“It was the Best of Times, It was the Worst of Times”
—Corporate Investigations

Dan Ray of JHI member firm Hemming Morse Inc, California, gives an overview of forensic accounting in the context of recent corporate scandals.

“It was the best of times, it was the worst of times.” At some point in the future, people may quote this famous opening line from Charles Dickens The Tale of Two Cities to describe today’s business environment – the “worst of times” describing the extraordinary number and dollar magnitude of corporate scandals which are uncovered on a near-daily basis, and the “best of times” describing the opportunities afforded forensic accountants who provide corporate investigation services.

During the past several years, the public has been exposed to corporate and accounting scandals involving such stalwarts as Enron, Arthur Andersen, Adelphia, Tyco, Martha Stewart and the entire mutual fund industry. Without trying to oversimplify the complex issues surrounding these debacles, the common denominator may simply be that those entrusted to ensure the accuracy and integrity of representations made in a variety of forums, most often through financial statements, may have failed to do their jobs. This scandal-filled era is clearly not the first time in U.S. history in which corporate officers, or seemingly entire industries, appear to be ethically challenged. The example that comes to mind is the Savings and Loan crisis of the mid-eighties. As a Special Agent with the FBI in Southern California during that period of time, I was assigned the responsibility of investigating numerous failed financial institutions. I believe, however, that the current financial scandals are different in the following ways: (1) the dollar amounts of the losses are greater; (2) the industries are more varied; (3) the frequency, or at least the reporting of allegations of such scandals, appears greater; and (4) the public tolerance for such corporate high jinx has run out.

As with almost every negative, this also appears to have a positive flip side. Specifically, there is a tremendous opportunity to those practitioners having the requisite skills, training, and experience in the area of corporate investigations to land engagements of this type. The opportunities to provide such services may be greater now than during other periods of financial crises because of the following: (1) the collapse of Arthur Andersen has narrowed the playing field; (2) the subsequent enactment of Sarbanes-Oxley has shifted some of this work to smaller regional firms; (3) the impacted shareholders, bondholders and lenders demand such investigations; (4) the reduced capability of the FBI to investigate allegations of white collar crime due to the redeployment of Agents to homeland security and domestic terrorism assignments; and (5) the emergence of the niche practice area called “forensic accounting” or litigation support. Not too long ago the public had never heard the term “forensic accounting.” Nowadays, there appears to be a widespread understanding of this niche practice. About 18 months ago, I was contacted by a local news station and was asked to comment about a jobs survey that identified forensic accounting as one of the fastest growing careers in the country. Also, several years ago the New York Times ran a story called, “And Now, a Case for the Forensic Accountant.”

Corporate investigations typically employ many of the same techniques used in fraud investigations and other forensic accounting assignments. The difference between the two, however, is that corporate investigations are often broader in scope. For example, a fraud investigation typically involves analysing a defined set of transactions for the purpose of determining whether an indicia of fraud exists. A corporate investigation, however, may extend beyond allegations of fraud to include issues such as breaches of fiduciary duty or improper corporate governance. It often attempts to answer such questions as: How was this allowed to happen? Did we as an organisation properly respond? How can we prevent this in the future?

The usual impetus to a corporate investigation is an allegation or concern of an impropriety raised by a party-in-interest. This resulting investigation almost always involves conducting a detailed review and analysis of the underlying accounting, banking or other financial records to ascertain, with as much precision as possible, the true nature of the questioned transactions. Corporate investigations, however, often extend beyond an analysis of the business records. The extensive use of two additional techniques comes to mind: (1) the conducting of interviews and (2) the use of computer forensics.

Auditors have been required for some time now to conduct interviews with select key personnel during the course of a financial statement audits. This requirement was recently strengthened with the enactment of Statement on Auditing Standard (“SAS”) 99. Litigation professions have been aware for a long time that on many occasions the knowledge of the truth of the matter often lies in the minds of individuals and not contained on paper. The interview process is quite often a critical component of a corporate investigation. Great care should be taken in the identification of who should be interviewed as well as the order and timing of the interviews. Specialised training on how to conduct interviews is available through a variety of professional organisations including the California Society of CPAs and the Association of Certified Fraud Examiners.

Another vital technique often employed during corporate investigations is the recovery and review of electronic data. This may include correspondence, spreadsheets, e-mails and instant messages. The files to be reviewed can be found in a variety of places including the hard drive of the computer, or the network and its back-up tapes. Critical information that was previously deleted may also be recovered through the use of computer forensic techniques. These techniques, when employed by qualified professionals, have the potential to uncover compelling evidence. Qualified computer forensic professionals will have received training from either a law enforcement organisation such as FLETC (Federal Law Enforcement Training Center) or through courses offered at a major university such as the ones offered by New Technologies, Inc. and Oregon State University. Additionally, computer forensic software certification, such as the EnCE (Encase Certified Examiner) offered by Guidance Software for their Encase product, is a good qualification.

Professionals who conduct corporate investigations need to strike a delicate balance between being thorough and complete without violating the rights of those being investigated. The professionals need to work closely with corporate counsel to ensure that Right to Financial Privacy and Fair Credit Reporting Act laws are followed. Furthermore, questions asked about particular individuals need to be phrased in such a manner so as not to slander the subject of the investigation.

For more information, please contact Dan Ray at rayd@hemming.com or 1-415-836-4046.