Internal Control: What Those Charged with Governance Should Know

Tempe, October 31, 2017; Technical Staff

This document is a part of The AACI series of anti-corruption resources made available to our CACM members . The contents of this document constitute an integral part of the CACM Review textbook that would be available in countries where the CACM will only be offered by exam. 

Those charged with governance should have proper and adequate anti-corruption intelligence to prevent and deter corruption and avoid negligence or gross negligence in performing their duties. 

The AACI defines anti-corruption intelligence as: 

" the minimum, optimum knowledge a decision maker should have to avoid fraud and corruption intelligently. Such knowledge includes the proper blend of due diligence, internal controls, anti-corruption, governance, decision making, process auditing ( from a management perspective and duties) to avoid anti-corruption and fraud. By avoidance, we emphasize the concept of deterrence and prevention.  Corruption prevention is less expensive and better than any cure."

Internal control is a pillar of anti-corruption intelligence. Regardless of her background, a decision maker should master the concept of internal control. This mastery should include, at the minimum, the executive summary of Internal Control - Integrated Framework. 

We issued "Introduction to Internal Control" in October of this year and emphasized the importance of the control environment component of internal control.  It is the foundation of other internal control components. It is unfortunate that too many decision makers and board members have misconceptions about internal control. 

Delusions of internal control include, but not limited to, the following: 

• Internal control is the policies and procedures of an organization.

• Internal control is not directly related to preventing, deterring, and detecting fraud and corruption.

• Internal control is not required in small and medium-sized (SMEs) entities.

• Internal control is not related to business risks.

• Good governance is not related to internal control.

• Strategic management is not related to internal control.

• Internal control is not related to the board responsibilities.

• Accountability, transparency, and responsibility are not related to internal control.

• Compliance is not part of internal control.

• Expenditure on internal control is a waste of resources and expense.

• Internal control is static.

• Internal control prevents and detects every fraud and corruption event.

The more widespread these misconceptions among decision makers of an organization, the higher the corruption risks and business failure. 

Why do we call these assertions and beliefs "misunderstandings about internal control"? 

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The First Interview with Mr. L. B. Files, president of The American Anti-Corruption Institute (AACI)

The First Interview with Mr. L. B. Files, president of The American Anti-Corruption Institute (AACI).

As The American Anti-Corruption Institute's (AACI) journey approached five years since launching its operations in late 2012, fraud and corruption scandals continued to make headlines. Though the Volkswagen Dieselgate costs exceeded $30bn to date, and Samsung's CEO will spend time in prison for corruption charges, the corporate world does not seem to be paying attention. Corruption removed several heads of states from power, in South Korea, Brazil, a senator in the United States, UN officials and Ambassadors and, EU officials.

Despite the setbacks, or maybe because of the exposure, the global political landscape became more determined than ever to fight graft. For the first time, the United States equated the efforts of combating corruption to the fighting financing terrorism.

Fighting corruption has, in fact, became a prerequisite to fighting financing terrorism. Amid the global turmoil of corruption, the media and public relations of The AACI met Mr. L. Burke Files, the president of The AACI, at its headquarter in Tempe, Arizona to discuss The AACI's global efforts in fighting corruption, among other relevant issues.

The AACI: On behalf of our members, constituents, and advocates worldwide, we thank you Mr. Files for this opportunity to answer our questions.

Files: You are most welcome.

The AACI: As you know, corruption is a prevalent phenomenon hitting all over the world. How do you evaluate the commitment of the international community to fighting corruption?

Files: The 1977 Foreign Corrupt Practice Act, The United Nations Convention against Corruption (2005), the UK 2010 Bribery Act and those of the OECD relevant anti-corruption demonstrate an unprecedented global commitment to unequivocally fighting corruption. The most explicit U.S. message in this regard came at the May 2016 London anti-corruption summit where John Kerry, the former US Secretary of State said:  “We are fighting a battle, all of us. Corruption, writ large, is as much of an enemy, because it destroys nation states, as some of the extremists we are fighting or the other challenges we face." This proclamation changed the global landscape for fighting corruption. It tied, in public, for the first time, combating terrorism and combating corruption.

