Dawn of the Forensic Accountant
Bernie Madoff, 150 years. Dennis Kozlowski, 25 years. Bernard Ebbers, 25 years. Jeffrey Skilling, 14 years. Walter Forbes, 12 years.
Dozens of top executives are now serving prison terms for fraud, insider trading, misappropriation, and other financial crimes, while investors and employees have lost billions of dollars in stock and savings as the schemes have surfaced.
A slew of financial scandals over the past two decades has prompted a flurry of accounting regulations, from the Sarbanes-Oxley Act of 2002 to the Dodd-Frank Wall Street Reform and Consumer Protection Act, as well as an increasing interest in the industry that uncovers such financial crimes: forensic accounting.
“Everyone seems to be paying attention,” said Casey Evans, an executive-in-residence who led the team of investigators and forensic accountants looking into Bernard L. Madoff Investment Securities.
But first, there was Enron Corp. And Tyco. And WorldCom. And Adelphia.
The companies that had once looked so prom- ising on paper, reporting billions of dollars in earn- ings, began to unravel upon closer examination in the late 1990s and early 2000s.
“The bubble started to burst, and frauds were exposed,” Evans said.
And Enron was the star of the show. Executives at the energy company used illicit business deals and accounting loopholes to misrepresent earnings and grow the company into an enterprise reportedly worth more than $60 billion in 2000.
“That was really just the culture of the time,” Evans said. “Because we didn’t have strong regula- tion at the time, companies could operate in a very, very gray area of accounting.”
But by fall 2001, the Securities and Exchange Commission had launched an investigation into Enron; as the massive accounting fraud was discov- ered, the company declared bankruptcy. More than 5,000 employees lost jobs and $2 billion in pensions when Enron collapsed.
Similar fraud surfaced in 2002, again resulting in bankruptcy—this time of WorldCom, which once reported $103.9 billion in assets. Also in 2002, Adelphia, once the fifth-largest cable provider in the United States, declared bankruptcy after former CEO John Rigas and his two sons misused corporate funds and hid billions in loans and debt.
Tyco International managed to avoid bankruptcy that year after CEO Dennis Kozlowski and CFO Mark Swartz received more than $150 million in unearned bonuses and loans from the company for six years.
So regulations were created.
The Sarbanes-Oxley Act (SOX), enacted in July 2002, was a direct reaction to the corporate accounting and fraud scandals that resulted in billions of investor losses and shook public confi- dence. The act aims to protect investors from future fraudulent accounting by corporations, mandating strict disclosure procedures.
Under the law, senior management officials must certify that financial statements are accurate and, along with auditors, establish internal controls and reporting methods.
The act also set penalties for those who know- ingly certify inaccurate financial statements or try to retaliate against whistleblowers, and it created the Public Company Accounting Oversight Board (PCAOB) to oversee the auditors of public companies.
“[It] forced companies to pay a lot more atten- tion to financial fraud,” Evans said.
Regulation was added again in 2010 under the Dodd-Frank Wall Street Reform and Consumer Protection Act. Though the law’s primary intent is to prevent the risk taking and predatory lending that led to the recent financial crisis, it also addresses regulation by the SEC in light of Madoff’s $65 billion, decades-long Ponzi scheme.
The SEC investigated Madoff’s company several times but never detected the largest fraud ever by an individual, which had ensnared charities, celebrities, and Nobel Peace Prize laureate Elie Wiesel alike. Title IX of the Dodd-Frank Act now requires that all auditors of registered broker-dealers be regulated by the PCAOB, unlike the two-person unregulated company that audited Madoff’s firm.
As with all regulation, there are increased costs. Evans acknowledged that SOX can be time-consuming and costly for a company, as it requires reviews of internals controls and examining “every step” of the accounting process “by people who usually have other jobs to do.” But the act, she said, also leaves less room for manipulation.
Increased regulations have led to a surge in the forensic accounting industry. The big accounting scandals of the past two decades were just the tip of the iceberg: according to Evans, there have been hundreds of cases since Enron.
“You’d probably be hard pressed to find a company that doesn’t have problems,” she said. That’s why lawyers, government agencies, and companies themselves have hired forensic accountants to investigate and prevent potential fraud, bribery, and other financial malfeasance.
In some cases, these companies were victims of fraud at the hands of their employees. In others, top-level managers were scamming board members, the public, or their own employees. Some companies seek to prevent violations and preemptively search for wrongdoing.
