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© May/June 2002
Association of Certified Fraud Examiners
Corruption and Fraud Stunt Third-world Growth
Corrupt officials burden developing countries with unfinished projects and crushing debt - conditions that lead to
economic decline and international terrorism.
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The newly independent country urgently needed the $100 million humanitarian aid project, funded by several developed
countries, to alleviate the consequences of a decades-long civil war. The war had ruined roads and cities and driven tens
of thousands into squalid refugee camps.
Five years later, many of the cities hadn't been rebuilt, many of the roads were still impassable, and the refugee camps
were even more crowded and filthy, which fueled the outbreak of disease and the spread of AIDS.
The government blamed continuing rebel activity in the area, but investigations revealed that the primary cause was
fraud and corruption. Bribes, kickbacks, and embezzlement drained more than half of the project funds, which made it
impossible for contractors to complete the project.
While U.S. business loses more than $600 billion a year to fraud, it's even worse in many parts of the developing world
where corruption and fraud lead to the waste of vast amounts of aid and investment funds.
At the cost of their jobs, careers, and even their lives, whistleblowers in impoverished countries have reported millions of
dollars stolen from projects that provide desparately needed housing, hospitals, medicines, and vaccines for the poorest
of the poor. What remains are sick children, half-completed structures, and towering debt.
This article describes the serious nature and extent of the problem. Endemic corruption and fraud contribute not only to
economic decline but also to the conditions that lead to international terrorism.
Recent studies by the anti-corruption advocacy groups and other organizations have found that corruption and fraud in
many parts of the third world are "endemic," "systemic," and "pervasive," and is the norm rather than the exception.
Even more dismaying, corrupt governmental officials and contractors are siphoning international aid and investment
funds, which then stunts the countries' development.
In fact, corruption is now considered to be a leading cause for the failure of many development programs in sub-Saharan
Africa and other parts of the third world, despite the investment of billions of dollars a year, and more than a trillion
dollars in just the last 30 years. Because much aid is given as loans, the wasted funds further burden the countries with
unproductive, crushing debt.
The situation is just starting to get the attention it deserves. The World Bank and other development agencies are
funding anti-corruption initiatives for their members and have formed investigative units to monitor its own programs.
European and Latin American countries have signed treaties and passed legislation to outlaw the bribery of foreign
officials. International business groups and local beneficiaries have insisted on more oversight and accountability.
Still the problem outstrips the resources marshaled against it. In many parts of the third world, corruption must be
expected and dealt with on virtually every project. Unless more is done quickly, corruption will threaten the reputation
and continued funding of donors, the development and stability of the poorer countries, and even the security of the
West, as corruption contributes to the poverty and despair that helps fuel international terrorism.
Transparency International Corruption Index
According to the Corruption Perceptions Index for the Year 2001 prepared by Transparency International, a private
international anti-corruption advocacy group, countries perceived to be the most corrupt in the world, in order, were:
Bangladesh, Nigeria, Uganda, Indonesia, Kenya, Cameroon, Bolivia, Azerbaijan, Ukraine, and Tanzania.
The least corrupt countries, in order, were: Finland, Denmark, New Zealand, Iceland, Singapore, Sweden, Canada, the
Netherlands, Luxembourg, and Norway. (For a complete list see www.globalcorruptionreport.org/.)
Most Common Schemes
Bribes and Kickbacks
Most corruption schemes begin with demands from project officials rather than offers from contractors (although the
latter occasionally occurs, as do cases in which both parties conspire greedily and equally to defraud the project). The
extortionate nature of most schemes suggests it might be possible to recruit unhappy contractors to participate in
confidential reporting or voluntary disclosure programs.
Officials typically demand bribes of 10 percent to 20 percent of the price to award a contract. This can amount to millions
of dollars on a single contract. Bribes for favors later in the project to issue permits or approve invoices, for example,
generally are for lesser amounts. Project officials often target contractors who perform poorly for bribe demands in lieu of
canceling the contract. The damage done by this type of corruption is obvious and can be severe.
In some cases, 40 percent or more of project funds can be consumed as bribes. Contractors can't afford to pay these
amounts, or even half that, and still complete the project according to specifications. This illustrates the real damage of
corruption - not the unjust enrichment of greedy or underpaid officials, but the slowing or halting of projects or a
country's entire development agenda. For instance, a small country can't export its one cash crop because the roads to
the seaport, which are poorly maintained because of the burden of bribes, wash away every year after the first rain.
In countries with "systemic" corruption the problem is well organized and entrenched with regular distribution channels
persisting from regime to regime. The corruption affects every project and every contractor must pay. Project officials,
supervising governmental officials, cabinet ministers, and sometimes the presidency, share the bribes proportionately.
