How Getting Too Close to Clients Can Lead Accountant Malpractice Claims

Accountant malpractice claims have been a growth industry for litigators for more than two decades, thanks to increasingly strict professional standards for auditors and accountants.

 

And there’s no letup in sight. In fact, even in 2020, with the coronavirus wreaking havoc with the business community, regulators have continued to crack down on auditors who fail to take seriously their duties to uncover fraud or to follow the rules regarding the conduct of their relationships with clients. Regulatory action leads inevitably to accountant malpractice claims from clients.

 

As we have noted previously, relationships between CPAs and their clients may be very close, especially among smaller accounting firms and businesses. Yet those relationships can quickly disintegrate if the client suffers a fraud scheme that the CPA failed to uncover.  And when an accountant gets too close — and fails to adequately question the data and assumptions made by a company during the audit process — the results can be particularly devastating for a CPA firm and its individual partners.

 

FINES AND PENALTIES

 

Consider this recent action by the U.S. Public Company Accounting Oversight Board (PCAOB) against Texas-based Whitley Penn LLP. The firm and three of its partners were hit with fines and other penalties for violating PCAOB standards while conducting audits for its client United Development Funding (UDF), which specializes in real estate investments.

 

The PCAOB noted that one of the partners had identified a fraud risk involving a significant line of credit, but relied on UDF management’s estimates, data and assumptions without sufficiently evaluating their reasonableness. In their disciplinary report, PCAOB regulators found that the auditor “failed to perform…analysis with due professional care and, as a result, failed to obtain sufficient appropriate audit evidence to support…conclusions about the [line of credit].”

 

The firm and the auditors were cited by the PCAOB for failing to test the “accuracy and completeness of management-provided data” and for their failure to exercise “due professional care, including professional skepticism” in connection with the procedures they performed. In earlier audits, the accountants had neglected to appropriately respond to evidence of potentially fraudulent activity, the PCAOB said. This resulted in regulators citing the firm for “failing to maintain an adequate system of quality control, both during and after those audit failures.”

 

As a result, the firm was hit with stiff penalties, as were the three partners:

 

  • The firm was ordered to pay a $200,000 fine and to take several remedial actions.

 

  • One of the partners was barred from being associated with a public accounting firm for at least two years; fined $25,000; forced to limit audit activities; and required to complete 40 hours of continuing professional education.

 

  • Another partner received a one-year suspension from practice with a public accounting firm and was required to pay a $15,000 fine; limit audit activities; and take additional professional education courses.

 

  • The third partner was fined $10,000, required to complete addition professional education and restricted from audit activities for two years.

 

TOO CLOSE FOR COMFORT

 

The PCAOB’s action against Whitley Penn is just one example of how an accounting firm’s failure to design their audit to detect fraud can lead to legal trouble.

 

Recently, I was engaged in a case where the auditors failed to detect a $4 million fraud scheme. The chief financial officer of the company had written himself personal checks from a related enterprise during a six-year period. All of the checks were for amounts of less than $10,000.

 

Unfortunately, the CPA firm did not catch the fraud. It also had developed a cozier-than-usual relationship with the company and the CFO. First, the CPA firm’s engagement partner had led the company’s audits for more than 15 years. This is an arrangement prohibited by the PCAOB for publicly traded companies. Partners must be rotated out of an audit arrangement on a regular basis. And the lead partner had become personally close to the CFO. They frequently dined together, and the partner regularly accepted tickets to sporting and entertainment events from the CFO.

 

The CFO has been indicted, has pled guilty to the fraud and now is serving time in a federal prison. And the CPA firm? It is facing significant litigation involving accountant malpractice claims.

 

TOUGHER STANDARDS

 

In 1997, the accounting profession adopted the “Consideration of Fraud in a Financial Statement Audit” standard for CPAs. With that new standard, I posited in articles and at industry conferences that accounting firms would be subject to a flurry of lawsuits over failures to detect fraud. My prediction has proven true over the years. Insurers have noted that fraud claims now drive the most significant losses when it comes to accountant malpractice claims.

 

Unfortunately, some firms and CPAs haven’t seemed to receive the message. A number of CPAs who came to the profession before 1997 hold the mistaken belief that they are not responsible to design their audit to detect fraud. Many are relying on outdated teachings. Fraud didn’t even appear in leading accounting textbooks before 1997, and that year was the first time I recall the word being used by the American Institute of Certified Public Accountants. CPAs had been taught that it was not their duty to look for fraud – only to let their clients know if they saw or suspected any “defalcations.”

 

Yet failing to stay up to date on accounting standards or ignoring the ever-growing list of firms held liable for accountant malpractice claims is a highly risky proposition. The public expects auditors to detect and prevent fraud, and so do regulators and the courts. They have said that auditors have a legal responsibility to design their audits to detect fraud. Taking a company’s management at its word is not enough. In fact, if an auditor simply relies upon the word of company officials, it can face legal exposure and regulatory actions (as the examples above show). Auditors must gather corroborating evidence and diligently perform their auditing responsibilities.

 

If they don’t, they will almost certainly face a lawsuit. In almost all cases where a company suffers from a fraud, executives either sue their CPA or strongly consider doing so. This is true no matter what service the CPA provided, including simple compilation services.

 

In the end, it may be difficult to tell a client with whom a firm or CPA has developed a close relationship that fraudulent activities are suspected. But the relationship will become even more fraught if a CPA fails to do so.

 

To learn more about ways we can help investigate accountant malpractice claims, contact us for consultation.

 

 

 

 

 

 

 

Fraud Examination: Protecting Your Business from Workplace Fraud 

Despite the distractions and upheaval the Covid-19 pandemic has had on your business, be careful not to overlook another threat that could be looming around the corner — fraud in the workplace.

Occupational fraud is the misuse of one’s occupation for personal gain and includes anything from stealing office supplies to cooking the books to embezzlement fraud.  According to the Association of Certified Fraud Examiners’ (ACFE) most recent Report to the Nations on Occupational Fraud and Abuse, organizations lose an estimated 5 percent of revenues each year to occupational fraud – which translates to annual global losses of nearly $4.5 trillion. 

How can you protect your organization and avoid the necessity of conducting financial fraud investigations? The starting place for any successful fraud prevention program begins with two key elements: your organization’s ethical culture and the perception of detection.

AN ETHICAL CULTURE

The cornerstone of any fraud prevention effort is the ethical tone set by an organization’s leadership. Organizations that face financial fraud investigations have often failed to regularly communicate management’s anti-fraud stance or to properly train employees. 

One of the best ways to educate employees about fraud is to develop, implement and enforce a written fraud policy. Fraud awareness training can be incorporated into an employee’s orientation, annual training programs, and an annual statement acknowledging the employees’ understanding of your organizations’ anti-fraud policies. 

Common elements of a fraud policy include:

  • Fraud policy scope.  This section should clearly define the actions that constitute fraud and include language that the policy refers to all employees, including management and executives.
  • Disciplinary Action. Here, the organization should define the administrative process that will be followed if an investigation results in a recommendation for disciplinary action. 
  • Reporting procedures. Employees need to be aware of how and to whom they should report suspicious activity. Fraud reporting mechanisms, such as hotlines, must allow anonymity and confidentiality. Clarify that employees who report incidents will not suffer retaliation.  According to the ACFE’s Report to the Nations, tips are by far the most common fraud detection method. More than 40 percent of all cases reported in the 2020 edition were detected via tips — more than twice the rate of any other detection method. Employees accounted for nearly half of all tips that led to the discovery of fraud.
  • Investigation responsibilities. In this section it’s critical to identify who is assigned the responsibility to investigate alleged fraudulent incidents, and to whom those acts are reported (i.e. management, law enforcement, legal counsel).

THE PERCEPTION OF DETECTION

The second element of a well-rounded fraud prevention program is to increase the perception of detection. By nature, those who are tempted to commit wrongful acts are less likely to follow through if they believe they will be caught.

An organization can implement a variety of policies and procedures that help increase this perception, depending on the size and complexity of the organization. Examples include:

  • Segregation of duties. Think of a transaction like a circle. Employees should never be in a position to complete the entire circle alone. To overcome the challenge of segregating duties in a small business, insert management into the process. Increase the perception of detection by having bank statements sent to the business owner. To be effective, open and review the statements before delivering them to the bookkeeper. 
  • Mandatory vacations. Concealment is the modus operandi of fraud.  Mandatory time off reduces the opportunity to hide wrongdoing.
  • Job rotation. The longer a person is in one position (largely unsupervised), the risk of occupational fraud likely will increase.
  • Surprise audits. Keep employees on their toes. Surprise audits, where feasible, reduce the opportunity to alter, destroy or misplace evidence of wrongdoing.

By instituting a fraud policy, fraud training and procedures to increase the perception of detection, you can decrease the likelihood that your organization falls victim to occupational fraud.

To learn more about how we can help clients detect fraud, contact us for consultation.

