“You Can’t Always Get What You Want…”
Forensic Accounting: Issues and Implications
Presented to:
Accounting 614 – Seminar - Accounting and Society
St. Louis University
April 22, 2009
Thomas E. Hilton, MS, CPA/ABV/CFF, ASA, CVA
Anders Minkler & Diehl LLP
St. Louis, MO 63101
thilton@amdcpa.com
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Forensic Accountant
“ An accountant who performs an orderly analysis,
investigation, inquiry test, inspection or examination
in an attempt to obtain the truth and develop an
expert opinion.”
- Forensic Examiner
May/June 2001
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Definition of Forensic Accounting
Forensic accounting services are non-attest services that
involve the application of special skills in accounting, auditing,
finance, quantitative methods and certain areas of the law,
and research and investigative skills to collect, analyze, and
evaluate evidential matter and to interpret and communicate
findings, and consist of :
→ Litigation services
→ Investigative services
Source: AICPA Interpretation 101-3
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Forensic Skill Sets
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Fundamental Forensic Knowledge
• Basic civil and criminal law
• Federal and State Rules of Evidence
• Federal and State Rules of Civil Procedure
• Basics of alternative dispute resolution, negotiation,
arbitration and mediation
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Fundamental Forensic Knowledge
• Interviewing
• Research
• Written and oral reporting
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Specialized Forensic Knowledge
• Asset tracing
• Bankruptcy and Insolvency
• Computer forensics and data mining
• Economic damages
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Specialized Forensic Knowledge
• Valuation
• Fraud investigations
• Family Law
• Shareholder disputes
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Certified in Financial Forensics
(CFF)
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Shareholder
Disputes
Specialized
Forensic
Knowledge
Asset
Tracing
Bankruptcy &
Insolvency
Family
Law
CPA
Core Skills
Computer
Forensics
and Data
Mining
Fraud
Investigations
Valuation
Economic
Damages
Fundamental
Forensic
Knowledge
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Evidence
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Evidence is anything that can cause
another person to believe that a fact or
proposition is true or false
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Role of Forensic Accountant
Rule 702 - Federal Rules of Evidence
“If scientific, technical, or other specialized knowledge will assist the
trier of fact to understand the evidence or to determine a fact in
issue, a witness qualified as an expert by knowledge, skill,
experience, training, or education, may testify thereto in the form of
an opinion or otherwise.” (Emphasis added)
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Types of Evidence
•
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Direct
Circumstantial
Real
Documentary
Testimonial
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David Duncan
Arthur Andersen
Houston, TX
“If it’s destroyed in the course of normal policy and
litigation is filed the next day, that’s great.. we’ve
followed our policy and whatever there was that
might have been of interest to somebody is gone
and irretrievable.”
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Walter Van de Vijer
Royal Dutch Group
April 2004
“I am sick and tired of lying about the extent of our
reserve issues and the downward revisions that
need to be done because of far too aggressive
projections.”
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Business Damage Claims
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Common Elements of Business
Damage Claims
• Harmful act has occurred
• Harmful act has reduced the plaintiff’s earnings or stream
of economic value
• Principle of economic equivalence
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Lost Profits vs. Loss of Business Value
Loss of Business Value:
•
Destruction of Business
•
Temporary Impairment
•
Slow Death
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Loss of Business Value
Destruction of Business:
$2,000,000
Expected Profits
Profits
$1,600,000
$1,200,000
Lost Profits
$800,000
Actual Profits
$400,000
$0
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Lost Profits
Temporary Impairment:
Expected Profits
Profits
$1,600,000
$1,200,000
Lost Profits
$800,000
$400,000
Actual Profits
$0
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Lost Profits vs. Loss of Business Value
Slow Death Scenario:
$2,000,000
Expected Profits
Profits
$1,600,000
$1,200,000
$800,000
Lost Profits
Actual Profits
$400,000
$0
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Lost Profits Example
Facts:
•
Broker is lured away from investment division of a
large bank on December 31, 2005
•
Broker generates (on average) $2 million annually in
gross revenue
•
Bank’s variable costs are 40% of revenues
•
Broker is subject to non-solicitation agreement
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Lost Profits Example
Projected Performance (in millions)
