When accounting practices go under the microscope: once a financial investigation has begun, it's time for an all-hands-on-deck alert. Time is precious, and help from a broad-based forensic team--lawyers, accountants and other specialized professionals--can be highly valuable.
Regardless of one's personal perspective, the reality is that the accounting scandals of the past few years have yielded a variety of changes in both the regulatory climate and the governmental focus on how companies handle their accounting and financial reporting. The Sarbanes-Oxley Act has created paranoia aplenty, the Department of Justice and the Securities and Exchange Commission (SEC) are on the prowl and various other government agencies are redefining what is--and is not--acceptable corporate behavior on a seemingly day-to-day basis.
In this new business environment, no organization is immune to the prospects of a financial investigation.
When a company is in the throes of a financial probe, the stakes are enormously high. Daily business operations are interrupted, stock prices and market capitalization can quickly plummet and shareholder and employee confidence often erodes. Time is of the essence--every hour, every day, every week counts.
Overview of Forensic Financial Investigations
Financial investigations are accounting inquiries aimed at ascertaining whether a company's financial results were misstated or whether one or more employees received an improper financial benefit from the company. Sometimes these activities rise to the level of being "forensic financial investigations." The word "forensic" simply means that the information uncovered is capable of being used in court. Most of these investigations are conducted by a team that includes lawyers, accountants and other specialized professionals.
Typically, investigations are begun because someone raises questions regarding the propriety of a transaction or group of transactions. They can also be tipped off because of a concern that the company's financial statements may contain errors, either by intentional falsification or inadvertent mistake.
In many cases, forensic financial investigations are initiated by a company's board of directors, audit committee or litigation committee. Sometimes, investigations are conducted at the behest of management or the company's in-house counsel. When a company is in bankruptcy or receivership, such investigations are often done at the direction of a creditor's committee, the receiver or a bankruptcy trustee.
Triggers for Financial Investigations
There are a variety of possible triggers for a forensic financial investigation, but most of them fall into one of four categories.
1. Regulatory Inquiries. For public companies, an internal accounting investigation often results when the SEC challenges a company's financial reporting or disclosure practices. If the SEC's questions appear to entail valid concerns, a financial investigation is likely to commence right away.
Other regulatory and self-regulatory initiatives can also precipitate internal investigations. For example, a state insurance department might raise questions in connection with the examination of an insurance company's books, or the National Association of Securities Dealers (NASD) might find apparent irregularities in the records of a member securities broker/dealer.
Generally speaking, internal accounting investigations triggered by circumstances such as these are aimed at "self-policing" a company--in other words, having a corporation clean its own house. In such situations, the potential threat to a company from a regulator can often be minimized by initiatives that demonstrate good "corporate citizenship" and a proactive approach to rectifying any possible irregularities. Moreover, a board of directors or audit committee may have a legal obligation to determine independently whether indications of wrongdoing have substance or not.
2. Shareholder Actions. Under most state laws, shareholders of a corporation have a right to request (or "demand") that the company or its directors take action to redress alleged harm caused to the corporation by its officers or board members. That right is typically exercised when one or a group of shareholders files suit, demanding that the corporation take action against specified corporate officials who have been accused of fraudulent financial reporting or "self-dealing" transactions.
The legal basis for these types of claims is typically "breach of fiduciary duty" by the specified corporate officials--in essence, the shareholders are seeking to have the corporation sue or otherwise take action against individuals for failing to properly carry out their duties or for putting their personal interests above that of the company.
For a variety of legal and business reasons, companies cannot simply brush aside these actions. One response is to address the allegations of official wrongdoing by forming a "special litigation committee" (SLC) comprised of members of the board. The SLC is ideally made up of directors who are not also employees of the company, but, at a minimum, excludes individuals accused of wrongdoing.
The SLC ordinarily employs its own counsel and forensic accountants. Since independence from management and others named in the shareholder action--in both reality and appearance--is important, counsel to the SLC should have few or no other relationships with the company. The forensic accountants engaged by the SLC or its counsel are similarly expected to be independent of those involved in the allegations.
3. Internal Audits. A company's internal audit department sometimes raises issues that may trigger a financial investigation. In large companies, the internal audit group itself often has the resources to conduct a forensic accounting investigation; in smaller companies, they often do not. Even where the resources are available, however, serious issues may be investigated by outside lawyers and accountants simply because the results are likely to be perceived as more independent of management and therefore more credible.
