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See you in court.


THE BUSINESS COMMUNITY'S philosophy for dealing with fraud has changed over the past decade. At one point businesses were willing to write off losses; now they want to prosecute and seek civil recovery from the responsible parties.

The following factors contributed to this change in handling fraud:

* White-collar crime costs the American public between $40 billion and $200 billion per year.(1)

* The public's confidence in American business was shaken when major scandals involving leaders in industry and government routinely appeared in the media.

* Both the public and private sectors became more adept in detecting sophisticated fraud through the increased use of accountants, certified fraud examiners, and computers. Both sectors developed special programs to investigate cases of economic crimes to prevent theft, identify fraud in its early stages, seek prompt financial recovery, and punish wrongdoers.

* The justice system made great strides in dealing with business fraud. Individuals convicted of criminal acts now frequently receive prison sentences instead of mere fines and suspended sentences. The enactment of the Racketeer Influenced and Corrupt Organizations (RICO) statute set stiff penalties against those who commit any of a variety of federal offenses including white-collar crimes. The RICO statute also provides powerful civil redress.

* Potential liabilities faced by companies and their officers through possible suits by shareholders or trustees in liquidation,(2) as well as compliance regulations and financial disclosure rules, require that detected frauds be investigated, reported, and acted on.

Investigations of illegal activities by or against company personnel look at such issues as

* internal control weaknesses in accounting or compliance areas,

* potential company exposure for illegal activity involving theft or loss of assets,

* questionable payments, and

* disclosure requirements affecting the company's financial position. A public investigation may expose the company to potential civil liability. By investigating the fraudulent activities before this point is reached, the company can keep the investigation confidential by maximizing the protection of the attorney-client privilege and the work-product doctrine.

MOUNTING A SUCcessful investigation requires a select group of specialists - accountants and investigators working under the direction of outside counsel. This experienced team can address and resolve the problem quickly so management can concentrate on company business with minimal interruption.

Outside counsel. The attorney responsible for the investigation should be involved from the outset to guide the investigation, to avoid legal pit-falls, and to maximize the privileges in maintaining confidentiality. Armed with the facts, the attorney can pursue civil actions on behalf of the defrauded company as well as encourage a parallel prosecution by public authorities.

It is best to retain outside counsel to oversee the business fraud investigation and conduct any necessary litigation. Courts generally preserve the confidentiality of attorney-client communications and work product if the work is performed in preparation for litigation and is not merely regular business advice - a service often provided by in-house counsel. Outside counsel also provides the independence necessary for conducting an internal corporate review.

The attorney's role in the investigation is to identify and pursue the goals of the defrauded party. Beyond the investigation, these goals may include halting the activity, recovering the stolen assets, deterring future thefts, and laying the foundation for criminal prosecution.

Fact gathering cannot be limited to the attorney's office. Outside counsel must employ seasoned investigators to gather the facts in the field. This may consist of on-site observations, witness interviews, and, where appropriate, surveillance and undercover activity.

The outside counsel and the investigator should gather all relevant documents no matter how staggering the number may be. As fraudulent activity is often disguised behind a myriad of shell corporations and straw people, the outside counsel must work through this maze of documentation to pin liability on the culpable parties and reach assets to satisfy forthcoming judgments. This process can be aided by an accounting analysis that allows the attorneys to follow the money trail.

In sum, outside counsel's job is to guide the civil prosecution team successfully through the investigation and maximize its results in any legal action that may follow.

The accountant. A fraud investigation requires specialized accounting to detect and interpret the truth behind recorded transactions. A fraud investigation differs in both its objectives and methodology from the routine audit done in accordance with generally accepted auditing standards (GAAS). For example, GAAS auditors are responsible for detecting irregularities that may be material to the company's financial statement. While objective, the GAAS auditor may fail to find fraud because of the use of selective testing and the perpetrators' collusion to mask it.

When retained by counsel, the accountant can function as a consultant, expert witness, or forensic accountant. As a consultant, the accountant advises counsel on the economic or financial issues involved. The accountant will not be called on to testify about his or her work or opinion. Working closely with counsel, the consultant's work is protected by work-product privilege and will not be disclosed to the adversary.

As an expert witness, the accountant renders an opinion as a witness at a trial. The expert - because of special education, skill, or experience - can testify with authority on accounting issues. All work performed by the expert witness is discoverable by the opposing side.

