How can CPA firms, their clients and the investors and lenders with whom they do business easily access shared documents? How can CPA firms ensure that their signature won’t be used fraudulently or that there won’t be unauthorized changes in their financial reports?
In a recent AICPA Insights blog post, Erik Asgeirsson explores these questions and discusses some of the challenges faced by CPAs that serve private company clients. He shares the story behind the development of RIVIO and highlights some of the benefits, which include:
View the full blog post on AICPA Insights: http://blog.aicpa.org/2016/08/technology-revolutionizes-the-transfer-of-private-company-information.html#sthash.D57JuTh8.OEWc6kJC.dpuf
Other areas of finance outside of M&A have been transformed by the use of large data sets and applying advanced statistical software tools. Just look at the composition of trading floors today, which are populated by PhD mathematicians, statisticians, physicists, data scientists, and computer programmers. You have quantitative hedge funds like the legendary Renaissance Technologies, Goldman Sachs suing a former computer programmer for allegedly stealing black box algorithmic trading strategies, and Michael Lewis explaining the world of high frequency trading in his book Flash Boys. Or even look at how hedge funds have flocked to analyze granular credit card transaction data from vendors like 1010Data to discern trends, correlations, and make investment decisions based on those insights.
While the nature of data analysis in M&A situations is different, data tools applied to the diligence process is picking up steam. Detailed SKU analysis, looking for customer demographic level trends at the transaction level, analyzing pricing practices, looking at the impact of weather patterns or seasonal impacts by product category, or other granular analyses of large volume data sets often times far exceeds the capabilities or even cripples the computing capabilities of a simple Excel spreadsheet. Diligence advisory practices within accounting firms have sub-specialty groups that deal with querying and analyzing large data sets. Database tools, data visualization programs, and business intelligence software like Tableau, Qlikview, and Palantir are now more user friendly and accessible.
Here are just a few interesting and emerging “big data” examples, applications, trends, tools, and first movers in the M&A diligence arena:
These anecdotes are merely representative of the activity, interest level, and promise big data solutions have for the M&A diligence process. It will be interesting to observe (and participate in) these changes, as big data solutions become more available and adopted resources in the M&A process.
About the Author: Richard Grosshandler is Co-Founder of Splash 4 Partners, LLC, a provider of diligence advisory and consulting services to private equity firms and privately held businesses. He is also a Deal Sherpa and Curriculum & Training Director for Private Equity Primer, a hands-on training and professional development firm for M&A deal professionals. He is a recovering private equity and investment banker himself. He can be reached at firstname.lastname@example.org or at email@example.com.
Financial fraud unfortunately remains prevalent in today’s business world, despite the volume of information available to lenders and investors. It’s still extremely easy for organizations to falsify financial statements and mislead financial stakeholders like banks or private equity firms. And while most companies operate ethically, some executives succumb to the pressure of manipulating earnings or other business metrics which can be difficult to detect.
This was the case for KC United LLC, a holding company for five construction service companies in the Kansas City area. During the economic downturn in 2008, KC United, like many other organizations, was facing financial turmoil and losses. According to the Kansas City Business Journal, Tom Fitzgerald, the organizations CFO, was instructed by company ownership to manipulate the financials to show a profit. Ownership of KC United thought this was imperative because the company would be at risk of not being able to maintain its banking and bonding relationships. Following the directions from company ownership, Fitzgerald submitted the 2008 financial statement which fraudulently showed a profit to their bank, Bank of Blue Valley in 2009. In addition to showing a bogus profit on the financial statement, Fitzgerald created a fraudulent cover letter on phony letterhead from an outside accounting firm which stated the financial information was reviewed and approved by their firm. The phony financial statement was accepted and approved by the Bank of Blue Valley which renewed KC United’s outstanding loans of over a million dollars. One would hope this type of event would be a onetime occurrence, but unfortunately, it was not. This behavior continued for several quarters. In 2010, Bank of Blue Valley even increased KC United’s credit line to $2.8 million basing its decision on what later turned out to be phony financial statements.
As with most frauds, after a period of time it came to an end when three of five subsidiaries of KC United filed for bankruptcy in April 2011. Fitzgerald’s tenure with KC United also ended around this time. In 2012, Bank of Blue Valley was forced to sell its position in KC United’s outstanding loans which lead to a loss of nearly $900,000 for the bank.
After an investigation into the fraud, Fitzgerald wound up pleading guilty to one count of conspiracy to commit bank fraud. Additionally, the Kansas Board of Accountancy stripped Fitzgerald of his CPA license and fined him $5,000.
Why do stories like this continue to happen? How can an organization commit financial fraud for that long without being caught by their bank? The answer to those questions is that until now banks had no way to verify their clients’ financial statements came from a validated source - a licensed CPA firm - or that the financial statements hadn’t been altered by management. Unlike public companies, private businesses are not required to submit their financial statements through the Securities and Exchange Commission’s EDGAR.
The good news is there is now a digital service on the market that allows lenders and investors to do their due diligence to ensure that their clients’ financial statements are received in an unaltered format from a legitimate CPA firm. RIVIO is to private company investors and lenders what EDGAR is for those who invest in and lend to public companies.
From the outside, Canopy Financial looked like the picture of success. The Chicago-based health care software company, which helped administer health savings accounts for clients, was in a hot field and had strong support from venture capital firms. In 2009, it landed in the No. 12 spot on the prestigious Inc. 500 list of fastest-growing private companies.
But unknown to investors and the board, two executives of the company were engaged in a massive $93 million fraud. Canopy’s president and chief operating officer, Jeremy Blackburn, and its chief technology officer, Anthony Bansa, were cooking the books and siphoning millions of dollars for their own use – including expensive trips to Las Vegas resorts, home renovations, jewelry purchases and the assembly of a fleet of expensive cars such as Bentleys, Lamborghinis and a Rolls Royce Phantom.
How’d they do it? In part by brashly claiming that KPMG had audited the company’s financial information and given it a thumbs up – even though KPMG hadn’t been engaged at all.
“According to court documents, Blackburn and Banas used false information about Canopy’s financial condition, including a bogus auditor’s report and falsified bank statements, to fraudulently obtain approximately $75 million from several private equity investors in 2009,” the FBI said in a press release after the two executives’ sentencings in 2012. “Approximately $39 million of that money was used to redeem shares of other Canopy investors, including approximately $1.6 million that went to Blackburn and $975,000 that went to Banas, while another $29 million obtained from investors was deposited into Canopy operating accounts. Blackburn and Banas also misappropriated Canopy operating funds for their own benefit.”
Canopy is an outlier in some ways because of the scope of the wrongdoing. But financial statement fraud in general results in much higher losses than the typical case of occupational fraud, according to the Association of Certified Fraud Examiners, which does an annual global survey of incidents. The median loss for occupational fraud in 2016 was $150,000. For financial statement fraud, it was $975,000.
Canopy’s fortunes began to unravel when KPMG caught wind that its services had been misrepresented. Blackburn and Bansa eventually pleaded guilty to wire fraud and were sentenced to 15 and 13 years, respectively. Blackburn committed suicide the day before he was to report to prison. And the company itself went bankrupt, leaving investors in the lurch.
The lesson here is that fraudsters thrive when solid information lags behind lies. The good news: Digital tools, the real-time delivery of data and validated sources of information can now be harnessed to eliminate that fog and reduce risk for investors, lending institutions and other affected parties. It’s a new day.