In the Hunt for Fraud, the Red Flags Start With the Auditor

With its Adani report, Hindenburg zeroed in on the tiny firm’s thin staff and client roster.

Illustration by II

Illustration by II

Hindenburg Research’s scorching report on Adani Group alleging pervasive fraud at the Indian conglomerate had some sound advice for safety-minded investors.

Check out the auditor.

The massive January 24 report, totaling more than 32,000 words, proffered exhaustive allegations of, among other things, accounting fraud, stock manipulation, and money laundering. It took two years to compile, according to Hindenburg.

But the simplest warning sign was the dubious credentials of a firm auditing two of Adani’s biggest companies. The firm, Shah Dhandharia & Co. LLP, had no current website, just four partners, a skeletal staff and only a single other publicly traded client, according to Hindenburg.

Shares of Adani’s seven public affiliates have since plunged between 9.3 percent and 78.9 percent as of March 7, wiping out more than $120 billion of market capitalization or 56.5 percent of their collective total, according to Morningstar data.


Adani soon issued a 400-plus page rebuttal of Hindenburg Research’s report, referring to the firm as the “Madoffs of Manhattan” and calling the report “nothing but a lie.”

Neither Hindenburg nor Adani responded to emails. A partner at Shah Dhandharia contacted on LinkedIn did not respond.

Adani is on a long list of companies in which the choice of auditors and information in their reports could have provided a warning to investors. But audit firm red flags often go unheeded.

“Nobody does due diligence,” says Francine McKenna, a lecturer at the University of Pennsylvania’s Wharton School, who adds that auditors themselves are focused on billings, not uncovering fraud. “Get the client, keep the client, please the client,” she says.

In 2017, Eros International, a big backer of Bollywood movies, was the target of critical research by FG Alpha Management. The short selling firm pointed to a lawsuit alleging money was being channeled to family members in addition to dicey financials, accusations of money laundering, and a big pending debt repayment deadline.

FG founder Dan David says the auditors, and there were nine of them at one point, were a clear danger sign. “At some of the subsidiaries, some of the auditors, we couldn’t find them,” says David, who founded a successor firm, Wolfpack Research.

Shares of Eros, now Eros New Media, recently traded hands at 1 cent apiece. Eros did not return an email seeking comment.

In 2018 Gabriel Grego, founder of short selling firm Quintessential Capital, said he was curious why nervous investors were dumping shares of luxury goods retailer Folli Follie.

The key was Chung & Partners, the auditor Folli Follie was using for its fast-growing China business. The firm had just two partners and was thinly staffed.

Folli Follie stock was trading at 5.5 times forward earnings, less than half the multiple of peer retailers, due to investor concern over the questionable auditor. Given the controlling family’s stake in the company, Grego questioned why it chose to remain with Chung when upgrading to a better-known firm could conceivably double their wealth.

Quintessential hired researchers who eventually found in filings with China’s State Administration for Industry and Commerce that Asian sales were less than a tenth of what it claimed and that the number of stores it ran was vastly overstated. Folli Follie shares were suspended from trading shortly after Grego made a presentation to investors in New York detailing his findings. Chung did not respond to an email seeking comment.

An audit by a Big Four firm is no Good Housekeeping Seal. Exhibit A, of course, is Arthur Andersen, whose most notorious client, Enron, filed for chapter 11 after booking fraudulent profits with the help of off-balance sheet accounting vehicles. Arthur Andersen was convicted of obstruction of justice.

After the global financial crisis, China-based affiliates of Big Four firms signed off on the financials of a flotilla of dubious Chinese companies that debuted on U.S. markets and were later shown to be cooking their books—and worse.

Grego suggests checking what other public companies an accounting firm has worked on and searching for disciplinary infractions with regulators.

Crowe UK LLP was auditor for Akazoo a music streaming company Quintessential was researching in early 2020. Grego was suspicious of the play lists the company disclosed of music downloads that included decades-old songs.

Crowe LP, its U.S. affiliate, had recently agreed to a $1.5 million fine and censure by the Securities and Exchange Commission for its work at another company, for among other things failing to identify related party transactions and evaluate its ability to continue as a going concern.

After a critical report by Quintessential, Akazoo in May 2020 announced that a committee of its independent directors had determined that company management and associates had defrauded the company’s investors. It reached a settlement in 2021 to pay $38.8 million to settle SEC charges in the matter.

A spokeswoman for Crowe LP in an email said that Akazoo had never been a client of her firm, the U.S.-based affiliate.

Even though audit reports are filled with boiler plate language, investors need to scrutinize them. Grego points to the wording of Grant Thornton UK LLP’s audit of the June 2021 annual report for then newly public Darktrace, a U.K.-based cybersecurity firm.

Darktrace has close ties to Michael Lynch, who backs the company and is currently fighting extradition to the United States on fraud charges related to his role as CEO at Autonomy, a software firm acquired by Hewlett-Packard for more than $10 billion in 2011.

Last year Hewlett-Packard’s successor companies won a civil fraud case against Lynch alleging that he had fraudulently inflated the value of Autonomy before the sale. A large number of Darktrace executives — including current CEO Poppy Gustafsson — formerly worked at Autonomy.

Quintessential’s January 31 report on Darktrace alleges past channel-stuffing and possible money laundering involving independent offshore shell companies with ties to organized crime. Specifically, the report states that during the period leading up to Darktrace’s early 2021 initial public offering, Quinessential identified transactions “seemingly involving simulated or anticipated sales to phantom end-users through a network of willing resellers.”

Grant Thornton UK LLP’s independent auditor’s report for fiscal 2021 ending in June says, “We identified revenue recognition as one of the most significant assessed risks of material misstatement due to the risk of fraud.”

Among other things, the report goes on to say that with regard to new contracts, “we consider this to be where the opportunity and incentive for revenue misstatement could occur.”

“Secondly, we focused on the increased fraud risk in partner channels due to immaterial findings relating to existence of end users in the prior year.”

In the end, however, Grant Thornton stated that Darktrace’s financial statements gave a fair assessment of the company and were prepared in accordance with applicable accounting standards. Grant Thornton and Darktrace both declined to comment on the record. A lawyer for Lynch did not return an email and phone call.

In response to Quintessential’s report, Darktrace issued a statement on February 1 that said that in preparation for its IPO, it had reviewed control procedures regarding its contracts.

The company stated that “a small number of contracts” that were not validated in the runup to the IPO were not included in any of its public company financial statements.

“Where processes could be strengthened, Darktrace has done so,” the company said in its statement.

On February 20, the company said it had hired Ernst & Young LLP to provide a third-party review of its financial processes and controls.

The lesson: “When you read the auditor’s report look at the text very carefully,” says Grego.