Survey Says: Nearly 40% Of PE CFOs Have Encountered Fraud In-House Or In Portfolio
As middle market firms reach further across the globe, finding out if your firm is close to backing the former leader of a drug cartel is becoming an increasing concern for chief financial officers of private equity and venture capital firms.
According to a recent survey of 36 private equity CFOs conducted by business investigations firm Corporate Resolutions Inc., 39% of respondents had encountered fraud at some point during their tenure as CFO within their own firms or at a portfolio company. A further 81% had not invested in a company because of suspected fraud or integrity issues.
The most frequent violation cited was asset misappropriation, which 67% of the CFOs reportedly encountered. A further 17% uncovered corruption, while 7% discovered fraudulent financial statements.
Part of the issue is conducting thorough due-diligence on management teams that may be located thousands of miles away.
“Mid-market firms now have their tentacles in Latin America and Asia,” said Corporate Resolutions President Ken Springer. “They need better controls in place because they’re further away.”
The good news is that most – more than two-thirds- of the surveyed firms had anti-fraud controls in place at the time of the detected fraud. In most cases, according to respondents, the fraud was detected in under a year and was revealed through a management review, account reconciliation, through surveillance or monitoring or by internal audit – though some frauds were discovered completely by accident.
Of the surveyed firms, 91%, currently conduct background checks on employees at their firms and portfolio companies, and 88% reported they are spending either the same or more money and time on preventing and detecting fraud now than in the same period a year ago.
Nearly two-thirds of respondents indicated that more thorough background checks would be helpful in detecting discrepancies. As Springer points out, a simple criminal check is not enough in some countries where records might “disappear.”
He cites the example of a background check of one business owner, which uncovered that the person in question had made his fortune two decades ago running a Latin American drug cartel.
“He was trying to reinvent himself as an entrepreneur,” Springer said.
Concerns extend beyond just management teams.
“When you’re investing overseas, you need to go further to truly know who you’re acquiring, especially with the Foreign Corrupt Practices Act,” he said. “Employees and third-parties have to be vetted adequately as well, because the repercussions can be tremendous.”