UK: An Introduction to Forensic Accountants
UK: Forensic Accountancy
Forensic Accountancy involves several interconnected practice areas: dispute resolution, expert witness, expert determination and litigation support, financial and accounting investigations and advisory. The UK forensic accounting industry is intimately interlinked with global trends – shaping international developments whilst being itself impacted by legal, economic and technological events.
From a disputes perspective, commercial courts are recovering from the record levels of activity seen during the pandemic. In 2021-2022, the UK Commercial Court saw 732 claims issued, a 10% decrease from prior year, although new cases increased in the Circuit Commercial Court, which tends to deal with smaller value claims. The London Court of International Arbitration (LCIA) received 293 arbitration referrals last year, a decline of 9% on 2021.
In an example of the typical time lag between external events and dispute proceedings, just over 20% of disputes heard by the LCIA in 2022 related to agreements concluded within the prior year, with 74% of cases relating to agreements concluded within the prior five years.
From an investigations perspective, the difficult economic environment, complex geopolitical developments and the regulatory focus on technology, economic crime and ESG are shaping the types of cases and nature of work in the industry.
In this article, we look ahead to the possible developments in the UK forensic accounting industry in the next 12 months, articulating the practice-specific trends that are set to drive forensic accountants’ work as well as the enforcement priorities that will shape our industry. Each of the trends are themselves interdependent – their impact will cut across multiple facets of the forensic accounting industry.
Financial statement manipulation
During previous economic crises, cases of corporate accounting fraud increased and were typically focused on manipulating financial results with the objective to bolster stakeholder confidence, avoid breaching bank covenants, maintain or boost share prices, trigger bonus pay-outs or meet requirements for transactional earn-out payments. As we enter another downturn in the economic cycle, these areas are likely to re-emerge as focal points of investigations.
Common manipulation methods include fictitious or inflated sales, early recognition of revenue, late or non-recognition of liabilities, and overvaluation of assets (for example by deploying inappropriate accounting policies or valuation estimates). Therefore we expect to see investigations increasingly deploy technical accounting experts to dissect the commercial substance of accounting statements.
EU directive expands whistleblower protection
In January 2023, the EU Whistleblowing Directive, in place since 2019, was expanded to require firms with more than 50 employees to offer whistleblower protection. This includes reporting channels, confidentiality and safeguards against retaliatory action. UK and global companies with EU-based operations are in scope, irrespective of their headquarter locations.
In view of the greater degree of protection, we may see more potential whistleblowers feeling empowered to disclose allegations of corporate wrongdoing. With improved whistleblowing protections and the increased scrutiny of financial statements by investors, regulators and other stakeholders that arises during times of financial crisis, it is likely that more corporate accounting fraud will be uncovered and investigated in the next year.
Increased valuation uncertainty
Forensic accountants typically assist dispute resolution by constructing financial models to quantify loss. Loss quantification is underpinned by assumptions about parties’ financial results, operating arrangements and economic conditions. Global economic pressures will cast a sharper focus on the basis on which the assumptions are made.
The robustness of data used in quantum calculations will also come under greater scrutiny. As interest rates continue to rise, the present value of future cash flows becomes more vulnerable to erosion through the time value of money. The disconnect between historical energy and raw materials costs, and current inflation may mean that models relying on historical data underestimate future expenses. Valuation uncertainty will remain elevated given the uncertainty around the sustainability of some of the pandemic-era business trends.
Company insolvencies driving focus on directors’ conduct
The number of company insolvencies in England and Wales Q1 2023 was 18% higher than during the same quarter in the previous year. In the 12 months to 31 March 2023, the company liquidation rate was also higher than in the 12-month period ending on 31 March last year.
This increased activity suggests that the coming year is likely to see an increase in investigative and enforcement action relating to directors’ duties. Following insolvency, the appointed Insolvency Practitioner(s) – or, in the case of forced liquidations, the Insolvency Service’s Official Receiver – will investigate directors’ actions in the lead up to liquidation, including any signs of misconduct.
Legal developments – such as the Supreme Court’s BTI 2014 LLC v Sequana S.A. decision in late 2022 – have clarified the scope of directors’ duties in insolvency. The decision affirmed that when it becomes likely that a company will enter insolvency, directors have a duty to consider creditors’ interests. Where liquidation is inevitable, creditors’ interests take precedence over those of shareholders. Forensic accounting expertise is likely to be required to assess whether a company’s financial position at specific points in time indicates insolvency being inevitable, tipping the balance of when creditors’ interests take precedence over those of shareholders.
