Iranian Association of Certified Public Accountants IACPA Auditors

Iranian Association of Certified Public Accountants (IACPA) Auditors & Anti-corruption By: Gholam hossein Davani Member of High Council of Iranian Association of Certified Public Accountants IMA, AAA, BAA, EAA, IIA, FMA, AFA, CAAA, IICA, AAFM March 11, 2004 1

“…You should also check their activities and have people who report on them who should be truthful and faithful, because your watching their actions secretly will urge them to preserve trust with and to be kind to the people. Be careful of assistants. If any one of them extends his hand towards misappropriation and the reports of your reports reaching you confirm it, that should be regarded enough evidence. You should then inflict corporal punishment on him and recover what he has misappropriated. You should put him in a place of disgrace, blacklist him with (the charge of) misappropriation and make him wear the necklace of shame for his offence. ” Part of Imam Ali’s letter No. 53 to (Malek Ashtar) 2

Your honor, Just now sitting at the patio with your honorable sibling and having a bite of board with her honor, I was informed that your honor has prattled and reappointed price Movasegholdoleh, governor of Qom, formerly deposed due to bribery and buying off. I had him sent to Tehran under guard, so that your Majesty will understand that one can not rule a country on his aunt’ prescriptions. Forgive me for being over impertinent, Taghi Amir Kabir’s (Current Pre minister) letter to King Naseraldin Shah Just as one can not let go of the taste of honey or poison on the tip of his tongue, a governmental agent dealing with governmental budget, can not avoid tasting at least a little of the King’s wealth. Kaochila ertashsetra, Indian edifications, first decade Annone Domini 3

Definition of Corruption • • The term "corruption" comes from Latin "romper" which means "to break or violate", i. e. , in corruption something breaks or violates which might be a moral or legal norm, or even administrative regulations. • corruption as a phenomenon raised from public and private sectors' interest coincidence, is the result of profiteering behavior of those who act on behalf of public sector or enjoy the fruits of governmental powers and authorities, and take advantage of them for personal, familial or other purposes to gain whether political or economic opportunities. • In other words, financial corruption is misusing or abusing the governmental (public) power, property, authority and post for securing the interests of a particular person, group, party, tribe or caste. Definition 1: Violating (or breaking) the existing rules or regulations for securing personal interests Definition 2: Illegal reward paid in order to making one to offend against his/her duty (Webster Dictionary) Definition 3: Corruption, to abuse governmental power in order to securing personal interests (World Bank) 4

Types of Corruption Administrative corruption (Bureaucracy) Bribe (Main essence of financial corruption): bribe, gratuity, remuneration, fees of pandering to the evil designs of others, tip, hush money, present Embezzlement: To withdraw or abuse the governmental (public) properties by those who are responsible for managing and keeping them (breach of trust) Rent seeking Corruption in transactions and contracts (commission) Fraud Political comption Political corruption of senior authorities of the government Corruption arising from policy makings Stranding Favoritism (a type of embezzlement) Discrimination Nepotism Cronyism Patronage Extortion Protection or security money 5

Factors effecting on forming of corruption • The role of state and governmental instruments • The nature of society's political system • Judiciary and supervisory system • Special social characteristics of any country • Governmental rules and regulations, privileges and authorities • Special characteristics of tax system • Policies and decisions pertaining to national and public expenditures 6

Financial corruption forming bases Incorrect common law and administrative customs The income and revenue levels of the government's employees The weakness of judiciary and supervisory system The weakness of intra-organizational supervisory sections Non – transparent rules and regulations Lack of a proper social security system Lack of job security for government's employees 7

The roots of financial corruption Shadow Economy Under ground Economy Smuggling Drug smuggling Goods smuggling Human Traffic Shadow Economy consists of a set of economic activities, whether in production or service sectors, which try to gain more out of prescribed framework of official economy. bribery – embezzlement of public properties by government organs and senior employees – tax evasion – nepotism – unauthorized production – black markets for unobtainable goods - foreign exchange transactions – fraud 8

