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Forensic accountants: They ferret for fraud

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Judy Doyle, senior manager, Forensic & Valuation Services Group, WithumSmith+Brown.
Judy Doyle, senior manager, Forensic & Valuation Services Group, WithumSmith+Brown. - ()

U.S. businesses lose tens of billions of dollars annually to occupational fraud, employee embezzlement and other theft, according to consensus estimates, and that's where forensic accounting enters the picture.

“A newly appointed U.S. CEO of a multinational company in the household goods industry — with domestic headquarters in New Jersey — was ‘kicking the tires’ and examining the books and operations of the closely held company,” said Hubert Klein, a partner in the Financial Advisory Services Group at EisnerAmper LLP. “Something seemed out of kilter, so our forensics team was brought in to investigate.”

It turned out that the chief financial officer was in cahoots with the head of human resources, and for years the HR chief was reimbursed multiple times for a single expense report.

“First, the individual was paid legitimately,” Klein recalled. “Then the person would submit an American Express card with the same charges and was again reimbursed. Finally, funds for the amount of the HR expense report were then wired directly to the CFO’s personal bank account, based on minimal documentation.”

Hubert Klein, EisnerAmper LLP.
Hubert Klein, EisnerAmper LLP.

The CFO was running another scam that ultimately tipped off the forensic CPAs.

“Periodically, the CFO would have invoices issued to the company’s large corporate customers, billing them for bogus sales. By artificially inflating his company’s sales, the CFO qualified for significant performance bonuses. To keep the inventory records straight, he shipped the correct quantity of merchandise to the customers and sent the excess to a warehouse for storage.”

When the customers disputed the invoices, the CFO issued a write-off, or adjustment, to accounts receivable.

“The whole thing started to unravel when we noticed the unusual billings for the inventory storage units,” said Klein. “Then we saw all the accounts receivable write-offs and began to put everything together. Ultimately, the embezzlement scheme totaled about $4 million.”

Variety of forensic cases

Forensic accountants get called in for other kinds of assignments, too, like the time a New Jersey couple who own a successful consumer products company decided to divorce, but still wanted to work together on the business. There were some twists, however.

Ilan Hirschfeld, Marcum LLP.
Ilan Hirschfeld, Marcum LLP.

“For one thing, the wife agreed to have the husband buy out half of her 50 percent interest in the business, and we got called in to establish an appropriate valuation,” said Ilan Hirschfeld, partner-in-charge of the New Jersey Advisory Services practice at Marcum LLP. “But at just about the same time, they had a significant licensing agreement to produce an item, and the licensor wanted to buy them out earlier than the scheduled end of the agreement. So we were also called in to suggest a license buyout price. Of course, that early license termination would affect the value of the business for purposes of determining the husband’s buyout of 50 percent of his wife’s business interest.”

Complicated, to say the least. “But after a lot of negotiations, everyone was satisfied,” Herschfeld said. “We’re seeing more cases that require forensic accountants who receive special training and often have special credentials. Finding the money, or determining valuations are similar to playing chess — you have to read between the lines and strategize.”

“That’s one reason to require people to take a vacation, so someone else can handle their job for awhile and possibly spot irregularities. The diligent employee who stays late and never takes vacation may be falsifying records.”

Hubert Klein, partner at EisnerAmper LLP

A forensic specialization attracts a special type of person, said Judy Doyle, senior manager in Withum’s Forensic & Valuation Services Group.

“It can be a high-pressure atmosphere to be associated with a litigation matter,” Doyle said. “But it can also be very rewarding.”

Among other recent cases, her department was asked to comb the books of a New York literary agency after its bookkeeper allegedly transferred more than $3.4 million that belonged to the agency and its clients to bank accounts the bookkeeper controlled.

To evade detection, the bookkeeper “made changes to the agency’s accounting records to disguise the nature of the transfers,” the U.S. Department of Justice revealed in May.

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Fraud tipoff

Sometimes a company’s parking lot can be a tipoff to fraud.

Tim King was an internal auditor at hospital products company and was asked to help with a fraud audit.

“Two employees, who were good friends, used to carpool together,” said King, now co-managing partner of the Insolvency and Litigation Services department of Bederson LLP. “Suddenly, each bought expensive cars and drove to work separately. They also each bought an expensive house. We went to the local hall of records and pulled the data on the homes and found that the cost of each was way beyond their salaries. Additional investigation showed that one was purchased with no mortgage, and the other had a very small mortgage.”

A thorough investigation of the company’s bank and other records turned up “payments to companies we never heard of.”

Added King: “The county prosecutor was called in, and discovered that these strange business were taking the checks and making payoffs to a few individuals in the company that employed the fraudsters. It turned out they had looted about $500,000 from the firm. Three people went to jail, and others were fined.”

At Bederson, King’s caseload included the $300 million Solomon Dwek fraud case that took a decade to resolve.

“Among other issues, were about 200 properties, some worth millions of dollars, that had multiple mortgages on them,” he said.

In some cases, $1 million-plus mortgages were issued on properties that may not have even existed, King noted.

“Basically, we follow the money trail,” summarized Sean Raquet, a Bederson partner and past president of the New Jersey chapter of the Association of Certified Fraud Examiners.

“Forensic accounting is a very broad term and can encompass many different practice areas that include, but are not limited to, fraud, valuation, bankruptcy, commercial damage assessments, shareholder disputes, divorce engagements,” Doyle said. “A bachelor’s or master’s degree in accounting, finance or a related field is generally required. In addition to obtaining the CPA designation, many firms encourage individuals to attain various related credentials.”

Not-for-profit organizations can be tempting targets for fraudsters, said Douglas Schwartz, a Director in the Advisory Services Group Director at Marks Paneth LLP.

“Nonprofits tend to trust employees, but in two cases — one in New Jersey and one in New York — a trusted employee in each was able to sign, record and cash checks to themselves for about $100,000 each,” Schwartz recounted.

That points up the need for internal controls, such as segregating duties so different individuals can act as a check and balance on each other. So the person who reconciles bank accounts, for example, shouldn’t have access to checks or have signatory power.

“Each employee’s work should also be periodically reviewed by others,” said EisnerAmper’s Klein. “That’s one reason to require people to take a vacation, so someone else can handle their job for awhile and possibly spot irregularities. The diligent employee who stays late and never takes vacation may be falsifying records. Also, a business should maintain, test and update their internal controls on a regular basis and ensure they’re actually being used. Policies and procedures can look nice as a book on a shelf, but they have be living documents.”

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