"This proclamation changed the global landscape for fighting corruption. It tied, in public, for the first time, combating terrorism and combating corruption."

The AACI: Why does The AACI focus all its efforts on executive management and those charged with governance?

Files: To answer your question, let me remind you that our founders are visionaries and responded strategically to the financial crises of 2008. The financial meltdown of 2008 shocked us though we had SOX and all the other relevant laws. When you read the report of THE NATIONAL COMMISSION ON THE CAUSES OF THE FINANCIAL AND ECONOMIC CRISIS IN THE UNITED STATES, you will find the crises was 100% avoidable. Further, that corporate of America suffered from significant weakness at the top. We found that the “tone at the top” was severely weak and at best sickened from significant lack of anti-corruption intelligence and short-term visions. We believe that the Board Of Directors and Executive Management must possess the minimum required anti-corruption knowledge and skills to enable them to meet their duties. As of today, The AACI is the only organization all over the world that targets decision makers to help them deter, prevent, and detect fraud and corruption through the methodical management anti-corruption certification program Certified Anti-Corruption Manager (CACM).

"The AACI is the only organization all over the world that targets decision makers to help them deter, prevent, and detect fraud and corruption through the methodical management anti-corruption certification program Certified    Anti-Corruption Manager (CACM). "

The AACI: What do you mean by anti-corruption intelligence?

Files: The AACI coined it to mean the minimum, optimum knowledge a decision maker should have to avoid fraud and corruption intelligently. Such knowledge includes the proper blend of due diligence, internal controls, anti-corruption, governance, decision making, process auditing ( from a management perspective and duties) to avoid anti-corruption and fraud. By avoidance, we emphasize the concept of deterrence and prevention.  Corruption prevention is less expensive and better than any cure.

Click here for the complete interview

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Certified Anti-Corruption Manager (CACM)

Part 1(C): Fraud and Corruption Deterrence - Government Entities

What is the resilience of an entity in preventing, deterring, and detecting fraud and corruption?

Tempe, March 29, 2017

Technical Staff

Increase the Likelihood of Detecting Corrupt Acts

A government entity would enhance its deterrence of corruption when it increases the likelihood of detecting corrupt or fraudulent acts. The perpetrator would usually weigh the benefits and costs of his fraudulent act. Under normal psychological and emotional conditions, he will rationally decide whether to commit fraud or corruption. The more the perpetrator believes that his fraudulent act would be uncovered, the less likely he will commit fraud or corruption. For example, when a cashier knows that the internal audit department personnel are competent and usually carry out surprise physical cash count of money in his custody, he will not take a high risk of being caught “borrowing” cash from his custody. 

Systems of internal control that are well designed and implemented effectively would support the organization’s deterrence of corruption. Although internal control systems have their inherent limitations, a whistle-blowing policy would create a significant deterrence impact on the perpetrator’s perception of the likelihood of being detected. Prevailing honesty and integrity within the government entity’s culture also support its deterrence of corruption.

However, the efficacy of deterrence of corruption depends on the following two fundamental deterrence principles:

(a)   Severity of punishment, and
(b)   Certainty of punishment

Severity of punishment

Punishment is severe when it deters a perpetrator from committing a fraudulent or corrupt act. However, one cannot conclude that whenever there is corruption, its associated punishment is not severe. A severity of punishment would be measured by the degree to which a perpetrator understands the risks (costs) of corruption and the extent to which it deters him from committing fraud.

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Part 1(B): Fraud and Corruption Prevention - Government Entities

What is the resilience of an entity in preventing, deterring, and detecting fraud and corruption?

Tempe, February 27, 2017

Technical Staff

As we stated in Part 1(A): Fraud and Corruption Prevention - Government Entities, there is not a cut-and-dry measurement for fraud and corruption risks. These risks should be addressed at the following levels: internally and externally.

The following questions and their respective answers would constitute a foundation for identifying and assessing the fraud and corruption risks attributed to the external environment of a government entity. The process should include the following factors:

• Constituents and customers
• Suppliers and creditors
• Public expectations of services
• State audit
• Local laws, rules, and regulations
• Society social norms, values, and culture
• Prevailing corruption or perceived corruption in the community / country

Constituents and Customers

1. Does the government entity have a documented current system to receive, process, and respond timely and appropriately to constituents and customers' suspected corruption complaints?
2. Does the government entity interact with its constituents and customers via social media platforms? If yes, does the government entity monitor its constituents and customers' perception of its integrity and ethical practices?

