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There can be no doubt that fraud, along with other economic crimes such as money laundering and corruption, place a huge burden on both the SA economy and individual organisations.

But the cost is not only financial. Incidents of economic crime, once uncovered, can do serious harm to an organisation’s reputation and the trust its stakeholders have in it. Once lost, that reputation and trust can be tough to claw back. It is also true that ridding an organisation of fraudsters, once they have infiltrated it, can be a complex and expensive exercise.

As such, every organisation must do everything possible to prevent incidents of economic crime before they happen. In this respect forensic due diligence is a highly effective and powerful tool for an organisation to have as part of its arsenal of tools to mitigate the risk of fraud and other commercial crime activity.

Before looking at why forensic due diligence is such a powerful fraud prevention tool, one needs to understand what it is. At the most basic level, conducting due diligence means doing one’s homework. It is essentially understanding who it is that one is doing business with.

An effective due diligence safeguards an organisation from significant risks and/or losses that may be encountered later on in a transaction or business relationship.       

Most organisations conduct background screening on prospective employees. These are done to determine, among others, whether prospective employees may have a criminal record, whether the qualifications listed on a prospective employee's curriculum vitae have in fact been obtained, and whether prospective employees have any fraud listings linked to their name.

These checks are performed to determine whether the prospective employee may pose any risk to the organisation if they are employed by the organisation. In the same way, it is important for organisations to conduct an effective due diligence on its business partners to determine whether these entities pose any commercial crime risk to the organisation.

However, when engaging with third parties and/or business partners, many organisations merely request these entities to complete a questionnaire (and at times, request certain documentation from these entities as part of an onboarding process).

The onboarding process often stops there and pure reliance is placed on the information received from the relevant business partner without any further independent verification or interrogation of the information received. While it is important to request certain information from a business partner upfront, it is critical to verify and interrogate the information received, as well as to conduct additional due diligence procedures to understand whether such entities may pose a commercial crime risk to the organisation.

The results of such an exercise will place an organisation in a position where it may make an informed decision on whether to proceed engaging with the relevant business partner or whether to walk away from the transaction or look for an alternative supplier or service provider should the results of the forensic due diligence be indicative of possible commercial crime risks.

The importance of doing all of this upfront, before entering into any business relationship with the relevant entity, cannot be overstated. It is a lot easier to so say no at the beginning of the process and walk away from the transaction than trying to walk away from a transaction or business relationship after it has been entered into.

Types of risk

Forensic due diligence procedures usually cover two types of risks: those posed by third parties such as service providers, suppliers, agents, consultants and intermediaries, as well as those entities in which an organisation intends to invest or purchase. It typically focuses on conducting procedures to determine, among other things, the relevant third party or business partner’s reputation, reliability and commercial crime risks.

The type of procedures performed will ultimately be based on the nature of the intended transaction or business relationship as well as the possible risk profile of the relevant third party or business partner.

Organisations that have conducted meaningful forensic due diligence on their business partners and/or third parties have seen the benefits of investing in these procedures. In one case, a company was in the process of purchasing the entire shareholding in a business. As part of the overall due diligence procedures, the company conducted a detailed financial analysis of the target entity’s financial records and noticed a R60m discrepancy.

Upon further investigation and analysis, it was discovered that the target entity was being defrauded by employees of large sums of money every year. As a result of poor internal controls the target entity was unable to identify the discrepancy in its financial records. Ultimately, the company decided to proceed with the purchase of the target entity, however, given the findings of the forensic due diligence exercise, it was able to negotiate a significantly lower purchase price for the business while at the same being fully aware of the control weaknesses inherent in the target entity’s business so that these could be remediated.      

In another case, an organisation based in Johannesburg was in the process of entering into a business relationship with a third party, which had listed an address in Cape Town as the address of its business premises. As part of the due diligence procedures, a physical site visit was conducted to verify the address provided.

The site visit revealed that the address provided was the location of an abandoned warehouse with no indication of any business activities being conducted there. In addition, background checks on the directors of the third party entity revealed negative media coverage highlighting the involvement of these directors in possible corrupt and fraudulent activity. As a result, the organisation decided not to proceed with the business relationship.   

Had either of those transactions been allowed to progress without having first conducted meaningful forensic due diligence, the losses these entities may have suffered later could have been significant.

Ultimately, an organisation’s priority should be its sustainability and wellbeing. Therefore, while some may not be comfortable asking difficult questions when entering into a business relationship with a third party or may consider a detailed forensic due diligence invasive, one should always remember that if one intends entering into a business relationship with an ethical third party, such procedures will be welcomed and will provide both parties with the comfort of knowing exactly who it is they are doing business with.

• Mohamed is director and head of corporate Investigations & forensics at CMS SA.

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