Mitigating Multinational Business Risk in Asia:
A Checklist of Risk Factors

by Stephen Vickers

Financial frauds in Asia are increasing. In the past two years, US and foreign multinationals with a presence in the Asian region have experienced a dramatic increase in the number of significant financial frauds affecting their organizations.

How can you tell if your corporation is at risk? The following is a checklist of common factors that characterize recent frauds in the Asian marketplace. For the purposes of this checklist, a significant financial fraud has been defined as one that exposed the corporation to losses of US$5 million or more. If three or more of these factors apply to your organization, then it is appropriate for you to pay immediate attention to risk and fraud prevention measures.

• The multinational concerned utilizes a matrix management system.
• The company concerned has recently been through a business process re-engineering exercise or significant restructuring.
• Expatriate management rotates every two years or so.
• Local staff turnover is high.
• Internal controls are insufficient or not appropriate to the Asian environment.
• Where present, sophisticated controls or "fire-walls" fail to allow for collusion amongst staff in different departments.
• Insufficient pre-employment screening is in place and recently hired executives are permitted to recruit personnel from their previous companies.
• A recent audit by an international accounting firm leads managers to assume that no problem exists.
• Internal accounting procedures are weak and internal auditors are reluctant to confront local management.
• Previous early warnings or minor fraud incidents have been covered up for internal corporate or political reasons.
• Morale is low.

When a collection of these factors are at work, there tends to be a great deal of movement within the organization, and very little understanding of what the people responsible for key financial functions are actually doing. The best practice for managers in Asia wishing to avoid and mitigate risks to their organization is to utilize a hands-on style of management that is based on the understanding that basic assumptions made by directors in the West are not always applicable in Asia. Ultimately, there are only three ways to avoid fraud: employ honest people, maintain effective systems of control and use visible deterrents.

Fraud Mitigation Do's and Don'ts for Managers

• Do check out people. Do not accept CVs at face value. Do follow up interviews and demand documentation even from low level employees.
• Do proper due diligence. Do not depend upon what you are given by a potential partner or supplier. Go the extra mile, be proactive.
• Use your vendors and customers as an early warning mechanism.
• Keep an eye on key employees and monitor their lifestyle in a human way. If anyone is leading the lifestyles of the rich and famous, you need to know why.

Stephen Vickers is Senior Managing Director of Kroll Associates' Asian Operations.

Environmental Compliance in Today's Industrial Sector: Is Your Program Adequate?

By Dennis P. Farley

The successful maintenance of a corporate compliance program is a complex and arduous task for companies operating in the industrial sector. Corporate standards and procedures, customer specifications, general legal compliance, and perhaps most burdensome &endash; safety, health, and environmental compliance &endash; require constant corporate attention and routine monitoring. At no point has this issue been more critical for corporations, nor corporate behavior so intensely scrutinized. Seemingly minor compliance problems can carry potential exposure beyond regulatory action, and situations with ethical or legal overtones can negatively impact customer relations, public perception and shareholder value. Loss of market share resulting from such fallout places new emphasis on the importance of successfully maintaining a corporate compliance program. There is likely no more important time than now for corporations to evaluate the adequacy of their compliance programs.

Currently at work are significant external and internal factors that further highlight the need for effective compliance programs in the industrial sector. Externally, corporations are susceptible to increased regulatory enforcement. In the U.S. during recent years, the criminal reach of environmental regulations has been debated at some length, as it is a sizable hammer for compliance issues that are assessed through increasingly complex and evolving measures. There is no disputing, however, that enforcement activity is once again gaining pace. For example, the U.S. Environmental Protection Agency has assigned 200 new criminal agents over the past year, resulting in a reported 65% increase in the number of criminal defendants. In fiscal 1997, companies paid more than $160 million in criminal fines for noncompliance.

Internally, many industrial sector corporations are faced with problems resulting from an aging infrastructure. Marketplace changes, product phase-outs and general budgetary constraints tend to take precedence over necessary maintenance and upgrades, which often receive minimal focus. The lost efficiencies of a poorly-operating manufacturing facility can result in major headaches, such as product manufactured that does not meet customer specification, excursions from established environmental criteria and poor overall morale. A corporation is at significantly increased risk for compliance problems in such a scenario, including fraud and other behavior that can pose criminal liability to the corporation.

