What to Expect
When the Forensic
By Donald F. Conway, CPA
Once financial fraud is suspected in a municipality, the fraud examination methodology requires that all allegations be handled in a uniform, legal fashion and be resolved on a timely basis. At each step in the fraud examination process, the evidence obtained and the approach is continually assessed. This investigation is frequently conducted for a municipality by a forensic accountant.
In a municipality issues can arise relating to:
• Violations of the local public contracts law with respect to bidding practices and contract selection;
• State and local “Pay to Play” regulations and ordinances may be an area for fraudulent activity such as improper disclosure of entity ownership or improper political contributions;
• Municipal court operation or the tax collector’s office where there is a large volume of cash transactions;
• Payroll Disbursement Schemes that fall into two categories: (1) ghost employees in the form of “no shows” or fictitious employees, and (2) falsified hours and salaries. An example would be where a full time employee for one municipality works part time for another during the same time period;
• Unlawful manipulation of the process for procuring goods and services. This form of fraud is especially common in both municipalities and industry, such as construction, where lucrative contracts are awarded.
Definition of Forensic Accounting The term “forensic accounting” has seen a wide increase in usage over the past few years. Not only is the term forensic accounting being used more frequently, but it is being applied to many diverse situations resulting in its meaning becoming less precise. Some compare forensic accounting to the process of trying to put together a one thousand piece jigsaw puzzle when you do not have the picture on the box to know what it is going to look like.
However, I believe that a meaningful definition of forensic accounting is as follows: Skillfully applying a body of accounting and finance knowledge in an investigative manner whereby its conclusions meets the standards that can be used in a court of law.
It should be kept in mind that forensic accounting is not limited to investigations that result in legal prosecution. However, the standards used to reach conclusions, and the investigative techniques employed and analysis made in a forensic accounting investigation, must meet the standards required in a court of law.
Also, it is important to note that because of the recent number of fraud cases and Ponzi schemes receiving publicity in the media, forensic accounting is becoming associated with fraud investigations; however, fraud is not part of the above definition. Forensic accounting investigations are used in many situations that do not involve fraud, including shareholder disputes, valuation of marital assets, valuation of business entities, and determination of loss profits in business situations.
Forensic Accounting vs. Traditional Accounting Traditional accounting involves using accounting knowledge to prepare financial statements, to communicate the results of financial transactions, and to present the information in a form that can be used to manage the entity being reported upon. Traditional accountants determine whether the financial statements present fairly, in all material respects, financial position, results of operations, and cash flows of the entity being reported upon. They are concerned with material misrepresentations or omissions that would effect the decisions of a user of the financial statements. However, because their focus is on material error and not on fraud, which is more difficult to detect than errors, and because they test the detail behind the financial statements by sampling, they may not uncover fraud.
On the other hand, forensic accountants who are performing a search for fraud concentrate their efforts in areas most likely to contain fraud and often examine the entire population in a class. Forensic accountants must understand that white collar crimes and fraud often do not involve a “smoking gun.” Forensic accountants probe beyond the contracts and the numbers to uncover the reality of the situation and the real intention of the parties, which in the case of white collar crimes and fraud is not stated and not apparent if one just looks at the surface of the transaction.
Skills of the Forensic Accountant Those who practice as forensic accountants must have a broad based skills set, including.
Both verbal and written communication skills to clearly report their findings in a concise and effective manner to their clients and to the users of their reports.
Accounting knowledge to analyze and interpret the financial information required to build a case for an investigation. That knowledge must be broad based and include skills in financial reporting as well as the ability to follow the flow of data through the financial system.
Computer investigations and computer forensics knowledge are necessary tools for the forensic accountant in a world where computers are a part of our daily life. Not only does the forensic accountant have to be aware of the investigative methods used to detect computer fraud but also must be aware of the unique legal aspect for the handling of computer evidence so that one can document one’s findings in such a manner that they will not be challenged.
Legal knowledge is also critical to the success of a forensic accountant as much of their work finds its way into court. Therefore, knowledge of court procedures enables forensic accountants to identify the type of evidence necessary to meet the legal standards of the jurisdiction in which the case is to be heard and establish evidence in a manner that meets the criteria of the court.
Not mentioned above, but in my opinion the most important skill that a forensic accountant must possess is that of professional skepticism. Professional skepticism is a mindset that all accountants must possess in order to think like a fraudster or a white collar criminal. That is, you must put yourself into management’s shoes, know who their professionals are, try to understand their motivation and their hidden agendas. In my opinion, forensic accountants must employ this principal of professional skepticism as their guiding light.
In my practice we have adopted a motto that personifies this; “nothing is what it appears to be.” That motto has served us well over the course of the years. One example of employing this principal relates to a case in which we were looking for money that had been laundered. One method of laundering money is for a business to pay large fees for a service that was either not performed or performed for an inflated amount. The business receiving the payment in a money laundering scheme is, in reality, a nominee for the business making the payment. That nominee upon receipt of the payment will in turn pass the funds on to a party designated by the business making the payment. In our case when we came across a large payment to a professional service firm we asked for documentation to support the payment. The company being examined could not produce the documentation when it was requested, but told us they would obtain a duplicate copy of the bill from the professional service firm.
Following receipt of the alleged duplicate invoice from the professional service firm, we applied the “nothing is what it appears to be” principal. The invoice was rendered on professional letterhead and dated as of the transaction date. However, upon further examination of the professional letterhead we noted that the telephone number printed on the stationery included an area code that was not in existence as of the letter’s date. This led to additional inquiries and, ultimately, to the admission of the money laundering transaction. If we had accepted the document as is and had not applied our professional skepticism we would have missed the money laundering transaction.
Donald Conway is a partner at Mercadien, P.C., Certified Public Accountants in Hamilton and heads their forensic accounting department. He recently wrote a graduate level forensic accounting course for Thomas Edison State College. Conway has been an expert in such high profile cases as the Robert Brennan penny stock fraud as well as serving as Fiscal Monitor, Court Appointed Chapter 11 Trustee and/or Receiver, for various entities.
This article was originally published in New Jersey Municipalities magazine. Vol. 86, No. 9, December 2009