Two more awards today.

UK (Private sector): The UK Water Industry

Not spending enough money (and failed regulation…)

There were a number of long-running procurement-related scandals which continued to rumble on this year, notably the investigations into the Grenfell tower disaster, and the Horizon Post Office scandal.  Both showed appalling behaviour from various suppliers along with failures on the buy-side. Procurement weakness allowed supplier failings to translate into tragic consequences for those affected by the Grenfell fire and those who lost their livelihoods or wrongly went to prison in the case of the Fujitsu / Post Office Horizon IT system. The judges were also tempted to look into the causes behind the global shortage of chips (electronic, not potato), which affected supply of all sorts of items. But they decided that was all a bit too complicated …

So the multiple winners here are the private water and sewage companies. Research by the Financial Times showed that they slashed investment in critical infrastructure by up to a fifth in the 30 years since they were privatised.  That reduction in spending came about despite bills going up 31% in real terms – and some £372 billion has been paid out in dividend payments to parent companies and investors. In 2019, only 16 per cent of England’s rivers and seas met the minimum “good or better” ecological status as defined by the EU’s water framework directive. And 2021 saw reports of raw sewage being regularly discharged straight into rivers and the sea whenever it rained hard. My friends who swim in the Thames thought it was algae coating their skin after their river swimming this autumn … 

Of course, this is a regulated industry so we might call it a joint public / private sector award as the government must share the blame for inadequate regulation and what is in effect a market failure. But this is a case where the “bad buying” failure is in not spending enough (rather than overspending). So we will hold our proverbial noses whilst awarding the water industry the Bad Buying UK (Private Sector) Award.

…….

UK (Public sector): Covid Test and Trace Programme

Incompetence in Managing Consultants

The judging panel had a difficult task in this category, with continued overspend on HS2 (and every other rail project), and more revelations about PPE expenditure. Social care is experiencing a sort of market failure, whilst the MOD Ajax armoured vehicles programme was particularly unfortunate not to win the prize given the various elements of that particular fiasco. And the panel argued long and hard about whether the crazy regulatory structure of the energy market which ended up with dozens of firms going bust might count as “bad buying”.

But ultimately, for a clear waste of money through inappropriate procurement and even worse ongoing contract management, the UK pandemic Test and Trace programme was finally declared the narrow winner.  

The programme kicked off during the first wave of Covid in early 2021, and we could understand why initially consulting resource was needed to make things happen quickly. But for 18 months now, various officials in the Department of Health and Social Care (DHSC) have promised that the number and cost of consultants was going to be dramatically reduced. But nothing appears to have happened, as hundreds of millions have been spent with the big consulting firms.

David Williams, then the DHSC second permanent secretary, assured Parliament’s Public Accounts Committee back in January that there was a plan in place to “reduce markedly” the number of consultants from Deloitte who were working on the programme. (Williams has since become permanent secretary at the Ministry of Defence – that bodes well for sorting out waste in that area!)  But at the time he claimed there were “around 900” staff from the consultancy working on Test and Trace, who he expected were costing £1,000 a day each – meaning the daily total was close to £1 million just for one firm.  Some Deloitte staff were charged at a rate of over £6 a day too.

Dr Jenny Harries, chief executive of the UKHSA which now runs NHS Test and Trace, said in July 2021 that there was a ‘very detailed ramp-down plan’ to reduce the number of contractors. But 1,230 consultants were still employed at the end of October, figures showed. At the sort of rates paid, that was still costing over £1.3 million A DAY.

This is not “consulting” in the true sense of the word. It is “warm reasonably intelligent bodies sitting at desks / at home on their laptops”. It is staff substitution, not consulting, and those people should not be costing £1000+ a day.

DHSC has had 18 months to actually recruit people on fixed term contracts at maybe £50K a year to replace the £250K a year consultants.  The profit for Deloitte partners (and indeed those of other firms who have been involved on the programme) is enormous, all based on undeserved income from the public purse. And it is not even as if the programme has been a great success … but let’s not get into that.

Despite the tough competition we are confident that this case is a worthy winner as it represents a basic old-fashioned lack of concern for spending public money with consultants – something that is far too common, unfortunately.  So the Test and Trace programme wins the Bad Buying UK (Public Sector) Award.

Look out for the final two awards tomorrow!

Welcome everyone and yes, it is time for the inaugural Bad Buying Award Ceremony – virtual of course.  Over the next three days we will announce the six winners of these prestigious awards, given to those who have demonstrated truly Bad Buying.

