Nathan A. Orien and Professor Walter L. Whipple, Germanic and Slavic Languages

Financial fraud is damaging many businesses and destroying investor confidence in our capital markets, as witnessed by the long string of accounting scandals uncovered in the U.S. While some businesses, such as Enron, have suffered complete dissolution as a result of catastrophic management fraud, smaller forms of business corruption all take their toll in reducing a company’s profitability.

In post-communist Poland, where black markets and bribery are still quite common, business corruption is a serious threat to the profitability of existing and future financial investment. Since joining the European Union in 2004, Poland has improved its chances of attracting outside resources. Investors need to know the risks and costs associated with financial crime. They also need assurance that there are sufficient controls set up to minimize them.

This report summarizes the results of a research paper which defines the main forms of business corruption, provides a brief history of financial corruption in Poland during communism, explains why Poland and other post-communist countries have been especially vulnerable to fraud, sheds light on recent corrupt political and business activity in Poland, discusses recent survey results of fraud in Polish businesses, and explains the effects of fraud on the individual and the market economy. Finally, solutions are provided for minimizing this bottom-line-buster via a better understanding of the rule of law and a more effective implementation of internal controls, in accordance with new policy.

The major forms of business corruption highlighted in the paper are bribery, money laundering, embezzlement, and falsified financial statements. Based on news articles and surveys results examined, bribery appears to be the most prevalent form of financial crime in Polish businesses.

In a 2003 Deloitte survey of the top 1000 Polish companies, results indicated that bribery and corruption were considered to be the largest problem with over 80% of chief executives stating that they took it [corruption] as a “major threat.” In the same survey, 22% of respondents stated that money laundering was a problem. Organized crime, falsification of financial statements, and money laundering were mentioned by about one-quarter of respondents as being problematic. Detection rates were believed by 30% of respondents to be 50% or less and 20% thought the detection rates were less than 25%. In 2005, PricewaterhouseCoopers also conducted a survey of Polish businesses and reported that: “54% of Polish companies have fallen victim to economic crime over the past two years – (46% in our previous survey)”.
Communism in Poland created an atmosphere ripe for corruption—in politics and business. Price controls, quotas, and the bottleneck of resources and decision-making caused by legions of officials all combined to stifle economic growth and promote illegal, underground activity. Now 17 years since the collapse of communism, Poland continues to suffer residual effects as bribery continues to be a leading threat.

On May 26, 2006, a report was released about white-collar crime in the Ministry of Finance. A group of senior officials was arrested and escorted from the building on charges that between 1994 – 2004 they were part of a criminal group that bribed tax authorities and secured favorable decisions for various companies. Prison terms could be up to 10 years.

Regarding the effects of financial crime on the individual, Polish economist Kolodko explains:

“…corruption weakens motivation and hampers labour productivity. If a share of income is due to illegal activities, including the acceptance of bribes, the motivation for sound effort and an increase in labour productivity is dampened.

Therefore, business corruption erodes the most important piece of the economy—individual workers. With regard to the economy as a whole, business corruption negatively affects investor confidence by creating an atmosphere of mistrust, which in turn creates a sense of higher risk, which leads to less investment, which slows the economy, which finally results in a lower standard of living.

The democratic rule of law is vital to a prosperous market economy, of which the United States has been the best example. The security and lower levels of risk that are afforded by the rule of law encourage investment and market activity. Without the rule of law, the costs of entrepreneurship may greatly exceed the benefits.

In the wake of the accounting scandals of the early 2000’s, U.S. Congress addressed the need for greater prevention by passing the Sarbanes-Oxley Act of 2002 – SOX, whose purpose is “to protect investors from the possibility of fraudulent accounting activities by corporations.”

Bribery and business corruption have been around for a long time in Poland and will never go away completely, but there are definite ways in which they can be reduced, ideally minimized, and allow the prosperous functioning of a free market economy. The Polish legislative system should follow a similar route as the U.S. Congress in providing a better framework for auditing public companies to ensure the integrity of business activities and financial reporting. The rules should be made widely-known and established by democratic rule of law. Timely prosecution and penalties should be imposed, commensurate with the crime.

References

• Adlem, Michael. Fraud in corporate environment – results of the survey 2003. Warsaw, Poland: Deloitte, 2003. www.deloitte.com/pl/naduzycia
• O’Brien, Brian. The Economic Crime Survey 2005 – Poland. Warsaw, Poland: PricewaterhouseCoopers, 2005. www.pwc.com/pl/investigations
• White Collar Crime: Ministry of Corruption. http://www.warsawvoice.pl/view/11431. May 26, 2006. Accessed June 2, 2006.
• Kolodko, Grzegorz W. Post-Communist Transition, The Thorny Road. Rochester: University of Rochester Press, 2000.
• “Sarbanes-Oxley Act of 2002 – SOX.” Investopedia. Investopedia Inc., 2000. Answers.com 24 Jun. 2006. http://www.answers.com/topic/sarbanes-oxley-act-of-2002-sox