The forensic accountant in practice

Transcription

1 The forensic accountant in practice 01 Fiona Hotston Moore and Simon Martin Learning outcomes The purpose of this chapter is: To provide an introduction to forensic accounting and how this compares to the role of auditor. To provide an explanation of the skills required in forensic accountants and how these are obtained. To provide an overview of the different roles a forensic accountant can take. To provide an overview of the different types of work undertaken by forensic accountants. To enable readers to understand how the forensic accountant in practice obtains work. Introduction In this chapter we outline the roles and skillsets of the forensic accountant in practice, comparing them to that of the traditional accountant and auditor. We then outline the different areas in which the services of a forensic accountant are typically utilized and provide

2 2 Forensic Accounting and Finance an overview of the work that is undertaken, including the professional considerations underlying that work. We also look briefly at sources of work. Forensic accountancy The services of a forensic accountant in the United Kingdom are generally sought for two purposes: financial investigations and litigation support. Forensic accountants in practice often trained originally as statutory auditors or accountants and therefore have, as a minimum, the key audit professional skills including strong numeracy; being adept at communication, both oral and written; good attention to detail; business and commercial acumen; and a sound working knowledge of the main accounting, audit and tax regulations. A key difference between auditing and forensic accounting is that auditing is undertaken within a framework of auditing regulations and tends to follow standardized audit programmes, whereas every forensic accounting assignment tends to be different. Forensic accountants must agree the objectives of the assignment, determine how they can fulfil these and prepare to deal with unexpected variations as the work is undertaken. Forensic accounting assignments share many of the characteristics of an audit and, in certain circumstances, could be described as targeted auditing. However, unlike the audit of financial statements, there are no official standards or practices to be followed in a forensic accountancy assignment. The depth and breadth of potential instructions makes each forensic accountancy assignment a niche activity and requires skills in addition to those held by auditors. The forensic side of accountancy involves the application of accounting and auditing skills in the context of a financial investigation. The aim and purpose of the investigation will differ in each case, from the valuation of matrimonial business interests to the investigation of a potential fraud. Forensic accountancy assignments can also extend into expert witness roles. This is where the forensic accountant is required to prepare and, potentially, present or defend, an expert report to assist the court in understanding the quantum of a case or, possibly, liability issues.

3 The Forensic Accountant in Practice 3 In all professions, quality assurance standards are generally set to ensure that practitioners continue to achieve the high standards required in their specialist field. Forensic accountants who are professional ly-qualified accountants are bound by the regulations, ethical requirements and quality standards of their professional associations, but the forensic accountancy sector tends to be selfregulating in that a steady stream of work requires the forensic accountant to build up a network of referrers throughout his or her career. If clients and referrers are unhappy with the standard of work carried out, it is likely that this will damage the accountant s reputation, both as a forensic accountant and as an expert witness, and lead to a reduction in work. There have been many expert accountants whose careers have come to a sudden halt following an arduous day of cross- examination in court. Skillset of a forensic accountant An audit has a clear structure and end result whereby the financial statements and audit report are presented to the shareholders. While this path may deviate to take into account unique business characteristics, the vast majority of assignments will follow the same structure. The majority of audit firms will subscribe to a particular prepared audit methodology and testing programme that will be at the core of all of their audit assignments. The audited entities and the components of the financial statements will differ from job to job, but the approach and structuring of the work will remain the same. This is the main differentiator between audit and forensic accountancy assignments that have a multitude of different aims, structures and outcomes. Therefore, forensic accountants require additional skills and knowledge over that of a traditional statutory auditor. The Institute of Chartered Accountants in England and Wales (ICAEW) notes that forensic accountants are trained to look beyond the numbers and deal with the business realities of situations. 1 At the outset of the assignment the forensic accountant must ascertain the intended objective from his or her instructing solicitor or client.

