I enjoyed reading this article from the team at Latham & Watkins looking into the risk of fraud within M&A deals. As they state: "In our view, instances of fraud in the context of acquisitions are more common than is often thought. There can be (or have been) allegations of artificial inflation of reported revenues, revenue growth and gross margins or other distortions...". All of these have the result of destroying value in the company itself and the investment being made.
But fraud is not an easy thing to identify, quantify or prove - and is often being concealed to such an extent that getting through to the underlying truth is not easy. However, that does not mean it should be ignored - it is a risk that can damage a deal much as any other risk can - therefore it must be managed appropriately.
One of the key resources at hand to a buyer is data. However, in the early stages of a deal this tends to be limited in availability and granularity - regardless whether there are certain tasks that can be carried out. But as the transaction proceeds, a deeper-dive should be performed across the relevant data sets as soon as feasible.
A key component of this deeper-dive would be a look at key structured data systems (e.g. accounts payable, general ledger, accounts receivable) in order to run a series of analytical tests to help detect indicators of fraud. It is unusual for these tests to conclusively prove something is fraud but they will produce a number of findings that warrant subsequent investigation.
As the article sets out, there are a number of legal options available if fraud becomes apparent. Data is a crucial tool to be used in determining whether this has occurred or not.
Fraud is difficult to spot and even more difficult to prove — and it can have a rapid and detrimental impact on the value of an M&A deal, with fines and penalties for associated wrongdoing. Deal teams must balance targeted due diligence with the commercial deal realities, remaining alert to risks and seeking legal advice to aid discovery of wrongdoing and recovery of lost value.