By Pamela D. Wickes
Each year most of the professional services I render relate to litigation. Whether assessing economic damages for lost profits, investigating alleged unreported income, quantifying the damages from employee embezzlements, performing various forensic accounting investigations for divorces, or tracing assets, cash flows or other financial transactions, I find that a breach of trust is often at the heart of the allegations.
It’s in these unfortunate criminal and civil issues that lawyers and forensic accountants intersect. Forensic accountants can work closely with attorneys in virtually every step of the litigation process to streamline the discovery and investigation, to interpret and communicate findings, to facilitate settlement, and to provide expert testimony, if necessary.
You wonder–How is a forensic accountant different from the traditional accountant that prepares my tax return? The forensic accountant has attained fundamental forensic knowledge and credentials beyond their CPA license, such as certified in financial forensics (CFF), certified fraud examiner (CFE), or certified forensic financial analyst (CFFA).
Fundamental forensic knowledge includes certain areas of the law, dispute resolution and courts, and information gathering and preservation. In addition, CFEs have attained education and experience in the areas of fraudulent financial transactions, criminology and ethics, legal elements of fraud, and fraud investigation.
Forensic accounting is accounting characteristic of, or suitable for a court of law. A fraud investigation always qualifies as forensic accounting because it either is, or has high probability to be, related to a lawsuit. Yet, interestingly, forensic accounting is not always a fraud investigation. For example, when performing forensic accounting procedures to determine whether an asset should be classified as pre-marital (before marriage) or marital (after marriage) pursuant to a divorce matter, does not constitute a fraud investigation.
Employee embezzlement (fraud) is the area in my line of work where I most often see the breach of trust I referred to above.
Each time I investigate an employee embezzlement, the jaded employees left behind almost always describe their shock that one of their most trusted employees has committed fraud against the company. It’s unfortunate that I am most often engaged after there has been an incident reported or a lawsuit commenced because companies would benefit more from hiring someone like me before they uncover an issue to help them establish preventive controls.
Did you know a recent fraud study revealed that the typical organization loses an estimated 5 percent of its annual revenue to fraud?
What’s worse, in my opinion, is that external audits of the financial statements were the most commonly utilized control analyzed; employed by more than 80 percent of the victim organizations in said fraud study, which was performed by the Association of Certified Fraud Examiners. Yet, in contrast, only 3 percent of the frauds in the study were detected by an external audit.
My concern is that non-CPAs place too much reliance on the financial statement audit to detect fraud, when, in fact, an auditor cannot obtain absolute assurance that material misstatements due to fraud will be detected due to the concealment and characteristics of fraudulent transactions. A financial statement audit is planned and performed to obtain a reasonable assurance that the financial statements are free of material misstatements; not to specifically search for fraud.
An external audit is a passive anti-fraud policy. Passive anti-fraud policies typically result in higher losses when a fraud occurs due to the comparatively longer duration of the fraud scheme before detection. Conversely, internal audits, documentation examinations, IT controls, and management reviews are proactive measures and have been found to result in smaller losses and shorter duration.
Further, formal management reviews, employee support programs and hotlines were correlated with the greatest decreases in financial losses.
A hotline is a very effect reporting mechanism, as it provides tipsters, which can be employees, vendors, customers, competitors, etc., with anonymity. If you don’t have a hotline or other confidential system for reporting suspected violations of the ethic and anti-fraud policies within your organization, I recommend you reconsider.
Studies show that this is the top method of fraud detection. If you have such confidential reporting system in place, you should survey your employees to see if they are aware of it.
Part of an anti-fraud program is raising awareness. Therefore, I encourage you to ask your employees not only about anonymous tipping, but also other questions that will allow you to assess their awareness of the anti-fraud program and the probability of a fraudulent event occurring within the organization.
It’s amazing what people will tell you when you ask; that which they would not otherwise have offered. Following are some questions to consider: Does the company have an ethics statement? Does senior management exhibit and encourage ethical behavior? – (the tone should signal that fraud will not be tolerated). Does the company have written fraud policies and procedures?
Are employees provided formal written job descriptions? – (duties performed outside of job description represent a red flag). Do employees appear to be spending far more than they are earning? – (common red flag). Do employees have a close association with vendors or competitors? – (common red flag).
Lastly, in the event a company is the tragic victim of a fraud, in addition to retaining a lawyer to seek judgment against the perpetrator, it may be able to make a claim against its fidelity and crime insurance policy. Forensic accountants prepare reports for such purposes; however, many companies are not sufficiently covered for fraud losses.
The median loss reported in the aforementioned fraud study was $140,000, and more than one fifth of the cases involved losses of at least $1 million.
Hopefully, you have time to implement some additional prevention and detection measures before Fraudster Way intersects with Legal Street.
Wickes, CPA, CFE, CFF, ABV, is the director of forensic accounting services at Teal, Becker & Chiaramonte CPAs in Albany. She can be reached at 456-6663 x108 or pwickes@tbccpa.com.