A Case Study in Fraud: Raysum Co., Ltd. and the Importance of Internal Controls
A Case Study in Fraud: Raysum Co., Ltd. and the Importance of Internal Controls
Real fraud case: Kickback
Welcome to fraud enquirer, a newsletter about corporate governance, risk management, and internal control. This is written by Terry Tamai, who was in the audit practice at a Big 4 accounting firm for 30+ years including 17 years as a partner.
In the world of corporate governance and risk management, real-life examples often provide the most valuable lessons. Today, we delve into a recent case that has shaken the construction industry: Raysum Co., Ltd., a company that fell victim to internal fraud. This case study underscores the importance of robust internal controls and offers valuable insights for accountants seeking to bolster their knowledge in this critical area.
A Real Story
Raysum Co., Ltd., established in 1992 in Japan, operates in the construction industry, managing three key businesses: asset value creation, asset value improvement, and future value creation. However, the company recently found itself in the midst of a fraud scandal involving a former employee, referred to as Mr. A.
The fraud scheme was intricate yet devastatingly simple. Mr. A, in collusion with a specific construction subcontractor, inflated outsourcing costs over several years. After placing an order, part of the inflated costs was received as a kickback. The total amount of the kickback was 176 million yen or $1.3 million.
The mechanics of the fraud were as follows: Mr. A would receive a formal estimate from the subcontractor for a construction project. He would then inflate the estimated amount by correcting the unit price listed in the file. The inflated quotation would be printed out, sealed, and sent back to the subcontractor. Part of the inflated amount would then be received by Mr. A as a kickback. The construction projects subject to this kickback were decided by Mr. A alone.
The company's internal control system was not robust enough to prevent such fraud. The system had a series of checks and balances in place, such as segregation of duties, control of construction budgets and estimated amounts, and a manual for responding to inappropriate incidents. However, these controls were not sufficient to detect the fraudulent activities carried out by Mr. A.
For instance, when approving a request for a project, the focus was on whether the order amount was within the total cost estimate, rather than evaluating the appropriateness of the price of individual cost items. The company also had rules for selecting suppliers and a mechanism for examining the appropriateness of the price of individual construction details. However, these controls failed to detect the inflated costs in the estimates provided by Mr. A.
Analysis
What went wrong?
The root cause of the fraud was a lack of internal controls and oversight within Raysum. The company's system did not have adequate checks in place to prevent or detect such fraudulent activities. The fraud was only discovered after Mr. A had retired, indicating a significant lapse in the company's internal control systems.
What could have prevented it?
The fraud at Raysum could have been prevented with more robust internal control.
Segregation of duties within the company could have provided better checks and balances.
Strengthening control on construction budgets and estimated amounts could have made it more difficult for Mr. A to inflate costs.
A manual for responding to inappropriate incidents, rules regarding the selection of suppliers, and a mechanism for examining the appropriateness of the price of individual construction details could have further safeguarded the company.
Lessons to be learned
Detailed Review of Estimates: It's crucial to thoroughly review all estimates and quotations in any business transaction. This includes evaluating the appropriateness of individual costs, not just whether the total cost is within budget. A detailed review can help detect any inconsistencies or unusually high costs, preventing potential fraud.
Segregation of duties: A system where multiple individuals share responsibilities can help prevent fraud. This ensures that no single person has unchecked control over a process, and it allows for additional oversight. Regular rotation of duties also prevents complacency and encourages fresh perspectives, which can help identify potential issues.
Supplier Selection Process: Having a robust supplier selection process is essential. Conduct thorough background checks on new contractors or suppliers to ensure they are reputable and reliable. This can help reduce the risk of fraud and ensure that the company is working with trustworthy partners.
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