at WTO we talking ‘at’ each other rather than with each other. This need to stop. The real issue is perceived economic insecurity and the deficit of trust. Institutional growth in developing world would ultimately result in win-win for both the parts of the world. Challenges for the respective nations even greater. International support would could only provide funding or technical support. Real correction can only arise with is ‘in-house’ (national) capacity building in governance and regulatory framework. Real challenge is lack of governance framework. This deficiency breeds corruption.

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National and International Agenda (6) The present state of affair of ‘States’ in the developing world is well described by the Indian writer Mr. Arun Shouri as: “Administration degenerates into notings on files. Regulations entangle regulations. Institutions, set up to solve problems, become problems. Even matters that endanger national security lose their way in courts, get buried in files. Enterprises become havens of patronage, slovenliness. A public sector least accountable to the public, becomes the truly private sector of ministers, officials. The way out: An Enabling state the first requisite .”

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National and International Agenda (7) National anti-corruption strategy to involve: 1. Increasing transparency in public procurement 2. Increasing access to information 3. Ensuring the independence and transparency in judiciary 4. Enhancing public sector integrity through codes of conduct and conflict of interest rules 5. Protection for whistleblowers 6. Improving transparency in financial services 16

Level of Common Understanding and the Role of Accounting Profession (1) Accounting Profession acts as a ‘catalyst’ in the economic and financial matters. Profession’s direct or indirect access to the nature and status of the economic transaction places it at a higher pedestal for the responsibility in supporting anticorruption and anti-money laundering activities. 17

Level of Common Understanding and the Role of Accounting Profession (2) The level of common understanding of the problem, its nature, gravity, and impact is astonishingly low specially in the business community. Here the profession has to play a proactive as well as reformatory role. This includes developing standards and code of ethics for the professional conduct and means to ‘audit’ or attest the adherence and compliance by the other stakeholders. Code of Corporate Governance and its reporting, Corporate Social Responsibility (CSR) dialogue and other aspects are parts of the same process. This also opens the debate for the extent and limitation of the scope of audit and perception gap. 18

Governance and corruption (1) Governance in a country’s perspective has been defined to measure the level of development for the following aspects: 1. 2. 3. 4. 5. 6.

Voice and accountability Political stability and of lack of Government effectiveness Regulatory quality Rule of law Control on corruption

violence

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Governance and Corruption (2) In this broader framework control on corruption is one part of the overall governance indicators however in societies where there are shortcomings in the first five elements whole economic and social fabric is disturbed. Economic activities have to continue in usual course in every society lack of first five indicators result in multiplier effect in the acceleration of corruption.

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Governance and Corruption (3) There is no short term or easy solution. In the end, there has to be ‘Home Grown’ strategy based on international best practices. The minimum compulsory requirements are (1) human resources development, (2) privatization and (3) smaller self-sustaining governments. Furthermore there has to be a consensus as to the policy that ‘Private sector’ growth with public sector being a facilitator only would prevail. Reins to manage the system are (1)proper regulatory framework and (2) effective fiscal system ensuring equitable distribution of wealth. This is the only workable economic model for the future world. 21

Governance and Corruption (4) Ingredients in designing anticorruption strategy includes: 3. 4. 5. 6. 7. 8.

Driven by political will and local ownership Holistic and balanced Need based, targeted and sequenced Resource and capacity-based Measurable Transparent, non-partisan and mindful of relevant conflict of interest issues 22

Corporate Governance and its Challenges (1) Reduction in the role of government with lesser controls and regulations and increased role of corporate bodies requires proper governance models for the corporations. Studies reveal that private sector corporations would hold major parts of earning assets of the world and availability of the funds for the philanthropy leading to a support for health, education and human developments in future. This requires proper corporate governance procedures and practices (not necessarily codes in every sense) otherwise the results could be worse than a a ungoverned public sector. That sector is any way ‘accountable’ to a larger audience. 23

Challenges for Corporate Governance (2) The challenges for corporate governance are: 4.

Under resourced regulators

6.

Profit versus values: corporate incentives and controls

8.

Uninterested inactive shareholders

10. Lack of bottom up communication 12. Weaknesses of the board 14. Lack of reliable audits 16. One size fits all governance codes 24

Fraud Detection and Regular Audit Audits are perceived to be conducted to detect frauds. This is the view of an ordinary man on the street. This implies in a common mind that an audited financial statement has been ‘certified’ to be free from fraud and corruption. For us this is not the case. The scope limitation, opinion versus certification and extent of checks are relevant and appropriate distinctions, however these remain technical matters for general purposes. However in future within the context of the matter identified earlier certain ‘extensions’/ additions in work to be conducted and correction in perception is required. We understand the resistance faced at the time of auditing standards on fraud however that bridge need to be crossed.

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Anti-money laundering Regulation and implementation (1) Money laundering is defined as converting criminal income into assets that cannot be traced back to the underlying crime. It is conventionally divided into three stages; the placement of funds derived from crime, the layering of those funds in order to disguise their origins and the integration of the funds into the mainstream economy. 26

Anti-money laundering Regulations and implementation (2) Anti-money laundering (AML) is an activity which prevents or aims to prevent money laundering from happening. Such activities include introduction of a requirement for the financial institution to identify their customers, maintaining records of the customers, cooperation with the law enforcement agencies and training of the staff with respect to laws etc the breach of which result in money to be laundered.

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Anti-money laundering Regulations and implementation (3) Anti-money laundering strategy suffers from primary two challenges: a) Regulators Gaps: No International Agency Hedge Fund business and derivatives having complex structures encouraging layers; etc. c) Communication Gap: Lack of feedback Lack of publicity

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Anti-money laundering Regulations and implementation (4) There is a very clear link between the profession and the efforts for AML however its needs to remembered that: “it would be completely unfair to expect professional accountancy firms to be unpaid police and customs officers” 29

Anti-money laundering Regulations and implementation (5) This efforts mainly relates to financial institutions and fiscal authorities. Nevertheless there are serious issues with regard to the effectiveness of the AML regulations; The conclusion derived by one the Senior Partner of law firm are very relevant: “Big money laundering is conducted by very sophisticated people-will always find ways round the regulations. The way to stop them is to make money laundering less attractive. 30

Anti-money laundering Regulations and implementation (6) If the effectiveness of AMLR is improved then money laundering will be increasingly deterred, prosecution and assets seizures will become more frequent and can be made more visible. If these improvements happen then the cost of implementing AMLR will be perceived as less of a burden and more of an acceptable cost of doing business in a modern , civilized society and the world. 31

The future course of action International and regional coordination and cooperation in anti-corruption drive Capacity building on global and regional basis Review of regulatory framework in tax heavens and substitution of the same with the tax friendly jurisdictions Development of accounting accountable entities

standards

for

non-publically

Recognition of proper compensation for services for the professional in areas other than ‘attestation Close coordination between corporate, banking and fiscal regulators, judicial systems and the profession on national and international levels International public debate and publicity corruption both on demand and supply sides.

on

issues

of 32

Conclusion Achievement of Millennium Development Goal requires corruption free world. Islands of corruption represent a malignant tumor in one part of the body that could effect the whole system and endanger life. The cost associated in curing the disease may seem too high in relation to the problems being faced at the early ‘stage of disease’. However if a diagnosis has been done, efforts for cure have to be undertaken at every cost. Thank you 33