PEs rope in specialists to detect fraud

Technology and data analytics seen as useful tools in early detection

Increasing instances of frauds involving companies that have received private equity (PE) funding have made funds cautious, forcing them to keep a tab on their investees. Many funds are engaging independent diligence firms, which have access to modern technology-enabled tools. Those who already use these services are deepening their engagement, as the challenging business environment keeps the industry vulnerable to frauds.

Specialised firms are better equipped to conduct such checks, says Nikhil Bedi, senior director (forensic services) at Deloitte Touche Tohmatsu India. "Such due diligence requires the ability to conduct specialised research and obtain information across many domains such as litigation history, watch list check, unfavourable publicity, political or social affiliations, most of which are not publicly available. Hence, it becomes crucial that diligence of such a nature be carried out by experts who have the investigative and financial proficiency."

These independent firms are increasingly using technology to monitor portfolio companies. Data analytics is a powerful technology tool that helps in identifying trends of potential unethical dealings of portfolio companies with their business partners.

Bedi says such a tool can help detect irregularities in common problem areas such as vendor or customer payment data, payroll, reconciling of bank statements with the vouchers and invoices, reconciling payroll costs with employee data. "These can also help in isolating red flags, through integrity checks in vouchers/ invoices, etc," he adds.

Once the investment is complete, the investee company is not obliged to disclose any further data, unless the PE or venture capital firm holds majority stake in the company.

Currently, most PEs hold minority stake in investee companies. They can't influence decisions and have limited access to information. This is where things usually go wrong. Some of the recent examples include clothing retailer Lilliput, which received funding from Bain Capital, TPG Capital, SAIF Capital-funded Catmoss, and Fourcee Infrastructure, where General Atlantic and India Equity Partners were investors.

Due diligence firms such as Kroll say it's a win-win situation. Reshmi Khurana, MD, Kroll Advisory Solutions, says: "PE firms give us independence and tell us, 'give us all the information, good and bad, in the most objective fashion'. This allows advisors to focus on the objectivity and accuracy of the information."