Does Something Smell Fishy? An Investigation of a Closely Held Seafood Provider

Anomalies, irregularities, or inconsistencies in financial statements and financial data can be the result of intentional manipulation. Financial statement manipulation can take many different forms, including the concealment of kickbacks.

“Kickback” is defined by Black’s Law Dictionary as “a sum of money illegally paid to someone in authority especially for arranging for a company to receive {a} lucrative contract; especially, a return of a portion of a monetary sum received, usually as a result of coercion or a secret agreement.”

Think about the following scenario: An individual facilitates a sale of product by “Company A” to “Company B,” and in turn receives payment from Company A. What is the nature of the payment? Is it a commission, a royalty, gratuity, or a finder’s fee? Or is it a kickback? The distinction lies in the intent of the parties.

If the payment is made in the normal course of business for receiving a service, the payment is most likely a commission. If, on the other hand, the payment is a benefit or thing of value, and “Company A” received an advantage inconsistent with its ordinary business dealings in exchange for the payment, it could be construed as a kickback or bribe. Such a payment would need to be examined on the basis of facts and circumstances.

The 2018 Report to the Nations by the Association of Certified Fraud Examiners classifies kickbacks, bribery, illegal gratuities, and economic extortion under “corruption” on the fraud tree. The report makes clear that corruption has the highest probability of occurring in upper/executive management and the purchasing department. These types of acts occur with the greatest frequency in the manufacturing and energy industry, and among government and public officials.

In cases of corruption, individuals or companies receive something of value in return for some sort of act or forbearance intended to benefit another. “Things of Value”¹ can take many forms and include, among other things:

• Expensive paid travel and lavish entertainment;
• Loans, whether or not repaid;
• Employment of the children or spouses of vendors/officials;
• Overpaying for assets; and
• Direct cash payments.

Case Study: Kickback Investigation of a Closely Held Seafood Provider

Consider this example: The board of directors of a seafood provider (“provider”) initiated an investigation based on increasing revenues and declining profit margins and net income. Ultimately, the investigation uncovered a kickback scheme, along with other financial record manipulations, by a sales manager in collusion with suppliers to the provider.

The kickback scheme incorporated unrecorded sales, payments for nonexistent product, product substitution, and overpayments for products actually received. The scheme was perpetrated by the providers sales manager and the owners of two suppliers to the provider.

The investigation uncovered the following:

• The division president/sales manager was accepting kickbacks from a major customer.
• The kickbacks were, in turn, channeled through an entity set up in the name of the sales manager’s wife.
• Payments were made for inventory that was never received.
• False inventory records were created to conceal these fictitious purchases.
• Inventory records were falsified to conceal unrecorded actual sales.
• Import violations occurred due to the mislabeling of product, which disguised the country of origin.

Kickbacks to the sales manager occurred during the importation and sale of crawfish by the supplier. Initial imports of crawfish were in compliance with U.S. Customs laws; however, these initial imports eventually led to subsequent transactions in violation of applicable U.S. Customs import laws. An arrangement between the sales manager and the supplier was the catalyst for kickbacks.

The sales manager had persuaded the supplier to sell crawfish and other seafood products to customers with little or no profit margin, with the understanding that the customers would sell the crawfish and other products at the market rate to third parties. The sales manager and the supplier further agreed that a portion of the profits would be paid to a third entity controlled by the sales manager. This arrangement continued until the end of the sales manager’s employment with the provider.

Financial records of the entity controlled by the sales manager revealed additional payments from other customers of the provider. The sales manager was not authorized by his employer to provide services to or receive payments from these customers.

Internal Controls

A process for approving vendors would have identified the sales manager-controlled entity. The sales manager’s home address matched the mailing address of the entity he controlled. A vendor approval process would have also revealed that the sales manager’s wife was a director/officer in the entity.

The sales manager for the provider also falsified inventory records. The provider used pre-printed, sequentially numbered inventory tickets to track the location, number of units, and value of product. The product information on the ticket was handwritten. A review of the inventory tickets identified the use of the same pre-numbered inventory ticket being used to overstate product totals by changing the date. These falsified inventory records inflated the inventory of certain seafood products and enabled the sales manager to create fictitious movement of product.

The provider sustained losses approaching $2.3 million, of which nearly half — more than $950,000 — was attributable to kickbacks. In addition to the losses caused by the fraudulent acts of the sales manager and customers, the U.S. Custom Services assessed more than $23 million in fines and penalties directly attributable to the violations of various regulations dealing with importing of seafood.

Although kickback schemes can be difficult to identify, a clear understanding of the company’s financial statements and data could precipitate further investigation when anomalies emerge and come into focus. A thorough vendor approval process may have identified payments from entities controlled by employees or related parties. That said, business owners should regularly review their financial statements, and ask questions when things don’t feel right. A lack of internal controls and regular review processes enables the thief.

Sources

1. International Anti-Corruption Resource Center (IACRC.org)