Patisserie Valerie – and fraud prevention measures

If there was one case study that could be used to highlight the importance of fraud prevention procedures, it would be that of Patisserie Valerie.

What happened?

The high street café chain began life as a single outlet in 1926 and remained as a modest family-run operation for the bulk of its history. This changed when the descendants of the founders sold out in 1987 and the new owners, the Scalzo brothers, grew the business to nine branches.

However, it wasn’t until 2006, when controlling interest in the firm was acquired by Luke Johnson’s Risk Capital Partners, that the chain began a rapid expansion. Over the period from 2006 to 2017, the chain expanded from a base of 8 stores to 206 stores nationwide, plus an online delivery service.

This was the zenith of its rise. However, for the following year, the discovery of potentially fraudulent accounting anomalies saw trading in its shares suspended. This came after the company announced there was a shortfall between the reported and actual financial status of the company.

In early 2018, Patisserie Valerie had been valued at £450m. By January 2019, the firm had collapsed into administration following unsuccessful talks with banks.

What caused it?

The company admitted the move was instigated as a direct result of significant fraud.

The entire circumstances that led to the collapse of the chain are still unclear. But at the heart of the matter is an announcement the company made in October 2018, stating that instead of having £28m in cash, as was declared in its accounts, the reality was that the chain was actually £9.8m in debt.

This was just the tip of the iceberg though. A forensic analysis of the company’s finances by the administrators, KPMG, concluded that the company’s accounts had been overstated by approximately £94m.

As a result of the initial discrepancies, the Serious Fraud Office announced it was investigating.

Commenting on the incident, Patisserie Valerie chairman Luke Johnson said he had been tricked by a fake picture of the company’s financial health, and questioned the validity of the glowing bill of health provided by auditors Grant Thornton (www.theguardian.com/business/2019/jun/09/patisserie-valerie-luke-johnson-says-he-was-tricked). This is an argument that Grant Thornton has rejected, stating that it did not have a duty to detect fraud and claiming that the company’s directors were reckless (www.thetimes.co.uk/article/grant-thornton-fights-back-on-patisserie-valerie-5z2xxqtfh).

The fall from grace that Johnson suffered was particularly acute. He owned a 37 per cent stake in the business and had made desperate attempts to save the business, including lending it £10m of his own money.

As a result of the move into administration, the company closed 90 of its stores and laid off over 900 workers.

Unfortunately, the tale of Patisserie Valerie falls into the category of closing the barn door after the horse has bolted. This is too often the situation with fraud cases, with many companies believing that, because they have appropriate accounting and audit procedures in place, falling victim to fraud is highly improbable.

The scale of the fraud that took place under the nose of a highly experienced businessman is testament to the vulnerabilities of any unwary business.

This wasn’t a one-off incident that was sneaked through a back door – it is fair to say that senior management was taken by surprise when they discovered that the company had borrowings of close to £10m, but the signs were there and should have been spotted far earlier.

Potential buyers were told that the accounts were unreliable as far back as 2014, this infers that the fraud was long-running. Further reports suggest that thousands of false accounting entries have been identified.

A set of strong, and strictly adhered to, measures to prevent and detect fraudulent behaviour would have detected such irregularities.

Having a basic set of monthly stocktaking and revenue reconciliation procedures in place, which actively pinpoint discrepancies before they can grow to any scale, is essential. This is a standard control Capcon implements within any business we work with in the hospitality industry, coupled with an effective response policy to further manage risk.

In the case of Patisserie Valerie, the fact that these processes and safeguards weren’t present contributed significantly to the demise of the company, the losses to shareholders, and the damage to the reputation of its senior management.

The name of Patisserie Valerie is still present on the high street after it was subject to a management buyout funded by Causeway Capital Partners, an Irish private equity firm. The deal, worth £13m, is a fraction of the company’s worth before the fraud scandal, and a lasting testament to the importance of due diligence.

Marcus Jones is the CEO of Capcon Ltd, specialist providers of compliance and risk management services to businesses: capcon.co.uk