Finance's role in fighting food fraud

In 2013, Europe was hit by the "horsemeat scandal" in which DNA testing found that products labelled as containing pure beef were in fact at least part horsemeat. There was no health risk. The real outrage shown by the public was in the perception that they had been let down by trusted supermarkets and brands. It was a supply chain fraud, and in 2017, the perpetrators who had passed off horsemeat as beef through their processing company were sentenced on a single count of fraud. The evidence was in the accounting documentation — falsified invoicing was their downfall.

Food fraud, the deliberate misrepresentation of food and drink for economic gain, is commonplace worldwide and has also involved cheese, honey, seafood, olive oil, and spices. Economically motivated food manipulation can be linked to tax and duty evasion, false accounting, and funding terrorism.

There can be food fraud instances in otherwise legitimate businesses seeking to fulfil large orders at short notice from major retailers or caterers, or simply seeking to survive another day in a frenetic industry with paper-thin margins. Or it may be committed by organised criminal groups.

The honey trade in the Middle East has been linked to allegations of terrorist financing. There are cases of tax and duty evasion involving smuggled garlic from China being sold as European garlic. Certifications might be false, with a worldwide problem in verifying organic produce, for example.

In most cases, the food being passed off is not unsafe. But where it is unsafe, the consequences can be fatal. For example, ground nuts or peanuts are frequently used to substitute for other, more expensive nuts, which is dire for those with allergies. Food fraud may also prevent people from getting the nutritional benefits they should from some foods. This is a problem in everyday foods, as even tea, coffee, juices, spices, and meats are subject to substitution, particularly when processed or blended. There is an even bigger problem in nutrient-dense foods considered particularly healthful, also known as superfoods, or fashionable foods that carry a premium.

What can finance professionals do?

In the UK, a government inquiry into the horsemeat scandal led to the setting up of the National Food Crime Unit within the Food Standards Agency following the model of agencies in Denmark and the Netherlands. Both these agencies have forensic accountants on the team. Also, the British Retail Consortium standards were amended to require companies to carry out detailed fraud risk assessments on individual ingredients. And the University of Portsmouth in 2014 established the Food Fraud Group to recognise the potential of forensic audit and counter-fraud techniques as detection and prevention mechanisms. In the US, the Global Food Safety Initiative and Michigan State University have led the way in establishing risk assessment exercises and education.

The 2011 US Food Safety Modernization Act requires many businesses that manufacture, process, pack, or hold human food in the US to install preventive controls to minimise or prevent safety hazards. The US Food and Drug Administration is in charge of ensuring the requirements are met. A risk-based supply chain programme for manufacturers is part of the preventive controls. It must include:

• Approved suppliers;
• Supplier verification activities such as on-site audits, sampling and testing of raw materials, and reviews of suppliers' food safety records; and
• Documentation of supplier verification activities.

Regulation to prevent economically motivated food misrepresentation is also in effect in other countries and jurisdictions, including Australia, Canada, and the EU.

One of the weaknesses in food and drink companies, and in their supply networks, is the fragmentation of systems. The initiatives around food fraud risk assessment are largely given to quality and technical teams to implement. They are experts in food safety but not in fraud. In addition, the quality systems are seldom well integrated with finance, human resources, purchasing, diagnostic testing, or sales systems. The result is that the masses of data produced are often not used to create useful information.

The Food Fraud Group at the University of Portsmouth takes a different view on the approaches needed. The group asserts that the management control and accounting systems and processes in an organisation or supply chain are as vital as food safety and food quality systems to combat fraud. The Food Fraud Group points to counter-fraud (anti-fraud in the US) and forensic auditing to help identify potential violations and fraud. It also points to cross-functional teams and innovative business analytics to help improve traceability of products. In turn, this ensures more effective management of food supply chains by streamlining data on what might be many thousands of purchases of ingredients and products. This is where business partners from finance and accounting can make a real difference.

Management accountants can ensure that management control and data analysis systems are designed to prevent and detect fraud of all types, not just in food. Better prepared organisations have fraud policies and procedures in place, along with designated fraud officers and whistle-blowing systems designed to protect the whistle-blower. They also have monitoring and evaluation systems that include reporting of key performance indicators that measure losses through shrinkage, theft, and fraud to the board of directors (possibly via an audit committee). One of the biggest issues in the food industry, though, is that many businesses are small or midsized, without the resources for comprehensive counter-fraud measures.

A few inexpensive steps that SMEs can take include due diligence on suppliers, customers, and employees; training and education; keeping good records; and investing in IT to ensure traceability of ingredients and products going out. (See the sidebar "Assessing and Mitigating Vulnerabilities" for steps Switzerland-based multinational food and drink company Nestlé takes to mitigate its vulnerability to food fraud.)

