CONSULTING

When dealing with swindled clients and their lawyers,

it pays to know the rules.
The CPA As Sleuth:
Working the Fraud Beat
B Y C R A I G M . B E E K , W . M A X R E X R O A D ,
L I N D A M . L E I N I C K E A N D J O Y C E A . O S T R O S K Y
PAs can trade in their spreadsheets for trenchcoats and fedoras.
They'll need to if a client ever requests help with a business fraud in-
vestigation. In fact, often its a CPA who finds the "smoking gun"
the forged check or the purchase orders for nonexistent goods. Be-
What might a CPA's fraud casebook
look like? LCF Associates, Boston-
based private investigators who
often work with CPA firms on frauds,
has shared some of its case files
with the Journal. These cautionary
tales, in which accountants play
prominent roles, appear throughout
the article. Names have been
omitted to protect the innocent.
cause most frauds usually have a fmancial component.
CPAs can be of great help in solving them.
But those uncovering fraud need to take care to avoid
costly missteps. Accountants who serve as consultants to
their clients, or even those who work as controllers or
(^,FOs, need to he aware of the key legal issues, so they can
work effectively with a company's lawyers. Their reward?
('PAs who know their way around fraud investigations
greatly increase the likelihood of fmancial restitution to
clients, and thus provide a value-added service.
, THE LAWYER
Once a company has asked a CPA to look into a business
fraud, the first step he or she needs to take is to advise the
client to hire an attorney, specifically to establish privilege
of information. (Of course, CPAs who suspect fraud while
f an andit are bound by additional rules and regu-
lations. See "The Auditor and Fraud," JofA,
Apr.97, page 32, and "The CPA as Fraud-
liuster,"JofA, May9H, page 69.) Basically, privi-
lege of information means attorney/client
privilege will cover any information the CPA
discovers. {Also see "A Matter of Privilege,"
page 21.) The CPA's engagement letter must
specify that he or she will work on the case at
the direction of tlie clients attorney. The letter
also should clearly state the legal purpose of the
accounting services to be provided; failure to
do this could result in the loss of privilege.
20 JOURNAL 0/ ACCOUNTANCY Apr i l l ' >' "i
T
Additionally, upon learning more about just
how complex the fraud case is, the CPA may want
to advise the client to hire a professional investiga-
tor with a law enforcement background. While
C^PAs bring a knowledge of the client's financial
transactions and systems to the investigative effort,
the pn.)fessional investigator also brings expertise
in proper investigative procedures, interviewing
techniques and civil and criminal laws.
PLAN OF AHACK
Early in the investigation, the attorney and the
CPA need to agree on an appropriate legal strate-
gy. For example, if they're contemplating a civil
suit, wht)what individuals or corporate entity
would the suit be filed against and what charges
would be brought? Likewise, if they want to pur-
sue criminal charges, what jurisdiction has venue
and what statutes have been violated?
The attorney understands the legal elements the
client needs to win a civil suit or criminal case. Thus, at a
very early stage, the CPA and the attorney must determine
what type of evidence they need. For instance, if they want
to file a federal mail fraud case, the CPA must gather evi-
dence to meet the necessary elements of pn^of under that
statute. In such cases, establishing that a document traveled
through "the mail" is essential. Specifically, the C-PA must
establisli who prepared the document, who mailed it, that
it went through the mail, that it was fraudulent and that
the preparer knew it was fraudulent. CPAs should be aware
that any private or commercial interstate carrier, such as
UPS and Federal Express, may qualify under the federal
mail fraud statute. The envelope is critical because it bears
the carrier's name and the mailing date. Also, it may be
necess;iry to dust the fi-audulent document for fingerprints.
Select the jurisdiction. The attorney and CPA need to
carefully consider the many factors that can come into play
when selecting the casesjurisdiction. For example, has a
federal or state law been violated? One problem: With
state cases witnesses normally cannot
be subpoenaed across state lines; in
federal cases they can. The dollar
amount of the fraud is important, as
well. In the Chicago area, a $10,000
fraud case may barely interest local
prosecutors, but prosecutors in a rural
jurisdiction may relish the opportuni-
ty. Another con.sideration is the court
precedents of the various jurisdictions
where a c;ise might lie filed.
