Pressure for Growth Can Lead to Earnings Fraud
While historical accounting and earnings fraud cases, such as Enron and Parmalat, continue to garner occasional headlines, the number of new cases has declined in recent years. However, in 2015, reporting of accounting irregularities and fraud gathered pace, with a number of high-profile brands—including UK-based grocer Tesco and Japanese consumer electronics giant Toshiba—announcing enormous issues with historical accounting practices during the year.
Despite mixed predictions for global economies in 2016, there is no let-up in the pressure on boards to deliver continually improving results and investor value. Historically, this desire for growth has led to the emergence of accounting irregularities, as management looks to maintain and expand revenues while supressing costs. Expect to see a number of accounting and earnings scandals throughout 2016 as the pressure on stricken management intensifies.
Depressed Commodity Prices Squeeze Already Tight Margins
Commodity prices continued to be depressed in 2015, and the World Bank estimates that they will remain this way throughout 2016. Businesses that are heavily reliant on buoyancy in commodities markets are therefore suffering, with already tight margins being squeezed and transaction volumes drying up.
This pressure may be exacerbated by the global economic slowdown many predict will occur in 2016, and companies that lose favourable investment-grade ratings on their bonds as a result are likely to face difficulties in accessing affordable and practical trade financing. In a highly competitive and strained market, the prevalence of fraud in commodities-reliant businesses in 2016 is likely to increase, particularly in companies struggling to keep up with market performance.
High M&A Volume May Expose Irregularities
The past year was an intense one for high-value M&A activity, with some industries reporting the highest deal activity since 2007, and the Wall Street Journal declaring 2015 the “biggest year ever for mergers and acquisitions.” Many of these deals—including multibillion-dollar deals such as Shell’s acquisition of BG Group and Nokia’s recent acquisition of Alcatel-Lucent—are due to close in 2016.
While the benefits of a merger or acquisition are widely publicised, a detailed investigation into a target’s operations (both pre- and post-completion) often uncovers fraud or misstatements that can hamper the integration of new operations. This holds particularly true where a pressure exists to inflate sales prior to acquisition, or defer costs post acquisition. On the other side of the fence, companies may attempt to hide the results of ineffectual acquisitions by artificially inflating combined results or adopting inappropriate accounting policies.
Either way, an increase in M&A activity is often followed by an uptick in reported fraud and accounting irregularities. With 2016 M&A activity predicted to exceed 2007 levels, those considering a deal would be wise to keep this trend in mind.
Changing International Relationships Increase Businesses’ Vulnerability to Fraud
The year ahead looks to be another year of shifting sands in terms of how the world interacts, with recent events—such as the lifting of sanctions in Iran and the arrival of the first US crude oil cargoes in Europe since the 1970s—changing the competitive landscape for many industries.
Companies operating in multiple jurisdictions will recognise that changes in international relations can materially affect their business models. In addition, change is often a catalyst for fraud. As companies seek to match or beat their competition and look to exploit new opportunities, they may be vulnerable to fraud from new, untested suppliers or existing suppliers outstretching their capabilities.
Business Email Compromise Scams Target Accounting Departments
The last few years have seen an increase in business email compromise scams in which finance employees receive spoofed emails purportedly from a senior executive, such as a CEO or CFO, requesting a change in payment details or asking that a supplier payment be urgently expedited in unusual fashion. This type of fraud accelerated in 2015 and there is no reason to believe it will slow in 2016.
Several companies have reported receipt of over 30 of these targeted spoof messages from spammers pretending to be company executives each week. These companies rely on robust payment processes and the diligence of finance staff to prevent illicit and incorrect payments.
However, the success of these attacks is underreported; savvy fraudsters concoct targeted messages that match the style and tenor of the purported sender, meaning that many payments are made and not detected. Process-driven companies that approve a large volume of payments on a daily basis are particularly at risk, and will need to carefully consider their approach to combating this fraud.