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Unravelling Supply Chain Fraud

This article explores the threat caused by Supply Chain Fraud, how it manifests and what you can do to protect your business and customers.

Summary

Supply Chain Fraud is a threat lurking in all businesses. The process of providing goods or services, at some stage, will require interaction with a third party. Both the financial and reputational cost of fraud infiltrating your organisation’s supply chain, whether from internal or external bad actor, can be extremely damaging.

What is a Supply Chain?

A supply chain is a way to describe every step that is involved in getting a finished product or service to an end consumer or customer. For some businesses, such as those involved in the manufacturing of real goods, it involves a complex system of logistics that converts raw materials into finished products. For the services industry, it might include agents, intermediaries, resellers, distributors and partners.

Whatever your business, there will almost inevitably be some form of supply chain, sometimes, multiple supply chains, to manage.

Why are Supply Chains Vulnerable to Fraud?

The supply chain is often seen as the beating heart of business operations. The process of procurement and the supply chain serves as the gateway in and out of your business, making it one of the most at risk areas to fraud of all organisations.

Supply chains will typically have at least two parties in a contractual relationship focussed on supply and demand. That contract might be simple and short reduced to a small written contract, or the speed of demand for the supply might lead to informal agreements not committed to writing which naturally this creates exposure to the threat of those who might seek to exploit the fluidity of the arrangements to extract gains for themselves, be that financial or benefits in kind.

Supply chains might be complex affairs governed by large tender processes governed by law such as the Public Procurement Regulations or a private tender process seeing onboarding of panel suppliers through applications, audit requirements, governance agreements and / or detailed written contracts. In larger supply chains where there are greater volumes and scales of transactions they can become difficult for businesses to monitor, and greater reliance is often placed on the parties to adhere to the terms in good faith and for employees and agents to act with honesty and integrity in the performance of their duties.

The Impact of Supply Chain Fraud

The impact of supply chain fraud can be extraordinarily damaging to businesses and cause significant financial losses, reputational damage and potentially unwanted litigation. In addition to this there would likely be operational disruptions for the companies involved, even if they are not directly linked to the victim company.

What Fraud Threats are Supply Chains Open to?

There are many ways in which a supply chain can be under threat from fraud. Some of the most common are:

  1. Invoice Fraud: This is where fake invoices are generated, or legitimate invoices are altered to overcharge for goods or services, or to divert funds for seemingly genuine goods/services into a fraudster’s account. This is an area of risk typically associated with cybercrime.
  2. Product Substitution: This is when there is substitution of products used in the supply chain for inferior or counterfeit materials. These are often of poor quality and can lead to the overall product being defective causing quality control issues and customer dissatisfaction.
  3. Kickbacks and Bribery: This occurs when individuals within the supply chain accept bribes or kickbacks from suppliers in exchange for favouring their products or services, often at the expense of the victim company’s best interests. Company’s should also be aware of the Bribery Act 2010 [1] which (amongst other offences) states that a commercial organisation can be guilty of an offence if they fail to prevent persons associated with it from bribing.
  4. Data Manipulation: Fraudsters may manipulate supply chain data, such as inventory levels, production figures, or sales data, to mislead stakeholders and create false financial statements. An example of this is the Patisserie Valerie scandal [2].
  5. Ghost Employees and Vendors: This is where fraudster create fictitious employees or vendors to issue fraudulent payments and divert funds.
  6. Collusion and collaboration: This is where multiple employees conspire together to bypass and/or override certain business protocols and transactions to undertake fraud. This can often include external third parties.
  7. Sanctions violations: There are occasions where economic sanctions are put in place that restrict the flow of assets to or from certain countries. By importing goods from these countries businesses may be placed breach of these sanctions which can cause significant reputational damage (as well as monetary). There are many ways in which sanctions can be violated and this often takes the form of disguising where goods have come from. Examples of this are deliberately disabling a ship’s tracking system or setting up a complex and confusing network of companies to avoid detection.
  8. Contract and Misrepresentation Fraud: This is where there is a misrepresentation in terms of pricing, ability to deliver a project based on experience or resource, or other aspects of the supply chain contract which can lead to losses for one of the contracting parties.

What Fraud Threats are Supply Chains Open to?

To reduce the risk of supply chain fraud, businesses must implement robust risk management strategies, conduct thorough due diligence on suppliers, and establish processes for monitoring and securing the supply chain. By building a resilient and transparent supply chain, organisations can minimise vulnerabilities that often lead to fraudulent activities. In cases where procurement or supply chain fraud is detected, conducting an investigation is necessary to determine the extent of the concerns and understand the circumstances surrounding the incident.

If you require assistance in assessing the risk of fraud in your supply chain or need guidance on recovering from losses and terminating supplier relationships, we are here to help.

Please get in touch at hello@tenetlaw.co.uk

Authors Liane Atcheson

[1] https://www.legislation.gov.uk/ukpga/2010/23/contents

[2] https://www.bbc.co.uk/news/business-48736447

Published on December 4, 2023

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