Forensic Accounting: Strategies for Detecting and Controlling Fraud Intermediate D. Larry Crumbley, CPA, Cr.FA, CFFA, FCPA KPMG Endowed Professor Department.

Forensic Accounting: Strategies for Detecting and Controlling Fraud Intermediate D. Larry Crumbley, CPA, Cr.FA, CFFA, FCPA KPMG Endowed Professor Department of Accounting Louisiana State University Baton Rouge, LA Fax Dr. Crumbley is the editor of the Journal of Forensic Accounting: Auditing, Fraud, & Risk, former chair of the Executive Board of Accounting Advisors of the American Board of Forensic Accountants, member of the NACVA’s Fraud Deterrence Board, and on the AICPA’s Fraud Task Force ( ). A frequent contributor to the Forensic Examiner, Professor Crumbley is a co-author of CCH Master Auditing Guide, along with more than 50 other books and 350 articles. His latest book entitled Forensic and Investigative Accounting is published by Commerce Clearing House ( ). Some of his 12 educational novels have as the main character a forensic accountant. His goal is to create a television series based upon the exciting life of a forensic accountant and litigation consultant. I am not engaged in rendering legal services or legal opinions. If legal advice or assistance is required, the services of a competent attorney should be sought.

Forensic Report

Glimpse Forward Overview of Forensic Accounting
PCAOB, Smaller Businesses Indirect Methods of Determining Income Procurement Frauds Developing Fraud Interviewing Skills Some Forensic Accounting Tools Best Practices of Litigation Services Federal Rules of Civil Procedures Federal Rules of Evidence Surviving Daubert/Frye Challenges Privileges Testimony Best Practices Now John at the bar is a friend of mine. He gets me my drinks for free. Sing us a song, you’re the piano man. “Piano Man” Billy Joel 3 3

Forensic Accounting Factors
Time: Forensic accounting focuses on the past, although it may do so in order to look forward (e.g., damages, valuations). Purpose: Forensic accounting is performed for a specific legal forum or in anticipation of appearing before a legal forum. Peremptory: Forensic accountants may be employed in a wide variety of risk management engagements within business enterprises as a matter of right, without the necessity of allegations (e.g., proactive). With a single clue or minor inconsistency, a forensic accountant can solve a fraudulent mystery.

Forensic Accounting Areas
Investigative Auditing Litigation Support Forensic: Latin for “forum,” referring to a public place or court. Black’s Law Dictionary: Forensic, belonging to the courts of justice. Note: Corporate spooks are used to check on competitors.

Definition of Forensic Accounting Litigation Service
Forensic accounting litigation services are the professional assistance accountants provide related to the litigation process. These services may involve accounting, financial, auditing, tax, quantitative analysis, and investigative and research skills, as well as an understanding of the legal process to provide assistance for actual, pending, or potential legal or regulatory proceedings before a trier of fact in connection with the resolution of a dispute between parties. “Briefly, forensic accounting is a science that deals with the relation and application of facts to business and social problems.” Lenny smiled and turned toward the jury. “As I tell my students, a forensic accountant is like the Columbo or Quincy character of yesteryear, except he uses accounting records and facts to uncover fraud, missing assets, insiders’ trading, and other white-collar crimes.” Lenny turned back to the pinstriped lawyer. I.W. Collett & M. Smith, Trap Doors and Trojan Horses, Thomas Horton & Daughters, p. 76

Forensic Auditing Forensic auditing is a type of auditing that specifically looks for financial misconduct, and abusive or wasteful activity. It is most commonly associated with gathering evidence that will be presented in a court of law as part of a financial crime or a fraud investigation. Source: B.L. Derby, “Data Mining for Improper Payments,” Journal of Government Financial Management, Winter, 2003, pp Life is good, the grass is green The good Lord smilin’ on you and me Sweet sunshine everywhere I look You love me like no one could Life is good Kenny Chesney

Fannie Mae Forensic Probe
BOD hired investigators who cleared the current management of Fannie Mae of knowingly participating in any wrongdoing. The report took 17 months; 616 pages plus 2,000 plus pages of supporting documents. Cost of $60 million to $70 million. The fraud was estimated to be $11 billion. Former N.H. Senator Warren Rudman used The Huron Consulting Group.

A Forensic Accounting Expert Witness
Harvey R. Kelly led the investigation and testified against CEO Richard M. Scrushy (HealthSouth). He acknowledged turning up “nothing that had Mr. Scrushy’s name on it,” that connected the former CEO to the fraud at HealthSouth, which inflated earnings by $2.7 billion. “Our job wasn’t to figure out who all the bad guys were. Our job was to help the company get the right numbers and figure out how much the fraud was.” He and his investigators sifted through millions of documents during their 23,000-hours fraud investigation. PWC was paid about $9 million to conduct the forensic audit in 2003. HealthSouth deleted old s every 60 days. Now with the NYC office of Alix Partners LLC, he was being paid about $700 an hour by the government for his testimony Source: Evelina Shmukler, “Scrushy Team Cross-Examines Forensic- Accounting Witness,” WSJ, February 1, 2005, C-4

Need a Certification American College of Forensic Examiners (2750 E. Sunshine, Springfield, MO 65804; ; DABFA and Cr.FA; 2000) Certified Fraud Examiners (Association of CFEs, The Gregor Bldg., 716 West Avenue Austin, TX 78701; ; Certified Insolvency and Reorganization Accountant (CIRAs). Accountants, lawyers, consultants included in insolvency and bankruptcy matters. 3-part exam. 4,000 hours AIRA, 221Stewart Avenue, Suite 207, Medford, Or Forensic CPA Society (FCPA); formed in July 2005, Spokane, WA. Certified Forensic Financial Analyst (NACVA, Salt Lake City, Utah 84106; ). Also, Certified Fraud Deterrence (CFD) analyst. National Litigation Support Services Association (NLSSA, III East Wacker Drive, Suite 990, Chicago, IL 60601; ). Not-for-profit. About 20 firms. $1,825. Canadian Institute of Chartered Accountants (CICA) – CA.IFA – Alliance for Excellence in Investigative Accounting. Certified Forensic Investigator (CFI) – Canada Early 1980’s. Certified Fraud Specialist (CFS), not-for-profit, educational anti-fraud corporation located in Sacramento, Calif., for those dealing in white-collar crime, fraud, and abuse issues. Association of Certified Fraud Specialists.

Possible AICPA Action At the Spring 2007 meeting of the AICPA, Robert Harris, chair of the National Accreditation Commission said the ABV designation will reach its goal of 2,718 holders early (currently at 2,688). He also indicates that the Commission has received good feedback on the AICPA’s establishing a designation for forensic accounting, including on the possibility of partnering with another organization to create the designation. Further study is expected to result in a business plan for the Council to consider at the fall meeting, and thus decide if the AICPA should proceed with a forensic accounting certification.

PCAOB Guidance: Smaller Public Companies
Scaling the Audit for Smaller, Less Complex Companies. Evaluating Entity-Level Controls. Assessing the Risk of Management Override and Evaluating Mitigating Actions. Evaluating Segregation of Duties and Alternative Controls. Auditing Information Technology Controls in a Less Complex IT Environment. Considering Financial Reporting Competencies and Their Effect on Internal Control. Obtaining Sufficient Competent Evidence When the Company has Less Formal Documentation. Auditing Smaller, Less Complex Companies with Pervasive Control Deficiencies.

Attributes of Less Complex Companies
Use of entity-level controls to achieve control objectives. In smaller, less complex companies, senior management often is involved in many day-today business activities and performs duties that are important to effective internal control. Consequently, the auditor's evaluation of entity-level controls can provide a substantial amount of evidence about the effectiveness of internal control. Risk of management override. The extensive involvement of senior management in day-to-day activities and fewer levels of management can provide additional opportunities for management to override controls or intentionally misstate the financial statements in smaller, less complex companies. In an integrated audit, the auditor should consider the risk of management override and company actions to address that risk in connection with assessing the risk of material misstatement due to fraud and evaluating entity-level controls. Source: PCAOB, October 17, 2007, pp. 7,8

Attributes of Less Complex Companies (cont.)
Implementation of segregation of duties and alternative controls. By their nature, smaller, less complex companies have fewer employees, which limit the opportunity to segregate incompatible duties. Smaller, less complex companies might use alternative approaches to achieve the objectives of segregation of duties, and the auditor should evaluate whether those alternative controls achieve the control objectives. Use of information technology (IT). A smaller, less complex company with less complex business processes and centralized accounting operations might have less complex information systems that make greater use of off- the-shelf packaged software without modification. In the areas in which off-the-shelf software is used, the auditor's testing of information technology controls might focus on the application controls built into the pre-packaged software that management relies on to achieve its control objectives and the testing of IT general controls might focus on those controls that are important to the effective operation of the selected application controls. Source: PCAOB, October 17, 2007, pp. 7,8

Attributes of Less Complex Companies (cont.)
Maintenance of financial reporting competencies. Smaller, less complex companies might address their needs for financial reporting competencies through means other than internal staffing, such as engaging outside professionals. The auditor may take into consideration the use of those third parties when assessing competencies of the company. Nature and extent of documentation. A smaller, less complex company typically needs less formal documentation to run the business, including maintaining effective internal control. The auditor may take that into account when selecting controls to test and planning tests of controls. Source: PCAOB, October 17, 2007, pp. 7,8

Entity-Level Controls
Controls related to the control environment. Controls over management override; the company's risk assessment process. Centralized processing and controls, including shared service environments. Controls to monitor results of operations. Controls to monitor other controls, including activities of the audit committee and self-assessment programs. Controls over the period-end financial reporting process. Policies that address significant business control and risk management practices. Source: PCAOB, October 17, 2007, pp. 12.

Judging Entity-Level Controls
Purpose of the control. A procedure that functions to prevent or detect misstatements generally is more precise than a procedure that merely identifies and explains differences. Level of aggregation. A control that is performed at a more granular level generally is more precise than one performed at a higher level. For example, an analysis of revenue by location or product line normally is more precise than an analysis of total company revenue. Consistency of performance. A control that is performed routinely and consistently generally is more precise than one performed sporadically. Correlation to relevant assertions. A control that is directly related to an assertion normally is more likely to prevent or detect misstatements than a control that is only indirectly related to an assertion. Source: PCAOB, October 17, 2007, pp

Judging Entity-Level Controls (cont.)
Criteria for investigation. For detective controls, the threshold for investigating deviations or differences from expectations relative to materiality is an indication of a control's precision. For example, a control that investigates items that are near the threshold for financial statement materiality has less precision and a greater risk of failing to prevent or detect misstatements that could be material than a control with a lower threshold for investigation. Predictability of expectations. Some entity-level controls are designed to detect misstatements by using key performance indicators or other information to develop expectations about reported amounts. The precision of those controls depends on the ability to develop sufficiently precise expectations to highlight potentially material misstatements. Source: PCAOB, October 17, 2007, pp

Characteristics of Less Complex IT Environments
Transaction processing. Data inputs can be readily compared or reconciled to system outputs. Management tends to rely primarily on manual controls over transaction processing. Software. The company typically uses off-the-shelf packaged software without modification. The packaged software requires relatively little user configuration to implement. Systems configurations. Computer systems tend to be centralized in a single location, and there are a limited number of interfaces into the system. End-user computing. The company is relatively more dependent on spreadsheets and other user-developed applications, which are used to process, accumulate, summarize, and report the results of business operations, and perform straightforward calculations using relatively simple formulas. Source: PCAOB, October 17, 2007, pp. 26.

Evaluating Management’s Oversight
Whether management recognizes situations for which additional expertise is needed to adequately identify and address risks of misstatement. How management determines that the outside professionals possess the necessary qualifications. Whom management designates to oversee the services and whether they possess the suitable skill, knowledge, or experience to sufficiently oversee the outside professionals (Note: Management is not required to possess the expertise to perform or re-perform the services). Whether management has established controls over the work of the outside accounting professional (e.g., controls over the exchange of information and controls to test their work) and over the completeness and accuracy of the information provided to the outside professional. How management participates in matters involving judgment, for example, whether management understands and makes significant assumptions and judgments underlying accounting calculations prepared by an outside professional. How management evaluates the adequacy and the results of the services performed, including the form and content of the outside accounting professional's findings, and accepts responsibility for the results of the services. Source: PCAOB, October 17, 2007, pp. 36.

Pervasive Control Deficiencies
Ineffective control environment (considering the risk profile of the company). An ineffective control environment can increase the risk associated with a control. Also, certain controls in the control environment, such as maintaining financial reporting competencies, might be necessary for the effective functioning of other controls. Ineffective IT controls or information systems. For example, ineffective information systems could impair the effectiveness of certain IT-dependent controls. Pervasive lack of segregation of duties without appropriate alternative controls. When a person performs two or more incompatible duties, the effectiveness of some controls might be impaired without appropriate alternative controls. Frequent management override of controls. A control that is frequently overridden is less likely to operate effectively. Source: PCAOB, October 17, 2007, pp. 46.

Lifestyle Probes Lavish residence Expensive cars and boats
The lifestyle of a taxpayer or employee may give clues as to the possibilities of unreported income. Obvious lifestyle changes may indicate fraud and unreported income: Lavish residence Expensive cars and boats Vacation home Private schools for children Exotic vacations 22

IRS Financial Status Audits
If someone is spending beyond his or her apparent means, there should be concern. If a forensic accountant suspects fraud or unreported income, a form of financial audit may be appropriate that will enable the investigator to check the lifestyles of the possible perpetrators. 23

Forensic Audit Approaches Used by the IRS
Direct methods involve probing missing income by pointing to specific items of income that do not appear on the tax return. In direct methods, the agents use conventional auditing techniques such as looking for canceled checks of customers, deed records of real estate transactions, public records and other direct evidence of unreported income. Indirect methods use economic reality and financial status techniques in which the taxpayer’s finances are reconstructed through circumstantial evidence. 24

Indirect Methods An indirect method should be used when:
The taxpayer has inadequate books and records The books do not clearly reflect taxable income There is a reason to believe that the taxpayer has omitted taxable income There is a significant increase in year-to-year net worth Gross profit percentages change significantly for that particular business The taxpayer’s expenses (both business and personal) exceed reported income and there is no obvious cause for the difference 25

Market Segment Specialization Program
The Market Segment Specialization Program focuses on developing highly trained examiners for a particular market segment. An integral part of the approach used is the development and publication of Audit Technique Guides. These Guides contain examination techniques, common and unique industry issues, business practices, industry terminology, and other information to assist examiners in performing examinations. A forensic accountant can use this resource to learn about a particular industry. 26

Minimum Income Probes For non-business returns, an agent question the taxpayer or representative about possible sources of income other than reported on the return. If there is no other information in the file indicating potential unreported income, the minimum income probe is met. For taxpayers who are self-employed and file a Schedule C or F, an analysis is made of tax return information to determine if reported income is sufficient to support the taxpayer’s financial activities. 27

Cash T A cash T is an analysis of all of the cash received by the taxpayer and all of the cash spent by the taxpayer over a period of time. The theory of the cash T is that if a taxpayer’s expenditures during a given year exceed reported income, and the source of the funds for such expenditures is unexplained, such excess amount represent unreported income or possible fraud. 28

Preliminary Cash-T Gross Receipts: Business Expenses: Schedule C
$120,000 $95,000 Preliminary Understate-ment Personal Living Expenses $60,000 $155,000 $35,000 29

Source and Application of Funds Method (Expenditure Approach)
This technique is a variation of the net worth method that shows increases and decreases in a taxpayer’s accounts at the end of the year. The format of this method is to list the applications of funds first and then subtract the sources. If the taxpayer’s applications exceed his or her known cash receipts (including cash on hand at the beginning of the year), any difference may be unreported income. 30

Source/Application of Funds
2006 2007 Bank balance increase Down payment on home Closing costs on home Purchase of SUV Rent payment (4 months) Mortgage payment Down payment on boat Credit card payments Miscellaneous (living) Balance $7,300 15,000 3,700 17,600 2,000 4,200 - 14,000 11,500 75,300 $29,500 8,400 10,000 38,800 37,000 $123,700 Known sources of funds: Cash on hand Salary Consulting Dividends and interest Loan proceeds Net unreported funds $3,600 49,500 7,000 3,000 $63,100 $12,200 $1,700 53,000 13,000 $77,700 $46,000 31

Net Worth Method The net worth method is a common indirect balance sheet approach to estimating income. To use the net worth method, an IRS agent or forensic accountant must: Calculate the person’s net worth (the known assets less known liabilities) at the beginning and ending of a period Add nondeductible living expenses to the increase in net worth Account for any difference between reported income and the increase in net worth during the year as (a) nontaxable income and (b) unidentified differences Hollard v. U.S., 348 U.S. 121 (1954). 32

Net Worth Example Total assets (at cost) Less: Total liabilities
Net worth, end of the year Net worth, beginning of year Increase/decrease in NW Add: living expenditures Estimated Income Less: Known sources of income Unexplained income $1,200,000 (550,000) 650,000 530,000 120,000 145,000 265,000 (130,000) $135,000 33

Net Worth Application 2004 2005 2006 Calculated Net Worth1
Computed Net Worth2 Net Asset increase Unexplained net worth increase Income Expenses Net asset increase $225,000 225,000 11,000 ____0 $62,000 51,000 $11,000 $421,000 310,000 $111,000 21,000 $90,000 $81,000 60,000 $21,000 $610,000 420,000 $190,000 23,000 $167,000 $87,000 64,000 $23,000 1 Actual Net Worth recalculated based upon actual assets less liabilities. 2 Net Worth based upon reported income less expenses. 34

Bank Deposit Method The bank deposit method looks at the funds deposited during the year. This method attempts to reconstruct gross taxable receipts rather than adjusted. Gleckman v. U.S., 80 F.2d 394(CA-8, 1935). 35

Formula for Bank Deposit Method
Total deposits to all accounts Less: Transfers and re-deposits = Net deposits plus: Cash Expenditures = All total receipts less: Funds from known sources = Funds from unknown sources $195,000 21,000 174,000 68,000 242,000 119,000 123,000 36

Formula for Expenditure Method
Expenditures less: Known sources of income = Unknown sources of income $210,000 115,000 $95,000 37

Percentage of Markup Method Gross Profit on Sales Formula
Sales per books Gross profit percentage Gross profit as recomputed $100, % $25,000 Sales on Cost of Sales Formula Cost of Sales-Percentage of Sales Price Cost of Product A Cost of Product B $10,000 $20,000 Cost of Sales – Percent of Selling Price Product A Product B 25% 50% Recompiled Sales of products A and B Sales as recomputed $40,000 $80,000 (10,000/.25) (20,000/.5) Ratio Analysis Formula Restaurant Sales Number of waiters Average sales per waiter Customer’s tip percentage Waitress tip income as recomputed $90,000 3 30,000 10% $3,000 38

Unit and Volume of Sales Method
Average sales price per machine Number of machines manufactured Total sales as recomputed Total sales per return Unreported sales: Suppose: Beginning inventory Ending inventory $900 1,100 $990,000 720,000 $270,000 $220,000 $250,000 39

Some Exercises Given the following facts about Sammie Bright, calculate his preliminary understatement using the Cash-T method. Schedule C expenses $102,000 Personal living expenses ,000 Schedule C receipts ,000 31) Based upon the following facts about Phil Tizzard, in Sour Lakes, Texas, calculate any unexplained net worth increase (if any): Computed Net worth (reported income less expenses) $520,000 Calculated Net worth (actual net worth recalculated upon actual assets less liabilities) ,000 Income ,000 Expenses ,000 32) Ben Lautenberg is a waiter in Las Vegas, and reports tip income of $4,200 for the year. The restaurant sales where he works were $360,000 and there were 5 waiters. Assume that the waiters have about the same amount of sales. Compute Ben’s tip income recomputed if customers’ tip percentage is approximately 11%. 40

Other Techniques A check spread deals with disbursements and may be used when a target uses checking accounts. George A. Manning says the following information is needed to perform a check spread: date, payee, check number, amount, bank from, bank to, first endorsement, second endorsement, and second signatory. Check spreads show patterns of activities and can gather data for the net worth method. A deposit spread deals with the receipts into a checking account, and shows patterns of activities and gathers data for the net worth and expenditures methods. Credit card spreads may be used for legal and stolen credit cards to show where a target has been geographically over time. Source: G.A. Manning, Financial Investigation and Forensic Accounting, Boca Raton, FL: CRC Press, 1999, pp 41

Financial Statement Fraud May Serve Many Purposes
Obtaining credit, long-term financing, or additional capital investment based on misleading financial statements; Maintaining or creating favorable stock value; Concealing deficiencies in performance; Hiding improper business transactions (e.g., fictitious sales or misrepresented assets); and Resolving temporary financial difficulties (e.g., insufficient cash flow, unfavorable business decisions, defense control in maintaining prestige). Source: Zab Rezaee, Financial Statement Fraud, New York: John Wiley & Sons, 2002. 42

Increasing compensation through higher reported earnings;
Management may also engage in financial statement fraud to obtain personal benefits of: Increasing compensation through higher reported earnings; Enhancing value of personal holding of company stock such as stock-based compensation; Converting the company’s assets for personal use; and Obtaining a promotion or maintaining the current position within the company. Source: Zab Rezaee, Financial Statement Fraud, New York: John Wiley & Sons, 2002. 43

Fraudsters Should Be Prosecuted
Rest Of The Story: Fraudsters Should Be Prosecuted Although large frauds may be reported to law enforcement agencies, smaller frauds are often not reported. This failure to report fraud incidents and the reluctance of police to aggressively tackle the issue only empowers the fraudsters and diminishes the victims. Ultimately, these unreported incidents are precursors to larger and larger acts of violence. If we do not deal with simple crimes, we will eventually have to deal with homicide. Source: Stephen Doherty, “How Can Workplace Violence Be Deterred,” Security Management, April 2002, p. 134. 44

Ask for an installment payback.
Use IRS Form 1099 Threat For fraudsters and embezzlers, use the threat of filling a Form 1099 for amounts stolen. Ask for an installment payback. If they stop payment, report them to the IRS on a Form 1099. 45

