The appointment of additional administrators to scrutinise Laura Ashley’s finances and pension scheme in the lead up to its administration is a reminder of the added value that forensic accountants often bring to insolvency processes. While Laura Ashley’s collapse was not specifically linked to coronavirus, a significant increase in the number of retailers and other businesses feeling financial strain, and the growth of COVID-19 related fraud, may well result in a spike in demand for forensic accounting skills in the coming months. Gavin Cunningham, partner and head of forensic services at accountancy firm Menzies LLP, discusses the role of forensic accountants and why they may soon be in demand.
The use of forensic investigation techniques in insolvent situations can unravel transactions that contributed to the downfall of a company and lead to asset recoveries to benefit creditors. Fraud can be a factor and the detection of irregular or inaccurate accounting practices may lead to the discovery of underlying fraud. The ability of forensic accountants to sift significant volumes of data to identify potential causes for a company’s financial difficulties, including in some circumstances the misapplication of funds, can help to secure the best possible outcome for creditors by enabling recovery action against those responsible.
The combination of tough economic conditions and the availability of government-backed wage grants and support packages means that the conditions are right for a rise in opportunistic fraud. At the same time, the lockdown restrictions and the large numbers of businesses claiming under such schemes are making it more difficult for organisations to address any financial shortfalls.
The combination of tough economic conditions and the availability of government-backed wage grants and support packages means that the conditions are right for a rise in opportunistic fraud.
In the business world, the lines separating best practice, acceptable practice and illegal business practice can sometimes become blurred. This means that to the untrained eye, it may be difficult to determine whether a business insolvency is simply the result of ineffective management, or whether other nefarious activity may have occurred. Forensic accountants are experienced in uncovering the truth behind what appear to be suspicious or unusual transactions and assisting the appointed insolvency practitioner in reaching decisions about the recovery strategy.
When instructed to investigate the financial position of a business leading up to the insolvency proceedings, forensic accountants will begin by gathering information related to the company before it fell into financial difficulty. This often involves delving deeper into a particular financial issue. In the case of Laura Ashley, for example, questions have been raised about the activities of the company’s directors before filing for administration. To get to the bottom of what happened, the forensic accountant will gather evidence from a wide range of sources – from complaints made about the business on social media, to direct conversations with individual employees, as well as securing the financial records of a company. Analysis of all the evidence gathered could potentially uncover clues about the behaviour of the directors in the months leading up to the appointment of administrators.
For a forensic accountant there are often ‘red flags’ observed, which could indicate irregular business practices in the past. For example, some obvious signs include a rapid decline in the value of assets which could indicate rapid disposals or overvaluation, high volumes of transactions with associated companies, or changes in balances owed on director loan accounts. Occasionally, the discovery of irregular or inaccurate accounting practices may also be a sign of underlying fraud. When there is evidence of unusual financial behaviours, it is then the job of forensic accounting specialists to investigate whether or not there is a clear explanation for this and it may show people obtaining financial benefit through dishonest or deceptive behaviour. They can then investigate how much has been obtained and follow through the money trail to see if the losses may be recoverable.
Depending on the circumstances, the review of historical financial performance may lead to restorative action being possible for the Insolvency Practitioner under various recovery provisions of the Insolvency Act 1986. These cover antecedent behaviours and thorough analysis might show that directors could be civilly liable for their past actions, including, in some circumstances, for wrongful trading.
This statutory provision can render directors of a company liable for losses suffered if trading continues past a point at which they should have concluded that there was no reasonable prospect of the company avoiding an insolvent liquidation, or insolvent administration. They then have an overriding duty to take steps to minimise potential losses to the company’s creditors and should they fail to stem losses personal liability can follow. The provision has itself fallen foul of the pandemic such that the Government temporarily suspended it from 1 March 2020 until at least 30 September 2020. As a result, in the aftermath the process of calculating company losses resulting from wrongful trading will become even more complex.
With many businesses likely to be feeling the financial effects of coronavirus-related disruption in the months ahead, a further surge in insolvency cases is likely. Helping to get to the root cause of an organisation’s financial problems, forensic accounting skills can help to restore value for creditors and mitigate the financial crisis resulting from the pandemic.