Fraud Advisory Services

A forensic accountant is an expert accountantand business advisor that is asked by one party in a dispute to provide clarification and opinion concerning the issues being debated. There are a wide range of circumstances that can involve the need for forensic accountants. These can range from valuing assets for one or both parties in a matrimonial dispute in order that a division of wealth can be made, to establishing how much profit has been lost as a result of a factory stoppage that is being blamed on another party. Quantification of damages or losses is a big part of a forensic accountant’s work.

One of the main branches of forensic accounting involves fraud. Indeed the general public often associate one with the other. Fraud by its very nature involves some form of accounting annomoly or financial deceit. It is the manipulation of accounting records to hide the theft. As such, one of the most important persons needed to investigate and deal with fraud is the expert accountant.

It is the financial and business expert that is able to recognise the fraud, the reasons it was possible to commit and the route the losses have taken leaving the victim company. It is this forensic accountant who traces these losses and demonstrates the ultimate destination by analysing bank statements and other financial records when “following the money”. It is arguably the most important part of the fraud investigation because without it interviewing suspects or gathering evidence does not have a focus.

When confronted with a new case, the forensic accountant does not have a set procedure. Every fraud is different, it is the unusual and new loophole that every fraudster is seeking in order to surprise an organisation that thought it had covered all the bases. The money trail is the starting point and establishing how the losses occured and how much has been stolen is the first task.

The forensic accountant may enlist the help of competent accountants to analyse bank statements. He or she may even use an organisation’s own resources. Often accounting software is utilised to make the trepetitive tasks easier, such as IDEA for Windows or Altia statement analysis software.

It is the interpretation of results and provision of opinion wher the forensic skills are mostly brought into play. An opinion may have to be supported when under cross examination and the other party is not going to simply accept one persons say so. It can be very lonely in the witness box for a forensic accountant!

(This newsletter is circulated in hard copy format around solicitors and baristers throughout the UK)

Welcome to the second edition of “Fraud Briefing” this year.  Following positive feedback gratefully received from many of you, I am now planning to publish this newsletter every two or three months. Given the vagrancies of the postal system and a recent flurry of new cases I have decided to send this one out in good time and apologise if this festive edition reaches you before the season begins.

New cases picked up recently include old favourites of criminal defence frauds, money laundering indictments and Proceeds of Crime confiscations, but I was glad to get the opportunity to work on another Ponzi based scam. This time my interesting task is to look at the professional involvement of an accountant providing services to the investment fraudsters. I also seem to be receiving a few enquiries with an international flavour, possibly because I have put in more commitment to my Internet marketing through technical article writing?

Insolvency cases – when will the floodgates open?

One recent approach from an individual residing in the Far East has now turned into an investigation into a “pre-pack” administration in the UK. Pre-packs have been the subject of much criticism, being a process with little regulation and making it far too easy to establish a “phoenix” company when businesses fall on hard times. I understand that such has been the public complaint that the Insolvency Service carried out a review of the 572 pre-packs that took place in the first six months of 2009. It is astonishing to learn that 35% of these did not comply with government legislation and that 17 were deemed serious enough to be referred for full investigation.

My source in the Insolvency Service tells me that  the typical problems being seen are when a company diverts its trade and debtors elsewhere in order to demonstrate insolvency. Then the administrator is astonished to find that the company that he sold the business assets to is suddenly being managed by the same directors as before.

It is still asset stripping…the diversion of trade prior to a pre-pack seems to continue the theme that I discussed in my previous newsletter. Is there no end to the methods devised by the fraudsters for obtaining value from a business and then leaving the creditors to pick up the pieces?

The future of criminal defence under threat?

I don’t want to be alarmist or jump the gun, but the intention of the Legal Services Commission to reduce expert fees in criminal defence cases by 20% has given me a number of sleepless nights over the past two months.  I have always prided myself on managing a broad portfolio of fraud related assignments, from investigating fraud, asset recovery and assisting the regulators to providing expert accounting witness services to the defence team in criminal fraud and proceeds of crime cases.