Some Exercises 46

Notify your insurer. Failure to notify may negate your coverage.
KPMG provides 10 steps to follow when an organization finds or suspects fraud: Shut the door! Keep assets secure until you can provide appropriate long-term security. Safeguard the evidence. Ensure that all records and documents necessary for an investigation remain intact and are not altered by you or anyone else. Notify your insurer. Failure to notify may negate your coverage. Call a professional. Do not confront or terminate the employment of a suspected perpetrator without first consulting your legal advisor. Prioritize your objectives. What’s most important: punishment, loss recovery, prevention, detection of future occurrences? 47

KPMG’s 10 steps to follow contd..
Consider prosecution. Before you make the call, weigh the plusses and minuses and determine if your insurance company requires prosecution. Terminate business relations. If the fraud is external, business relations with the suspect individual or organization should be terminated. Seek advice and assistance. An important consideration is whether you have the knowledge and resources necessary to effectively manage the process. Prepare a witness list. It is important that statements be taken before a “party line” can develop. Consider the message. Whatever you do will affect future situations. Now may be the time to change the way your business operates. 48

Catch Me If You Can Punishment for fraud and recovery of stolen funds are so rare, prevention is the only viable course of action. Frank W. Abagnale 30 years ago Abagnale cashed $2.5 million in fraudulent checks in every state and 26 foreign countries. Was later associated with the FBI for 25 years. 49

Over-all Fraud Plan Background checks Avoid Nepotism
Signed Conditions of Employment Agreement Non-compete Agreement Confidentiality of Information Agreement Bonding Two-signatures on checks/ wire transfers/ lines of credit Lockbox Positive pay Check security and restrictive endorsements Check stock (can not be scanned and it smears easily) Close out cash registers at unpredictable times Back up computer files Accounting personnel can not cancel debt Have an internal audit CEO signs numbered check request form E.J. McMillan, Policies and Procedures to Prevent Fraud & Embezzlement, 2006, John Wiley. 50

Types of Misappropriations
Embezzlement Cash and check schemes Larceny of cash Skimming Swapping checks for cash Check tampering Kiting Credit card refund and cancellation schemes Accounts receivable fraud Lapping Fictitious receivables Borrowing against accounts receivable Inventory fraud Stealing inventory Short shipments with full prices Fictitious disbursements Doctored sales figures Sham payments Price manipulations: land flipping, pump and dump, and cyber-smearing Money laundering Bid rigging 51

How Cash Is Misappropriated
% Median Loss Inflow: Skimming 18.9% $76,000 Cash larceny 14.2% 73,000 Disbursements: Billings 28.3% 130,000 Expense Reimbursements 19.5% 25,000 Check Tampering 17.1% 120,000 Payroll 13.2% 50,000 Wire transfers 6.5% 500,000 Register Disbursements 1.7% 26,000 Source: 2006 Wells Report, ACFE. 52

Cash Wheel Accruals Cash Accounts Receivable Adjusting Entries
Accounts Payable Depreciation Accruals Cash Source: Fraud Auditing Small Businesses With The Wheel , James A. Goldstine 53

Some Employee Schemes Embezzlement/skimming involves converting business receipts to one’s personal use and benefit, by such techniques as cash register thefts, understated/unrecorded sales, theft of incoming checks etc. 54

Some Skimming Schemes (off-book)
Unrecorded sales. Theft of incoming checks. Swapping checks for cash. Auditing Suggestions Compare receipts with deposits. Surprise cash count. Investigate customers complaints. Gross profit analysis (also for money laundering). Check for reversing transactions, altered cash counts, and register tapes that are “lost.” Camera surveillance. 55

Review and analyze each journal entry to the cash account.
Preventive Measures Segregation of duties, mandatory vacations, and rotation of duties help prevent cash larceny. Review and analyze each journal entry to the cash account. Two windows at drive-through restaurants. Signs: Free meal if no receipt. Blank checks and the automatic check signing machine should be kept in a safe place from employees. Pre-numbered checks should be logged and restricted to one responsible employee. Require two signatures on cashier checks. 56

Processing Checks Best Procedure
Step 1. The invoice is approved for payment. Step 2. A check request form is completed. Step 3. The CEO approves the check request. Step 4. The check request is forwarded to accounting. Step 5. Accounting processes the check. Step 6. The CEO signs the check. Step 7. A second designated employee (who does not approve the payment and is not in the accounting department) should cosign the check. Therefore, 4 people involved. E.J. McMillan, Policies & Procedures to Prevent Fraud & Embezzlement, John Wiley, 2006, p.44. 57

Processing Checks Best Procedure
Invoice is approved for payment. Check request form is prepared. The CEO approves/ signs the numbered check request form. Check request form is forwarded to accounting. Accounting processes the check. The check is signed by two authorized individuals. The check is mailed. The bank statements are sent to the CEO’s home (or P.O. box) for review. The CEO forwards the reviewed bank statements to accounting for reconciliation. E.J. McMillan, Policies & Procedures to Prevent Fraud & Embezzlement, John Wiley, 2006, p.45. 58

Some Employee Schemes (contd .)
Kiting: building up balances in bank accounts based upon floating checks drawn against similar accounts in other banks. Wire transferring makes kiting easier. Auditing Suggestions Look for frequent deposits and checks in the same amount. Large deposits on Fridays. Short time lag between deposits/withdrawals. Bank reconciliation audit [cut-off bank statement]. 59

Some Employee Schemes (contd …)
Cut-off Bank Statement Shorter period of time (10-20 days). Bank statement sent directly to fraud auditors. Compare the cancelled checks, etc. with the cut-off bank statement. Helpful for finding kiting and lapping. 60

Cash Schemes Other Cash Schemes
Theft of checks (bottom or middle of checks). Checks may be intercepted or payee altered (washing checks). Forged endorsements (disappearing ink). Stolen credit cards. Refund schemes. Kickback schemes. 61

Refund Schemes A television station’s former accounting director pleaded guilty to stealing more $1.8 million from her employees and spending it on jewelry, paintings, and fur coats. She would overpay the station’s travel bills and divert the refunds to her own credit card bills and personal accounts. She was sentenced to 7 ½ years in prison on a single count of theft from CBS affiliate WBBM – TV Source: AP, “Ex-Accountant at CBS Affiliate Sentenced,” Las Vegas Sun, November 5, 2003. 62

Accounts Receivable Schemes
Lapping. Fictitious receivables [for a fictitious sale], which is later written off. Borrowing against receivables (use receivable as collateral). Improper posting of credits against receivables. 63

Lapping Lapping Recording of payment on a customer’s account some time after receipt of payment. Later covered with receipt from another customer (robbing Peter to pay Paul). Lapping is more successful where one employee has both custody of cash and record keeping responsibility. 64

Warning Signs of Lapping
Increase in complaints. Excessive billing errors. Delays in posting customer payments. Trend of decreasing accounts receivable payments. Accounts receivable details do not agree with the general ledger. 65

Lapping (cont.) Audit Steps
Independently verifying customers who do not pay. Reviewing write-offs. Reviewing customers’ complaints. Compare the checks on a sample of deposit slips to the details of the customers’ credits that are listed on the day’s posting to the customer’s account receivables. Closely monitor aging accounts. 66

How Non-Cash Assets are Misappropriated – 2006
Category % Median Loss Inventory 16.6% $55,000 Information 3.6% 78,000 Securities 1.5% 1,850,000 Source: 2006 Wells Report, ACFE. 67

Inventory Inventory Fraud
Stealing inventory/supplies for personal use or for sale at flea markets/garage sales. Kickback schemes (vendor/supplier and an employee). Sale of unreported inventory at inflated prices. Audit Steps for Inventory Fraud Use renumbered inventory tags matched to count sheets; use count procedures for work-in-progress items; separate duties between purchasing and logging receipts of shipments Check for same vendors. Prices higher than other vendors. Purchasing agent does not take vacation. Only photocopies of invoices are available. Aging of inventory. Inventory turnover There is data-mining software. 68

Stealing Diamond Inventory
Farrah Daly was charged with stealing at least 39 diamonds (1 to 3 carats), one at a time over several years from a diamond sorting area. She and her husband allegedly had friends and others sell the approximately $500,000 worth of diamonds at pawn shops and jewelry stores. Source: AP, “Ohio Woman Accused of Stealing Diamonds,” Las Vegas Sun, November 10, 2003. 69

Reducing Bad Debts Before MCI was acquired by WorldCom, Walter Paulo a billing manager, had to reduce a $180 million bad debt expense down to $15 million. Eventually MCI had to write-off $650 million in bad debt. His schemes: Allow a customer to sign a promissory note to turn the receivable into a short-term asset. Redacting invoices. Developing interpretations to explain why some items are aged so long. Using questionable codes. Used unapplied cash to cover. Arthur Andersen did not audit the smaller bad debt accounts where the questionable accounts occurred (e.g., the third tier). Paulo said that the AA auditors were young, inexperienced, and fresh out of college. Source: J.M. Jacka, “An Environment for Fraud,” Internal Auditor, April 2004, pp 70

Accounts Payable Fraud Red Flags
Duplicate payments (2% of total purchases) $80 million times 2% = $1.6 million loss. Extract only the numerical digits of an invoice number and match on only the numbers portion of the invoice. Try identifying the dates that are similar such as dates that are less than 14 days. Try matching on the absolute value of the amount. Rounded-amount invoices. Invoices just below approval amounts. Abnormal invoice volume activity (two invoices one month and 60 the next). Vendors with sequential invoice numbers. LC 0002, LC 0003, LC 0004 6. Above average payments per vendor. C. Warner and B. G. Dubinsky, “Uncovering Accounts Payable Fraud,” Fraud Magazine, July/ August 2006, pp 71

Top 10 Financial Red Flags of Insurance Fraud
Visible alteration of documents. Conflicting dates and/ or information. Missing pages of documents. Missing key information. Significant discrepancies between tax returns and other financial documentation. Poor financial condition prior to loss. Business appears to be winding down immediately prior to loss. Discovery or previously undisclosed financial or business interests. Expenses continue while not working or operating. Income and/ or ownership is transferred to family. D. W. Draz, “Insurance Industry Anti-Fraud Insights,” Fraud Magazine, July/ August, 2006, p.63. 72

Look For Fraud Symptoms
Source Documents. Journal Entries. Accounting Ledgers. 73

Source Documents Checks. Employee time cards. Sales invoices.
Shipping documents. Expense invoices. Purchase documents. Credit card receipts. Register tapes. 74

Source Documents Fraud Symptoms
Photocopies of missing documents. Counterfeit/false documents. Excessive voids/credits. Second endorsements. Duplicate payments. Large numbers of reconciling items. Older items on bank reconciliations. Ghost employees. Lost register tapes. Lots of round numbers. Too many beginning 9’s. 75

Journal Entries Fraud Symptoms
Out-of-balance. Lacking supporting documents. Unexplained adjustments. Unusual/numerous entries at end of period. Written entries in computer environment. Many round numbers. Too many beginning 9’s. 76

Controls Over Journal Entries
Controls that prevent or detect unauthorized journal entries can reduce the opportunity for the quarterly and annual financial statements to be intentionally misstated. Such controls might include, among other things, restricting access to the general ledger system, requiring dual authorizations for manual entries, or performing periodic reviews of journal entries to identify unauthorized entries. As part of obtaining an understanding of the financial reporting process, the auditor should consider how journal entries are recorded in the general ledger and whether the company has controls that would either prevent unauthorized journal entries from being made to the general ledger or directly to the financial statements or detect unauthorized entries. Tests of controls over journal entries could be performed in connection with the testing of journal entries required by AU sec. 316. Source: PCAOB, p. 21.

Unusual Entries Officer Loan $40,000 Cash $40,000
Officers Salary $40,000 Officer Loan $40,000 Staff Salaries $40,000 Officers Salary $40,000 Cost of Goods Sold $35,000 Inventory $35,000 [No related sales transaction] Allowance of Bad Debts $32,000 Account Receivables $32,000 Expense accounts where no department or person has control General maintenance account General transportation account Stationary/ general office supplies Scrap disposal accounts Suspense and cash sweep accounts Deferred asset or liability Contra-accounts (bad debt reserve, accumulated depreciation) Intercompany accounts Accounts over which a sole, domineering, incompetent, or frequently absent individual has control. 78

Underlying assets disagree.
Ledger Fraud Symptoms Underlying assets disagree. Subsidiary ledger different than general ledger. Investigate and reconcile differences between control accounts and supporting ledger. Difference may be concealed fraud. 79

Which of these statements are false?
A high degree of competition accompanied by declining margins would be an example of an opportunity for fraudulent financial reporting. Personal guarantees of debt of a company that are significant to one’s personal net worth is an example of a pressure/incentive for fraudulent financial reporting. A heavy concentration of one’s wealth in a particular company would be an example of a rationalization condition for fraudulent financial reporting. An excessive interest by management in maintaining a company’s stock price is an example of rationalization for fraudulent financial reporting. Anticipated future layoff would be an example of an incentive to misappropriate assets. A large amount of cash on hand would be an example of a rationalization to misappropriate assets. Inadequate internal controls is an example of an opportunity to misappropriate assets. 80

Which of these statements are false?
A high degree of competition accompanied by declining margins would be an example of an opportunity for fraudulent financial reporting. F (I/P) Personal guarantees of debt of a company that are significant to one’s personal net worth is an example of a pressure/incentive for fraudulent financial reporting. T A heavy concentration of one’s wealth in a particular company would be an example of a rationalization condition for fraudulent financial reporting. F (I/P) An excessive interest by management in maintaining a company’s stock price is an example of rationalization for fraudulent financial reporting. T Anticipated future layoff would be an example of an incentive to misappropriate assets. T A large amount of cash on hand would be an example of a rationalization to misappropriate assets. F (O) Inadequate internal controls is an example of an opportunity to misappropriate assets. T 81

Payroll Payroll Schemes
Ghost Employee: A person on the payroll who does not work for that company. False Workers’ Compensation claims: Fake injury to collect disability payments. Commission schemes: Falsify amount of sales or the commission rate. Falsify hours and salary: Exaggerate the time one works or adjusts own salary. 82

Stop Ghost Employees Ensure that the payroll preparation, disbursement and distribution functions are segregated. Look for paychecks without deductions for taxes or Social Security. Completely fictitious employees frequently don’t have any. Examine payroll checks that have dual endorsements. Although most of them are legitimate, two signatures could signal the forgery of a departed employee’s endorsement, which the thief also endorses and deposits into his or her own account. Use direct deposits. This method, although not foolproof, can cut down on payroll chicanery by eliminating paper paychecks and the possibility of alteration, forgery and most theft, although it doesn’t prevent misdirection of deposits into unauthorized accounts. Check payroll records for the presence of duplicate names, addresses and Social Security numbers. On occasion, hand-deliver paychecks to employees and require positive identification. If you have leftover paychecks, make sure they belong to actual employees, not ghosts. Be wary of budget variations in payroll expense. Higher-than-budgeted labor costs can indicate ghost employees. Source: J. T. Wells, “Keep Ghosts Off The Payroll,” Journal of Accountancy, December 2002. 83

Fictitious Disbursements Multiple payments to same payee. Multiple payees for the same product or service. Inflated invoices. Shell companies and/or fictitious persons. Bogus claims (e.g., health care fraud and insurance claims). Overstate refunds or bogus refunds at cash register. Many fictitious expense schemes (e.g., meals, mileage, sharing taxi, claiming business expenses never taken). Duplicate reimbursements. Overpayment of wages. 84

Other Fraud Schemes Stealing inventory/scrap. Stealing property. Theft of proprietary assets. Personal use of assets. Shoplifting. False down grading of products. A land flip involves a situation where a company decides to purchase land for a project. A person or group will find the land and buy it under a front name or company. The fraudster then increases the price of the land before selling it to the company. Money laundering is the use of techniques to take money that comes from one source, hide that source, and make the funds available in another setting so that the funds can be used without incurring legal restrictions or penalties. 85

Other Fraud Schemes (contd …) A ponzi scheme is a pyramid-type technique where early investors are paid with new money collected from future investors, who lose their investments. Bid rigging occurs when a vendor is given an unfair advantage in an open competition for a certain contract. 86

Some of the women received the pay-off, but most lost out.
Ponzi Scheme Example Women Helping Women group hosted invitation – only “birthday parties” that promised $40,000 in the future to each woman who invested $5,000. Some of the women received the pay-off, but most lost out. $12 million pyramid schemes. Cheryl Bean, the leader, given 3 years probation, ordered to pay $15,000 in restitution, and $10,000 to a charity fund. Source: AP, “Pyramid Scheme Leader Pleads No Contest,” Las Vegas Sun, November 8, 2003. 87

Hammersmith Trust Ponzi Scheme
Hundreds of sophisticated investors put $100 million in this prime banking scheme that promised as much as 1,600% annual return. The scheme revolved around the so-called international prime banking instruments (e.g., high-yield commercial paper or secret bank debenture programs). There is no market for prime bank instruments. “Not a single dime is invested in anything – save the fraudulent pyramid itself, with some money going from one investor to the other in the form of purported “interest” and “return of principal “payments – while most of it sticks to the pyramid or rather, to the people running the pyramid.” Source: John Anderson, “Take The Money & Run,” Smart Money, December 2003, pp 88

How Sellers on eBay Fix Auctions
Seller places bids on own items using fake identities (shill bidding). Shill bidding may be commonplace on eBay. Associates of seller bid up the price. 89

Forensic Auditing Steps
Count the Petty Cash Twice in a Day Investigate Suppliers (Vendors) Investigate Customers’ Complaints Examine Endorsements on Canceled Checks Add Up the Accounts Receivable Subsidiary Audit General Journal Entries Match Payroll to Life and Medical Insurance Deductions Source: Jack C. Robertson, Fraud Examination for Managers and Auditors, Austin, TX: Viesca Books, 2000, pp 90

Forensic Auditing Steps (contd …)
Match Payroll to Social Security Numbers Match Payroll with Addresses Retrieve Customer’s Checks Use Marked Coins and Currency Measure Deposit Lag Time Document Examination Inquiry, Ask Questions Covert Surveillance Source: Jack C. Robertson, Fraud Examination for Managers and Auditors, Austin, TX: Viesca Books, 2000, pp 91

Vendor Allowances In exchange for better shelf space or advertisement mentioning its products, a merchandise vendor will pay stores an extra fee--an allowance often based upon the amount of products sold. Employees at OfficeMax “fabricated supporting documents for approximately 3.3 million in claims billed to a vendor to its retail business.” Six employees were fired, and CEO Christopher Milliken resigned. The SEC sued three former executives in December 2004 at Kmart Holding Corp. for their role in a $24 million accounting fraud that booked these allowances early. The SEC settled a case in October 2004 with Ahold NV involving allegations of fraudulent inflation of promotional allowances at U.S. Foodservice, Inc. unit. Source: David Armstrong, “OfficeMax Results To Be Restated; CEO Steps Down,” WSJ, February 15, 2005, p. A-3. 92

Capacity of parties to perform Something of value exchanged
A Valid Contract? Offer/ Acceptance Lawful objective Capacity of parties to perform Something of value exchanged Appropriate form (e.g., in writing) Entered into freely 93

Breach of Contract Breach of contract: a party fails to perform or says he/ she will not perform. Other party can sue for damages. The intentional failure to perform a contract, however, does not necessarily constitute fraud. Must show that the party did not intend to perform the contract and deliberately misled the other party. Civil or criminal action: party knowingly and willfully that the contract (or statement) was false with the intent to deceive or defraud. With this extra burden, may not be worthwhile to try to prove the fraud. Just get rid of the person because of a conflict of interest. 94

Some Contract/ Procurement Frauds
Bribes and kickbacks. Bid rigging. Defective pricing. Phantom vendors [ Product substitution. Conflict of interests. False claims. Cost mischarging. Contract specification failures. Duplicate, false, or inflated invoices. Split purchases. Unnecessary purchases. Defective delivery. H.R. Davia et. al, Accountant’s Guide to Fraud Detection and Control, John Wiley, 2000, p.62. 95

Leaking bid information. Unbalanced bidding.
Types of Bid Rigging Collective bidding. Exclusive bidders. Change order requests. Manipulation of bids. Leaking bid information. Unbalanced bidding. 96

Potpourri of Bribes Vernon Jackson admitted to bribery of Rep. William Jefferson, D-LA. More than $400,000 to one million paid to a company controlled by the congressman’s wife in exchange for help promoting iGate. Gave 24% stake in iGate and paid $80,000 in travel expenses to Africa. [$90,000 found in Jefferson’s freezer.] Two prominent Baton Rouge restaurateurs and four other businessmen accused of bribing a parish tax auditor and an undercover FBI agent with cash, diamonds, trips, whiskey and women to avoid paying taxes on $10 million, face federal charges. An indictment alleges Laymon offered an undercover FBI agent posing as an East Baton Rouge Parish auditor $800, a weekend trip to Costa Rica and two prostitutes a day if he concluded that Arzi’s didn’t owe any sales tax. BR Advocate ( ). 97

Potpourri of Bribes A Greek prosecutor is investigating claims that Siemens Greece paid up to $550 million in bribes to officials at the defense and interior ministries in order to win a security contract for the 2004 Olympic games in Athens. A senior Siemens accountant said bribery was a common practice at Siemens. A Paris judge launched an investigation into allegations that Total, a French oil and gas group, paid bribes to win a $2 billion gas contract in Iran. The investigation stems from the discovery of $82 million in two Swiss bank accounts, allegedly by Total to an Iranian intermediary to help the French company consortium to win an Iranian contract. A report claims that AWB, the company responsible for selling Australia wheat, paid over $221 million to Alia, a Jordanian hauling company, ostensibly to distribute its wheat in Iraq. In fact, the money was going to the Iraq government. 98

Potpourri of Bribes Armstrong Williams, an American columnist and television host, was paid $240,000 by the Dept. of Education to comment regularly on “No Child Left Behind,” an education-reform bill. Nineteen individuals indicated for receiving bribes and rigging bids for school window washing contracts. Congressman Randy Cunningham, R-Calif., resigned from Congress (2005), hours after pleading guilty to taking at least $2.4 million in bribes to help friends and campaign contributors win defense contracts. Prosecutors said he received cash, cars, rugs, antiques, furniture, yacht club dues, moving expenses, and vacations from four co-conspirators in exchange for aid in winning defense contracts. In January 2007, Peter Hartz was given a two year suspended prison sentence and fines for bribing the head of the labor union ($3.25 million) for secret bonuses and fake consultancy fees. Involved sex holidays and paying for prostitutes for labor officials. 99

