Combatting fraud and corruption in the Middle East: the evolving landscape

July 2024 | SPOTLIGHT | FRAUD & CORRUPTION

Financier Worldwide Magazine

July 2024 Issue

Combatting fraud and corruption is a major challenge in some parts of the Middle East. The challenge is also an opportunity: improving a country’s perception as a clean place for business is a driver for foreign investment and for growth.

The relationship between business risk factors such as fraud and corruption (or the absence of them) and investment decision making has come into sharp focus in recent years, in part due to increased awareness and engagement by businesses with environmental, social and governance (ESG) considerations.

Business leaders now see ESG compliance as a key agenda item, with accountability to stakeholders including shareholders, lenders, customers, the workforce and others acting as a major factor in business decision making. This, in turn, is driving an increase in diligence measures to assess a range of business risks when entering a new market, with the risk of fraud and corruption high on the list of concerns.

The fraud and corruption challenge in the Middle East stems in part from the rapidly emerging nature of many of the states in the region, high personal wealth making for a target-rich environment and the opportunity for gaps and weaknesses in law, regulation and enforcement to be exploited. Corruption at the small and mid-size enterprise level, where the need to incentivise individuals with the power to award valuable contracts, is perceived to be far more prevalent than officially reported.

This article identifies a number of the key issues and trends in this area, with a focus on the United Arab Emirates (UAE), and what the future might hold.

Coming off the FATF’s grey list but challenges still persist

Although not specifically a fraud issue, a major challenge in recent years has been to combat money laundering and terrorism financing and, importantly, being recognised as having effective systems at a national level to do so.

The Financial Action Task Force (FATF) sets international standards that aim to prevent these illegal activities and the harm they cause to society. The FATF conducts assessments of countries’ anti-money laundering (AML) and countering of terrorism financing (CTF) regimes. The FATF’s country reports identify areas for particular attention, and countries which have significant shortcomings in their AML and CTF regime are identified as requiring enhanced monitoring (the grey list).

The UAE was placed on the FATF grey list in February 2022. Identified risks and shortcomings included the UAE’s proximity to conflict zones, its cash-intensive economy and role as a trading location for gold and diamonds, and its significant banking and real estate sectors. Issues were also raised with the level of regulatory understanding of the risk environment and how to address it. Subsequently major improvements were implemented in the country’s AML and CTF infrastructure and the level of prosecutions for breaches and regulatory scrutiny increased.

In 2024, the UAE was removed from the grey list. This is a positive sign, recognising the enhanced efforts by the government to prevent the country’s financial systems from being abused and to help prevent and detect financial crime including fraud. In particular, increased AML and CTF education and awareness in both the private and public sector will make corporates more alert to a range of potential wrongdoing and to prevent or report it promptly, limiting the damage that may arise.

One major challenge that remains in this area is the continued presence in Dubai of high profile foreign criminals and their valuable real estate, which they have acquired and which they may continue to occupy or take profits from. The last few years has seen a number of successful extraditions of individuals accused of serious crime outside the UAE but the perception remains that the UAE is a relatively safe place for a person fleeing justice abroad to live or invest. Combatting this perception would be a game-changing development for the nation’s profile as a legitimate investment destination.

Weaknesses in the accounting and audit sector have also contributed to the level of fraud in the region. There are various examples of companies in the Middle East operating fraudulently, for example by obtaining funds from new investors and diverting those funds to pay themselves or existing investors profits rather than to invest them as required. Such Ponzi schemes are often well hidden but a stronger audit and regulatory environment would help both to deter and to identify early such schemes.

Legislation vital for increased transparency

A key factor in any economy’s ability to prevent and tackle fraud and corruption is the transparency of business information. The Gulf Cooperation Council (GCC) states do not generally promote transparency in relation to the ownership of assets such as companies or real estate and accessing the information that is available is not straightforward.

For example, the UAE has, in addition to different company law arrangements across its seven distinct emirates – multiple free trade zones which provide incentives to companies to operate in specific sectors and which have different requirements in relation to the need to supply beneficial ownership information, director details and financial records in order for the company to be established and operate.

