Riverbend Marine Service Auction

Tuesday, November 22, 2011

The Importance of Due Diligence

By James S. Peet, Ph.D., CFE

The transportation world is afloat in fraud, and that includes the maritime sector. While most in the shipping industry are aware of the grander fraud schemes, such as phantom ships (a result of piracy), scuttling of vessels for insurance purposes, documentary fraud, cargo theft, and fraud related to chartering vessels, one area that affects almost all firms, and is seldom proactively addressed, is occupational fraud – theft of company property by those entrusted to it. A good example of this is the recent case of a Hudd/MDSI billing clerk in Sumner, Washington, who defrauded the company of more than $260,000 over a three-year period.

The billing clerk was able to commit fraud by submitting false check requests to the company’s accounting department, and having the checks sent to her for distribution, or to vendors who thought they had been overpaid and returned the checks to the billing clerk. Her fraud led to the company having to cancel the annual employee bonuses.

Could this fraud have been prevented? With due diligence and proper internal controls, the answer is most likely ‘yes.’

In occupational fraud there exists a concept known as the fraud triangle, where the three legs of motivation, rationalization, and opportunity exist to perpetuate fraudulent activity. In the clerk’s case, the motivation was a drug and gambling problem, a financial need she couldn’t quite share with her co-workers. The rationalization was probably something akin to “they don’t pay me enough” or “I need it more than the company does” or “they won’t really miss it, since they’re a big enough company.” The opportunity came in the form of having the ability to get the accounting department to send checks to her, or to convince vendors to return overpayments to her.

According to the Association of Certified Fraud Examiner’s 2010 Report to the Nation (www.acfe.com), more than 80 percent of occupational fraud was committed by individuals in six departments: accounting, operations, sales, executive/upper management, customer service, and purchasing. Employee fraud, such as the billing clerk’s activities, usually lasts for about 13 months before being uncovered, with the average loss being $80,000.

Any company that hires employees who handle cash, checks, or who has access to such (which is every business entity known), should develop a fraud prevention program to deter and detect fraud. Had a strong program been in place at Hudd/MDSI then the company would not have lost so much money, nor would it have been detected so late.

In personnel matters, due diligence is the process of investigating and evaluating a person to ensure he is who he says he is. It differs from a standard background check in that more resources are used and much more information is gathered to ensure the best possible decision is made. Due diligence looks at past employment, references, education, criminal and civil actions, and current lifestyle, to list just a few of the things reviewed. A basic background check might verify past employment and check for a criminal record, along with a drug test, but that may be all that’s done.

One should also have a process in place, as part of a fraud prevention policy, to allow continued due diligence for current employees in positions of financial authority, such as CEOs, CFOs, accountants, and billing clerks. This could be as minor as annual credit checks and drug testing, or could go so far as to ensure these employees are not exhibiting some classic fraud red flags, such as living beyond their means.

Had Hudd/MDSI bonded the billing clerk with a fidelity bond, the employees would probably not have missed out on their annual bonus and salary increases. A fidelity bond, also known as an Employee Dishonesty Bond is one that provides coverage for dishonest and fraudulent acts of employees that may take place while handling your company’s money or securities. Obtaining a fidelity bond requires conducting due diligence on those employees to be covered. As with the due diligence, employees to be covered should include CEOs, CFO, accountants, and anyone else entrusted with the company’s money or securities. In some cases, it might be best to conduct due diligence prior to seeking a fidelity bond on a current employee, because if the employee is already committing fraud, their prior actions will most likely not be covered by a future fidelity bond.

A fraud hotline should also have been in place, with all employees and vendors aware of its existence and having information on how and why to call. It’s probable that the billing clerk showed many of the classic red flags of fraud, particularly living beyond her means. Had her fellow employees been made aware of these red flags and had a clear way to report the issue anonymously, it’s doubtful that the crime would have lasted three years.

While establishing and maintaining these controls may appear daunting, particularly for smaller shipping firms, consider the alternative. According to the ACFE’s 2010 Report to the Nation, while the median loss for all companies is $231,000, most small companies (those with fewer than 100 employees) hit with fraud usually suffer losses of $155,000. This size loss can be the difference between being successful or going out of business for most small companies. One case I investigated cost the company $250,000 out of a $6 million contract they had– that’s a four percent loss!

James Peet, a Certified Fraud Examiner (CFE), is the principle manager of Peet & Associates, LLC, a fraud examination business located just outside Enumclaw, Washington. He is a graduate of two law enforcement academies and has earned a BA at the University of Miami, an MA from California State University, Hayward and the Global Trade, Transportation, and Logistics Certificate, as well as a Ph.D. from the University of Washington.