Forensic accountants can also testify as expert witnesses, explaining their interpretation of financial evidence as a lawyer makes a case in court.
They often work for the Big Four accounting firms—PricewaterhouseCoopers, Ernst & Young, KPMG, and Deloitte; for consulting firms such as RGL Forensics; for companies as internal auditors; or for government agencies like the FBI, the SEC, and the Consumer Financial Protection Bureau.
Though the work forensic accountants does appear similar to that of auditors, there are some notable differences.
Auditors provide an opinion on whether records are free from material weaknesses, covering every- thing under a broader focus on the company’s finan- cial situation. They typically do the same review of the same company every year, and often work openly with the company.
Forensic accountants “find the needle in the haystack,” Evans said, often looking at one account, for example, where fraud may have occurred. They also have no prior experience with the company and tend to keep a low profile so as not to scare employees into tampering with evidence.
Chelsey Fekishazy, BSBA ’08/MSA ’09, discovered that her background as an auditor was helpful in her new role as a forensic accountant. Fekishazy, who has been working as a forensic accountant at FTI Consulting for about a year, said it’s now second nature for her to make sure the proper controls are in place when she is investigating potential wrongdoing.
As the forensic accounting industry has expanded, so too has the need for qualified employees. Kogod’s new graduate certificate in forensic accounting, led by Evans, seeks to address that need and prepare professionals for the growing field.
A forensic accountant’s investigation process typically goes like this:
An attorney or a company hires forensic accoun- tants and gives them an overview of the situation. The team gathers emails, documents, accounting books, bank statements—any and all paper and electronic records—usually with the help of technical professionals.
The team then reviews the data and interviews employees to begin putting together the story and filling in gaps.
Usually the interviews are conducted in a board- room—not like the interrogation rooms seen on TV, Evans said—while lawyers for both sides are present.
And sometimes there’s a language barrier.
Fekishazy recently traveled to Kraków, Poland, to look into a possible violation of the Foreign Corrupt Practices Act of 1977. A subsidiary was being investigated for possibly bribing Polish groups to obtain contracts, which would violate the law.
Fekishazy spent her time looking through paper copies of five-year-old receipts, books, and other paper documents—all in Polish.
A Polish lawyer translated as many of the documents as possible, though the investigators had Google Translate open the entire trip, Fekishazy said.
To get through the building, the subsidiary’s employees had to walk through the room where the four investigators sat, “which made things a little bit awkward,” Fekishazy said. “You need to get comfortable with being uncomfortable.”
Investigations often take years. Evans worked on the Madoff case for about three years, spending six months alone in the company’s office, reviewing documents, analyzing records, and working with lawyers for the trustee and the FBI to put the story together.
Evidence of potential wrongdoing can be anything from questionable records to a text message, Evans said. Emails and handwritten notes have often been key triggers. “You’d be surprised by what people put in email—still.”
When Evans was a fairly green forensic accountant, working at a small accounting firm in Tennessee, she discovered an email that helped move a fraud case forward. A message from the controller told the accountant to book revenue in the wrong period. “For me, it was a big find within an investigation,” Evans said. “When you find little nuggets like that, it helps build the case.”
Sometimes it can be an employee that tips off investigators. Uuljan Djangazieva, BSBA ’11, is a forensic associate at KPMG. She helped investigate a US subsidiary of a manufacturing company that allegedly stole $18 million over 17 years. The parent company, based in the United Kingdom, hired the firm to investigate the subsidiary before an upcoming shareholders meeting.
The subsidiary was buying contracts “like mail-in rebates,” receiving double the refund, Djangazieva said. The company had two sets of accounting books and an employee whose entire job consisted of tweaking records and removing refunds and kickback—an obvious red flag for Djangazieva.
Proof of wrongdoing came primarily from interviews, she said, and the chief financial officer seemed almost proud of being able to keep up the game for 17 years. “It was part of the corporate culture of that company,” Djangazieva explained. “Everybody was like, ‘Wait, it’s not OK to do that?’”
In Evans’s view, the newer regulations, with newer rules to break, will likely prompt a flurry of cases in the coming years—including those brought under Dodd-Frank.
Heightened awareness isn’t established over-night, nor are the results and penalties of fraudulent accounting. “It takes a little while for rules to get put in place—and also to get broken,” Evans said.
Though the industry is waiting for cases to catch up with regulations, Fekishazy doesn’t worry about its potential. “There’s always fraud,” she said. “Always.”