2006
2007
2008
Total
$12.0
$13.0
$14.0
$39.0
Fixed
($2.5)
($2.5)
($2.5)
($7.5)
Variable
($4.8)
($5.2)
($5.6)
($15.6)
$4.7
$5.3
$5.9
$15.9
Revenue
Operating Expenses:
Operating Profit
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Lost Profits Example
Actual Performance (in millions)
2006
2007
2008
Total
$10.0
$11.0
$12.0
$33.0
Fixed
($2.5)
($2.5)
($2.5)
($7.5)
Variable
($4.0)
($4.4)
($4.8)
($13.2)
$3.5
$4.1
$4.7
$12.3
Revenue
Operating Expenses:
Operating Profit
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Lost Profits Example
Millions
Operating Profit (Projected)
$15.9
Operating Profit (Actual)
$12.3
Lost Profits
$ 3.6
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Lost Profits Example
Millions
Lost Revenue
$ 6.0
Variable Costs Avoided (40%)
($2.4)
Lost Profits
$ 3.6
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Fraud
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Types of Irregularities
Financial Irregularities
Errors
Fraud
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Conditions Generally Present
When Fraud Occurs
• Incentive/Pressure
• Opportunity
• Attitude/Rationalization
Statement on Auditing Standards (SAS) No. 99
Consideration of Fraud in a Financial Statement Audit
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The Fraud Triangle
Source: SAS 99
Opportunity
Circumstances that allow a
misrepresentation to occur.
Attitude / Rationalization
Incentive / Pressure
A frame of mind that justifies the
misrepresentation.
A reason to misrepresent.
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The Fraud Diamond
Source: December 2004/The CPA Journal
Incentive
Opportunity
Rationalization
Capability
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The Components of Capability
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•
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Position/Function
Knowledge
Confidence/Ego
Coercion Skills
Effective Lying
Immunity to Stress
Source: Wolfe & Hermanson
The CPA Journal
December, 2004
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Fraud Case Example
• Findings Presented to Court:
– Project was significantly behind schedule
– Construction entity was several million dollars
over budget
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Fraud Case Example
• Findings Presented to Court:
– Construction entity was out of cash
– Billed and collected for labor hours not worked
– Billed and collected for other direct costs not
substantiated
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Ponzi Schemes
• A financial fraud that induces investment by promising
unusually high returns with minimal risk
• The victim gives money to the perpetrator expecting that
it will be invested as promised
• Rather than investing the funds as promised, the
perpetrator pays “profits” to old investors with funds
received from new investors
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Ponzi Schemes
• These payoffs, as well as account statements that purport
to show each remaining investor’s stake to be growing,
induce further investment
• The perpetrator makes money by siphoning off funds from
investors and converting them to his/her own use
• When the fraud is discovered, some early victims usually
have made money, most investors has lost money, and the
perpetrator either has spent the money or invested it in
something other than the scheme
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Ponzi Schemes
• Red Flags:
– A Ponzi scheme is usually an “affinity fraud”
– If it sounds “too good to be true,” it probably is
– You cannot tell what you own, trading detail is
suppressed, or holdings are converted to cash at the
end of each reporting period.
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Other Ponzi’s
• Joseph Forte
Internal F/S – No Audit
• Nicolas Cosmo
No CPA – No Audit
• Morris Schrenker
No CPA – No Audit
• Stanford Group
No Audit on CD Enterprise
Audit on Broker-Dealer
• James Nicholson
Fictitious Accounting Firm
Virtual CPA Office
Fraudulent Self Audits
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Ethical Implications
Character: Constellation of a person’s
virtues and vices
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Ethical Implications
• Ethics
• Social Responsibility
• Moral Judgment
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Ethical Implications
• Purpose/Role:
Teach students how to increase
profits including the short-term
share price
• Consequences: Outsourcing
Layoffs
Deferring R&D
Neglecting corporate reputation
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Ethical Implications
Fundamental Principles
– Dignity of every human person
– Common Good
– Subsidiarity
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Ethical Implications
Michael Novak “The Spirit of Democratic Capitalism”
– Capitalism is the one economic system that lifts the
greatest numbers out of poverty
– Capitalism is itself not selfish, exploitive or unequal
– Capitalism cannot exist in a void – it requires an
underlying moral edifice – a knowledge of right and
wrong
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Thank you for your attention!!
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