4 4 Forensic Accounting and Finance To be effective, a forensic accountant needs to develop the following additional skills: Innovation the breadth of aims and assignments means that, often, planning the work to be undertaken will start with a blank piece of paper. Flexibility the nature of dispute resolution work (and court deadlines) means that proactivity can be required. This means being on hand when the lead first arrives, through to carefully managing the assignment so as to meet deadlines, which can be laid down by the court. There can also be a need to relate numerous different pieces of legislation to arithmetical outcomes, depending on the type of work being carried out. Negotiation skills the forensic accountant will often be the face of the dispute due to being the one who has collected the information. It is vital that he or she can maintain a constructive dialogue with representatives from both sides to minimize professional costs and aid a swift resolution to a dispute. Composure it is likely that the dispute will create a state of flux for the client, which may impact on his or her rationality and ability to make decisions objectively. Forensic accountants must remain calm and collected and communicate the facts that support their opinion. Robustness particularly key when being cross-examined in court. It is likely that the opposing counsel will be aiming to challenge the integrity of the expert s report and opinions, so forensic accountants must be able to stay strong and effective when their evidence is challenged. Professional credibility in the event the forensic accountant does take on the role of an expert for court purposes, it is of the utmost importance that the individual safeguards his or her professional reputation, and the expert carries out this work in his or her own name rather than the name of his or her firm. A high level of professional credibility ensures that the expert s opinions and findings are given due weight by the court. There are a number of organizations in the United Kingdom that assist forensic accountants and expert witnesses to maintain or

5 The Forensic Accountant in Practice 5 enhance the quality of their work. The Network of Independent Forensic Accountants (NIFA), for example, organizes training for its members to cover both forensic accounting and expert witness work; the Academy of Experts and the Expert Witness Institute both provide accreditation to their members to cover the expert s role and responsibilities, regardless of the area of expertise and, last but not least, the forensic accountant will also be required to comply with the ethical and professional standards of his or her respective professional bodies. The roles of a forensic accountant in litigation In addition to many different types of assignment, the forensic accountant can also perform a range of roles depending on the type of instruction. Party adviser Acting as a party adviser sees the accountant stay on the periphery of the case. In this role, the forensic accountant advises one of the litigating parties based on the information and/or facts that are being presented. Litigating parties who have appointed party advisers are given access to ad hoc expert advice without necessarily committing to the production of a full expert report. At this stage, the forensic accountant s duty of care is to the instructing party. Party appointed expert After receiving initial advice, the party may decide to instruct the forensic accountant to prepare a report in a format suitable for presentation to a court. Court permission to present an expert report must be sought to allow the forensic accountant s findings to be presented in support of the case. Once granted, the forensic accountant s role becomes that of a party appointed expert (PAE). A PAE will be required to prepare a report that is compliant with the relevant court rules on expert evidence. The PAE has an overriding

6 6 Forensic Accounting and Finance duty to the court, and the PAE has to provide an independent and impartial opinion and to act with integrity. Once both parties have submitted their reports, a meeting of experts may be scheduled where the respective PAEs will discuss points of agreement and disagreement to narrow down the issues on which the court has to deliberate. A joint experts statement will be produced that highlights the areas of agreement and disagreement between the experts and will be supplied to the court along with the main reports. Due to the subjective nature of disputes and, in particular, valuations, it is not unusual for opposing PAEs to arrive at very different conclusions even when working with the same set of facts. The different results then present the judge with an additional dilemma: which expert opinion is to be preferred? This is one of the factors behind a preference in certain cases for a single joint expert to be appointed. Single joint expert The single joint expert (SJE) is an expert who is jointly selected by both parties and whose appointment is approved by the court. As the SJE works for two opposing parties, it is important that he or she demonstrates independence and objectivity throughout the assignment. Any ongoing correspondence must be copied to both parties to facilitate that perception. In some cases where an SJE has been appointed, the party adviser may be used as a shadow expert to challenge the appointed expert. If the appointment is of an SJE rather than a PAE, the SJE will compile his or her report and deliver it to both parties. Although the published report of the SJE is intended to be definitive, sometimes one or both parties will seek a second opinion from a party adviser, who can in some instances be instructed as PAE, culminating in three experts on the same case, all with potentially differing opinions. It is worth emphasizing that the overriding duty of the PAE and SJE is to the court, whereas party advisers and shadow experts owe their duty of care to their instructing parties, and are not regulated by court rules. However, party advisers or shadow experts need to always remain aware that there is a possibility that they could be appointed as PAE or SJE, and therefore the advice they give even when not appointed should be as unbiased and independent as possible.