In most areas of my work each new assignment brings different issues and varied circumstances in which fraud has occurred.  However in criminal defence work a pattern really does emerge and “practice” definitely does make perfect.  Having worked as an expert in criminal defence matters for many years now I like to think that my approach has become efficient and most certainly cost effective as far as LSC funding is concerned.  It does seem rather a shame that they are now threatening to make good on their proposals originally aired in a consultation five years ago and currently being discussed again – that defence experts are paid at rates commensurate with  prosecution costs or more aptly…public sector pay scales.  This is a ridiculous hypothesis and a couple of objections (I know there are many more) spring to mind:

• The Government fraud regulators, prosecutors and the LSC have all seen fit to waste astonishing sums of money on pursuing certain headline causes when the political will has been there and then complain that they do not have enough to manage their day to day business – think of the £15 million Rover investigation, £60 million for the London Underground fiasco…; and
• The rates they are proposing are more likely to be in line with public sector remuneration levels, yet we do not have a guaranteed pension, secure job and flexible hours that might make the low rates more bearable.

I am sure we will all muddle through.  It may be that the poorer criminals will not have the access to justice that they have enjoyed in the past.  It may be that sophisticated fraudsters will be able to fund their high quality defence and the less successful criminals take what they are given. 

What will the New Year hold?

We wait to see what will happen with expert funding as we do with all the other areas of public sector funding cuts.  In the meantime it has to be business as usual.  I believe that I am in a position to continue to give personal and efficient attention to criminal defence cases, small and large, with an experienced team of criminal defence forensic accountants behind me.  I will also be looking to that area of expertise that gives me much satisfaction – recovering assets in insolvencies.  This I feel will become  hot topic soon as I do get the feeling that there is a huge volume of businesses teetering on the brink – despite the ever hopeful claims of being out of the depression/recession. 

Corporate asset stripping will continue to keep me occupied it seems, and as the world shrinks and the Internet grows I am alert to the possibility that more and more of my work will involve telephone calls in the middle of the night from different time zones.  Fortunately there is less likelihood of foreign travel now given the ease with which we can communicate – but I am having to brush up on my “KYC” due diligence procedures!

I wish you a Merry Christmas and a Happy New Year.

Mark Jenner

If an employee steals from the organisation he or she is working for there are a number of ways in which this can be dealt with. The decision will no doubt be based on the organisation’s fraud policy and what it wants to achieve. Does it want its money back, to sack the fraudster or to make a public example of the issue? The alternatives include:

• Reporting the employee to the police – the police may or may not be interested. If they are – they may investigate. If they do, this can be disruptive to the business. Often however, given the shortage of police fraud investigation resources the response to a fraud report may well be a request to provide comprehensive details of the occurrence i.e. effectively to go and investigate the fraud yourselves!
• Commencing some form of disciplinary action in order to safely remove the fraudster from the business. This has to be done with care because inappropriate treatment of staff can lead to claims for unfair dismissal or constructive dismissal – even by the guilty fraudster!
• To investigate the fraud using internal or external resources with the view to instigating some form of civil litigation for recovery of the losses due to fraud.

Very often, however, an organisation will do none of the above! They will let the perpetrator go with a reference on the understanding that this is the end of the matter. Incredible though it seems, this is exactly what some major financial institutions or publicly listed companies will do. Not wanting any publicity to impact share prices perhaps, they prefer to hush the matter up!

I am aware of one major building society turned bank that caught one of its employees recently having fraudulently obtained substantial loans and conducted a preliminary investigation. Then they simply asked the person to leave. Around a month later it emerged that the person was working nearby, in one of the UK’s largest credit card insurance providers!

The fraudster was able to obtain another sensitive position, obviously with the assistance of a reference from its former employer. This is irresponsible action by the bank, as it sends out a strong message to would-be fraudsters that it is possible to get away with it. It flies in the face of all fraud prevention efforts being preached by the regulators, various fraud fora and even by fraud experts like myself. How can we combat fraud, if we do not deal with it fully when discovered?

The recent news that a number of T Mobile employees were selling customers details to competitors shows how lenient penalties can encourage fraud and theft. In this case we have the Information Commissioner complaining that the maximum fine of £5,000 from the Magistrates Court is unlikely to be reached, and that harsher penalties should be available to deter this activity. Why do we not simply prosecute – it is theft after all!

The Ponzi fraud is a classic example of an investment fraud. It dates back to early last century when Charles Ponzi made the idea of camming investors by using their own funds to pay interest, famous. I am willing to bet that he was not the first to see the potential in dishonestly circulating capital funds to increase income in an investment fraud.