Potpourri of Bribes In the 1950s in the U.S., record companies would pay money for the broadcast of records on radio, called payola. Now outlawed. In England, police interviewed Prime Minister Tony Blair in February 2007, about allegations that honors, including seats in the House of Lords and Knighthoods, were given to individuals who loaned money to the Labour party ($9.8 million). Under Bill Clinton, Democratic National Committee donors were allowed to spend the night in the Lincoln bedroom for a contribution of $150,000 (e.g., Chairman of Occidental Petroleum). Then in 1997, Clinton made an exception so that OP could pursue a venture in Sudan. A lawsuit in February 2007, alleged that Intel provided secret kickbacks to Dell in order to ensure it remained the computer makers sole microprocessor supplier. 100

Bribes Are Universal Give people power and discretion, and whether they are grand viziers or border guards, some will use their position to enrich themselves. The problem can be big enough to hold back a country’s development. One study has shown that bribes account for 8% of the total cost of running a business in Uganda. Another found that corruption boosted the price of hospital supplies in Buenos Aires by 15%. Paul Wolfowitz, the head of the World Bank, is devoting special efforts during his presidency to a drive against corruption. “How to Grease a Palm,” The Economist, December 23, 2006, p. 115. 101

Tone at the Top: Germany
A sales director once bragged at an office party about how he had bribed several large retail customers. Some only responded to very large gifts, he said, recalling one case when he discreetly pushed a car key to the other side of the negotiating table. The trick was to find out what they liked, and then you were almost done. I was one of this man’s employees – during a stint at this particular company that was mercifully short. What bothered me the most about his remarks was the way he bragged about it. In that company, as in countless others, bribery was not only tolerated, it was cool. If you wanted to become a successful marketing executive, this was what they expected of you Wolfgang Munchau, “A dangerous precedent for corporate corruption,” Financial Times, December 28, 2006, p. 15. 102

Bribes/ Kickbacks Scenario
Something of Value Later Influence an Official Act Cash Gifts Trips Entertainment Drugs Sexual favors Loans Credit cards Fees Spouse’s high salary Discounts (e.g., house) Awarding Selection Higher Prices Excessive Quantity Accepting Lower Quality No, Delayed, or Short Delivery Prove the corrupting influence circumstantially through factors on the right, or outsider received more and more business as the insider gets more and more value. Use indirect methods on employee. 103

Kickback Example Paul J. Silvester, former state treasurer for Connecticut, admitted accepting cash kickbacks in return for placing millions of dollars in state pension investments with certain equity funds. Mr. Silvester was sentenced to 51 months in prison for taking bribes in return for investing $527.5 million from the state pension fund in five investment funds. Source: Marc Santora, “After Help in Corruption Cases, Central Figure Gets 51 Months,” N.Y. Times, November 21, 2003, p. C-12. 104

Parmalat Kickback Scheme
Former Bank of America executive Luca Sala told investigators that over 7 years he took $27 million in a kickback scheme involving Parmalat. He obtained the monies by a kickback arrangement with an outside broker who helped organize bond issues from Parmalat. Mr. Sala (corporate finance head) helped organize several bond placements for Parmalat for which the bank regularly received fees. Source: A. Galloni and C. Mollenkamp, “Ex-Parmalat Banker Admits Stealing $27 Million,” WSJ, February 27, 2004, p. A-3. 105

Some Bribery Red Flags Lack of standard invoices.
Requests for fund to be routed to a foreign bank. Requests for checks made payable to “cash” or to “the bearer.” Commission substantially higher than going rate. Requests for a large line of credit from a customer. Insistence by a government official that a certain third-party agent or supplier be used. Lack of staff or facilities to actually perform the service. Request by a local agent for a rate increase in the middle of negotiations. Suggested need to utilize more than one local agent. Source: M. T. Biegelman and J. T. Bartow, Executive Roadmap to Fraud Prevention and Internal Controls, John Wiley, 2006, pp 106

Duty to Cooperate 107

Audit Rights 108 1. Audits under clause 2 may be conducted of:
the Contractor's practices and procedures as they relate to the Contract, including security procedures; the manner in which the Contractor performs its obligations under the Contract; the compliance of the Contractor's invoices and reports with its obligations under the Contract; the Contractor's compliance with all its obligations under the Contract; the Contractor's compliance with its confidentiality, privacy, security and Commonwealth policy obligations under the Contract; and any other matters determined by [Agency] to be relevant to the performance of the Contractor's obligations under the Contract. 2. Audits The Contractor must participate in audits of the Contract at the frequency and in relation to the matters specified by [Agency], (including on an ad hoc basis if requested by [Agency]), for the purpose of ensuring that the Contract is being properly performed and administered. [Agency] may appoint an independent person to assist in the audits. Audits may consider all aspects of the Contractor's performance including but not limited to any performance indicators, benchmarks or targets. The Contractor must participate promptly and cooperatively in any audits conducted by [Agency] or its nominee. Except for those circumstances in which notice is not practicable or appropriate (eg. caused by a regulatory request with shorter notice or investigation of theft or breach of contract), and without limiting any other right, recourse or remedy of [Agency], must give the Contractor reasonable notice of an audit and where reasonably practicable an indication of which documents and/or class of documents the auditor may require. Subject to any express provisions in the Contract to the contrary each party must bear its own costs of any audits. Subject to clauses 2.6 and 3.6, the requirement for, and participation in, audits does not in any way reduce the Contractor's responsibility to perform its obligations in accordance with the Contract. [Agency] must use reasonable endeavors to ensure that audits performed pursuant to clause 2.1 do not unreasonably delay or disrupt in any material respect the Contractor's performance of its obligations under the Contract. [Any amendments to the Contract resulting from audits must be effected by agreement in writing between the parties in accordance with the Contract amendment provisions of the Contract.] The Contractor must promptly take, at no additional cost to [Agency], corrective action to rectify any error, non-compliance or inaccuracy identified in any audit in the way the Contractor has under the Contract: (a) supplied any goods or services; or (b) calculated fees, or any other amounts or charges billed to [Agency]. 108

Purchasing Agent’s Kickback Checklist
He or she doesn’t take time off. The purchasing agent has personal financial problems. The agent’s lifestyle is too extravagant for his or her income. Close personal relationship between purchasing agent and vendor. Favoritism toward one vendor. Excessive purchases from one vendor. Prices charged are higher than market average. Expenditures come in just under the review limit. Multiple purchases over a short period. Substandard products or services. Accelerated payment of invoices. Sole-source purchases of merchandise or services. Be sure different personnel handle the following duties: vendor approval, purchase requisitions, purchase approval, receiving, and payment (e.g., separation of duties). Source: J. T. Wells, “The Case of the Pilfering Purchasing Manager,” Journal of Accountancy, May, 2004. 109

Red Flags for Phantom Vendors
Invoices for unspecified consulting or other poorly defined services. Unfamiliar vendors. Vendors that have only a post-office-box address. Vendors with company names consisting only of initials. Many such companies are legitimate, but crooks commonly use this naming convention. Rapidly increasing purchases from one vendor. Vendor billings more than once a month. Vendor addresses that match employee addresses. Large billings broken into multiple smaller invoices, each of which is for an amount that will not attract attention. Source: J. T. Wells, “Billing Schemes Part I: Shell Companies That Don’t Deliver,” Journal of Accountancy, July, 2002. 110

More Phony Vendors Red Flags
Ensure those involved in purchasing cannot approve vendors. Before approving a new vendor, evaluate its legitimacy by Obtaining its corporate records and other relevant documents. Checking its credit rating. Confirming that it is listed in telephone directories. Contacting its references from clients and others. Being particularly cautious about a vendor with a post-office-box address or a name composed entirely of initials. Determining whether its business address matches any employee’s home address. Once the company approves a new vendor, the CPA should closely monitor the account by Watching for increases in the amount or frequency of billings. Observing variances from budgets or projections. Comparing its prices with those charged by other sources. Source: J. T. Wells, “Billing Schemes Part I: Shell Companies That Don’t Deliver,” Journal of Accountancy, July, 2002. 111

Preventing Procurement Fraud
Create an Approved Vendor List. Separate job responsibilities. Look for cliques. Establish a hot-line for whistle-blowers. Do the parking-lot test. Get insurance. Baseline, “Six Steps to Prevent Procurement Fraud,” June 6, 2006, 112

Evidence s may be a prime evidence source for procurement and contract fraud. Obtain subpoenas for the s of all suspects, persons of interest, and any other parties that may have information. In U.S. starting , a company must recognize, declare, and produce E-documents whenever it is involved with civil litigation. Courts will no longer accept incompetence or computer problems as an excuse for failing to meet E-document requests. Morgan Stanley hit with a $1.45 billion judgment (2005). 113

Bid Rigging or Bid Pooling
Sherman Antitrust Act – illegal restraint of trade. Felony. Substantial fines and up to three years. Group of dealers choose one dealer to bid on items. Later the dealers themselves bid on the items bought and they, therefore, share the profits. 114

Bid Rigging Red Flags Low turnout of auction attendees.
Winking, hand signals or other similar signs among dealers after the bidding is opened. A uniformity to the bidding. For example, Dealer One bids on a particular lot and buys it with little or no activity, and then Dealer Two buys another lot, again with little or no competition. Difficulty getting things going. A lot of handshaking and other signs of recognition among several dealers before or after the auction takes place. An air of silence throughout the auction since auctions are generally noisy – or conversely, a lot of conversation among bidders during the sale of lots they normally should be bidding on. Low competition among known dealers who normally bid strongly against one another. Source: The Official Government Auction Guide. 115

Interviewing Executives
One way to detect fraud is to interview company personnel. The AICPA Fraud Task Force provides an interviewing template of 13 questions for CEOs, CFOs, and Controllers. Explain the purpose of interview- need to assess risk and comply with audit responsibilities Inquire whether they are aware of any instances of fraud within their organization- Do they have reason to believe that fraud may have occurred or is occurring? Has the CEO or CFO ever approved an accounting treatment for transactions that were not appropriate? Have there been any instances where someone has attempted to inflate assets or revenue or deliberately understate liabilities and expenses? Is there any member of management that has a direct interest or indirect interest in any customer, vendor, competitor, supplier or lender? Is any member of management related to any other member of management? Does anyone in the company have any personal, financial or other problems that might affect their job performance? If there was an area within the company that might be vulnerable to fraud, what would that be? Has anyone within the accounting department been let go or resigned within the past year? Is there anyone in management that appears to be living a lifestyle beyond their means? – expensive cars, trips, jewelry, vices Has anyone been involved in civil or criminal proceedings or filed bankruptcy Does the company have a strong ethics policy? Has anyone ever been fired for committing fraud against the company? Source: Ronald L. Durkin et. al, “Incorporating Forensic Procedures in an Audit Environment,” Litigation and Dispute Resolution Services Subcommittee, New York: AICPA, 2003. 116

Selecting the Right Interviewees
“Someone knows what is going on. If you tune in, you will get a feel for it.” Lorraine Horton, Kingston, R.I. “It is important that you select the right person to interview, and be conversant in interviewing techniques. For instances, pick someone from customer complaints or an employee who didn’t get a raise for two years, as they would be likely to provide the needed information.” R.J. DiPasquale, Parsippany, N.J. Source: H.W. Wolosky, “Forensic Accounting to the Forefront,” Practical Accountant, February 2004, pp Listen to rouges and whistle-blowers who complain. 117

Interview vs. Interrogation
Interview-non-accusatory process where person asks questions to develop factual information (e.g., who, what, when, where, how). Interrogation-accusatory interview to obtain an admission of guilt. “Doubt leads to inquiry, and inquiry leads to the truth.” Saint Thomas Aquinas 118

Differentiate Between the Two
Interview Interrogation Involves a witness Involves a suspect Involves a victim Involves custody No Miranda rights Requires Miranda rights General information Specific facts Less demanding More demanding Casual Highly structured Interview in the field Interrogate at the office Information not known Confirm known information Scattershot approach Pin-down approach Don Rabon, Interviewing and Interrogation, Durham: Carolina Academic Press, 1992, p.5. 119

Moving from Unwilling to Willing Chair
Ask general questions. Win them over. Make them feel that this is what’s best for them. Take away the foundation. Gain their confidence. Explain the facts. Relate to them. Deescalate the crisis. Give them a way out. Explain the advantages of cooperation. Give them a change to explain. Lie to them. Downplay the disadvantages of cooperation. Understand them. Hang it on them. Use deception. Put it on them. Play on their sympathy. Threaten them. Play on their conscience. Get them to trust. Determine their frame of mind. Mimic their manner. Talk to them. Empathize. Know how far to push. Show them what they’re looking at. Get on their level. Show them acceptance. Speak their language. Develop a rapport. Show them. Tell them. Don Rabon, Interviewing and Interrogation, Durham: Carolina Academic Press, 1992, p.8. 120

Advantage and Disadvantages
Advantages of an interview (non-accusatory) Facilitates the development of cooperation. Easier to develop rapport. More effective way of developing usable information. Disadvantages of interrogation Interviewee may be alienated and refuse to speak to anyone later. If interviewee will not speak to anyone, ability to obtain information or admission is diminished. Source: John E. Reed Associates, Inc. 121

Some Persuasive Techniques
Indirect Approach. Complete-file approach. I-know-everything approach. Utility technique. Quick questioning approach. Incentive approach. Repetition technique. Silent approach. Change-of-scene technique. Emotional approach. Psychological technique. Good-guy, bad guy approach. Cold shoulder approach. Don Rabon, Interviewing and Interrogation, Durham: Carolina Academic Press, 1992, p.8. 122

Interrogators’ Hints Interrogation, at its most artful, is a contest of wits. By intimidation or bluff, the gator must somehow find a way to turn the person against his own cause. Ego up, with flattery. Ego down, with denigration Con games, tricking a person into believing you already know something (you do not really know) Or feeding them misinformation about their friends or family. Avoid making offers, but dangle promises. “Gator may promise to talk to the boss.” Fear is the most useful interrogation tool. Mark Bowden, “The Ploy,” The Atlantic, May 2007, pp 123

Verbal and Nonverbal Behavior
Verbal behavior includes not only words, but timing, pitch, rate, and clarity of the responses. Nonverbal behavior includes body movement, position changes gestures, eye contact, and facial expressions. See “Interviewing & Interrogation,” The Reid Technique, John E. Reid Associates, Inc., L.E.R.C Law Enforcements. 124

Nonverbal Language 60% of communication is nonverbal.
Previous contact with person helpful. During President Bill Clinton’s testimony he touched his nose several times when he was lying, but did not touch his nose during truthful testimony. Two-thirds of truth interviewees cross their legs. Source: “Lying 101: There May Be Nonverbal Indicators of Lying,” 125

Posture Language Truthful Deceptive Frontally aligned.
Upright or forward. Open (perhaps crossed legs). Dynamic, comfortable changes. Deceptive Non-frontally aligned. Slouched, retracted or leaning. Barriers (crossed arms, purse in lap). Frozen and rigid. Source: John E. Reid Associates, Inc. 126

Some Lying Signs Covering mouth with hand. Rubbing nose.
Frequent blinking. Biting lip. Moving or tapping foot. Crossing arms. Leaning forward. Handling objects (e.g., pencil, pen). Avoiding eye contact or averting eyes. Clearing the throat. Closing and opening coat. Picking at lint on clothing. Playing with collar. Moving away. Shrug gestures. Slow response. Higher pitch. Long answer. Gap between words becomes longer. Non-words such as uh. Source: “Lying 101: There May Be Nonverbal Indicators of Lying,” 127

Deception Indicators Frequent changes in position Tapping of feet
Dryness of mouth Restlessness Frequent changes in position Tapping of feet Fidgeting Gripping arms of the chair Elbows held close to the body Running hands through the hair Chewing of fingernails, pencils, or other objects Excessive sweating Pulsation of the carotid artery Pallor, flushing, or change in complexion, color Excessive swallowing Avoiding direct gaze Appearance of being disturbed and/or very tense Audible turbulence in the stomach. Don Rabon, Interviewing and Interrogation, Durham: Carolina Academic Press, 1992, p.139. 128

Lying: James R. Brown Style
“I lied in person to investors when I met them. I lied in company’s filings. I lied in the company’s press releases.” Adelphia Communications vice-president of finance. He had no formal training in accounting and finance. Adelphia began manipulating its financial reports soon after the company went public in 1986. We regularly fabricated statistics on the number of subscribers, cash flow, cable-system upgrades, and other closely followed metrics. 129

Lying: James R. Brown Style (cont.)
Top executives would meet on Saturdays to determine if we were meeting loan agreements. If not, we would make other types of manipulations of either arbitrarily moving expenses between companies or adding invented affiliate income or interest income from one internal company to another. For more than 10 years we kept two sets of books. Source: Chad Bray, “Adelphia Witness Lays Out Lies,” WSJ, May 19, 2004, pp. C-1 and C-2. I swear on my heart I was telling the truth at the time. Baby I lied. Baby I lied. Deborah Allen 130

Voice – Analysis Software
Developed in Israel; can be used over the phone. Nemesysco system. Measures stress levels and displays them on a screen. U.K. insurers are using it, connected between the telephone and computer. Screen flashes “High Stress.” 70% O.K. Of 30% high risk, 12% prove O.K., but 18% rejected as fraudulent. Source: Charles Fleming, “Insurers Employ Voice-Analysis Software to Detect Fraud,” WSJ, May 17, 2004, pp. B-1 and B-4. 131

Fewer People Lie in E-mail
People tell fewer lies in s than in phone calls and face-to-face conversations. Possible reason: Most people know that s leave a record. J. T. Hancock, Corporate Human Interaction I got one thing to tell you, I…oooo, I ain’t tryin’ to sell ya’, No lies. Grand Funk Railroad 132

Interviewing Techniques
“Bosch didn’t say anything. He knew that sometimes when he was quiet, the person he needed information from would eventually fill the silence.” (pp. 5-6). “Just listen. You are a detective. Detectives are supposed to listen. You once told me that solving murders are getting people to talk and just listening to them.” (pp ). Source: Michael Connelly, The Black Ice, St. Martin’s Paperback, 1993. 133

Progression of Interpersonal Communication
Investigative Communication Type Investigative Conversation Structured Investigative Interviewing Basic Forensic Interrogation Advanced Forensic Interrogation Time Requirements Flexible Thirty minutes to one hour Three to six hours Required Environment Private setting Intimate setting 134

Skill/ Training Requirements Minimal training required. Preferable to have training in active listening skills, question formulation and basic behavior analysis as well as psychology of investigative discourse. Minimum fifteen hours training in structured interview formats and behavior analysis. Minimum fifteen hours interviewing training plus thirty hours of training in Reid Nine Steps.* Minimum standards for structured formats and basic interrogation as well as minimum ten hours of advanced training. *Inbau, F.E., Reid, J. E. & Budkley, J.P. (1986) Criminal Interrogation and Confessions, third edition (Baltimore, Williams and Wilkins). Source: William Morrisette, Intuition, 21 Garden Avenue, North Providence, R.I 135

Appro- priate Use and Restrictions When you are looking for direction in an investigation. Result is a gamble rather than a predictable outcome When you have established the need for a formal investigation and are interacting with witnesses, victims, complainants or suspects. Must accept information as it is presented without confrontation. When you are interacting with an uncooperative suspect and require a truthful account of that person’s guilt. Make use of perception manipulation and as such requires comprehensive quality control. Most desirous form for uncooperative suspects of severe offences or suspects who may be emotionally unstable. Does not use perception manipulation and therefore beneficial when you need to identify true motivation for the offense. Source: William Morrisette, Intuition, 21 Garden Avenue, North Providence, R.I A Thousand Lies What is a man that stays true to the game But has to cheat a little to get by Well that is a person that I know too well What if a man doesn’t stay true to the game Don’t care for no one, only cares for his greed. Machine Head 136

Chance of Confession John Baldwin found in 600 investigative interviews that 35.7 percent of suspects confessed from the outset and an additional 16.2 percent confessed initially to part of the allegation. “Police Interviewing Techniques,” British Journal of Criminology, Vol. 33, 1993. William Morrisette believes that “an investigator who properly identifies and implements the appropriate investigative communication type should be able to achieve an 85 percent confession rate through basic interrogation and a 95 percent rate by way of advanced interrogation.” 137

Fraud Detection Questions
Reason Why? Do you know why you are here today? Principle: Innocent subjects will acknowledge the reason for the interview, while the guilty subject will generally avoid indicating knowledge of the issue. Wayne Hoover, “Non-Confrontational Approach to Interviewing,” NACVA’s Twelfth Annual Consultants’ Conference, Philadelphia, June 1-4, 2005. 138

Know/Suspect: Who do you think may have taken that $5,000 from the safe? Principle: Innocent subjects are more likely to volunteer a name or offer a suspicion. Wayne Hoover, “Non-Confrontational Approach to Interviewing,” NACVA’s Twelfth Annual Consultants’ Conference, Philadelphia, June 1-4, 2005. 139

Vouch: Is there anyone that you work with that you feel would not have taken that $5,000 from the safe? Principle: Innocent subjects will vouch for others, while the guilty will vouch for themselves or no one. Wayne Hoover, “Non-Confrontational Approach to Interviewing,” NACVA’s Twelfth Annual Consultants’ Conference, Philadelphia, June 1-4, 2005. 140

Think: Do you think that the $5,000 was actually stolen? Principle: Innocent subjects will generally agree that the money was actually stolen. Wayne Hoover, “Non-Confrontational Approach to Interviewing,” NACVA’s Twelfth Annual Consultants’ Conference, Philadelphia, June 1-4, 2005. 141

Opportunity: Who do you think would have the best opportunity to take that $5,000 from the safe? Principle: Innocent subjects will usually offer a name of an individual or named position who would have had the best opportunity. Wayne Hoover, “Non-Confrontational Approach to Interviewing,” NACVA’s Twelfth Annual Consultants’ Conference, Philadelphia, June 1-4, 2005. 142

Happen: What do you think should happen to the person who stole that missing $5,000? Principle: Innocent subjects will generally offer harsher punishment than the guilty. Wayne Hoover, “Non-Confrontational Approach to Interviewing,” NACVA’s Twelfth Annual Consultants’ Conference, Philadelphia, June 1-4, 2005. 143

2nd Chance: Would you be inclined to give someone a second chance? Principle: Innocent subjects generally continue to offer harsh punishment, while the guilty are more likely to offer a second chance. Wayne Hoover, “Non-Confrontational Approach to Interviewing,” NACVA’s Twelfth Annual Consultants’ Conference, Philadelphia, June 1-4, 2005. 144

Corporate Spies There are ways for businesses to protect themselves
from corporate spies. Personnel must be made aware of the damage from financial spies, and the normal closed-circuit cameras and security guards patrolling premises are important. Other preventive measures include An eavesdropping protection kit that releases a soft noise that blocks out voices, making it impossible for eavesdroppers to hear. A vanishing , called VaporStream, lets people send s that leave no trail. The s cannot be tracked copied, or printed. Cost is $40 a year. A wiretap-detection device that alerts you if a phone is being tapped, or if there is any interruption in the phone line. FiberGuard Net 800 uses fiber optics that send an alert if a fence or gate is cut or if someone climbs over the fence. Joseph Pisani, “Spy v. Spy: Corporate Espionage,” Business Week Online, October 2, 2006

Some Forensic Accounting Tools
Chain of Custody. Questioned Documents. Continuous Controls. Timeline Analysis. Tracing Schedule. Link Analysis. Invigilation. Genogram. Proof of Cash. Entity Charts. Full - and False – Inclusion Tools.