Our definition of Bad Buying incorporates a number of different but linked topics. Obviously, it includes failure in procurement (poor performance on the buying side of the table). It can also relate to a contract that goes badly wrong because of supplier performance, failure or fraud that is not properly managed or mitigated by the buyer, client or customer. Or it can be a more general fraud linked to the procurement process, such as fake invoice scams or corrupt collusion between buyers and sellers.

So today, we will start with our two international awards.  

International (Private Sector): Kraft Heinz

Awarded for Creative Use of Supplier Contracts

Food giant Kraft Heinz (KH) was charged by the US Securities and Exchange Commission (SEC) with mis-stating its accounts following the merger of Kraft and Heinz in 2015. The firms said the deal would deliver cost savings of $1.5bn a year, and procurement savings-related targets were set for staff. But after 2017, savings proved hard to find,  As the SEC said, management “pushed procurement division employees to come up with ideas to generate additional immediate, same-year savings”.

The dodgy accounting practices were then based around manipulation of supplier-related payments. For instance, buyers negotiated “prebates” (!!) – a sugar supplier gave KH $2 million up front in return for a 3-year contract, with the agreement that the money would be recovered by the supplier through the contract. Or  suppliers might reduce prices in the short term in return for a longer-term increase. These schemes when recorded as current-year “savings” and added immediate profit, rather than being accounted for properly.

Kraft Heinz had to restate its accounts, correcting a total of $208m in wrongly-recognised cost savings. The CPO, Klaus Hoffman and the COO Eduardo Pelleissone were accused of violating anti-fraud provisions, failure to provide accurate information to accountants and violating accounting controls.

Without admitting or denying the allegations, in September Pelleissone agreed to pay a civil penalty of $300,000.  Rather than addressing risks after being made aware of issues, “he pressured the procurement division to deliver unrealistic savings targets”. Hofmann agreed to pay $100,000 and was barred from serving as director or officer of a public company for five years. KH agreed to a penalty of $62m, also without admitting or denying the findings.

This was a very interesting and unusual case, which demonstrated approaches that the judging panel had not previously seen in their many years of procurement service. Given that creative application of supplier negotiation and contractual mechanisms, this was a very worthy winner of the Bad Buying International (Private Sector) Award.

………

International (Public sector): Balfour Beatty Plc

Awarded for Over-invoicing of US Defence Clients

In December 2021, the US housing management subsidiary of UK engineering and services firm Balfour Beatty agreed to pay fines and restitution of $65 million after admitting over-charging US defence clients for some years. Under the terms of the plea agreement, Balfour Beatty Communities agreed to make the payment  after a federal investigation into its scheme to claim performance bonuses by submitting false information to various clients. 

The issues came to light when living conditions at US Air Force bases were found to be unsatisfactory. The company’s homes did not meet fire safety codes and had mould, rodents, pests, radon gas, and other defects. An investigation then found that the firm maintained two sets of maintenance records at some bases. One included the issues of mould, asbestos, and leaks that were not promptly fixed, whilst the other showed fake quick repairs that allowed the company to claim contractual bonuses from the Pentagon.  As always in these cases, the company blamed a few rogue individuals who have presumably now left.  It also appears that the firm is still engaged on the contract which seems a little surprising.

In cases like this, it is arguably not so much “bad buying” as a “bad supplier”. However, where the issue runs for some time, it usually indicates a failure of contract management, as well as bad behaviour by the supplier. At least the client did eventually identify the issue and take action – but it is an interesting case study in supplier behaviour, and on that basis, Balfour Beatty and its affected clients win the Bad Buying International (Public Sector) Award.

Two more prize winners tomorrow!

I presented last week as part of an event run by CIPFA –  the Chartered Institute of Public Finance and Accountancy. As you can imagine, their live events are notorious for wild behaviour and partying, but this was online, luckily for me. (OK, just my little public sector accountancy joke there…) Anyway, I talked about Bad Buying, particularly in the public sector context and with a focus on corruption and fraud which I thought would most interest accountants.

One of the other speakers, Mohamed Hans, a lawyer and public procurement adviser, talked about the “typical” profile of a corporate fraudster. Most work within the organisation, and apparently, he – and more often than not it is a “he” – is most likely to be middle aged, with quite a few years of service, well-respected internally, and in a management position.

I guess that all makes sense. You need to have some authority generally to commit fraud – in the procurement space, it really helps if you are a budget holder or can sign off expenditure in some way. If you have been around a while in the organisation, you are more likely to understand the systems and processes, and how to get around them to commit your fraud. All of that points to someone of a certain age, seniority and length of service.

