EU auditors: 'Blacklisting is underused in protecting EU funds against fraud' 

EU auditors: 'Blacklisting is underused in protecting EU funds against fraud' 
Credit: ECA

Blacklisting is not used effectively to prevent EU funds from being paid out to individuals, businesses or public organisations involved in illegal acts such as fraud, corruption and other irregularities according to a new report on Monday by the European Court of Auditors.

Blacklisting – or exclusion – is a key tool that governments and international organisations use to protect their finances. According to the EU watchdog (ECA), it is widely used by for example the US federal government and the World Bank. In the EU, a system for an early detection and exclusion system (EDES) was introduced only in 2016.

The system operates only at EU level and aims at flagging risky counterparties to those responsible for authorising the spending that the Commission manages directly or with partners. The EDES does not apply in the structural funds, e.g., agriculture and cohesion, which are under shared management by the Commission and the member states and account for ca 74 % (€111 billion) of annual EU spending.

“Blacklisting can help ensure that EU funds do not fall into the wrong hands, but it is not being used effectively: we have a patchwork of different approaches to exclusion at EU and Member States level,” said Helga Berger, the Austrian ECA member in charge of the audit. “A system is only as good as the information fed into it,” she added.

The audit covered the period 2016-2020. The audit team focused primarily on assessing whether the EDES operated effectively in direct and indirect management by the European Commission and its implanting partners.

As regards shared management, the team reviewed the arrangements in Estonia, Italy, Poland and Portugal. The four member states were selected to reflect the diversity of approach with respect to the management of public funds. In addition, the team compared the EDES to the exclusion systems of the US federal government and the World Bank Group, which were visited before the outbreak of COVID-19.

The Commission’s Internal Audit Service (IAS) identified already in 2018 shortcomings in EDES but the new audit goes further and deeper, the audit team told The Brussels Times.

“Our audit covered the results of the operation of the EDES up until the end of 2021 and we have analysed data from different sources. We highlight that few counterparties have been excluded in practice and explain why we think that is the case. Another crucial difference is that we also cover the exclusion obligations and arrangements in member states that was not part of the IAS audit.”

ECA concluded that the current patchwork of exclusion arrangements undermines the overall effectiveness of blacklisting and results in uneven protection of the EU budget across Europe.

On the positive side, the auditors found that EDES despite some limitations has robust decision-making procedures and includes a broad range of situations in which counterparties should be blacklisted. In practice, it has hardly been used by the Commission.

Out of 448 counterparties named on the EU blacklist as at the end of 2020, all but 18 had been excluded due to insolvency and bankruptcy – and are therefore unlikely to apply for EU funds again anyway – and only two due to fraud and corruption. Only two cases related to fraud and corruption and no case to financial irregularity.

US federal government excludes over fifty times more counterparties than the EU does under the EDES. The relatively low exclusion rate for EDES indicates that there may be shortcomings in the EU’s arrangements for identifying counterparties in exclusion situations, according to ECA.

One main reason for the low exclusion rate are shortcomings in the communication between the Commission’s authorising officers, who are responsible for grant and tender decisions, and the EDES panel. Another shortcoming lies in the reporting of cases to and from the Commission’s antifraud office, OLAF, because of lack of clear guidelines or procedures.

But even where relevant data exists at EU level, for example on fraud investigations, it is not always used or usable. In addition, the Commission relies too much on the declarations of those applying for grants or offering services in tenders: if they declare that they are not in any exclusion situations, the Commission simply accepts their claims without vetting them.

What can the EU learn from other exclusion systems to improve EDES?

“The US system benefits from applying to all types of federal government spending,” ECA member Helga Berger replied to The Brussels Times. “US contract managers also have an effective tool for identifying whether counterparties are in an exclusion situation. That is why we recommend extending the EDES to cover shared management expenditure and improving the availability of data.”

Irregularities are one of the exclusion grounds and much more common than fraud but appear not to be sufficiently reported to OLAF and figure hardly in the black list. How do you explain this?

“Irregularities, such as serious breaches of contract, can lead to exclusion, irrespective of whether there was fraud involved. The Commission is responsible for notifying OLAF of irregularities, where it suspects there may have been fraud. We found the low level of exclusion based on irregularities surprising given the number of irregularities identified during the period.”

Helga Berger blames the situation on the lack of awareness on the part of the authorising officers. The Commission has also not been centrally monitoring the use of irregularities to identify excludable counterparties. “That is why we recommend that the Commission should promote the use of the EDES and strengthen corporate monitoring of the follow-up given to irregularities.”

Was the set-up of EDES in 2016 proof of that the use of self-declarations could not be trusted?

 “The main reason for introducing a system like EDES is that the results of checks by one authorising officer can be relied on by others. If one authorising officer identifies and ‘blacklists’ an untrustworthy counterparty in their area of spending, then that counterparty can be excluded from receiving spending in areas managed by other authorising officers.”