Chain of Custody Just as in the movies or on a television show such as CSI, forensic accountants must safeguard evidence through a financial chain of evidence. There must be a way to show that the evidence has not been tampered with or damaged. If documents are seized, the forensic accountant should put his or her initials and date of the seizure on the back of each document. Or put the document in a transparent envelope and write a description on the envelope. Store the original and work only with a copy.

Enforcement Manual Enforcement Manual
History and Custody of Documents U.S. Department of Labor Pension and Welfare Benefits Administration Date _______________________________ Case Number________________________ Case Name __________________________ 22. How were the documents obtained? ____ By consent (note any significant comments of the principal or third party witness and any unusual circumstances which occurred)? ____ By legal process (describe). What is the relationship between the documents and the person submitting them? 22. Were manual transcripts or facsimile copies made of any of the documents either in whole or in part?. ______ Yes ______No If Yes, list documents copies. Manner of reproduction 22. Have all copies been compared with the original documents and identified? _____Yes _____No If No, why not? Were the original documents described herein under your control or supervision at all times prior to their return to the principal, third party witness, or representative? _____Yes _____No If No, set forth circumstances of any transfer in control Did the principal, third party witness, or a representative request access to the documents during your custody? ___ Yes ___ No If Yes, who requested access and what action was taken? Signature ___________________ Title ________________________ PWBA (May 1987)

Continuous Monitoring
Correlation is well suited to environments where there are (a) a large number of audit units (departments, divisions, franchisees, or customers, etc.), (b) a series of time-stamped revenues, expenses or loss amounts, and (c) the goal of developing a formal process to compare each audit unit against a valid benchmark. Correlation and time-series analysis are techniques that could be used by forensic accountants in a monitoring role to find evidence of intentional or unintentional errors in situations where there are many audit units. The techniques could be used to proactively search for errors without any preconceived belief as to their existence, magnitude, or pervasiveness, or where the forensic accountant seeks to provide additional evidence showing that such errors occurred after the errors were detected using some other detection method. If intentional errors were discovered using other methods of discovery, then the techniques could be used by the forensic accountant to show that the revenue or expenditure or loss streams of an audit unit differed significantly from a valid benchmark. M. J. Nigrini, “Monitoring Techniques Available to the Forensic Accountant,” J. of Forensic Accounting, Vol. 7, 2006, pp 149

Continuous Monitoring
Management engages an independent outside supplier to install and manage software to continuously analyze every transaction within business applications to detect improper activities and anomalies that indicate errors, control overrides, and fraud [Oversight Systems]. The software sorts incidents into errors, misuse, and fraud (a detective control). Suspicious transactions can be identified and categorized for future follow-up. Flag items such as manual income-increasing adjustments, adjustments made late in the year, large dollar amounts. Large companies with revenues over $1 billion. Over the course of a year monitoring each module (e.g., A/P, Sales, G/L) is designed to cost approximately the amount the company would pay for one fulltime internal auditor per module. One company saved $2 million of external auditing fees for using C/M in the 404 area. D. R. Hermanson, B. Moran, C. S. Rossie, and D. T. Wolfe, “Continuous Monitoring of Transactions to Reduce Fraud, Misuse, and Errors,” J. of Forensic Accounting, Vol. 7, 2006, pp 150

Timeline Analysis Timeline analysis (TA) may be used to show the chronology of a dispute, and certain software tools can prepare trial exhibits. Investigative analysis software can show all detail from the beginning of the event until the apprehension of the target. TA helps forensic accountants communicate the timing of case related events and summarizes the investigation. Each link of the timeline chart includes a reference to a source or a direct link to a database. An insurance fraud scheme timeline from i2 Inc is shown in the next Table:

Insurance Fraud Scheme

Tracing Schedule A tracing schedule can be used to show the flow of funds from bank-to-bank, from bank-to-entity, from entity-to-entity, or from person-to-person. A tracing schedule is helpful in money laundering cases.

Link Analysis Link analysis (LA) is a subset of network analysis which shows associations between people and data. For example, a link analysis could compare the mailing addresses of company executives and the cell phone numbers that they have dialed during a given time frame. LA provides crucial relationships between many objects of different types that are not apparent from isolated pieces of data. Table 5.1 is an example of LA with respect to the primary suspect, David Hoover. Wikipedia, the free encyclopedia, en.wikipedia.org. Stuart Weiss, “Forensic Accounting Tools and Techniques,” The Value Examiner, January/ February, 2007, pp

Table 5.1 Link Analysis

Invigilation Invigilation is a rather expensive investigating technique that can be used in potential fraud situations to discover the fraud and can later be used in the courtroom. Here detailed records are kept before and after the invigilation period to determine the amount of fraud. During the invigilation period strict controls are imposed (e.g., cameras) so that the fraud is virtually impossible. Or the invigilation period could be while the suspect is on vacation.

Invigilation Technique
No controls Controls or vacation 14 days $67,000 lost $0 lost $62,000 lost

Genogram A genogram is a pictorial display of personal relationships among related or unrelated parties. There are software programs that are custom designed for genograms, such as GenoPro 2007 ($49 at Simple symbols represent the gender (box for male and circle for female), with various lines to illustrate family relationships. People who are not related would not be connected with a line, but could be placed on the genogram. They can lead to determining the motive of a crime or provide evidence that the person had no direct involvement in the fraud.

Genogram

Proof of Cash The proof of cash procedure is similar to a bank reconciliation, except more detailed and extensive. This procedure can be used to verify that cash accounts on the books are in agreement with the cash transactions recorded by the bank. The Wyoming Department of Audit’s proof is shown as Table 5.2.

Table 5.2

Entity Charts Entity charts show entities and owners with the relationship between them. The charts can show how income and assets are diverted, particularly among seemingly unrelated parties and entities. Microsoft Excel drawing tools may be used to prepare entity charts. For example, an entity chart could show the creation date of off-shore bank accounts and the subsequent decrease in the target’s U.S. bank accounts. Or identification of other unrelated parties may suggest additional investigation is needed. D. D. Dorrell and G. A. Gadawski, “Financial Forensics II,” May, 2005, Vol. 3, No. 3, p. 50.

Full – and – False Inclusion Tests
These tests are used to ascertain the proper universe of data under investigation, so that no appropriate data is excluded and no extraneous data is included. Full-and-false inclusion tests may be helpful for finding hidden assets.

Questioned Documents Invoices and other documents may be
fake or altered when Font sizes or types are not consistent No address is shown for the vendor or customer; this situation is especially suspicious if a vendor has not identified an address to which a check can be sent. The document has no identifying numbers such as invoice number, purchase order number, or customer number. All invoice numbers – on invoices from vendors – are numbered sequentially, with no numbers skipped. No tax is shown for taxable items. No shipping or freight cost is shown for items that would have been shipped at the purchaser’s expense. Little or no detail is provided on the invoice or document. T. W. Golden, S. L. Skalak, and M. M. Clayton, A Guide to Forensic Accounting Investigation, Hoboken, N.J.: John Wiley & Sons, 2006, pp

A Stamp Perforation match
Paper shreds demonstrating different optical properties under ambient and specialized lighting Inks of different intensities used on the same document

Expert Fees Collecting receivables?
What Can You Charge? Collecting receivables? Guide to Expert Fees, National Forensic Center shows a range of fees. You can charge Hourly rate Half-day Full-day Combination

Compensation Can charge variable rates Testifying/deposition $400
Research $200 Travel Time $100 May charge more for videotaped deposition. Some charge on a portal-to-portal basis or “turn off the meter.” Imitate attorney: charge for talking on phone, Internet searching, research. Your initial telephone conversation and forwarding your resume and contract agreement probably not chargeable--- marketing costs. Your rate should be the same for the plaintiff and the defendant.

Collecting Receivables
Get an advance. Keep the retainer until the final bill? Some experts make the retainer non-refundable. Get paid before you testify! Doctors set up a schedule of fee penalties for cancellations and postponements. Frequent billing is important. Offer a one or two percent discount if bill is paid within 10 days (especially for the government). Do not have contingency payments.

Deposition Answer I am being paid for my time, experience, expertise and my out-of-pocket expenses, and not for my opinion.

Top Niche Services 1. Business Valuations 89% 2. SOX Compliance 77%
3. Litigation Support 69% 4. Attest Services 67% 5. Estate/Trust/Gift 66% 9. Forensic/Fraud 56% Source: Accounting Today (2005).

Six Areas of Litigation Services
Damages Lost profits Lost value Lost cash flow Lost revenue Extra cost Mitigation Personal Injury Environmental Antitrust Analysis Price-fixing Market share, market definition Pricing below cost Dumping and other price distribution Anti-competition actions Monopolization Accounting CPA malpractice Bankruptcy/ reorganization Tracing Contract cost and claims Regulated industries Frauds (civil and criminal) Historical analyses Family law Valuation Business and professional practices Pension Intangibles/intelligent property Property General Consulting Arbitration Mediation Actuarial analyses Statistical analyses Projections Industrial engineering Market analyses Computer consulting Industry practices Merger/acquisitions Document management Analyses Tax bases Cost allocations Tax treatment of specific transactions Source: Management Advisory Services Technical Consulting Practice Aid 7: Litigation Services, (AICPA, 1986);

Forensic Accountant’s Knowledge Base
Law Investigative Auditing Criminology Forensic Accountant Computer Science Accounting © Hugh M. Christensen

Quotes “A lawsuit is like a parachute jump; you have to get it right the first time.” - Hal Rosenthal “The party who has command of the paper trail most often controls in the courtroom.” - D. Larry Crumbley

Foreign Language “Accounting concepts are a foreign language to some lawyers in almost all cases, and to almost all lawyers in some cases.” U.S. v. Kovel., 296 F.2d 922 (CA-2, 1961)

Three Branches of Government
Executive (regulations) Legislative law [takes precedence] Judicial law [a referee]

U.S. Tort Costs Climbing U.S. tort system cost $260 billion in 2004, which is $886 per U.S. citizen ($12 in 1950). U.S. tort costs accounted for 2.27% of GDP, (similar to 2003). In 2002, the increasingly inefficient U.S. tort system returns less than 50 cents on the dollar to people it is designed to help; only 22 cents to compensate for actual loss. Medical malpractice costs totaled nearly $28.7 billion in 2004, more than $91 per person (compared to $5 per person in 1975). Tort costs increased by a total of 40% in past 4 years. Tillinghast-Tower Perrin, U.S. Tort Costs: 2004 Update, December 10, 2005.

Camico August 2003 Survey · 62% of the prospective jurors agreed that a professional accounting firm would “look the other way” if a client violated the law in order to maintain the client relationship. · 57% of prospective jurors agreed with the statement “Accountants often manipulate their numbers and opinions to say what their clients want them to say.” 17% were neutral and 26% disagreed. · 74% of prospective jurors agreed that an auditor “should easily detect fraud.”10% were neutral and 16% disagreed. · Who is responsible for the legal and/or ethical problems facing corporate America? CEO, 70% Board of Directors, 55% Senior Executives, 68% Inside Accountants, 53% CFO, 62% External Accountants, 42% Inside lawyer, 58%

Civil Procedure Body of rules and practices by which justice is handed out by the legal system. Federal Rules of Civil Procedure (FRCP): governs U.S. district courts.* Federal Rules of Criminal Procedure. Federal Rules of Evidence. * Find at

Hard To Convict You have to remember one thing, and that is the fact that our laws aren’t designed to punish guilty people; they’re intended to protect innocent people. E.J. McMillan, The Audit, Churchton, MD: Harwood Publishing, 2000, p. 259. Robert Durst in Galveston, Texas admitted killing his neighbor, cutting up the body, and tossing the pieces in trash bags in the Gulf. He was found innocent. Deanna Laney claimed God ordered her to bash in the heads of her two sons. She was acquitted in April 2004 by a Tyler, Texas jury.

Hard To Convict I have never come to terms with a system based on the principle that it is better to let a hundred guilty people go free rather than wrongly convict one innocent person. It’s okay for people to be victimized again and again as long as no one is mistakenly locked up. Clinton McKinzie, The Edge of Justice, New York: Bantam Dell, 2002.

Tim McGraw’s Position “Well you do what you do, and you pay for your sins.” Tim McGraw’s “Red Ragtop” “ It’s a Great Day to Be Alive” Travis Tritt And it’s a great day to be alive I know the sun’s still shinin’ when I close my eyes There’s some hard times in the neighborhood But why can’t every day be just this good?

Miscellaneous Ideas A lawyer’s job is ultimately to avoid trial.
Largely uncontrollable variables such as individual juror predisposition, judicial bias and even the skill and acumen of opposing counsel make all trips before the bar of justice a veritable crapshoot. Therefore, opt for pre-trial settlement. As an investigator, your role in avoiding the cost and uncertainty of trial can not be overestimated. Source: H. Silverstone and M. Sheetz, Forensic Accounting and Fraud Investigation, Hoboken, N.J.: John Wiley & Sons, 2004, p. 233

Knowledge of Legal Concepts Necessary
Since forensic accounting is often used in legal forums, forensic accountants must be familiar with legal concepts and procedures. Nothing spoils a great case quicker than the lack of evidence. Expert opinions are evidence. FRE 702. Source: D.W. Squires, “Problems Solved With Forensic Accounting: A Legal Perspective,” Journal of Forensic Accounting, Vol. IV, 2003, p. 132.

Five Major Phases of Litigation
Pleadings Discovery [Much of our work occurs here]. Trial Outcome Possible Appeal

Pleadings Complaint – Plaintiff files.
Service of Process – served on defendant. Answer – Defendant must admit or deny allegations. Demurrer- No cause of action exists. Possible cross-complaint Sharp v. U.S., 199 F. Supp. 743 (D.Del 1961), aff’d 203 F.2d 783 (3rd Cir. 1962).

Major Ways to Sue Two major methods are 1) by ambush, and ) by serve and volley. With the ambush, we would prepare the skeletal framework of our allegation, run to the courthouse, file the suit, leak it to the press, and hope we could prove what we thought we knew. The advantage was surprise, and embarrassment for the defendants, and, hopefully, public opinion. The downside was the legal equivalent of jumping off a cliff with the strong, but unconfirmed, belief that there was a net down there somewhere. The serve and volley would begin with a letter to the defendants, in which we made the same allegations, but rather than sue we would invite them to discuss the matter. The letters would go back and forth with each side generally able to predict what the other might do. If liability could be proved, then a quiet settlement would probably occur. Litigation could be avoided. Source: John Grisham, The Street Lawyer, New York: Bantam Dell, 1998, p. 274

Expert Witnessing Our purpose: Assist the trier of the facts.
Question of Facts v. Question of Law [not always clear]. Negligence may be either.

Frequent Terms (1) Appellant (Petitioner) (Plaintiff): Person filing suit. Respondent (Defendant): Person sued. Stare decisis: case once decided, will control. Doctrine of precedential authority: follow prior case only where issues/facts are essentially the same. Judge not required to follow judicial precedent beyond own jurisdiction.

Frequent Terms (2) Res judicata (collateral estoppel): Once case or issue resolved, matter precluded from being litigated again. Law of the case: Once an issue decided one way, if not properly challenged, will not be reconsidered. Full Faith and Credit Clause: Court in one state must honor and enforce judgment of another state. Venue: The appropriate court to bring a dispute (cause of action occurs or where crime committed).

Frequent Terms (3) Pro se: Party representing himself or herself.
Per curiam: Decision of the whole court. en banc: decision rendered by full court. Concurring opinion: Agrees with court’s conclusion, but… Dissenting opinion: Disagrees with majority. Dicta (Dictum): incidental facts; not binding on future cases. 30 (b) (6): names a public or private organization for deposition.

Frequent Terms (4) Affirmed (aff’d; aff’g): agrees with lower court.
Reversed (rev’d; rev’g): disagrees with lower court. Writ of Certiorari: Asks Supreme Court to hear your case. Cert. Granted Cert. Den. Remand: Vacate the lower court decision and send back for further considerations Overruling: Does not impact either party in the earlier case. Overrules a previous case

Frequent Terms (5) Ad hoc: for one particular or special purpose (e.g., an Ad hoc committee) Ad valorem: According to value (e.g., in tax, assessment of taxes based on property value). Bona fide: in good faith and without fraud or deceit. Covenant: an agreement or promise to do or not to do something. Dejure: in law or lawful; legitimate. Deposition: A written statement of a witness under oath, often question/answer

Frequent Terms (6) Enjoin: to command or instruct with authority (e.g., judge can enjoin someone to do or not to do something). Habeas corpus (writ of): procedure to determine if authorities can hold a person in custody. Nolo contendere: a party does not wish to fight or continue; person will not fight a charge. Parol evidence: renders any evidence of a prior understanding of a party to a contract invalid if it contradicts the term of a written document.

Frequent Terms (7) Brief – written arguments supported by citations of court decisions, statutes, and other authorities. Stipulation – voluntary agreement before trial between opposing parties concerning the disposition of certain facts or points. Amicus-curiae – a brief filed by a party not directly related to a lawsuit. Habeas corpus – a writ which permits a prisoner to challenge a conviction on constitutional grounds. Executor/executrix – one appointed by a will to execute the provisions. Ex parte hearing – court hears only one side of an issue. Special Master – appointed by a court or judge to decide certain facts, etc. Pro bono- providing a professional service without compensation.

Frequent Terms (8) Subpoena ad testificandum – command to appear and testify as a witness. Default judgment – judgment won by the plaintiff because the defendant failed to respond to a summons or appear at trial. De novo – new; a new proceeding without regard to prior legal actions. Double jeopardy – prohibition in the U.S. Constitution, 5th amendment, against trying a citizen twice for the same crime. Enabling act – legislation by which an administrative agency is created and powers are delegated to it. Jurisdiction – power of a court to hear and decide the issues in a case and to bind the parties. Long-arm statute – a state law extending personal jurisdiction over out-of-state persons (including corporations).

Frequent Terms (9) Pleadings – papers in court, with copies to other parties, in preparation for bringing or defending a lawsuit. Scienter – with intent to deceive; with guilty knowledge. Voir dire – jury selection process; lawyers and judges ask. Actus reus – brought about the criminal act. Mens rea – caused the criminal act with guilty knowledge; state of mind indicating culpability. Staples v. U.S., 511 U.S. 600 (1994). Preponderance of the evidence – greater than 50%. Civil trial. Clear and convincing evidence – ca 70%. Beyond a reasonable doubt – greater than 95%. Criminal trial.

Frequent Terms (10) Bates numbers - a numerical or alphanumeric system placed on documents retrieved during the discovery process. Stipulations – before trial the parties agree to certain facts to simplify the trial. Ipse Dixit- thing speaks for itself. Sidebar – discussion between judge and lawyers at the bench, outside the hearing of the jurors. Soddit- Some Other Dude Did It! Vacatur- a decision is set aside, annulled, or vacated.

Frequent Terms (11) Chain of custody – accounting for evidence and documents from the time obtained until the end of the trial. Capias – a court writ directed an officer to arrest a person. Ad damnum – the damages claimed by a plaintiff. Demurrer – plea for a dismissal of a dispute on the grounds that even though the plaintiff’s arguments are true, they are insufficient to sustain a claim. Intestate – one dies without a will. Stay – delay a legal order (e.g., an execution).

Marketing of Services Internet Sites- give-way something free.
Potential/Client Database Contacting Attorney/Judges/ Networking. Articles/columns/reprints. Direct Advertising-Yellow Pages. Listing in Internet Sites/referral services. Speaking engagements. Conventions/seminars/meetings. Books. Direct Mail Advertising Brochures

More Marketing Inform your immediate circle. Create referrals from your peers. Build relationships with other expert witnesses. Trade business with your competitors. Ask for referrals. Send thank you notes.

Network with Attorneys/Judges
Adopt a networking mentality. Do not be timid. Meet attorneys speaking at expert witness conferences. Become involved with law schools in your area. Exhibit at state bar and trial attorney association conventions. Socialize with attorneys at judicial fundraisers. Contribute to and attend attorneys’ charity events.

Network with Attorneys/Judges
Attend Continuing Legal Education Classes. Teach CLE classes for attorneys. Go where the attorneys/judges are. Attend attorneys’ group meetings. Nametags. Keep in touch.

Staffing “Rather than combing through torn clothing,” forensic accountants “comb through corporate books, looking for oddities that could signal swindles,” says Bruce Dubinsky. Investigations can be extremely complex, with crates and crates of documents and thousands of computer files. Investigators look for flags or patterns that would not normally occur. Source: Mark Maremont, “Tyco Is Likely to Report New Woes,” Wall Street Journal, April 30, 2003, p. C-1.

Staffing “Forensic accounting is very different from auditing in that there is no template to use. There are no set rules. You don’t know when you go into a job how it is going to be.” Lorraine Horton, Kingston, R.I “Forensic accounting “is a very competitive field. What is interesting is that you may be a good accountant, but not a good forensic accountant. The training and the way you look at transactions are different.” Robert J. DiPasquale, Parsippany, N.J. “Unlike auditing, lower-level staff often can’t be used for an engagement. They normally will not spot anything out of the ordinary, and an experienced person should be the one testifying as well as doing the investigative work.” Lorraine Horton, Kingston, R.I. Source; H.W. Wolosky, “Forensic Accounting to the Forefront,” Practical Accountant, February 2004, pp

Documentation Engagement Letters Expert Reports
Have a document referencing system. Reference sources of your work. Avoid writing notes on your files. For charts, reference sources on back. Be careful, everything may be discoverable.

