Daily Archives: July 2, 2008

Some Examples of Supply Chain Fraud

Today’s guest post is courtesy of Norman Katz, Certified Fraud Examiner, of Katzscan, Inc. and maintainer of the Supply Chain Fraud website as well as the Supply Chain Sarbanes-Oxley website. Both of these supply chain sites are worth checking out. After all, you don’t want to join Fox in SOX!

In accepting the holistic view that the supply chain extends beyond the walls of the company, can encompass raw materials, finished goods, monies, and services, and can be in fact more internal than external, the types of supply chain frauds become more numerous and in some cases, more severe.

One of the most glaring examples of supply chain fraud is the tainted product scandals that have surfaced over the past year. However, not all of the problems were associated with lead-tainted paint; some product recalls of toys were due to small parts breaking loose that a child could put in their mouth and choke on. If the toy was not being designed overseas, but just manufactured overseas, than the toy designer should be faulted for a poor – if not dangerous – design. Was the overseas manufacturer given any guidelines in regards to stress tests to gauge whether a child could pull off a small piece?

In this example, the fraud itself would have started with a poor design and would have occurred early in product lifecycle management (PLM). Was there a quality assurance (QA) review during PLM to cover aspects such as this? Was there QA testing of prototypes and products after go-live production to ensure quality standards – if established in the beginning – were being adhered to?

Similarly, in terms of the tainted food products, what tests were performed by the product company to ensure the manufacturer was adhering to standards and not introducing unsafe ingredients? This is especially true in the pet food scandal, were an unsafe ingredient was added by the overseas raw material supplier and/or overseas manufacturer to (artificially) boost protein levels during product testing. Why was there no testing for foreign substances?

In the above examples, if the QA department’s ability to function as needed was reduced due to unnecessary or unwise cost cutting by executives, especially if the goal was to increase executive bonuses or inflate stock prices by reducing costs, the executives themselves can be considered the perpetrators of the fraud and may be civilly and/or criminally liable for the results.

In another case that was caught before the supply chain fraud occurred, a military contractor was prevented from outsourcing the manufacturing of night vision goggles to a company in China. The US military is quite particular about who can manufacture their technologically advanced equipment, and rightfully so! The reason the company executives stated they were looking to outsource the production was greed, pure and simple: they wanted to lower costs to gain more profits, and were willing to do so at the real risk of giving away US military secrets to a country known for producing pirated software, videos, music, and merchandise imitations!

Internal thefts of raw materials and finished goods are an obvious supply chain fraud. How about when machinery and equipment are not maintained according to schedule, even though the maintenance supervisor swears they are? Abuse of equipment is most certainly a type of fraud, but when the abused equipment produces less-than-first-quality finished goods, the fraud has now become more widespread. Further, if the less-than-first-quality finished goods can cause injury or death, then the impact of the fraud just became much more serious.

Internal thefts can also include monies when fraud happens in the account department. Also, a person with the right authority may be able to set up a fraudulent services-only vendor for the purposes of stealing money via the submission of fake invoices paid to a fictional vendor who is really the fraud perpetrator themselves.

Thanks, Norman!

For more examples of where fraud can occur in the supply chain, check out the new Supply Chain Fraud wiki-paper over on the e-Sourcing Wiki.