A related internal trigger of financial investigations can be "whistleblower" complaints. On occasion, a current or former employee raises issues by making accusations about the conduct of corporate officials or a company's financial reporting. (By law, all publicly traded companies must have a mechanism in place to permit employees to "blow the whistle" without employment repercussions. This is usually a "hotline"--typically an 800 number--through which such information can be communicated anonymously.)
In addition, when a new management team--or even just a new CFO--takes over, they sometimes find situations that indicate some impropriety by former management. This, too, can precipitate a forensic financial investigation.
4. Independent Audits. In the post-Enron era, outside auditing firms have become increasingly sensitive to any indication of financial reporting fraud. While auditors have a professional responsibility to follow up on "fraud indicators," they also are cognizant of the potential for having their findings viewed skeptically if they are the only ones who conducted an investigation.
This concern is particularly important when allegations extend back to periods in which the auditors previously expressed an unqualified opinion on financial statements. Regulators and others have begun taking a dim view of auditor-conducted investigations that appear--in part, at least--to be the auditor investigating its own work.
One common response: the auditors refuse to release their audit report until the company has conducted an independent investigation. Normally, such an investigation is done under the auspices of the audit committee.
Calling in Experts: Components of A Forensic Financial Investigation
Most executives would probably prefer to make a single phone call and access an experienced team of professionals who can step in immediately, quickly assess a situation and develop a plan for managing the investigation in a way that produces the best possible outcome.
These outside experts are typically made up of a prominent team of industry leaders with expertise in SEC accounting and enforcement matters, complex forensic accounting challenges, Sarbanes-Oxley compliance issues and electronic evidence discovery requirements.
The outside experts should have extensive hands-on experience in deconstructing the economic, contractual and electronic discovery aspects of complex financial investigations. It's often valuable to engage a multidisciplinary group of professionals, "hand-picked" from among the industry's top experts.
These can include certified fraud examiners, forensic computer experts, former prosecutors and law enforcement officials having significant experience providing services for a wide range of high-profile financial investigations conducted within litigation, arbitration and courtroom settings.
From the moment of the first phone call, the outside experts can work collaboratively with the corporate client to unravel complicated transactions, reconstruct events from incomplete or corrupt data, uncover vital evidence, identify potential claims, conduct internal investigations, advise on corporate governance issues, trace funds and assets, gather evidence and prepare reports, and testify regarding their findings.
Here are some of the key areas in which an outside team can be extremely valuable during a financial investigation:
* Investigations -- Discovering and analyzing the most sophisticated circumvention of internal controls, unwinding complicated transactions and reconstructing events.
* Forensic Accounting -- Identifying, collecting, analyzing and interpreting financial and accounting data with methodologies that produce independent thoughts, reports and expert individual opinions that will stand up to the toughest scrutiny.
* Electronic Discovery -- Dissecting complicated transactions and exposing vital evidence--a crucial capability since more than half of business documents are stored in electronic form.
* Compliance -- Working closely with both in-house and outside counsel to provide advice on Sar-banes-Oxley issues, corporate governance matters and a variety of compliance requirements involving restatements and disclosures.
* Litigation Consulting -- Assistance in developing solutions to resolve identified issues and present findings to the SEC, PCAOB, courts and other venues.
In summary, corporate accounting practices and financial reporting procedures are under the microscope more than ever. When any one of several possible triggers creates the need for a forensic financial investigation, it's crucial for financial executives to act swiftly and decisively
The company's financial health, legal exposure and public reputation are all at risk during these crucial first moments. A comprehensive action plan, implemented by seasoned professionals, may be essential to minimize impact on operations, protect market capitalization and maintain the confidence of shareholders and employees.
Neal Hochberg (firstname.lastname@example.org) is Senior Managing Director at FTI Consulting and the national coordinator of FTI's forensic accounting and investigations practice. FTI is a provider of corporate finance/restructuring, forensic/litigation/technology and economic consulting services to corporate boards.
RELATED ARTICLE: takeaways
* In the post-Enron era, with its stepped-up regulatory vigilance, no organization is immune to the prospects of a financial investigation.
* The word "forensic" in financial investigations implies that the information that is uncovered is capable of being used in court.
* Most forensic actions stem from one of four sources: regulatory inquiries, shareholder actions, internal audits or outside audit concerns.
* In addition to the experience they bring, a forensic team's reports carry an independence that wouldn't be true of those from the company's outside auditor.
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|Author:||Hochberg, Neal A.|
|Date:||Jan 1, 2006|
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