Ethics is one of the most prominent aspects of any field. The intent of paying a kickback might be positive or negative, but the practice has been unethical. The practice starts with the intent of the player or receiver. The payments are usually referred to as commission in some or other form.
In this blog we will discuss in detail how kickback business works, the kickback definition and more.
Did you know? Although kickbacks are punishable under law, they are not technically illegal. If the kickback does not violate state or central laws and it is offered to clients in the industry, the kickback may not be considered illegal.
How Does Kickback Work?
Let's first know the kickback meaning. A kickback is an unethical act of mutual gain wherein a commission or a sum of payment is made to a person within the organisation. The process revolves around unethical payments to attain preference over a capable individual. It specially occurs for any discriminatory or premium treatment for supplying goods or services. The payment could be cash, credit, goods, preferential allocation or any valuable material or service.
However, the organisations have internal policies and control to avoid instances of kickback. The question arises how does it work even if there are policies in place? The answer lies in the fundamental mindset and psychology of the person indulging in such activities. We have compiled the following observations through which instances of kickback in an organisation may arise.
For instance, bidding on a job that you have got where you need to pay someone for getting it. The payment made in such circumstances can be considered as an example for kickback.
There are people who possess an attitude or a character that allows them to knowingly and intentionally commit a dishonest act. Thus, a person may be able to rationalise committing a fraudulent act. Even if there may be instances that employees are expected to produce unrealistic results within a short time frame, then instances of kickbacks may arise to match the expectation of senior management. For example - a person paying the bribe may rationalise their act as “This is how it works”.
2. An Opportunity
Managements usually design internal control in place to avoid instances of kickbacks. However, every system in place can be over-ride or has weaknesses. If a particular weakness is known to the employees, they may explore the opportunity for personal gains.
3. A Perceived Environment
Small businesses usually fail due to a lack of controls in place. Employees may take advantage of loose control to commit frauds or indulge in petty theft. There is also a lack of proper accounting in small businesses.
Thus, unethical behaviour is the reason for a person to indulge in a kickback. It is usually committed at the operational level since the number of employees is large. However, it is not a rule of thumb and could be committed anywhere or by anyone.
Examples of Kickbacks
1. Stock Trading
**Stock brokers sometimes manipulate the clients towards slow and high-cost trade that has less benefits than any other trade. Such practice can be considered as “Rebate. Brokers can take kickback as an exchange of routing of trade to that particular exchange**
The stock brokers sometimes route their trade to an exchange that offers a slow and high-cost trade to the client which may not be beneficial to the client. Such a practice is termed “Rebate”
The benefit of advertising can’t be traced to individual customers. The same way it goes around in the advertising business, the client may want to show the advertising in a particular time frame or in the middle of a particular show, etc. The advertiser may not follow up with the client accurately and charge an abundance of fees for a low service delivered.
Online marketing methods like websites and media sites create alliances, referring customers back and forth to one another, thereby sharing the revenue. Prominent examples include affiliate marketing programs, pay-for-performance deals, revenue sharing agreements, bounty systems, bartering, and more.
There are multiple forms of kickbacks in every organisation or in different industries. Let's first start with kickbacks at the organisational level -
1. A Competitive Environment
Competition is usually a motivation to perform better. It is a very common practice to encourage employees to perform at their best. However, if too many unrealistic goals are exerted on employees they may feel underpaid for being overworked. This encourages them to commit kickbacks and obtain personal gains.
2. Related Party Transactions
A related party transaction means transactions wherein both the parties or entities are under common control or have the same management. For example - A Ltd. company dealing in automobile manufacturing has a director named Mr. Arun Mehta and Company B Ltd. dealing in automobile parts have a director named Ayushi Mehta who is the wife of Mr. Arun Mehta. There may be instances where B. Ltd supplies low-quality parts to A Ltd. and charges goods at high prices leading to reduced profitability of A Ltd. and poor quality automobiles. Such a practice will slowly or quickly kill A Ltd. in the market. Ind AS 24 (Indian Accounting Standard) requires them to disclose related party transactions in their financial statements. However, statements can be falsified.Ind AS 24 (Indian Accounting Standard) requires them to disclose related party transactions in their financial statements. However, statements can be falsified.
3. Discrepancies in the Accounting Records
There may be unsupported or unauthorized transactions that may be recorded leading to fraud as happened in Satyam Computers Scam where fake sales invoices were generated to inflate the profit.
There are different forms of kickbacks in different industries. Here are a few of them.
1. IT Industry
Probably one of the biggest scandals of Modern Corporates in India is Satyam Computers. Mr. Ramalinga Raju, then CEO of Satyam Computers admitted in the press that he inflated the asset to approximately US$1.5 billion out of which nearly US$1 billion of liquid assets were missing. This caused a huge blunder leading to nearly losing all the value of stock price and the collapse of the Satyam Computers. On further investigation, it was found that there was negligence on the part of the auditor which was PWC LLP.
In response to the scam, the New Companies Act, 2013 was drafted in place of the previous Companies Act, 1956 incorporating various stringent provisions, some of them including class suit action, criminal liability provisions, etc.
2. Government Contracts
Government contracts are one of the most perfect ways to describe kickbacks where a direct benefit is passed to contractors in exchange for a huge sum of money. It is evident in USA military contracts for the supply of food and equipment and it is a serious crime in the eyes of US legislatures but the system still exists. It is not different in India as well, where tons of road contracts were passed on to incapable contractors in exchange for bribes to ministers and authorities.
3. Financial Service Industry
In recent years, ethics have been developed by CFA (Chartered Financial Analyst) institutes, and strong legalisation warrants establishing best ethical practices. But still, kickbacks are the most common in the financial service industry. Recent front running case in the Axis mutual fund where the accused fund manager Mr. Viresh Joshi was found guilty of making profits from front running at the loss of clients.
4. Public Works
According to the Anti-Corruption Bureau statistics, the Public Works Department had the most number of officers under the scanner for inappropriate assets in 2013, close to ₹17.87 crores.
How to Control Kickbacks?
Kickbacks account for huge losses for companies or governments across the world. Unethical employees sometimes if left uncontrolled could force the companies to shut down like what happened in one of England’s oldest banks. “Barings Bank” where Nick Leeson, one of the employees, forced the company to shut down. However, here are the best measures to control kickbacks.
1. Internal Control
Management must design a system of internal control in place where misappropriation of assets can be traced. Internal controls can be established in the following ways -
a. Segregation of Duties
Segregation of duties is the best way to check the authenticity of employees where two or more employees are responsible for the discharge of a single duty. For example - A person who places an order to a supplier for the purchase of raw materials should not be in charge of making the payment and a different department should be appointed to check the quality of raw material.
Bank statements should be reconciled to the cash books to check the appropriateness of bank balances. This way misappropriation of liquid assets could be checked.
2. Internal Audit
Big corporations are required to appoint an internal auditor under laws and regulations. The auditor has the duty to assess the governance process for establishing ethics, values, and accountability in the company, assessing the risk areas where internal controls are weak, etc.
3. Entity’s Environment
Management has the responsibility to give direction to the workforce. They are also responsible for establishing an environment of honesty and high ethics. Such a practice could reduce the risk of kickbacks.
It is the employees’ honesty and ethics that push an entity to its best potential. If employees are dishonest and do not feel a sense of belongingness with the company, they may indulge in kickbacks or bribery for personal gain setting aside the interest of the company. There are controls in place to check the wrongdoings and companies have made arrangements to have control over such practices. We hope this article helped you get an insight into kickback definition, kickback business ethics, and what is kickback.
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