That fits with my personal experience. Probably the closest I came to a major case was when a senior procurement executive who had a “dotted” reporting line to me was prosecuted for a fraud where he appeared to be in league with some very unpleasant “Russian gangsters”, according to the police. My firm was not aware of the fraud but the police spotted odd transactions at the gangster end of things, which it emerged came from our villain signing invoices for non-existent furniture purchases, with the payments going to the gangsters. He was in his forties, in a senior role, and had been with the firm for at least a decade, so he fit that archetype perfectly!

Other cases in my Bad Buying book include a mid-level executive for Toys ‘R ‘ Us at Maidenhead in England. He was a  “typical middle-aged accountant to colleagues, living in a semi-detached house near Reading and driving an old Vauxhall car. But actually he lived a double life and was stealing millions from the firm, spending money on sports cars, prostitutes and even an estate in Nigeria for his secret mistresses! He was ordered to repay £3.6 million when he was finally caught, as well as being jailed in 2010 for seven years. (His jail term will increase if he doesn’t pay the money back.)

His fraud was simple. He created a fictitious toy manufacturer, a ‘supplier’ to the firm, and then made regular payments of £300,000 a month over more than two years to that account, which of course he controlled. When this was reported in the press, one reader’s comment was amusing: ‘so he spent £2.4 million on call girls and sports cars – and wasted the rest’!  But it’s not really funny; this was shareholders’ money, and sympathy is due to his wife and family, who knew nothing about it and did not benefit in any way”.

Just to show it isn’t only men, the (female) interim director of operations at Ealing Hospital NHS Trust stole more than £200K back in 2008 to pay for (among other things) horse semen, needed for her stud-farm business. She fraudulently signed off payments, which went into her own bank accounts rather than to genuine suppliers. The judge said that she was, ‘a woman of very great ability and up to this point of very high character. The difficulty and sadness of cases such as this is only people of high ability could get themselves in a position where they can defraud people and the NHS of the amount of money you took.’

However, in most cases, fraud can be prevented quite simply. The most basic advice includes that no single person should be able to “create” a new supplier, and onboarding checks must be made. Then again, no one individual should be able to authorise a payment (e.g. by signing off an invoice) to any supplier, without some sort of check from another person.  It is not unknown for two or more people to collude in frauds, but in my experience establishing that sort of basic control reduces the probability of fraud by a significant factor. Carrying out a fraud alone is one thing; asking another person to collude with you brings another level of risk for the fraudster.

And don’t assume someone couldn’t possibly be a fraudster because they are respected, have worked in the organisation for years, are senior, go to church, are kind to animals …. Criminals come in all sorts of shapes, sizes and disguises!

There was a cri de coeur from Matthew Parris in  today’s Times newspaper (behind the paywall). He was concerned about the British public’s expectations that the government could sort out all and any of our problems. As he put it;

“Even we lucky British will sometimes encounter shortages and gluts. Is it now the government’s business to smooth them out for us? Increasingly, that is the assumption”.

We’ve seen in recent weeks issues with supply of food to supermarkets (although I can’t say I have noticed much of a problem), stories that Nando’s were short of chicken, then we’ve had genuine shortages of carbon dioxide and a petrol “crisis” caused mainly by politicians telling us there wasn’t a crisis. Parris sees this expectation that the government should solve every problem as a slide leftwards politically. He is a believer in the free market, which is why he originally became a Conservative supporter and MP, and thinks the government should stand back more often.

I believed in the free market, in Adam Smith’s Invisible Hand, and the quiet, patient but unstoppable power of price in regulating demand and stimulating supply. I believed that if you’re short of applicants for a job you raise the wage. I laughed at government attempts to control prices as a way of keeping down inflation. I knew you couldn’t buck the market”.

I also share his fondness for free markets. However, the problem is that very few markets are truly “free” in the theoretical sense and certainly few function perfectly. Indeed, that is something most procurement people understand from their own bitter experience. For instance, a perfect free market is open to new entrants, and indeed it is easy for existing players to withdraw. It is unregulated except perhaps for fundamental criminal laws (don’t poison people with your beer or sell cars with no brakes).

But for a number of reasons, it feels like fewer and fewer markets really are anywhere near perfect or free. Take the shortage of lorry drivers – something that is hitting the UK particularly badly, but is an issue elsewhere in Europe too. (It does appear however that Brexit is a contributing factor in the UK, according to the industry expert view).

In a truly free market, thousands of people would be rushing to change jobs to earn the £50K per year plus now on offer for driving trucks. But we insist that new drivers (not unreasonably, I should say) go through extensive testing. That is a time and cost related barrier to entry. We have restricted free movement of people into the UK post Brexit, closing another “free market” option.