Corporations tend to evaluate the sufficiency of their compliance programs on whether the organization has successfully avoided regulatory penalty. Even the best-designed programs can fail, however, leading to a period of intense reflection over exactly what went wrong. In many cases, one of the two classic sources of problems &endash; human error or willful behavior &endash; are typically identified and assailed as "personnel problems" as opposed to system, or compliance program problems. Such a characterization is not correct, as there is much that a compliance program can do to minimize the potential for disasters to occur. One common mistake is to over-emphasize the role of an annual audit program as the existence of a sound compliance program. While auditing is an important and integral part of any compliance program, it has evolved today into a "checklist" type of exercise that only verifies the existence of predetermined criteria. Audit programs typically do not evaluate the risk for problems to occur nor do they assess the potential liability exposures associated with the failure of various components of the compliance program.

One of the most cost-beneficial steps a corporation can take is to evaluate and assess exactly where the "soft points" in its compliance program lie. This should include evaluating which elements of the program are more vulnerable to intentional circumvention, which aspects are relatively more susceptible to human error, and the degree of severity to which compliance procedures collide with operations. This is not only applicable at the macro, or program level, but also at the facility operations level &endash; where most problems are initiated.

Such an assessment needs to be done frankly and necessitates cooperation at all levels of the organization. Voice should be given to employees at all levels, in order to separate reality from theory in understanding the daily conduct of operations. The key to remember &endash; first and foremost &endash; is that this exercise is not a compliance audit. Such an exercise needs to be conducted from the standpoint of error analysis &endash; where can something go wrong in this particular process? Consideration given to human error and intentional circumvention allows a corporation to build in the necessary redundancies and controls to help avoid future problems. It is a necessary component to successfully mitigating risk and avoiding a crisis.

In the next issue: When a Compliance Program Fails

Dennis P. Farley is Managing Director of Kroll’s Environmental and Engineering Services Practice Area.

Integrity Hotlines: Getting the Inside Word on Fraud, Waste & Abuse

By Chris Marquet

A recent anonymous caller to a 24-hour integrity made an allegation of serious fraud being committed by a senior-purchasing manager at her corporation. A professionally trained integrity duty officer took down the allegations from the informant, asked a few pointed questions to obtain verifiable specifics, and immediately sent a detailed summary of the issues to the client's in-house counsel's office. A fast-paced probe followed, requiring sensitive internal inquiries into the client's internal and external financial arrangements, which validated the tipster’s claims. This led to a thorough investigation that produced hard evidence of kickback arrangements, fraud and other financial malfeasance on the part of the purchasing agent in question.

The hotline and crisis response teams retained by the corporation made it possible to immediately terminate the employee for cause and make a criminal referral to the local District Attorney's White-Collar Crime unit. The dismissed employee was quickly indicted, tried and sentenced to 10 years in prison. Some financial restitution was made by the ex-employee, in part based upon the crisis response team's asset recovery efforts, and the corporation was made whole after the crisis response team prepared and defended a proof of loss report in the resulting fidelity bond claim.

While not every call to an integrity hotline is as dramatic as this example, such hotlines provide a valuable resource to companies that are seeking to reduce fraud, waste and abuse in the organization. Hotlines can also be the key to uncovering a broad range of employee practice liability issues including incidents of sexual harassment, wrongful termination, workplace violence and discrimination. Often, hotline tips help companies discover problems and address them before they become disasters.

To be successful, integrity hotlines must guarantee anonymity, be widely publicized, and their use encouraged in the organization. It is important that hotlines are viewed by employees as independent of the organization, with no potential for retribution. The promise of anonymity is particularly important because it encourages greater disclosures, although callers should be aware that they may be questioned further in an ensuing inquiry (though they may continue to remain anonymous if they wish, through the use of a confidential ID#). Companies who have set up a crisis or integrity hotline should ensure that the numbers are regularly published in internal communications, posted in meeting areas and on company intranets, and included in regular compliance reviews and human resource orientation materials.

Equally as important as internal awareness and understanding about integrity hotlines is the quality of the hotline service provider and crisis response team retained by the corporation, as well as corporate dedication to the process. A carefully planned system of reporting and response must be in place prior to activating a hotline program, and once the program is installed, each call must be carefully screened and recorded. Dedicated individuals within the organization must be named and given the responsibility for mobilizing immediate corporate response when necessary. Urgent calls, such as threats of workplace violence must be handled immediately at any time of day, and inflammatory allegations, such as claims of sexual harassment and discrimination, must be handled delicately, as some turn out to be false, and motivated by disgruntled employees.

