Forensic accounting
Forensic accounting is a potentially rich source of value-added in financial environments. Part of forensic accountancy is an art, part science and the rest is detective work. There are three ways in which it can provide a valuable service in organisations:
1. Investigate a case post facto to see where a loss has occurred within the investment environment; sniff out the cause or possible rats, then set up the enquiry for full regulatory/judicial process and compensation/redress where possible.
2. Examine a business to spot current areas of weaknesses that may cause future losses. Shore up, fire, retrain or recruit staff to reinforce the system.
3. Compile a list of weaknesses within the organisation and detail reasons for investment loss.
This exercise is a training tool for auditing and back-office staff. Such forensic investigations must feed active front-office trading personnel, compelling them to document significant risk events for the benefit of the back office.
There is more incentive to promote this type of procedure under Basel II regulations for market transparency and discipline. Part of the Basel II philosophy of risk is predicated on the notion that top management want to grasp the nettle and actively manage OpRisk. The first thing forensic accounting can provide is a corporate health check or a company risk audit.
They may use a variety of techniques to derive this audit:
Self-assessment of risk areas – running a checklist audit or workshop to identify the strengths and weaknesses of the company’s business environment, especially against potential stake- holder lawsuits.
Risk mapping – diagramming the various constituent business units and process flows.
Each area and its associated risk are identified and documented, then the follow-up risk management action recommended. Risk mapping can be used within functional areas for key risk indicators (KRIs). Departments can define operational limit bands of functionality like a risk thermometer. Crossing these limits (e.g. asset-liability gaps) shows the company’s risk exposure here is “hot”. The responsible party or group designated with the risk origination can also be flagged, and the risk management group alerted.
Business scorecards – these build on Kaplan and Norton’s seminal work in measuring and quantifying the performance of corporations.22 These are qualitative performance levels, but the resulting scorecard can identify areas of weakness that may be reinforced with additional capital and training.
Loss database – this keeps a historical log of above-threshold value financial losses. Statistically significant losses or high damages can be highlighted automatically for the attention of senior management.
We have developed advanced tools and techniques for:
Corporate governance.
Benchmarking and measuring performance.
Identifying areas of risk or weakness.
The problem is that an investor is an irrational animal and other influences often take over the driver’s seat. This is certainly true at the top executive level, and OpRisk groups have less to say about how strategic decisions are made.
The two main risk horizons remain for financial institutions.
Strategic policy risk – the fundamental asset allocation and performance benchmark design. This has been the subject of much research, but behavioural factors do exert a strong influence. Strategic policy risk has the greatest influence upon bank and fund success. Governance and trustee defined roles working under a multilayered control hierarchy can keep a better link between declared corporate objectives and the actions of managers.
Tactical implementation risk – investment manager structure and manager selection. Investment managers are generally recruited from a narrow band of skills and social backgrounds, so they can develop a tendency to socialise and to invest as a herd. This leads to a restricted range of assets chosen for investment. Careful interviewing and screening of recruits can reduce undesired wayward behaviour.
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