Funds often are used to defray campaign and other political expenses.
In some cases, officials of international aid organizations share in or even initiate the corruption
by taking bribes through project officials, middlemen, or directly from the larger contractors to
approve expenditures. Even some project auditors pay kickbacks to get work or demand
kickbacks to cover up problems.
Corruption schemes sometimes begin with an official demanding or offering relatively small gifts,
lavish entertainment, paid travel, or paid study tours or educational expenses for the official's
children (a common scheme). A contractor might "rent" property owned by a project official for the
duration of the project. (The contractor pays money to a project official to "rent" office space but is
actually making bribe payments. Often the space is never occupied.) However, once the contract
is awarded and the contractor has access to a steady source of funds, a monetary kickback is, of
course, the most common method of payment.
The fraudster often makes the payments in cash. But cash in large quantities can be an inefficient
medium of exchange because it's difficult to generate, transport, and spend without drawing
suspicion. Also, cash transactions are difficult to deduct as business expenses for tax purposes.
More sophisticated parties involved with larger projects conceal bribes as payments to a local
"agent" or subcontractor who fronts for a project official. This allows the contractor to deduct the
payments, and if bribes are later discovered, it enables him to deny knowledge or intent. In some
cases, the parties will conceal bribes by paying the agent or retaining the subcontractor through a
subsidiary or affiliate, which might be located halfway around the world.
The agent, who typically operates through a shell company in a secrecy jurisdiction (a tax haven
country that has strict bank secrecy laws), will keep part of the fee and forward the balance to the
recipient, perhaps through a network of other shell companies and accounts. This could be a U.S.
dollar account in a developed country where the corrupt official travels on business or holiday. His
relatives might live, or his children might study, in that country. Otherwise, the destination of the
funds usually can be predicted by geographical or political connections and language ties.
Generally, corrupt officials in Eastern Europe or Africa seem to prefer to stash money in Western
European bank accounts. English-speaking persons use accounts in London or Switzerland, the
French in France or Switzerland, the Portuguese in Portugal, and so on. Russians often use
Cyprus banks because of that country's proximity.
Corrupt officials on the subcontinent use Dubai in the Persian Gulf because it is a strong secrecy
jurisdiction. Perpetrators in China, East Asia, and South East Asia will use Hong Kong. (These
bank account arrangements might change with the recent enactment of the Anti-Corruption
Convention of the Organization for Economic Cooperation and Development, which will be
discussed in part two in the July/August issue of The White Paper.) The U.S. Foreign Corrupt
Practices Act (FCPA) and money laundering laws make the United States a less popular
jurisdiction, although foreign bribes have been deposited into U.S. accounts.
Finally, bidders or contractors commonly make corporate contributions to local government
"social funds" to pay bribes and preserve deniability.
Front Companies
Dishonest project and government officials can secretly own a contracting or subcontracting
business that's working on a project, therefore enabling them to take larger chunks than they
would from kickbacks. The inherent conflict of interest inevitably leads to higher costs and lower
quality product or services, if indeed any are provided.
Of course, local companies are the most likely to be fronts. Supply and construction companies,
engineering and consulting firms, business advisors, and translation services are prime
candidates for hidden ownership. Crooked officials often foist these firms as subcontractors on
larger companies bidding for work.
It's common for corrupt officials to demand that those companies bidding for work purchase such
items as office computers, printers, and faxes from local companies owned by the crooks. The
corrupt vendors inflate the products by 300 percent or 400 percent and re-sell the items to the
project. Legitimate vendors are aware of the practice but don't object too strenuously (especially
U.S. companies subject to the FCPA) because it allows them to make sales without dealing with
corruption demands. For example, a copier manufacturer sells to the local company (a front for
the corrupt project officials) at the price the copier manufacturer wants and doesn't have to pay a
bribe to make the sale. Then the front company marks it up and sells to the project and kicks
back a percentage of the excess profit to the corrupt party officials.
The fraud is often compounded when the crooked vendors sell used or defective equipment as
new. Everyone loses except for the junk supplier and the greedy project official.
Bid Rigging
Corruption naturally leads to bid rigging. Bribes inflate the bidder's cost, making it harder to
compete on price, and bidders willing to pay the biggest bribes often are the least qualified
technically. Eventually, honest bidders will tire of the expense and futility of competing in a corrupt
environment and abandon the field to the most corrupt.
