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A Challenge for the Indian EPC Sector
Richard Dailly, Managing Director & Head of Kroll's Operations in India. Kroll, experts in Fraud Intelligence and Investigations. The engineering, heavy engineering and manufacturing sectors globally are most vulnerable to fraud and corruption. In India, hearsay and industry commentators suggest that the engineering and manufacturing sector faces a growing problem with procurement fraud. To tackle fraud it is important to pick up the warning signs. The author delves in to fact files of Indian fraud and also on ways to curb it.

India's economy is expected to expand by 8.5 percent this year and some estimates show that growth may exceed 10 percent in the next few years. India's legal system, its use of English for the business purpose and a business culture already used to globalised markets, suggest that India's success story is likely to continue in the near future. India's success story can be seen in the domestic manufacturing and engineering sector. The EPC sector which is based in Chennai, Pune and Kanpur contributes close to USD 120 billion to GDP.

The 3 key drivers which have been pushing the growth are:-

• Importance, and economic might of India's middle class
• Foreign multinationals which have made India their manufacturing hub for global operations and
• The continued need to develop India's infrastructure. The business opportunities are so large and the financial gains potentially so great that it is easy to overlook the frauds and corruption risks.

According to Krollís experience, "the engineering, heavy engineering and manufacturing sectors globally are most vulnerable to fraud and corruption". In India, hearsay and industry commentators suggest that the engineering and manufacturing sector faces a growing problem with procurement fraud. To tackle fraud it is important to pick up the warning signs, such as a small scale pilferage. Such small scale fraud might not have any significant financial implications but it is symptomatic of lax accountability and poor processes which could provide fertile breeding grounds for more serious issues. Failure to investigate in the short term can cost your company long term financial and reputational damage.

What Exposes the Manufacturing & Engineering Sector to Fraud?
A key driver of fraud and corruption is the frequently isolated geographical location of operations. While such a plant may manage itself on a day-to-day basis, in Kroll's experience, working methods and procedures are often open to abuse. Within an isolated plant, management is easily dominated by a key individual: checks and balances - the tools of accountability - can go out of the window. When a powerful and charismatic individual manages an isolated facility with few accountability measures in place, the opportunities to manipulate tenders to friendly or related parties, to over invoice, pay kickbacks to business partners and to take other operational and process shortcuts can be too tempting to resist. Kroll has seen numerous cases in which a powerful individual effectively runs a facility for his own benefit and cases in which senior, respected and charismatic individuals with great industry expertise control every aspect of a facility's operations. These individuals are frequently dismissive of compliance and control processes and contemptuous of modern, international management standards.

Such individuals may recruit like-minded junior staff with the enticement of increasing their potential financial reward and in return encouraged to keep any illicit scheme quiet. In such situations, senior management at corporate headquarters may not even be aware that such networks exist. Yet, time and time again Kroll has seen cases where individuals within the fraud networks are connected through family, or through previous places of employment where a number of individuals have worked together for a different employer. With senior management in the dark and not seeing anyone involved in day to day operations of a facility, and juniors on either side being too scared to blow the whistle, procurement and contract fraud can be rife and extremely hard to unearth. According to a survey undertaken by Kroll in October 2010, 29 percent of fraud in India has as its key perpetrator vendors, suppliers, agents, and partners combined. Given the small partnership evident in the manufacturing and EPC sectors and often not recorded with the Ministry of Corporate Affairs, proving ownership can itself be problematic. As a result, uncovering related party interests between distributors and contractors who may be old friends or family relations in a small and isolated community, almost always relies on investigative intelligence, because finding a paper trail will in most cases be impossible.

In addition, to the financial consequences of corrupt staff controlling a plant, the use of counterfeit spare parts in the EPC sector, provided by unauthorized manufacturers presents a unique risk in this sector. By way of example, Kroll is aware that the automotive manufacturing sector in India is awash with counterfeit spare parts; even helicopter manufacturers have inadvertently replaced bona fide spares with unauthorized components with catastrophic consequences. While these might be extreme examples, all heavy engineering equipment is potentially dangerous, so not only is the company passing on the risk to the customers but potentially also to their employees. Kroll recommends that warning signs such as indications of pilferage, over-controlling individuals and rumours of low level fraud, might be symptomatic of a facility which has far more serious problems and should not be neglected.

What risks are you running?
The consequences of procurement fraud are beyond just immediate financial loss. Imagine the damage to a company in the engineering sector which was inadvertently procuring unauthorised counterfeit components, or spares for its products and one of those components failed. Clearly, the damage done to a company's reputation in this situation is going to be significant. Think of the reputational damage incurred by any major brand when they are compelled to issue recall notices, sometimes globally. Apart from the immediate cost of undertaking such a recall exercise, consider the long term implications to sales, and where your brand then sits in the market. Then there is the cost of mitigation. The public relations machine would need to go into overdrive; an independent investigation would need to be undertaken as soon as it became evident that there was a problem to determine the facts. What caused the component failure? Was it counterfeit? Where was the component sourced? Who really manufactured it? Who authorised its procurement? Are there connections between individuals at the manufacturing plant and the vendor?

Legal advisers would need to be consulted to advice on the risk of litigation. If the products are sold across the world it is plausible that exposure could be international. Indian legal advisers will not be sufficient; international counsel may well need to be sought, adding to the cost. Then there is the cost of repair and regaining market position. Ensuring that appropriate accountability and fraud prevention tools are in place. Developing and maintaining independent whistle blower hot-lines, thorough screening of all staff, vendors and the vetting of entities involved in procurement chains are crucial. Once bitten, twice shy. In Krollís view, thorough due diligence and accountability built into the system could save significant cost, stress and ensure a sustainable business built on high levels of corporate governance. What may seem like a manageable and small scale case of pilferage from a remote location may be your indicator that the facility is not being managed in an effective, professional and secure manner. Looking into this red flag further could save you millions. These are just a few ways in which the manufacturing and EPC sector faces unique and difficult fraud challenges in India. Krollís experience is that the three major problems highlighted Ė isolation, poor management, and a propensity for counterfeits Ė often go hand in hand. Operating on the ground, it is often obvious that management has to root out those who have taken advantage of their positions in order to operate in their own interests. However, it is unfortunately not uncommon for the management of an entire facility to be implicated in wrongdoing.

Kroll would strongly recommend that to reduce the economic, legal and reputational risks associated with fraud in this sector in India; management must look closely at some of these red flags and if any doubt exists as to how a facility is operating begin to carefully investigate.