When implemented and executed properly, integrity hotlines have proven effective for organizations in dealing with a broad range of situations including: vendor fraud, kickback schemes, financial manipulation, embezzlement, theft of proprietary information and intellectual property, extortion, sabotage, computer crimes, expense report and time card cheating, theft of office equipment, workplace violence, sexual harassment allegations, discriminatory practices, substance abuse, gambling problems, criminal conduct and countless other issues. Integrity hotlines are often a critical first step in helping organizations mitigate risks in this broad range and potentially very damaging spectrum of issues.

Chris Marquet is Senior Managing Director of the Kroll-O'Gara Company. For information about Kroll-O’Gara’s Integrity and Crisis Hotline Services, please call Kroll Information Services at (703) 319-8050.

Managing Risk In Post-Communist Countries: The Importance Of
Political Awareness

By Dr. Jay Ulfelder, Ph.D.

The collapse of communism and the acceleration of economic globalization have created a host of new opportunities for multinational firms in the 1990s. With these new opportunities, however, come significant risks. Many of the newly opened countries and markets in which firms might invest are still struggling to establish the basic institutions that define the local business environment. In post-communist countries in particular, many basic functions of the state taken for granted in liberal democracies remain underdeveloped or unstable. The resultant state weakness gives rise to multiple risks that make strategic and security planning particularly complex.

What many of these risks have in common is a connection to politics -- that is, to the exercise of state power and efforts to influence it. Therefore, efforts to mitigate risk in post-communist countries require a level of awareness about political events higher than firms usually deem relevant.

Consider the following problems, which, while not unique to post-communist countries, are often more pronounced there:

• POLITICAL LEADERSHIP. Strategic planning in foreign countries depends on a good sense of who the political players are, what their agendas contain and how much power they wield. In many post-communist countries, however, the weakness of political parties and the absence of any precedent for the transfer of power render these questions especially unclear. Without an established political party system, electoral outcomes are more difficult to predict and politicians are freer to pursue their own policy agendas. Where the transfer of power is unprecedented -- in the case of the Russian presidency, for example -- the process of political change itself can become a major source of instability.
• CONTRACT ENFORCEMENT. From a business perspective, perhaps the most basic function the state performs is the enforcement of contracts. In many post-communist countries, however, the state is either too weak or too unaccountable to enforce contracts in a manner that is predictable, fair and timely. State weakness -- exemplified by underfunded law enforcement agencies, underdeveloped judicial systems and uncertain divisions of power -- invites the rise of alternative means of enforcement, such as organized criminal gangs, that present their own, often graver risks. A lack of government accountability -- fostered by entrenched bureaucrats and constraints on free speech -- invites corruption that renders enforcement arbitrary. In this environment, contract enforcement often follows a political rather than procedural logic; thus, efforts to enforce business agreements depend on awareness of local politics.
• TERRORISM & ORGANIZED CRIME. The most fundamental state function of all is the protection of life. States incapable of deterring terrorist or criminal violence present firms with particularly troubling risks. In many post-communist countries, the weakness of law enforcement agencies has created new criminal opportunities, and the dramatic transformation of the political landscape has given rise to new forms of terrorism.

Each of these examples, illustrating issues of critical importance to multinational firms, represents a fundamentally political problem; at their hearts lies the nature of the state and its relationship to its citizens. Therefore, changes in these areas -- in other words, changes in the risk environment important to strategic and security planners alike -- will tend to come from the arena of politics.

Given this fact, firms already in these markets and those considering entry must recognize the importance of understanding the political environment as a basic function of risk assessment. By identifying the sources of political risk in a given market, and understanding how those risks are likely to change over time, firms can prudently pursue the opportunities these countries present, while managing the attendant physical and economic risks

Dr. Ulfelder is Kroll Information Services’ Senior Political Risk Analyst for Europe and Central Asia.

A New, Unconventional Wisdom: Business Intelligence

By Ernest Brod

In their headlong rush to globalize, companies around the world often conduct extensive, sophisticated analyses of the strategic and financial considerations of an overseas investment or market entry. But when it comes to selecting a local partner, assessing the strengths and weaknesses of the in-country competitors and understanding all the practical risks of doing business in a distant, culturally unfamiliar market, many companies are settling for less than optimum intelligence. With each passing day, the risks and consequences of this approach are becoming clearer.

Consider the following:

• The local operating partner chosen by a large telecommunications firm for its privatization project in Eastern Europe had been convicted of criminal fraud on four separate occasions in Germany. In two years of posing as an operational expert from the West, his past had never been uncovered.
• A western company bidding for corporate properties through a Latin American privatization was unaware that local government authorities were deciding to make additional properties available, which would tilt the process toward the specific interests of a competing bidder.
• The proposed local partnership team of a broadcast venture in Russia was closely connected to a particularly violent faction of Russian organized crime. The investors pursing the partnership only realized this after one of the proposed participants was murdered and a second suffered a suspicious "accident."

