When an anonymous e-mail reached senior executives at National Steel Corporation (NSC), its charges were explosive: an NSC executive vice president had extorted millions in kickbacks from a scrap-iron vendor, which in turn had overbilled NSC $1 million to $3 million annually for seven years.
David Highlands, NSC's internal audit director, had detected, and broken up, bribery schemes in the past but not anything of this magnitude. So he took no chances; he called a trusted external specialist with the right credentials and experience.
CFE ON THE CASE
Seconds after picking up the phone, Craig L. Greene, CFE, saw that history had repeated itself – again.
"This case broke open in 2000, but I saw my first [kickback scheme] a long time before then, and I still see them now," he said. "Time passes, but the lessons of these investigations live on. Help your clients learn them, or they'll suffer the consequences."
Greene, who's also a CPA and CFF, is an ACFE faculty member and partner in charge of financial investigative services for McGovern & Greene LLP, a forensic accounting and litigation services consulting firm with offices in Chicago, Atlanta, and Las Vegas.
"Like nearly all the bribery and corruption cases I've worked on, this one was exposed by a tip," Greene said.
During his investigation, he dug deep into NSC's business and history. He performed background checks on every party mentioned in the anonymous e-mail and searched for the characteristic red flags of kickback schemes. Examples include: exorbitant increases in vendor charges, "shell" companies established by employees or vendors, and extraordinarily rapid payments to particular vendors.
In 2000, NSC was the fourth-largest steelmaker in America, and its shares were traded on the New York Stock Exchange. As Greene knew, NKK, a massive Japanese competitor, had bought a controlling interest in NSC. And, as he would discover, therein lay one side of the fraud triangle – motivation (or financial pressure) – for the corruption inside NSC.
The trouble began when NKK leaders slashed salaries and made other changes at NSC. American tempers flared, especially among longtime employees. One of those longtime employees, James H. Squires, the executive vice president named in the tip, was born and raised in Granite City, Ill., where the second-largest NSC mill stood, just across the Mississippi River from St. Louis, Mo.
Over a 40-year NSC career, Squires had risen from the plant floor to the executive suite. He worked hard to increase not only his salary but to acquire managerial control of the Granite City operation. Greene's investigation revealed that Squires fiercely asserted his independence from the intrusive new regime – by any available means.
And that motive, coupled with opportunity and rationalization, completed the fraud triangle. Greene eventually discovered Squires had solicited massive bribes from vendors.
"I can only reason that I did this as some sort of retaliation," Belleville News-Democrat reporter Beth Gransmann quoted Squires as saying to the presiding judge when he was convicted of extortion in 2001.
SO FAR, JUST GOSSIP
When the tip came in, however, there was no immediate proof that Squires was on the take. Conclusive evidence hadn't yet been developed. And not everyone would have been optimistic about finding it.
"Some CFEs think most bribery and corruption cases are just too hard to prove," Greene said.
He pointed to two key factors that can improve an investigator's chances of finding evidence that will stand up in court.
First, Greene had found that crooked vendors often pay bribes because one or more of a client's employees demand to be paid off in exchange for giving the vendor business. You need access to the vendor's books and records to prove this, he said.
"Getting at the vendor's books can be problematic if you haven't made the right preparations," Greene said. "If the vendor won't voluntarily show them, you have to file a civil suit and get a subpoena. But the best way is to insert a 'right to audit' clause in all your vendor contracts and purchase orders." Fortunately, NSC had done so.
Second, he said, you have to follow the payoff to its recipient. Often that will be a shell company the bribe-taking employee has set up to disguise his possession of the payoffs. Greene's background checks on Squires and the vendor, Marbi Inc. of West Palm Beach, Fla., revealed that both merited further investigation.
Squires, whose salary for years had been slightly more than $100,000, lived in a $700,000 home he had bought without a mortgage. Strangely, the home was owned by a Missouri corporation in which Squires was the only shareholder. According to Greene's tax counsel, this arrangement gave Squires no apparent tax benefit. Why then, Greene wondered, had Squires chosen it? Also, Greene estimated that Squires' personal net worth was more than he likely could have accumulated by visible means.
And another issue remained unresolved – Greene could find no link between Squires and Dennery Ltd., a Bermuda-based shell company the tipster alleged Squires had set up to hold his bribe income.