What Beneficiaries Can Do to Help Spot Fraud in a Trust or Estate

It’s an all-too frequent concern for people who are no longer managing their own finances: Are they being taken advantage of by a trustee, executor, or attorney-in-fact—and what can they do to spot and prevent such activity?

At Forensic Strategic Solutions, we are often approached by beneficiaries or their loved ones to investigate possible trust and estate mismanagement. Time and again, we have found serious breaches of fiduciary duty, including embezzlement, the comingling of personal and trust or estate assets, conflicts of interest, and self-dealing.

Identifying mismanagement or fraud in a trust or estate requires beneficiaries (or their loved ones) to be attentive to the sources and uses of their funds. Knowing how one’s money is being deployed by a trust or estate is simply sound practice, even if fraud or mismanagement isn’t suspected. But a strong familiarity with one’s assets can also help a beneficiary spot red flags that require further action and investigation.

RED FLAGS

Red flags for fraud or mismanagement can include:

  • Dwindling account balances.
  • Assets that are missing or have been sold.
  • Transactions between a trust or estate and the trustee, executor, or attorney-in-fact or their associates.
  • A trustee, executor, or attorney-in-fact’s failure to respond to questions from beneficiary.
  • Failure to timely provide reports, accounting, or updates.
  • Reports, accounting, or updates lacking in substance or detail.
  • Past due notices.
  • Credit card balances that are higher than normal.

FINDING EVIDENCE

Noticing a red flag— or following that funny feeling in one’s gut that something isn’t right—is just the first step in investigating potential wrongdoing. Evidence is needed, and a great place to start is a review of bank statements.

  1. Review how funds are being used. Look for cash withdrawals or transfers to unknown accounts. Withdrawals or transfers to the executor or trustee should receive additional scrutiny. Be aware of the “I was repaying myself” or “it was a loan” excuse, all transactions should be appropriately recorded and have supporting documentation.

We have found instances of the trustee, executor, or attorney-in-fact making distributions for their own benefit, often rationalized that they are due these funds for their time and effort, especially when the trustee, executor, or attorney-in-fact is a family member.

Also, look for evidence inconsistent with the lifestyle. In the case of a deceased, are credit card bills being paid, when the deceased did not use a credit card or exceed amounts usually charged? If a high-level review of the bank statements identifies red flags after the date of death, it may be helpful to review asset activity in the months prior to the individual’s death, especially if the deceased was in poor health or reliant upon the trustee, executor, or attorney-in-fact for care.

Activity of interest prior to death may include: large gifts to some but not all beneficiaries, specifically the trustee, executor, or attorney-in-fact; purchase of large assets that are no longer in the deceased’s name; large cash withdrawals just before or immediately after the date of death. Pay special attention to the signature on checks for irregularities or signs of forgery.

  1. Review the sources of funds. Review deposits to make sure that income has not been diverted. A review for a period of time prior to the date of death or appointment of an attorney-in-fact should help to identify a pattern of income to help establish if any sources of income have been diverted. Be aware of regular dividend or interest deposits that could be easily diverted. If assets were sold look for evidence that all proceeds are deposited to the trust or estate account.

NEXT STEPS

One of the challenges of delving into a trust or estate can be the sheer volume of accounts and transactions involved. As assets move among several accounts it can be challenging to trace activity.

When faced with such complexity, a beneficiary would be well-served to contact an experienced forensic accountant. At FSS, we have found that it often requires years of experience and expertise in investigations and advanced data analytics to uncover and thwart fraud.

To learn more about how we help beneficiaries and their loved ones, contact us for consultation.

How to Prevent Workplace Corruption and Collusion? Think Like a Financial Fraud Investigator

When financial fraud investigators discuss corruption in the workplace, they are usually referring to a single employee who is exploiting their position for personal benefit.

Collusion, however, involves multiple people working together to abuse their power. When a collision occurs, the damage to a company’s finances and reputation multiplies. And pinpointing the perpetrators and the extent of their wrongdoing can be far more difficult than in the case of one corrupt worker acting alone.

Though tough to spot, workers involved in corruption and collusion often leave a trail of financial breadcrumbs that savvy employers can spot if they are proactively monitoring their enterprise. Employers can also take a few steps to prevent corruption and collusion before it devastates their companies.

Monitoring Behavior

Financial schemes are tough to weed out because corrupt and colluding employees rarely ever record their financial schemes on a company’s books. That said, employers can and should enact a monitoring system that allows them to pick up on signals of corruption and collusion that can appear in the purchasing and disbursement process. They should look closely at:

1) Preset Limits. Be sure to examine preset limits, because they can deliver a treasure trove of corruption signals. In a recent case, FSS investigated, an organization set its transfer approval limit set at $50,000. Investigating a potential fraud, we analyzed transfers at $49,999. Doing so revealed 48 instances within a 60-day period of transfers a mere $1 below the approval limit.

2) Consecutive Vendor Invoice Numbers. In another investigation, we identified that 99.9% of all invoices submitted by a vendor were just below the preset limit requiring a purchase order. The vendor submitted hundreds of consecutively numbered invoices each day for purchases by the same department for similar parts. This was done to circumvent the requirement for a purchase order and supervisory approval.

3) Behavior. Pay attention to attitudinal characteristics common among perpetrators of workplace fraud. These include consistent unhappiness with their position, habitually circumventing established policies, and refusing to share tasks or information with coworkers or management. These indications—although not proof of fraud—could point toward the existence of corruption or collusion in the workplace.

Preventative Measures

Employers can and should take preemptive steps to prevent corruption and collusion from occurring or to mitigate damages from an existing fraud. Steps include:

1) Training. Employers should require ongoing fraud training for all employees so they can better understand warning signs and become effective whistleblowers within the organization. Training can be held via a number of methods, including digital videos, live sessions, or interactive self-study.

2) Creating a Safe Environment. Management should prioritize creating an environment that promotes ethical behavior, where the staff is comfortable declaring in writing any potential, perceived, or actual conflicts. Everyone should feel that it is safe to be transparent when reporting relationships and positions that could cause a conflict.

3) Educating Management. Management must be educated on the procedures for handling potential corruption and collusion cases. The moment after a problem is discovered is not the time to develop procedures. Rather, management should be implementing procedures already put into place. Make sure that leadership in your organization is properly educated by offering additional reading, learning opportunities, and courses on fraud.

Although the possibility of corruption and collusion in your company can be daunting, there are ways to combat the threat. If leadership is sensitive to the warning signs of wrongdoing and actively works to create a culture of prevention, the likelihood of corruption and collusion will drastically diminish.

Contact us to learn more about FSS and its financial fraud investigation capabilities.

The Shift to Teleworking: Protecting Your Business Data from Fraud

The mass exodus of employees from traditional offices in the wake of the COVID-19 pandemic and the growing ease with which information can be moved and shared has made one thing clear: Businesses are facing a risk-filled new frontier when it comes to their data security.

The rapid shift to telework has only expanded the size and complexity of that risk, increasing the scope of internal and external threats, and challenging the effectiveness of current data security measures. Unsuspecting businesses face breaches that may damage their brands and rob them of revenue and intellectual property.

Internal controls have long been the gold standard to help businesses identify, assess, and manage risks. Increasingly, organizations have made the shift to include proactive monitoring of their transactional data to identify fraud, waste, and abuse. However, in the post-COVID new frontier, the universe of data is so much broader than simply monitoring transactional data that may not be enough.

Hackers and cyber-criminals tend to grab the biggest headlines, but less obvious threats can be equally dangerous. While trusted employees are moving, sharing, and exposing corporate data just to do their jobs, a malicious employee may be taking confidential information for personal gain or other nefarious reasons.

A strategy to proactively monitor unstructured data such as email, voicemail, internet logs, text messages, social media, blogs, documents, presentations, websites, and online customer reviews can help companies identify and manage emerging risks before they become major crises requiring a forensic investigation.

Implement a New Strategy to Reduce Risk                                              

Developing and implementing new strategies to monitor a broader array of internal and external data may sound complex – and even a bit intrusive. Yet, if managed correctly, the new strategies will help protect sensitive data and preserve profits.  A multi-pronged approach is recommended:

  • Educate employees. Employee training and awareness is critical. Many employees are not even aware that they are putting their employers at risk by moving or sharing company information across multiple media. Others simply do not believe that taking confidential company information if wrong. Create and enforce policies detailing the do’s and don’ts of information use and provide regular security awareness training. Make sure employees are aware that policy violations will affect their jobs.
  • Establish policies on confidentiality and privacy. Make sure that policies are in place that defines an employee’s expectation of privacy and your company’s right to monitor activity conducted on the company’s premises, equipment, and networks. Policies should also include the use of personal devices used for company business.
  • Use and enforce non-disclosure agreements. Employment agreements should include specific language regarding the use of confidential company information and the employee’s responsibility to safeguard such information. Conduct exit interviews with departing employees that include a review of their non-disclosure agreement. Be sure to collect all company-owned computers, tablets, phones, and electronic storage devices.
  • Implement monitoring technology. Leverage technology to gain insight on where information is going and how it is leaving the company. Implement monitoring technology to notify management when sensitive information is sent, copied, shared, or otherwise exposed. Inbound information is equally relevant as some downloads could leave the network vulnerable or accessible to the outside. Proactively monitor unstructured data where timing and information flow generate risk – for example, the departure of key employees, new product development, shifts in corporate strategy, or other major announcements.

