- First-of-its-kind report into corporate intelligence background searches shows miscreant directors targeting businesses in financial, energy and technology sectors
- Key integrity risks relate most frequently to owners and directors, not companies
- Middle East, North Africa, Central and Eastern Europe are ‘red flag’ hot spots
Corporate intelligence experts at KPMG - who conduct background searches on behalf of clients before they enter into business relationships with companies or individuals - have launched the first study into the risks companies take when they enter into business relationships. ‘Astrus Insights’, which analysed some 8,000 integrity due diligence reports, found the financial services sector is the most exposed of any industry to the threats of fraud, corruption, insider trading, negligence and bankruptcy.
Nearly half of reports conducted in the financial services sector raised ‘red flags’, while nine out of 10 of the highest risk reports were completed for banks. These reports included serious risks such as directors or shareholders on sanctions lists, or associated with fraud or corruption charges.
The results of the analysis reflect in part the fact that the financial services sector is generally further advanced than others in reviewing its third party relationships, in particular with customers, and in identifying high risk relationships requiring due diligence. Yet the industry is still getting to grips with the scale of the risks faced. Over £57 million was paid out in fines by financial institutions to the Financial Services Authority in 2012* relating to money laundering, corruption or other integrity issues potentially involving third parties.
KPMG’s analysis shows that financial institutions are right to take this risk seriously as our due diligence uncovered high levels of risk either in their existing portfolio or prospective customer relationships.
Alex Plavsic, Head of Forensic at KPMG said: “While some banks are doing their utmost to delve deeper into the backgrounds of those they do business with, we know that many are still applying a cursory review, only going as far as a sanctions check and an internet search for their research. This is not sufficient. Our analysis shows that these checks typically fail to identify nearly 84% of potential risks. Indeed, in some cases, checks are only being carried out after the institutions have already signed the contract with a third party. As association like this could give rise to serious legal, reputational or commercial risks.”
Third parties are only as trustworthy as the people who run them and the single greatest risk identified was the integrity of directors, shareholders and ultimate beneficial owners of a company. Negative information on individuals running or owning a company accounted for 68% of red flagged reports in the financial services industry since 2009. Fraud was also the most prevalent risk uncovered, exceeding all others including money laundering, regulatory violations and business disputes.
David Eastwood, Forensic Partner, said: “Fraudsters pose, in equal measure, the most sinister and most clandestine of risks which banks must be alert to when entering into business arrangements. In many jurisdictions it can be a challenge to accurately identify shareholders and ultimate beneficial owners. This information is often not readily available on corporate filings and the use of proxy or nominee shareholders or bearer shares can confuse matters. However, regulators have made it clear that financial institutions should seek to unmask the individuals behind the organisations they deal with; ultimately it is people that pay or receive bribes, launder money or commit fraud, not legal entities.”
The latest analysis also shows that the location where financial institutions choose to do business matters, with certain geographical locations found as greater hotspots for third-party risk than others. The Middle East and North Africa pose the greatest risk, accounting for 72% of all red-rated reports, followed closely by Central and Eastern Europe (including Russia) accounting for 71%, and then Central Asia (70%).
Eastwood continued: “Financial institutions face competing commercial and regulatory pressures, with the potential of tapping into high growth areas quickly countered by regulatory fines and sanctions if things go wrong. While many are doing their best to compete in the new world, too many are still overlooking the risks.”
An investment bank was looking at a correspondent banking relationship in the Middle East. Background research revealed that the bank’s shareholders had been accused of corruption; the bank had allegedly conducted transactions for terrorist organisations, and had been involved in stock manipulation. The bank had been fined for deficient Anti Money Laundering (AML) controls and several of its directors were politically exposed persons. The majority of the investigations and allegations into the bank were identified through research outside of the country of the bank’s operations and required an international review of litigation and blacklist checks, and full reviews on the banks ultimate beneficial owners and directors. The Astrus due diligence identified a number of critical red flags that may otherwise have gone undetected, including significant concerns over the subject’s level of regulatory compliance that may not have met the standards required by the banking client.
A US firm was looking for a way to manage its logistics in Russia and was recommended a customs broker. On the surface, the company looked to have a good reputation and had not been referenced in sanctions or blacklist checks. The firm’s main contact point at the customs broker, the general director, had a good reputation. However, further investigation revealed that the shareholders were caught up in allegations that they had paid bribes to customs officials and had faced various administrative fines through other businesses. They were also embroiled in litigation in the US as a result of their activities there and were suing their business partner for fraud. Intermediaries and agents involved in customs clearance activities are generally considered higher risk and warrant enhanced due diligence, even if it is indicated that they have a good reputation.
An oil and gas firm had been recommended a joint venture partner in a central African country. The company appeared to have the requisite track record, some well-known international customers, and was endorsed by local and international players in the oil and gas market. However, due diligence uncovered that the ultimate beneficial owners of the company were all politically exposed, had been accused of corruption and embezzlement of funds and been linked to arms smuggling scandals. These factors combined made the firm re-evaluate the recommendation it had received.
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Notes to Editors:
* According to KPMG calculations of all of the fines imposed by the FSA in 2012 in relation to corruption, money laundering, insider trading, market abuse. Does not include Libor or mis-selling fines.
About the KPMG ‘Astrus Insights’ report
KPMG’s Astrus Insights report analyses the findings of c8,000 integrity due diligence reports. These reports draw on an extensive range of public information sources across the world and include analysis by experienced corporate intelligence specialists.
Integrity risk factors are categorised according to: the company or individual’s background details, shareholders, directors, adverse press and media comment, litigation, exposure to sanctions, Politically Exposed Persons (PEPs) and published lists of high risk entities.
The full report is available as a separate pdf.
Astrus is a service of KPMG’s corporate intelligence team, which provides research and intelligence to support clients in understanding business partners, compliance due diligence and monitoring, entry into new markets and investigations support.
KPMG LLP, a UK limited liability partnership, is a subsidiary of KPMG Europe LLP and operates from 22 offices across the UK with over 12,000 partners and staff. The UK firm recorded a turnover of £1.8 billion in the year ended September 2012. KPMG is a global network of professional firms providing Audit, Tax, and Advisory services. We operate in 156 countries and have 152,000 professionals working in member firms around the world. The independent member firms of the KPMG network are affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. KPMG International provides no client services.