The authorities which operate these free trade zones also apply varying levels of scrutiny to the companies they host. Not only is the information held by these free zone authorities generally limited, but public access to such information is also heavily restricted.

The level of privacy available is attractive to individuals who operate legitimate businesses but will also naturally attract those who wish to conceal illegitimate activities or to allow beneficial owners with criminal records or who may be subject, for example, to foreign economic sanctions, to operate without detection. This is a key challenge for those seeking to understand who they are entering a business relationship with – without publicly verifiable records, much must be taken on trust.

Although it may be understandable and consistent with cultural norms that certain information is treated as confidential, the consequences of this lack of access to comprehensive company information is a key factor in the battle against fraud. Legislation to require transparency and public access would be a significant step forward, as would enhanced regulation by the many free zone authorities. This is clearly in evidence in some of the leading free zones, such as the Dubai International Financial Centre and the Abu Dhabi Global Market – the UAE’s two leading centres for international financial services and related businesses, which impose far greater disclosure and governance standards on the companies they host.

The UAE introduced value added tax in 2018 and corporate income tax in 2023. The new tax laws require companies to file tax returns. The financial information that companies will now be required to provide to comply with these tax laws will give the government significantly more information about taxpayers’ economic activities than before.

These new laws also require companies to put in place enhanced financial and document management systems to be able to prepare accurate tax filings. This will drive improved corporate governance and potentially help to prevent and detect fraud among many companies that were not previously concerned with tax matters (unlike subsidiaries or branches of large international companies).

Staying alert as online scams rise

The UAE is seen as a safe place to live and work. The absence of crime has undoubtedly been one of the lifestyle considerations that has helped to drive population growth. However, it is fair to question whether it has also led to complacency, in particular regarding financial scams and fraud. E-commerce has expanded rapidly in the Middle East and customers may have limited awareness of fraud risk in online transactions or the risk of connecting to public Wi-Fi to conduct them.

The hacking of online banking apps and contactless payment systems is also on the rise, as is the use of ever more sophisticated email-based phishing schemes in the Middle East, with Egypt among several other countries in the region having suffered significant problems in this area. Such fraud involves obtaining sensitive personal or bank account data by sending an email or making a phone call while masquerading as a legitimate colleague, bank official or businessperson who may be known to the recipient and who dupes them into providing their details, and results in theft of funds.

Many such emails or phone calls are easily identified as illegitimate, but fraudsters are learning rapidly and artificial intelligence (AI) is helping them. Faking phone calls using AI such that the recipient believes they are speaking to a known colleague or friend is a worrying advance in the fraudster’s armoury.

In Saudi Arabia there has been a significant increase in fraud in the financial sector as the financial services industry has itself grown rapidly in recent years.

Issues such as fake investment promotions, impersonation and internal fraud are perceived to be on the rise, combined with a lack of investment in anti-fraud systems and controls. In Kuwait, the Kuwait Investment Authority has recently issued warnings to the public about the misuse of its name in fake investment promotions and fraudulent attempts to obtain personal financial details. These issues demand attention and investment by businesses as well as greater public education about the risks.

One gap in the law in this context is the limited level of data protection law and enforcement in the Middle East. There has been a drive to improve this in the last two to five years across the GCC but it remains the case that personal data is treated with a lack of care or worse by many businesses, with limited if any sanction. Clamping down on this will help, although law and regulation will not be enough on their own. It requires all of us to be aware of the threat.

However the risks and the sophistication of fraudsters may evolve, there is one constant: people are both the weakest link and the first line of defence. We must all stay on the alert to detect and report attempted fraud if we and the businesses we work for are not to become victims.

Stuart Paterson is a managing partner at Herbert Smith Freehills LLP. He can be contacted on +971 (0)4428 6308 or by email: stuart.paterson@hsf.com.

Stuart Paterson

Herbert Smith Freehills LLP