The U.S. Cybersecurity and Infrastructure Security Agency recently issued a warning to businesses that fraudsters are focusing on virtual private networks (VPNs) and increasing phishing emails to teleworkers to steal usernames and passwords. “As organizations use VPNs for telework, more vulnerabilities are being found and targeted by malicious cyber actors,” the agency said.

The threats are real. To remain safe in this new data security frontier, businesses must recognize the emerging challenges they face, review their protocols, and take action quickly to help prevent potentially devastating internal and external breaches.

Contact us to learn more about ways our team can help you protect your business and conduct forensic investigations.

Accountant Malpractice Claims Are Likely to Rise. Are You Prepared?

CPAs, especially those in smaller accounting practices, usually have close relationships with their clients—and rightfully so. After all, who else is better positioned to understand clients’ finances and businesses than their trusted accountants?

That is until they suffer a financial fraud scheme that a CPA has failed to uncover. Then, what I call the “client appreciation curve” takes a precipitous bend toward the negative, as the client questions whether their CPA should have done more to detect fraud. 

It’s a scenario that often ends in an accounting malpractice case against the CPA. And given the pressure businesses are facing in 2020, such litigation is likely to become a growth industry in the months ahead. This year, as a result of the financial effects of the COVID-19 pandemic, Insurance Risk & Management reports that business failures are expected to increase by 25 percent. Yet, many companies appear unprepared for the rapidly rising fraud risks that accompany such economic turmoil. 

PwC’s 2020 Global Economic Crime and Fraud Survey notes that of the 5,000 companies surveyed, half have experienced fraud in the last two years – and the majority of those failed to conduct an investigation into the incidents. Companies are also lagging in deploying modern tools to detect fraud: For instance, only a quarter of the businesses surveyed by PwC said they are using artificial intelligence tools (AI) to help spot fraudulent activity. Auditors appear even less equipped to detect fraud. A report by the Public Company Accounting Oversight Board (PCAOB) succinctly summarized the reasons: Auditors lack the knowledge, training, and experience necessary for fraud detection.

Given the growing threat, and to avoid being swept up in a wave of fraud-related accounting malpractice claims, accountants need to act now to ensure they have the training and tools necessary to uncover fraud. They also need to understand how the role of the CPA has changed—and will continue to change—in the years to come.

A Turning Point for Malpractice Claims

In December 1997, the American Institute of CPAs (AICPA) enacted a new fraud-detection standard for accountants. The “Consideration of Fraud in a Financial Statement Audit,” holds that an “the auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud.”

At the time, I predicted that the new standard would help trigger a substantial increase in the number of lawsuits against accountants for failing to detect fraud. How true that prediction has become! Without fail, in almost all cases where fraud has occurred, a company will sue its CPA (or consider suing them). This is true no matter what service the CPA has provided, including tax and consulting and simple compilation services.

I based my prediction at the time on the fact that this was the first time that the AICPA had used the word “fraud” in its standards. At the time, fraud wasn’t even included in accounting textbooks. CPAs had been taught that it was not their duty to look for fraud—they only had a responsibility to let their clients know if they saw or suspected any “defalcations.” 

Fraud Is Serious Business

Unfortunately, many CPAs, especially the older ones, still hold the mistaken belief that they are not responsible for detecting fraud. Too many CPAs have failed to take their duty to detect fraud seriously. In fact, in a presentation I made to CPAs in 2019, 92% said they had no responsibility to detect fraud.

Professional standards require greater vigilance—and so do the public and the courts. A study by the CAMICO Insurance Services found that the public expects CPAs to detect fraud and that fraud drives the largest losses in terms of accounting malpractice claims.

Regulators have stepped up their efforts, as well. The Dodd-Frank Act lowered the legal bar to go after accounting firms for their failures, and the Commodity Futures Trading Commission has been particularly active in pursuing cases against firms that fail to detect fraud.

Scrutiny of CPAs’ actions has only intensified in the near quarter-century since 1997. The famed WorldCom and Enron frauds are just a few of the early examples. Significant fraud cases are now a matter of routine. Just last year, PwC’s failure to properly plan its audit to detect fraud at Colonial Bancorp Inc. led a federal court to award more than $625 million to the FDIC.

My prediction remains the same as in 1997: Accounting malpractice litigation is a growth industry. The coronavirus will only accelerate existing trends, creating more claims and inflating awards against accounting firms. CPAs who fail to take precautionary steps—for example, leveraging AI technology to help spot fraud—or who adhere to the notion that they aren’t obligated to find fraud are likely to pay the price. 

Worried About Workplace Fraud? Pay Attention to These Employee Behaviors

Economic turmoil can serve as a powerful accelerant for employee fraud, pressuring cash-strapped companies to sacrifice compliance activities to save money and fueling financial insecurity and temptation among workers.

The current recession is no exception. A recent survey by the Association of Certified Fraud Examiners found that nearly 70 percent of its members were worried about an increase in fraud in the wake of the COVID-19 pandemic. A third of the members said they have already seen a spike in employee embezzlement cases, and four in 10 reported more instances of bribery and corruption.

To fight fraud, companies need to pay close attention to potential warning signs—particularly an employee’s behavior. As in poker, fraudsters have tells, and their behavior often follows similar patterns from workplace to workplace. While the mere presence of a certain type of behavior does not mean an employee is committing fraud, it does provide a cue to management to pay closer attention to prevent or halt a potential issue.

WORKPLACE ATTITUDES

Employers have repeatedly identified attitudes common among workplace fraudsters, including:

  • Unethical behavior. If a person is willing behave to dishonestly in other aspects of their life, it often follows that the same inclination exists at work. Is the office buzzing about a person’s unethical behavior outside the workplace? It’s worth paying close attention to that individual to ensure unethical behavior does not occur inside the company as well.
  • Constant dissatisfaction. An employee who routinely expresses dissatisfaction with his or her job may be more likely rationalize inappropriate actions against an employer.
  • Cutting corners. Employees who are habitually looking for ways around company policies and procedures may also attempt to beat the system for personal gain.
  • Hoarding information. A dishonest employee often shies away from sharing information or relinquishing control over a task. They may conceal fraud by ensuring key documents and data never leave their grasp.
  • The first one in and last one out. An employer might overlook an employee who comes in early, stays late, and never takes a vacation. But the employee may be looking for opportunities to be alone in the workplace. A number of frauds have been uncovered when “too-good-to-be-true” workers finally miss work and are unable to prevent incriminating evidence from coming to light.

 

PERSONAL PROBLEMS

Personal problems and habitual behavior are common red flags for employers. Employees with substance abuse issues, gambling habits, or who are clearly living beyond their means may be more susceptible to fraud. It’s critical for managers to trust their instincts: An employee who shows up in the parking lot with an $90,000 automobile when he earns $40,000 a year may be worth keeping an eye on.

Here are a few other key issues to consider:

  • Is an employee facing instability outside work? Financial pressures may be mounting because a spouse has lost a job. Or medical expenses for the employee or family member may be creating extraordinary pressure. Fraud is often driven by issues occurring in an employee’s family life.
  • Does the employee have legal problems? Legal issues often create financial pressures that may lead an individual to take desperate measures.
  • Is the employee involved in an infidelity? Cheating spouses may spend lavishly on luxuries and may find themselves in a predicament to make up a shortfall.

 

WHEN FRAUD IS UNCOVERED

If you suspect fraud in your workplace, you must have a plan of action in place to stop the activity immediately. Take the following steps:

  • Secure the Evidence. Gather and protect any evidence that could be helpful to your investigation teams, such as computers, flash drives, cell phones, and digital accounts. “Secure” is the operative word. Don’t tamper with the evidence. Instead, assemble a team of forensic experts to investigate as soon as you can.
  • Don’t Fire the Employee—Yet. When fraud is discovered, resist the temptation to terminate the employee. Employees have a duty to cooperate with employers during a lawful investigation. Until evidence has been gathered by investigators, consider keeping them on the payroll.
  • Do Restrict the Employee’s Access. To prevent them from covering their tracks or stealing proprietary information, restrict the employee’s access to the workplace and the company’s systems.
  • Call Your Insurer. As soon as possible, contact your insurer. Many policies have a 30- or 60-day notification provision, beginning from the first day that you discover a potential loss. Failing to notify an insurer may void your coverage.

AN OUNCE OF PREVENTION

Even if you do not currently suspect wrongdoing in your workplace, keeping a close eye on employee behavior can help you spot a potential problem and act quickly to protect your company.