The trouble is, the very principle underling the Ponzi investment fraud also underpins the fundamental concept of banking. If you go into you local branch of Barclays you can pay £500 into your savings account. The, somebody else in the que behind you might ask to make a £500 withdrawal. Your £500 is given to this other person. Don’t worry, your account shows another £500 has been added whereas the other person’s will show a withdrawal. But the point is that a bank does not have enough funds to cover everything invested. Typically it will lend out a multiple of the liquid funds its holds in the expectation that it will never be called upon to repay all its investors at one time (i.e. a run on the bank).

This is the same principle used by the Ponzi investment scam, the only difference being is that a bank aims to make a profit with the money invested by, in turn, investing the money itself at a higher rate than it is paying out to its customers. It is effectively making a margin between the rate it borrows at and the rate it lends. It is supposedly a commercial proposition. The true Ponzi scheme will not be interested in making a profit from such “buying and selling” of funds. It will be simply looking for as many people to invest as it can, and keeping those investors happy by returning some of their capital to them every now and again as “interest”. So long as too many people do not want to make withdrawals and the message of high returns perculates to the investor population, more funds will come in than are going out – yet no real investment activity will be going on.

There are shades of grey of course – wher we get the investment fund that opperates like a Ponzi but tries to invest the funds. Perhaps it is investing in a bigger Ponzi scam itself, expecting a return on its own investment. Perhaps it is simply making poor investment decisions (shades of the Credit Crunch!) and is having to repay its own investors out of capital. There are so many similarities between the way the mainstream banking sector was opperating during the times of high credit availablity and Ponzi scams that the general public have a right to be angry at the scale of the banking sector’s bonuses.

Every year we hear of new Ponzi scams that have come to light, perhaps when the schemes begin to crumble when more than just a few investors want their capital back. The biggest recently was the Madhoff affair involving billions of dollars and pounds that had supposedly been invested for lucrative rates of return. But is you check the news archives, fraud blogs and other reports you will see that there are dozens of these scams emerging every year.

Last year I worked on a reasonably large case that had been brought by the Serious Fraud Office in the UK against a couple of businessmen based in the Midlands. This case has been reported in the press and involves around $200 million of investors funds that the authorities say were invested by UK victims who, once the scheme folded, lost their money.

The UK arm of the alleged Ponzi fraud was part of a much larger investment scheme being headed by somebody in the USA – which had already led to a plea bargain situation. Of course pleading guilty gave the UK perpetrators little chance of repreive – yet they had believed that the USA arm was going to repay them with interest. Gullible perhaps, criminal…maybe.  At the time I remember doing a bit of research on Ponzi frauds and being amazed about the number of current cases that were being investigated or being dealt with by the courts!

Now I am faced with yet another case this week where I am asked to look at the professional conduct of an accountant recruited by the opperators of an investment fund. If the fund was a Ponzi, should the professional have known about it and reported under Money Laundering Regulations to the Serious and Organised Crime Agency in the UK? Should he have known that funds he was holding were proceeds of crime?

I am not in a position to report about this at present as it is sub-judicae - however we have what looks like another Ponzi scheme. Effectively we have a large number of ostensibly rich investors looking for a larger return than expected from a bank or other mainstream investment opportunity. Why do people keep on investing in such a way. Promises of several % interest each month abound and it is not easy to see why people do not approach these investment opportunities with more caution. Do people never learn?

The problem is of course, these High Yield Investment opportunities are indeed based on a shred of truth. There is a backbone of legitimacy behind the very idea that you can find investment opportunities offering higher returns than other more recognised sources such as the banks. It is this very element of secrecy and intrigue I believe that encourages the unwary to fall for the scams! Whereas there might have been, and some say still are, high yielding returns to be made for massive investments used effectively as global hedge funds by a number of altruistic and very rich organisations and individuals – these are likely to spawn glamourous tales of rich pickings to be had even when they do not exist anymore.

Remember, the UK and USA have injected trillions into the economy over the last year or so – have you ever wondered how much back room/under the table dealing has gone on around these incomprehensible figures?

The trouble is that if the climate is ripe for such massive movements of money then the fraudsters see the opportunity to start weaving their spells again! It is a setting for even more Ponzi scams to be generated.