A matter of privilege. At the inves-
tigation's outset, the client needs to
maintain control over the information
generated during the fact-finding
phase. If all of the information-gather-
ing is done at the direction of the
clients attorney, all information gath-
ered could he considered "privileged"
and may not be n^adily available to the
'he owner of a luxury car dealership couldn't believe it when his
bank called to tell him he was $1.7 million in arrears on his
line of credit, especially when sales had seemed steady. The
owner called his attorney, who, without alerting the controller,
brought in a team of outside accountants and private investigators.
The accountants quickly picked up discrepancies in the daily de-
1__ - - posits and the private investigators, while search-
ing public records and discreetly interviewing
former employees, uncovered the controller's com-
plex scheme to buy out the troubled dealership af-
ter fraudulently converting close to $1 million in
company assets and inventory to his personal use.
Investigators staged a sting operation. In coop-
eration with the attorney general's office, they pOsed as investors in-
terested in the dealership. State troopers listened in to th(-
controller's conversations, sealing his fate. He was convicted and
sentenced to 15 years in state prison.
CASE no. 932
Sleuths with laptops: Robert Long (seated),
LCF president and a former detective
lieutenant in the Massachusetts state police;
Paul Byron, LCF senior vice-president.
opposing side in a civil lawsuit. However, if criminal prose-
cution occurs, the court may grant the defense attorney ac-
cess to the information even if the privileged material is
marked "attorney-client work product." In all cases, it is in
the client's best interest to maintain control of what is
turned over to the other side. Although laws vary from ju-
risdiction to jurisdiction, the client's attorney should issue a
letter to the CPA advising him or her to maintain the privi-
lege of the information. This letter should direct the C'PA to
investigate the situation and report the findings only to the
attorney, not directly to the client. In addition, any briefings
the CPA gives to top management regarding the fraud in-
vestigation's status should be done only at the attorney's di-
rection. The CPA needs to clearly mark all work papers as
"attorney work product," and should not disseminate any of
them without discus.sing the situation with the attorney.
Best evidence rule. This rule requires that if any original
dtjcunients, tor instance, invoices, receipts or checks, are
available, theynot copiesmust be used in court.
Therefore, CPAs need to either ob-
tain original documents as the investi-
gation progresses or be sure they will
be available when needed. Obviously,
these original documents must be
safeguarded.
Chain of evidence. Maintaining a
proper chain of evidence means C'PAs
need to be able to document where
all of the evidence has been at all
times and who had custody of it. For
example, if a canceled check is a criti-
cal piece of evidence, the CPA must
prepare a receipt for the person or in-
stitution from which it was obtained
indicating the time and date the
check was turned over. From this
point forward, the CPA has to keep a
detailed log of the whereabouts of the
check. If it is sent out for handwriting
Apr i l JOURNAL ACCOUNTANCY 21
CONSULTING
analysis, it must be sent by registered mail, with
the times, dates and parties involved documented.
These procedures help ensure that the evidence's
integrity will not be questioned in court.
Investigative report. One of the major purposes
ot the CPA's investigative report, in addition to
documenting the chain of evidence, is to provide
an organized presentation of the evidence collect-
ed to facilitate potential court proceedings. The
attorney can help with the report's format.
Generally the report should arrange the various
fraudulent transactions by witness and by docu-
ment. It should carefully isolate all evidence relat-
ed to a particular witness to prevent the opposing
attorney from obtaining unintended information
upon subpoena. If, for instance, the report pre-
sents evidence from two witnesses on the same
page, the opposing side s attorney gains access to
evidence from two witnesses by subpoenaing the
documentation related only to one.
O
n his graduation day from Harvard University, a popular cus-
tomer service representative (CSR) at a Boston bank walked
into his employer's office wearing his graduation cap. gown
and Harvard ring to celebrate with his fellow employees and supervi
sors. Two months later, management fired him after they caught him
making excessive calls on the bank's telephone to a (900) gambling
hot line. The bank president quickly called for an
internal audit and summoned private investigators
to look into what an ex employee with a possible
gambling habit had really been doing while working
at the bank. The auditors discovered that the CSR
had embezzled close to $1 million from the bank
and some of its elderly customers. The investiga-
tors learned that the employee had never attended Harvard and had
been working under an assumed identity: he was really a federal
fugitive wanted in both Hawaii and Utah for simitar offenses. The
Boston investigations led the bank to recover more than $350,000
in liquid and real assets and also provided key information to the FBI
that led to his arrest inwhere elseLas Vegas.
tCASEno.1039
KEEP THE CLIENT IN CONTROL
After a client and CPA have established that a fraud oc-
curred, the client's next decision is whether and when to
notify outside autliorities. (Note that in certain highly reg-
ulated industries, such as banking or insurance, statutes
may require that the client notify the proper outside au-
thorities. Some insurance policiesfor example, bonding
policiesalso may require timely notification.) This is not
to surest that the client can postpone forever dealing with
outside authorities when a suspected fraud has occurred.
