Foren­sic au­dit biz soars as firms head for bank­ruptcy

Business Standard - - FRONT PAGE - ASH­LEY COUTINHO Mum­bai, 22 Jan­uary

Foren­sic de­part­ments of large au­dit firms and in­de­pen­dent in­ves­ti­ga­tion agen­cies have been in­un­dated with re­quests for foren­sic work fol­low­ing the push to clean up the bad debt mess un­der the In­sol­vency and Bank­ruptcy Code (IBC).

Ac­cord­ing to some es­ti­mates, the foren­sic busi­ness linked to the IBC has more than dou­bled in the past few months, and ex­perts be­lieve it will only in­crease. The work pri­mar­ily in­cludes do­ing back­ground checks on pro­mot­ers, as­set searches, ver­i­fi­ca­tion of cred­i­tors, and foren­sic mon­i­tor­ing of cash flows. For big ac­count­ing firms, this is the ic­ing on the cake as they are al­ready work­ing on bank­ruptcy cases as in­sol­vency pro­fes­sion­als.

Checks on pro­mot­ers

Back­ground checks on pro­mot­ers have surged af­ter the re­cent amend­ment to the In­sol­vency and Bank­ruptcy Code (IBC). This stems from con­cerns that pro­mot­ers or their al­lies might try to buy back the com­pa­nies at a dis­counted value through proxy in­vestors. This is es­pe­cially true when the bid­ders are over­seas en­ti­ties or come from a seem­ingly un­re­lated in­dus­try.

“We are be­ing asked to do checks on the back­ground and link­ages of bid­ders in the ma­jor­ity of cases,” said Reshmi Khu­rana, manag­ing direc­tor and head of South Asia, Kroll. “A thor­ough as­sess­ment of the back­ground of bid­ders, their in­tent, source of funds, and past track record has be­come crit­i­cal for the banks while selecting the buyer.”

The con­nected par­ties’ def­i­ni­tion un­der the amended IBC is quite ex­haus­tive, and the onus is now on in­sol­vency pro­fes­sion­als and the committee of cred­i­tors to abide by the re­quire­ments and carry out the nec­es­sary diligence, ex­perts say.

“Sev­eral In­dian com­pa­nies work through a maze of sub­sidiaries and as­so­ciate com­pa­nies that have com­plex cross-hold­ing struc­tures and mul­ti­ple di­rec­tor­ships. Also, sev­eral com­pa­nies of­ten do not dis­close who the re­lated par­ties are, even in an­nual re­ports. This makes it dif­fi­cult to as­cer­tain who the re­lated par­ties are,” said Vikram Bab­bar, part­ner, fraud in­ves­ti­ga­tion & dis­pute ser­vices, EY In­dia.

Ac­cord­ing to ex­perts, there have been in­stances in the past when back­ground checks have helped iden­tify si­phon­ing off large funds through dummy or shell com­pa­nies and the in­fu­sion of pro­mot­ers’ eq­uity by round-trip­ping of bor­row­ers’ or bankers’ funds.

Foren­sic ex­perts have also iden­ti­fied fake cus­tomers and ven­dors who un­der­take fi­nan­cial trans­ac­tions to in­flate fi­nan­cial state­ments.

“Both bankers and IRPs (in­sol­vency res­o­lu­tion pro­fes­sion­als) want to un­der­stand trans­ac­tions with re­lated or con­nected en­ti­ties that may be used for as­set strip­ping, di­ver­sion or si­phon­ing,” said Su­veer Khanna, part­ner - spe­cial sit­u­a­tions Group, KPMG In­dia. Added Ra­jesh Jhun­jhun­wala, an ex-banker­turned-in­sol­vency pro­fes­sional: “We are reach­ing out to tech com­pa­nies that sur­vey so­cial me­dia and firms that ver­ify de­tails such as ad­dress proof, pan card de­tails and credit pro­file.”