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Part 1(A): Fraud and Corruption Prevention - Government Entities

What is the resilience of an entity in preventing, deterring, and detecting fraud and corruption?

Tempe, February 27, 2017
Technical Staff

Where to Start?

A smart start at an entity to prevent fraud and corruption would be seeking an answer to the following question:

What is the current status of fraud and corruption in the government entity?

The answer to this question could be qualitative or quantitative. Qualitative responses, for example, could be very low, low, medium, medium-high, high, and catastrophic! Quantitative answers could be a point on a numeric or percentage scale.

This is what we call fraud and corruption risk identification, or sometimes we call it fraud and corruption risk mapping. Fraud and corruption risk is a business risk. Because it is a business risk, it should be embedded in the organization’s strategy. Needless to say that neither this risk nor the strategy is static: they are dynamic.

Fraud and Corruption Risks in a Government Entity

There is not a cut-and-dry measurement for fraud and corruption risks. These risks should be addressed at the following levels: internally and externally.

The following questions and their respective answers would constitute a foundation for identifying and assessing the fraud and corruption risks attributed to the internal environment of the government entity.

Are the elected public officials financially literate?

Is there an orientation program for senior officials and newly elected public officials

Is there an effective internal audit function?

Should circumstances warrant, does the government entity have effective and competent functions similar to those applied in its industry?

Does the government entity have effective compliance function?

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Fraud and Corruption Detection: Part 1 (D)

January 29, 2017

What is the resilience of an entity in preventing, deterring, and detecting fraud and corruption? 

Part 1(D) Fraud and Corruption Detection in a For-Profit Organization

Detection of fraud and corruption is directly related to fraud and corruption prevention and deterrence. While prevention of corruption is fundamentally based on anticipating what could or may go wrong, detection of fraud and corruption is principally designing and implementing policies, processes, and procedures to find out when fraud and corruption occur. Therefore, one will never systematically detect a fraud or corruption incident unless it was initially expected to happen. An effective internal control system is a partial answer for detecting fraud and corruption.

Presuming a proper tone is set at the top, the foundation of detecting fraud and corruption consists of the following pillars:

1.    Effective internal control system

2.    Effective corruption prevention policy

3.    Proper anti-corruption competencies of board members, executive management, and employees

4.    Effective support functions

As we will discuss each of these pillars separately in the anti-corruption series, the following section briefly discusses their fundamental importance and impact on fraud and corruption detection.

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The Sins of Ann Twomey – HPAE of New Jersey

Do you know who Ann Twomey is, and what she is alleged to have done?  No matter how you feel about unions conceptually, and no matter what you think about the very top union representatives and their true intentions, one thing is for certain: private sector unions are made up of largely hard working, blue color American men and women, who are just trying to do their best to support their families in dignity. Steelworkers in Ohio, auto plant mechanics in Michigan, flight attendants in Illinois, or nurses in New Jersey, they are the backbone of our labor force.

That’s why corruption within a union feels so much worse than any Wall Street-manufactured Ponzi Scheme.  Somewhere deep inside we find it harder to cry for some hypothetical fat cat investor that comes to mind, even though in the reality, of course, it’s false and financial fraud often hurts the most vulnerable members of the society.

Yet there is something particularly morally repugnant about schemes and corruption associated with unions. Because, at least on paper, unions are there to serve and protect the interests of hardworking middle-class Americans -- your average Joe the neighbor next door, and Jane the single mom down the block. They faithfully pay their union membership dues and come out to support union activities because they sincerely believe that the union is there for them, and will give them if not prosperity, then at least a sense of financial security. Taking advantage of these people’s goodwill and defrauding them seems like a step out of the boundaries of “usual evil.” 

Ann Twomey is the president and a founder of Health Professionals and Allied Employees, New Jersey’s largest health care union and accused of serious wrongdoing. The actual allegations surfaced in a lawsuit filed back in 2014, with new allegations being added in 2015, but the case has resurfaced again now because of the latest round of depositions and the things one can glean from it.