In other areas, the government has attempted to create dynamic new markets, but it is not as easy as it seems. Take the domestic energy market. We have seen plenty of new market entrants, but with increasing regulation and price control from the government, it has moved far away from the vision of a truly free market. That whole market is now unwinding and collapsing with the increase in wholesale gas prices. (There is also what feels like an increasing tendency for con artists and scammers to get involved in these quasi-markets – maybe that is a topic for another day, but it feels like the UK is becoming steadily more susceptible to business-related fraud and corruption).

And during the pandemic, the government “interference” in how markets operate was even more extensive. The government stopped tests for new lorry drivers because of social distancing rules, for instance. We might understand why that was the case, but it has been a contributing factor towards the current shortage.

Indeed, coming back to Parris and his complaint, the government has “interfered” so much in our lives during the pandemic, I think increasingly people do feel that the government can and should sort out every problem.  Those in charge told us where we could go for a walk and who we could visit, so why not expect that they can guarantee my Nando’s will be available and make sure there are enough lorry drivers to go round? That might not be an appropriate view, but I suspect it is quite prevalent.

What does all this mean for procurement professionals? Aside from many now operating in fire-fighting mode, simply focusing on securing immediate supply into their own organisations, it points out the importance of truly understanding how your own key supply markets work. Are they genuinely free markets that respond quickly to changes in demand, with new entrants, innovation and dynamism? Or are they controlled or restricted in some way – by government or by other barriers to entry (it wasn’t regulation that led to Facebook’s domination of its market, for instance).  

The pandemic shock has highlighted vulnerabilities in supply chains and exposed markets that already had inherent issues and weaknesses. So to avoid “bad buying”, understanding how your key markets really operate must be a priority.

(Two posts in a row about blood – that’s a bit weird)!

Earlier this month, Elizabeth Holmes went on trial in San Jose, California, accused of six counts of fraud.  That relates to the blood-testing firm she founded and ran, Theranos, which was claimed to use unique technology to perform a range of tests with just a small sample of blood. The claims were later revealed to be largely nonsense and in some cases the results might even have proved misleading or dangerous to the user. When one of the Theranos laboratories was inspected in Newark, California, in November 2015, the inspectors concluded that “the deficient practices of the laboratory pose immediate jeopardy to patient health and safety.”

The cautionary tale has been turned into a best-selling, award-winning and definitive book, Bad Blood by John Carreyrou and is going to be the subject of a film with Jennifer Lawrence playing Holmes.  But in real life, it seems that her defence during the trial may claim she was under the influence of her older and more experienced business partner and one-time boyfriend, Ramesh Balwani.  They may also claim that she really did believe in the product and it was others within the firm who misled her about the actual way it worked (or didn’t).

Although some experts warned from the early days of Theranos that there were questions to be answered about the product, Theranos raised hundreds of millions in investment from famous people such as Henry Kissinger and Rupert Murdoch.  Perhaps they were dazzled by this confident, smart young blonde woman, who seemed to be particularly effective at persuading older men to stump up large investments!

But as well as the investment aspect to the story, there was also a Bad Buying link to the events. Here is how I described it in my book (“Bad Buying – How organizations waste billions through failure, fraud and f*ck-ups)”.

“Buying failure comes into this because the pharmacy chain Walgreens spent $140 million with Theranos over seven years, hosting around forty blood-testing centres in their stores. They got very little benefit from that and recovered some $30 million after a lawsuit and settlement following the eventual disclosure of the issues. Amazingly, as Bad Blood reports, Walgreens’s own laboratory consultant, Kevin Hunter, had seen early on that something wasn’t right with Theranos. But the executive in charge of the programme at Walgreens said that the firm should pursue the pilot because of the risk that CVS, their big competitor, would beat them to a Theranos deal.

Again, buyers wanted to believe that something was real, even in the face of mounting evidence that it wasn’t. This relates back to comments around believing the supplier– those earlier examples weren’t demonstrating fraudulent behaviour, but the principle is similar. It is easy for a naive or gullible buyer to be sucked into believing what the supplier wants them to believe.

Suppliers will take advantage of this tendency – whether it is the relatively innocent ‘Yes, we can install this new IT system in six months’ or the more dangerous ‘This equipment will find hidden bombs’. And FOMO – the fear of missing out to the competition – is something else suppliers will use, and that can lead to bad decisions. It’s not just physical goods, either. The top consulting firm selling its latest ‘strategy toolkit’ will mention that the potential client’s biggest rival is also very interested”.

So the message is – treat claims made by suppliers about their products with caution, maybe even with a touch of cynicism if they seem unique, outlandish or truly earth-shattering! And don’t let FOMO take you into the realms of Bad Buying.