As a forensic accountant, the accountant may be called to render an opinion on market conditions or make industry forecasts after he or she analyzes evidential documents. This is especially true in cases of antitrust, bid rigging, business frauds (both civil and criminal), and other cases involving the assessment of liability or when damages are an issue. In this role, the accountant might apply a what-if scenario using accounting principles, theories, and models to show that the pattern of activity indicates a bid-rigging conspiracy by the suspects. The objectives of the case will determine the role played by the accountant.

The investigator. Business fraud investigations are often complex and involve a wide variety of situations from outside stings to internal defalcations, from preparing insurance claims to preparing for litigation.

Over the past decade attorneys have turned increasingly to financial investigative specialists for business investigations and litigation support. These fraud investigators are educated and experienced in a variety of relevant fields including accounting, fraud auditing, banking, securities, computer science, insurance, and criminal and civil law. Also, a skilled fraud investigator on the case ensures that vital financial information is identified and analyzed for the team; corporate management, governmental, and regulating agencies; and the courts.

In conjuction with the team accountant, the fraud investigator can perform an array of services, including

* assisting in developing an investigative strategy,

* analyzing business records and documents,

* following paper trails,

* locating and interviewing witnesses,

* recovering stolen assets,

* discovering and evaluating flaws in the opposition's case,

* providing detailed support for depositions and cross-examinations, and

* providing expert witness testimony.

ONCE THE TEAM IS ASSEMBLED AND the roles are identified, the outside counsel, accountant, and financial investigator can use their skills in planning and conducting the investigation.

Planning is key to a successful investigation. A poor plan will misdirect the investigation and reduce the opportunity for success. The investigation plan should

* provide a course of immediate action for the team members,

* ensure all investigative steps are taken,

* provide a system for locating and evaluating useful documents, and

* provide for a complete and persuasive case package for court.

An investigation plan consists of three parts. Part one is a brief, specific statement of known facts and the investigation's goals. For example, determining who may have received kickbacks is too broad an objective and offers little direction for the team. A better way to describe the objective of the investigation is to determine if anyone in the purchasing department personally benefited from dealing with specific vendors during a specific period. Such a statement can help direct the investigators and can help all team members remain focused.

Part two contains the steps of the investigation. It lists

* individuals involved and to be interviewed;

* records and documents to be obtained, reviewed, and analyzed;

* places to observe;

* notifications of other company departments and federal, state, or local agencies; and

* investigative steps to use, such as sampling techniques and cash flow analysis.

Part three contains a more comprehensive statement of facts that can be expanded during the investigation as information is obtained through document reviews, interviews, and observations.

ONCE THE INVESTIGATION HAS BEEN planned, the team members can begin investigating. The accountant is a major resource to the team. He or she can assist the investigator and attorney by explaining business facts and issues in support of their search for evidence and developing legal theories. For example, in a business fraud investigation the accountant can review and analyze both business and personal financial records for the truth behind recorded financial transactions.

Depending on the circumstances of the case, the accountant will take particular interest in

* accounts payable and receivable records, the general ledger, trial balance, and preliminary financial statements, and the status of delinquencies;

* indications of cash flow problems for the company or its personnel;

* outstanding loans - both business and personal;

* inventory flows;

* travel and expense vouchers;

* sales and other primary sources of income; and

* results of operations and indications poor management.

The accountant may apply forensic accounting techniques to evaluate a questionable business operation. Such an investigation would include an investigation and analysis of earning trends, operating performance, forecasted future performance, industry conditions, the quality of comparables, and economic factors. These and other points determine the true earnings capacity of the company, its real value, and the integrity of the targets of the investigation.

While the financial data is being compiled and analyzed, the financial investigator can follow the paper trail. Using accounting information as it is developed, the investigator can collect evidence to locate assets and prove or disprove theories on how the crimes were committed, what the scope of the loss is, and who the responsible individuals and potential witnesses are.

A major role of the financial investigator is to locate assets stolen by potential defendants. This is accomplished by conducting a financial investigation of the targeted entity or individual. The investigator should obtain the information noted on the accompanying chart.

AFTER THE INVESTIGATION IS CONducted and it is determined the company has suffered from fraud, the company must take steps to recover the stolen funds and deter future losses by prosecuting the guilty parties.