Lawyers and accountants correctly stress how difficult it is to conduct due diligence abroad, where potential business partners have a different approach to legalities, financial niceties and the exchange of "private" information. To better understand the strengths, weaknesses and dangers of a given business engagement, company executives are often encouraged to travel abroad, "press the flesh" and make their own assessments.

While that step should certainly be taken, investors must remember that they are the "road team": the playing field may not be level and the home team's rules apply.

When managers decide they need more business information than they can obtain from their own sales force, colleagues, normal advisors and contacts, they may be confused by the bewildering number of "consultants" available. There are experts on specific regions, countries, particular industries, geopolitical issues, business strategies and other specialized areas. However, it is very difficult--and often critical--to know the connections, loyalties and motivations of one's consultants.

For example, in India, an American power company recently hired one such "advisor" to assist in finding an appropriate local partner and to aid in raising local capital. As a key qualification, the Indian consultant had touted his local connections, especially his direct family relationship to a senior government official. It was later found that this local consultant had no appropriate personal or business relationships and no experience in any related industry. All he had was a common, famous last name.

The New Business Intelligence

In a new approach to obtaining precise, practical intelligence about individuals, companies and markets around the world, companies are increasingly turning to global investigative firms that are well known for their work in most parts of the world and are also able to leverage unusual local connections and intelligence abroad.

In fact, "intelligence" is a new buzzword in international business, for a full range of business needs--everything from high-end assessment of major companies in worldwide corporate contests, to planning new trade in an unfamiliar market, to identifying partners for overseas ventures.

Of course, not all intelligence engagements produce such dramatic outcomes. But they do share a common goal: to provide accurate timely, carefully assessed intelligence to enable companies expanding in uncertain new environments to make more informed strategic and operating decisions.

Targets of Understanding for Business Intelligence

Based on the recent lessons of business intelligence in new markets, a certain minimum of understanding is required when companies are candidates for an acquisition, joint venture, strategic alliance, involvement with project finance or critical supplier or distributor relationship. This intelligence includes the following:

• Is the company available?
• Is it over-leveraged, over-expanded or badly operated?
• Does it have significant contingent liabilities?
• What is its legal nature--public or private, single asset or complex business?
• What is the nature and extent of its operations?
• Is its management strong, well-connected, committed?
• What is the state of its technology; how committed has it been to research and development?
• Are they people of integrity?
• For US companies, are there Foreign Corrupt Practices Act issues?
• Doe they have a track record as partners?

Intelligence gathering skills can also be used to determine key information about one's competition. "Competitor intelligence" can, for example:

• identify current competitors in a geographic and industry market
• assess their various operating, financial and management strengths and weaknesses
• evaluate the likelihood of a competitor's moves or strategies which will significantly impact one's company.

Focusing next on "customer intelligence," similar skills can help companies to understand how buying decisions are being made by current and prospective customers--and who in the company is making them. For example, an exporter of high-end capital goods learned that buying decisions were not being based on price and support but rather on broader political matters.

Still other relationships and techniques can help companies to reach political risk judgements and provide a blueprint to the rules of doing business in a given country.

Intelligence can also be critical to solving problems once companies have already moved into an overseas market without an accurate appraisal of their partner. For companies selling goods or services in foreign countries, investigative support is especially critical to identify and solve headaches related to:

• Distribution systems controlled by the partner
• Distribution systems with kickbacks to customers
• Distribution systems with equity ownership by customers and employees.

For example, a consumer goods manufacturer eager to attach the Chinese market relied heavily on a local partner to build and activate its distribution network. The manufacturer later learned that the network was rife with kickbacks and pay-offs and was loyal to the local partner.

It should not be surprising that investigative and intelligence services are often used to address possible corruption or mismanagement of the affairs of one's affiliates or business associates. What is novel, however, is a growing reliance on intelligence services to plan, initiate and conduct marketing and business activities, especially in new geographic and industry markets.

Today's wisdom: gain as much intelligence as possible about your future business environments and associates--tapping the best possible international expertise and proven trustworthy sources. And do so before and during market entry--not after-- to avoid falling victim to the many seen and unseen threats of unfamiliar waters.

Chris Marquet is Executive Managing Director of the Kroll Associates, New York.