A few other preventative measures can also help curb an employee’s temptation to commit a financial crime. Consider segregating duties, placing daily and monthly limits on company credit cards, and monitoring electronic audit trails. Check the backgrounds of new hires and avoid hiring those with a questionable past. If possible, rotate staff in financial areas, such as accounts receivable, cash management, or purchasing, where the temptations for bad behavior tend to multiply.

Taking these steps can help an employer ensure that no employee gains too much power or is able to keep secrets about segments of the business. They may take extra work but the payoff—protecting an enterprise from the devastating effects of fraud—is worth it.

Contact us to learn more about ways our team can help you fight and investigate fraud in the workplace.

 

CATEGORIZED UNDER: Uncategorized

Eight Tips for Detecting Fraud in Accounts Payable

According to the Association of Certified Fraud Examiners 2018 Report to the Nations, fraudulent disbursement schemes remain the costliest form of asset misappropriation fraud to threaten small businesses. Although this risk can seem overwhelming, it may be avoidable through taking proactive steps against fraud within your company.

Here are eight tips to help you expose this popular employee fraud scheme:

Rotate Accounts Payable Employees

A fresh set of eyes is a great way to expose unusual patterns in vendor invoices. If your company has more than one accounts payable clerk, each one is likely responsible for the processing of a set group of vendors. Consider rotating these employees across vendor groups to keep their perspective fresh.

Require Mandatory Vacation for Employees

Concealment is the modus operandi of fraud. Requiring employees to take vacation helps remove the opportunity for concealment and exposes unexpected patterns and irregularities. Remember: an employee who is hesitant or unwilling to leave the office may have something to hide. Don’t ignore this important red flag.

Vendor Review

You can expose fictitious vendors and conflicts of interest by analyzing employee information alongside the information of approved vendors:

  • Compare employee addresses to vendor addresses to identify payments directed to an employee’s home.
  • Compare vendor tax identification numbers to employee social security numbers.
  • Fuzzy matching can identify vendors and employees that have the same street and city.

Approval Limits

Vendor invoices or payments just below a pre-set approval limit is a common method to circumvent approval controls. The analysis of payments or vendor invoices just below the limit can expose transactions that require additional examination. If, for example, your company requires management approval for purchases over $2500, vendor invoices of $2499 should sound an alarm.

Duplicates

When searching for fraud, duplicates are anything but twice as nice. Duplicate invoice numbers and invoice amounts from a single vendor can be an indicator of a disbursement scheme. This can also occur by utilizing duplicate invoice amounts submitted on the same date but under different invoice numbers. Using a data mining software, run a twist on a duplicate test by searching for “Same, Same, Different.” For example: same vendor number, same invoice amount, same invoice date, different invoice number. And don’t forget to search for duplicate vendors and duplicate payments to vendors!

Gaps

Beware of gaps in pre-numbered business records that should be sequential. Checks written for the payment of vendor invoices are a perfect example. If you identify missing checks, review your accounting system’s audit log and bank statements to ensure the missing checks haven’t cleared the bank.

Irregular or Unusual Transaction Dates

Most business offices operate during a traditional Monday through Friday 9-to-5 schedule. A search that reveals transactions processed on nights, weekends, and holidays deserves an extra look, as an employee could be conducting nefarious activities during non-business hours. Be sure to run a similar search on invoice dates and check dates.

Unusual Activity

Unexpected changes to the dollar amount and frequency of transactions with a vendor or within a department of your business can be a warning signal for fraudulent activity. Search for and analyze rapid or unusual changes on a monthly and annual basis. This continual evaluation will not only uncover possible fraud, but also alert potential fraudsters that you are vigilant about detecting unusual activity. Additionally, analyzing activity by budget cycle may expose additional patterns.

When combined with the review of supporting documentation, these eight tips can go a long way in uncovering fraud in accounts payable. Remember: fraud detection is best conducted through early and proactive efforts. By putting these tips into action now, you may protect your company from devastating financial and reputational damage in the future.

Brilliance v. Ethics – Which One Wins?

Originally published by ACFE Insights.

Smart people commit fraud every day. A recent case gives us a prime example.

A federal judge asked Donald Watkins, Sr. to step away from the jury box as Watkins, Sr. made an impassioned plea in his closing argument. Watkins, Sr. was in the personal space of front-row jurors, who were clearly agitated and restless as they leaned, twisted back and forth and from side to side to move away from the attorney. Watkins, Sr. was pointing his finger at the jurors and leaning directly into them.

In their March 2019 fraud trial, Donald Watkins, Sr. and Donald Watkins, Jr. were both convicted of defrauding investors of more than $10 million. An FBI agent described both as “financial predators who truly represent pure greed.”

Condoleezza Rice, the Rev. Martin Luther King III and former Birmingham mayor Richard Arrington, Jr. testified for the prosecution at the trial. Former NBA star Charles Barkley also testified, as he is a former friend of Watkins. In over a decade, Barkley invested more than $6.1 million and “never got a dime back.” Other professional athletes also invested with Watkins and have not been repaid. According to prosecutors the investors were given “materially false and fraudulent pretenses, representations, and promises.”

The guilty verdict was delivered in the same Birmingham, Alabama, courthouse with the same federal judge as the infamous Richard Scrushy case. On June 29, 2005, Scrushy, founder and CEO of the $2.7 billion fraud-ridden HealthSouth Corporation, walked out of Federal Judge Karen Bowdre’s courtroom a free man — represented by Waktins, Sr. Scrushy was the first CEO indicted and tried under Sarbanes Oxley.

How did Scrushy make it out of the courtroom unscathed? Prior to the trial, Scrushy bought a local public television station, from which he and his wife produced a religious evangelism program. Soon, Scrushy became a lay minister, preaching at local churches and reportedly making large contributions to the congregations. This trial strategy, a strategy of positive image and strong community outreach, worked in securing an acquittal.

Unfortunately, Scrushy did not fare as well when, four months after his acquittal, he was indicted in a political corruption scandal with the governor of Alabama. Both Scrushy and former governor Don Siegelman were convicted of a political conspiracy in a federal criminal court in Montgomery, Alabama. Both were sentenced to over five years in federal prison.

Scrushy also received a bitter defeat in a later civil case. While incarcerated in 2009, a state court judge ruled “Scrushy was the C.E.O. of the fraud” at HealthSouth. The judge awarded a $2.8 billion judgement to the stockholders of HealthSouth against Scrushy.

By all accounts, Richard Scrushy was regarded as brilliant. He built a Fortune 500 company from scratch (albeit, by fraudulent means) and grew his self-proclaimed net worth to more than $600 million. But, after his criminal conviction and civil judgment, he lost his wealth and his freedom. Clearly, in this battle of flawed ethics vs. brilliance, Scrushy’s flawed personal ethics emerged victorious.

Donald Watkins, Sr. orchestrated his own defense in his fraud trial. The indicted 70-year-old attorney represented himself and testified as a defense witness. He would ask himself questions, then answer those questions. Unsurprisingly, this proceeding was exceedingly strange — the prosecutor even objected that Watkins was asking leading questions!

Watkins, Sr., who had developed a national reputation by representing Scrushy and the City of Birmingham’s then-mayor, Richard Arrington, Jr., was reported by several news sources to be a billionaire. According to Watkins, Sr., he was “certified by Goldman Saks” as being qualified to make a bid for the St. Louis Rams football team. Like Scrushy, however, Watkins’ alleged wealth and intellect met a test of brilliance v. flawed ethics.

The November 2018 indictment against Watkins and his son was filed after a 2016 SEC civil suit claiming Watkins duped investors into paying millions of dollars to a bank account controlled by Watkins, Sr. Rather than being used to finance the growth of two international companies, the funds were used to finance an elaborate personal lifestyle, paying for personal expenses such as American Express bills, private jet expenses, taxes, alimony, clothing and personal loans.

On March 8, 2019, the federal jury in Birmingham, Alabama returned a verdict of guilty on all 10 counts of the indictment against Watkins, Sr., along with a guilty verdict on two counts against Watkins, Jr. Sentencing for both men is set for July 16, 2019. In this battle between personal ethics and brilliance, flawed personal ethics again emerged the winner.

At FSS, we are a team of certified fraud examiners, certified public accountants, investigators and forensic technology experts – learn more about our work here.

Auditors Who Stole the Exam Are Convicted of Fraud

This failure of duty matters – it violates public trust and costs innocent people their jobs, their pensions and above all – faith in a system.

The Wall Street Journal reported on March 11, 2019 that David Middendorf, the former national managing partner for audit quality and professional practice at KPMG, and co-defendant, Jeffrey Wada, former employee of the Public Company Accounting Oversight Board (PCAOB), were convicted in a Manhattan federal court. The federal prosecutors termed their actions a “Steal the Exam” conspiracy.

In a previous blog about the trial, I described why this violation of trust matters, and why auditors must design audits to detect fraud.