Bates Numbers Unpublished- some federal appellate opinions are not published in the Federal Reporter, but after January 1, 2001 now appear in West publication known as the Federal Appendix. Sometimes called nonprecedential, they are not binding. About 40% of Federal appellate Daubert decision are unpublished.

Attorney: Walking Away
You got to know when to hold ‘em, know when to fold ‘em, know when to walk away, know when to run. You never count your money when you’re sitting at the table. There’s be enough time for counting them when the dealing’s done. The Gambler by Kenny Rogers

That First Telephone Conversation
Answer all the questions and keep the conversation simple and to the point; avoid hesitation and long pauses. The attorney is well experienced is asking questions; in a sense, you are being cross-examined. Let the attorney explain fully the case, in his way at his pace. Be a good listener ( attorneys like that). Ask as many questions as necessary in order for you to understand the case. Show that you know what you need to know in order to evaluate the situation. If you have been contacted by the opposing party in this particular matter, immediately disclose that to the caller. Some courts do not allow an expert to testify for one side if he has been contacted previously by the opposing side. When asked your expertise and experience, especially in the particular area of interest, be succinct. Say, “ I have given expert testimony in

The First Telephone Conversation
ten or twelve such cases over the past four or five years,” instead of trying to enumerate each case. Avoid arrogance. Show your desire to meet with him soon at a time and place most convenient for him. He may simply ask you to mail, or fax your CV and fee schedule, and later may retain you on basis of this material- and the phone conversation. (What’s more likely, however, is that the attorney will want to meet with you to personally evaluate your demeanor and dress.) Be firm and direct so that the attorney will feel confident in retaining you. If the conversation goes on at length or otherwise appears that the attorney is serious about engaging your services, you might want to ask some questions: Is he a one-man operation or part of a large law firm? How large is his staff? What back-up does he have (e.g., how many paralegals)?

The First Telephone Conversation
What is his experience in using experts in general and experts in your particular field? How did he get your name? Source: Jesse E. Dines, Expert Witness Manual, Irvine, CA: Pantex International, 2004, Ch.12. The attorneys each acted in the role of opposing movie directors--calling witnesses and orchestrating carefully timed presentations. All of it designed to sway the jury’s disposition in favor of their respective client’s position. Civil cases, like this one, are decided based only on which side has the greatest preponderance of evidence in its favor. Evidence of guilt or innocence beyond a reasonable doubt is the criterion for deciding criminal cases only, and therefore did not apply to this case. It turned out my role was relatively small in this case, but the per diem fees were quite substantial. I.W. Collett and D. Forgione, Costly Reflections in a Midas Mirror, Thomas Horton and Daughters, p.131

Finding Information About Attorneys
Search on Internet ( e.g., Legal Database, Legal Match, Thompson FindLaw) American Bar Association Martindale- Hubbell, paper and internet Prentice-Hall Directory

The Federal Judicial System
SUPREME COURT 9 Justices U.S. COURT OF APPEALS Federal Circuit (Created in 1982 by a congressional statute; formed by merging the Court of Claims and the Court of Custom and Patent Appeals; sit in panels of three on cases involving customs, copyright, trademarks, and patents.) U.S. COURT OF APPEALS 12 Circuits (Three-judge panels, not the entire circuit court, hear most cases.) U.S. DISTRICT COURTS 50 States Washington, D.C., Puerto Rico, Virgin Islands, Guam* U.S. Tax Court 19 judges, with 1 judge hearing most tax cases ADMINISTRATIVE AGENCIES (In some cases, appeals to a U.S. District Court, instead of the circuit courts.) U.S. Court of Federal Claims and some special agencies (e.g., Board of Contract Appeals, Patent/Trademark Boards, and Merit Systems Board) U.S. COURT OF INTERNATIONALTRADE (Created in 1980, formerly the U.S. District Court, instead of the circuit courts.) U.S. BANKRUPTCY COURTS U.S. MAGISTRATES * Patent disputes go from the district courts to the Federal Circuit.

Some Judicial Facts Have right to jury trial in district court, but jurors can only determine facts (not law). No jury trial in probate, family law, estate issues equitable issues, Tax Court, and Court of Federal Claims Automatic right to appeal from trial court to the first level of the appellate process. But higher court (e.g., Supreme Court) must decide whether to hear dispute. To get to Federal court, must raise the question of a federal law or diversity of citizenship (e.g., different state) For Federal court, controversy must exceed $75,000. State courts have trial courts, appeals courts, and supreme court.

Facts Determination The Seventh Circuit had this to say about a trial court’s right to determine facts: The trial court … has ‘the best opportunity to observe the verbal and nonverbal behavior of the witnesses focusing on the subject[s]’ reactions and responses to the interrogatories, their facial expressions, attitudes, tone of voice, eye contact, posture and body movements, as well as confused and nervous speech patterns in contrast with merely looking at the cold pages of an appellate record. Source: United States v. Duarte, 1 F.3d 644, 651 (CA-7, 1993), cert. denied, 510 U.S. 1058, 126 L.Ed. 2d 688, 114 S. Ct. 724 (1994).

Helpfulness Helpfulness to the trier of the facts is the ultimate touchstone for the admissibility of expert testimony. To be helpful the (1) witness must be qualified as an expert, (2) expert must have a reasonable factual basis for the testimony, (3) testimony must be based upon reliable methods, and (4) testimony must be relevant to the facts in dispute. Accounting testimony can be the subject of expert testimony. Sources: In Re Paoli Railroad Yard PCB Litigation, 916 F.2d 857 (CA-3, 1990). Fed. Rul. Evidence 702 and 703; General Electric Co. v. Joiner, 522 U.S. 136 (1997). Computer Systems Engineering, Inc. v. Qantel Corp., 740 F.2d 67 (CA ).

The Judge Controls A 2000 dispute involved an alleged Ponzi scheme where a defendant sold airline tickets procured by debtors using frequent flier miles purchased by brokers. The defendant relied on an expert who was a CPA, a bankruptcy trustee, an insolvency accountant, and a fraud investigator with substantial experience and impressive qualifications and credentials. The judge, Herbert A. Ross, was not impressed with this expert, F. Wayne Elggren, employed by Arthur Andersen. At trial Mr. E questioned the experts of the trustee and the expert of the plaintiff (who had no CPA or certification). Mr. E found numerous faults with the methodology and analysis of the trustee and the plaintiff’s expert, E. Jayne MacPhee. Mr. E concluded his argument by stating there was too much unaccounted for cash and profits from the ticket business to claim it was a sham or Ponzi scheme. He relied on a “smoking gun” of $9 million in ticket revenues. Ms. MacPhee found only $6 million and the trustee only $4.8 million. The judge said that Mr. E had misunderstood or had been misadvised about the context of the $9 million of ticket sales “He [Elggren] is hoisted on his own petard when he uses it to analyze the debtors’ business history.” The rest of his criticisms are of “such small size or consequence, or so speculative or inclusive, that they are akin to straining at gnats.”

The Judge Controls The judge had this to say about MacPhee’s lack of a CPA degree or certification in certain accounting fraud detection professional organizations and Mr. E’s criticism of her: The type of expertise truly needed in this case is someone who can take poorly kept, incomplete records, involving commingled funds, and reconstruct the business out of them. MacPhee has training in accounting matters and experience in forensic accounting situations. She has worked as an accounting analyst reconstructing what really happened in the M&L Business Machine case, one of the major Ponzi schemes to reach the bankruptcy courts. Experience and training, despite the lack of a specific degree or designation, qualify her to render an expert opinion on accounting matters related to the reconstruction or analysis of business records, especially when a Ponzi-type business, with commingling of funds, is suspected. While she does not have the credentials of belonging to all the professional groups that Mr. E does, she has accounting training and experience in working on Ponzi cases, and has done an admirable job in assisting the court in understanding debtors’ operations - - a much more intellectually honest job than Mr. E at that. She qualifies as an expert in reconstructive accounting in a situation where the books and records are incomplete and not up to standards, and the funds of the debtors are commingled.

The Judge Controls Likewise, the trustee, even though he is a party, may qualify as an expert, even though his bias can be challenged. He is a CPA and a panel trustee in Alaska, which have given him on-the-job experience in understanding and reconstructing financial transactions. Judge Ross concluded as follows: In short, I find that Mr. E’s report is based on substantial factual mistakes, speculation, innuendo, and inferences which are not supported by full explanations and analysis. It is not worthy of an expert of his caliber, nor worthy of admission as evidence in this case. His expert opinion will be excluded. Source: In re Bonham, 55 Fed. Rul. Evidence Serv. (Callaghan) 419; 2000 Bankr. Lexis 727.

Motion: Requests a rule or order in favor of the applicant
Motions Motion: Requests a rule or order in favor of the applicant Motion to dismiss: The moving party is requesting that a cause of action be dismissed because the alleged facts, even if proven, do not constitute a valid legal claim. Motion for a directed verdict: The moving party requests at trial that a cause of action be dismissed because the party with the burden of proof has failed to establish sufficient facts so that a reasonable fact finder (e.g., the jury) could find in the claimant’s favor. For example, in a complex toxic tort case, the plaintiff’s only expert witness is barred from testifying as to causation under the Daubert rule. After the plaintiff rests, the defense moves for a directed verdict on the grounds that the plaintiff has not submitted sufficient proof of causation through an expert witness. Motion for judgment notwithstanding the verdict: This motion is made by the losing party after an adverse jury verdict. The moving party is asking that the judge reverse the verdict of the jury. These motions may be granted if the judge determines that the jury verdict had no reasonable support in fact or was contrary to law. Motion for a continuance: The moving party is requesting that a scheduled event, for example a hearing or trial, be postponed or continued to a later date. Motion in limine: The moving party is requesting that evidence it expects the opposing side to offer be held inadmissible. For example, a party may make a motion in limine to exclude the testimony of an expert for failure to comply with the Daubert rule. Motion for summary judgment: The moving party is requesting, prior to trial, and based solely on documentary evidence (including expert deposition transcripts, reports, and affidavits), that the court grant judgment in its favor because no material facts are in dispute. This device is used to throw a case out of court without it ever getting to the jury. Many times a lawyer with a weak case will seek to survive summary judgment in order to be able to settle the case on favorable terms over the threat of a jury trial. Source: Babitsky et. al, The Comprehensive Forensic Manual, Seak, Inc.,

Discovery: process of getting information from the other party
Fed. R. Civ. Pro. 26(b)(1). Parties may obtain discovery regarding any matter, not privileged, which is relevant to the subject matter involved in the pending action, whether it relates to the claim or defense of the party seeking discovery or to the claim or defense of any other party, including the existence, description, nature, custody, condition, and location of any books, documents, or other tangible things and the identity and location of any persons having knowledge of any discoverable matter. The information sought need not be admissible at trial if the information sought appears reasonably calculated to lead to the discovery of admissible evidence.

Privilege: discovery may not be made of privileged matters
Attorney – client Husband – wife Physician – patient Government secrets Ordained clergyman-parishioner Attorney work product [FRCP 26 (b)(3)] [But not experts who will testify] Something is happening here, but you don’t know what it is, do you, Mister Jones?” Ballard of a Thin Man Bob Dylan (1965)

Elements of the Attorney-Client Privilege
Communication. Between attorney and client. For obtaining legal advice or services. Intended to be confidential. Privilege is not waived. [Be careful with s and cell phones.] U.S. v. United Shoe Machine Corp., 89 F. Supp. 358 (D. Mass. 1950)

Work Product Privilege: Tug of War
Fed. Rul. Of Civil Procedure 26(b)(3): Subject to the provisions of subdivision (b)(4)…, a party may obtain discovery of documents... Prepared in anticipation of litigation or for trial by or for another party or by or for that other party’s representative (including the other party’s … consultant, …) only upon a showing that the party seeking discovery has substantial need of the materials in the preparation of the party’s case and that the party is unable without undue hardship to obtain the substantial equivalent of the materials by other means. In ordering discovery of such materials when the required showing has been made, the court shall protect against disclosure of the mental impressions, conclusions, opinions, or legal theories of an attorney or other representative of a party concerning the litigation.

Split in Federal Courts: Tug of War
Majority of courts: a bright-line rule mandating disclosure of all documents, including attorney opinion work product given to testifying experts. In re Pioneer Hi-Bred International, Inc., 238 F.3d 1370 (Fed. Cir. 2001). Regional Airport Authority of Louisville and Jefferson County v. LFG, LLC, 460 F.3d 697 (CA-6, 2006). Trigon Ins. Co. v. U.S., 204 F.R.D. 277 (E.D. Va, 2001). Elm Grove Coal Co. v. Director, Office of Workers’ Compensation Program, U.S. Dept. of Labor, 480 F.3d 278 (CA-4, 2007). Fidelity Nat’l Title Ins. Co. of N.Y. v. Intercompany Nat’l Title Ins. Co., 412 F.3d 745 (CA-7, 2005). Kern River Gas Transmission v. 617 Acres of Land, 156 Fed. App. 102 (CA-10, 2005). Minority of courts: Allow some flexibility University of Pittsburgh v. Townsend, WL (E.D. Tenn., 2007). Haworth, Inc. v. Herman Miller, Inc., 162 F.R.D. 292 (W.D. Mich., 1995).

Protecting Work Product Privilege
Attorney should directly retain the consultant. Agreement should be between attorney and expert. Expert should obtain facts through, or at direction of the attorney. Investigation should be done at the direction of attorney. Attorney included when meeting with client. Source: Zeph Telpner and Michael Mostek, Expert Witnessing in Forensic Accounting, Boca Raton, FL: CRC Press, pp. 209 – 237. If opinion work product is shared with a testifying expert, it is discoverable (e.g., Lamonds v. General Motors Corp., 180 F.R.D. 302 (W.D. Va. 1998)

SAMPLE AGREEMENT Our understanding is that you have retained us as consulting experts. If you decide to change our status to that of testifying experts, we will return all documents, records and any work product to you and request from you only those documents and records necessary for our testimony.

Accountant Privilege (§7525)
Taxpayer’s communications made to federally authorized tax practitioners (e.g., lawyers, CPAs, enrolled agents) Applies only to tax advice: given by an individual regarding a matter that is within that individual’s authority to practice as a federally authorized tax practitioner under Treasury Circular 230. I.R.C. §7525(a)(3)(B)

Accountant Privilege (§7525)
Contains many exceptions, either poorly or not at all defined, thus limiting the privilege’s effectiveness in protecting the confidentiality of taxpayer communication. Can not be asserted in (1) criminal tax matters, (2) investigations by regulatory agencies, and (3) tax advice regarding the promotion of corporate tax shelters. Source: R.J. Buchanan, “Corporate Tax Shelter Exception to the Accounting Client Privilege,” Tax Notes, September 16, 2002, p

Accountant Privilege contd …
Tax practitioners are not entitled to privilege when they are doing other than lawyers’ work. Information provided to a practitioner for purposes of preparing a client’s tax return is not privileged. U.S. v. Frederick, 182 F.3d 496 (CA-7,1999) Federal District Court: Most tax advice falls into the category of return preparation for which there is no privilege [U.S. v. KPMG, No (D. D.C. Dec.20, 2002)] The practice of tax is not the practice of law (U.S. v. KPMG).

Evidence KPMG is fighting clients about questionable tax-shelter products. The IRS disclosed s dated March 14, 1998, in a Tax Court case involving an estate in litigation against the IRS. The s document discussions among high level KPMG executives about a product known as FLIP. One of the s referred to the product’s “troublesome issues.” s created on a company’s system belongs to the company. evidence has been used in cases involving accounting fraud, harassment, antitrust, discrimination, retaliation, whistle-blowing, insider trading, trade secrets, and more. Discovery is broad: instant messages, web visit logs, hard drives, PDA’s, pagers, voice mail, laptops, back up tapes, and cell phones call records. Source: Rita Risser, “ = Evidence: How to Protect Yourself,” Fair Measures.

E-mail Evidence (cont.)
In October, 2003, a special master recommended to federal court that KPMG does not have to produce many tax-shelter documents. In mid-October 2003, a federal judge blocked prosecutors from using an that Martha Stewart wrote to her attorney as evidence in her upcoming trial. She had forwarded the same to her daughter the next day after sending it to her attorney. Source: Rita Risser, “ = Evidence: How to Protect Yourself,” Fair Measures.

Best Practices Know and follow employer policies.
Assume a boss or judge is reading your . Don’t send s in anger. Do not be sarcastic. Don’t send or receive jokes from work. Insure mail lists are current for confidential information limit copies. Do not mark ‘Attorney-Client’ unless authorized. Don’t mark ‘Company Confidential’ unless authorized. Source: Rita Risser, “ = Evidence: How to Protect Yourself,” Fair Measures.

Dangers Aiding and abetting is a favorite phrase on cop shows and courtroom dramas. For Motorola Inc. and Scientific-Atlanta Inc., the phrase is hitting close to home these days. The names of both companies have surfaced frequently in the federal fraud trial of four former executives of Adelphia Communications Corp., most recently in an message read aloud in court earlier this week that indicated top Scientific-Atlanta executives approved a transaction that allegedly helped Adelphia cook its books. The electronic message, read by a defense attorney, comes on top of earlier testimony about the same set of transactions by the government’s star witness, former Adelphia finance executive James R. Brown. Source: Jesse Drucker and Mark Maremont, “An Casts Two Key Suppliers As Adelphia Abettors,” WSJ, June 1, 2004, p. C-1.

IRS Summons Accountants have very little protection under federal law from the enforcement of IRS Summons. Couch v. U.S., 409 U.S. 322 (1973). U.S. v. Arthur Young & Co., 465 U.S. 805 (1984).

Methods of Discovery Interrogatories: Written questions [FRCP 33(a) – max. 25 / 30 days]. Requests for Production of Documents. Depositions [FRCP 30(a): limits each side to 10]. Subpoenas duces tecum: request for specified documents for inspection and copying (especially from people not parties to a lawsuit, e.g., expert witnesses). Physical examination. Production of tangible things and entry upon land.

Experts’ Depositions Covered by FRCP 26 (b) (4) (A).
Can not occur until attorney has disclosed the required written report. Have no right to attend another expert’s deposition. Some beach somewhere, There’s a beautiful sunset burnin’ up the atmosphere. Blake Shelton

Civil Trial Jury selection and Pre-Trial Motions. Opening Statements.
Burden of Proof: In Civil trial, preponderance of evidence – 51% or greater. Sometimes, higher clear and convincing evidence. For the opinion of an expert to be admissible, it must meet the 51% test: “My opinion is based upon a reasonable degree of scientific (or medical or economic or accounting) certainty.” Otherwise, opinion may be stricken from evidence.

Pyrrhic Civil Victory Even if you win at a civil trial, no assurance that any award will be paid. O.J. Simpson, $474 million. Robert Blake had a $30 million civil judgment against him. He declared bankruptcy.

Incentive Test A(n) ______ is a device used by courts to have disputing parties to agree in advance of a trial to facts, evidence, etc. A(n) _____ _____ brief is filed by a party not directly related to a lawsuit. The _____ _____ doctrine states that a case once decided will control. The appropriate court to bring a dispute is called _____ . ______ is opinions of a judge which goes beyond the facts before the court and are not binding on future courts as precedent. A higher court ______ a lower court decision and sends it back for further consideration. You file a writ of ______ to ask the Supreme Court to hear your dispute. _____ _____ refers to a decision of the full court. A ________ is a written statement of a witness under oath, often in a question/answer format.

Incentive Test The ____ _____ is preliminary questioning by the court (or lawyer) of jurors to determine competency. A motion in _____ is a request before trial that evidence (or expert) of opposing side is inadmissible. The complaint and answer would be called the _____ . The _____ is the person sued. A subpoena _____ _____ is a command to produce documents to a court that become evidence. A subpoena _____ _____ is a command to appear and testify as a witness. A(n) _____ _____ is appointed by a court or judge to decide certain facts, etc. Models, forms, and exhibits would be considered ______ evidence. ______ ______ means a party is representing himself.

Incentive Test A(n) stipulation is a device used by courts to have disputing parties to agree in advance of a trial to facts, evidence, etc. A(n) amicus curiae brief is filed by a party not directly related to a lawsuit. The stare decisis doctrine states that a case once decided will control. The appropriate court to bring a dispute is called venue . Dicta is opinions of a judge which goes beyond the facts before the court and are not binding on future courts as precedent. A higher court remands a lower court decision and sends it back for further consideration. You file a writ of certiorari to ask the Supreme Court to hear your dispute. En banc refers to a decision of the full court. A deposition is a written statement of a witness under oath, often in a question/answer format.

Incentive Test The voir dire is preliminary questioning by the court (or lawyer) of jurors to determine competency. A motion in limine is a request before trial that evidence (or expert) of opposing side is inadmissible. The complaint and answer would be called the pleadings . The respondent is the person sued (defendant). A subpoena duces tecum is a command to produce documents to a court that become evidence. A subpoena ad testificandum is a command to appear and testify as a witness. A(n) special master is appointed by a court or judge to decide certain facts, etc. Models, forms, and exhibits would be considered demonstrative evidence. Pro se means a party is representing himself.

Getting Paid The other side schedules a deposition, deposes you, and does not pay you a reasonable fee. Who is required to pay you? Fed. R. Civ. Pro. 26(b)(4)(c): The party seeking discovery pays the expert a reasonable fee for time spent in responding to discovery.

Evidence “Anything perceivable by the five senses, and any proof such as testimony of witnesses, records, documents, facts, data, or tangible objects legally presented at trial to prove a contention and induce a belief in the minds of a jury.” Black’s Law Dictionary A trial is too important to put in the hands of the jury. Runaway Jury

Best Evidence Rule Under the best evidence rule (also referred to as the original writing rule), to prove the contents of a writing, recording, or photograph, the original writing, recording, or photograph usually must be presented.

Two Types of Evidence Direct evidence: directly proves a fact at issue, without the need for an inference or presumption (e.g., testimony of a witness). Circumstantial: a fact or issue may be proved indirectly (e.g., a person was present at the time of the theft). Law does not value circumstantial evidence any less than direct evidence.