There is a lot of ground to cover with the subject of investment fraud, so in order to provide an informative guide to such schemes and what to watch out for I am splitting the subject into the following:

• Ponzi schemes – any basis for the hysteria?
• How a Ponzi scheme works
• Characteristics of a Ponzi schem to look out for
• How great is the Investment Scam market?

As a forensic accountant and fraud investigator, a scam such as a Ponzi fraud is a classic example to me of the reason why fraud flourishes. Ask yourself if greed might have something to do with it – of the fraudsters and the victims alike!

For those of you that read my fraud investigators diary blog I will be announcing these articles over the next week – otherwise please leave a comment or trackback if you would like to receive notification of this research (no repeat email spam will be sent).

Consider the situation where a company begins to struggle in a harsh economic climate. It finds it harder and harder to pay its suppliers as promptly as usual. However, the suppliers are struggling themselves, and allow the additional credit that is being taken as they are desperate for sales. Eventually after a few months, with huge debts mounting up, the directors of the company decide to fold. They transfer the business to another with a similar name and inform all its customers of the changes. A “phoenix” company arises out of the ashes without the burden of its previous debts and continues to trade successfully. This is the basis for many a fraud that has been investigated over the years but it is astonishing to discover that there is also a completely legal process that, if carefully followed, can allow this very course of action!

Around fifteen years ago a colleague and friend of mine started his own business growing mussels in the west coast of Scotland. The early years of such a business venture can be more fraught with problems than others. Dealing with livestock and the vagrancies of the Scottish climate meant that he faced one major problem after another. He had to deal with difficulties in obtaining the young mussels to grow on, attacks by predators wanting to eat his crop, solving design problems with his equipment, problems with security and trouble with harvesting the final product. Solving each of these problems in turn cost a great deal of money, which he borrowed from various sources including the bank, from his family and from the government. He managed to find solutions to all his problems and eventually after two or three years had a healthy core business up and running. However, by this time his debts had grown to such a level that the business was no longer viable. He sought insolvency advice and ended up having a receiver appointed over his business. He was then able to buy back his business assets from the insolvent estate and continue his business debt free. He currently runs a successful business, yet the original unsecured creditors were never paid.

This was well over a decade ago, and was always an area of the insolvency process that raised criticism with its commentators. However, the Enterprise Act 2002 introduced an even faster process known as “administration” that was easier and cheaper to implement. Unlike the process used by my friend, it did not need the approval of the courts to ensure any deal being done was fair. The process has been termed a “pre-pack” and allows a phoenix company to arise using the assets of a failing company and trade, often using the same or similar name as before and the same directors to run it.

The way in which a pre-pack works in practice involves a secured creditor, the directors or owners of the company arranging with an insolvency practitioner to sell the assets of the business before it is placed into administration. Then, when the administrator is officially appointed, the sale of the business is a “done deal”. There is no requirement for the business to be marketed externally and only a reasonable expectation that a fair price is received. The unsecured creditors may receive nothing after those having security are paid.

There is a great deal of criticism surrounding pre-packs because they allow an administrator to wipe the debts of a distressed business and sell it on quickly to the previous owners. The Insolvency Service, the government agency that is supposed to ensure that administration procedures  operate within the legislative framework of the Insolvency Act 1986 and Enterprise Act 2002, has recognised the vulnerability of the system to abuse and introduced additional guidelines in January 2009 by way of Statement of Insolvency Practice 16 to force insolvency practitioners to disclose more information to all creditors. Even so, figures they released recently show that in the first 6 months of 2009 some 35% of the 572 pre-pack processes commenced showed compliance failures and of these 17 cases are currently being investigated for serious anomalies.

Clothing retailer USC was bought back by its owner Sir Tom Hunter out of administration, by purchasing 43 of the 58 outlets. Chief executive of the Officers Club David Charlton bought 118 of the 150 failing menswear stores. The coffee dealership chain Wittard and furniture retailer MFI were also both recent subjects of pre-pack buy backs. It is true to say that the previous owners or directors are allowed to cherry pick the best bits and start again debt free. However, in support of the process the object of finding the best way of realising the value of an insolvent and failed business without negative publicity is often achieved. The goodwill and jobs of the workers are preserved and the whole process of the insolvency is usually quick and efficient.