Conflicts of interest as a ethical topic has always been relevant in procurement, both public and private sector. Here is a quick quote from my book, Bad Buying.

At a local level, I’ve worked with organisations whose top management didn’t even want to put in place a clear “conflict of interest” policy. That would mean staff having to disclose any interest they (or close family / friends) have in another business that might be a supplier or a customer of the organisation for which they work. But there’s usually a reason for that hesitancy.  Where you see organisations that won’t support anti-corruption activities, then you might draw obvious conclusions”.

Conflict of interest is a key issue within the fight against procurement-related fraud and corruption. We want buyers and everyone involved in the process to select suppliers, negotiate and manage contracts without being biased because they have an external interest that affects their behaviour.

We’ve seen these issues come up a number of times over the last 18 months through the pandemic with spend on products such as PPE (personal protective equipment) being in the public eye. So some recipients of huge contracts for PPE have had links with politicians and other powerful people, which has led to suggestions that decisions were impacted by these conflicts of interest.

The standard approach when developing procurement policies and practices is to ask those involved in the process to declare any potential conflicts upfront. Somebody can then decide if that is significant, and if so, how to handle that. At the extreme, I’d suggest it might eliminate a potential supplier from consideration completely. That doesn’t happen often, but appointing a small consulting firm to do a procurement review when that firm is run by the Procurement Director’s wife might not be a good idea.

But more frequently, it is a case of making sure the person with the conflict does not play a central role in key stages of the process, such as selecting the supplier or negotiating the contract. Suppose a senior executive who has an interest in the service being purchased discloses that their sister is a senior manager in one of the bidding firms. I would not expect that firm to be disqualified, but the executive should not be involved in the key aspects of the procurement. There are potential issues of confidentiality as well as bias of course – so if the exec is going to have access to confidential information, then they need to understand that any breach will lead to disciplinary action! Or you may simply choose to keep such information away from them.

There are questions however about how far we can and should go. That came to mind with the revelations around Mathew Hancock, the UK Health Minister who resigned because he broke covid rules with his ”friend”. But another part of that report claimed that his friend’s brother runs a firm that has won NHS contracts.

Is that a worry?  If your friend’s brother is bidding for a contract with your organisation, do you need to declare that as a potential conflict of interest?  That probably depends on just how close the “friend” is. If they are in effect a partner (legally or secretly) then it probably should be declared. But frankly, I would very rarely have known what any of my friends’ siblings did for a living!  So we have to be reasonable in terms of how meaningful the risk is.

A similar argument applies to shareholdings. Most of us hold shares indirectly through pension schemes or investment funds and we may well have direct holdings too. We can’t be expected to know exactly where “our” money is invested in every case. But what about if I have just a couple of hundred pounds worth of shares held directly in a potential supplier? I’d suggest that it is sensible to declare that, but I would not necessary exclude someone from the process for that level of “conflict”. However, if it were several thousand pounds worth, or if we were considering share options in a start-up that could prove valuable one day, the position might be different.

These are tricky issues.  The key is to impress on everyone that if they are in any doubt, it is better to declare the potential conflict and let others decide how serious it is. That is much better than having to plead later on that “I didn’t realise it mattered”. 

And if you want to hear more about this and related topics, I’m speaking as part of a CIPS (Chartered Institute of Procurement and Supply) webinar on July 13th, 2021, at 12.30 pm. It is all about ethics and is titled “50 shades of Procurement – an Ethical Perspective”.  It should be interesting – and it is open to CIPS members AND non-members, so anyone can book here.

(The picture shows my cycling friends enjoying an outing with me last year – no contracts were awarded!)

Have you seen the price of compost this spring? I reckon it has close to doubled – three large bags from Longacres garden centre last year cost £10 (for 180 litres). Now, you will get just 100L for the same price.

Talk to a local builder, or gardener, or fencing expert, and they will tell you of shortages in markets such as timber, cement and other basic but vital materials. In another market altogether, farmers are complaining about a lack of workers to harvest crops, and restaurants of a lack of waiting and kitchen staff. Some are having to increase wages or other benefits to attract staff.

Without going into all the causes (Brexit, pandemic, lockdown-influenced career decisions), there is one very likely outcome here – inflation. There are already some warning signs, and consumer prices in the US jumped 4.2% in the 12 months through to April, up from 2.6% in March and marking the biggest increase since September 2008.  That seemed to take inflation from warning mode into “this is actually happening”.  But many economists believe the effect will be short-term, a blip rather than anything that becomes established.

But we can’t be sure of that. One test is whether price rises for materials and commodities then drive wage inflation, which can result in the sort of inflationary spiral we have seen in the past. But in any case, it seems likely that many procurement professionals will be facing a difficult time in terms of the cost of what they are buying. And for the younger members of the procurement community, this might be the first time they have faced suppliers coming in with demands for significant, maybe double-digit price increases.  