Ensuring Admissibility
Assume that documents or other evidence one handles may be used in a legal proceeding. Do not mark, staple, or otherwise alter the document. Record how you obtained the evidence and who handled it. Keep evidence in a secure location – fireproof safes or locked cabinets. If possible, avoid putting your or other investigators fingerprints on the document. Use see-through holders. Internal auditors at WorldCom worked at night and put much of the records on personal CD ROMS (e.g., bought own CD burner).

Ink Analysis Martha Stewart was undone by a blue ballpoint pen.
Stockbroker belatedly inserted a note to help cover up Ms. Stewart’s improper stock trading. Blue ballpoint ink used is different from ink elsewhere on the trading worksheet. Prosecutors used forensic ink analysis in Rite Aid case to show that certain documents were backdated (ink used to sign letter was not commercially available until 3 months after the letter was dated). Xerox laser printers now encode the serial number of each machine in tiny yellow dots in every printout, nestled within the printed words and margins. It tracks back to you like a license plate. Fraudsters: use pencil. Source: Mark Maremont, “In Corporate Crimes, Paper Trail Often Leads to Ink Analysts’ Door,” Wall Street J., July 1, 2003, p. A-1.

Computer Forensics Important
Joan Feldman: “Within three years, I’m sure all evidence collected in discovery will be electronic-based.” President of Computer Forensic, Inc. (Seattle). Players from three areas: Accounting-forensic units of big CPA firms. Data-recovery and computer-repair specialists, Litigation support services. “Corporate investigations used to mean following a paper trial, but these days many follow an electronic one. Increasing demand for the skill and technology necessary to unearth digital secrets has led to the birth of a small but growing industry: computer forensics.” “They can dig up and documents that seemingly have been deleted, determine what web sites were visited and which key words were used to get there.” Source: Ellen Byron, “Computer Forensics Sleuths: Help in Rooting Out Fraud,” Career Journal, Wall Street J., reviewed June 16,

Computer Forensics Primer
Defined: acquiring and analyzing digital evidence in a manner that protects the integrity of the evidence to investigate a potential fraud. Currently only 5% of fraud investigations use electronic data in investigations. This low percentage is likely because much of the collected digital evidence is forensically unusable. SAS No. 99: In an IT environment, it may be necessary for the auditor to employ computer-assisted audit techniques (for example, report writers, software or data extraction tool, or other system-based techniques) to identify the journal entries and other adjustments to be tested. [par. 61]. Source: G.S. Smith, “Computer Forensic: Helping to Achieve The Auditors Mission,” Working Paper, December 2003.

Digital Evidence: Today’s Fingerprints
“The sight of hard drives, Internet files, and as courtroom evidence is increasingly common.” “In the wired world almost every crime intersects with the digital realm at one time or another.” “Laptops, digital cameras, phones and hard drives provide mountains of raw data for experts to sift through, part of the expanding field of computer forensics.” “A single file, credit card purchase or stray messages can provide the proof that clinches a case.” Source: Michael Coren, “Digital Evidence: Today’s fingerprints,” Digital+evi…

Data Extraction v. Data Investigation
There is a difference between the procedures used for traditional data extraction (i.e., data mining) and data investigation for evidentiary purpose. With traditional data extraction, tools such as Interactive Data Extraction and Analysis (IDEA) or ACL software are used to interactively extract, sample, and analyze data. Yet simply checking a client’s files or cross comparing data, files for forensic investigations are damaged. Such actions are similar to sending a housekeeper in to tidy up a murder crime scene before the forensic investigative team is allowed to start analyzing the evidence. For forensic purposes, software tools collect digital data without changing it. After the data is collected, it is analyzed. Examples of forensic software tools are Encase, SafeBack, or Ontrack’s Easy Recovery software. Increasing the time lag between initial fraud suspicions and the recovery of the related digital data makes the evidence less valuable. Source: G.S. Smith, “Computer Forensics: Helping to Achieve The Auditor’s Mission,” Working Paper, December 2003.

Data Mining Data mining is an information extraction technique designed to discover hidden facts or red flags that may indicate previously undetected fraud, abuse, waste, or mismanagement. Using a combination of statistical analysis algorithms, exploratory analyses, modeling techniques and data base technology, data mining finds patterns and subtle relationships in data. One can not push a button and expect the software to pick the one bad apple out of the panel. Source: B.L. Derby, “Data Mining for Improper Payments,” Journal of Government Financial Management, Winter, 2003 Vol. 52, No. 4, p. 11.

Gene Morse Used Data Mining at WorldCom
The beauty of the new [software] system, from Mr. Morse’s perspective, was that it enabled him to scrutinize the debit and credit side of transactions. By clicking on a number for an expense on a spreadsheet, he could follow it back to the original journal entry – such as an invoice for a purchase or expense report submitted by an employee, to see how it had been justified …. By the first week in June, Mr. Morse had turned up a total of $2 billion in questionable accounting entries. Mr. Morse grew increasingly concerned that others in the company would discover what he had learned and try to destroy the evidence, he says. With his own money he went out and bought a CD burner and copied all the incriminating data onto a CD-ROM. He told no one outside of internal audit what he had found. Source: Pulliam Susan, Deborah Solomon, “Uncooking the Books – How Three Unlikely Sleuths Discovered Fraud at WorldCom,” Wall Street Journal, 30 October 2002.

CSI, Las Vegas, paraphrasing Gil Grissom
Rules of Evidence The rules of evidence are the rules governing the admissibility of evidence in a legal proceeding and the weight to be given to evidence that is admitted. It’s all about the evidence. The dispute has no face. You are not responsible for what the jurors or judge decide. CSI, Las Vegas, paraphrasing Gil Grissom

What Is Evidence? Evidence is testimony, writings, and material objects offered to prove an alleged fact or proposition. Direct evidence is evidence that directly proves a fact at issue, without the need for any inference or presumption (e.g., copy of a check that has been altered). Circumstantial evidence is evidence from which a fact at issue may be proved indirectly (e.g., bank records show a deposit of unknown origin).

Evidence Varies All relevant evidence is admissible, unless inadmissible due to another rule of evidence. Rule 403: probative value is substantially outweighed by the danger of unfair prejudice, confusion of the issues, misleading the jury, or by considerations of undue delay, waste of time, or needless presentation of cumulative evidence.

Fingerprints Are Needed
Legal experts say it remains far easier to prosecute those directly involved in disputed transactions because they leave a paper trail that can be easy for prosecutors to follow. “The government has been relatively successful against lower-level people in accounting cases,” said Howard Schiffman. Top brass are much tougher to prosecute because they rarely come out and say “go cook the books” and are hardly ever directly involved in the details of individual transactions, particularly smaller ones, legal experts say. Instead, bosses tell subordinates more-ambiguous things about not disappointing Wall Street. Employees who extrapolate that as a code for “cheat” are at great risk since “their fingerprints are all over the documents,” Mr. Schiffman said. The Quest executives were acquitted in mid-April, 2004. Source: Shawn Young, “Quest Case Shows Underlings Vulnerabilities,” WSJ, April 2, 2004, p. C-1.

Types of Witnesses Lay witness (or fact witness): a non-expert who gives testimony about facts, etc. Not subject to Daubert/ Frye challenges. Expert witness: one who can offer an opinion as a result of special skills education, experience, or training. Subject to Daubert/ Frye challenges. Summary witness: voluminous writings, recordings, or photographs which can not conveniently be examined in court may be presented in the form of charts, summaries, or calculations. F.R.E Daubert may not apply. U.S. v. Caballero, 277. F.3d 1235 (CA-10, 2002). Eye witness: one who testifies to what was seen.

Rule 701. Opinion Testimony by Lay Witnesses
If the witness is not testifying as an expert, the witness, testimony in the form of opinions or inferences is limited to those opinions or inferences which are (a) rationally based on the perception of the witness, and (b) helpful to a clear understanding of the witness’ testimony or the determination of a fact in issue, and (c) not based on scientific, technical, or other specialized knowledge within the scope of Rule 702.

Federal Rules of Evidence 702 – 705 (deal with expert witnesses)
Rule Testimony by Experts "If scientific, technical or other specialized knowledge will assist the trier of fact to understand the evidence or to determine a fact in issue, a witness qualified as an expert by knowledge, skill, experience, training, or education may testify thereto in the form of an opinion or otherwise; if (1) the testimony is based upon sufficient facts or data, (2) the testimony is the product of reliable principles and methods, and (3) the witness has applied the principles and methods reliably to the facts of the case.” (amendment in bold) Fed.R.Evid. Rule 702 requires the Trial Court to perform the gatekeeper role described in Daubert regarding all expert testimony Proffered expert testimony must be both relevant and reliable to be admissible

Federal Rules of Evidence Section 702 Comparative Analysis
Source: AICPA Proposed Statement on Responsibilities for Litigation Services No. 1, December 1, 2001. Generally, if you meet the applicable AICPA professional standards, you probably meet Rule 702.

Sources of information an expert may use include:
Rule Basis of Opinion Testimony by Experts “The facts or data in the particular case upon which an expert bases an opinion or inference may be those perceived by or made known to him at or before the hearing. If of a type reasonably relied upon by experts in the particular field in forming opinions or inferences upon the subject, the facts or data need not be admissible in evidence.” Sources of information an expert may use include: Firsthand knowledge Information admitted into evidence during the trial Information made known to the expert before the trial The facts themselves need not be admissible as evidence if they are “of a type reasonably relied upon by experts in a particular field.”

Rule 704 - Opinion on Ultimate Issue
"Testimony in the form of an opinion or inference otherwise admissible is not objectionable because it embraces an ultimate issue to be decided by the trier of fact." The ultimate issue is that which is pivotal for the defendant or the plaintiff and determines the outcome. Rule Disclosure of Facts or Data Underlying Expert Opinion "In civil cases, the expert may testify in terms of an opinion or inference and give his reasons therefore without prior disclosure of the underlying facts or data, unless the court rules otherwise. The expert may in any event be required to disclose the underlying facts or data on cross-examination.” Experts are, generally, allowed to testify about their opinions or give reasons for their opinions without first testifying about the underlying facts or data. The court may require the expert to disclose the underlying facts or data during cross-examination.

Rule 706 – Court-Appointed Experts
The Court has the authority to appoint an expert whom all parties may cross-examine when: The Court believes the experts for the litigants are “hired guns,” and their testimony is unreliable or prejudicial. The proffered expert opinions have failed to adequately explain the complex issues upon which the Court must decide. The Court has ultimate discretion regarding the admissibility of all expert testimony

Special Master and Court Appointed Experts
A court may appoint someone (e.g., a financial expert) to determine certain facts in a dispute. They may be appointed pre-trial, during trial, or post-trial to oversee one or more aspects of a dispute. Appellate courts generally hold that special masters are reserved for special or unique circumstances. Special Masters can be subject to Daubert challenges. Source: See W.A. Lagraize and D. L. Crumbley, “Special Masters and Court Appointed Experts,” Journal of Forensic Accounting, Vol. V(2004), pp

Relevancy and its limits (evidence)
Rule 401 – Definition of “Relevant Evidence” Evidence is relevant if it tends to prove or disprove an alleged fact. Rule 402 – Relevant Evidence Generally Admissible; Irrelevant Evidence Inadmissible It is the attorney’s responsibility to insure that sufficient evidence is admitted at trial to support the expert’s opinion. Rule 403 – Exclusion of Relevant Evidence on Grounds of Prejudice, Confusion, or Waste of Time Relevant evidence may be excluded if it is prejudicial, needlessly cumulative, threatens to confuse or mislead the jury, or causes an unnecessary delay or waste of time.

Fed. Rules of Evidence (more)
Rule 615. Exclusion of witnesses. Witnesses may be excluded so that they cannot hear testimony of other witnesses. Rule 802. Hearsay Rule. Hearsay, is generally not admissible. Many exceptions. Rule Requirement of Original Rule Admissibility of Duplicates Allowable. Rule Admissibility of Other Evidence of Contents. Rule Public Records Certified copy.

Fed. Rules of Evidence (more)
Rule Summaries. Voluminous material may be summarized (e.g., charts, summary, calculations) Rule Functions of Court and Jury. In case of dispute, trier of the fact determines.

Evidence Prima facie evidence: unless overcome by other evidence, suffices as proof of a fact in a dispute. Probative evidence: testimony which establishes or contributes toward truth. Parol evidence rule: an agreement in writing can not be modified by oral evidence. Secondary evidence: copies of instruments or oral evidence. Chain of custody: a log of evidence obtained and who had access to such evidence.

Hearsay (evidence) Rule 803 – Hearsay Exceptions; Availability of Declarant Immaterial Generally, hearsay is not admissible as evidence. Exceptions relating to expert testimony Business records such as memoranda, reports, records, or data compilations kept on a regular basis by a person with knowledge Public records; such as records, reports, statements, or data compilations kept by public offices or agencies Market reports and commercial publications; such as market quotations, lists, directories, etc. relied on by the public Learned treatises; such as almanacs of business information and technical literature Missing business records; reports normally prepared daily or the fact that they were not prepared is admissible Business records, such as computer printouts, may be entered into evidence without the testimony of the employee who actually prepared the records as long as the court considers the source of the information and the method of preparation trustworthy Experts are not required to prove that the information upon which they have relied is trustworthy May be grounds for a Daubert/Kumho challenge if confirmation is required or recommended by standards of practice.

Hearsay evidence: a statement made outside the court to prove the truth of the matter stated
You, Larry, try to state in the courtroom that Joe said “Paul is a crook.” Hearsay may be offered to prove a nonhearsay purpose. Trustworthiness. Unavailability of declarant. Practical considerations. Exemptions to Fed. Rules of Evidence. Major exceptions Excited utterances. Business records. Official records. Dying declarations. Learned treatises. Commercial publications.

Credibility Is Paramount
Most trials boil down to one issue: Credibility Expect the other side to present evidence that you are biased (to throw out your testimony). Prior Inconsistent Statements. You are an advocate for the truth.

Lies v. Truth Prosecutors in the Lay/ Skilling/ Enron criminal trial used a poster board divided into black and white parts. The black side said “lies” and the white side said “truth.” The four month case boiled down to a simple decision over who had told the truth and who had lied. The prosecutors said the defendants were evasive and had use the answer “could not recall” more than 200 times. Source: Sheila McNulty, “Enron Case Hangs in the Balance as Jury Retires,” Financial Times, May 18, 2006, p.16.

Ten Commandments of Demonstrative Evidence
Keep it Simple Use Graphics with Every Witness (show & tell) (memory increases 700%) Improve Interest Through Variety Test Your Charts with Those Unfamiliar with the Dispute Use Only Properly-scaled and Labeled Color Charts Use Word Charts Rarely Remember the Seriousness of the Setting Charts Improve the Entire Process Keep Up with Technology (ELMOs) Get Help Fulcrum Inquiry, "The Ten Commandments of Demonstrative Evidence in Litigation."

Entertainer As strange as it may be, an attorney wishes to present an expert who is “guaranteed to entertain and interest the jury - - the hallmarks of an expert who will be able to persuade.” Experts are now in the television and entertainment business. Source: D.M. Malone and P.J. Zwier, Effective Expert Testimony, Notre Dame, IN: NITA, 2000, p. 93.

The Expert’s Paradox You are an advocate hired by one party in an adversarial dispute. However, you will only be persuasive if the jurors or judge believe that you are a neutral and objective expert (like a scientist), with an opinion that has not been influenced by the adversarial nature of the forum. Source: Sarah E. Murray, “Standing At The Crossroads of Truth and Advocacy,” NACVA Conference, Miami, June 3, 2004.

Six Ways to Discredit Testimony
If an expert, the witness is not qualified. The witness did not consider all the facts. The witness relied on erroneous facts. If an expert, the witness’s conclusions do not follow from a correct analysis of the facts. The witness’s testimony is inconsistent with prior testimony. The witness was biased or prejudiced and therefore shaded his or her perceptions or conclusions. A fact witness employed by the defrauded party generally will be grilled more than an expert witness about bias or prejudice. Source: D.R. Carmichael, et. al, Fraud Detection, 5th, Fort Worth: Practitioners Publishing, 2002, p. 8 – 39.

Avoid Conflicts of Interest
You must not have present or past relationships with individuals on either side of the dispute which will prevent or interfere with objective testimony. Checking your firm’s files and records for professional conflicts early is extremely important.

Bias Goes to Weight “An expert’s bias goes to the weight, not the admissibility of the testimony, and should be brought out on cross-examination.” “A party who is otherwise qualified as an expert may testify as an expert in his own case regardless of concerns that the party is plainly self-interested.” U.S. v. Kelley, 6 F. Supp. 2d 1183 (D. Kan. 1998) 4 Weinstein’s Fed. Evidence, §702.06[8], pp , 1997. For example, court allowed Doug Carmichael to testify for the FDIC even though he was the Chief Auditor of PCAOB. Grant Thornton tried to get him disqualified. Grant Thornton v. FDIC, 297 F. Supp. 2d 880 (D. W. Va. 2004).

Side-Taking A trial judge may dismiss an expert witness who is influenced by side-taking. Hints at a lawyer’s line of arguments provided before reviewing evidence can influence an accounting expert’s decision about an auditor’s compliance with GAAS. The degree of certainty in an expert’s report can affect a mock judge’s decisions in settlement rulings. Jury trials in auditor-liability disputes are uncommon. D.N. Ricchiute, “Effects of an Attorney’s Line of Argument on Accountants’ Expert Witness Testimony,” Accounting Review, January 2004, pp Expert testimony is not useful when the expert is merely an advocate for the position argued by one of the parties. Estate of Jameson, T.C. Memo

Result-Oriented Work Estate of Bessie I. Mueller v. Commissioner, T.C. Memo , Doc (57 pages), the issue was the valuation of stock of the Mueller Co. The IRS produced as its expert on the valuation questions Dr. Shannon Pratt, managing director of Willamette Management Associates and the acknowledged dean of business appraisers. Tax Court Judge Renato Beghe nevertheless concluded that “Willametie’s report was result-oriented and this was reflected in Dr. Pratt’s testimony.” The Judge noted that appraisers “have third-party responsibilities – just as certified public accountants do – to those who rely on their opinions, and their determinations must be independent and objective….” Dr. Pratt strayed from the standard of objectivity and cast aside his scholar’s mantle and became ‘a shill’ for respondent.” In Mueller, as a result, Judge Beghe rejected most of both the Willamette report and Dr. Pratt’s testimony, but did take account of Dr. Pratt’s criticism of the taxpayer’s expert’s reports and testimony. Source: B.J. Raby and W.L. Raby, “Reasonable Compensation, Expert Witnesses, and the Tax Practitioner,” Tax Notes, September 15, 2003 p

Alternative Dispute Resolution
Mediation: appointment of an agreed-upon third party to facilitate settlement negotiations. before or after suit is filed parties control the outcome and all resolutions are voluntary. Arbitration: parties submit the dispute for resolution to an agreed-upon arbitrator or panel. rules less formal faster and cheaper can be binding or non-binding. Example: Arthur Andersen and Andersen Consulting. When testifying, remember arbitrator more sophisticated than the average juror.

Written Agreement The written agreement should cover the following matters: The name of the attorney’s client. The litigants’ names and place for the legal proceeding. The nature of the litigation services to be performed. Whether the practitioner will be asked to testify as an expert witness. What restrictions will be imposed on use and disclosure of the practitioner’s work. Whether the practitioner has any conflicts of interest with the litigants and/or their attorneys. Whether the practitioner’s work will be protected by the attorney work product privilege. Circumstances under which the practitioner may terminate his or her engagement. Stress the independence of the expert. Fee (including payment arrangements).

Motions To Exclude Expert Testimony
1. Daubert challenges. 2. Frye challenges. 3. Does not qualify as an expert by knowledge, skill, experience, training, or education. 4. Requires a valid connection to the pertinent inquiry as a precondition to admission. 5. Courts remain vigilant against the admission of legal conclusions. 6. In re Paoli Railroad Yard PCB Litigation, 35 F.3d 717 (3rd Cir. 1994) lists others. a. Relationships of technique to methods already established to be reliable. b. Existence and maintenance of standards controlling technique’s operation. c. Expert witness’ qualifications and non-judicial uses to which method has been put. 7. Side-taking or result –oriented work. 8. Conflict of interest. 9. Ghost-written report. 10. Spoliation. 11. Name not disclosed within time limit. 12. Improper expert witness designation.

Admissibility Of Experts
Daubert for federal courts. 26 states apply Daubert or similar standards (e.g., Louisiana, Texas, Arkansas, Connecticut, Massachusetts). 10 states still follow Frye (e.g., Arizona, California, Florida, New York, Pennsylvania). 11 states have not rejected Frye but apply Daubert factors (Alabama, Colorado, Hawaii, Nevada, Wisconsin). 4 states have developed their own tests (e.g., Georgia, Utah, Virginia, Wisconsin). 4 states open to Daubert (Illinois, Minnesota, New Jersey, Washington).

States Following Daubert
Alaska Arkansas Connecticut Delaware Georgia Idaho Indiana Iowa Kentucky Louisiana Maine Massachusetts Mississippi Montana Nebraska New Hampshire North Carolina Ohio Oklahoma Oregon Rhode Island South Dakota Texas Vermont West Virginia Wyoming

States Rejecting Daubert
Arizona California Florida Kansas Maryland Michigan Missouri New York North Dakota Pennsylvania

States Using Modified Daubert
Alabama Colorado Hawaii Nevada New Mexico South Carolina Tennessee Utah Virginia Wisconsin District of Columbia

Qualifying as an Expert Witness
Under the older Frye standard, the test for admitting expert testimony is: Whether the expert’s testimony will assist the trier of fact in understanding the evidence or in determining a fact in issue Whether the theories and/or techniques relied upon by the expert are generally accepted by the relevant professional community Whether the particular expert is qualified to present expert testimony on the subject at issue

Under the Federal Rules of Evidence, a judge will permit an accountant to testify as an expert witness only if the judge decides that: The accountant’s testimony will help the jurors or judge understand the evidence or determine a fact in issue The accountant is qualified as an exert by knowledge, skill, experience, training or education The accountant can show that his or her testimony (a) will be based on sufficient facts or data and (b) will be the product of reliable principles and methods that have been applied reliably to the facts of the case

In Daubert v. Merrill Dow Pharmaceuticals, Inc., the U.S. Supreme Court established the rule for federal courts that trial judges have a special responsibility to ensure that scientific testimony is not only relevant, but also reliable. In Kumho Tire Company, Ltd. V. Carmichael, the Supreme Court decided that a judge’s “gatekeeping” obligation applies not only to scientific testimony but to all expert testimony.