By quickly recovering the lost money and putting the criminals behind bars, the victimized company can restore its credibility. Failing to make this effort may lead to lawsuits by shareholders or others against the company for mismanagement or negligence in recovering the losses. Failure to take immediate steps also may paint the company in a negative light as one that assists in or covers up criminal activity.

After determining who was responsible for the losses, the company's management and outside counsel should consider what immediate action to take. Speed is important; it is a race to freeze the money before the criminal spends it and to beat other potential claimants who may assert an interest against assets the team has identified.

Counsel can go to court to obtain a temporary restraining order (TRO), which freezes the flow of the money, and a writ of attachment, which establishes the company's legal interest in the stolen funds. The TRO stops the criminals from spending or further transferring fraudulently obtained money. The writ of attachment establishes the company's legal interest in its assets and also helps to establish priority over other claimants to those funds.

To obtain a TRO and a writ of attachment, counsel must show the court that a fraud was perpetrated and that the money is being spent or transferred out of the court's jurisdiction. The company also may have to post a bond covering potential claims against it in case it is wrong. Once such a showing is made and a bond is posted, the court can give counsel the necessary orders to trap the money.

In addition to trying to recover the losses from those directly involved, the company and the outside counsel also may consider claims against other such as those who helped or allowed the fraud to happen and insurance companies that insured the company against such losses.

Many entities may be secondarily responsible for the company's losses. Banks, accounting firms, brokerage houses, law firms, and medical professionals may have actively assisted in or negligently permitted the theft of the company's money. Many of these entities have the assets to repay the victimized company for its losses.

The RICO statute is an action commonly used against those who have stolen funds or actively assisted in stealing funds. This statute was passed by Congress in 1970 "to seek the eradication of organized crime in the United States." Congress provided that it "be liberally construed to effectuate its remedial purpose." In addition to criminal provisions, RICO provides for civil remedies and allows private parties to sue under its provisions. The law covers virtually all types of fraud.

The civil RICO action allows the case to proceed in federal court with its more expert judges and its less congested calendars. The RICO action lends itself to parallel prosecutions and effective use of criminal convictions.

The statute allows for a substantial and meaningful recovery - triple damages, costs, and attorneys' fees. RICO's substantive provisions require proof that a person conducted a pattern of racketeering activity or collection of unlawful debt directly or indirectly through investment in or maintenance of an interest or participation in an enterprise affecting interstate commerce.

RICO's conspiracy provision provides that "it shall be unlawful for any person to conspire to violate any of the [substantive] provisions." The term person includes any individual or entity capable of holding a legal or beneficial interest in property. Thus, corporations, companies, associations, firms, and partnerships are all included.

Racketeering activity defined under RICO is any of a number of federal offenses including mail fraud, wire fraud, interference with commerce, and interstate transportation of stolen property. It also includes certain state crimes including any act or threat involving arson.

A pattern of racketeering activity consists of at least two acts of racketeering activity within 10 years of one another. An enterprise includes any individual, partnership, corporation, association, or other legal entity and any union or group of individuals associated in fact although not a legal entity. The term enterprise includes both commercial entities and associations.

To prevent and restrain RICO violations, the federal courts are empowered

* to order any person to divest himself or herself of any direct or indirect interest in any enterprise;

* to impose restrictions on future activities or investments of any person, including prohibiting that person from engaging in the same type of endeavor as the enterprise engaged in; and

* to order the dissolution or reorganization of any enterprise. Some courts have interpreted the statute to allow restraining orders during the pending lawsuit.

Besides RICO, other theories of recovery against those directly involved include fraud actions and conversion actions. Even if the losses cannot be recovered from those who directly took the company's funds, the company might be able to recover from others involved. Outside counsel also can assert many different types of claims against those secondarily responsible either through conspiracy theories (conspiracy, partnership, agency, alter ego, aiding and abetting, etc.) or through negligence theories (breach of fiduciary duty, breach of custodial duty, uniform commercial code violations, etc.). Those parties' liability to the company depends on their degree of participation and the duties they owed to the company.

Other potential sources of recovery are insurers or reinsurers. The company may have insurance, such as all-risk policies, that cover fraud losses. If those inside the company were involved in the fraud, the company may also look to insurance companies issuing fidelity bonds or errors and omission insurance to recover its losses.