Acting quickly to get at potential proof of the bribe payments, Greene had contacted Mark Koch, Marbi's owner, to schedule what he described as a "normal" vendor review. After Koch's attorney advised him to honor the right-to-audit clause, he agreed to open his books for inspection.
RED FLAGS GALORE
As he and NSC's audit director flew to Florida for the vendor audit, Greene reviewed the indications of potential fraud revealed by his background check of public records on Marbi Inc.:
• The owner had no previous experience in the steel industry.
• Most of the vendor's business (62 percent) came from NSC.
• The vendor's main office was the personal residence of the owner's mother.
• Marbi's owner was closely associated with eight other companies, seven of which seemed to be outside the steel industry.
• The vendor's suppliers and customers had filed several breach-of-contract lawsuits against it.
Greene decided to search the vendor's books during his audit because he suspected they contained valuable evidence. When he and NSC's audit director arrived at Marbi's office/home, the owner wasn't there, but his mother, Marilyn – the company's president and accountant – was.
She cooperated to the extent required by the right-to-audit clause. Marilyn presented the company's records for inspection and provided details on the company's history and her son's other career as a film producer. The vendor's financial statements revealed insubstantial assets and large disbursements to Koch, his mother, and the various companies associated with them.
According to Marilyn, the companies were involved in her son's film production business, which required frequent infusions of capital. Proudly, she spoke of several Hollywood films Koch had produced including the 1998 hit, "Lost in Space," that had taken in a record $20 million in box office receipts on its first weekend.
But Greene focused on the other side of the equation. It must take a lot of production capital to fund a film that earns tens of millions in three days, he reasoned, and that pressure, he figured, was Marbi's motive for fraud.
As the audit progressed, the investigators found a key piece of evidence: Marbi invoices indicated it was billing NSC $25 more per ton of scrap iron than it was charging other Marbi customers. Only bribery of an NSC official could ensure acceptance of terms so harmful to NSC. This confirmed one of the anonymous tip e-mailer's key allegations. But so far, the investigators had found no proof of Squires' involvement in the scheme.
'CAN I SEE ALL YOUR BOOKS?'
Greene looked deeper into Marbi's disbursement records and found large payments to a man named Craig Brennan. "Who's he?" Greene asked Marilyn. She explained that Brennan had managed the NSC account for Marbi until Koch fired him after a dispute two years before. She also said Brennan had done time in federal prison for drug-related offenses.
Greene then asked where Brennan had gone after Koch fired him. "Well, he moved to the Gulf Coast and set up a company that competes with us for NSC's business," Marilyn replied.
Greene now had a motive for Brennan, who probably had sent the anonymous e-mail to discredit Marbi, his main competitor for NSC contracts.
During their conversation, Greene's years of experience interviewing witnesses helped him develop a rapport with Marilyn. At one point, he deliberately drifted toward a topic – the movies – that he knew Marilyn would like to talk about. Then he guided the conversation back to the audit when he knew that she would be even more cooperative and relinquish specific records that weren't necessarily required by the right-to-audit clause. He told her the small sample he'd taken from her records wasn't sufficient and asked to see her canceled checks dating back a couple of years.
"Sure," she said. "They're on shelves in the garage, but you'll have to get them down yourself; I can't reach them."
Their film chat had relaxed the atmosphere, which made it possible for Greene – without deceit or duress – to get at records that could contain the case's missing evidentiary link.
Within minutes of opening the trove of older checks, he found one payable to Dennery Ltd., the entity alleged to be Squires' Bermuda shell company. The check had been paid at The Bank of Bermuda. Numerous other checks were payable to Dennery Ltd. On one, Squires' name had been written on the memo line and then crossed out, but it remained legible.
Greene took photographs of both sides of every potentially useful check and document. He believed Marilyn's voluntary presentation of the checks would make them admissible as evidence.
INTERVIEW LEADS TO CONFESSION, EVIDENCE
Greene and company didn't waste a moment. He located Brennan and called him to request an interview. Brennan agreed, and before he changed his mind the investigators promptly chartered a plane to take them to Florida's west coast.
During the interview, Brennan fully admitted paying off Squires to ensure the business for Marbi at exorbitant prices. He had heard of Greene's investigation, and was ready to confess and face charges for his role in the scheme.