The volume of shadow Economy in various countries per GDP USA %10 - %33 Australia %4 - %12 Russia %25 Germany %25 Italy %10 - %33 Japan %4 -%15 Britain %3 -%15 Today America's foreign trade deficit is about $500 b that is said without "dirty money", America's foreign accounts would be entirely disabled, the living standards would fall off, the dollar weakens, the existing or available capital would impair, and Washington wouldn't be the Emperor of the world anymore! 9

Income combination of criminal capitalism (financial corruption) Human traffic and prostitution credit cards (mostly in Hong Kong cafeteria owners' activity area) Gambling den, betting and lottery (football, boxing, horse- racing and…) Illegal transaction of weapons Drugs and alcoholic drinks sale, about $120 b to $300 b in a year To attend in international tenders (brokerage commission) produce or sale the unauthorized or illegal products such as porno movies and CDs Transactions by foreign exchange Nepotism, abusing authority and office position, jobbing To give or receive bribe (illegal commissions) Other incomes 10

Main players of the underground economy Rent- Seeking financial – economic foundations and institutions Big credit networks out of government control, unauthorized financial and credit institutions Non profit and the so called charity institutions Frontier market places operators Hoarders who buy rarely found goods in advance and sell them very expensive 11

Characteristics and special features of financial and administrative corruption A long- term and permanent crime The profit resulting from it, outshines the country's economy cycle too An organized crime, an organized group enjoying governmental powers (plurality of commissaries) Financial corruption is the enemy of the meritocracies system 12

The choices of financial corruption Bribery, Kick back, Extortion, Protection or Security Money, Baksheesh Commercial arrangements, Gratuities, Sweeteners, Pay-offs, Hush money, Greasing palm Embezzlement Abusing administrative posts or authorities Rent seeking Sex abuse, Prostitution Smuggling, trafficking (Goods and services, drugs, weapons, human) 13

Social- economic effects of financial corruption Corruption annihilates the economic security which is the precondition for any economic activity Corruption increases poverty and privation Corruption eliminates creativity, initiative, the motive of working and job creation Corruption retards or stops proceeding towards democracy and market economy Corruption brings about lawbreaking and disorder Corruption decreases the state's governing role or derange it (i. e. , its obligations, to execute contracts, …) Corruption eliminates the government's ability of enacting controlling and supervisory rules for improving market deficiencies Corruption makes people pessimist toward the government (because they consider them as accessories) Increasing underground activities (gray and black) Deranging long term local and foreign investments Deviating priorities Annihilating the meritocracy Increasing the expenses of the commercial exchanges Corruption increases class distinctions severely 14

Unofficial statistics of financial corruption in Iran Yearly volume of smuggling from $3 b to $5 Yearly capital flight about $2 b to $3 b Money circulation in drugs dealing, $5 b Yearly volume of embezzlement in banking network and big public (governmental) companies, $1 b The commission of government's foreign purchases is estimated about 1 to 3 percent of total imported goods According to a non-governmental estimation, 20 to 25 percent of agricultural sector's yearly credit is provided by market Brain drain (as the greatest social wealth) 15

Developing effects of good governance "Anti- corruption" Financial burden of legislation is very low Hope for living is high and infants death rate is very low The right of expressing opinions (liberty of speech) and full responsibility system High rate of literacy and the rule of law More investments (Social- economic security) High rate of employment and low rate of joblessness Class distinctions, and number and rate of the poor will become less Better allocation of public expenditures and tax revenues increasing More civil rights for citizens Liberty of the press is the basis of responsibility system 16

