Fighting fraud with Confirmation (Sponsored)

Aug 01, 2019
Kyle Gibbons, Managing Director of Europe with Confirmation, explains how some of the world’s most high-profile frauds could have been prevented during the audit process had the right technology and processes been utilised.

Fraud prevention is not just about protecting businesses from losses, it’s about protecting society, employees and ordinary savers and investors from criminals. That’s the view of Kyle Gibbons, Managing Director of Europe with Confirmation, who believes job losses and other human costs should be the key drivers in the fight against fraud. 

Parmalat

Gibbons points to the employees and ordinary Italians who lost their livelihoods and life savings as a result of the Parmalat fraud as an example of this human cost. “These people often tend to be forgotten in the media coverage, but they are ultimately who should matter the most.”

Parmalat was founded in Parma, Italy in 1961 by Calisto Tanzi. The company grew very rapidly on the basis of its key UHT milk product, and had sponsorship deals with Formula One and the local football team, which turned Tanzi into a celebrity.
Everything looked good until 2003 when the company had trouble selling a $500 million bond. The alarm bells really started ringing when Parmalat defaulted on a $150 million debt in December of that year. And that’s when the trouble really started.

Bank of America triggered the collapse when it announced that Parmalat didn’t hold the nearly $5 billion in assets that it claimed. Parmalat released a document stating that it did, in fact, have more than $4 billion in assets with a subsidiary of the bank. Bank of America then responded saying the document from Parmalat was a forgery. Parmalat filed for bankruptcy the following day.

“This had huge implications for the auditors and banks involved as well as thousands of small investors in Italy, some of whom had invested their whole life savings,” says Gibbons.

Gibbons points out that the main fraud involved a single forged document confirming the funds held on deposit, which the auditors accepted at face value. “They actually had no verification for the document and didn’t check the source properly,” he says. “If they had used a secure online platform like Confirmation, it would have quickly shown that these assets didn’t exist in the Bank of America account. The ultimate value of the fraud was €14 billion, the biggest bankruptcy in European history at the time.”
Sadly, the audit confirmation processes currently used by many auditors would still allow this fraud to occur. “The risk is still there that if a firm is using traditional confirmation methods, they are not ensuring information can’t be intercepted,” Gibbons notes. “You can’t rely on a fax or paper as this case has shown. Many banks allow auditors to choose what confirmation methods to use, but that still leaves a risk. To reduce that risk, one step taken by Bank of America was to implement and require the use of Confirmation’s online platform for all auditors across the world.”

Peregrine Financial Group

Another case Gibbons points to is Peregrine Financial Group, where the main character involved was founder, CEO and sole shareholder, Russell Wasendorf. “In 2009, Wasendorf was photographed outside the firm’s new headquarters building in Cedar Falls, Iowa. Three years later he attempted to commit suicide in the parking lot of that building. He is now in prison.”

The brokerage firm started out in the Chicago Mercantile Exchange and moved to Cedar Falls in 2009. “Wasendorf had a private jet and owned several restaurants, but he was extracting client money from the business throughout this period,” says Gibbons.

Everything looked rosy in 2011 when the client account showed a healthy balance of $218 million. Things started to change early in 2012, however, when the firm had to make some layoffs and remaining staff had to take a 10% pay cut.

Then came the day of reckoning. The National Futures Association (NFA), an American self-regulatory body for the over-the-counter futures and derivatives industry, came to carry out its annual audit of its member firm. Wasendorf supplied the bank statements as usual but the NFA said that was no longer enough and asked instead for authorisation to put in an electronic request to the bank for the information.

Wasendorf demurred initially but found there was no way out. He provided the signature and within 24 hours of the NFA making requests, a massive fraud was uncovered using the Confirmation platform. “The fraud had been going on for 20 years,” Gibbons points out. “Wasendorf would intercept the bank statements and create forged versions. The total fraud uncovered was approximately $200 million, and the client account that purported to have $218 million turned out to have only $10 million. Some auditors today would still fall for that. An auditor would have no way of knowing if the physical mailing address to which they were sending confirmation letters is legitimate or set up as a scheme to commit fraud. Similarly, an auditor would have no way of knowing if the website address provided for the online banking services of some of the smaller banks is legitimate or fraudulent – it’s easy to fake a website. Using a secure online platform like Confirmation reduces those risks and gives auditors comfort and confidence that they are dealing with a legitimate bank and that bank’s authorised team.”

Patisserie Valerie

The final case Gibbons refers to is ongoing. Patisserie Valerie was founded in Soho, London in 1926 by a Belgian couple. In 1965, the company was purchased by another family who later sold it in 1987 to the Scalzo brothers. The business had grown to nine branches by 2006, and a controlling interest in the business was acquired by private equity firm Risk Capital Partners. Patisserie Valerie subsequently expanded quickly to more than 200 branches, employing 3,000 staff. It floated on the Alternative Investment Market in 2014 and all seemed to be well.

In October 2018, trading in its shares was suspended following the discovery of potentially fraudulent accounting irregularities. A police investigation was launched within days, and Risk Capital Partners announced a plan to raise £20 million in order to stabilise the business, but to no avail.

In a fraud which centred on undisclosed overdrafts and misstatements regarding payments to creditors and overstatements of debtors, it has emerged that cash on the books had been overstated by £54 million. In its latest update on the fraud, KPMG estimated the misstatement to total €95 million.

The firm has subsequently been acquired by Causeway Capital for a fraction of its 2014 market value following the closure of a third of the restaurants and the loss of hundreds of jobs. A statement around the time of the takeover revealed one of the issues uncovered during investigations into the fraud: “When someone decides to stop using butter in puff pastry in a patisserie you know that something is seriously wrong.”

“It is difficult to see how those fraudulent practices would not have been picked up if a modern confirmation platform like Confirmation had been used,” Gibbons concludes. “A request to the bank for confirmation of the financial data would likely have returned the information in relation to the overdrafts, for example. It is important for society that we do everything we can to prevent fraud. Fraud undermines the foundations of business, erodes wealth and impacts ordinary people’s savings, investments and livelihoods. The real value of fraud prevention lies in the confidence it gives people that they can trust the financial information given to them by companies and organisations. Without that trust, everything collapses. The audit confirmation process is a small but important part of that fight against fraud.”