There are particular red flags for fraud that accountants and auditors should be looking for when processing transactions and compiling analytical management accounting reports in the food and drink industry. Let's look at three areas where this applies — internal management, suppliers, and customers.

Internal management

• More (or fewer) processed/packaged items are going out than the ingredients purchased would make. This is where systems should be integrated, to link recipes and specifications with the finance system. Another approach is to carry out regular "mass balance" exercises: What comes in less what is wasted should equal what goes out. It might be that one ingredient has been substituted for another or that dates have been changed.
• The company is paying even prices for ingredients over a long period of time. Commodity prices are notoriously volatile. It may be that there is some contractual pricing arrangement in place, backed with futures contracts, hedging, etc. Or it may be that the goods supplied are not as promised.
• The gross margins on products are even over time, even when ingredients are difficult to source due to weather- or disease-related problems. Checks, where possible, against competitors may reveal that substitutes are being made from nonagreed sources. Again, it is a volatile and unpredictable industry — evenness could be a sign of great management or a big red flag.
• Unusual requisition orders are made for packaging and ingredients.
• There is evidence of systems override. Are regular checks carried out on who accesses the computer systems both on the production side and in finance?
• Standard red flags for internal fraud: authorisation-level violations or frequent payments just under the authorisation level; evidence of kickbacks, perhaps in the creation of sundry or special account codes that are not routinely checked; suppliers and customers with links to employees; and so on.

Suppliers

• The supplier consistently gives the lowest prices. Questions should be asked about such a supplier, especially if no one else can meet that price or give such a generous margin. This is an industry that typically runs on an average of 1% net margin — no one can afford giveaways.
• Alternatively, the supplier offers to get hard-to-source premium products that will ensure your status as a premium producer or retailer. You are willing to pay a little extra, but you should check. Saffron, for example, is one of the most substituted ingredients in the world and one of the most expensive. Fine wines can be affected by the same kind of fraud. Like saffron, the bottle and label might look authentic, but the contents could be a much cheaper wine. This is where lab test results really do need to be checked against financial records.
• The supplier can get hold of ingredients easily and quickly, even when the market is affected by shortages. This is where business partners working as a cross-functional team add value by simply comparing notes and issuing alerts.
• Significant use is made of open markets, agents, and brokers. This leads to a well-recognised supply chain issue: What do you know about your suppliers' suppliers?
• There is a request to put a supplier on the authorised list on short notice as demand exceeds supply or to make a short cut in authorisation. Collusion between the supplier and the buyer is possible.
• One supplier is paid fractionally more than another. This is largely a low-margin, high-volume industry. In a case in the UK, the buyers agreed on a price for potatoes that was around a penny a bag higher than their other suppliers. This mounted into an alleged fund of several million pounds, used for kickbacks for the buyer and the supplier. The retailer uncovered the fraud by asking the right questions, but the finance director of the supplier was one of those who went to jail.

Customers

• Is your business under pressure from its customers? Answer: Always. Whether your customer is the consumer, retailer, caterer, or processor, everyone is trying to get a share of that market, to hang on to that tight margin. Everyone wants a discount. If as a supplier, you find co-workers or a competitor fulfilling last-minute or unusually large orders when demand exceeds supply, for example, then this is a red flag.
• On another level, is the customer sending back inventory? Is it resold or sent to waste? Can it be traced, or is it being reprocessed or otherwise used to create an income for someone?

Keeping it clean

Finance professionals should be designing systems that facilitate traceability exercises and audit tests that detect anomalies in systems. By treating food fraud as seriously as other fraud, the finance team can help build resilient businesses that tackle fraud from all angles. The lab, the production system, and the management systems — and the teams involved — need to integrate more fully. In the end, it is not just the profits and reputation of the business that are at stake. It is the health, wellbeing, and lives of those who eat.

Assessing and mitigating vulnerabilities

How vulnerable a food item is to economically motivated manipulation depends on several characteristics, including the market price of its raw ingredients and whether they have been manipulated in the past and its level of processing.

The Switzerland-based multinational food and drink company Nestlé uses vulnerability assessments and mitigation processes to prevent food fraud. The mitigation involves these steps:

• Establish measurable specifications to control raw materials. For example, the quality of olive oil can be measured by its absorption of ultraviolet light.
• Monitor raw materials and verify their authenticity with analytical methods.
• Build trusted relationships with suppliers. Factors such as approval of suppliers’ production sites, readiness to share information, and suppliers’ reputation play a role.
• Audit specific raw material production and handling sites.
• Map your supply chain and identify sources of risk through, for example, questionnaires and supplier assurance and audit processes.
• Eliminate sources of risk in the supply chain.

Lisa Jack, Ph.D., is professor in accounting in the Accounting and Financial Management Department at Portsmouth Business School. To comment on this article or to suggest an idea for another article, contact Sabine Vollmer, an FM magazine senior editor, at Sabine.Vollmer@aicpa-cima.com.