We’ve all heard stories about students stealing exams. Years ago, when I was a young auditor, a student who had passed the CPA exam was discovered taking the exam for other candidates. In response, the controls to monitor the exam were changed.

That CPA was expelled by the state board, but on appeal, was surprisingly allowed to keep his CPA certificate. He then got a degree to practice law. Perhaps I was naïve in thinking this was an anomaly and would not happen again. Now, we have the case of the auditor and the regulator who oversees the auditor both being convicted of fraud.

Auditors have received a lot of publicity about their failures to detect fraud. Just a year ago in March 2018, Federal judge Barbara Rothstein ruled that Big 4 accounting firm PwC failed to design their audit to detect fraud at Colonial Bank, resulting in the bank’s failure. She entered a judgment of $625 million against the firm.

When auditors don’t design an audit to detect fraud, unfortunate circumstances may result – the failure at Colonial Bank cost thousands of employees their jobs; stakeholders lost their entire investment; all lost their retirement savings, and some lost a fortune in Colonial stock.

When the KPMG auditors stole the exam and knew which audits would be reviewed by the regulator, they took actions to cover their failures. KPMG wanted to improve their performance on inspections because they had performed poorly in past reviews.  For example, they were under close scrutiny by the SEC for their failure to detect problems at GE and Wells Fargo.

Rather than focus efforts on improvements such as performing their work at an acceptable level of care and committing to higher-quality work, the defendant at KPMG took an easier approach – he illegally obtained knowledge of which audits the inspectors would review, and made poor work appear better than it actually was.

We now see a fraud scheme where we didn’t expect to ever see one – among the group whose duty it is to detect it. And this is a question of ethics – both personal ethics and business ethics. I don’t see how you separate the two. How does this happen? As a fraud examiner, I was taught the Fraud Triangle. One of the three legs of the triangle is rationalization – the mindset of a person who rationalizes their fraudulent action. However, I will never understand how fraudsters rationalize these actions!

Auditors must be taught how to recognize fraud – and we have a mandate to teach them. Unlike a cat who attempts to cover its tracks, cover-ups and stealing the exam are unacceptable. It is simply fraud.

For information about our accounting malpractice work, contact us today.

Cash Flow and Fraud Go Hand-in-Hand

Imagine working at a company for a period of time, checking your bank account and realizing that no paycheck had been deposited in exchange for your work. This scenario would undoubtedly raise red flags. Similarly, cash flow analysis performed by lenders and auditors that reveals stagnant or negative cash flow can also serve as a warning sign that something is awry – and it could be fraud.

Cash flow is a significant indicator of a company’s overall health and operations. It allows investors, lenders and auditors to gauge the relative stability of a company by assessing its ability to avoid excessive borrowing, grow its business and endure hard times. Merger and acquisition professionals, business appraisers and lenders are keenly interested in the free cash flow of an organization. Auditors should be particularly aware of free cash flow and its ramifications, especially in designing an audit to look for fraud.

It is imperative to note how cash flow increases as sales increase, since both should be moving at a relatively consistent rate. This analysis can be conducted using a ratio of net operating cash flow to net sales, which shows how many dollars of cash are produced by each dollar of sales. Remember: the higher the percentage, the better.

2010 2011 2012 2013
Operating Activities:
Net Income (loss) (76,604) (64,815) 4,385 52
Adjustments to reconcile net income (loss) to net cash from operating activities:
Depreciation of property & equipment 41,501 37,235 36,535 38,085
Loss on Sales of Equipment 10,895
Decrease (Increase)
Inventories (107,265) (2,809) (88,442) (97,986)
Accounts receivable, net and other 164,231 (810,465) 376,837 (198,482)
Deferred Income Tax Benefit 202,360 (15,666) 48,710 10,620
Other Assets 16,502 (13,333) (22,318) 13,860
(Decrease) Increase in:
Accounts payable 207,525 523,501 (367,398) 42,004
Accrued expenses and other (62,082) 33,047 (22,746) (5,185)
Deferred Income Taxes Payable (8,673)
Franchise Tax Payable 3,277
Deposits on Hand (205,000)
Prepaid Deposits (16,255) 174,005
Net cash provided by (used in) operating activities 172,495 (310,028) (39,797) (23,027)
Total Net Sales 1,106,112  1,156,410  1,299,210  1,946,820
Operating Cash to Sales Ratio 16% -27% -3% -1%

 

In the table above, the operating cash to sales ratio is low, and cash is decreasing despite sales increasing. Cash that is stagnant or decreasing when sales are increasing should set off alarm bells for anyone, especially an auditor. Fraud and cash go hand in hand. When there is a cash flow pattern such as this, it is probable that there may be fraud lurking under the surface.

Companies often have an asset-based revolving line of credit in which the company receives loan advances based on a set percentage of asset balances such as accounts receivable. The gross receivables are typically reduced by receivables 90 days and over to calculate the eligible receivables balance as the borrowing base. This balance is then multiplied by the agreed advance rate (usually between 75 and 85 percent) to arrive at the available loan advance amount.

A common fraud scheme related to this type of lending arrangement occurs when a company inflates accounts receivable to increase their borrowing capacity. While this can be executed in a variety of ways, the cash flow analysis shown above would reveal that something is amiss. For example, assume a company generates fake receivables to increase its borrowing base. After the fake receivable goes over 90 days old, the receivable is written off and the borrowing base is decreased – the company now must pay down its loan. Typically, to continue the fraud scheme, the company will then create a new receivable to replace the old fake receivable in order to maintain a level borrowing base. Once the company finds that this scheme works, it will then create more false receivables and begin a cycle which generates cash flow through fraudulent bank loans. Thus, a negative or lower cash balance will exist because receivables should have generated cash, but did not.

Auditors should always follow the cash when evaluating a company. External auditors are required to plan an audit to detect fraud. Internal auditors and regulators should also include this procedure cash flow analysis in their audits as a “best practice.” Cash decreasing despite an increase in sales could be an indication that fraudulent activity is occurring – and prudent auditors will find this procedure invaluable on their path to determine the source of the cash flow problem.

For more information on cash flow, visit our blog center. Learn more about our work here.

Big 4 CPA Firm Knew in Advance Which Audits Would Be Inspected by Government Watchdogs

This is violation of trust, and it matters!

Auditors must design their audits to look for fraud, and failure to do so may cause massive losses for stakeholders, investors, creditors and retirees. Neglecting to detect fraud can be truly life-altering — especially for retirees.

While teaching a business ethics class in Jackson, Mississippi, I was approached by an employee of the former fraud-ridden company Worldcom. “Emily Simmons” (an alias) and her husband, “Jim”, both of retirement age, had worked at Worldcom and its predecessor companies for over 30 years. Their combined retirement plans (all in Worldcom stock) previously had a value of $3 million. After the fraud was discovered, the plans were worthless.

With tears running down her face, Emily said to me, “Jim and I cannot retire. I was looking forward to a comfortable retirement and helping my daughter raise my grandchildren. Now I can only visit them twice a year. I hope that one day I’ll have some sort of retirement – although I am not optimistic – where we can spend a little time together before Jim and I die.”

Time Magazine’s 2002 “Woman of the Year” Cynthia Cooper and her team of internal auditors at Worldcom blew the whistle on Worldcom CFO Scott Sullivan and CEO Bernie Ebbers. The fraud unraveled, the perpetrators went to jail and Worldcom – along with its value – ceased to exist. Because of the Worldcom fraud, Section 404 of the Sarbanes Oxley Law was written, requiring companies to have much stronger internal controls and for those controls to be tested by auditors. But these requirements did not help Emily and Jim.

The Sarbanes Oxley Law (SoX) was enacted in 2002 by Congress in response to the massive fraud schemes that occurred at Worldcom, Enron and HealthSouth, among others. In SoX, Congress established the Public Company Accounting Oversight Board (PCAOB) as the government watchdog to oversee and regulate public accounting firms who audit and report on publicly traded companies. Previously, these firms were self-regulated. The leadership of PCAOB consists of a five-member board, appointed by the Securities and Exchange Commission, whose duty is to oversee audits of public companies with yearly exams to protect investors and the public interest.

A recent case has brought into question the integrity of both auditor (KPMG) and government watchdog (PCAOB). KPMG has been under intense scrutiny for years for failing to find problems at audit clients such as General Electric and Wells Fargo. When the PCAOB recently issued long-awaited reports on examinations of KPMG, it was disclosed that almost half of the audits had serious deficiencies. Two previous PCAOB inspections of KPMG were compromised by the firm’s advance access to the information. When the PCAOB replaced some KPMG audits it previously reviewed with new ones, the new audits had a much higher rate of problems. This illustrates the extent to which the advance access helped KPMG.

So, does it matter that “Big Four” accounting firm, KPMG, knew in advance which of its audits would be inspected by the PCAOB? You bet it does, because SoX was enacted to regulate a former self-regulated industry when it comes to publicly traded companies. Now the watchdog has been compromised.

