When Japan’s largest steel manufacturer Kobe Steel was first suspected of supply chain fraud in 2017, there was no way of knowing the impact the ensuing scandal would have on the company and its supply chain until later. 

Employees at Kobe Steel admitted falsifying quality certificates relating to the strength and durability of its products, which were widely used in automotive, aerospace and rail industries.

“The case triggered an enormous tracing process,” says Jonathan Wheatcroft FCA, Partner, Forensic Services at FRP Advisory. “Organisations had to identify if affected products had ended up in their products, potentially causing safety issues. It was a global supply chain issue.”

The widespread fraud had been going on for over ten years, affecting 5% of output and over 500 companies. It resulted in criminal charges, supply chain recalls and huge reputational damage.

As Wheatcroft explains, this type of product quality fraud is notoriously difficult to manage because the certification process may be far removed from the end user. In Kobe Steel’s case, fraud was only discovered after routine quality testing uncovered discrepancies in internal test data and product certifications. 

Supply chain fraud can take a number of guises, but essentially, it refers to fraudulent activity which takes place anywhere in the flow of goods and services with the intention of evading tax, inflating costs or generating illicit profit, says Michelle Sloane, Partner at law firm, RPC.

“Supply chain fraud exploits gaps in oversight, where businesses are relying on third-party information and third-party controls,” Wheatcroft adds.

Examples of supply chain fraud

Missing trader fraud: Goods are imported VAT-free, but are sold inclusive of VAT before the trader disappears without paying tax.

False invoicing: Using fake or inflated invoices to reclaim VAT or reduce tax liabilities, sending duplicate invoices, or invoicing for non-provided goods or services.

Counterfeit or misdescribed goods: Goods are incorrectly described or undervalued, resulting in lower rates of customs duty and import VAT.

Tendering fraud: Manipulation of the procurement process to dishonestly secure contracts through collusion and inflated prices or insider corruption. 

Product quality fraud: Falsifying certifications or material specifications.

Cost-plus arrangement fraud: Inflated invoices and expenses by subcontractors are passed up the supply chain to increase profit margin, amplifying total cost for the end user.

Modern slavery: Sourcing products which are known to be the result of forced labour and exploitation. 

The telltale signs of fraud

Businesses should be on the lookout for these signs:

• Entities with little trading history, frequent change of directors or a long history of liquidations and administrations. 
• Highly complex, ‘opaque’ supply chains which do not have a legitimate commercial purpose.
• Prices which are significantly below market value.
• Invoices which lack detail, clear narrative and explanation.
• Suppliers who are resistant to questions, scrutiny and due diligence checks.
• Delays and/or excuses in response to requests for information and documentation.

“Damaged stock can also be a red flag because it often indicates that goods have been repeatedly moved between borders in a carousel fraud,” says Sloane.

Suspicious tendering is also an issue, according to Wheatcroft. “For example, an employee might have a personal relationship with a supplier and keep awarding tenders to them.”

Protect your business

It may be a minefield, but businesses can take steps to protect themselves against supply chain fraud through robust due diligence, clear contractual safeguards and fostering an internal culture of risk awareness.

“Know your supplier,” Sloane recommends. “Verify trading history, check company records and the background of directors. If a supplier suddenly appears as a ‘trusted’ electronics wholesaler but its leadership has no track record in that sector, treat that as a red flag.”

Wheatcroft advises including a ‘right of audit’ clause into contracts upfront which will allow organisations to check supplier documentation and carry out regular supply chain reviews and audits to ensure costs are appropriate and compliance standards are being met. 

Updating fraud risk assessments to identify potential risks and document detective and preventative controls is also highly recommended. 

“Supply chain fraud is an increasing threat to businesses of all sizes,” says Sloane. “Being unwittingly caught up can have devastating financial and reputational consequences. Businesses must take all the steps they can to ensure their supply chain is free of fraudulent activity."