If insured, the company may recover not only the money lost directly through the fraud but also the investigatory and legal costs incurred. Counsel must first file a claim or proof of loss with the insurer or reinsurer citing the facts of the case and specifying the damages incurred. Should the insurance company refuse to pay the claim on other than legitimate grounds, the company may be able to assert an additional claim against the insurer for bad faith denial and seek to recover from the insurance company not only the losses but also punitive extra exemplary damages.

In addition to seeking financial recovery, the company may encourage criminal prosecution of the guilty parties. This will deter others from attempting to steal money from the company in the future. Further, a criminal conviction greatly assists the company's efforts in seeking civil recovery of its financial loss.

Because government prosecutors are busy, the company will have greater success in getting the prosecutors to act if it has counsel put the case together for the prosecutors. An attorney, assisted by the accountant and financial investigator, can save the prosecutor a great deal of time by outlining the case and presenting the supporting documents for the prosecutor's consideration.

This action not only is civically responsible but also shows the company will seek vindication and thus deter future thefts. Too often companies remain silent about frauds and thefts. One consequence of remaining silent is that the government, the public, and potential claimants may view the company as corrupt and a target for investigation and civil action.

A civil prosecution team is a valuable tool for a defrauded company. An experienced investigative and legal team can ferret out the fraud, determine whether those inside the company are responsible, identify the scope of the fraud and the location of stolen assets, obtain civil recovery from those directly or indirectly responsible, obtain appropriate insurance recovery, and assist government prosecutors in pursuing the case. These actions not only are essential for financial recovery but also may be necessary for financial survival in the future.

Record Checks

Business entity

* corporate name, addresses, and phone numbers

* incorporation data, including the state and date of incorporation, other parties involved in the business, etc. Individuals

* names and known aliases

* names and addresses of family members

* residential and business addresses and phone numbers

* dates of birth

* social security numbers Credit profiles

* bank accounts

* brokerage accounts

* credit card accounts

* loans and mortgages

* outstanding judgments Motor vehicle bureau

* drivers' licenses and vehicle registration

* traffic summons and vehicle accident information Criminal records

* arrests and convictions by federal, state, or local law enforcement agencies

* immigration records (aliens)

* State Department (passports) Liens and judgment records

* outstanding judgments

* liens Bankruptcy court files Uniform Commercial Code files Property and tax records (county level) Litigation records Lis pendens notice files Voter registration records Government agency records

* identification requirements

* federal loan information

* government claims, fees, fines, and penalties

* government contracts

* license applications, activities, and reports

* permit applications

* government grants and awards Business reports

* annual statement reports

* Standard & Poor's industry surveys

* Dun & Bradstreet reports

(1) FBI Director William H. Webster's speech before the Nation Retail Merchants Association, June 6, 1985.

(2) See Hager, as liquidator of Carriers Insurance Co. v. Ruan, No. CL 70-41628 (Iowa District Court, Polk County, June 11, 1987). (This is a $63 million suit against directors, alleging gross negligence and mismanagement.) See also Foordree, commissioner of insurance of Iowa, as liquidator of Iowa National Mutual Insurance Co. v. Durham, CL 64-37701 (Iowa District Court, Polk County, January 10, 1986). (This is a $40 million suit against officers and directors, alleging mismanagement, breach of fiduciary duties to the corporation and its shareholders, and failure to exercise due care.)

About the Authors ... Marvin A. Katz, CFE (certified fraud examiner) is director of insurance consulting and special investigative services at Laventhol & Horwath in New York City and is a member of ASIS. Neil V. Getnick is a partner at the law firm of Getnick & Getnick in New York City. Robert M. Horkovich is a partner of the law firm of Anderson, Kill, Olick & Oshinsky in New York City.
COPYRIGHT 1989 American Society for Industrial Security
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1989 Gale, Cengage Learning. All rights reserved.

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Title Annotation:an experienced investigative & legal team can quickly ferret out fraud; includes related information
Author:Katz, Marvin A.; Getnick, Neil V.; Horkovich, Robert M.
Publication:Security Management
Date:Sep 1, 1989
Previous Article:Evidence makes the case.
Next Article:Searching for safe procedures.

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