In addition, the Commission’s key goal in setting up the EDES was to strengthen respect for counterparties’ fundamental rights in the exclusion procedure to address legal issues with its predecessor, the “Early Warning System”.

The normal principle of cost-effective control is to “trust but verify” self-declarations. If applicants do not believe that self-declarations will be checked, then the risk is that untrustworthy counterparties will apply for EU funds on the basis of false declarations. Over-reliance on self-declarations without control defeats the purpose of setting up EDES a system like the EDES, she explained.

Why did EDES did not cover shared management from the very start?

“As we understand it, the Commission originally proposed an exclusion system covering all areas of the EU budget. As our audit shows, EU member states have not traditionally used blacklisting systems like the EDES as part of their financial arrangements. The principle in shared management is that member states should manage EU funds as diligently as they manage national funds.”

Asked for figures on potential savings if EDES would had been used effectively, Helga Berger replied that such an analysis was not feasible in the audit because the necessary data is distributed widely in EU and national data bases are not readily accessible or interoperable. An estimate of savings would have been very hypothetical, especially as a good exclusion system has also a preventive effect by deterring others from applying.

“That is the basis for the audit recommendation about the need to improve the tools and data available for identifying counterparties in an exclusion situation. This will be a long-term process where progress will need to be made step-by-step but should start as soon as possible.”

Currently, there is no way of knowing if the few beneficiaries that were blacklisted by the EU have received EU funding by member states after the blacklisting. “There is no single list of recipients of EU funds against which we could check EU funds under shared management. But we found that counterparties, once excluded, are unlikely to receive further EU funds in direct management.”

In theory, if EDES would apply also in shared management, then the Commission would be able to exclude also the persons receiving money in the member states, which currently is not the case.

Member states would not be able to give EU funds to recipients blacklisted in EDES - it would not matter whether the excluded recipient had applied for or received EU funds from a spending programme directly or indirectly managed by the Commission or from a member state implementing a shared management spending programme. But it too early to speculate at this stage how EDES would be used in the member states.

The cost-benefit issue

The lack of figures on the costs of extending EDES and potential savings explains why Brian Gray, a former Director-General and head of the internal audit (IAS) at the European Commission, finds the report difficult to assess. “The ECA report is no doubt factually correct, but is disproportionate,” he told The Brussels Times.

“The cost-benefit issue is not addressed in the audit. Fraud as opposed to irregularities, such as failure to comply with a condition of a grant, is a very small proportion of EU funds, as the ECA finds itself in its annual financial audits. The error rate is relatively small and only a minimal number of detected errors are suspected fraud cases reported to OLAF.”

He thinks that even if EDES would be extended the benefit will be rather small and refers to the previous early warning system when exclusion was difficult to apply. “Under the principle of innocent until proven guilty, a conviction of fraud takes years before a final judgement is reached after all appeals. Until then, any entity placed on an exclusion list can successfully appeal and claim damages.”

Another point is the impact on EU’s reputation. “Getting off the EU-wide register may take years of expensive legislation. The EU is already unpopular, and such ‘Big Brother’ proposals would make things worse. In any event, a full and equal application of EDES and definition of key concepts in all member states is unlikely. In agriculture, they are already required to exclude beneficiaries who make irregular claims “

“ECA is making a mountain out of a very valid molehill,” he concluded.

Positive Commission response

Despite the severe findings, which the Commission tended to play down in its formal reply to the audit report, the audit ended on a positive note with the Commission accepting all audit recommendations.

“The Commission was very cooperative throughout the audit,” Helga Belger says. “Like us, I think that they saw that our special report could provide valuable information and insight relevant to the stakeholders involved in the legislative process for a recast Financial Regulation. I think our report provides convincing evidence and argument for improving EDES and extending its scope.”

A Commission spokesperson confirmed to The Brussels Times that the Commission will now study the report in detail. “Protecting the EU budget and making sure that every euro is well-spent has always been a Commission’s top priority. To further strengthen the protection of the EU budget, the Commission proposed on 16 May 2022 to reinforce the EU financial rules, the Financial Regulation.”

The Commission also promises to work hand in hand with the European Parliament and member states in the Council towards a swift adoption of a revised financial regulation.  “If implemented, the change on EDES will fully address the criticisms of ECA as expressed in its report.”

Among others, the Commission will propose to address the need of an enhanced protection of the Union’s financial interests at EU level, via a targeted and proportionate extension of EDES to shared management, while respecting the primary responsibility of the member states in sanctioning and investigating such cases at national level under shared management.

However, exclusion at EU level would be possible and necessary where the member states notify the Commission of any exclusion situation concerning the most serious misconducts (fraud, corruption, etc) established in a final judgment or final administrative decision.

Under the new proposed rules, it will also be possible to target new categories of subjects, when falling in one or more exclusion situations, such as beneficial owners, affiliated entities and natural persons with power of control, management or representation.

Update: The article has been updated to include  comments on the cost-benefit issue related to the audit recommendations.

M. Apelblat

The Brussels Times

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