Those of us of an earlier vintage may even remember the days of the mid-70s, during which UK retail prices doubled over about 5 years. After moderating slightly, inflation picked up again and in 1980, my first full year as a graduate trainee with Mars Confectionery, inflation hit 18%.  Great for making your pay rise look impressive, less good for buyers. Suppliers often demanded massive price increases, and buyers would go to their boss and say, “good news, I’ve negotiated a great deal – the price is only going up 10%”!

If inflation does take off, it will also put pressure on all those procurement functions that aren’t really that capable, but have had an easy time over the recent years of low inflation, when claiming “savings” has been relatively easy. However, “cost avoidance” is never a totally convincing argument and will be even harder in an inflationary world when the CFO can see real bottom line costs spiralling.

There will also be a dilemma around locking in prices. If you think inflation has further to run, this might prove to be a very good time to negotiate long-term contracts and lock-in prices now with suppliers. On the other hand, if this is a “blip”, agreeing £5 a bag for compost now might look really silly if it is back to £3 by Christmas!  There is no right or wrong answer to this – but you will need to think carefully about the right approach, which in many case means balancing risk, cost and security of supply.

So this will be a real test for many procurement people and teams. If you want to avoid inflation driven “bad buying”, then here are three quick tips. There is much more that can be done of course, but these strike me as useful and sensible whatever your situation.

  • Market and supplier research is more important than ever in this situation. Suppliers will tell you all sorts of “facts” about the market, prices and so on. You need to be as well informed as them (better, if possible) so you can respond and understand what the real situation is.
  • Think carefully about your negotiation strategy – and if negotiations get tough, go back to basics. As well as research, look carefully at your BATNA (best alternative to a negotiated agreement), try and improve it quickly if it is week, and look at the range of negotiation preparation and approaches that might work. You don’t have to accept price increases – but you need to know how you would respond if your hard-ball negotiation really ends up with the supplier walking away.
  • That includes looking beyond price – are there other benefits you can offer the supplier maybe in return for better pricing? Or if you end up accepting some price increase, can you agree some other wins for your organisation (payment terms, additional services, etc).

There is a lot more we could say, of course, but that’s a start at least and might stimulate some thinking. Meanwhile I’m redoubling my efforts to create home-made compost. (We do have no less than four large compost bins and two “heaps”)!

(But a Government procurement leader joining a supplier while still working as a civil servant is!)

In my last article about fraud related to supply chain finance (which came to mind because of the emerging Greensill / Gupta developments), I said that I hadn’t come across that type of fraud previously. There are plenty of other variants on invoice-related fraud in my book, however.

That brought a call from a friend. He told me of a case he had seen where a business created fake invoices to “clients” and used those invoices to obtain funding from their supply chain finance (SCF) provider. The amusing angle was that the finance provider was a major bank, and the fake invoices included a number that were supposedly issued to the same bank!

So the finance was provided by a bank on the basis of non-existent delivery of goods or services to the same bank … you might have thought that someone would have spotted this or checked to see if the supposed supplier was in their AP system. But perhaps they did, given the fraud was discovered eventually! You also wonder whether the fraudster was stupid, secretly wanted to be caught or was just having a laugh at the expense of the bank itself.

Exploring this theme further, it is clear that supply chain finance related fraud is not new. Just last year, a major scandal in Singapore saw the Him Leong oil trading company collapse. Part of that was down to false invoicing and over stating of receivables, which enabled the firm to obtain financing based on these invoices.

As the spglobal website reported, “financial statements for the year ended 31 October 2019 grossly overstated the value of assets by “an astonishing amount of at least $3 billion” comprising $2.23 billion in accounts receivables which had no prospect of recovery and $0.8 billion in inventory shortfalls”.

There are also cases that are not overtly “fraudulent” but are misleading. When leading UK construction and facilities management firm Carillion collapsed in 2017, the use of supply chain finance was one of the ways it concealed its problems until the final reckoning.  Carillion worked with Santander bank to offer its suppliers payment earlier than its ridiculous 120-day standard payment terms (in return for a fee, of course). Santander then retained the money it owed for the full period.

Globalconstructionnews website reported that “Carillion tucked the cash managed through reverse factoring into the box labelled “trade and other payables”, to which it had added “other creditors”. This, believes S&P, allowed it to show a modest increase in working capital from 2012 to 2016, because “working capital” does not usually include trade payables.  After 2012, the growth in money owed under trade payables ballooned from £263m that year to £761m in 2016. Reverse factoring, said S&P, allowed Carillion to “hide a substantial part of its debt from view”.