“Thus, in our view, the Court’s emphasis on reliability as well as on relevancy embraces within its standard the credibility of the witness proffering expert opinion. This is particularly true where, as here, it is the district court judge sitting as a finder of fact who must rule on issues is evidence. In the instant case, the District Court ruled that Dr. Gotteimer’s testimony would not be admissible for three reasons. First, the court found that Dr. Gotteimer’s educational credentials were not of the highest caliber. Second, during voir dire, the District Court found Dr. Gottheimer not to be credible because he had made statements about his credentials that were inconsistent with his deposition testimony. Finally, the District Court found that Dr. Gottheimer’s experience was in property casualty insurance, not life insurance, and that Gottheimer had admitted in his deposition that there are “fundamental” differences in evaluating the two types of insurances….” Source: In re Unisys Shavings Plan Litigation, 173 F.3d 145, (CA-3, 1999), cert. denied, 528 U.S. 950 (1999).

Daubert’s Five Factors
Whether the theory or technique used by the expert can be, and has been, tested; Whether the theory or technique has been subjected to peer review and publication; The known or potential rate of error of the method used; and The degree of the method’s or conclusion’s acceptance within the relevant community. Are there standards controlling methodology and principles?

Kumho Tire Co. Ltd. v. Carmichael, 119 S.Ct. 1167 (1999).
Daubert factors apply to nonscientific testimony as well as scientific expert testimony Court will probably not exclude testimony on the basis of one factor alone. Frye rule: general acceptance rule may still apply, especially in certain state courts. Daubert challenges generally occur after the deadline for naming experts. Thus, disaster if disqualified. Can open expert up to a malpractice claim.

Kumho Tire Supreme Court said:
“The objective of that requirement is [Daubert] to ensure the reliability and relevancy of expert testimony. It is to make certain that an expert, whether basing testimony upon professional studies or personal experience, employs in the courtroom the same level of intellectual rigor that characterizes the practice of an expert in the relevant field My job would be to provide credible expert opinion on complex accounting issues. The opposing attorney’s job would be to make me look like a lying idiot. Any anger, loss of confidence, or other emotional lapse he can drive or insult me into, will inure to his purpose. My experience as a professor would work to my favor, since my career centers around explaining complex accounting issues in clear understandable terms. What I need to guard against, is treating the jury like my students. The opposing lawyer will accuse me of grandstanding and thinking I’m back in my ivory tower. He’ll try to make me look like a fool. The judge owns the courtroom. The witness is just a guest, and one that not every party appreciates. I.W. Collett & M.Smith, Trap Doors and Trojan Horses, Thomas Horton & Daughters, p.127

Daubert Challenges Simple Daubert Challenge Motion of limine.
Motion of summary judgment. Documents filed. Hearing with judge and lawyers. Motion for summary judgment may or may not be granted. Complex Daubert Challenge Multiple day hearing. Live Witnesses. Challenged Expert Rebuttal Expert

A Hired Gun? On January 6, 2005, Andrea Yates’ capital murder conviction for drowning her children was overturned by an appeals court because of Dr. Park Dietz’s erroneous testimony about a nonexistent TV episode on Law & Order. His photo was shown on Fox News, and the talking heads called him a “hired gun.” One talking head said that “he’s dead.” Dr. Park Dietz during the 2002 Houston court case.

Qualifying as an Expert
In an infringement of trademark and misappropriation of trade secrets, plaintiff offered an expert with 15 years’ experience with the marine crane industry to testify about profits. Excluded because so-called expert had no formal training in accounting and conducted no independent examination of defendant’s gross sales figures, which were supplied to expert by plaintiff’s counsel. Seatrax. Inc. v. Sonbeck Int’l. Inc., 200 F.3d 358 (CA-5, 2000).

In an antitrust dispute a District Court excluded an economist and awarded summary judgment to plaintiff. Fourth Circuit affirmed the exclusion, saying that the expert had an MBA and significant executive experience in the relevant industry, but he subscribes to no economics journals, could identify no economics journals, had published no economics-related articles, was unfamiliar with basic terms employed by economists in antitrust analysis, had never conducted any relevant market analysis, and had read only materials provided to him by counsel. Berlyn, Inc. v. Gazette Newspapers. Inc., No (CA-$. Aug. 18, 2003) (unpublished). Just because the expert has a MD degree is not enough to qualify him to give an opinion on every conceivable question. Christopherson v. Allied Signal Corp., 939 F.2d (CA-5, 1991)

In a franchise termination suit, Seventh Circuit said that the CPA was not doing science, he was doing accounting. Based on financial information furnished by plaintiff and assumptions supplied by counsel, he calculated discounted present value of lost future earnings. Accountants are qualified to do that. Zelinski v. Columbia 300, Inc., 335 F. 3d 633 (CA-7, 2003)

The Courts’ Opinion Valuation testimony that considers no other independent variables than the sequences of events will be rejected as a matter of law. Blue Dane Simmental Corp. v. American Simmental Association 178 F. 3d 1035 (CA-8, Cir. 1999). Unbelievable valuation testimony will be rejected as a matter of law. Frymire-Brinati v. KMPG Peat Marwick, 2 F. 3d 183 (CA-7, 1993). An expert may base opinion on business records reviewed even though records were not in evidence. Carter v . Steverson & Co., 106 S. W. 3rd 161 (Tex. App. 2003). “When a litigant is knocked out after tying both its hands behind its back, a court may properly refuse to heed the litigant’s plea to be given a second chance for a fair fight.” There is no second chances where defendant presents no independent damages evidence or contrary expert testimony. Century 21 Real Estate Corp. v. Meraj International Investment Corp., 315 F. 3d 1271 (CA-10, 2003). The NACVA certification was mentioned as element in support of qualifications for business appraiser doing bank valuation. First Western Bank v. Olsen, 621 N.W. 2d 611 (S.D. 2001). Zelinski v. Columbia 300, Inc., 335 F. 3d 633 (CA-7, 2003)

Rejecting Experts In Frank J. Laureys, Jr., 92 T.C. 101 (1989), the IRS offered the testimony of Dr. Bradford Cornell, a professor of finance and economics at UCLA, to demonstrate that taxpayer was never “at risk” as to his option trading activities. About his proffered testimony, Tax Court Judge Mary Ann Cohen commented: We agree with petitioner that the factual premises of Dr. Cornell’s report are unreliable and that neither his testimony nor his qualifications assist in determining petitioner’s purpose in engaging in the transactions in issue…. [W]e do not believe that the type of economic analysis set forth in Dr. Cornell’s report is relevant to the type of risk covered by section 465(b)…. Dr. Cornell’s testimony is tainted by his perception that, from an economic standpoint, wash sales are not legitimate. Source: B.J. Raby and W.L. Raby, “Reasonable Compensation, Expert Witnesses, and the Tax Practitioner,” Tax Notes, September 15, 2003, pp

Rejecting Experts Second, his isolation of data as to certain transactions, on certain dates, chosen from a few transactions selected by respondent among hundreds engaged in by petitioner, is not reasonably representative. It is also inconsistent with his own statement that his analysis must consider “the investor’s overall strategy.” Third, his assumption of predictability of stock prices is inconsistent with reality and with the existence of an active national options exchange in which differing views of the future create buyers and sellers at different prices. Source: B.J. Raby and W.L. Raby, “Reasonable Compensation, Expert Witnesses, and the Tax Practitioner,” Tax Notes, September 15, 2003, pp

Weight v. Admissibility
Daubert analysis should not replace trial on merits, but any defects in an expert’s methods should be addressed through cross-examination. Mathis v. Exxon Corp., 302 F.3d 448 (CA-5, 2002). Defendant did not argue that the expert fails to comport with Daubert factors, but rather argues that his calculations do not support his conclusion. This attack is not a true Daubert challenge, but rather goes to weight. TFWS v. Schaefer, 325 F. 3d 234 (CA-4, 2003). Duty of district court is to ensure that basis of expert’s opinion is not so fatally flawed as to render his opinion inadmissible as matter of law. Inre Visa Check, 280 F.3d 124 (CA-2, 2001), cert.den. 122 S.Ct (2002).

Weight v. Admissibility (Continued)
Admissibility affirmed. Defendants did not object at trial court level and so review is for plain error. Defendants say expert is unqualified, but he spent 33 years as IRS agent, mostly investigating financial fraud. Defendants also fault expert for basing analysis solely on bank records supplied by plaintiffs, rather than broader array of transactions, but this objection goes to weight, not admissibility. Microfinancial, Inc. v. Premier Holidays Int’l, Inc., No (1st Cir. Oct 5, 2004). Exclusion affirmed. Creditors argue that company’s quarrels with expert’s approach went to weight, not admissibility, but district court identified no fewer than eighteen deficiencies, and testimony was riddled with implausible and unexplained assumptions. No abuse of discretion. Lippe v. Bairnco Corp., 288 B.R. 678 (S.D. N.Y. 2003), aff.d No (2nd Cir. Apr. 9, 2004) (unpublished)

Weight v. Admissibility (Continued)
Admissibility affirmed. Exxon did not waive appeal of pretrial evidentiary ruling by failure to renew objections at trial, such renewal being unnecessary under Fed. R. Evid. 103(a), as amended in 2000, when the district court has made definitive pretrial rulings on motions to strike. But expert was qualified and his opinion were admissible. Exxon says expert’s method were unsophisticated and that he should have concluded “competitive impact analysis” for each station to show that Exxon’s price caused it to loose business. But purpose of expert’s testimony was not to isolate precise economic effect for each station, but rather to show that Exxon had set commercially unreasonable price. Daubert analysis should not supplant trial on merits, and any defects in expert’s method could be addressed through cross-examination. Mathis v. Exxon Corp., 302 F. 3d 448 (5th Cir. 2002). Admissibility affirmed. Plaintiff’s expert was qualified, and used mathematical extrapolation, straight line linear progression, and averaging to arrive at his figures. Defendants attacked none of these methodologies, and their objections go to weight, not reliability. CDM Mfg. v. Complete Sales Representation, Inc. No (9th Cir. Oct. 29, 2002) (unpublished).

Bench Trial v. Jury Trial
Trial courts should be more reluctant to exclude evidence (e.g., expert testimony) in a bench trial than in a jury trial. Builders Steel Co., 179 F.2d 379 (CA-8, 1950). Thus, in bench trials evidence should be admitted and then sifted when the district court makes its findings of fact and conclusions of law. Field Eng’g & Equip., Inc. v. Cargill, Inc., 651 F.2d 589, 594 (CA-8, 1981). A trial court, capable of ruling accurately upon the admissibility of evidence, is equally capable of sifting it accurately after it has been received, and, since findings are based on the evidence that is found competent, material and convincing, there is no harm in the presence in the record of testimony that the court does not find competent or material. Where the court has assumed the role of fact-finder in a bench trial, “the better course” is to “hear the testimony, and continue to sustain objections when appropriate.” Easley v. Anheuser-Busch, Inc, 758 F.2d 251, 258 (CA-8, 1985).

Searchable Databases of Daubert Decisions
Daubert Tracker (launched August 2002) 570 accounting decisions (mid-July 2006). 314 accounting experts admitted, 203 denied, 53 admitted/denied in part. 55%, 36%, and 9.3% ratios 14,000 trial and appellate opinions. 21,000 expert reports. Composed of five distinct services. The searchable database of all reported cases. Core documents – docket sheets, briefs and transcripts – for each case. An update of new cases from the previous week. A quarterly journal with articles by trial attorneys, law professors, judges and experts. A series of “Web lectures” delivered by authorities on Daubert and scientific evidence. A year subscription is $295.

Searchable Databases of Daubert Decisions (contd …)
“Daubert on the Web” Online free tracking service. In June, 2006, 84 cases were under the field “Accountants and Economists” with an admissibility rate of .595. There are a total of 25 fields with various “admissibility rate,” such as Appraisers Computer experts, Criminologists, Marketing experts, Polygraphers, Statisticians, In Louisiana, there have been at least 33 Daubert challenges with a 60% admission rate.

Successful Daubert Challenges
Accountant failed to incorporate into his opinion (without explanation) some of his findings that contradicted his testimony [similar to Kumho Tire engineering expert’s testimony]. Target Marketing Pub., Inc. v. ADVD, Inc., 136 F.3d 1139 (CA-7, 1998). Accountant testified from un-audited financial reports, did not analyze data covering the entire period of time in question, did not compare revenue to budget projections of revenue, and allowed his opinion to be influenced by subjective statements of an interested party. SEC v. Lipson, 46 F.Supp.2d 758 (N.D. Ill.1998). In comparing hosiery made by different manufacturers, expert relied upon an inadequate sample and destroyed the records of his methodology. Lithuania Commerce Corp. v. Sara Lee Hosiery, 179 F.R.D. 450 (D.N.J. 1998)

Successful Daubert Challenges (cont.)
Tax Court listed 18 reasons why P’s damage expert was excluded (CA-2 affirmed). Failed to use the most reliable DCF analysis; numerous outright and largely admitted errors in analysis. Failed to offer meaningful explanations. Lippe v. Bairnco Corp., 99 Fed. Appx. 274 (CA-2, 2004). P’s damage experts were unreliable; no similarity between P’s companies and businesses relied upon for earnings benchmark; failed to allow for losses caused by other factors. El Aquila Food Prods., Inc. v. Gruma Corp., 131 Fed. Appx. 450 (CA-5, 2005). Used unreliable data; did not understand computers or computer market; changed opinion from one he gave in an earlier expert report; testimony non-technical. Lantec, Inc. v. Novell, Inc., 306 F.3d 1003 (CA-10, 2002).

Testifying at a Deposition
Expert witnesses can expect to be asked about the following at a deposition: The scope of their assignment Their current employment (job title, duties) Their educational background Licenses Work experience Memberships in professional organizations Publication and lectures Fields in which they are qualified as an expert Other work they have performed as an expert or other litigation consultant What compensation they are receiving (and what percentage of their compensation is derived from testifying as an expert witness) What opinions they have formed The bases for their opinions Source: Crumbley, Heitger & Smith, Forensic and Investigative Accounting, 2003, p. 8-13

Almost Unlimited Almost any question can be asked during a deposition. In the fraud-related trial of Worldcom Chief Executive Bernard Ebbers, the judge ruled that the defense could question the prosecution’s star witness [CFO Scott Sullivan] about his ‘marital infidelities’ because it reflects on his truthfulness. U.S. District Court Judge Barbara S. Jones said that “the defense is entitled to wide latitude.” Source: A.Latour, S. Pulliam, and S. Young, “Ebbers Defense Rings Up a Win Over Testimony,” WSJ, January 19, 2005, pp. C-1 and C-4

Clause In Written Report
I have not attempted to set forth verbatim every detail of my expected testimony and every fact that supports my opinion. Thus, I may provide additional facts and address additional topics in response to arguments or assertions offered during the course of deposition and testimony.

Preparing to Testify as an Expert Witness
Maintain independence from the client Evidence upon which experts may rely Use of confidential client information Expert reports Working papers Evaluation of other experts Exhibits and other demonstrative evidence Source: Crumbley, Heitger & Smith, Forensic and Investigative Accounting, 2003, p. 8-13

Differences Between Fact and Expert Witness
Purpose of testimony To provide the court with relevant facts relating to the case. To help the court or trier-of-fact understand technical issues. Training No specialized training is necessary, unless the witness undertakes a factual investigation. The witness must qualify as an expert. Therefore, he or she must have specialized knowledge, training, experience, or other qualifications (for example, writings) in a subject outside the average person’s understanding. What determines whether the witness will testify? The witness will be allowed to testify if he or she has information relevant to the case, and the testimony is not prejudicial or unnecessarily duplicative of evidence already presented. The judge must determine whether the witness has the qualifications needed to testify in the case. The testimony also must be relevant and must not be unnecessarily duplicative or prejudicial. Testimony Facts and observations based on the witness’s perceptions and everyday common information. Facts and opinions based on the witness’s knowledge, training, and experience and the fraud procedures performed by him or her. Evidence and exhibits All documents referred by the witness must already be in evidence. The witness can testify about documents that have not been entered into evidence if they are of the type normally relied on by experts in that field to form an opinion. Can the witness testify about hearsay evidence? No. Yes, as long as it is something that is normally relied upon by experts in the field. Payment of fees The witness is only entitled to the statutory daily fee (which is very small in most jurisdictions). The witness is entitled to a reasonable hourly rate. Source: D.R. Carmichael, et. al, Fraud Detection, 5th, Fort Worth: Practitioners Publishing, 2002, p. 8-3.

Four Phases of Interrogation at Trial
Direct Examination – friendly attorney – no leading questions. Cross-examination – opposing attorney – credibility of the witness and generally what was covered in direct. Leading questions O.K. Redirect examination – friendly attorney gives expert opportunity to clear up confusion. Recross-examination – not required. New matters subject to re-cross exam. Own attorney has right for last words with expert.

Direct Examination “ Trial rules permitted direct examination by the side giving its case-in-chief, then cross- examination by the opposition, then another round of questioning should they be required by the side that had called the witness in the first place. This last round was the redirect, and Powell was up and rolling before Freeman got back to the defense table.” Source: J.T. Lescroart, The 13th Juror, New York: Dell Publishing, 1994, pp

Leading Questions Didn’t the defendant appear to you to be stealing money from the cash register? A question that suggests a desired answer (e.g., yes or no). Leading questions can be directed to opposing parties and adverse witnesses during examination. Better questions: How much money was the defendant taking from the cash register? How can you estimate that amount? How was she taking the money?

Leading Witness “ Did you hear her? Was she, for example, singing in the shower or something like that? Moving furniture around?” Freeman was taking advantage of the rules that allowed defense in cross-examination to lead witness, and Freeman was also using this bantering tone to get back into a more relaxed mode with Fred, showing him what a regular Joe he could be.” Source: J.T. Lescroart, The 13th Juror, New York: Dell Publishing, 1994, p. 310.

Some Research Findings
65% of surveyed jurors were influenced by expert testimony. Merely referring to a witness as an “expert” affords the witness credibility. Jurors assign more credibility to government rather AICPA standards. Jurors hold auditors to higher standards of care when the audit failure is severe. Juror decision making is not independent of the use and reliability of decision aids. Source: D.N. Ricchiute, “Effects of an Attorney’s Line of Argument on Accountant’s Expert Witness Testimony,” Accounting Review, January 2004, pp

High Tech Is Best Studies show that the average person retains as much as 87% of information presented visually and as little as 10% for information given orally. Computer animations are even more persuasive. Both types of delivery impact the weight given to evidence by jurors (or judges). Use visual aids, computer animations, and other visual help whenever possible while on the stand. Source: David Yale, “Computers on the Witness Stand,” Univ. of Conn. Law School, Fall 1996, Moral: A picture is worth a thousand words.

Important Visual Rules
Storyboard your testimony (series of sketches). Do not overdo it. Design illustration so jurors can take away the message in 5 seconds. Title should give your conclusion. Color is important. Put the most important information in the top right-hand corner of the chart. Do not simply enlarge document. Highlight important stuff. Practice with your exhibits. Source: D.S. Scott and R. Laguzza, “Communication With The Jury,“ Litigation Services Handbook, John Wiley, 2001, pp.15-2 and 15-3. Give your exhibits to the jurors in a plastic protective folder.

Types of Witnesses Percipient witness – one with direct personal knowledge of the facts, circumstances, and events surrounding the dispute (e.g., fraud, the robbed bank teller). Peripheral witness – may be able to provide background information. Hostile – normally unfriendly to the forensic accountant or to the lawyer. Friendly – friendly toward your position.

Dines’ Exhibits Hints Keep the number of exhibits to a minimum to prevent confusion. Refer to only the most important issues of the case. In fact, do not use more than ten minutes to explain a chart, as this is about the average attention span of most juries. Provide only one message per exhibit. Make sure that your exhibit supports and explains your opinion and conclusions. Make sure that your exhibit is accurate and relevant, not misleading or difficult to understand. Keep the contents of the exhibit simple and clearly organized in order that people viewing it can easily identify and understand what they are seeing.

Dines’Exhibits Hints Attach a copy of the source to the reverse of each exhibit and make it available to the court. Sign and date each exhibit for court reference. Keep your exhibits in a dry cool place, even after the court has returned them to you, for possible future use, such as in an appeal. Cover your exhibit up if it is set up in the courtroom before you identify it. You don’t want to distract the jury from other evidence being presented, and you do want to build up the jury’s curiosity. Keep in mind that the opposing attorney will be constantly looking for ways to discredit your exhibit.

Dines’ Exhibits Hints Tests made to produce the exhibit must be done under the same or at least under very similar conditions in which the event occurred. Do not over do the making of a demonstrative exhibit by, for example making it over dramatic. An excellent exhibit is one that is self-explanatory. Standing by itself, it should tell a story, prove a point, or substantiate an opinion. It should leave an indelible impression with the jury after the evidence is removed. Make sure you assign your own in-house number to each exhibit. This number should be placed on the back of the exhibit. Once accepted, the court will assign its own exhibit number as well.

Dines’ Exhibits Hints Have your attorney provide the assigned court exhibit numbers to you so that you can cross-reference them with your in-house numbers. This will enable the judge, jury and attorneys to quickly identify your exhibit, saving time and enhance your efficiency, a plus. A rushed impromptu exhibit should not be considered. The lack of time needed to reason it out carefully and completely can result in inconsistencies or mistakes. If you’re lucky, the court will not let such an exhibit to be entered as evidence. If possible, fax or mail copies of the exhibits to your attorney as soon as you finish them. If there are problems from the attorney’s standpoint, you want to hear about them as soon as possible.

Dines’ Exhibits Hints Stand to the side of the exhibit when explaining it in order not to block it from the judge’s view. When speaking, speak directly to the jury, letting your eyes roam to several of them and never only to one. Encourage the jury to continually look at the exhibit while you focus your attention towards them at the same time. Leave your demonstrative evidence uncovered while the opposing side is presenting its case or during cross-examination so that it will make a continuing impression on the judge and jury. Source: Jesse E. Dines, Expert Witness Manual, Irvine, CA: Pantex International, Ch. 8.

