Waving the Red Flag – Heeding Warnings Can Lead to Faster Discovery of Fraud

by SC Blog Contributor, CFE

Two currently-unfolding international fraud scandals share an important common denominator: red flags – brought up by reliable sources nonetheless – were ignored. In each scenario, legitimate agencies and sources pointed out questionable financial tactics, and that information was either not heeded or not shared with the relevant parties who could have minimized the impact of each fraud.  Investigative due diligence is an important element in early discovery, and even prevention, of these types of frauds.


Fall of the House of Diamonds


In the case of Indian jewelry magnate Nirav Modi, as recently reported by The Indian Express, “bogus purchases, huge over-valuation of stocks, suspicious payments to relatives, dubious loans — all these and more were red-flagged more than eight months before the scam broke, in a crucial Income Tax investigation report that was not shared with any other agency.”  The Income Tax probe report on diamond jewelers Nirav Modi and his uncle, Mehul Choksi, now fugitives on the run, spanned about 10,000 pages and was finalized by the agency in June 2017.  The article explains that the report “was not shared with other agencies like the Serious Fraud Investigation Office (SFIO), Central Bureau of Investigation (CBI), Enforcement Directorate (ED) and the Directorate of Revenue Intelligence (DRI) until February 2018, when the Punjab National Bank (PNB) scam became public…Sources said the tax department, before February 2018, also did not share its findings through the Regional Economic Intelligence Council (REIC), a mechanism for sharing of information between various law enforcement agencies.”  Modi and Choksi fled in January 2018 and are at large to date.


Too Much Autonomy for Autonomy


In the United Kingdom, The Guardian reports that “Hewlett-Packard ignored red flags” ahead of announcing that “it would take an $8.8 [billion] write-down on its acquisition of U.K.-based Autonomy, for which it paid over $11 [billion] not long ago.”  Among the red flags cited in the article, it was reported that “companies that do a lot of acquisitions tend to have trouble keeping track of all the businesses that come in…HP has done 10 significant acquisitions in two years, which puts a lot of pressure on the company to make all those other companies fit together, like a complicated puzzle.”  Further, Autonomy’s Chief Executive, Mike Lynch, was said to be “combative” when fielding analysts’ questions on how the company was faring.  Likening this to Enron’s CEO, Jeff Skilling’s, past behavior, the article states that “a lot of executives don’t naturally take well to criticism from Wall Street analysts. But when a company is uncommonly thin-skinned towards analysts, it can be a sign that something is unsettled in its financial picture.”  A third red flag that was ignored: HP’s head executive, Meg Whitman, confessed her regret for ignoring “bloggers [who] had suggested there were problems at Autonomy.”


A lesson in each: where there’s smoke, there’s often fire, even when authorized agencies and trusted parties like auditors are saying there’s not.  The Guardian article fittingly concludes: “All of this indicates that auditing a company – or looking for trouble at a company – is not only about reading balance sheets. Auditors are the gatekeepers to corporate health, but all they see is numbers that they must trust for a really good picture of what companies are struggling with, watch not what they say, but what they do.”


The investigative background vetting portion of a due diligence process is of particular importance for this key reason – it is structured to provide an overall picture of who an executive or company is, and what they’ve done, either in courts, media coverage or other aspects.  Learn from these current examples and if a red flag is waving, pull your car over and see why.


SC Blog Contributor, CFE