7 The Forensic Accountant in Practice 7 Hot-tubbing The term hot-tubbing (also known by its official name of concurrent expert evidence ) refers to the practice of both PAEs being called to the witness box at the same time to face judge-led examination. This practice is popular in Australia and was formally introduced to the United Kingdom courts in April 2013 as a result of Lord Justice Jackson s recommendations (Jackson Reforms) regarding the costs of civil litigation. The take-up has been relatively slow in the United Kingdom, and the Civil Justice Council commissioned a working group to review into its usage in August The findings and suggestions for amendment to the rules and guidance on this practice are, at the time of writing, with the Civil Procedure Rule Committee for consideration. Court vs non-court The starting point in a forensic accountancy project can often be an investigation targeted at a certain area of the financial records. In many cases, there can be a suggestion of misstatement either through error or design, and management may initially be looking to quantify the potential loss arising. While the initial instruction may not be for any specific litigation, the situation can develop where the forensic accountant may be asked to prepare evidence for court as part of a litigation process, or to assist in a mediation or arbitration. Litigation is the process of taking legal action in a court of law or tribunal in a dispute with another party. Litigation can be a costly exercise, which is why the parties are encouraged or required to try to find a compromise either through mediation or arbitration. In the United Kingdom, a forensic accountant acting as expert witness can be required to give sworn evidence at any of the three types of court in operation: criminal, civil or family. There are also tribunals at which an expert witness opinion may be required, and the rules on the expert s role and responsibilities are the same as for court. Most disputes are settled before there is a need for the forensic accountant to give evidence in court, with perhaps only around one in 20 cases requiring the accountant to attend court.

8 8 Forensic Accounting and Finance Mediation Mediation is one method used to try and avoid disputes being taken to court. A mediator is impartial, but will attempt to enable a flow of communication between the parties to find a solution that both feel is acceptable. Mediation is voluntary and, should it fail, discussions that have taken place in mediation are not referred to at court. An expert may be instructed to give written or verbal comment in the mediation. Arbitration Arbitration is also a method of settling disputes instead of resorting to public litigation before the courts. An arbitrator or panel of arbitrators is appointed to hear the dispute. The arbitrator(s) has judicial power, and the parties are bound by the tribunal award. An expert may be instructed to provide a written report to or verbal evidence before the tribunal. If the mediation or arbitration route fails to arrive at a satisfactory conclusion, the case proceeds to court. Different types of work that involve forensic accountants False accounting and fraud investigations Professionals in fraud investigations often refer to the fraud triangle. A number of versions exist but in essence the concept of the fraud triangle is the theory that fraud is most likely to happen when three factors are present: pressure (financial or emotional), opportunity and rationalization, ie justification for the steps taken to perpetrate the fraud. An employee can take advantage of his or her position at work. Signs of fraud can include working unsociable hours and an improved lifestyle. If it is suspected that a fraud may have taken place, a forensic accountant can conduct a covert review and quantify the loss suffered by the employer as a result of the employee s actions. (This is covered in more detail in Chapter 4 on fraud and Chapter 8 on auditing and financial reporting.)