International background of anti- corruption act Palermo conference Palermo Conference 1. Any contracting state will adopt legislative and other measures which are necessary to treat the following actions as felonious crimes when they are accomplished deliberately: a) Any promise, offer or an unjust benefit giving directly or indirectly to a public services official for him/ her, or another person or institution in order to make him/her to do or avoid of doing a specific job. b) Any request or acceptance of an unjust benefit, directly or indirectly, by a public services official or another person or institution in order to make him/her to do or avoid of doing a specific job. 2. Any of the contracting parties will consider all above – mentioned measures in order to treat financial corruption and other types and forms of it as felonious crime. 3. Any contracting state will adopt necessary measures in order to treat participation and partnership in financial corruption as a crime. 4. According to paragraph 1 of this article and article 9 of this convention, "public services official" is one who fulfils a public job or obligation. 17

International Anti-corruption conferences 1 - The United states of America 1999 2 - The Netherlands (la Hague) 2001 3 - South Korea (seol) 2003 4 - Brazil 2005 18

Responsible persons and Institutes in Anti- corruption campaign according to the EU Operation Program Recommendation State authorities, members of parliament and people who have an influence on elections Persons be in charge of the legal professions (Judiciary) Self –employed persons such as merchants Journalists Auditors 19

Corrupted financial resources basis Banking activities particularly in international banks, because it is hard to control and supervise them. Cooperation of some bankers with money laundering, easily makes financial corruption possible. Funds and institutes which grant interest free loans and their activities and operations are parallel to operations of regular banking system. Futures markets in which brokers buy-sell shares, bonds, … Artworks and antiques – attending in unofficial sectors of economy such as precious metals and oil transactions. Free trade zones that are free of control- tax haven areas. Religious centers with economic activities, charity institutions and the like, particular foundations and cooperative funds. Money changing gives a suitable chance for money laundering. 20

The means and methods of preventing economic crimes (financial corruption) Penal and juridical rules amendment Government's authority should by employed in such a way that reduces the incentive of corruption agents through using proper tax and financial mechanisms Proper mechanisms should be created for money and capital markets in order to establish high supervision To control financial – administrative corruption in public sector To develop auditing and financial supervision sector in order to economic transparency and preventing tax evasion 21

Fundamental obstacles of anti- corruption in Iran Lack of a specific governing system in exercising the government's sovereignty Lack of harmonious management among the three sectors of the state To change financial corruption into a political case and to protect offenders politically Not to pay attention to preventive solutions and limit the campaign to occasional juridical encounter Financial corruption occurrence in the world's big companies during past 3 years Disagreement of offenders, losers, simpletons and spiteful persons Penetration of corrupt persons into the anti- corruption campaign, spreading of "nepotism" in administrative – financial – political system of the country "Oiling the wheel" Idea, some believe that the corruption is needed to such an extent that prepares the means of livelihood, this idea related to the activists, inspires its concept from southern east Asian countries The idea that believes anti- corruption brings about insecurity and capital flight 22

Auditors Responsibilities Social Responsibility - Social welfare - To protect shareholder's rights equally - Imaginary or false benefits - Feigned transactions - Since tax, as an income source for the state should be distributed fairly, in this connection an auditor has both legal and social responsibilities Legal Responsibility Professional Responsibility - Commercial code: articles 144 to 156 & 117 to 129 Imperfect execution of contracts or agreements - Direct Taxes Act: article 272 Errors: make mistakes in financial statements and accounting records - General Accounts Act: article 132 - Other Related Acts Irregularities: to make intentional alterations in financial statements which is often accompanied by forgery in accounting records Science / Intention: To deceive or cheat intentionally Negligence: To offend against duties Gross negligence: be completely careless towards responsibilities Fraud: To alter an important fact, mendacity, to present false information in order to cause to sustain a loss to others Constructive fraud: To be careless in performing important tasks, to pretend doing important job and seduce the others, contrary to "fraud", one know nothing about alteration in financial statements 23

