How Financially Crime Savvy are you, Mr Financial Crime Investigator?

I wanted to start a series of financial statements – financial crimes related series.  This shall be the first of the several short articles that I will write.

While financial statements are not the only source of information detailing the individual and/or corporate Source of Wealth and Source of Funds; it is a critical piece of information.  More so, for the audited statements.

Trade finance expert, Mr. Lee To On, had in his earlier days, way before the term, Trade Based Money Laundering, was even coined; painstakingly advised his students that the footprints are left imprinted on the trade documents.  This means, the traces of trade crimes would be evident on the trade documents, as they are presented to the Bank.  In the same light, traces of corporate mala fide practices are also evident in the financial statements.  The flags are there; the question is, can one spot them?

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Preface

An appreciation of financial statements is important, not only from a credit risk (i.e. loan accommodation) management standpoint but is imperative in fighting financial crimes.  The use of audited financials has, however, been largely ignored and its application not understood or appreciated by the Bank financial crime investigators.  Having conducted 2 rounds of Forensic Review of Financial Statements - A Non-Accounting Perspective, under the ambit of the Institute of Singapore Chartered Accountants (“ISCA workshop”), it only further cement my views that this topic clearly needs a stronger buy-in especially for the Bank Compliance officers dealing in financial crimes investigations.  To better combat classic financial crimes such as “double financing”, the key lies in understanding the (a) client’s business operations, (b) the audited financials and how the (c) observed cash flows actually fits in.   One does not need to be forensic accountant to be able to make full use of the financial statements.  For clarity sake, we are referring to audited financials as opposed to Management Accounts.

How are financials potentially manipulated?  For a start, let’s look at some examples: -

Case Illustration 1: -

A large corporation paid an agent several million dollars, ostensibly for customs clearance in a foreign country.  In fact, the payment was made to the re-election campaign of that country’s president.  The company recorded the expense as Accounts Receivables for Reimbursable Operating Expenses on the balance sheet.  Much later, the company decided to exit the country and “settle” its accounts receivable balances.   The company wrote off the uncollected balances to bad-debt expenses, including the campaign contributions sitting in the Reimbursable Operating Expenses account. [example extracted from my ISCA workshop - [ re: Use of Accounts Receivables to Conceal Bribes ]  Ask yourself one question, “do you (even) question how financial items are recorded and accounted for?”

Complex Case illustration 2: -

“How would a company reflect bank-related financing in its financial statements?”  Before you contemplate answering, think (very) carefully, if, you really think you know what it is treated.  Now, how do you like, if I were to propose something innovative, shifting some of the bank-borrowings to say, ‘Other Payables”, or perhaps, a little more reflective of the business modus operandi, say, “Trade Payables & Other Creditors”?   Objections, anyone, please?  Going once, going twice and going thrice.  Sealed!  I do not run afoul of any accounting conventions, do I? 

Let us look at this hypothetical example: -

1. Buyer A purchases goods from Supplier B, say, credit terms, 60 days.

2. Buyer A enters into a certain Accounts Receivable Financing program with its financing bank.

3. The financing modus operandi: -

• Supplier B will be able to submit the invoices it has issued to Buyer A.

• Upon validation, Buyer A submits the same to the Bank for accelerated payment.  Assume that Supplier B gets paid after 10 days rather than at the end of the credit tenor.

• The financing bank will also often allow Buyer A a longer tenor to repay the invoices.  Assume that instead of 60 days, another 60 days financing is accorded.  In effect, this is using a financial institution to extend payment terms.

4. In this example, Company A is borrowing 120 days of its accounts payable from the financing bank, while the latter pays the Supplier B.

5. But consider this, while the particular stream of debt that Buyer A owes the financing bank is reflected as “debt” on its balance sheet, it is parked under “Accounts Payables” or “Other Payables”. 

The implications are, as follows: -

• The scale of the liability to the financing bank(s) would not be evident from the Balance Sheet; and

• The money borrowed from the financing bank turns into becomes cash inflow on the cash-flow statement.  (further commentary: unless one scrutinizes the company’s financial statements, one would not be able to decipher the source of cash, which is supposed to be generated by the business operations.)

Assume that you step into the shoes of another financing banker to Buyer A and: -

• You are not cognizant of the above financing arrangement and similarly,

• You have ignored the substantial growth of the “Accounts Payables” or “Other Payables” in the company’s accounts.

What say you?  A disaster awaiting to happen or?  Company A collapses in due course and credit losses were attributed to the company’s illiquidity.  Is this the true reflection of financial difficulties or something else had transpired without the other banks’ knowledge. 

Financials, please don’t ignore it!