The process of con­duct­ing back­ground checks on pro­mot­ers can take three to six weeks de­pend­ing on the depth of in­for­ma­tion re­quired. Foren­sic ex­perts typ­i­cally ap­proach in­sol­vency pro­fes­sion­als for in­for­ma­tion af­ter first scour­ing through pub­lic data. This is fol­lowed up with field checks on spe­cific en­ti­ties in­volv­ing site vis­its and in­ter­ac­tions with key ven­dors and sup­pli­ers. Com­mon di­rec­tor­ships, past le­gal cases and ben­e­fi­cial own­ers also help in iden­ti­fy­ing link­ages with pro­mot­ers.

“We don’t need to find a direct link. Of­ten, lack of suf­fi­cient in­for­ma­tion on the bid­der’s back­ground, source of fund­ing, and track record is enough to deter banks from con­sid­er­ing them,” said Kroll’s Khu­rana.

As­set searches

In the event of de­fault, it is not un­com­mon for pro­mot­ers to claim bank­ruptcy when banks try to en­force the pro­mot­ers’ per­sonal guar­an­tees. Un­de­clared as­sets can be at­tached by banks; even as­sets with an in­di­rect link can be used to put pres­sure on com­pa­nies to re­pay. So, it has be­come crit­i­cal for banks to iden­tify hid­den un­en­cum­bered as­sets of dis­tressed com­pa­nies and their pro­mot­ers.

“The idea is to iden­tify the po­ten­tial ap­pli­ca­tion of funds which may have been di­verted from any en­tity. Typ­i­cally, a sig­nif­i­cant part of such funds will be in­vested in land, real es­tate or other phys­i­cal as­sets,” said Samir Paranjpe, part­ner, Grant Thorn­ton In­dia.

Iden­ti­fy­ing hid­den as­sets can be chal­leng­ing as as­sets are of­ten held through proxy own­ers, which can­not be linked back to the pro­mot­ers. The prox­ies may in­clude cur­rent and former em­ploy­ees, close con­fi­dants of the pro­mot­ers and even their mi­nor chil­dren or older par­ents.

“The glob­al­i­sa­tion of busi­ness and the ever-ex­pand­ing world of off­shore fi­nance means that it can be rel­a­tively easy to set up com­plex cor­po­rate struc­tures to hide the true own­er­ship of as­sets,” ob­served Khu­rana. Ac­cord­ing to Khanna, in­for­ma­tion shar­ing across coun­tries can be a chal­lenge, which is why foren­sic ex­perts rely on global data­bases, to the ex­tent in­for­ma­tion is pub­li­cally avail­able.

Sweet­heart deals

Trans­ac­tions specif­i­cally re­lated to the IBC sec­tions 43, 44, 45, 46 and 66 are be­ing looked at by foren­sic ex­perts. These sec­tions deal with iden­ti­fy­ing pref­er­en­tial and un­der­val­ued trans­ac­tions, and those de­lib­er­ately en­tered into to de­fraud cred­i­tors. These sec­tions also deal with iden­ti­fy­ing undis­closed re­la­tion­ship/s be­tween the en­ti­ties and the com­pany.

For in­stance, pref­er­en­tial trans­ac­tions as per section 43 of the code would cover trans­ac­tions where there is a trans­fer of prop­erty or an in­ter­est in respect of an ex­ist­ing debt or li­a­bil­ity. An un­der­val­ued trans­ac­tion as per section 45(2) of the Code is one where a cor­po­rate debtor makes a gift or trans­fers one or more as­sets for in­signif­i­cant con­sid­er­a­tion, pro­vided that such a trans­ac­tion has not taken place in the or­di­nary course of busi­ness of the cor­po­rate debtor.

Bankers, IRPs and po­ten­tial buy­ers are also con­cerned about in­ter­nal frauds per­pe­trated by em­ploy­ees, pro­mot­ers and third par­ties such as ven­dors and cus­tomers.

IL­LUS­TRA­TION: AJAY MOHANTY

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