KPMG fired David Middendorf and other KPMG partners accused of being involved when the PCAOB information leak was revealed in 2017. Middendorf was directly responsible for dealing with the PCAOB. He is now a defendant in a federal criminal trial that started February 11, 2019, in Manhattan. He faces charges of wire fraud and conspiracy. Former inspections leader at PCAOB, Jeffrey Wada, is a second defendant in the trial.

Three other defendants have pled guilty and are expected to testify against Middendorf and Wada. One of the now-convicted felons is a former KPMG partner who helped oversee audit quality at the firm and another partner who formerly worked at PCAOB before joining KPMG.

This story is important because the individuals who are supposed to be guardians of innocent people like Emily, Jim and thousands more have been let down. Auditors are supposed to ferret out frauds and protect stakeholders, creditors, investors and retirees. Unfortunately, we are now left to question those who have a duty to protect – both the auditor and the watchdog.

Last week, it was gratifying to read a post on LinkedIn by Richard Chambers, CEO of the Institute of Internal Auditors. Richard reminded internal auditors of the important role they play, and reminded them that, “I am respected and admired, because I am a guardian of trust!”

I heartily commend Richard Chambers for imparting this message to auditors, and I suggest that all auditors adopt this moniker. “Guardians of Trust” instills a sense of pride, because all business and individuals in the private and public sectors want assets safeguarded, and to know that someone is watching over the operation to see that those assets are protected. Sometimes, unfortunately, unscrupulous individuals and firms will be tempted to put their hand in the cookie jar – we call them thieves and fraudsters.

The story of the criminal trial involving the KPMG partner and PCAOB inspector is extremely relevant to those in our industry. This is a high-profile scandal which may have helped a “Big Four” accounting firm look better to its regulator — and hurt average people like Emily and Jim. It is up to the rest of us to do better, and take up the mantel of “guardians of trust.” If we fail to do this, the vicious cycle of fraud will undoubtedly continue on for years to come.

Capital Expenditures, Depreciation and Amortization in a Cash Flow Forecast and the Impact of the New Tax Law

The US Tax Cuts and Jobs Act (“TCJA”) passed by Congress on December 20, 2017, will impact forecasts of a company’s cash flow and thereby will likely impact the valuation of a company. One of the forecast elements impacted is the forecast of capital expenditures, depreciation and amortization.

The lowering of the C Corporation income tax rate from 35 percent to 21 percent will have a positive effect on the cash flow of affected corporations, all else held constant. With less cash going to pay taxes, more cash will be available for other uses, including capital expenditures (“capex”). This necessitates an increased scrutiny of a capex forecast, as recent historical expenditures may no longer be relevant as an indication of expected future expenditures.

The TCJA also allows for a first-year bonus depreciation of 100 percent — it was 50 percent prior to the TCJA — for certain qualified tangible property placed in service between September 28, 2017, and December 31, 2022, that has a depreciable life of up to 20 years. Generally, this bonus depreciation then declines in subsequent calendar years (exceptions for certain property):

2023 80%
2024 60%
2025 40%
2026 20%

The impact of these tax law changes will not be reflected in book basis depreciation calculations that appear in US GAAP financial statements; therefore, it is necessary for projections to be on a tax basis if they are being used for an income approach in a valuation of a business.

Business valuation analysts must be aware that the TCJA will cause the relationship between capex and depreciation to have an irregular pattern, and it will affect a much longer projection period than both company management and the valuator may be accustomed to preparing and analyzing. A longer forecast period is necessary due to the impact of timing differences on the present value of forecasted cash flows.

The always-important issue of normalizing capex and depreciation for the terminal period in a discounted cash flow model is further complicated by the depreciation provisions in the TCJA. A valuation analyst may address the issue by using a multi-stage model and capturing the depreciation provisions of the period 2018-2022 in the first stage, 2023-2027 in the second stage, and the length of the third stage being a function of the lives of the company’s assets. A valuator may also normalize the capex/depreciation for the terminal period in the year following the end of the projection period, and then separately adjust for the present value of the remaining TCJA induced capex/depreciation differences. The tax benefit of the amount not captured in the projection period would be calculated and then present valued over its remaining life at the terminal year. This amount would be added to the value of the company obtained from the discounted cash flow model. A valuator may use other multi-stage models customized for the type and lives of a company’s assets.

Overall considerations when forecasting capex/depreciation/amortization are as follows:

  • Normalized future capex would typically be greater than depreciation in a projection for a growing company, to allow for inflationary growth in the replacement cost of fixed assets.
  • Amortization has a limited life and should not be projected into perpetuity. The tax benefits of amortization subsequent to a projection period should be valued separately from the terminal value and added to the enterprise value.
  • The tax benefit of the depreciation on long-lived assets subsequent to a projection period would be treated and calculated similarly as amortization.
  • Due to the effects of provisions of the TCJA, valuation analysts must consider:
    • Obtaining or preparing longer-term schedules of capex/depreciation forecasts;
    • Building multi-stage models that account for the present value of changes in cash flow based on the depreciation provisions; and,
    • Reviewing all management-supplied information for reasonableness and internal consistency, as other changes in the TCJA could also impact forecasted cash flows.

If you are interested in learning more about how you can strengthen your case with a business valuation expert or want more information about our services and team, please contact us.

The Power (and Variety) of Data in Forensic Investigations

Time and time again, we trumpet the incredible value of advanced data analytics in forensic investigations – often, it is the key to finding the needle in the haystack. Fortunately, our firm remains at the forefront of utilizing data to identify unexpected patterns when investigating financial fraud – that red flag that tells us something isn’t as it should be – whether for a qui tam case involving kickback schemes or a case of underreported revenue. While we’ve discussed the importance of data analytics in a past blog, it’s also important to understand the variety of data that’s available and why you should enlist an expert to help translate the immense amount of information.

There are two general categories of data: structured data and unstructured data. While there are critical differences between the two, it’s crucial to understand how their distinctions work in concert to help us put the pieces of the puzzle together.

Structured Data

Structured data includes information that is highly organized and transactional in nature, like accounting system data and bank account data. By its nature, structured data is readily searchable.

Without data analytics, anomalies in structured financial data can be difficult to detect – but with the right tools and a little knowledge, implementing analytical techniques can bring forward the evidence needed. Here’s a key example: FSS worked with a school district that had a control in place that limited funds that could be transferred without board approval to $50,000. Knowing this, we searched for transactions of exactly $49,999. We found that one of our persons of interest had transferred this exact amount 48 times within 60 days.

Thanks to the structured data and an understanding of the organization’s policies and procedures, we easily honed in on this anomaly among millions of transactions – something that couldn’t have been accomplished without the use of data analytics.

But what if there is more to the story — what if more questions need answers?

Unstructured Data

While structured data is, well, structured – unstructured data is essentially the opposite. Structured data plays a key role in data analytics, however, we continue to see the rise of unstructured data to bring context to our cases. The analysis of this “nontraditional” data can help investigators follow the electronic trail often left behind by wrongdoers. Unstructured data includes:

  • Email
  • Text messages
  • Social media
  • Public records
  • Word documents
  • PDF’s
  • Presentations

As time goes on, forensic investigators will be forced to branch out beyond traditional analytics. The use of advanced data analytics with the combination of structured and unstructured data can give investigators a broader understanding of their subject and can help uncover a wealth of evidence that may go undetected when only considering traditional data sets. Advanced data analytics can be particularly useful when faced with incongruent information systems or spotty evidence.

Validating & Comparing Varied Data

Recently, FSS was hired to investigate whistleblower allegations that a company violated the Anti-Kickback Statue and submitted false claims to the government.

This qui tam case involved a company that worked alongside a third-party organization that provided goods to customers in exchange for referrals. Allegedly, the company paid the third-party organization a percentage of the compensation they received from the federal government as a result of the referrals. As part of this investigation, FSS requested and analyzed the following data:

  • Transaction details used to submit claims to the government from two disparate billing systems (structured data)
  • Word documents and PDF records of purchases from vendors of goods provided to their customers (unstructured data)
  • Emails between the company and their customers requesting and acknowledging receipt of the goods (unstructured data)

Through the testing and analysis of this disparate data, FSS was able to identify evidence that customers were incentivized to do business – and that the third-party company was paid kickbacks. The structured data was used to establish that the claims were submitted to the government. The unstructured data was then used to compare against the structured data – allowing us to draw the connection among the incentivized referral (goods provided to the customer), claim submission to and payment received from the government, and commission payment to the third-party organization.

Without access to the varied types of data and the use of advanced data analytics, it would have been much more difficult to develop the evidence and reach our conclusion.

The Power of Advanced Data Analytics

The combination of structured and unstructured data in forensic investigations is a game-changer, particularly when used in conjunction with other techniques, such as interviews. Data analytics allows investigations to move faster and cost less, all while allowing our examiners to synthesize unlimited amounts of quantitative and qualitative data to identify trends, relationships, unexpected patterns, inconsistencies and irregularities – and helping them find the proverbial needle in the haystack.