To widen the discussion to fraud generally, I believe that Boards, CFOs and CPOs should regularly ask themselves, “how would I defraud this organisation if I was an evil criminal genius”? Or maybe employ an actual evil criminal genius consultant to do that for them (I’m available at very reasonable evil genius rates). Read most of the cases I quote in the Bad Buying book, and you realise that any intelligent insider could have spotted the flaw in process that allowed the fraud, if only they had spent some time thinking about that.

However, the problem with much SCF related fraud or dubious practice is that it is almost always an internally generated fraud. It might involve third parties, innocent or not so innocent, but it is often driven by very senior people in the business, or even owners and founders. So there would not have been much point asking the Board of Carillion to look at the use of SCF if they were complicit in the  bad practice. If it is found that the Gupta companies did issue fake invoices to generate SCF funding  from Greensill, then no doubt that will have originated at a pretty high level in the business.

Meanwhile, back to other aspects of the Greensill affair, and yesterday we saw newspaper revelations that Bill Crothers actually joined Greensill two or three months before he left the civil service, while he was still Chief Commercial Officer for the UK government. Such a move seems very odd but it was all signed off within the Cabinet Office, apparently.  That seems to show very poor judgement at best from Crothers, and perhaps the judgment of the experienced top-level civil servants who approved this was even more suspect. More to come on all this, I’m sure.

We’ve written a couple of times about the Greensill affair, and now more is emerging about another key player in the financial scandal. Greensill in effect lent billions to Sanjeev Gupta, creator of the GFG Alliance of steel businesses.  That appears to have been based on both financing the invoices where GFG owed money to their suppliers, and also making early payment to gupta’s firms where GFG invoiced its own customers.

But the Financial Times, which has been instrumental in exploring matters, reports that Grant Thornton, the administrator for Greensill, has contacted some GFG “customers”.  Clearly, they in theory owe Greensill money. However, “some of them say they did no business with Gupta”.  In other cases, there are allegations that the customers were friends or associates of Gupta.

If this is true, it seems that Greensill was advancing money to GFG based on their invoices which had in theory been issued.  Greensill would collect the money owed from the customers in line with payment terms. So note this is financing Gupta based on its sales, rather than improving its cash flow by helping on the purchase side. But if these invoices – or some of them – were fake – then we have a real fraud, and Greensill obviously won’t be able to collect its debts. Maybe Greensill was an innocent victim, being told by GFG these were real customers and real debts. Or maybe not.

Anyway, this link with supply chain finance is for me potentially a new type of invoice-related fraud. I must admit I did not cover this in Bad Buying, but it might be in the 2nd edition / follow-up!

The more usual invoice frauds that I describe in my book fall into three categories.

  1. Fake invoices are created, submitted and authorised by someone inside the organisation. The money is paid to firms (probably set up for this purpose) which the insider(s) controls.
  2. Fake or inaccurate invoices are submitted by an external party, either “on spec” in the hope that the internal systems are poor and they get paid, or to be authorised by an accomplice internally. The supplier may even be genuine, but the amount invoiced may not reflect the actual goods supplied or work done.
  3. Invoice mis-direction, where the fraudster persuades the firm to pay a genuine invoice to the fraudsters bank account rather than to the real supplier’s account.    

“Fake invoice” fraud by insiders happens in the private sector, in government, and even in the charity sector. And it can be the most unlikely people – as in this case (taken from my book), where the former head of counter-fraud at Oxfam, the charity that fights poverty globally, was jailed after stealing more than £64,000 from the organisation.

Edward McKenzie-Green, 34, defrauded the organisation while investigating fellow charity workers in earthquake-hit Haiti. He filed fake invoices from bogus companies, making £64,612 in nine months before resigning because of unrelated disciplinary proceedings. The scheme was discovered after an internal inquiry was launched to investigate allegations that he’d behaved unprofessionally while leading a team in Haiti in 2011.

He agreed to resign, was given a £29,000 “golden handshake”, but then investigators unearthed 17 fraudulent invoices from two companies under his control.  An audit of his own counter-fraud department revealed payments to “Loss Prevention Associates” and “Solutions de Recherche Intelligence” in 2011. Investigators contacted the supposed head of one company, Keith Prowse, for an explanation of invoices for ‘intelligence investigation’, ‘surveillance equipment’ and ‘Haiti Confidential’. But there was no Mr Prowse – that was, in fact, Mackenzie-Green.  (The “real” Keith Prowse founded a very successful corporate hospitality firm in the UK).