9 The Forensic Accountant in Practice 9 Figure 1.1 Source Thanks to Fiona Hotston Moore, Ensors Accountants LLP and Higgins@HigginsCartoons.com for granting permission for the use of the cartoons in this publication Case study False accounting and fraud investigations Company X employed an individual in the role of financial controller. No issues were identified with the employee s work until, after taking a day s annual leave, she was seen on the news arriving at the Central Criminal Court in London. It transpired that her previous employer had sacked her for suspected fraud. The forensic accountant was instructed by Company X to carry out a full investigation of the company s books and records to identify whether a similar fraud had been perpetrated there by the financial controller. A large fraud was subsequently identified from sample testing. The fraud had been carried out by making payments to cover personal expenses, credit card bills, and even ongoing legal fees from the previous fraud! The payments were then posted to the ledger with a slightly different description, enough to not instantly stand out but not falsified so much that they would appear obviously incorrect on inspection. For example, the legal fees payment had a narrative similar to monies received in error from legal firm. This is a classic fraudster technique, to try and create an overly complex situation to deter further enquiries, while also offering up an apparently plausible explanation.

10 10 Forensic Accounting and Finance Quantification of loss (including personal injury) If an incident or accident occurs that was not caused by the affected party, it is common that the wronged party will seek redress. In such a case a forensic accountant will assess the impact and quantify the loss suffered. For personal injury, this would involve calculating the loss of earnings over the individual s lifetime. Generally, this would require an assessment of variables, and frequently actuarial tables are used, commonly the Ogden Tables, to assist in preparing these calculations. (This is covered in more detail in Chapter 13 on personal injury.) Professional negligence Unfortunately, on some occasions accounting professionals do not carry out their assignments with the due care and competence their professional regulatory body requires. Forensic accountants can review the working papers of tax advisers, auditors or other accounting professionals to assess whether they have acted negligently and, if so, the loss arising from the failure to fulfil their professional and/or contractual responsibilities. An expert will give a view on whether the professional conducted his or her work to the standard of a reasonably competent professional. (This is covered in more detail in Chapter 6 on professional negligence and Chapter 12 on insolvency.) Case study A professional negligence claim A number of members of a family invested in a film partnership. The investment was subject to a tax investigation by HMRC and the expected tax relief was denied. While the individuals accountant had not been formally engaged to advise on the investment, he had attended a number of meetings and been party to the correspondence on the investment. The individuals filed a claim against the accountant for the loss they incurred on the investment. A forensic accountant was appointed by the firm of accountants to act as expert witness on their behalf. Key to the case was determining the relevant tax

11 The Forensic Accountant in Practice 11 legislation, tax practice and appropriate professional advice at the time of the investment (rather than the date of instruction), with the benefit of hindsight and a proliferation of recent tax cases in the area. The forensic accountant s report considered the advice given to the individuals by the accountant in relation to the tax legislation at that time and the position of various relevant tax cases that were going through tax tribunal and the high court at the time the investment was made. During meetings with the other PAE, the forensic accountant was able to significantly reduce the areas of disagreement. After an exchange of expert reports from both sides and on receipt of the joint experts statement on the eve of the court hearing, the matter was settled out of court. Fraud prevention A common oversight when considering the services of a forensic accountant is to disregard the proactive approaches that can be utilized to minimize the potential of a fraud occurring. Fraud prevention reviews can be targeted at specific areas and look into the detail in more depth than a financial statements audit. (This is covered in Chapter 5.) HMRC or National Crime Agency investigations Individuals and businesses can often feel overwhelmed in an investigation as the information requested will be in a format or level of detail they are not used to. A forensic accountant can act as the intermediary between the authorities and the investigated party/parties. (Tax investigations are covered in more detail in Chapter 3.) Case study National Crime Agency A taxpayer who was under investigation by the National Crime Agency (NCA) for tax evasion engaged a forensic accountant to assist. The nature of the case and the sums involved was such that HMRC had passed the matter to the NCA to resolve. The initial estimates of the potential liabilities for tax evaded amounted to a figure in excess of 2 million.

