"In the blink of an eye" - how to avoid a portfolio plunge.
Managing risk in any single business is a challenge; managing risk in a private equity portfolio, with all of the inherent moving parts and variable factors, is a herculean challenge.
Given the potentially high expense and complexity of top-down risk prevention efforts, PE firms may decide that the costs outweigh the benefits and instead allocate funds into other areas such as bonuses and other investments. After all, your portfolio companies may never be affected by fraud, scandal, cyber-attacks or other such issues; when it comes to "what-if" risk scenarios, there just isn't any guarantee.
But, are the costs really that prohibitive? And, are the benefits really not worth it?
In their report "safeguarding private equity firms" KPMG notes that by choosing not to effectively "manage the risks inherent in your firm and your portfolio companies, you may find that all you built up is washed away in the blink of an eye". The report highlights six key risk areas including: technology risk, third-party risk, fraud and misconduct risks, cyber risk, compliance risk, and crisis management risk.
As a CPA and CFE (certified fraud examiner) with previous experience working with the fast-paced, deal-focused world of private equity I have often assumed that the risks of fraud, misconduct and other related issues are significant in the PE world - and KPMG's report seems to validate my assumptions.
The report notes that financial reporting fraud, asset misappropriation, bribery and corruption, and market misconduct are all areas of particular risk in the PE world - with scrutiny from investors and regulators increasing every day.
The KPGM reporters strongly recommend the adoption of a three-pronged risk management strategy including: prevention, detection & monitoring, and response. The first two being of extreme importance - while prevention and monitoring can be challenging (I will soon show how they can, in large part, be quite simply accomplished), the challenge of detection, evaluation, and response eclipses these other preventative efforts.
As a CFE I would often advise clients that they focus on up-front prevention. Attempting to clean up the messy aftereffects of a fraud or other related issue is a losing battle waged simply to try and mitigate the impact - full restitution is almost never a realistic outcome. Fortunately, prevention, detection, and monitoring can be accomplished quite easily and effectively, without the need for significant time, budget, or herculean strength.
In regard to prevention, detection, and monitoring the reporters lay down one particularly strong recommendation: in order to effectively manage fraud and misconduct risk you as the private equity firm should, at a minimum, "require that your portfolio companies implement “whistle-blower” mechanisms designed to encourage employees, vendors, and contractors to report instances of fraud, misconduct, or suspicious behavior".
It is with this one inexpensive tool, the "whistle-blower" reporting mechanism, that I believe that private equity firms can most effectively and easily reduce the risk of a portfolio plunge from fraud, scandal, or other such issue.
At Open Ears we have designed easy-to-implement, easy-to-use online "whistle-blower" mechanisms that specifically address the unique needs of private equity firms. Our tools allow you as the private equity firm to attach yourself as an Admin user on the account and immediately and directly be informed of every anonymous tip from all companies in your portfolio. Thereby reducing your reliance on management to hopefully provide the information upward and increasing your "odds of getting out ahead of potential issues".
As KMPG states “news—especially bad news—travels around the globe almost instantaneously thanks to the Internet and social media.” But, with Open Ears you'll never be the "last to know"!
Anonymous tip reporting systems are a universally recommended best practice supported by more than 20 years of comprehensive independent research by the world's largest anti-fraud organization, the association of certified fraud examiners. At Open Ears we understand the essential needs of private equity and our anonymous "whistle-blower" tools have unique characteristics that can easily and efficiently put your finger on the pulse of your entire portfolio helping you avoid a potential portfolio plunge.
Visit us at www.openears.io to learn more.
KMPG report: "Safeguarding private equity firms: Six key risk management strategies to head off trouble"