Case studies: Forensic Accounting
#1: Collusion and Fraud to Attract Business Investors
Summary of issue: Chris Hamilton Forensics was retained to quantify the effect of an alleged fraud and breach of contract. The organizers of a new business made multiple and extensive representations about intellectual property that was owned by the business and the prospects of converting that ownership into rather healthy cash flows in the future. Our client was persuaded to invest hundreds of thousands of dollars in stock and then, in subsequent years, over a million more dollars in the form of loans. The loans were convertible to equity.
In the course of attracting investors, the defendants presented an image of success and a high profile celebrity presence. A valuation firm was even retained that opined in writing that the business was worth more than $20,000,000. All of this masked the reality that the business never made a profit. In fact most, if not all, of the revenue was simply business diverted from another business controlled by one of the defendants. The intellectual property that was the basis for the entire business venture was owned by some of the defendants – but not the business that was issuing stock and borrowing money.
Chris Hamilton Forensics work: Our initial involvement was to re-create accounting records and attempt to identify a pattern of transactions that would suggest or support a case of collusion and fraud. Because of the financial constraints our work was very targeted and limited. Our work was used to support and assist the work of the team of lawyers in depositions, interrogatories, and other discovery. Our work was also useful in identifying the realizable value of the funds loaned to the business. We also calculated the value of the business for purposes of determining the value of the equity investments of the plaintiffs. Needless to say, the value of the debt and equity was zero.
Result: A jury trial was held. Chris Hamilton Forensics presented testimony at trial that was focused mostly on the valuation of a business and, more specifically, intellectual property. The trial lasted several days and the jury came back with verdicts for the plaintiffs.
#2: Embezzlement – What the Auditors Could Not Find!
Type of Matter: The Board of Directors and senior management of a large company with several divisions began to suspect that a division controller was embezzling significant amounts of cash. They initially brought in the outside auditors to review bank reconciliations and other reporting for the division. The company spent material amounts of money for up to 6 staff members from the outside audit firm reviewing bank reconciliations for over a week. The Board members began to get uncomfortable with the results of that review and decided they needed a focused fraud examination and called Chris Hamilton Forensics.
Chris Hamilton Forensics Work: At the initial meeting with Chris Hamilton Forensics, the bank reconciliations were specifically excluded from the work scope approved for Chris Hamilton Forensics. While this was understandable due to the enormous cost of reviewing them already, it became a point of significant contention. Ultimately, we refused to take the engagement unless we were allowed to review the bank reconciliations – essentially covering the same territory as the outside audit firm. Either the reconciliations accurately reflected the activity in the accounts or they were being fabricated to hide illicit activity. Either way, it was the logical starting point.
Once we were authorized to review the bank reconciliations we began work. On the first day it was determined that the reconciliations were indeed problematic. What became apparent very quickly was that the beginning cash balance on any given reconciliation did not agree with the prior month’s ending cash balance. The client was relieved that it did not require a week of Chris Hamilton Forensics’ time to evaluate the reconciliations.
Once we had proof that there were anomalies in the accounting for cash, further investigation was initiated to determine if the discrepancies were the result of human/software error or the result of intentional manipulation and misrepresentation.
Result: We found that material and significant misappropriation of company assets had taken place over an extended period of time. As a result of our fraud investigation, the Controller was terminated, arrested, subsequently convicted, and is serving time in state prison. The method of hiding the embezzlement was so simple that apparently 6 auditors didn’t think to check it, which although disappointing to the company, is a key reason why a professional fraud investigation team should be engaged to investigate such suspicions.
We provided several recommendations for company management in order to minimize the chances of future embezzlement. The company was greatly pleased with Chris Hamilton Forensics’s expertise, expediency, successful investigation and recommendations.
#3: Comparative Analysis for Family Law Dispute
Issue: Chris Hamilton Forensics was contacted to assist in a family court matter involving complex tracing matters. There was an ongoing dispute regarding whether certain material assets were separate or community. Determining the nature of the assets affected the division of assets and, because the cash flow associated with those activities were substantial, reimbursement claims would be significantly affected. Both parties came into the marriage with considerable separate assets.