12 12 Forensic Accounting and Finance An analysis was carried out on a substantial amount of data covering five years, including 80 bank accounts, trading records and property transactions. The forensic accountant produced a report on the under-declared tax liabilities and represented the client in the negotiations with the NCA. This case resulted in a final settlement of less than a quarter of the original tax assessed. Case study Tax dispute in tax tribunal Some high-profile individuals invested over a number of years in a series of partnerships, most of which were involved in the music industry. The tax affairs of the partnerships were subject to a protracted tax investigation that could not be resolved between the taxpayers and HMRC. The matter was therefore listed for hearing before the tax tribunal. PAEs were appointed by the partnerships and HMRC. The key issue was not the tax legislation but rather the appropriate accounting treatment of the partnership transactions under UK accounting practice, which drove the tax deductions. Both parties provided expert reports on the accounting matters and then provided the court with a joint statement outlining areas of agreement and disagreement. The case was heard before the tax tribunal and both experts were crossexamined on the evidence given in their reports. Many months after the hearing the case was determined in favour of HMRC and was not appealed by the taxpayers. Commercial disputes A commercial dispute can arise for a number of reasons and the scope of the work carried out by the forensic accountants will depend on the features of the dispute. Many commercial disputes will relate to or require a business valuation. (This is covered in more detail in Chapter 10 on commercial disputes and Chapter 7 on valuations.)

13 The Forensic Accountant in Practice 13 Case study Commercial dispute An international consumables manufacturer was accused of prematurely terminating a sales agreement with its agent. A forensic accountant was instructed by the defendant to quantify claims for breach of contract and the potential value of the agency at the termination date. The sales of the product increased sharply after termination, which the former agents alleged resulted from their efforts pre-termination. The total claim amounted to 3 million. A key difference of view between the forensic accountant and the other PAE was the relevance or otherwise of the fixed term of the agency agreement to the earnings multiple applied to the adjusted maintainable earnings. In the view of the forensic accountant, the multiple could not exceed 2 x, being the remaining term of the fixed agency. The other PAE adopted a multiple of 7 x, which ignored the agency term and reflected a large business. The matter went to trial, and the forensic accountant was called on to give evidence at court. The final settlement, without interest and costs, amounted to less than 300,000. Insurance claims If a party has suffered a loss but decides not to litigate, he or she may wish to claim from his or her insurance policy. In this instance, a forensic accountant will quantify the amount to be claimed under the insurance policy. The insurance company may appoint its own expert. (This is covered in more detail in Chapter 10 on commercial disputes and Chapter 13 on personal injury.) Matrimonial A common instruction from family solicitors is to value a business as part of matrimonial proceedings. It is also usual to be asked to assess the maintainable level of earnings to assist the lawyers negotiation of the settlement agreement.

14 14 Forensic Accounting and Finance Valuation exercises in these circumstances are often challenging due to the level of mistrust between the parties. It is often said that if both parties are slightly unhappy then the valuation of the business is spot on! (This is covered in more detail in Chapter 7.) Case study Matrimonial dispute A couple owned business interests in a group of companies specializing in installations of equipment. The wife s interest was limited to a 20 per cent shareholding in only one company in the group, Company A, in which the husband also owned 60 per cent. Other companies in the group were owned solely by the husband. The trading activity in Company A declined sharply when the relationship began to deteriorate, while trade gained momentum in another of the husband s companies in which the wife had no interest, Company B. The husband seemingly was attempting to devalue the shares of Company A, the erstwhile main trading company, in the hope that all of the lost business and goodwill could be transferred to Company B: the year-ends for Companies A and B were non-coterminous and statutory accounts were not yet available for Company B, which could help hide what was going on. The forensic accountant provided a view on the value of the business that had been diverted to Company B and the impact on the value of the wife s shareholding in Company A. Whatever the motivation behind the diversion of trade, it was unsuccessful as the court was provided with sufficient information through the expert report to formulate an opinion on the lost value. The wife also queried whether her dividend stream would continue it had stopped three years previously. Apparently unbeknown to her, she had been drawing down on her director s loan account and the forensic accountant s report showed she now owed the company in excess of 150,000. Shareholder disputes While many businesses start with unity and good intentions, it is sometimes the case that disputes arise between business partners. This can be particularly problematic as many friends and family who go into business do not draft a formal shareholder or partnership agreement; the business lacks a robust governing document. (Valuation issues in shareholder disputes are covered in more detail in Chapter 7.)

