The common pattern
With insolvency within companies commonplace it comes as no surprise to find
that, when analysed, the classical investigative auditing goals in insolvency
cases fall mainly into three fields:
► Investigations of irregular
activities by managers or employees of the company in the pre insolvency era,
which caused dilution of funds or assets of the company.
► Investigations of
possible fraud committed by clients or suppliers in respect of the company in
the pre insolvency era
► The tracing assets that belonged to the company and
disappeared in the final stages of the company closure before insolvency or even
beforehand.
In liquidation and receivership investigative auditing situations, we often find
that funds have disappeared before the onset of insolvency.
In such cases, the
main problem is locating all of the bookkeeping, documentation and recovering
the computer files of the company.
The investigative auditor might also come up against the company being used for
money laundering and would therefore have to be capable of spotting such
characteristic transactions.
The insolvency practitioner and the Investigative Auditor should map the
Company’s circles, controls and spheres of responsibility and should
particularly consider the wealthier ones as a source for reimbursement.
Such circles and spheres can include the following:
► Employees – usually have a full
knowledge of any wrongdoing in the Company.
Their willingness to cooperate with
the insolvency practitioner and the Investigative Auditor is based on the
immunity they will receive and sometimes on the reward they may expect.
► Managers – In Management Fraud cases
they are usually the main group that committed the fraud or collaborated with
the fraudsters.
In Corporate Fraud cases we usually find the fraud was committed
by one manager or a small group of employees.
► Suppliers – include banks and may
also include invoicing practice and overcharges by creditors.
Issues of
bartering and factoring might be of considerable interest to the Investigative
Auditor as a source of tracing irregular activities.
► Customers – some might be debtors
and will usually come up with payment disability excuses, some of which will be
genuine.
► Advisors – can sometimes be the
masterminds of the fraud, but are usually not part of it.
They earn their money
from their fees.
► Auditors – both internal and
external, may have a responsibility for not spotting the fraud when it occurred
or for lack of control that could have prevented the fraud in the first
instance.
The first phase of Investigative Auditing is based on
strong computer abilities and at times state-of-the-art IT tools, in order to be
able to trace, recover and analyse the computer files of the Company.
These files include book-keeping files and it is
important to be able to extract the relevant file from the millions of data
items.
We see that in many cases the insolvency practitioner neglects the
investigations if he does not see financing from the creditors or from the
insolvency’s own sources.
In other words, the insolvency practitioner will
usually look for convenient earnings rather than elaborate proceedings with no
definite incomes.
Most insolvency practitioners may be deterred by the
fact that in this kind of case, a positive outcome from the Investigative
Auditing might take years.
The investigations by the Investigative Auditing team
under the supervision of the insolvency practitioner may be tiresome and
expensive and involves not only tracing the assets of the fraud, but also the
need to recover the assets and the damages caused by the fraud.
It may involve an expensive and long legal procedure
and if the assets or the people involved are in foreign jurisdictions or areas
not common to the insolvency practitioner this, too, may deter him from
commencing with the whole issue or in some cases, stopping the investigation
midway.
In one of the cases conducted by the Investigative Auditing team, the
shareholder who committed a major fraud in the Company involving missing funds
of over £80,000,000 is still at large in an Eastern European country.
he legal proceedings that started about seven years
ago are far from over in spite of the fact that the Investigative Auditing team
proved in Court that the shareholder committed the fraud and caused the Company
insolvency.
In this specific case a small European bank that was
the main creditor went insolvent.
This complicates the situation as the insolvency
practitioner received no financial support from the creditors to conduct the
Investigative Audit and the legal proceedings that followed.
Another problem that often arises is when the
insolvency practitioner lacks the skills to conduct an efficient Investigative
Audit, but will try to do so anyway.
We have seen cases in which insolvency practitioners
sent a list of questions to the suspects which exposed his knowledge and the
directions of the investigations and gave the suspects enough time to build a
version and to destroy relevant and critical documentation needed for the
investigation.
The growing trend – IP fraud
However in some cases, although rare, a fraudulent activity can be found within
the UK insolvency industry in which Insolvency Practitioners collude with their
appointers to defraud a company and its creditors.
Unfortunately this is
becoming far more commonplace due to the lack of proper control over the
insolvency practitioner and his reports.
The main ongoing problem in such
wrongdoings is the lack of control of large sums of money under the direct
control of the insolvency practitioner.
In spite of the fact that large amounts
of money are involved, tax authorities often lack the control mechanism to avoid
misuse of the funds.
The main frauds discovered by Investigative Auditing teams involve elaborating
the following advantages that can be used to commit fraud under the insolvency
status.
Insolvency is a practical way to get rid of companies’ heavy debt
burdens but yet manage to maintain the assets.
For example, selling an insolvent
company to the same company’s shareholders at a low price, under the approval of
the Court, allows the owner to get rid of the debts, while paying only a
fraction of the sum to the creditors.
Furthermore, the division between the creditors is sometimes vague and the
procedure of verifying the size of the debt is solely in the hands of the
insolvency practitioner, and the decision of if and what to investigate is
purely in the hands of the insolvency practitioner.