Ann Twomey started HPAE and has been it’s unchallenged leader for the last 30 years. By all accounts, she turned the HPAE into a powerful regional union with her personal influence extended well beyond the Garden State. Listed at one of the 30 Most Influential Women in New Jersey Politics, Twomey’s national ambitions are absolutely transparent. She is a vice president of AFT (American Federation of Teachers), where she serves as vice chair of the AFT Nurses and Health Professionals program and policy council, a member of the AFT human rights and community relations committee; vice president of the New Jersey State AFL-CIO; co-chair of Patients First Coalition in New Jersey; a board member of New Jersey Citizen Action; Board Trustee at the American Labor Museum, and a member of the Advisory Board of the Felician College Nursing Program.

While HPAE is a union for health care professionals, it’s also used as a platform to advance issues that have little or nothing to do with health care itself. The union regularly pushes to abolish the Second Amendment and extends support to politicians promoting gun control. They played a vital role in forcing the New Jersey legislature to advance the $15/hour minimum wage. And just in these past months, HPAE has been involved in the Verizon worker’s strike, as well as the union move to bring down Atlantic City’s Trump Taj Mahal Casino.  Union dues and volunteers are being used to pursue her broader political agenda, often bringing no real benefit to the nurses and other health care professionals it’s meant to serve.

And then comes the lawsuit, Fonti v HPAE Retiree Medical Trust. The suit provides a rare opportunity to get a glimpse on the way this surprisingly secretive organization operates. It opens the veil on an organizational culture void of transparency, driven by personal ambition, and with either negligence or, as alleged in the lawsuit, by greed and personal gain.

The new charges allege that Twomey steered $1.4 million in legal fees to her boyfriend, New Jersey attorney Richard Loccke, without properly disclosing the relationship. According to the New York Post, the filing reveals that since 2006, Twomey has “awarded virtually all of the union’s legal work to her live-in boyfriend. The no-bid contracts directly benefit Twomey, who has been dating Loccke for 30 years and resides in his spacious Rutherford, NJ, home, the suit says.”

Most would agree that this is illegal under federal law and that the Department of Labor rules would require Twomey to disclose this conflict of interest. The $1.4 million in legal fees to her boyfriend was spent even though the HPAE already pays for an in-house council.

Court documents also show that HPAE is a defendant in the case, which means that union dollars are being used to defend Twomey’s alleged graft. So much for oversight, transparency, and fiduciary duties to the members.

A closer analysis of the financials available through public records paint an even grimmer picture. For the HPAE Retiree Medical Trust, according to their 2014 990 Disclosure statement. The plan’s revenue is 97.8% from plan participants and 2.2% from employer contributions. 16.7% of the expenses were plan benefit and 83.3% in administrative fees, including plan administration fees, legal and accounting with total assets of $9,970,775 for 5,800 members. These numbers beg the question will there be enough to cover the 5,800 plan members with an average of only $1,719.10 in assets available per member and all of their dependents?

Where is the oversight? Why has Twomey, been the uncontested president for 30 years, why has the union dissipated member funds by directing funds to live in boyfriend(s?), supporting unrelated causes, and giving money to other bodies unrelated to their cause? Is her top deputy and heir-apparent Jeanne Oterson compliant in all of this, and what can members expect from her leadership, given the fact that her husband, Richard Engler, has brought attention to himself by rewarding over $100,000 in sole-source contracts for outside lawyers and consultants without public notice or discussion at the U.S. Chemical Safety and Hazard Investigation Board, which he leads.

Can you imagine an investment pool that awards all legal work to relatives without disclosing the conflict of interest, gives member money to other funds, wastes member money on issues and events that are of zero benefits to the investors, and at the all the time funds management’s selfish quest for awards and adulation of public? I can, and I have, with names such as Magnus Peterson, Raj Rajaratnam, and Bernie Madoff and all end with the perp walk of shame.

L. Burke Files, President

The American Anti-Corruption Institute (AACI)

Notes: The Health Professionals and Allied Employees (HPAE)