Remain vigilant against fraud to avoid financial ruin, say experts

08 October 2020 Consultancy.asia

As businesses face heavy pressures due to the global economic downturn, companies and their stakeholders need to remain vigilant against fraud to avoid financial ruin, say experts from leading global consulting firm Alvarez & Marsal.

The global economic downturn is seeing more instances of fraud coming to light and some of these are leading to corporate collapses. The biggest problem is management fraud – often complex and destructive to businesses, it is no surprise that many companies do not survive the damage it causes. 

Chris Fordham, a Managing Director in the Disputes and Investigations practice of Alvarez & Marsal comments: “Management fraud involves not just simple meddling with expenses.” Management fraud often consists of elaborate schemes operated over many years by various stakeholders and key management colluding to hide the true position. 

Chris Fordham, Eddie Middleton, Alvarez & Marsal

“This type of fraud can eat into the roots of an organisation and jeopardise the whole business. As seen in the cases of Enron, China Forestry and Wirecard, billions of dollars can go missing in such fraud scandals,” said Fordham. According to the ACFE’s Report to Nations 2020, fraud committed by owners and executives cost $600,000 on average, which is much higher than the average for employee fraud, at $60,000. 

“The huge losses can be a knock-out blow and this explains why in many such cases, businesses head into financial difficulties and need to either restructure or liquidate,” says Fordham.

Although the least common (occurring in only 10% of cases), the most costly type of fraud is financial statement fraud schemes, which cost $954,000 in median losses; approaching 10 times worse than the median for the most frequent fraud of asset misappropriation.

Getting back on track

Once discovered, the consequences of fraud, observes Eddie Middleton, a Managing Director in Alvarez & Marsal’s Restructuring and Insolvency practice, will be immediate and can be ruinous, “the first casualty is always trust. All hell breaks loose as lenders, business partners, regulators and law enforcement all descend on the company demanding answers.”

“Financially, the consequences will be immediate as, suddenly, the company finds itself unable to access credit lines and, very often, existing lenders are calling an event of default and demanding immediate repayment. Liquidity suddenly becomes very tight and the company, out of nowhere, is embarked on a fight for survival.” 

That fight typically involves a financial restructuring, either by consensual negotiation or, if that cannot be achieved, through an insolvency process. For companies, says Middleton, “the starting point for a consensual restructuring has to be rebuilding trust. The watchword here is transparency, both in revealing the scale of the problem and in the conduct of the restructuring process.”

“Creditors, regulators and the like will expect the company to undertake a number of steps, including the appointment of a special committee, supported by lawyers and forensic accountants, to investigate the wrongdoing, and independent financial restructuring advisers in whom the aggrieved stakeholders can have confidence.” 

According to Fordham, “the real key to preventing, detecting and/or deterring management fraud lies in being prepared. Businesses should be vigilant, and this includes engaging experts with relevant know-how to assist and advise them in navigating the challenges.” 

From the investors’ perspective, they should conduct thorough due diligence and fully understand the business before investing. Upon investment, there should be continuous monitoring of a company’s performance throughout the investment life cycle to detect any red flags.

Middleton added that “liquidators and forensic experts should work as one team to achieve an efficient and effective outcome. At Alvarez & Marsal we embrace this practice, and this means we quickly get to the heart of issues and resolve them swiftly.”