Investment banks order forensic audit of promoters, key management staff

Recently, an investment bank based abroad got in touch with the city-based head of a forensic audit firm.

The bank wanted to run a background check on some Indian promoters looking to raise capital abroad.

As the offer was underwritten, the bankers wanted to ensure everything about the company and its promoters was above board.

Instances of investment bankers seeking reputational and forensic due diligence on promoters are many.

In fact, it is part of a global trend that is now catching on in India, too, experts say. Practitioners include Kroll Advisory, KPMG, EY and PWC.

“Investment bankers are using various means to get comfortable on capital raises, etc…I am seeing the first signs of some specific procedures in the nature of forensic checks being requested as part of the diligence process,” says Sandeep Dhupia, head, forensic services, KPMG in India.

At the root of such decisions is the fact that many offers are underwritten, which means the banker concerned offers to pick up the securities in an offer if these remain unsold. This could lead to large financial liability for the banker if an issue goes awry.

“It (the practice) has picked up through the past 12 months, as the economy has begun to look better.

“There are queries from both investment banks handling foreign capital-raising, as well as those looking at strategic investments in India.

“Sectors in which this has been seen include defence, insurance, pharmaceuticals and consumer goods,” says Reshmi Khurana, managing director and country head (operations), Kroll Advisory.

“Raising capital abroad has increased in the past few years due to lower costs and less paperwork and for a while now, forensic has been assisting capital-raising activities not just in the domestic market but also abroad.

“Forensic experts assist in reviewing the books and in conducting integrity checks on promoters.

“Given their money is at stake, such reviews have become the need of the hour for investment bankers,” says Dinesh Anand, leader (forensics), PwC India.

In India, the use of forensic services has largely been by private equity players or banks faced with bad loans.

While the former want to ensure their investments are in safe hands, the latter, at times, seek to know whether their money has been siphoned off by promoters.

Investment bankers face similar risk exposure and seek to run qualitative and quantitative checks on a person or a company with whom they conduct business.

“In the case of some IPOs (initial public offerings), the underwriter taking the exposure might appoint a firm to conduct reputational due diligence.

“This includes background checks covering the company, and its directors and key management personnel.

“Such due diligence could also include searching for unknown related parties, looking into significant transactions with such related parties, checking whether a key related party is in financial distress or has large loans backed by corporate guarantees and whether there have been regulatory issues associated with the parties involved,” says Dhruv Phophalia, managing director, Alvarez & Marsal.

He heads the firm’s global forensic and dispute services practice in India.

“India’s positive business environment has drawn the interest of global investment banks. “However, they are increasingly aware of the risks prevalent. . .background checks involve understanding the integrity and credibility of the individual to identify any red flag or dubious connection.

“We also see a trend of investment bankers becoming increasingly aware of requirements in relation to complying with international sanctions lists,” says Arpinder Singh, partner and national leader (fraud investigation & dispute services), EY.

A hurdle investment bankers often face is they have to carry out such forensic audits and, at the same time, not rub up senior managements or promoters the wrong way.

“What is missing, and not unique to this particular type of fund-raising, is post-facto checks and balances to confirm the use of funds in the manner expected.

“With defaults in redemptions increasing, this is slowly coming to light and gaining significant traction,” says Dinesh Anand of PwC India.

PLAYING SAFE

• Foreign i-bankers are now conducting forensic and reputational due diligence on promoters coming to them for capital raising abroad
• Bankers helping with a public offering might have to buy unsold securities in underwritten issues
• Investment bankers are also seeking such due diligence on Indian promoters on behalf of foreign strategic investors
• Sectors where this has happened include defence, insurance, pharma, consumer goods
• Firms say such checks have picked up over the last 12 months, with improving economic sentiment

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