However, it is usually in everyone's best interest if the
client determines the timing. Client control of both case
referral and timing is important for the following reasons:
CPAs conducting fraud investigations before notifying
outside authorities are not required to comply with the
same rules as law enforcement personnel when interview-
ing individuals. This is true because CPAs are not acting as
law enforcement personnel or, in other words, as "police
agents." For example, non-law-enforcement personnel do
not have to comply with the Miranda decision wlien inter-
viewing people. However, any statements obtained from
suspected perpetrators must be "voluntary" in order to be
admissible in court. For example, a court may rule certain
evidence inadmissible if a CPA obtained it from a suspect
who was threatened with dismissal for not providing an
honest response. On the other hand, if the CPA begins the
interview by saying, "Would you be willing to discuss the
events that have taken place?" then any incriminating evi-
dence obtained probably is admissible in court. The point
is to obtain the information on a voluntary basis.
Searches for evidence by CPAs, as opposed to law en-
forcement otTicials, generally are much simpler to carry
out. A CPA may search an employee's desk, work area or
E X E C U T I V E S U M M A R Y
AS PROFESSIONALS WHO KNOW THEIR WAY through a fi
nancial tangle. CPAs can be invaluable in a fraud investiga-
tionif they know the legal basics.
A CPA SHOULD ADVISE THE CLIENT to hire a lawyer if a
fraud is suspected specifically to establish privilege of infor-
mation. He or she should be prepared to work closely with
and forthe attorney to keep all information privileged.
A CPA ALSO NEEDS TO WORK WITH the attorney to plan
strategies, such as when to call in authorities and how to
determine venue.
WHICH PEOPLE ARE QUESTIONED and at what point in
the investigation are subject to certain important rules
CPAs need to know.
COURTS GENERALLY REQUIRE ORIGINAL DOCUMENTS.
CPAs who unearth them need to be aware of the "chain of
evidence" so opposing lawyers will not question the suitabil-
ity of the evidence.
CPAs HAVE TO KEEP IN CLOSE TOUCH with attorneys to
ensure certain reports and documents don't inadvertently
reveal too much to opposing lawyers.
CRAIG M. BEEK is manager, worldwide corporate security, at Deere & Co., Moline. Illinois. Ht- is a former director of clie Iowa
Bureau of Criminal Investigation. His e-mail address is cb]313()@deere.com. W. MAX REXROAD, Cl'A, Phi), is professor of
accounting at Illinois Statt- University. His e-niail address is \vnirexro@ilstii.edii. LINDA M. LEINICKE, CPA. PhD. is associutf
professor of accounting at Illinois State University, Normal. Her e-mail address is lin]eini(a^iistu.edu. JOYCE A, OSTKOSKY,
CPA. PhD, is associate pmfessor of Accounting at Illinois State University. Her e-nuit address isjaostro@ilstu.edu.
22 J O U R N A L o / A C C O U N T A N C Y A p r i l 1 9 9 9
CONSULTING
computer files for incriminating evidence as long as the
employee does not have a "reasonable expectation of pri-
vacy." Searches of an employees car or home are potential-
ly problematic; it's best to first obtain the employee's or
business owner's voluntary "consent." if an employee or
owner does not consent, the only other remedy is a search
warrant or subpoena. Searching an employees car or home
without consent may leave the client and the CPA open to
,\ civil suit for invasion of privacy or trespass.
A CPA can complete a great deal of investigative
work, and thus give the client a fairly clear and complete
picture of the fraud early in the process. The CPA can re-
port to theclient what took place, where it took place,
how it took pliice and who was involved, The client then
can contml the pace of the investigation to ensua^ it is con-
ducted on a timely basis. The client has the time and perti-
nent facts to develop an appropriate strategy for handling
the potential negative publicity ifthe case becomes public.