Brennan said Marbi's owner would regularly make the half-hour plane trip from West Palm Beach to the Bahamas, where he maintained a bank account. He usually would withdraw $25,000 to $30,000 from the account and express mail it to Brennan at his hotel near the NSC plant in Granite City. Brennan then would personally deliver the cash bribe to Squires. Brennan said that Squires would deposit the payoffs in his offshore account, registered with a Bermuda bank under the name Dennery Ltd.
The pieces all fit for Greene. It was time to present the case to the authorities.
THE FATE OF MAJOR PLAYERS
The audit director reported his and Greene's fully documented findings to NSC. The company's audit committee, including its legal counsel, recommended to the board of directors that Squires be dismissed immediately. The board agreed and instructed the CEO to fire Squires, retain legal counsel for civil prosecution, investigate for other corruption within NSC, and report the matter to federal law enforcement.
NSC's CEO, its head of human resources, and legal counsel then met with Squires at a nearby hotel and told him about the investigation and its consequences. Squires said little. He gave them the keys to his company car and was driven home by an NSC security staff member, who also had attended the meeting.
In court, Squires cooperated with the federal prosecutor and the ongoing investigation of other vendors from whom he had extorted kickbacks. Ultimately, he served 18 months in prison and repaid NSC $5 million of the $6 million he had received illicitly.
NSC filed a civil suit against Marbi Inc. for $3.15 million in actual damages plus undetermined punitive damages. NSC won a $37 million default judgment, but neither Koch nor Marbi nor any of Koch's affiliated companies had enough cash or assets to pay it. NSC didn't pursue the matter further.
Today, according to Koch's website (www.markwkoch.com), he is chairman of Prelude Pictures, which "produces and markets morally responsible message-based family films."
The Victimized Company
In 2002, NSC filed for federal bankruptcy protection. In 2003, U.S. Steel bought what was left of it.
Recognize That for Some, Bribery Is Just a Business Tactic
Understand the psychology of those who orchestrate commercial bribery schemes, Greene said. "Most white-collar criminals aren't hardened felons. They see themselves as businessmen, and will enrich themselves however they can."
This mindset can result in behavior that might surprise inexperienced investigators, who may fail to pursue valuable leads they deem improbable. For example, Greene said, most bribe payers can't resist deducting their payoffs as a business expense on their tax returns.
"Believe it or not, they write them off as commissions or professional fees," he said. "And naturally the bribe-payer sends a 1099 to the bribe-taker, who reports the payoff as earned income."
Investigators, therefore, should be alert to the possibility of tax records containing details of bribe payments and receipts.
Improve the Odds of Going to Trial
CFEs investigating bribery schemes should be mindful that criminal prosecutors are outnumbered by the number of cases presented to them. Civil attorneys also must balance likely legal fees against anticipated recoupments.
"Some fraudsters are spendaholics," Greene said. "There may not be anything left to recover." So if expected costs equal or exceed potential benefits, your client may not want to pay for bringing a civil case to trial.
To improve the odds of reaching court, do all the preparatory work yourself and present it forcefully.
"Show the prosecutor or civil attorney you have a confession or cooperative witness," Greene said. "You'll stand a better chance [of getting the case to court]."
Use Right-to-Audit Clauses Effectively
Advise your clients to make the most of the end-of-year holidays, Greene said. Have them send each vendor a letter of thanks for helping make the year profitable. Close with a reference to the attached copy of the client's code of ethics for its vendors.
"Be sure to request that the post office return undeliverable letters to a post office box controlled by your compliance staff," Greene said. "This will weed out phony vendor addresses and prevent anyone on the inside from intercepting returned letters."
The client's letter should call attention to the code of ethics' requirement that states vendors should report to the company all potential corruption including attempts by company employees to extort kickbacks. Greene said CFEs looking for an example of an effective code of ethics for vendors should examine the code of the Dormitory Authority of the State of New York (www.dasny.org), which relies on numerous vendors to fulfill its mission.
"Putting vendors on notice works," Greene said. "In one of my cases, a kickback scheme was stopped before it started. My client had sent its vendors such a letter and its ethics code. When the client's marketing director tried to extort nearly $9,000 a month for a contract renewal, the well-informed vendor knew the client didn't condone bribery, and he reported it. Result: no bribe, no problem, bad employee gone."
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