He can decide the scope of
the investigation and who to investigate and can stop the investigation at any
stage.
In addition, the insolvency practitioner decides on the allocation of expenses
of the insolvency practice, for example legal advisers’ fees.
Although the Court will scrutinise these expenses, it usually accepts the
insolvency practitioner’s advice.
Examples for the above:
► Making a deal with the
fraudsters for paying one of the creditors outside of the insolvency.
The creditor receives his money while no cash flows to the insolvency.
The insolvency practitioner gets his fee directly from the creditor. All the
other creditors receive nothing.
► Selling the assets back to the
owners through the Court. The Court is not aware of the true identity of the
buyer.
When sold through the Court the assets are free of any obligations or creditors.
If we look at figures from one case we see:
Total worth of assets sold: £ 4.5 million
Debts: £ 6 million
Assets sold for: £ 1.5 million
Apart from his own fees, the insolvency practitioner receives £500,000 from the
buyers who are also the owners of the Company, before the insolvency.
► The insolvency practitioner
sells assets of the Company for £2 million, but uses most of the money on
consultants, lawyers and auditors who will hire him in future cases or refer
other insolvency work to him.
► A private Company receives
loans from banks and is defrauded by its owner and later becomes insolvent. The
insolvency practitioner sells the assets of the Company and does not conduct any
investigation against the shareholder. The insolvency practitioner’s firm is
later hired by the same shareholder in another business owned by him.
► A creditor makes a false claim
for double his debt and receives the IP’s approval. When the insolvency monies
are paid, the creditor receives 70% of the money paid to the creditors. As
mentioned such activities are rare and are not typical only in the UK. We see
such cases in Central and Eastern European countries with a much lower level of
sophistication as the control over the insolvency practitioner in these
countries is much weaker.
► The insolvency practitioner
spends money from the insolvency’s funds without taking the trouble to verify
with the court the validation of the expenses. It is then no surprise then the
court does not approve retroactively of actions taken by the insolvency
practitioner. In such cases the insolvency practitioner will be obliged to cover
the expenses.
► The insolvency practitioner
can hide the insolvency’s incomes by arranging falsified reports to the official
receiver. On his part the official receiver frequently does not closely
supervise reporting made by the insolvency practitioner.
► Preferring of creditors may
commonly cause irregularities on two levels. First, and primarily on a
professional basis in which mistakes may occur because of negligence or
insufficient knowledge of legal procedures. Once again the court does not
function effectively as a check point and the failure will probably show up
after the distribution of some form will have already been made. Secondly, the
preferring of creditors may take place in a manner of not good faith which might
favor the insolvency practitioner’s future interests, in disguise of routine
reasoning.
► A clear example of
mistreatment by an insolvency practitioner was a case in which the insolvency
practitioner did not detect the company’s computerized bookkeeping because of
incompetence in accounting skills.
As a result of this the insolvency practitioner was never able to put his hands
on company’s assets purchased nearby the insolvency occurrence.
The insolvency practitioner didn’t try tracing assets through alternative
documentation and settled down with the superficial information gathered.
Moreover the insolvency practitioner did not detect the emptying of the company
by the way of ordinary and credit card withdrawals, after the insolvency had
already begun. Finally personal shareholders’ debts were not collected because
of insolvency practitioner’s tarrying.
► An insolvency practitioner’s
mistreatment can often be seen through ambiguous and inconstant reporting.
Another hint to misconduct is the non-performance of proclaimed investigations
and insolvency practitioner’s ambition to rush into peculiar settlements.
We frequently see that different legislation in different countries produces the
same outcome and indicates the lack of control by the Court or the creditors
over the insolvency practitioner’s proceedings regarding assets under his
responsibility, even if only as a kind of trustee.
Insolvency Practitioners seem unaware of a new danger that could result seeing
them criminally prosecuted.
Practitioners are of course aware of their duty to investigate and make reports
on the directors conduct both for disqualification purposes and in respect of
improper conduct, but the recent reporting obligation of the Money Laundering
and Proceeds of Crime Acts could see insolvency practitioners failing foul to
the law.
In order to comply with the new legislation, insolvency practitioners will be
required to maintain the company’s accounting and other records intact as they
may be required for future prosecution purposes.
An insolvency practitioner that losses valuable evidence on fraud or money
laundering could be prosecuted if a crown case is prejudiced.
Many insolvency practitioners’ fail to realize that a computer system is the
heart and sole of a company, and in addition to accounts preparation is also
used as a mean of communication.
As such it should be treated with the highest degree of diligence.
Upon his appointment the insolvency practitioner should secure the IT systems of
the company, and prepare a back up that will be kept in a secure location.
The importance of the computer system is often overlooked because of the limited
monetary value of second hand computers, and therefore it is either sold to
agents or sold back to the management.
What many insolvency practitioners fail to realize is that IT forensic experts
can obtain useful information out of the computer system.
Even if the computer system has been previously deleted or lies dormant in the
hard disc, an IT forensic expert will extract “water from the rock”.
Such information may include letters or emails detailing trading difficulties or
the setting up of phoenix companies.
Yehudah Barlev is a
renowned expert in the field of investigative auditing.
Source:
Credit Control Journal
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