Unfolding consequences of Ukraine conflict
The consequences of the Ukraine conflict continue to reverberate across the profession. Western states continue to expand the scope of sanctions programmes. In March 2023 , G7 countries announced the Enforcement Coordination Mechanism, to share information and compliance oversight. Between 2022 and 2023, the UK Office for Sanctions Implementation is expected to double in headcount. We are likely to see a rise in sanction-related investigations, including financial transaction analysis and commodity tracing.
As the global community contemplates the possibility of a return to peace, claims for war-related damages will gather pace. As of April 2023, there were 10 recorded cases of Ukrainian investors taking action against the Russian Federation on allegations of asset expropriation in Crimea. Of these, six decisions were pending, and four decisions were awarded in favour of the investor. Enforcement of awards will likely entail asset tracing exercises to identify and secure sources of compensation.
Trends in asset tracing
UK government sanctions arising from the Russia-Ukraine war continue to have a significant impact on the asset-tracing sector. In May 2023, the UK government shelved plans to limit Russian individuals’ savings in UK banks, but a raft of other measures had already been announced over the last year and we expect further announcements going forward. Forensic accountants have kept abreast of the latest sanctions, reacting in a timely manner to any changes, both in terms of the nature of the sanctions and the specific businesses and individuals involved.
The forensic accounting profession is seeing an increase in requests to trace assets that have been relocated due issues related to the ongoing conflict. Russian businesses and high-net-worth individuals that have been operating from or been domiciled in certain jurisdictions have either chosen to, or have been required to, relocate and this has led to the rapid movement of both physical assets and the domicile of holding companies and other asset-owning structures. Given the time periods allowed for filing company and financial information in different jurisdictions, creditors and other interested parties are experiencing periods of uncertainty.
Away from the impact of the conflict in Ukraine, there continues to be robust demand for asset tracing in the context of insolvency recoveries, due in part to fraud and business failures related to the COVID-19 pandemic. As discussed earlier, an increase in fraud is anticipated in light of the global economic downturn (e.g. financial statement fraud) and cost-of-living crisis affecting many countries (e.g. embezzlement by individuals), which in turn could increase the demand for asset tracing and recovery expertise.
In April 2023, the EU approved its first piece of legislation for tracing crypto-assets, and we expect demand for crypto-related tracing services to increase as a result.
Expansion of access to dispute resolution
Dispute resolution is global in its nature. The expansion of global dispute resolution hubs, and increased access to funding will present opportunities and challenges to UK forensic accountants. Asia is one case in point, with the Hong Kong International Arbitration Centre registering a 24% increase in arbitration filings in 2022 compared to the prior year. Financial services disputes made up the largest category (37%) of cases. As China’s reopening from Covid-19 restrictions continues to drive regional activity, we expect to see increases in the volume and value of disputes heard in Hong Kong.
The Singapore International Arbitration Centre has experienced a record number of cases filed in Q1 2023, with 322 new cases as compared to 357 new filings in the whole of 2022. The largest category of disputes related to trade, accounting for 74% of referred cases. In May 2022, the Singapore courts allowed lawyers and their clients to enter conditional fee arrangements for arbitration proceedings. We expect this change to widen access to arbitration proceedings and contribute to a rise in case numbers.
Furthermore, we expect third-party funding to become established in mainstream dispute resolution arrangements. Litigation funding can provide class action participants with the means to launch and progress claims, broadening access to dispute resolution avenues. The nature of class actions means that legal teams acting for claimants and respondents must deal with the collection, processing and analysis of large data sets, driving the need for forensic technology services. In addition, the arrangement of funding often involves an initial assessment of whether a proposed case is economically sound for financiers. These trends will drive the need for indicative, speedy quantum assessments from forensic accountants when parties may not have access to the whole universe of relevant facts and materials.
Slowdown in M&A activity
Global Merger & Acquisitions (M&A) activity continues to slowdown in 2023. In Q1 2023, the global value of M&A deals declined by 44% compared to the same period last year. The decline, coupled with market pressures to deliver returns may provide increased incentives for financial statement manipulation, as sellers face increased pressures to make acquisition targets appear more attractive.
Meanwhile, the M&A boom during the pandemic years may drive increased Sales and Purchase Agreement disputes over the coming months. As parties look to extract maximum value from historical deals in a sluggish M&A market, they may turn attention to ambiguous contractual clauses that could be interpreted in their favour. Parties may also question, whether warranties have been adhered to and whether deal economics were based on accurate information.
Therefore we expect to see continued rising demand for forensic due diligence in the context of M&A activity, as buyers become more concerned about identifying and mitigating governance and compliance risks associated with potential acquisition targets and business partners.
