Collateral Thinking: How Can You Ensure That a Major Debtor Won't Leave Your Business Seriously out of Pocket If It Defaults? Mark Anderson Explains How Companies Are Using Asset Tracing Methods to Manage the Risk
Anderson, Mark, Financial Management (UK)
"Asset tracing" is a term that's usually applied to the process of tracking down and recovering stolen funds stashed in offshore jurisdictions by international fraudsters and errant dictators. Yet, as traditional risk assessment measures and published financial data become increasingly unreliable in these uncertain times, many organisations are using asset tracing methods to improve their understanding of their financial risks and exposures in other situations.
Asset tracing has applications in areas such as:
* Assessing whether an external trading partner has enough assets to meet its obligations under a credit agreement.
* Evaluating actual underlying assets in equity and bond investments.
* Estimating asset values as a precursor to an administrative appointment or legal proceedings.
* Locating assets against which to enforce court orders and arbitration awards.
The complexities of today's global financial system make the tracing and identification of assets much harder than it was in previous economic downturns. This is largely because of the growth in the scale of the system itself, the increased number and availability of offshore jurisdictions and the sheer complexity of credit instruments.
At its simplest, an asset tracing investigation may involve two types of analysis: tracking the money from its last known position to its final destination--which is known as "tracing fund flows from A to Z"--and searching for title to assets held by counterparties--known as "searching for underlying assets at point Z" (see panel opposite page). A successful tracing exercise in a fraud case usually involves painstaking work at both ends of the flow of funds. Often the smallest of leads, derived from a witness interview, document review or external source, becomes the vital link in the chain of evidence. For instance, an apparently throwaway remark about a visit to Spain in a recent fraud case interview led to the identification of significant Spanish real-estate interests acquired using the proceeds of the fraud.
Although such processes can be lengthy, some of these techniques may be used independently and in less complex ways to solve other problems. For example, in order to invoke freezing orders and other legal remedies, a claimant in receipt of a court order or arbitration award will need to demonstrate only that the respondent has title to assets of a sufficient value to satisfy the order or award. Some ingenuity may need to be applied in an international asset search. For instance, it is favourable to identify title to illiquid assets in jurisdictions that are more amenable to judgments from international courts, but once enough assets have been identified and title can be clearly shown, no further work need be done.
Similarly, it may be sufficient for investors in bonds or equities to determine title to underlying assets held by those instruments through research at point Z, instead of embarking on a costly and time-consuming tracing exercise from A to Z. For instance, in a recent project, a client of my firm took control of a portfolio of unlisted stocks and international real-estate assets in an acquisition and sought independent verification that the title to the underlying assets had indeed been transferred and that there were no undisclosed competing claims to those assets. We achieved this through a comprehensive analysis of various ownership records without the need for a detailed interrogation of the managers and administrators of those investments.
In the current market conditions, financial institutions are particularly worried about possible defaults by debtors. This level of concern is likely to continue over the next 12 months. In such circumstances it pays creditors to keep track of any assets provided as security or under personal guarantee by major debtors. This allows them to stay abreast of any ownership or valuation changes, which may be warning signs, and also to enable administrators to move quickly to secure assets if required. In addition, investigative charting tools and relational databases can be extremely effective in helping creditors to determine the flow of funds within the debtor organisation, highlight complex inter-company relationships and show up any irregularities.
Beyond the creditor-debtor relationship, other commercial ties are also coming under financial pressure, including those between big companies and their distributors, key customers and suppliers. Depending on the terms of the commercial or credit agreements between the parties, financial managers on either side may be able to use forensic investigation and asset tracing techniques under rights to audit conferred by those agreements. If the relationship provides for access to the other party's figures, forensic data analysis techniques may be useful in spotting deteriorating trading conditions or unusual trading activities. Such methods can be extremely valuable both in periods of financial restructuring and at the point of administration or receivership.
The connection between all these scenarios is the desire to be better prepared for the worst possible eventuality, so that any action taken to protect and recover funds owed will be swift and effective. Some of these techniques may seem heavy-handed, but this is not a market that provides any respite for poorly prepared businesses.
Moreover, asset identification and tracing become much more complex once financial mismanagement turns into misappropriation. Such cases are undoubtedly becoming more common in this time of financial strain. The stress of poor corporate performance, particularly when accompanied by personal financial problems, causes people to rationalise acts of impropriety that they would never consider when business is good. Once that moment has passed, experience tells us that fraudsters will use all manner of schemes to cover their crimes, including opaque offshore jurisdictions and obfuscating legal instruments. It is then that investigators must use all the guile and tools at their disposal, working with legal advisers to support the recovery process.
Financial professionals need to be particularly vigilant in assessing counterparty risks and inventive in obtaining enough information to make those assessments. Although their traditional use is in fraud investigations, asset tracing techniques may provide greater clarity on the risks posed by trading partners, provide early warning signs of financial problems and prepare your firm better for taking legal or administrative action if the worst comes to the worst.
The two key asset tracing methods in brief
Tracing fund flows from A to Z usually entails some or all of the following:
* The forensic analysis of documents and accounting records.
* Requesting and reviewing bank statements and transfer balances (note that actual bank statements are required as evidence, as opposed to letters or photocopied statements).
* The tracing of funds through accounts and separation of co-mingled funds, using charting tools where appropriate.
* Using forensic technology tools to secure, search and analyse available data (where access is granted).
* The analysis of large amounts of transaction data in order to highlight patterns and anomalies.
* Interviews with key representatives.
* Using any right to audit or intervene wisely, including using external advisers to review the financial position.
Searching for underlying assets at point Z usually entails some or all of the following:
* The comprehensive international research of public asset registers and online databases on significant individuals and companies.
* Gathering intelligence from third parties--eg, other creditors, claimants and informants--and using the leads generated to inform further targeted public records research.
* Building relational databases of the data captured and conducting link analyses on the entity and individual names, addresses, phone numbers and other relevant information.
* Once they are identified, the revaluation of underlying assets at current market prices.
* The ongoing monitoring of asset registers for any changes in title.
Mark Anderson is director of forensic services at PricewaterhouseCoopers.…
Questia, a part of Gale, Cengage Learning. www.questia.com
Publication information: Article title: Collateral Thinking: How Can You Ensure That a Major Debtor Won't Leave Your Business Seriously out of Pocket If It Defaults? Mark Anderson Explains How Companies Are Using Asset Tracing Methods to Manage the Risk. Contributors: Anderson, Mark - Author. Magazine title: Financial Management (UK). Publication date: March 2009. Page number: 40+. © 2009 Chartered Institute of Management Accountants (CIMA). COPYRIGHT 2009 Gale Group.
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