The economic downturn has produced a lot of stress on companies for obvious reasons, but there is one significant risk that companies often overlook: fraud.  A recent study from the Association of Certified Fraud Examiners (ACFE) found that employee fraud has risen in the last 12 months and that financial pressures were the biggest contributing factor.  The recession has given employees as well as managers in key roles the opportunity, motivation/pressure, and rationalization to commit theft and fraud.  However, the problem isn’t just identifying fraud; it’s knowing what to do once it’s discovered.

And, when fraud is discovered often times there is no one to turn to.  The FBI Financial Crimes Section at the moment has over 400 corporate fraud cases that they’re working through and pursuing only 3-6 new cases per month.  They are primarily focused on significant fraud against individuals, businesses, and industries, or organized crime activities that are international, national or regional.  State and local police departments are very busy as well.  I was recently told by a client that the police department from a large city (a population over three million) would not take her case if she couldn’t provide hard evidence worth over $40,000.  Translation: the skill set to execute the Internal Audit function just expanded to include forensic accounting, internal investigations, financial fraud investigations, SEC enforcement matters, and extensive compliance reviews.

Again, the factors that lead to fraud are opportunity, motivation/pressure, and rationalization.  The opportunity to commit fraud can consist of workers being stretched out to cover more roles, giving them more access to more areas of the company and fewer supervisors to oversee operations.  Smaller businesses are more prone to the opportunity risk as they have limited resources to provide adequate segregation of duties. Motivation can spring from anywhere, but in times like these the pressures of the recession, a spouse’s job loss, or a reduction in pay are sufficient motivators.  People can always rationalize their wrongdoings when there is enough pressure and stress to skew their sense of logic and ethics.  Despite these factors there are ways for any business despite their size to prevent or detect fraud and ways to appropriately recover your losses.

The first and cost effective step to help safeguard your company is to develop a good control environment.  By developing comprehensive policies and procedures, setting good examples of actions and accountability from the top down, establishing an anonymous whistle blower hotline, and a clear organizational structure, a company can reduce the threat of fraud.  The next step is to implement a system of internal controls to further limit the risk of fraud.  This usually consists of the following five areas: segregation of duties, proper authorizations, adequate documentation and records, physical controls over assets, and independent checks.  These two steps are a great start to preventing and detecting fraud and keeping your company afloat in a time of uncertainty.

In a time of recession the need to find ways to address fraud proactively and cost effectively is a key priority.

Here are some links for more information on this topic:
The Institute of Internal Auditors (IIA) Main Website
IIA Upcoming events (Fraud)
IIA Fraud resources
Association of Certified Fraud Examiners (ACFE) Main Website
ACFE Upcoming events

I would imagine that business valuation proposals start out the same way as other service related assignments;

     1. Define the scope;
     2. Estimate the process by which you will arrive at a conclusion;
     3. Figure out a budget of time needed to complete the work; and
     4. Determine a range of fee to bid the work.

The work is then won on reputation, brand, recommendations, fair pricing and other key qualitative and quantitative inputs that clients use in making a decision to go with one firm over the other. Sounds fair, right? Yes, if you compete in an ideal business environment where the price is not the number one “utility” that differentiates service providers. But, at the same time that business valuation evolves its status as a profession, disruptive competitors have won recent battles by focusing on a low price, high volume approach.

I have found that unless there is a strong recommendation from an auditor, board member, investor, lawyer or other advisor for getting our firm involved, the sale process will almost always default to our fee and there is always someone out there that is lower. I believe that in the world of selling, it is always easiest to defend the lowest price, especially if you argue that there is no correlation between price and quality. So selling a higher fee for a product that may be perceived by the buyer as a commodity is simply a tough sell.

As I mentioned in my last blog, in addition to selling the quality of our platform and brand, we frame our service as part of a bigger solution and focus on “all-in” fees. This focus allows us to fight a perception of fundamental valuation as a commodity and introduce the real and time related costs associated with a lack of quality. In doing so, our argument is based on a simple assumption that more often than not, you get what you pay for. This assumption may be unfair to some service providers who provide good work at lower fees, but it is based on my experiences with auditors who bring us into a situation after they have kicked out a low-cost provider’s work product for a lack of quality.

So, now back to ROI. We make a simple case for a higher ROI for our solution by first highlighting the investment in fees (tangible) and management time (intangible) instead of focusing on the return. In most cases, the return for such an engagement should always be the same; sign-off on our valuation and the assurance (or rather insurance) that our report will stand up to scrutiny of current (Board and auditors) and future (the IRS, the SEC) readers and reviewers. So if the return remains relatively constant regardless of the provider, the focus on “all-in” fees clearly drives the ROI. Any firm with a high quality product and strong audit relationships should be able to win this argument on all-in fees.

Case in point; a low-cost provider who is NOT kicked out of a situation by an auditor will eventually get audit sign-off. However, the means to that end will involve significant (and at times uncapped) fees that the auditors incur by getting their valuation team comfortable with a low quality valuation. My last blog mentioned that these reviews more often than not take the form of “replicating and reconciling” rather than testing. Therefore, when the audit firm is not comfortable with the quality of a valuation report, the client is, in effect, paying for two valuations and the additional step of reconciliation. I have heard from clients that their review fees have been a multiple of the original valuation fee.

So battles may be won on price but in the end, the war is won on quality and focusing in on all-in fees. The takeaways here are simple but strong;

     1. Good work at fair prices creates opportunities to do more good work;
     2. Any service that depends on the knowledge of an expert is not a commodity; and
     3. If a low price sounds too good to be true, it probably is.