Emerging trends becoming embedded in practice
Digital assets in their various forms, be they digital currencies, security tokens or Non-Fungible Tokens (NFTs) are going mainstream with companies increasingly including them as part of their digital strategy. Frauds perpetrated using these assets are widespread and well documented using familiar methods but a different medium. However, these assets present their own unique challenges to forensic accountants due to their price volatility, issues with custodianship and the ability of bad actors to utilise tools to execute multiple transactions quickly, obfuscating the destination of illicit funds. To address this, teams will need to upskill and stay up to date with the latest developments in this fast-moving space.
Machine learning in the work environment will proliferate. Continuous Active Learning technology, for example, is increasingly supporting document reviewers to identify the most relevant material. Artificial Intelligence tools will become embedded in working practices. The industry will grapple with the risks of relying on tools that are inherently opaque in decision-making and results-generation processes.
Greenwashing will become more prominent in investigation and dispute resolution. The UK Competition and Markets Authority (CMA) is set to receive powers to impose fines up to 10% of global turnover for consumer protection breaches. In view of the CMA’s 2023 commencement of investigations into greenwashing among fashion brands , this is likely to fuel regulatory and compliance focus on companies’ ESG claims.
Legal developments in ESG and warranty breach claims may shape methods of damages calculations. A decision in an environmental warranty breach of MDW Holdings v Norvill last year concluded that if a buyer was induced into making a purchase by way of deceit, the loss calculation could quantify potential damages even if those damages had not materialised. Over the coming year, we may see analogous approaches to damages quantification paving the way for greenwashing disputes, with damages calculated on the basis of the potential impact of misleading environmental statements.
As companies pay more attention to diversity and inclusion, with greater transparency over historical issues, we may see more investigations and claims related to non-financial misconduct.
Cyberattacks continue to grow in sophistication, incidence and reach. In Deloitte’s polling of 1,100 C-suite executives, 35% of respondents reported that their organisation’s accounting and financial data was subject to cyberattacks in the year to October 2022. The nexus of artificial intelligence and increased digitisation means that the complexity of cybercrime will develop over the next 12 months.
Enforcement priorities
International regulators are focussing on how employee use of personal devices and third-party messaging applications undermine corporate financial crime controls. In March 2023, the U.S. Department of Justice (“DoJ”) advised that companies must maintain robust data preservation policies, including regarding “ephemeral” messaging capabilities. In May 2023, the U.S. Securities and Exchange Commission and the Commodity Futures Trading Commission imposed fines of $67.5 million on two banks, for employees’ “pervasive” use of third-party platform services and personal text messages for business matters. In the UK, the FCA pointed to the use of chat applications on brokers’ personal devices and a lack of related training among examples of broker conduct deficiencies, in its October 2022 final notice against a broker.
In the UK, the new failure to prevent economic crime offence is making its way to becoming law by the end of 2024. To navigate the regulatory requirements, firms are likely to need advisory support in implementing and testing the “reasonable measures” that will protect companies from fraud and from falling foul of the new offence. The legislation is likely to drive the continued regulatory focus on businesses’ supply chains, as the definition of “associated person” captures agent relationships.
We expect a continued regulatory focus on professional negligence in audit. In the period between January and mid-May 2023, the Financial Reporting Council has announced seven new investigations into accounting firms, under the agency’s audit enforcement procedures. This is in line with the volume of new investigations in the same prior year period. We expect to see continued litigation against auditors from stakeholders, including liquidators and creditors.
Trend watchlist
Below, we consider three “watchlist” trends – areas that are beginning to take shape as potential influencing factors on the need for forensic accounting services, with the impact crystallising over the longer term.
In January 2023, the HMRC reiterated its intentions to pursue enforcement action against facilitators of tax evasion. In the last two years, eight cases against enablers of tax evasion were brought by the UK tax authority, a marked decrease from the 43 cases in the two years preceding Covid-19. It remains to be seen whether HMRC’s intentions translate into more decisive enforcement action.
In August 2023, the current Director of the SFO, Lisa Osofsky, is due to stand down. In recent years, the SFO secured record payments from firms and individuals accused of wrongdoing, while also experiencing some high-profile challenges. Most recently, in 2023, the SFO secured an application to seize almost USD8 million of cash linked to a Latin American corruption investigation, the largest amount seized from a single bank account by the agency. We will be watching whether the agency’s historical disclosure and resource challenges will be overcome to drive the enforcement momentum.
2022 saw high-profile delays to filing accounts by various companies. In the period between 2021 and 2022, 1.6% of companies filed late accounts, which equates to over 70,000 instances of late filing. This is broadly in line with pre-pandemic levels, although it represents an increase over a 5-year horizon. We will be watching whether the trends discussed above will lead to increased financial difficulties and translate to higher rates of late filing, bringing with it reputational damage, market concerns and enforcement penalties.