15 The Forensic Accountant in Practice 15 Case study Shareholder dispute Most of an arable company was owned by the father of a family, with smaller shareholdings held by his daughter and sons. Shares in the company were split into Ordinary and A shares. The daughter had a higher holding due to being involved in the day-to-day running of the business. Before the father passed away he asked the daughter to sign an agreement that stated that dividends of x per cent of net profit before tax would be paid each year on the A shares, which post-death would be split evenly between the siblings. The father s will further stated that his shareholding of Ordinary shares would be passed down in proportion to his children s current holdings. After the father s death, the daughter rapidly grew the business s turnover and profits, and perceived it unfair that her siblings were gaining from her hard work. The family dispute related to the enforceability of the agreement on the A shares. The daughter did not accept it was enforceable and did not honour the dividend policy. The forensic accountant was instructed to value the Ordinary and A shares under two main scenarios: with the dividend policy, and without the dividend policy. The forensic accountant concluded that the valuations in the two scenarios were vastly different due to the A shares possessing an income stream under the first scenario, but holding only nominal value under the second due to making up just 0.1 per cent of total issued share capital. With the benefit of the forensic accountancy report, the matter was settled between the family members at mediation. Criminal cases A forensic accountant can be instructed as an expert witness to act for either the defence or prosecution in a criminal matter. The type of case can expand to any where the need for expert input on figures is required. Case study Criminal case A forensic accountant was instructed by the defence to provide an expert report to assist the court in relation to substantial alleged money laundering. The police had observed a group of individuals making various visits to casinos over a

16 16 Forensic Accounting and Finance four-year period, and it was alleged that these visits were made with the objective of laundering the proceeds of criminal activity. The forensic accountant s role involved reviewing the financial evidence identified by the Crown Prosecution Service to give an opinion on the extent of funds laundered through casinos. The forensic accountant showed that the prosecution s evidence had doublecounted certain criminal proceeds, and thus reduced the final sum from an alleged 10 million of laundered funds to 2 million. Where does the work come from? Non-litigious forensic investigation assignments can come from a wide spectrum of sources, including directly from the affected organization. The variety and scope of instructions are very wide and can be specific to the circumstances of the instructing organization. The forensic accountant needs to assess whether he or she has the specific industry or sector knowledge to be able to undertake the assignment. For the element of forensic accountancy work that is closely linked to court proceedings, it is to be expected that most instructions come from lawyers involved in cases. It is rare for litigious referrals to be received directly from the ultimate client; this is presumably because a lawyer will be the first port of call for a party in dispute, as unrepresented parties may not best understand the opportune moment at which the forensic accountant s portfolio of services should be engaged. It is therefore lawyers that provide the largest volume of referrals as they remain the first point of contact for many parties in dispute. Referrals can be received from any of the parties shown in Figure 1.2. Figure 1.2 Sources of referrals Individuals Insurers Mediators Insolvency practitioners Counsel Corporations Arbitrators Lawyers

17 The Forensic Accountant in Practice 17 Concluding summary While forensic accountants often trained originally as auditors or accountants in practice, the role of a forensic accountant is distinct from that of an auditor and requires additional skills, training and experience. In this chapter we have explained the role of the forensic accountant and how it differs from the role of auditor. We have outlined the key skillset required for forensic accountancy. The world of forensic accountancy is broad, and through case studies we highlighted the variety of work undertaken by forensic accountants in practice. Finally, we covered the various source of work referrals for forensic accountants. Note 1 the-work-you-can-do/forensic-accounting