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Reducing Litigation Costs Through Specialized Software

Posted by & filed under Forensic Accounting, Litigation Support.

Using specialized data-mining software in complex litigation support and forensic accounting engagements can yield significant cost and time savings. In most forensic accounting engagements, time is of the essence and, when litigation is involved, deadlines for discovery or accepting proposed settlement offers can become a major issue.

If it normally takes several weeks to perform a particular analysis of large amounts of data and the analysis results in a dead end, the use of data-mining software can be especially valuable in affording time to conduct alternate analyses. A recent engagement of mine, which I detail below, required only one person working for three days as opposed to a team of two people working for several weeks to perform the analyses and obtain the results.

In this particular engagement, a multi-location retailer believed that its controller may have been defrauding the company through a variety of means. It was suspected that the controller was purchasing goods from the company without payment and making fraudulent payments to one or more of her own businesses through accounts payable.

The controller had been married multiple times and had been known by eight different names including alternate spellings. In addition, she had lived at six different addresses during her tenure as controller.

I obtained an electronic copy of all company sales and accounts receivable transactions for the 10 years that the controller had been with the company. This consisted of more than 1 million transactions in more than 250,000 customer accounts.

Using specialized data-mining software, I was able to analyze customer accounts and transactions for matches with any of the controller’s names or known addresses. I also reviewed the write-offs of any balances in such customer accounts.

I determined that the controller had purchased goods through eight different customer accounts, that a former spouse had purchased goods through two different customer accounts, and that a former live-in boyfriend had purchased goods through yet another two different customer accounts. During further research of nonpayment account reductions in balance, I found that on 13 different occasions the controller had written and processed either credit memos or write-offs to these accounts. Each of these nonpayment account reductions was determined to be improper and had been processed without the proper approvals.

I also obtained the company’s vendor files. Using the same data-mining software, I compared the billing and payment addresses of the company’s 1,200 vendors with the known addresses of the controller. I was able to determine that payments had been made over several years to a consulting company with the same address as one of the controller’s known addresses.

As demonstrated by this particular engagement, the benefits of using specialized data-mining software in complex litigation support and forensic accounting engagements can be substantial and should be seriously considered in such cases for cost and time savings.

– See more at: http://thelegalintelligencer.typepad.com/tli/2012/04/reduce-costs-of-litigation-support-with-specialized-software.html#sthash.7N3YD25y.dpuf

Executive Culture is Essential in Preventing Employee Fraud

Posted by & filed under Forensic Accounting, Fraud, Fraud Deterrence.

I was recently involved in a fraud investigation of the CFO of a privately held company that spent years following the directives of the majority shareholder to run the majority shareholder’s personal and/or nonexistent expenses through the company. In addition, the CFO was directed to implement other schemes that the majority shareholder designed to defraud the minority shareholders. After a few years, the CFO saw an opportunity to enrich himself by embezzling funds from the company. He did so to the tune of more than $7 million. When caught, he explained his actions by stating he was just doing the same thing that his boss did.

“Tone at the top” refers to the ethical atmosphere created by company management. The Association of Certified Fraud Examiners has established a direct correlation between the tone at the top and the risk of employee fraud in companies. If company management sends the message – either explicitly or implicitly – that fraud is acceptable to management, then some employees will rationalize that it is OK for them to commit fraud. Management may send this message by engaging in such fraudulent behavior as:

  • Overstating revenues or understating expenses so that the company appears more profitable than it really is (financial statement fraud).
  • Understating revenues or overstating expenses so that the company appears less profitable than it really is (tax fraud).
  • Giving or accepting bribes, kickbacks or inappropriate gifts.
  • Engaging in price fixing.
  • Submitting false or inflated expense reports for reimbursement.
  • Having the company pay personal expenses.
  • Lying to employees, customers, vendors, regulatory officials or the public.

Because it is almost impossible for management to engage in such behavior without involving one or more employees (for example, having accounting employees submit improper entries to the financial reporting system; directing staff to pay knowingly false expense reports; or approving vendors who are not the lowest cost quality bidders), this fraudulent behavior becomes known to other employees.

Even if management is not committing fraud, its failure to communicate disapproval of employee fraud will lead employees to believe that those at the top are indifferent to fraud.

To prevent employee fraud, management must set the tone and actively communicate disapproval of fraud. This requires management to take the following steps:

Communicate to employees what is expected of them. This means establishing policies and procedures to let employees know that fraud is unacceptable to management and that the company is taking active steps to prevent such schemes. Employees should also receive regular fraud and ethics training.

  • Lead by example. Regularly demonstrate that management finds fraud unacceptable and will not engage in such violations.
  • Provide a safe mechanism for reporting violations. This can include establishing a confidential hotline for reporting fraudulent activity.
  • Reward integrity. Include acting with integrity in employee incentive programs.