The insolvency arena will always be a rich picking ground for the fraud investigator. In many cases it is simply because that is the time when the inner workings of a company y are laid bare for external scrutiny. However, in the case of the pre-pack process there may be a fine line between it being the best rescue package for a failing business and fraudulent trading to remove the full value of business assets from the hands of the disadvantaged creditors. It is likely that this process will throw up a number of incidents of fraudulent behaviour for the investigators over the coming months and years.

Mark Jenner writes a fraud and forensic accounting related blog that looks at the nuts and bolts of some of the investigation areas and fraud issues that he covers from day to day.

The need for proper research when seeking a part time business idea from the Internet is  is essential if fraud is to be avoided. No retailer would buy a new business premises or shop without spending £1000s on due diligence investigations. He would get a survey, look at any accounting records for previous businesses and do a business plan based on the research done. Why should you invest time and money trying to start a new business working for yourself without doing the same?
There is no need to spend money employing somebody else to investigate, but there are a lot of simple steps you can take. Here are three of the most basic:

• First – read as much as you can on the subject. You can never do enough research. You will soon realise if a business idea is a scam or fraud. What you want to know is not only will it work, but will it work for you. The research may include surfing the net of course, but look for solid and respectable publications you can pour through. Have one on your bedside with a pack of post its for interesting snippets or chapters. Have a trade journal, print off reports – don’t just rely on marketing hype from your surfing!
• Secondly – once you have ascertained that there is a viable business idea, jot some numbers down. You dont have to be an accountant to see if the business is viable. There is no use paying say £500 for start up costs, having £100 going out every month and spending 10 hours a week on a part time business to make £200 per month. Yes it would pay for itself but is it really worth it. You might have £700 in the bank at the end of the year – on which you ought to be paying tax at your full rate. If it was just a part time business to earn some extra cash, 10 hours a week work for a £10 per week cash return is not great! Often the numbers look ok till you set them out in black and white.
• Thirdly – decide if the particular business is for you. For example Internet Marketing can work if you get it right – but only if you learn, learn, learn about the business and then are able to churn out several 100,000 words of articles every year. Can you learn about a complex subject and then have you the patience to write? – If you can say yes to both, then as the “blurb” says you can build a useful business that needs little maintenance.

As a fraud investigator I see a lot of business opportunities that are clearly frauds and some that simply need a lot of hard graft. I am looking at as many as I can on my dedicated web site to investigate which have potential and which are scams. Read about my daily approach to fraud on my investigators diary blog.

There is no doubt of the commitment of the present UK Labour Government to the Proceeds of Crime Act 2002 and its intended use to cripple organised and career criminals. It has been applied in the field now for a number of years and is becoming a routine process in many cases.

So routine in fact that prosecutors do not bother to prepare a comprehensive Section 16 Statement anymore it seems! The Section 16 Statement are statements of information that provide the reasons, but not necessarily the evidence, for applying criminal lifestyle assumptions to a defendant’s assets. The Statement will set out the level of criminal benefit based on the crimes that have been committed and on the assumptions that other activities are also criminal. The Statement may also indicate the assets that the defendant has to satisfy any confiscation order and even give an indication, again not necessarily with evidence, of any assets thought to be hidden away.

With such a broad remit for indicating what is benefit and what may be available as realisable assets to satisfy the order it is clear that the prosecutors are simply setting out some of the information they have, regarding the defendant. This is on the basis that are adequately covering the likely scale of any order. In effect they are seeking to do enough to ensure that the defendant loses all he has, but are not bothering to be comprehensive in their approach.

This approach does happen in practice. Unfortunately, although it may deliver draconian but possible deserved justice for some, it creates a somewhat unfair situation for other defendants. For example take the case where a defendant has been convicted of trafficking drugs, has not kept details of any financial transactions and in all likelihood has not paid any tax on any legitimate work he has been undertaking as a cover for his drug dealing. If only one or two of the defendant’s bank accounts are analyzed and demonstrate adequate transactions to ensure the ensuing confiscation order is large enough, then the defendant will lose everything and no doubt the prosecution will argue justice has been served.

