A beginner's guide to accounting fraud (and how to get away with it): Part VI

The ones that got away

Sooner or later we all get found out. I know my short book did in 2020. When our time comes we need to know to walk away, and know when to run.

One way to go, when the walls are closing in, is to just make money up. As in, lie about our bank balance. There doesn’t have to be anything clever about how we do this, because only two things really matter here. One is that the auditor will always check what our cash position is. And the other is that they’ll only do it once a year. We could pay someone who works at a bank to run off a fake statement for us, with their name and number on to call when the auditor wants to confirm it’s legit. Or we can cut out the middle man and pay our auditor to say they checked when they never did. Either works fine, and both make it really difficult to spot fraud from the outside.

There are less flagrant options too. On 9^th September 2018 serial entrepreneur Luke Johnson shared his experience and wisdom in an article in The Times newspaper titled ‘A business beginner’s guide to tried and tested swindles’. Five days later HMRC petitioned the High Court to wind up his business, the cafe chain Patisserie Valerie, for an unpaid tax bill. He didn’t notice. Unfortunately I didn’t either.

On 10^th October Pat Val halted trading in its shares and suspended its CFO. It noted “significant, potentially fraudulent, accounting irregularities” that had materially impacted the cash position. I was familiar enough with the brand. I worked in an office a few doors down from one. It never seemed busy but there was nothing in the accounts that gave me good reason to think about shorting the company. But if I’d been able to now I would have, even at half the price it was halted at. The reason I was so confident it was screwed was precisely because I hadn’t spotted anything wrong in its numbers before (neither, apparently, had anyone else as there were no publicly disclosed shorts on the FCA list).

Pat Val’s published accounts were as straightforward as you’d expect from a simple business like a cafe. Sales taken in cash, not much held as stock and a few prepaid expenses. The only line items of any size on the balance sheet were the capitalised cost of fitting out stores, and money sitting in a bank. Not a lot to tweak if you needed to meet numbers. That’s why the company saying that its cash position was significantly misstated, while it was short on detail, had to mean that (probably) sales and (almost certainly) profit were faked. Working backwards there couldn’t really be any other story.

Things unravelled fast. The next statement from the company, later the same day, disclosed the winding up petition from a month earlier. The following day Pat Val said it couldn’t continue trading without a capital injection, which really amounted to saying the £30m of “cash” on its balance sheet wasn’t in the bank at all. And the day after that its CFO Chris Marsh was arrested. One trick (I should say allegedly, I guess) is depositing fat cheques just before year end – to show a big credit at the point in time when you know the auditor is going to look – only for them to bounce a few days later. Another is borrowing money – again giving a big credit to cash – and just not mentioning the debt part in the accounts. Most of the time that would still show up as higher interest payments (see e.g. Globo), but when rates are close to zero you can get away with a lot more.

So, as it turned out, Pat Val really was a good guide to tried and tested swindles. But it’s not the one to follow if you want to get away with it ;) Chris Marsh, his wife and a couple of others got a knock on the door this September:

Of course, the case has been put together by the SFO, so…

For me, no amount of money is worth a ten stretch. A smarter exit strategy is getting our company bought by a much bigger entity. Sure the people running it will work out pretty quick that they’ve been had. But no one likes to admit they’re a div, so there’s a fair chance they’ll hush it up instead of coming after us when that would make them look stupid in front of their friends. And no, I’m not talking about Schneider Electric. Or Atos for that matter. It all gets washed out in a non-cash, goodwill write off anyway, so did it even really happen?

The best deal of this kind I ever saw a junk company pull off went the other way, though, with the much bigger business reversing into it a worthless roll up. This company had bought the cases of thousands of 10 year old slot machines for next to nothing - because they were basically worthless and it would have cost the vendor to bin them - then claimed to sell the same machines on for tens of millions of dollars in some unnamed Latin American country. I never found those slots but that’s not the interesting part for us. The jackpot came when the little roll up managed to persuade one of the biggest players in online gaming (which, admittedly, had been operating illegally in its main market for years) to reverse merge into it (presumably because management didn’t fancy their chances of completing a US roadshow). So in the end it didn’t matter if everything else was trash, it all became a footnote to a real business that only used to be criminal – and those can be pretty valuable.

Nice work if you can get it, but I don’t fancy our chances of finding a plum business that can juice our lemons that way. So how about this instead? We do nothing. Just keep promising the world to the world and his wife as things falls apart around us. Capital gone. Investors out. Price zero. And all the shares we own in our company sat in a brokerage account. Doing nothing. Worth nothing. Just held there passively, on loan to a hedge fund in Cayman that’s been shorting the shit out of our business. One that knew all along it was a fraud, almost as if it was born to do this. We sail away to the Caribbean and no one gets hurt. A victimless crime, just capitalism doing more of god’s work. That’s my best and final offer.

PS and if it doesn’t play out like it’s supposed to you can always try putting on a dress and eating gherkins out of a jar.