Chris Hamilton Forensics work: The case had been active for over a year before Chris Hamilton Forensics was brought into the matter. The correspondence in that year included settlement offers from both sides. Both offers were immediately rejected as preposterous and even insulting. After this “attempt” to settle, forensic accountants were retained and the forces were being marshalled for battle in court. Each side made substantial commitments to preparing tracings to prove respective claims in trial.
Chris Hamilton Forensics immediately began the work of preparing the tracings for several bank accounts covering the period of the marriage and the year since separation. Based on some of the data and the conclusions becoming evident from the records, Chris Hamilton Forensics suspended the tracing work and analyzed the two rejected settlement proposals more closely. To understand the two offers, side-by-side marital balance sheets were prepared. On the left was the Petitioner’s version of assets, debts, and reimbursement claims as reflected in their Section 1152 offer letter. Similarly, on the right was Respondent’s version of assets, debt, and reimbursement claims. At the bottom of each balance sheet was a calculation of the net equalization payment due based on each party’s assumptions and conclusions.
Amazingly, what the parties perceived to be a massive gap between the two positions (millions of dollars) was actually, when put in a side-by-side analysis, a relatively narrow difference of a couple hundred thousand dollars. The emotional attachment to some of the issues by both parties and the enormous accounting complexity had masked the proximity of potential compromise.
Result: Chris Hamilton Forensics approached our client and presented the prospect that staggering legal and accounting fees could be saved if there was an openness to compromise on a much smaller difference than the litigants previously perceived. Our client approached opposing counsel and requested a settlement conference with both sets of attorneys and forensic accountants. It took most of an eight hour day, but the case settled. The two litigants were initially stunned at how close their two seemingly opposite positions actually were. Significant fees were saved and it is likely that at least two years were cut from the dispute resolution process.
#4: Found the Income! Asset Tracing in Family Law Cases
Type of Matter: In a divorce matter the “in-spouse” who controlled family business, real estate, and all other assets claimed minuscule monthly income, poverty, and no records. His wife knew better and didn’t believe any of it.
Background: After a lengthy marriage Mr. Husband decided to make some major changes in his life – including divorcing his wife. In the initial court filings, declarations of assets and debt as well as income and expenses are filed by both parties. In those disclosures Mr. Husband claimed minimal assets and poverty level income. He provided the filed joint tax returns for the previous several years to support his claims. These filings were contrary to the lifestyle described by his wife that included round-the-world travel, expensive cars, fine dining, and a growing inventory of real estate.
Chris Hamilton Forensics’ Work: After Mr. Husband filed financial disclosures with the court, his wife retained an attorney to provide some guidance. The attorney immediately knew something was wrong and called Chris Hamilton Forensics for assistance. A demand for production of documents was prepared and sent out. Buried in Mr. Husband’s response was the claim that all (everything) accounting records were unavailable because of a stolen computer. His wife had a decision to make – accept his story and her “fate” (poverty) or pursue the case at great risk and cost.
She decided to borrow the money to proceed with the case and that began the process of issuing subpoenas to all banks, escrow companies, credit card companies, etc. Once the records began rolling in Chris Hamilton Forensics began a full reconstruction of the accounting for the businesses and their personal accounts. The accounting was being recreated to cover as much of the marriage as possible as well as the separation period. Thousands of transactions were entered, reconciled, analyzed, and categorized. As records arrived in response to subpoenas, more data was included in the accounting.
What emerged from all the work was solid evidence of substantial assets, the marital standard of living, and evidence of preemptive sale and/or transfers of assets in anticipation of the divorce. Perhaps the most startling development was proof of average monthly income that was within $500 of what our client told us it was going to be.
Result: Our client took a significant risk to invest in a long and tedious forensic accounting process. That decision to move ahead with the accounting was vindicated when evidence was found supporting all her claims. The court was not happy with Mr. Husband. Likewise, he probably wasn’t happy with the court either as he was ordered to pay fees, sanctions, and sizable monthly support – prospectively and retroactively.