By setting the right tone at the top, management can demonstrate ethical leadership in preventing employee fraud.

 

Understanding Your Business’ Financial Statements Is the First Step Toward Preventing Fraud

Posted by & filed under Forensic Accounting, Fraud.

Many of my recent forensic and litigation engagements have arisen when business owners (including legal and other professional firms) suddenly learned that trusted individuals within their businesses had perpetrated a fraud upon the business. Most of these business owners had received regular monthly or quarterly financial statements for the business but had failed to read and understand them. Had they done so, they could have caught the fraud earlier or prevented it altogether.

Why does this happen? My experience reveals that most of these business owners had minimal knowledge and understanding of their business’ financial statements, and instead relied upon another owner/partner or trusted employee to handle all of the business’ financial matters. In each case, a careful analysis of the financial statements would have identified that something was wrong. Furthermore, when the economy was booming (as in the early to mid-2000s) and/or the company was growing, the fraud could be more easily hidden. However, when revenues and cash collection slowed down, it became more difficult to hide the fraud.

Let’s look at two examples.

Financial Fraud: Destroyed Cash Sales Invoices and Pocketed Cash

In one instance, the trusted employee in a business that generated a significant amount of cash sales destroyed cash sales invoices (so they were never entered into the accounting system) and pocketed the cash. In addition, at the end of each quarter (when he produced financial statements for the owners), the trusted employee made a large journal entry to increase the cash account balance so it appeared as if the business had more cash than it did. If the business owners had understood the quarterly financial statements, they would have noticed that: (1) the gross margin on sales had begun to decline significantly even though neither selling prices nor purchase prices had changed (because sales costs were entered into the accounting system, but the corresponding sales were not); and (2) the accounts payable balance kept growing significantly (because there was insufficient cash to pay the bills). Also, if any of the business owners had reviewed the monthly bank statements, they would have noticed that the cash balance shown on the bank statements was significantly lower than that shown in the financial statements.

Financial Fraud: Cash Distributions Without Informing Partners

In another instance, one business partner took significant cash distributions from the business without informing his other business partners. Because this business partner controlled the financial matters of the firm, he was able to mask these cash distributions by recording the distributions as increased operating expenses of the firm. If the other business partners had read and understood the financial statements, they would have noted that certain expense balances were much higher than expected, and they would have raised the issue with the financial management partner. (For example, more than $25,000 in office supply purchases in one month for this 10-person company or more than $20,000 in travel expenses in a month when no one in the company had traveled out of town.)

Business owners who regularly read and understand their business’ financial statements can identify warning signs in those statements and stop or prevent fraud from occurring.

Discovery of Hidden Assets

Posted by & filed under Forensic Accounting, Marital Dissolution.

In divorce proceedings and certain types of commercial litigation, counsel may suspect that the opposing side has hidden some assets. A forensic accountant can be of great assistance in formulating discovery information requests and conducting the analysis that will aid in the identification and location of potentially hidden assets.

In order to identify hidden personal and/or business assets, counsel must address his/her discovery requests not just to the known (items identified on the tax return, items of which his/her client is aware, etc.) but also to the potentially unknown.

Upon receipt of this information, the forensic accountant will perform analyses and asset searches that may identify or point to the potential existence of such items as:

  • Income or other payments received that have not been deposited to known accounts.
  • Funds deposited for which there is no documentation as to the source of the funds.
  • Funds withdrawn for which there is no documentation as to where the funds went.
  • Direct wire transfers made to or from unknown accounts.
  • Unusual activity involving the safe deposit box (this could be indicative of cash or other assets being placed in or removed from the box).
  • The existence of previously unknown off-shore bank accounts, or investment accounts or other assets.
  • The substitution of lower value assets for higher value assets (for example, substituting an inexpensive work of art for an expensive work of art)
  • The proceeds of expense reimbursements, loans or advances or other non-payroll payments from the spouse’s company.
  • The existence of off-balance sheet accounts.
  • The existence of intangible assets with a value in excess of the book value.
  • The existence of fixed assets with a value in excess of the book value.
  • Transactions with related parties (this may be indicative of non-arm’s length transactions that could have been used to reduce the value of the company).
  • Unusual company transactions with third parties (this could be indicative of attempts to reduce the value of the company by transferring funds or assets to third parties).
  • Hidden insurance policies for which the defendant is the beneficiary.
  • Trusts for which the defendant is a beneficiary.

Because each divorce or commercial litigation matter has its own particular set of circumstances, it is critical that the review of the discovery request between counsel and the forensic accountant occur as early as possible in the discovery process. The forensic accountant can help identify specific documents that should be included in the discovery request. This will allow the forensic accountant to conduct thorough analysis asset searches to identify or point to the existence of such assets.

– See more at: http://thelegalintelligencer.typepad.com/tli/2011/10/discovery-of-hidden-assets-.html#sthash.wO91XNyS.dpuf