Protecting Your Organization from Becoming a Victim of the Underground Economy

by James Marasco, CPA, CFE, CIA
Director, Corporate Services
StoneBridge Business Partners

Reprinted with permission from Fraud Matters Newsletter of CPA America .

Most organizations in this country operate their day-to-day operations without a passing thought to the “underground economy.” To most, it sounds like a television drama involving organized crime or narcotic dealers. However, unsuspecting businesses may become victims. How insulated is your organization?

There are many aspects of the underground economy. Three particular ones that we will discuss include money laundering, bid rigging and bribery. These frauds are listed under the corruption caption within the Occupational Fraud & Abuse classification of the Association of Certified Fraud Examiners. They may not be as uncommon as one would think. 

Money Laundering

To those in the Northeast, money laundering controls took front and center in early 2008. New York Governor Elliott Spitzer resigned due to his participation in a prostitution ring. What captured investigators’ attention wasn’t the company he was keeping, but the movement of funds between straw companies and various bank accounts with the intent to finance his indiscretions and avoid scrutiny.

Money laundering describes the process where illicit money is “washed” through legitimate businesses so it can be used without attracting attention. It can be operated in a three-step process. The first step involves placing funds into a legitimate financial institution. The second step is layering. Once the funds are deposited, perpetrators move the funds around in layers of complex transactions designed to conceal the source and destination of the funds. Integration of the money back into the economy is the last step. Businesses dealing in cash are typically used in these schemes. Restaurants, nightclubs, vendors serving these industries, and even parking garages make excellent candidates.

In 1996, the Suspicious Activity Report (SAR) was instituted by law. It now requires banks to report any known or suspected criminal activity. Since 9-11, banks have become more diligent in reporting this activity, as dollar thresholds do not apply. 

Unfortunately, perpetrators have found a way to circumvent these controls. Today, they’ve now turned to using open-system gift cards. These cards are reloadable and can be used at most retailers and ATMs. However, since they are not linked to a personal bank account, they avoid the scrutiny described above. It’s no surprise these prepaid cards have become a $63 billion dollar business. 

Bid Rigging

Strong internal controls suggest that capital projects or services expected to exceed a certain dollar threshold be subject to a bid/proposal process. However, if all the parties invited act in collusion, the independent bid process is compromised. This occurrence is more prevalent when the services are specialized, the qualified or potential bidders are limited and/or the purchasing manager is corrupt.

Bid rigging is more prevalent in the construction industry. Collusion between general contractors or subcontractors can add substantial costs to a project. In most instances, it can be very difficult to detect.

Bribery

The third item of discussion involves illegal gratuities or bribery. While this action may constitute a general business practice in many countries, it is illegal in the United States. Louisiana congressman William Jefferson was recently sentenced to thirteen years in prison for accepting bribes for influencing business dealings with Africa. Perpetrators rationalize their behavior by believing that they are actually facilitating the process. However, accepting and/or paying bribes can have serious legal consequences. Many large organizations and governmental agencies specifically prohibit the receipt of any type of gift by vendors, consultants, etc.

Safeguarding Against these Influences

If you own businesses that deal primarily in cash, you need to build strong controls if you’re an absentee owner. The federal government is also watching. A heightened sense of awareness by the banks and feds has this activity closely monitored.

Purchasing managers should be routinely rotated in larger organizations. Capital projects should have a “clerk-of-the-works” assigned to independently oversee the project from start to finish. All aspects of the bid process, subcontractors used, change orders, etc. should be closely monitored by the organization independent from the construction manager and architect. All requests should be advertised to seek the most wide-spread coverage possible.

All organizations should prohibit their employers from receiving gifts and notify their vendors of their policy. Employees working in influential positions should be watched for suspicious behavior. Ethics hotlines should be established to offer other employees/vendors the opportunity to assist in monitoring for this activity.

The “underground economy” may seem far removed from your own organization, but could be a lot closer than you think. As with most fraud, safeguarding against these influences starts with a general awareness and ends with a strong system of internal controls.

– James Marasco, CPA, CIA, CFE