According to those close to the issue, a growing number of companies are at an increased risk of fraud due to outsourcing critical functions to third parties.
And the risk is greatest, it turns out, in the very locations to which a growing proportion of work is being outsourced - the world's emerging markets.
"Fraud risks in emerging market countries are on the increase - but we're not seeing a trend that suggests that businesses have recognised the danger," says Neal Ysart, senior manager for forensic services at PricewaterhouseCoopers.
"What's more", he adds, "the tightening economic conditions of recent years mean that many of those businesses have also reduced the resources available to protect themselves from fraud."
Yet identifying fraud - during audits, for instance - isn't always easy, as managers at the outsourcing supplier can try to control information to which a forensic team has access.
"We had one client who failed to recognise that the internal audit team they sent to India was being fed with favourable information, and was being introduced to staff who had well-rehearsed answers ready and waiting," he says. "This meant that they had a false degree of comfort that the risk of fraud was well controlled-and it came as a shock when problems started to surface."
In short, he says, they had totally failed to recognise that their visit was being choreographed-and as a result missed the opportunity to identify problems at an early stage.
"The key problem," says Michele Edwards, fraud analytics global market lead at Atlanta, USA-headquartered PRGX, a specialist procurement analytics firm, "is that outsourced operations, combined with a tough economy that puts businesses under pressure, has provided an opportunity that can prove too tempting to resist."
"As companies move operations overseas, the risks of entering into a relationship with a corrupt third party - or a third party with corrupt employees - increases," she notes. "Companies simply aren't putting in place the controls and procedures that will identify and prevent fraudulent activity."
As a result, businesses such as PricewaterhouseCoopers and PRGX are receiving a growing number of calls to carry out checks on vendors in places like China and India. Yet prevention-as always-is better than cure, and both Edwards and Ysart acknowledge that firms could do more to protect themselves when establishing outsourcing relationships in the first place.
"It really reinforces the importance of putting in place good governance within an outsourcing relationship at the start," says Alistair Maughan, a partner at international law firm Morrison & Foerster. "To do otherwise is to ignore the possibility that fraud might occur - which is an unrealistic assumption."
Yet according to PRGX's Edwards, companies are still entering into outsourcing relationships without building into contracts the right to carry out audits - or even assessing suppliers' own anti-fraud controls, or codes of employee conduct.
Indeed, "a supplier's fraudulent employees pose a greater risk than many firms imagine-and one that they do relatively little to protect themselves from," warns Mike Pierdes, a partner with law firm Pinsent Masons.
"Under English law and that of many other jurisdictions, unless it is expressly specified in the outsourcing agreement that the outsourcing supplier is responsible for the fraudulent activities of its employees, the supplier could potentially argue that any fraud was carried out by the employee outside his or her scope of employment, and that therefore there is no vicarious corporate responsibility," he notes.
His advice? "Outsourcing agreements must specify that the supplier is responsible to the customer for the fraudulent activities of its employees-which isn't the law, and must be negotiated," he says. "The contract should also ensure that fraud is stated as an uncapped liability, and typically the customer should seek an indemnity from the supplier on this type of loss."
Source: http://www.procurementleaders.com/news/latestnews/4007-growing-threat-outsourcing/