Corruption Effects from Auditors' point of view Any type of financial corruption will affect financial statements somehow Contrary to money laundering, financial corruption will affect one of the balance sheet or profit and loss statement items (financial auditing) Financial corruption leads to incorrect evaluation of companies activities Financial corruption makes it difficult to distinguish taxable income correctly (tax auditing) Financial corruption damages the rights of some shareholders in favor of some other shave holders Financial corruption violates some citizens, social rights (auditor's social responsibility) Financial corruption can alter the auditors' independency too 24

Effective factors in financial corruption from Auditors' point of view Absence of experienced and truthful employees Excessive tendency to use cash in dealings Institutionalization of corruption and embezzlement in various parts of the state Lack of a proper auditing system guaranteed to be executed Absence of outstanding economic inspectors to control supervise the system in appointing state's senior officials Not to guaranty the delivery of financial papers and statements by all commercial units 25

Methods of Fighting against financial corruption To strengthen the political will To concentrate on the methods of preventing financial corruption Participation of people and civil organizations in fighting against corruption Concentration on permanent training C = M + D + A corruption = (Monopoly + Despotism + Accountability) 26

Auditors' duties in fighting against financial corruption To inspect and control the doubtful deals To detect and recognize the deals targeting to bribe government officials Particular applicable trainings for fighting against financial corruption To detect unlawful payments To consider and check the suspicious people's employing relations who might be paid regularly but have no responsibility and duty in a company and offer no service, to check the counselors' employment contracts 27

Examples of Fighting against financial corruption in financial statements Receivable accounts unexpected decrease through claims remained unpaid and to receive claims out of financial statements To receive unreal invoices (over invoice) and to draw money out of the company, and collusion of officials with vendors To use trickery in tenders To adjust the contract price during operating or after completing the project so much so that the new price exceeds the second bidder's price To buy goods in a price more expensive than market price, to sell goods and services in a price cheaper than market price, to hand company's financial resources and properties over to others To pay money to people or institutions that do not work for the company To buy shares in high prices and sell them in low prices or vice versa To assign the license of goods selling or sole agency to particular persons 28

Auditors' Temporary Guidebook (ICEAW Press) A criminal act is such an act that in case of occurrence in Great Britain is considered as a crime To avoid hesitation, criminal wealth includes the following: Revenues resulting from tax evasion Revenues resulting from a cartel's operations Revenues resulting from corruption and bribery Revenues resulting from negligence 29

Financial corruption in big companies of the world during last three years Enron (Arthur Anderson- AA) World. Com (AA) 2002 Parmalat (Grant Thornton- GT)- Deloitte US Tax Shelters (KPMG) Equitable (E&Y) Shell Oil Co. (KPMG & PWC) Refco. (KPMG) Xerox (PWC) AIG Group. (PWC) EOL Times Warner White collar crime Tyco 30

Big financial corruption in Iran Saderat Bank (Hadad & Rafighdost Case) (1. 2 b$) Gilan Pocket Listed Co. Arj corporation listed Co. Manna constructive company Shaharam Jazziery case Non profitable (interest free) funds 31

Sources • The recognition of financial corruption event (2 nd volume), Nashr-e Jahad press • Good Governance and Development, Islamic consultative Assembly's Research center • Auditors' social Responsibilities, Economy finance & Magazine, Gholamhossein Davani • The collection of "Tarjoman- e Eghtesadi" Magazines • Internet Data center on "corruption"; Independent commission against corruption • site: www. icac. new. gov. an • The International Transparency site • Miscellaneous Articles about financial – political corruption published in Iranian Magazine • International organized crimes in Palermo convention and its Effects, Legal Magazine, No. 29, Autumn 2003 IMA= American Institute of Management Accountants AFA= American Finance Association AAA= American Accounting Association CAAA= Canadian Academic Accounting Association BAA= British Accounting Association AAFM= American Academy of Financial Management EAA= European Accounting Association IICA= Iranian Institute of Certified Accountants IIA= Institute of Internal Auditors IACPA= Iranian Association of Certified Public Accountants FMA= Financial Management Association 32