Most of the bid-rigging schemes are relatively simple and include:
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drafting narrow specifications to exclude other bidders (this often is quite apparent and
includes specifying goods by brand name, or requiring that a bidder have been selected
before or have a local affiliate, etc.);
secret promises by project officials to approve later "contract amendments" to increase
the price after award so the contractor can bid low enough to win, (known as "buying in");
splitting purchases into several separate procurements to avoid reaching competitive
bidding levels, (a common ploy); and
a variation of the above: tipping off the favored bidder that certain components in the
request for bids won't actually be called for, allowing the insider to low-ball that line item,
a scheme known as "unbalanced bidding."
In some areas of the world, where a few companies dominate local markets, bid-rigging cartels
are endemic and greatly inflate prices. The cartels exclude outsiders with pay-offs or threats or
through corrupt relationships with project officials who rig bid specifications. If an outsider is able
to submit a bid, the insiders file formal protests to disqualify the new firm, often on flimsy grounds.
Information Brokers
Information brokers are purportedly legitimate businesses that use corrupt means to influence the
bidding and awarding of contracts on behalf of their clients - prospective contractors. (Information
brokers recently achieved notoriety, and prison sentences, after infiltrating North Sea oil
exploration
contracts.)
In this type of scheme, the broker bribes employees of the contracting organization to leak bid
data, tailor bid specifications, or offer other favors to help its clients win and allow it to inflate
profits. The information broker will launder the bribe payments through several secrecy
jurisdictions, making proof difficult.
Loan Brokers
Loan brokers provide services similar to that of an information broker on international aid projects.
A broker usually will present itself as a legitimate "procurement advisor" or business consultant
and sometimes as an affiliate of a substantial business organization. Many operate beyond the
reach of investigators or subpoenas from offices in the United States or United Kingdom behind
front companies organized in secrecy jurisdictions. The loan brokers typically provide these
services to their clients - corrupt project officials by:
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approaching large corporate bidders around the world to solicit kickbacks on the bigger
project components, and offering their services as "consultants" to conceal the bribe
payments;
setting up and operating front companies on behalf of project officials to bid on the
smaller jobs (such as local construction or supply contracts);
rigging the award of smaller office supply, vehicle, and information technology contracts
through a network of "competing" suppliers they control; and
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collecting the profits from the above schemes, taking their cut, sending the balance to
their clients, and then laundering the funds through a network of other shell companies
and accounts in offshore banks.
The brokers can be expected to cultivate contacts within the aid agency to obtain advance
information on upcoming projects and funding levels, and to share the proceeds of the fraud to
show their appreciation.
Fraud by Contractors
Corruption and fraud are linked as a contractor takes advantage of the corrupt relationship to
recover the cost of bribes and maximize profits. In the worst situations, project officials and
contractors have conspired to completely loot projects; local beneficiaries have complained on
more than one occasion that literally 90 percent of project funds have been stolen.
Opportunities for fraud are greatly enhanced by the generally poor supervision, oversight, and
auditing of international projects. Because no one has been looking, and almost no one gets
caught, nor punished if they are, many of the schemes are very straightforward.
Among the almost limitless variations are:
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billing for works never performed, consultants never employed, or expenses never
incurred, sometimes with elaborate counterfeit supporting documents making it possible
to steal 90 percent of a project;
delivering substandard or defective product; e.g., used vehicles or computers for new
ones (a common scheme), and adulterated drugs and pharmaceuticals;
overcharging for goods and works, sometimes by a factor of three, or four, or more;
billing for engineering or other studies or training programs at inflated rates, and
delivering boilerplate - product copied from other sources at virtually no expense (also a
common scheme);
failing to meet specifications and misrepresenting work done on civil works and roads
projects;
making fraudulent and unnecessary contract amendments or "change orders" to increase
the price of the contract sufficient to cover the cost of the bribes;
misrepresenting the contractor's qualifications and experience; and
submitting false or exaggerated staff resumes.
Theft from Local Accounts and Misuse of Project Assets
Local accounts also are susceptible to fraud and abuse because of the difficulty of exercising
effective oversight and supervision. The problem is growing more severe as more project
expenses are paid from such funds.
Corrupt officials inflate or create fictitious project expenses. In one large project, many of the
schools were never built and others lacked roofs, floors, desks, and chairs.
Also, fraudsters divert project assets, such as computers, automobiles, and heavy road-grading
equipment, for private use, seriously disrupting projects. Four-wheel drive vehicles - stripped of
tires, batteries, and other parts - can't be used for project sites.
Perpetrators also bill unnecessary foreign travel for supposed meetings with suppliers, study
tours or training, divert project revenue and fees for personal use, and create "ghost" employees
and payroll abuses.
Next issue: red flags, proof of fraud and corruption in international cases, and possible remedies.
W. Michael Kramer, J.D., CFE, has investigated corruption and fraud cases throughout the
world. He is an advisory member of the Association's Board of Regents. His e-mail address is
wmkramer@msn.com.
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