A downturn in profit often equals a commensurate rise in fraud. Samantha Bewick and Janice Edgar examine the modern role of insolvency professionals in
rooting out deception
Cheap money and the debt bubble concealed many problems around the globe. One of these was fraud. Fraud was there during the boom times, but no one had a great incentive to look for it. However, it has eroded the ability of many viable businesses to survive the downturn. Now, when every penny counts and people are using a more sceptical eye to view transactions, frauds has come into focus.
With the increase in economic stress and distress, many more companies are consulting restructuring practitioners. Where possible they seek to avoid an insolvency process, but irregularities and fraud may hinder this.
Cashflow is the lifeblood of companies in distress, so any unnecessary bleeding must be stopped. However, before a detailed examination takes place, some more general questioning of the patient is usual:
- How much fraud has occurred in the past? ‘None’ is the most worrying answer.
- Does the company have an effective whistleblowing line? This is the most common way of detecting fraud.
- What is the board’s policy towards fraud? What controls were put in place, and are they working?
- Is procurement organised centrally or is it treated as ‘shopping’?
Areas of concern could be:
- Is there one very dominant individual who can enforce their will on the company? Forensic accountants can review transactions if they seem irregular.
- Creditor payments – are all creditors genuine? Of particular concern is where they supply something intangible, such as unspecified ‘services’ or are connected to the company’s personnel.
- Does the finance director work long hours with no support? Does the cashflow make sense? Why does profitable trading not generate incoming cash?
- Are the auditors appropriate to the company and sector? A sole practitioner is unlikely to be appropriate for a global group.
Sectors where a restructuring professional should have heightened awareness of fraud include cash-based businesses, where there may also be a money laundering risk; regulated businesses, such as, but not limited to, those in the financial sector; and companies that operate in countries where fraud or commission payments are endemic. One should also, of course, be alert to convicted fraudsters and directors involved with previous insolvencies – although it is advisable to proceed with caution in respect to directors of private equity or venture capital companies, where a proportion of investments fail regularly.
The insolvency practitioner
Where a company cannot avoid insolvency, the insolvency practitioner’s (IP) aim is to realise the assets for the benefit of creditors. The IP starts with the statement of affairs, which lists the assets. The directors prepare and swear this. The immediate risk the IP faces is that the directors may exclude assets that may not otherwise come to the IP’s attention or that certain creditors are overstated. The Insolvency Act 1986 gives powers to investigate transactions and compel the provision of information.
The sort of warning signs that an IP looks out for could include:
- overly optimistic statements made to suppliers, customers (especially where deposits are involved) and to markets;
- continuing to trade when insolvent;
- failure to deal with client monies correctly;
- large payments made without proper justification;
- sale of assets to connected parties;
- credit taken just prior to insolvency; and
- washing funds and/or assets around a group, including into offshore companies.
In such cases an effective approach is to involve specialist forensic accountants working with the IP. Their expertise is in extracting relevant information from a company’s records to give an IP possible rights of action to boost the assets recovered for the creditors. This can include asset tracing, which involves the use of corporate intelligence and other forensic professionals.
Insolvency provides the forensic team with distinct challenges. Often the company’s records are disordered, incomplete or held by a third party. The involvement of the forensic team at the planning stage allows access to IT staff, giving an accurate picture of the information to be collected. The
team can target this once the IP has been appointed. However, Section 236 of the Insolvency Act will assist if the team is not involved until later.
Because insolvency usually requires redundancies, it is inevitable that some people the forensic accountant may wish to interview will have left. This knowledge gap can, however, be bridged, as the forensic team can reconstruct the corporate memory from information available electronically. This may be more reliable than relying exclusively on individuals, not all of whom may tell the truth.
When a company is stressed or distressed, the techniques of forensic accountants can help to provide the IP with relevant information for the benefit of creditors. This is a valuable option in the toolbox of any restructuring or insolvency practitioner.
Samantha Bewick is a director in restructuring and Janice Edgar is a senior manager in forensic at KPMG