How Attorneys Can Effectively Utilize a CPA in Litigation

The right expert selected to compute economic damages is a critical ingredient to help an attorney’s case involving economic damages. As CPAs, we are asked to provide independent, objective opinions and/or consult on issues in a case.

What CPAs do in litigation:

CPAs analyze financial information and other relevant data. These analyses are used to develop conclusions about the issues and form the basis to independently calculate economic damages that are defensible in a court of law or other forum.

We are hired in a variety of disputes and investigations:

  • Breach of contract
  • Breach of representation
  • Shareholder dispute
  • Insurance loss claims, especially those involving business profits
  • Franchise and distributor disputes
  • Intellectual property disputes (including patent, trademark and trade secrets)
  • Lender liability
  • Bankruptcy dispute and court appointed investigators
  • Trust and estate disputes
  • Marital dissolutions
  • Employee dishonesty or fraudulent financial statements
  • Accountants failure to detect fraud
  • Employment disputes

We perform a variety of tasks, including ones not solely related to the analysis of financial statements:

  • Developing deposition questions
  • Reviewing correspondence/non-financial information
  • Assisting with document requests/interrogatory responses

FSS helps attorneys in many ways in anticipated litigation:

We provide the analyses that attorneys use in settlement discussions even prior to a lawsuit being filed. During an initial phase of litigation, we can assess facts and provide a preliminary estimate of damages, if they exist.

FSS serves attorneys in litigation:

We serve as an expert witness or a consultant. As an expert witness, we are an advocate for our opinion, not the attorney’s client. There are nuances to litigation services work, which is why it is critical to enlist the FSS team, comprised of individuals who understand the litigation process.

When FSS serves as a consultant, our role is usually never disclosed, so our work is not generally discoverable. A consultant’s role is similar to an attorney’s advisor.

Reasons FSS is hired as expert witnesses by attorneys:

  1. Credentialed professionals bring credibility to important cases.
  2. Economic damages analyses and forensic investigations involve complex financial issues, which FSS can explain in clear, understandable terms. With the aid of the most advanced technology, FSS can show a trier the facts of what happened and the cost of what happened.
  3. Employees of a party to the litigation are not independent. Also, they are likely not trained to testify nor know how to calculate damages to a reasonable degree of certainty.

When an attorney should hire FSS as an expert witness: 

As early as possible.

While cost is always a consideration, cost can be managed by taking the appropriate steps in close communication with our client, the attorney. FSS can manage fees through the following:

  • Budgets and workplans
  • Work performed in phases
  • Regular billing to avoid any surprises

Whether serving as expert witness or consultant, FSS adds great value to attorneys. Learn more about FSS litigation services here.

 

CATEGORIZED UNDER: Uncategorized

Lost Profits Damage Measures: More than just a Mathematical Calculation

The methodology of a lost profits calculation of damages in a breach of contract claim or intellectual property claim attempts to restore the injured party to their prior financial position. To prepare a calculation that is not viewed as speculative, evidence of loss must match the facts of the case and cannot be cherry-picked.

The calculation of lost profits is not straightforward.

An expert must consider all evidence in the record. An expert who blindly assumes all lost sales are attributable to the plaintiff, without considering other reasons the defendant could have made those sales (especially if evidence exists), is open to attack. Failure to consider sufficient relevant data (a term of art in the CPA’s standard of care) is a major reason why experts’ testimonies get excluded from cases.

We rely on the numbers and the story the numbers tell. We must use common sense and consider whether the damage methodology and assumptions align with the facts of the case. Critical questions to answer when computing lost profits damages include:

  • Is there reasonable basis for the assumptions made?
  • Has the expert considered all independent data and reconciled it with other evidence in the record?

Damages must be computed with reasonable certainty. The following steps are helpful.

  1. Determine what evidence is in the record and what is relevant for determining damages.The expert needs to be involved in the discovery process and ask for information needed. An attorney is helpful in identifying categories of documents. However, the expert must decide what is relevant for his or her analysis.There will be times when specific information is not available. In that case, the expert should determine if there is sufficient relevant data to determine damages with reasonable certainty.
  2. Use third-party, independent research to form the basis of opinions.This information can also be used to test the reasonableness of assumptions and data used.
  3. Step back and ask the questions:
  • Does this make sense?
  • Is this calculation logical?
  • Do I have sufficient, relevant data to support my opinions?
  • Have I considered other reasons that would cause the assumptions to fail; if so, have I reconciled it to the data?

Why could an expert’s opinion be excluded?

  1. The expert has failed to consider sufficient, relevant data in the record, or readily available.An expert witness who cherry picks data and ignores other data is open to challenges and likely to have the opinion excluded by the court. The expert witness should investigate and consider the evidence within the totality of the record.
  2. The expert has utilized methodology which is not accepted.The expert must demonstrate their methodology is reasonable and generally accepted in the professional community, and/or has been tested by other professionals.

Takeaway: No case is simple.

The calculation of damages based on a lost profits damage methodology is not straightforward. It is critical to find a professional who understands the pairing of the damage calculations with the evidence in the record and, more importantly, can tell the story.

Learn more about our litigation services here.

 

CATEGORIZED UNDER: Uncategorized

Detecting Deception: Gathering Evidence and Seeking Admission

OPEN is a key word to remember when detecting deception. Open body language – and an open mind – are your best friends when looking for the truth.

An open mind is going to help keep you in the “information-gathering” mode, which usually proves to be more effective than the gruff interrogation techniques you’ve seen in the movies.

USING OPEN-ENDED QUESTIONS

Ask open-ended questions – and lots of them. The more questions you ask, the more information you gather – and the wiser you become.  Focus your questions on How, Who, What, When, Where and Why.

While there is place for yes-no questions, open-ended questions will allow you to gather as much data and facts (or lies) as you can:

  • The more information you gather, the more places you’ll be able to drill into when you identify a hotspot.
  • The more they talk, the more nonverbal cues you can gather.
  • The more words you hear, the more you can glean from statement analysis.

INFORMATION GATHERING

The interview process generally moves from general to specific, and information gathering is  more conversational and less threatening. Information gathering can help you understand process and procedure. It also leaves you open to other explanations that you may not have previously considered.

SEEKING ADMISSION

The secret to information gathering is to continue asking questions until you have what you need. Take your time and be patient. When it’s time to seek admission, your questions – many of which you will already know the answer to –  should become more specific.

Moving from general to specific questioning may look something like this:

  • Step One: Prime them for the truth

“I know you are an honest person…”

  • Step Two: Gather information

How does the deposit process work?”

  • Step Three: Drill a little deeper

“The front desk prepares the daily deposit – then explain to me again why you occasionally prepare the daily deposit?”

  • Step Four: “Maybe I’m wrong here…”

This step is where the baseline comes in – you are looking for those deviations when your subject becomes slightly uncomfortable. When you spot a deviation say something like, “Well, maybe I’m wrong here, but your explanation doesn’t make sense.”

  • Step Five: WAIT

WAIT stands for “Why Am I Talking?”

Silence is pure gold in an interview – no one likes awkward silence – but if you are patient and quiet, your subject will do almost anything to fill the silence.

  • Step Six: Confirm your hypothesis

Ask a question that confirms what you already suspect: “So, every time I see  ‘see detail’ written on the deposit slip, that means you prepared the deposit and took it to the bank?”

  • Step Seven: Move in with the strategic use of evidence

In this step, reveal some of the evidence and ask them to explain the contradiction. The television detective, Columbo, was the master of asking questions he already knew the answer to and strategically using evidence to find the truth:

“Explain: This deposit slip with ‘see deposit’ tells me that you prepared the deposit – why wasn’t the cash  deposited?”

WAIT

When they feed you a line, close in with a little more evidence:

“Really? That’s interesting, because every time there is a deposit with ’see deposit’ written on it, the cash wasn’t deposited. Why is that?

BINGO.

All of these techniques are helpful when questioning a suspected fraudster. Employing the right interview techniques can make the difference in leading you to the truth in a forensic investigation.

Detecting Deception: Body Language

Now that we’ve peeked behind the curtain of speech and facial expressions, it’s time to move on to body language. But before we focus on our subject’s nonverbal cues, let’s shine the light on our own body language.

Remember: when detecting deception, we aren’t looking for the lie – we are looking for the truth. One of your best chances to get to the truth is through trust. Open and honest body language is one tool to help you achieve trust.