Container Volume Falls at Port of Long Beach

The 2011-2012 fiscal year has gotten off to a shaky start for the Port of Long Beach, with the port recording an over 20 percent drop in the number of cargo containers moving through it in October 2011 compared with the same month in 2010.

Last month, a total of 240,248 loaded containers came into the port, a 20.8 percent drop from the 303,000 that entered in October 2010, according to newly released data. Also, about 118,300 loaded outbound containers moved through the port, a drop of about 21 percent from the about 150,500 that Long Beach handled in the same month the year prior.

The number of empty incoming and outgoing containers was also down, falling to 487,665 last month from 613,621 in October 2010, a decline of 19.3 percent.

The across-the-board drop amounted to a total negative change in TEU traffic of 20.5 percent.

The drop is being blamed in part by the scaling back by smaller carriers that called at the port. So far in 2011, five shipping lines operating vessels with about 3,000-TEU capacity have discontinued trans-Pacific service from China to the Long Beach due to weakened US imports.

During the first 10 months of the calendar year, Long Beach saw a 1.7 percent decline in total TEUs. By contrast, the adjoining Port of Los Angeles saw a slight rise in traffic during the first 10 months of the year.

The number of TEUs moving through L.A. rose by 44,653 containers – or 0.6 percent – from January through October. This includes a small bump in container traffic last month, a 4.4 percent rise to 712,586 TEUs, compared to October 2010’s 682,384.

When last month’s numbers at the two ports are combined, the port complex as a whole suffered a seven percent drop in imports in October, but a four percent increase in exports, mainly due to the Port of Los Angeles recording a 28 percent increase in loaded outbound cargo containers in October over the same month last year.

Imports also rose at L.A. last month, increasing by five percent compared with October 2010.

Container Traffic Rises Slightly at Tacoma

Continuing what’s been a mostly up calendar year for traffic, the Port of Tacoma saw a more than three percent increase in container volume in October compared with the same month in 2010.

According to newly released figures, the port moved a total of 123,623 TEUs in October, up from 119,600 during the same month last year, a 3.3 percent increase. It marks the seventh month out of 10 with an increase in traffic over the corresponding month the year prior.

Also, despite a more than three percent decrease in domestic container shipping recorded during the first 10 months of the year, the total number of TEUs moving through the port rose just over two percent during the time period, thanks for an increase of about five percent in foreign container movement.

Tacoma saw 1.23 million total containers during the first 10 months of the calendar year, a 2.1 percent rise from the 1.20 million containers of January to October 2010.

Of the amount, over 836,000 were foreign inbound and outbound TEUS, a 4.9 percent increase from the same 10 months last year.

However, the number of domestic containers – coming and going from Alaska and Hawaii – was down 3.3 percent, to 394,500 from 408,000.

Port of Oakland Planning Trade & Logistics Center

The city and Port of Oakland have applied for a $40 million US Department of Transportation grant to help pay for the planned conversion of a former waterfront Army base into a trade and logistics center.

The port says the grant would supplement local, state and private investment to aid the launch the $438 million first phase of the redevelopment of the former Oakland Army Base, which closed in September 1999, 58 years after it was first commissioned.

“The project is competitive because it is intermodal – with rail, port, and road components; focused on exports through one of the nation’s top five trade gateways,” Port of Oakland Executive Director Omar Benjamin said. “(It) will help us create thousands of jobs in one of the most impacted regions in our country.”

The redevelopment would include construction of a new rail terminal on 40 acres of port property to enhance ship-to-rail connections and reduce truck traffic and emissions on local roads; and construction of new trade and logistics facilities for warehousing directly within the port.

The plans also include restoration of Oakland’s sole deepwater break-bulk terminal to increase exports; and infrastructure improvements, such as street and road enhancements.

Port of Oakland Commission President Pamela Calloway said the strategic initiative is “critical” to the port’s future.

“This project is one way we are going to reach our job creation goals while making sure the port is an engine for inclusive economic development,” she remarked.

California’s Lt. Gov. Talks Jobs at Port of San Diego

Maritime jobs represent a “growth area” for California, the state’s lieutenant governor, Gavin Newsom, told an assemblage during a Nov. 18 meeting at the Port of San Diego.

During the conference with about a dozen executives, including Board of Port Commissioners Chair Scott Peters and Port District President Wayne Darbeau, Newsom said that ports in the US, particularly those on the West Coast, deserve infrastructure funding to improve both import and export business and thus produce good-paying jobs.

He also said China’s heavy investment in its maritime business sector is something that it learned from the US, and that it’s an approach that America needs to get back to.

“We’re envious of China because that used to be us,” he remarked. “They've figured out our secret sauce.”

Newsom was in town to address a San Diego Regional Chamber of Commerce luncheon. His topic was jobs and economic growth in California.