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An Appraiser's Role in Finding Fraud

By: Richard E. Schmitt, ASA, CVA, Chief Operating Officer, AccuVal Associates, Inc.

At its most basic, an appraiser's job is to provide a professional, realistic estimate of the market value of a company, asset, brand or patent, or even an idea. Although a number of changing factors can make finding that estimate difficult, a qualified appraiser – taking a detailed, thorough approach – can reach an accurate figure for the client at hand.

However diligent, an appraiser's valuation might be based on figures provided by a company and its management with intent to overinflate or mislead all parties, including the appraiser. Unfortunately in some cases, figures provided to appraisers are intentionally altered or omitted in an attempt to impact the results of an appraisal value. An appraiser isn't fundamentally responsible for spotting fraud, but with a careful approach to reviewing and vetting the information provided, he or she can help detect and even prevent illegal activities.

When extraordinary or hypothetical assumptions are ok

Keep in mind, there are times when knowledgeable parties related to the transaction might wish to perform an appraisal of assets based on extraordinary or hypothetical assumptions. These could involve an assumed contract with a major company, or the assumed construction of a new office building, for example. Although these might be valid reasons for putting forth projections not founded in past performance, extraordinary or hypothetical assumptions must be properly disclosed to not mislead those using the valuation report.

The beginning of fraud prevention: accurate reporting

An appraisal completed under the Uniform Standards of Professional Appraisal Practice (USPAP) will help create an accurate report – the first step in stopping fraud. When following USPAP protocol, an appraisal report should:

• state a clear purpose,
• avoid misleading language, and
• steer clear of unrealistic assumptions that lead to unrealistic values.

The report should properly disclose any hypothetical or extraordinary assumptions that might carry a high risk of occurrence and that, if changed, could materially alter an appraisal conclusion.

The appraiser should focus on the past to the extent it's a good predictor of future company performance. Significant changes in performance should be considered, discussed with management and reasonably explained. Those factors might include a projection for sales increases (being identified to specific customers added), expanding business or increased sales prices. This should be taken a step further to consider the impacts on costs of sales. Does the plant have enough equipment, personnel and space to store products to support increased sales? These are just a few of the considerations that, if investigated, can help identify assumptions that are not supportable and need to be disclosed.

Solid documentation is key, and so is transparency. A well-documented appraisal provides a roadmap of company collateral that includes descriptions, up-to-date quantities and clear photographs of what existed at the time of the valuation. On top of that, a well-written appraisal report details signs of misuse or collateral abuse that might indicate financial stress leading to fraudulent actions. Identifying cannibalized equipment or missing assets in subsequent inspections could be signs of activities where lenders might not be fully informed of conversions about their collateral. Questioning management on the changes that have taken place and properly reporting those changes to the interested parties, in updated appraisals, could also be a key to identifying fraud. All of this helps create a clear, realistic image of a company and the value of its resources.

Appraisers can (and do) spot evidence of fraud in:

• missing equipment,
• unreported storage areas of inventory,
• quantities of inventory reported far beyond what's physically there, and
• empty containers and represented inventory costs that greatly exceed reasonable market prices.

It's important to understand that appraisers, by function, aren't hired to and don't audit financial information in the traditional context. However, a thorough inspection, appraisal experience and knowledge of the industry can help identify suspicious happenings.

Good listening skills, healthy skepticism and a solid intuition can be invaluable for appraisers. Comments from employees on the production floor can reveal questionable practices, and additionally, appraisers should use their best judgment to determine if quantities just don't sync up with financial data. When in doubt, further questioning won't hurt.

Asking the right questions to prevent fraud

Although appraisers are not specifically tasked with fraud prevention, due diligence during inspections and reporting are key to stopping ongoing or would-be fraud. This can be problematic, though, as bankers request more and more desktop valuations, rather than on-site visits. When reporting and research are done from a distance, many questionable factors that could have helped detect fraud can be assumed away or overlooked.

Appraisers can take a few key steps to help fight fraud. Hired appraisers, first of all, should never have material financial relationships with clients where other significant aspects of the appraisal business depend on maintaining continued good terms with the company being appraised. Such deep financial dependency can create conflicts of interests, and the appraiser should be independent.

While compiling a report, appraisers should speak to multiple sources within the company being appraised and should ask important questions to more than one party. It's critical to confirm that data matches physical assets found during inspection and to obtain any documents needed to support figures. Appraisers must actively look for answers to any questions that don't make sense, logically or financially.

What to do when fraud is suspected

If fraudulent activity seems to be occurring, the first step for appraisers (or liquidators) is to discuss the suspicions with the appropriate parties and dig deeper to verify or rebut those suspicions. An onsite inspection should be done as soon as possible. Appraisers should be detailed when keeping records, especially for the secondary review.

A previous well-documented appraisal file can often be the source of support for a fraud. Such files are often used during litigation and can contain cost records, inventory reports, detailed photographs, statements made by senior management and other business-specific information. When assets are acquired outside of loan collateral, appraisers should value them – and then follow the money to determine if further investigation is needed.

Unfortunately, it can be easy for appraisers to be drawn into fraud unwittingly. Appraisers should consider that if any details of the process make them feel uncomfortable (the information provided, a special request to exclude information from a report or other comments), then there's probably a solid reason to consider how and what the report will be used for, and whether to accept the assignment. Companies who are too eager to rush valuations might be in a legitimate bind, or they might be hoping that no one will notice questionable figures when a job is finished quickly. When source information seems sketchy, it just might be.

Industry experience often helps sort out difficult questions. For businesses, consulting a seasoned appraisal firm usually produces the best, most accurate results. For appraisers, it never hurts to request a second opinion from someone within the firm. Fraud happens – but it doesn't mean that asking the right questions can't help stop it. While appraisers are not auditors, their experience can be a valuable asset to helping identify problems like these.

 

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About AccuVal
AccuVal provides a broad range of valuation, advisory and asset management solutions that contribute to growth or help ensure survival. We appraise the business enterprise and shareholder equity; bonds; intangibles and intellectual property; machinery and equipment; inventory; real estate and accounts receivables in over 100 industries worldwide. Learn more at www.accuval.net.