Compare the last case to another, where a businessman has been caught defrauding his employer by substantially inflating his corporate expense account for a number of months running, by several £1000s. He is caught, convicted and must serve a prison sentence as punishment for theft. Of course he will also have to pay back the money though subsequent confiscation proceedings. If he is technically deemed to have a criminal lifestyle, the prosecutor will throw the book at him, preparing a Section 16 Statement that will seek recovery of not only the money that he stole, but everything he owns and ever transacted going back 6 years. When all the receipts into the bank accounts over 6 years are totted up, this “benefit from general criminal conduct” can reach huge sums. The scale of such an assumed level of benefit, if awarded against the defendant as a confiscation order, can never be paid back. The unfortunate defendant would have to serve a default sentence having more years added to his original penalty.

Of course it is possible to defend such a situation. The defendant’s legal team would realise that whereas it would be necessary to repay the level of money stolen, it would be somewhat unfair to have to repay income earned legitimately over recent years. This is what an uncontested confiscation order would involve in such a case. Therefore, the defence must show to a civil standard of proof that his income other than the actual proceeds of crime was from legitimate sources.

This is where the forensic accountant would be called in. He will examine the Section 16 Statement together with all the defendant’s financial evidence (such as bank statements, business records etc) and demonstrate the legitimate nature of the income. This usually means that he must go further than the prosecutor because he will need to undertake a comprehensive review of everything – it is up to the defence to demonstrate the legitimacy of income or assets. To do this may mean examining accounts that the prosecutor has not bothered with, to show the source of all inter company transfers for example.

The big problem arises because the public funding of such cases is under threat. The public sector is having its budgets cut drastically by the Government in an attempt to redress the fiscal measures put in place to counter the pressure on banks over the past year or so. As an example the Legal Services Commission is losing some 5% of its current annual operating budget. It is reducing its spend on expert witnesses, i.e. the including the forensic accountants, by a disproportionately large amount – 20%. This is around £20 million less being spent on defence experts in the coming year.

The mechanics for doing this are being proposed in a current consultation paper regarding levels of experts’ fees. It is proposed that a forensic accountant will be paid between £47 to £100 per hour with the upper rate unlikely to be ever paid. For those that think that £100 per hour is a lot, remember this is the total cost – out of which must be paid pension, sickness, disbursements and the high cost of running a business. To put the rate into comparison, my work for my Masters Degree in Fraud Management showed that the average cost of a forensic accountant and of a police officer or member of the Court (clerk/manager etc) or of the Criminal Prosecution Service were broadly comparable. In fact the cost of putting an officer on the beat is a lot more than £100 per hour, let alone the cost of a detective in an economic crime unit.

If a well trained and experienced forensic accountant were to be paid £100 (assuming he or she can achieve this top rate) then they would be unable to remain in even a small firm of accountants as they would be unable to earn enough to fund their firm’s overheads. There is evidence that the Legal Services Commission see the solution as forcing the forensic accounting services into the hands of retired practitioners and “one man bands” who can survive (albeit barely) on the rates that are proposed. In a previous consultation paper about four years ago this very outcome was mooted as the way forward. At that time all that came out of the consultation perhaps was more determination by the public sector funding body to restrict and delay payments for experts.

As a fraud investigator who occasionally accepts the opportunity to tender for a white collar criminal defence case, I am finding that I no longer achieve the already low hourly rates I was using 10 years ago. Not only that, but many other forensic accountants who previously specialised in other areas such as business valuation and matrimonial disputes and turned their noses up at criminal defence work, are forgetting their scruples and tendering against those of us that have been carrying out the work for many years. When I do win work, I am not able to undertake such a broad review as in the past or undertake a fishing type investigation to see where an evidential trail leads, which may mean that aspects of a defence may be missed or at least not be as robust as they should.

The question being asked is where will it all lead? Will the good forensic accountants get priced out of the market? It is unlikely that they will leave regular employment in their droves to set up the sole practitioner firms envisaged by the Legal Services Commission. Will the mid tier and top tier firms return to their previous position of disdain for criminal defence work – finally being priced out the market completely? Will the white collar worker who gets caught with his hands in the till be able to defend himself from a totally unfair confiscation order?

Personally I see my work on criminal defence cases over the past decade or more being valuable experience. As an expert accountant specialising in fraud it would be hard to achieve the desired level of credibility before a court if all I had done is investigate and prosecute fraud. So now even if I focus more on catching the fraudster, defending a business against fraud and recovering stolen assets, when called to give evidence I can still draw on my past experience of criminal defence work when establishing my independence before the court.