The CPA also can provide a thorough analysis of the loss,
and the chent can then decide how it wants to deal with
that loss. The client may seek financial restitution from a
bonding company or may choose to put together a civil
suit to attempt recovery. When the investigation is com-
plete, the client has all the tacts to decide how, in the best
interest of the company, the case should proceed and can
choose whether to initiate a civil lawsuit, turn the case over
for criminal pnisecution or pursue some other disposition.
Once the case is turned over for possible criminal
prosecution, the client for the most part relinquishes con-
trol. Criminal cases tend to move very slowly through the
court system.
WHEN TO CALL THE COPS
As mentioned above, once a case is turned over to outside
authorities, any additional fact-finding may have to conform
to the same rules that law enforcement officers must follow.
Therefore, the client should make it a point to inform the
CPA and anyone else involved in the investigation exacdy
when the case is to be turned over to the authorities.
Ifthe CPA has conducted a thorough and complete in-
quiry into the fraud up to that point, he or she inevitably
becomes an invaluable resotirce to the law enforcement per-
sonnel or prosecutor handling the case. In most instances,
the CPA will be required to testify in courttestimony tak-
en by deposition from witnesses normally is not acceptable
in criminal court cases. At this point, the CPA needs to in-
form the client how much more time he or she will need to
spend and how much more money it will cost the client.
D
uring the recent construction of a Midwest power plant, a tip
pointed to a possible kickback scheme between a vendor's
employees and the company's on-site construction engineer.
While the company's internal auditors examined the project's con-
tracts, expenses and cost overruns, private investigators assisted
the auditors in conducting the appropriate fieldwork and background
Investigation of the parties involved. Although the
^^jjj^jj^j^i'i i kickback allegations proved false, other serious
problems surfaced. The engineer was unlicensed
and a federal court had issued a cease-and-desist
order forbidding him from ever again representing
I himself as an engineer. The international executive
search firm that had supplied the "engineer" had
not conducted a sufficient background check. Further investigation
revealed that the engineer's chief assistant wasn't an engineer ei-
ther, but a former police officer who had been dismissed from the
department for criminal conduct. The plant had to be shut down for
testing, which revealed shoddy welds, poor pipe fittings and poten-
tially dangerous construction techniques.
CPA WITH A BADGE?
It is of utmost importance
that the C'PA understand
the significance of the po-
lice agent issue. P^emember,
the rules of the game
change after notifying law
enforcement. Therefore, a
CPA who takes work direc-
tions from law enforcement
personnel can easily be con-
sidered a "police agent." As
such, the CPA must follow
all the same evidence-gath-
ering rules as the police.
From jurisdiction to j u-
risdiction, courts have ruled
difterendy on exactly when
a non-law-enforcement
person becomes a police
agent. Nonetheless, once a case is turned over to civil au-
thorities, any additional fact-finding by the CPA may have
to conform to the same rules that law enforcement officers
must follow. An exampleof particular interest to ("PAs
involves the gathering of business documents. Before out-
side authorities are notified, the client's work
policies may allow the CPA access to suspected
fraud perpetrators' desks, company files and
records, as well as any other company resources on
company property under the perpetrators' control.
However, once the case has been turned over,
search warrants or subpoenas may be necessary to
gain access to those same items.
For More Infomiation
The AlCV^A has courses
and publications on fraud.
Se.iR li oTi keyword "fnuid" at
www.aicpa.org for a list as
well as links to ASB references
and other resources.
The Association of
Certified Fnuitf Fi.\Liniincrs h,is
helpful nuiteri.i! oiihno
(www.cfenet.com) .is well js
inforiuntion on conferences.
The American Society for
Industrial Security', with more
than 3().(H)0 nienibers. offers
help on sfcurily in,in:iL;cint'nt.
Go to www.asisonline.org.
iCASEno.1362
KNOW BEFORE YOU GO
If any profession knows about following rules, it's
the CPA profession. The AIC:PA, FASB, SEC,
ASB and IRS all govern a C^'A's professional life.
And CPAs, like police officers, get their authority
from the state. Also, no professional knows more
about taking care of a client than an accountant in
public practiceit's a CPA's badge of honor. The
fraud investigation brings these two skillsfollow-
ing the rules and working with the clientinto a
new arena. The successful practitioner will keep in
close touch with client and lawyer to help recover
the cash and put the felons behind bars.
Apri l \9<i'i JOURNAL 0/ ACCOUNTANCY 23