McKenzie Green got two years in jail and Judge Wendy Joseph QC told him: “You have taken from those who desperately need it substantial sums of money. Worse, you have undermined the public confidence in a charitable institution. You were head of a department set up to counter fraud. This was a profound abuse of the trust invested in you.”

We suspect that the magnitude of the Gupta / Greensill affair might dwarf the Oxfam case and most of the others in the book, except perhaps for the Petrobras / Odebrecht scandal in Latin America, where fake invoicing was only a small part of the wider fraud and corruption picture. In any case, it will be interesting to see what emerges in the Gupta case over the coming months.

Readers of the Financial Times (or the Sydney Morning Herald) will be well up to speed with the events at Greensill Capital, a leading provider of supply chain finance funding and solutions. Other broadsheet newspapers and websites are also getting increaingly interested in the story.

Lex Greensill is the son of an Australian watermelon farmer. After an early career at Morgan Stanley and Citibank, he made a big impact in the UK as a “crown commercial representative” in Cabinet Office and supply chain finance tsar for David Cameron’s government. When Cameron stepped down, Greensill made him an adviser with (allegedly) a barn-full of share options.

Greensill also recruited Bill Crothers, government’s Chief Commercial Officer (the top procurement man) from 2012-15. Crothers was deputy chairman of Greensill for a while but resigned as a director in February, and has perhaps sensibly dropped all reference to Greensill now from his LinkedIn profile. Greensill also incomprehensibly got a CBE from the Queen in 2017, whilst Crothers got a CB in 2013, the equivalent award for civil servants.

However, in a few short months, Greensill Capital has gone from planning a flotation that would have valued the firm at $7 to basically going under. We don’t have the time or space to go into all the details here, but broadly, the Greensill proposition was this. A firm such as Vodafone might offer suppliers payment terms of, say, 60 or 90 days. But the suppliers have another option. Instead of waiting for payment, they can get immediate cash from Greensill – at a small discount. So if Vodafone owes you £10,000, then you can get paid now by Greensill for perhaps a 2% discount (£9,800).

Then of course Vodafone pays Greensill the £10K after 60 days, so Vodafone benefits from a cash flow perspective. Greensill makes its money on that margin (the £200).  Nothing wrong with this conceptually or ethically. Another version of this sees the finance provider making their offer to a supplier (rather than a buyer). So the finance might cover immediate payment against a wide range of invoices that the firm has issued.

Where does the cash come from?

In both cases, Greensill has to find the money to pay out up front to suppliers. Historically, the banks have offered this sort of service, because they have easy availability of money. But Greensill had to find a way of raising the cash. So they packaged up the offering into bonds, offering investors a decent rate of return, in return for providing the funding for the scheme. If you can turn over that funding 6 times a year based on 60 days payment cycle, making 2% each time, that is 12% – plenty to offer bond holders a decent return and make millions for Greensill too.

Just to make it even safer, the bonds were insured, so an investor knew that even if Greensill somehow didn’t get all the money owed to them back from the buyers, they were protected. So what went wrong?

The unravelling started with Greensill’s insurer refusing to continue covering that risk. The firm failed to find an alternative – so no insurance meant they couldn’t raise finance and could not continue to offer the service.  But the big unanswered question is this. Exactly WHY did insurance companies refuse to provide insurance? I mean, blue chip clients such as Vodafone aren’t going to renege on their agreement to pay Greensill (which for Vodafone is in effect simply the equivalent of paying their suppliers)?

So there must be more to it. Maybe Greensill has offered the service to buyers or suppliers who were less solid and secure than Vodafone, so the risk of default was greater. The position also gets murkier if you consider this possibility. What if the buyer / supplier relationship at the heart of the transaction was an inter-company relationship?  So one part of my business supplies another, and the supply side gets the payment from Greensill based on those invoices. But what if my sister company doesn’t really have the cash on the buy-side to then repay Greensill? It could be a way of raising money for a struggling firm, but maybe the underlying transactions aren’t even genuine?

One client of Greensill in particular has cropped up as a concern, and represents a pretty large proportion of the total business – do a bit of Googling and you can read more (it’s NOT Vodafone, I should stress)!  That might have got the insurance firms worried, to say the least. Then there was the alleged extravagance from Greensill. For what was still a pretty young business, running four corporate jets seems a little questionable.

So we will see what emerges in coming weeks, months and probably years. The reputations of Greensill, Crothers and Cameron are on the line, as well as potentially real jobs and businesses. There is nothing wrong with supply chain finance per se – but we might see the accountants and regulators looking harder at how firms report on their use of the technique.  And in the next edition of Bad Buying, will this go down as a failure, a fraud or a f**k-up? Time will tell.