Forensic accountants are the “CSI” teams of the financial world. They comb through a company's records, often with high tech tools that would be at home on any incarnation of the TV crime show.
They interview executives from the chairman to the shipping clerk to extract the facts from the rumors. They may not always look like David Caruso, but their purpose is eerily similar – to discover what someone is trying to hide.
More private equity firms are tapping forensic accountants at some point, either during the due diligence phase of a new acquisition or when signs of wrongdoing appear within the portfolio. But when and how should general partners pay for these specialized services? One could argue that every diligence process could use a forensic review, but such efforts are rarely cheap. So when, exactly, should a GP call in the CSI unit?
Transactions that involve emerging markets or that operate in multiple geographies are complex enough to warrant a forensic probe, say experts. Smaller private companies with shoddy or incomplete bookkeeping are also prime candidates. In addition, GPs are employing these teams as preventative measures, helping to review and establish processes at a portfolio company or even the firm itself, before any issue arises. For any of these efforts, buyout firms should vet forensic teams for the quality of their technology, the diversity of their staff and their investigative experience. Finally, the best forensic accountants will collaborate with a client on a work plan that acknowledges priorities, whether with regard to a timeframe or a budget. These projects tend to be fluid, as most clients rarely know if their inquiry will have simple answers or dredge up even more baffling questions.
So many countries, so little time
“You've got to respect the geographic complexity of the company in question,” says Brad Hillier, a managing director of KPMG's forensic practice. Hillier says that target companies active internationally with operations in multiple jurisdictions, especially within emerging markets, warrant a closer look. “It can be difficult for a buyout firm to conduct that type of diligence into the many records and people these deals involve.”
Hillier explains that companies in emerging markets can be connected with particular political interests that a firm may not want to be affiliated with, or conduct business in a way that runs afoul of the US Foreign Corrupt Practices Act of 1977 (FCPA). “Say you have a company in another country that paid a public official in some capacity, and in that country, it's considered standard practice,” he says. “But as soon as that company is owned by a US buyout firm, that same payment now risks fines under the provisions of FCPA.” Hillier notes that even with targets confined to developed countries, a firm's standard diligence team may not have the resources to study data and relationships in so many locales. “There's just a greater margin for error in these cases and we can help narrow that.”
Incomplete records or antique accounting practices are a concern no matter where a company's operations are, and are all too common among the targets of smaller buyout firms. “Smaller, private companies do tend to have less rigorous accounting and recordkeeping practices,” says Jeff Matthews, a national director of Grant Thornton's economic advisory services. “That's where we can step in and provide value, because it's very hard to know that something's broken without fully understanding what it looks like when it's correct.”
Several forensic accountants warn of records that seem to reflect no period of fiscal difficulties. “Every business has peaks and valleys – periods that involved bad debt and poor performance, even fraud,” says Matthews. These experts explain that any element of the balance sheet that doesn't add up should be room for concern. “When a [buyout] firm detects account balances that appear to be going awry or maybe vendor/supplier relationships that don't make sense – that's good reason to dig deeper,” says Greg Peterson, a partner with the transaction services practice of PricewaterhouseCoopers.
These days, more and more GPs are reaching out to forensic accountants even before any such anomalies appear in the portfolio or at the firm itself. “Private equity firms used to be small, agile teams,” says Hillier. “Now they're complex organizations that are inspiring regulatory attention, so they're looking at us to advise them on corporate governance and risk management issues.”
Both private and publicly listed funds are consulting forensic teams to develop the internal controls to prevent worst-case scenarios. “Even if the various money laundering statutes don't apply to private equity yet, the astute private equity fund is looking to establish a process for background checks and other enterprise risk management and internal audit functions,” says Ted Martens, a partner with the advisory services of PricewaterhouseCoopers.
“Some examiners have a predetermined set of questions, ask them, but don't listen to the answers before they're on to the second question.”
In truth, many private equity firms haven't even established advanced accounting systems for themselves. “We were talking to a big private equity firm that had never had corporate credit cards or an expense policy,” recalls Hillier. “People were paying for their expenses, and then the firm would pay them back. Now they want greater visibility on what their teams are spending their money on.”
Hillier finds that such efforts translate all the way down to the portfolio level. “Reviewing their own policies then gives them a framework from which to assess their own portfolio companies in this respect, to ensure the right tools and processes are in place to detect fraud,” he says.
Vetting the skeptics
Good forensic accountants have three core attributes: a diversity of skills within the team; in-house technology that can gather and analyze data; and investigative experience.
“Experience counts,” says Peterson. “You need to know that a team has conducted the type of investigation you're about to launch.” Given the confidential nature of such projects, a forensic team may not have a list of former clients, but there are other ways to judge their investigative experience.
“There is an art to asking questions,” says Matthews. “Some examiners have a predetermined set of questions, ask them, but don't listen to the answers before they're on to the second question.” Matthews suggests asking the proposed examination team about their interview procedures, such as how inquiries are made, what is done to ensure a creative approach during the sessions, how data is compiled and how follow-up is conducted.
A team's collective investigative experience should span a wide range of disciplines, from IT to law enforcement, from accounting to auditing. “In many ways, forensic accounting is about combining the advanced skills of an accountant, auditor or investigator,” says Matthews, “Since the greater variety of perspectives, the greater the chance for finding that hidden detail.”
Martens explains that as PwC's practice evolved it drew on auditors like himself, people with law enforcement backgrounds from the FBI or US Attorney's office, and finally computer science experts. “[These experts] allow us to process large volumes of data that we have at out disposal, which results in a more effective process,” says Martens. Many forensic teams stressed that their software and systems were vital to the success of any investigation.
“With so much information being digital today, if you don't have the ability within your practice to extract and study data electronically in an efficient manner, you're going miss a lot, or be very expensive,” says Hillier.
Most GPs aren't particularly tech savvy, but the forensic teams suggest asking how many members of the team are IT experts, and ask about the capabilities of what technologies they do use. “Our [tech] systems strip the info from a general ledger and sense patterns that are taking place, and we've got solutions that can search email databases with very specific criteria,” says Martens.
Hillier adds, “After interviewing your third forensic team, you'll find that one of the groups will make technology a real priority, with in-house tools and expertise.”
Follow the money
Even the most rigorous forensic accountants admit that it's hard to predict where an investigation may lead. As a result, the best teams will work closely with the client to develop a work plan with clear priorities. If there is a time constraint, the team might apply more resources to meet the deadline, or vice versa, if there is sensitivity on price, a project can be stretched over a longer period of time. However, there remains an X factor to all investigation that can quickly change the nature of the search.
While an incident involving a low-level employee may involve thousands of dollars, in most cases it would be isolated to that individual. By contrast, however, Hillier says a simple review that uncovers questions about how a CFO is handling his expenses could lead to larger questions about the integrity of his work which touches every aspect of the organization. “Suddenly we're reviewing multiple accounts and the parameters of our work have expanded considerably,” he says. “You've got to understand the allegation and develop a work plan that includes room for how it may develop.”
Many accountants explain that most clients remain open to expanding mandates, so long as the intelligence is good. “Work plans may change with circumstances, but our findings should always reflect the quality of our work,” says Peterson. Though in an ideal world, those findings would always be a slim volume proving all those doubts were unfounded.