As the interviewer, when you use open, honest, natural body language, your subject is likely to follow suit. When using open and honest body language, the honest person will tend to:

  • Turn their body and point their feet toward you
  • Lean forward with casual interest
  • Shift posture fluently without nervous tics

Continuing the analogy of the tightrope walker – when your questions probe into unwanted territory, your subject’s nonverbal cues will likely stray far from open and honest:

THE EQUIVOCATOR

Discrepancies indicating deception leak from the equivocator as obvious physical discomfort or gestures that are incongruous with what they are saying:

  • Ill-timed shoulder shrugs: Shoulder shrugs indicate uncertainty, so when a shrug shows up with a definitive statement it could indicate deception. For example, when a question like, “Have you stolen from your employer?” is answered with a resounding “No!” and partnered with a shoulder shrug, you may have landed on a hotspot. Beware –  these shrugs are usually quite subtle, and one shrug does not a fraudster make!
  • Involuntary bodily functions: The fight or flight response to stress can cause unintended physiological changes that can leak with the heightened stress the equivocator is experiencing.  Watch for clues like jittery hands, a growling stomach or a sweaty brow.

THE MAXIMIZER

Forever fighting to convince you of the truth, the maximizer’s body language is often anxious and laced with arrogance:

  • Timing of gestures: For the honest person, a hand gesture comes a beat before the words. An anxious liar’s gestures will follow the words.
  • Palm-down gestures: Palm-down gestures during an interview are often an attempt to control and keep a tight rein on the conversation. Used in a standing position, these gestures are often an attempt to get you to back off.
  • Steepling: For a liar, steepling is the non-verbal equivalent of “don’t even try me.”
  • The crotch display: Watch out for this one – it’s the ultimate attempt to communicate dominance, arrogance and defiance.

THE MINIMIZER

This behavior is among the easiest to spot. While the maximizer is busy puffing up, the minimizer is desperate to disappear.

Think about a time when you’ve embarrassed yourself in front of a group – didn’t you shrink just a little?

Watch for similar behaviors during an interview. If your subject’s open stance suddenly changes and they shrink, cross their ankles, or cover their face, they are minimizing – a perfect time to dig a bit deeper.

Minimizers will opt to have a table, a book, a purse – anything – in front of them. Keep this in mind and set your interview room so that nothing blocks your subject.

When the minimizer lacks physical blockers, they will likely resort to body-blocking behaviors, e.g., hands in front of the mouth, neck, throat or any other vulnerable area. Eye-blocking is another favorite – often accomplished by covering the eyes or squinting.

THE PACIFIER

Self-touch is often an unconscious way to relieve tension. Nail biting and hair twirling are examples of pacifiers in action.

Again, as with any nonverbal cues, be cautious – one cue or gesture does not necessarily mean you have found a fraudster.

SHARPEN YOUR SKILLS

Refining deception-detecting skills takes practice. People watching can be a great way to hone your skills. Deliberate observance of human interaction can provide invaluable instruction – watch for ill-timed gestures, changes in posture or other nonverbal cues.

Learn how we have used fraud examination techniques to catch fraudsters in the act.

Detecting Deception: Facial Expressions

THE FACIAL FAUX PAS

Now that you have gathered your intel – you have your subject’s baseline squared away and you’ve peeked behind their words – it’s time to focus on the facial faux pas. There are many facial signs that are likely indicators of deceptive hot spots.

When your subject’s expressions and gestures don’t match their words, pay attention. Spotting emotional “leakage” in the face, combined with other verbal and non-verbal cues, speaks volumes about the message your subject is trying to share… and that it may not be the truth.

As with any hints of deception, facial faux pas won’t give you all the information you’re looking for, but spotting them gives you potential areas to probe.

DETECTING FACIAL FAUX PAS

  1. Preparation: Our expressions affect each other dramatically – as interviewers, we need to continually be aware of the effect our own nonverbal communication has on our subject. Remember: how you approach any situation impacts the outcome. If you approach this step calmly, you will keep your subject at ease as well.
  2. Scale back on mirroring: Mirroring is important to establish rapport, but once rapport has been established you want to scale back, as it might interfere with your ability to detect deception.
  3. Remember the baseline: Without it, there is little relevance to non-verbal and verbal cues.
  4. Exposing hotspots: Remember, liars are like tightrope walkers whose goal is to stay upright while threading their web of deceit. You’ll see the same three categories of signals when looking for facial faux pas as you did when assessing verbal cues of deception in your subject:
  • The Equivocator’s Face
    • There are seven universal emotions that are hard-wired, no matter the person: happiness, sadness, disgust, fear, surprise, anger and contempt. Each of these emotions registers with very distinct patterns that are almost impossible to fake.
    • Micro-expressions of these emotions may leak out for only one-fifteenth of a second. They are a challenge to spot, but learning to spot these fleeting emotions is incredibly helpful.
    • With practice, learning to spot micro-expressions can significantly increase your ability to detect deception.
  • The Maximizer’s Face
    • Remember: the maximizer’s goal to bully their way through the interview. Classic facial faux pas for the maximizer include:
      • Changes in eye contact
      • Tight lips
      • Changes in blink rate
  • The Minimizer’s Face
    • The minimizer’s face is one of escape. Watch for these clues:
      • Facial blocking
      • Hiding in their hair
      • Lip sucking
      • Face wiping

Now that you know what facial expressions to look for in a liar, learn more about body language cues that can help you detect deception.

Detecting Deception: Speech and Voice as a Lie Detector

Once we’ve established the baseline, it’s time to drill down to expose the meaning behind the words. While body language has long been the focus of detecting deception, research has shown that the analysis of a person’s speech may be much more accurate than merely observing non-verbal behavior.

No matter the lie, there will always be verbal indicators of deception lurking in the tone and speech a liar uses.

THE VOICE AS A LIE DETECTOR

The tone of a person’s voice has an amazing effect on us. Singing a request versus shouting it in an exasperated voice can have a direct effect on trust.

Think about it: how many times have you gotten what you wanted when you used a buttery voice? You will almost never get what you want with an angry voice, unless you are trying to strike fear in someone.

Vocal tone is a powerful indicator of emotion – research has shown that a person’s vocal tone will waver from the baseline in up to 95 percent of all deceptive statements. It’s one of the most reliable indicators of deception, and whether it goes up or down depends on the emotions involved.

  • Vocal tone rises when we are angry or excited. You might see this when your subject is trying to convince you of something. Be careful, though – a truthful person will also get angry when wrongfully accused. The difference? The liar’s anger subsides more quickly.
  • Vocal tone lowers with sadness and shame. When your subject’s voice gets lower, pay close attention.

THE STORY BEHIND THE WORDS – STATEMENT ANALYSIS

Mastering the art of detecting deceptive speech is best learned through Statement Analysis – a system of analyzing the grammar and logic of words that come out of our mouths. Often the inconsistencies of a story can be picked up almost entirely from shifts in tense or word choice.

Picture this:

A liar is like a tightrope walker whose goal is to get across the canyon of your doubt and skepticism to freedom when they have convinced you of their tale. Their challenge is to remain upright and make steady progress throughout the interview. As the interviewer, your job is to watch for their imbalance or leaks of deception along their journey.

The extra baggage of deceit can be burdensome. This baggage includes:

  • The truth: the facts as they really happened
  • The “facts” in their own lie
  • What they’ve told you in previous conversations
  • The new “facts” they are feeding you
  • The fear of the unknown: what you know but haven’t disclosed
  • Your reaction to their tale

The extra baggage of deceit is likely to throw the liar off balance, triggering their fight or flight instincts.  Pay close attention, as this baggage creates three different categories of signals that can reveal your subject’s stress response and suggest there’s more to the story:

1. The Equivocator: the main balancing act. Consider the gymnast on the balance beam who might suddenly throw a leg out to one side to compensate for weight shift on the other. You will hear this same kind of equivocation when people are lying. Their speech wavers, deviating from its normal pattern and shifting in odd, uncharacteristic ways.

The equivocator will leak inconsistencies in many of their statements or try to make everything seem like sunshine and roses – liars don’t like to talk in the negative. If their answers don’t relate      to the question, or if their language is garbled or deviates from the baseline, it is cause for an amplifying question.

     Mixed-up tenses – When your subject recounts a story, pay close attention to the tenses they use – sometimes they will switch tenses in the middle of the story.

     Double-talk – Remember that it’s human nature to tell the truth. Because our brain is wired to tell the truth, when we lie, we may often say things in a strange way.

     Entering the Twilight Zone – This involves a variation on “one thing led to another,” using opaque language.

     Frequent pausing – When there is a dramatic pause at an inappropriate moment, your subject may be thinking of the word they want to say and then gathering another word instead.

     Start-Stop sentences –  Start-stop sentences occur when your subject realizes they’re about to tell you something they don’t want to tell you.

2. The Maximizer – the classic “fighter”.  The maximizer will try to overwhelm you with brute force language or nonsensical details. Honest people convey information, while liars try to convince.

3. The Minimizer – the classic “flighter”. The minimizer is reticent and subconsciously disappears into themselves in an attempt to avoid the truth and retreat from the conversation.

In forensic investigations, we look for deviations from normal behavior to catch a fraudster in the act. While speech and voice can help with deception detection, when combined with fleeting non-verbal cues like micro-expressions – the smallest and quickest of facial expressions – they can create a hotspot for a deeper dive.