Four Conditions An expert witness can state an opinion or conclusion if four conditions are satisfied: The validity of the opinion or conclusion depends on special knowledge, experience, skill, or training not ordinarily found in lay jurors; The witness must be qualified as an expert in the pertinent field; She must possess a reasonable degree of certainty (probability) about her opinion or conclusion; and Generally, in common law jurisdictions an expert must first describe the data on which her conclusion is based, or she must testify in response to a hypothetical question that sets forth such data. Source: J.R. Waltz, Evidence, New York: Foundation Press, 1999, p. 15.

Three Approaches to Testifying
Express opinion based upon facts personally observed, or facts communicated to him by another expert. Be present in courtroom and express opinion on such evidence (that is not in dispute). Base an opinion on a hypothetical question embracing evidence in the record. Source: J.R. Waltz, Evidence, New York: Foundation Press, 1999, p. 15.

Written Reports An expert should never draft a written report of any kind unless he or she has been expressly directed to do so by hiring counsel. Federal Rules of Civil Procedure 26(a)(2)(B) requires a written report. Keep a diary of interview dates, etc. Do not destroy interview notes.

Written Report Contents (FRCP 26(a)(2)(B))
All opinions to be expressed and the bases for them. Data or other information considered in forming the opinions. Any exhibits to be used as a summary of or support for opinions. Witness qualifications, including a list of all publications authored within the last 10 years. Witness compensation. List of other disputes in which the witness has testified at deposition or trial during the last 4 years. Signature of the expert testifying. Note: Federal Rule of Civil Procedure 27(e)(1) indicates that an expert must update a written report or disposition.

Types of Expert Reports
Fact-oriented report – gathers and evaluates facts and uses them to prepare a report. Check and re-check the numbers and the facts. Opinion report (e.g., valuation report) – more subjective and rely more on the professional judgment of the expert. Combination of above types.

Understanding Metadata
Electronic data not necessarily seen on printed document; not normally seen. Describe characteristics of data, such as when and by whom it was created, accessed or modified. Other side can access when users inadvertently share confidential information when sending or providing files in electronic format. For example, metadata analysis might reveal created years ago, adapted from another case, last 10 authors, editing time, not the original authors, and machine on which document created. Software available to view hidden metadata. Erica Garrison, “Metadata: What it is, Why it’s significant, and How to deal with it,” Focus, February/ March 2006, pp. 2-3.

Metadata in Microsoft Documents
Your name Your initials Your company or organization name The name of your computer The name of the network server or hard disk on which the document was saved Other file properties and summary information Non-visible portions of embedded OLE (object linking and embedding) objects The names of previous document authors Document revisions Document versions, including previous names Template information Hidden text or cells Personalized views Comments Erica Garrison, “Metadata: What it is, Why it’s significant, and How to deal with it,” Focus, February/ March 2006, pp. 2-3.

Limiting Metadata Disable “fast save.”
Remove name and initials from Microsoft Office. Be cautious when using “Track changes” (allows collaborating and review). Copy and paste document into a new blank file before saving. Erica Garrison, “Metadata: What it is, Why it’s significant, and How to deal with it,” Focus, February/ March 2006, pp. 2-3.

Ghost-Writing Reports
In a district court case in 2001, the plaintiff’s attorney argued that the government’s litigation consultants were ghost-writing expert reports, and the experts were destroying documents in order to prevent discovery. The court refused to allow the expert to participate in the dispute. “The more involvement the client’s attorney has with the expert’s report the more likely this involvement will be disclosed on cross-examination and result in the court discounting the expert’s testimony as lacking objectivity. Source: Jon Almeras, “Judges Offer Advice On Expert Testimony,” Tax Notes (March 18, 2002), p

Ghostwriting Reports (Cont.)
An expert report must be prepared by the expert and not by his or her attorney. An expert report prepared mostly from interrogatory answers prepared by the party’s lawyers is not sufficient. Source: FRCP 26(a) (2) (B)Smith v. State Farm Fire & Cas. Co., 164 FRD 49 (SD VA 1995) An attorney may provide assistance to an expert in preparing a report. Here the lawyers provided assistance in retyping and incorporating changes authorized by the expert Source: Marek v. Moore, FRD 302 (DKS 1997) Oh, I know there’s be hell to pay. But that crossed my mind a little too late! Well I know what I was feeling, but what was I thinking? From “What Was I Thinking” by Dierks Bentley

Although an attorney actually wrote the report, the attached opinions and work papers were those of the expert, and he testified at deposition that the report reflected his opinions. Source: Indiana Ins. Co. v. Hussey Seating Co., 176 FRD 293(D. IN 1997) “Trial counsel may well have legitimate cause to give assistance to an expert witness in the preparation of the report.” But “the court also emphasizes that in no way does it suggest the attorneys have license to change the opinions and report of the expert witnesses.” Source: Marek v. Moore, FRD 298 (DKS 1997)

‘ It appears likely that the U.S. Tax Court will allow an expert to serve as a scribe only when the expert is not capable of articulating his or her thoughts in the form of a written report.’ Source: S.M. Hurwitz and R. Carpenter, “ Can An Attorney Participate in the Writing of an ‘Expert Witness’ Report in the Tax Court?” Journal of Taxation, June 2004, pp

Citators Commerce Clearing House Citator (taxation)
Research Institute of America (PH) Citator and Citator 2nd Series (taxation only) Shepard’s (for virtually every case reporter series and specialized areas, e.g., taxation) RIA and Shepard’s give a notation why the case was cited. CCH does not.

Citators (cont.) Shepard’s CCH Citator (2 volumes)
Oldest. Greater breadth. Must know court reporter citation (not just name). Go through LEXIS or Westlaw. Does not furnish name of cited case. Gives references to selective law review articles. Gives citations to Federal Statutes and Regulations. CCH Citator (2 volumes) lists cited cases for each court decision in reverse chronological order Missing most current cases (two or three months).

Things to do Only use theories or techniques that have been tested and passed. Use theories or techniques that are objective. Specify the known error rate or potential error rate for the method. Use methods with acceptable error rates. Produce peer-review literature (i.e., journal studies, reports, and treatises supporting the expert’s conclusions and opinions). Produce reliable scientific data to prove that her methods and conclusions are generally accepted in the scientific community. Demonstrate that her theories existed prior to the commencement of the litigation. Not develop novel theories to support conclusions for specific litigation. Demonstrate that she maintained standards and controls (for example, good laboratory practices and simultaneous blinded controls). Source: Babitsky et. al, The Comprehensive Forensic Manual, Seak, Inc.,

Things to do … Demonstrate that findings can and have been replicated by others. Demonstrate that her methodology followed the scientific method as it is practiced by at least a recognized minority of scientists in the expert’s field. Offer testimony that is sufficiently tied to the facts of the case to help the jury to resolve a factual dispute. Avoid relying on coincidence. Avoid extrapolating unjustifiably from an accepted premise to an unfounded conclusion. Adequately account for obvious alternative explanations. Demonstrate the same care and accuracy as in the regular professional work. Use the real-world methodology of her field. Use an appropriate methodology to ensure that her opinion derives from and constitutes a form of specialized knowledge. Source: Babitsky et. al, The Comprehensive Forensic Manual, Seak, Inc.,

Judges Can Be Mean Judges can hurt an expert witness’ reputation by making negative comments about the expert in open courtroom. A judge in Florida’s Fourth District Court of Appeal said the following about an expert when a defense attorney asked why he excluded the expert: “Dr. ____ is an insidious perjurer who wouldn’t know the truth if it leapt up and bit him on the ***.” The expert is a doctor since 1963 and has testified for 25 years. On appeal the appellate court upheld the judge’s ruling that the expert’s claim lacked merit.

Risk Management There is an emerging trend of increased expert witness liability. General Rule: Immunity to a witness from civil liability from testimony / communication made in the course of litigation. Exceptions: Spoliation of evidence – losing or destroying evidence. Lying under oath. Defamation lawsuits against opponent's witnesses. Negligence (disappointed clients). $42M Mattco Forge decision (Acct. malpractice). Arthur Young [reversed on appeal on technicality] Court appointed expert can be liable for negligence. [e.g., Accountant in a divorce case: Levine v Wiss & Co, 478 F.2d 397 (N.J. 1984)]

Lying Under Oath Deadly
Prosecutors said that ink expert Larry F. Stewart committed perjury on the stand during the obstruction-of justice trial of Martha Stewart. Mr. Stewart, laboratory director for the U.S. Secret Service, was charged with two counts of perjury, facing five years in prison if convicted. Prosecutors said that Mr. Stewart lied when he said he participated in the testing of ink on a worksheet supposedly showing a pre-existing agreement with Martha Stewart to sell her shares of Imclone stock. Source: Chad Bary, “Stewart Ink-Test Trial Starts, “WSJ, September 24, 2004, p. C-4

Acquitted Larry Stewart was acquitted on October 5, He had said, “I performed a test to determine…..,” when in effect, he did not participate in analyzing the critical documents. One juror said, “ He put his foot in his mouth, and he couldn’t take it out because of his ego. He did not walk into the courtroom intending to lie.”

You Can Be Sued Witness Immunity State: State of Washington
Pennsylvania States Ignoring Immunity: Alaska California Connecticut Louisiana Missouri New Jersey [court appointed] Texas West Virginia

Hold-Harmless Provisions: Engagement Letters
Limiting Liability: generally valid between parties to the agreement ( but not third parties). Clause 1: In no event will our firm be liable for incidental or consequential damages, even if we have been advised of the possibility of such damages. Clause 2: You and your client agree to hold our firm, its partners, and employees harmless from any and all liabilities, costs, and expenses relating to this engagement, and expenses (and those of our legal counsel) incurred by reason of any action taken or committed at your direction and taken by us in good faith; and you agree to indemnify us for any such action taken at your direction. Limiting Damages: generally valid between parties to the agreement ( but not third parties). Clause 3: Our aggregate liability to [attorney] or [attorney’s client] whether in contract, tort, or otherwise, will be limited to the amount paid to us by [attorney] or [attorney’s client] for the services under this engagement letter.

Hold-Harmless Provisions: Engagement Letters
Protecting Against Daubert (Frye) Rejection: Attach your curriculum vitae (CV) as an exhibit to the engagement letter. Clause 4: As an exhibit to this engagement letter, I have attached my CV. If a court later determines that I am not qualified to offer testimony, such determination will not deemed a breach of this agreement, and you will still be liable for the payment of fees and expenses as set forth herein. Source: C.L. Wilkins and J.H. Kinrich, Business Valuation/Forensic and Litigation Services Practice Aid 04-1, “ Engagement Letters in Litigation Sercices,” a practice aid issued by the AICPA Forensic and Litigation Services Committee.

Breach of Contract A client may win a breach of contract dispute by showing that the expert failed to perform a specific contracted service, perform the service in a timely fashion, perform in a satisfactory manner, or comply with professional standards. Examples of specific service performance would include engagements such as a review of a client’s internal control system or conducting a complete audit. Source: “Breach of Contract” (New York Practicing Law Institute, January 2000), Ch. 3.2[B].

Lack of Immunity There is no immunity for communication made outside the context of the lawsuit. Probably no immunity if the alleged misconduct results in a professional disciplinary proceeding. If you present false evidence, may be subject to criminal prosecution (e.g, Larry J. Stewart) .

10 Guidelines to Meet Potential Legal Challenges
Apply the relevant professional standards Know the relevant professional literature Know the relevant professional organizations Use generally accepted analytical methods Use multiple analytical methods Summarize the conclusions of the multiple analytical methods Disclose all significant analytical assumptions and variables Subject the analysis to peer review Test the analysis – and the conclusion – for reasonableness Know the relevant professional standards Source: R.E. Figlewicz and Hans-Dieter Sprohge, “The CPA’s Expert Witness Role in Litigation Services: A Maze of Legal and Accounting Standards,” The Ohio CPA Journal, July-September, 2002, p. 35

Eleven Guidelines for Evidence
Relevance Objectivity Documentation Externality Sample Size Sample Method Corroboration Timeliness Authoritativeness Directness Adequacy of Controls Source: R.L. Ratliff and I.R. Johnson, “Evidence,” Internal Auditor, August 1998, pp.56-61

Ten Commandments for Depositions
Always tell the truth, but answer only the question asked. Think before answering. Never answer a question you do not understand. Do not guess or speculate. Do not bring notes, diagrams, books, or other written material to the deposition unless a subpoena or your attorney requires you to do so. Listen carefully to each objection made by your lawyer. Do not argue or become angry or hostile with the examining attorney. Even if a question calls for a yes or no answer, ask to explain your response if you feel a qualification or explanation is required to complete your answer. Beware of questions which involve absolutes. Do not memorize your answers before the deposition. Source: B.P. Brinig, “The Art of Testifying,” in Handbook of Financial Planning for Divorce and Separation, John Wiley, 1990.

Always Be Truthful An investigator was asked in cross-examination: “You said that you wrote your notes contemporaneously. Is that correct?” ‘Yes,’ replied the witness. ‘And was the interview conducted at normal conversation speed?’ Counsel asked and witness agreed that this was the case. ‘They were very neat and tidy, Mr. Jones, aren’t they?’ ‘Yes,’replied the witness and then added a fatal piece of humor: ‘Unlike lawyers and doctors, I have been trained to write nicely.’ ‘Very good, Mr. Jones. I am now going to dictate a passage to you at normal conversational speed, and I would like you to write down notes of everything I say.’ Within two minutes the witness was a blubbering wreck, because he could not keep pace with dictation. The case was thrown out. Source: M.J. Comer and T.E. Stephens, Deception at Work, Burlington, Vt: Gower Publishing Company, 2004, p. 397.

An Expert’s Advantages
They are experts. They are not intimidated by the process. They can hide behind their expertise. Trial work is more lucrative than office or classroom work. They are more highly educated than lawyers. They like to teach. Source: D.M. Malone and P.J. Zwier, Effective Expert Testimony, Notre Dame, IN: NITA, 2000, p. 56.

Getting to Experts However, Malone and Zwier point out how to “get to” unintimidated experts; they “may lose sight of the deposing attorney’s goal, which is to find means to diminish the expert’s credibility or to challenge the bases for the expert’s opinions.” Call it arrogant. “Because they think they are safe within their own field, experts at deposition may be more willing to provide explanations and lengthy answers, to volunteer information, and to educate their ignorant but interested students.” They advise lawyers to smile, nod, lean forward, maintain eye contact, and ask open questions to “play” the expert. Encourage them to teach at the deposition. Source: D.M. Malone and P.J. Zwier, Effective Expert Testimony, Notre Dame, IN: NITA, 2000, p. 57.

Seven Answers at Deposition
Yes. No. Green. I don’t know. I don’t remember. I don’t understand the question. I need a break. Source: D.M. Malone and P.J. Zwier, Effective Expert Testimony, Notre Dame, IN: NITA, 2000, p. 81.

Weaknesses of Experts It is the lawyer’s arena.
They cannot resist teaching. Their time is finite and the universe is infinite. They must rely on assumptions. They are concerned about consistency. They worry about facts they do not know. You know how to use FRE 803(18). Source: D.M. Malone and P.J. Zwier, Effective Expert Testimony, Notre Dame, IN: NITA, 2000, p. 73.

Federal Rule of Evidence 803(18)
Federal Rule of Evidence 803(18) permits the introduction of relevant material from written sources to get around the hearsay rule. The opposing attorney can get the expert to “concede the existence of reliable authorities in the field” that later may be used at trial to help their side. Source: D.M. Malone and P.J. Zwier, Effective Expert Testimony, Notre Dame, IN: NITA, 2000, p. 73.

Challenging The Opposing Expert
General educational background. Areas of claimed expertise. Education in the field. Job history, terminations, multiple careers. Work experience in the field, practical experience. Ever sued in professional capacity? Subject to any investigation? Published works. Engagements Other opinions rendered. Other cases where testified. Acknowledge and importance of: a. Using accepted methodology. b. Fairness c. Careful math, if applicable. Materials Transcripts How the party first learned of the case. Source: D.E. Heinberg and B.C. Riopelle, “The Use of Financial Expert Witness (or Consultant)--- From Both the Attorney’s and Expert’s Prespective,” The Value Examiner, November/December, 2004, p.48

Challenging The Opposing Expert (Cont.)
Prior contact with parties. Other work for same party. Prior testimony for same counsel. First meeting with counsel- “Did counsel tell you what they needed?” All communications with counsel: a. Written b. c. Verbal Engagement letter All communications with outsiders. All communications with co-workers, staff and independent contractors Notes s Anything destroyed? Source: D.E. Heinberg and B.C. Riopelle, “The Use of Financial Expert Witness (or Consultant)--- From Both the Attorney’s and Expert’s Perspective,” The Value Examiner, November/December, 2004, p.48

Terminology Precise methodology used Margin of error. Assistants involved, background checks, training Ever given an opinion on this subject before? Readings Precise opinions. All things relied on to give opinion. Theories rejected (e.g., if opinion is reasonable royalty, has he ruled out lost profits?) Process of preparing report: a. Ideas b. Exchange of drafts with counsel c. Changes suggested by counsel All opinions reached. Source: D.E. Heinberg and B.C. Riopelle, “The Use of Financial Expert Witness (or Consultant)--- From Both the Attorney’s and Expert’s Perspective,” The Value Examiner, November/December, 2004, p.48

Time spent on report Test all assumptions Access to facts and process for gathering. Order in which all tasks performed. Individuals whom he or she considers to be experts in the field. Look for inconsistencies. Check math Work remaining to be done. Time records and bills Comment on your expert’s report. Source: D.E. Heinberg and B.C. Riopelle, “The Use of Financial Expert Witness (or Consultant)--- From Both the Attorney’s and Expert’s Perspective,” The Value Examiner, November/December, 2004, p.48

Jerry Lee Lewis Judges do say negative things about experts, and if an expert witness is denied, that side may lose. Most often the deadline for listing experts has passed. An old saying by Jerry Lee Lewis is appropriate: “You don’t miss your water until the well runs dry.” If the expert and report is not admissible, the lawsuit may be over. For example, a plaintiff lost a breach of contract and breach of fiduciary duty dispute by summary judgment because their accounting expert report was “pure speculation, based upon utterly implausible assumptions and unreliable methodology.” But Daubert challenges must be timely. Sources: Target Market Publishing Co. v. ADVO, Inc., 136 F.3d 1139 (CA-7, 1998). Questar Pipeline Co. v. Grynberg, 2001 F.3d 1277 (CA-10, 2000).

Cross Examination Tactics
No substitute exists for good preparation. Before your cross-examination, question your assumptions and explore alternative positions. Study the opposing expert’s analysis. If you can’t answer the question yes or no, say so and shift the burden back to the lawyer to frame a proper question, one that can be simply answered or permits a fair explanation. Answer only the question asked. Become familiar with the examining attorney’s background, skills, and tactics. Be yourself, but be sensitive to negative habits which may distract from the quality or credibility of your testimony, such as averting your eyes when asked a difficult question. Be polite. Avoid the appearance of bias or untrustworthiness. Do not hesitate to concede an error. But be careful: “So, you just picked a number?” “So, your study isn’t accurate, isn’t it?” “So, after this brief, informal interview, you decided....” Don’t overstate your opinion. Source: B.P. Brinig, “The Art of Testifying,” in Handbook of Financial Planning for Divorce and Separation, John Wiley, 1990.

Cross Examination Tactics (more)
Do not speak to people outside courtroom while waiting and during breaks. Turn off your cell phone or pager before entering the court. Do not wear emblems. Avoid humor, but laugh at judge’s humor. Keep your hands on top of the table, not hidden. Be sure your attorney questions you in detail about your qualifications in order to impress the judge/jurors. Do not allow the other side to stipulate you as an expert. Dress neatly and conservatively. Arrive on time at the court house (have multiple reminders). When taking the oath as a witness, say loudly, “I do.” Be sincere and respectful.

Cross Examination Tactics (more)
Talk directly to the jurors (or judge if no jurors). Look them in the eyes. Make contact with each of the jurors. Explain number carefully, possibly using analogies with tax returns and checkbook. Pausing does not harm you. Use first person, active person: I reviewed these records, and I found…. Tell stories about people. Be careful when shown passages from textbooks, etc. Jurors have nothing to do for long periods. They are always watching. Be careful every place in the court house, even while driving to the court house. When you are in trouble in the court room, do not lean back. Instead lean forward. When you are finished, do not leave the courtroom until there is break.

Judd Robbins Computer Forensic Expert
"Judd Robbins is a litigator's dream expert witness: he not only has solid technical skills and a resume to support them, but is creative, litigation savvy, and a pleasure to work with, as well." Trial Attorney, New York, New York "Judd has that uncommon ability to take complex computer subject matter and break it down in a way that is understandable to a layman." Trial Counsel, Los Angeles, California "Judd related very well to the jury. He made himself available to us whenever he was needed. Easy to work with. Took the time to work with us. Always got back to us right away." District Attorney, South Dakota "He was easy to understand. ...made it seem easy... I believed his explanation." ……………..Juror Polling Feedback 4 Minute Video Deposition Extract

Judge’s Instructions to Jury:
“You have heard evidence in this case from witnesses who testified as experts. The law allows an expert to express opinions on subjects involving their special knowledge, training, skill, experience, or research. You shall determine what weight, if any, should be given such testimony, as with any other witness.” Jay W. Danker’s Four Rules: A relevant, coherent, understandable story. To keep their interest at all times. To be spoken to in clear, definite terms. Respect and sincerity.* * Jay W. Danker, Communicating with the Jury. Handout materials for the Fifth Annual National Expert Witness and Litigation Seminar, Hyannis, Massachusetts (June 20, 21, 1996) 2.

The Three Cs The jurors expect an expert to
Establish his/her competency. Convince the jury of his/her credibility. Communicate effectively his/her knowledge and opinions. “He made his testimony relate to something the jury could understand from their own experience gained from buying lumber at a lumber yard.” Source; Judge Joseph B. Morris, Today’s CPA, May/June 1991, pp

Kiss Business people often believe that their goal in a presentation is to deliver information. The reality is that information presented in a speech is rarely remembered. Images, metaphors, and anecdotes are what stick in listeners’ minds. Source: David Booth, “An Actor’s Guide to Giving a Great Speech,” Bottom Line Personal, March 1, 2004, p.8.

A Bulletproof Expert They give opposing counsel little or nothing
productive during cross-examination. This is dangerous to the other side because the jury expects counsel to make some good points during cross-examination. When few or no good Points are made during cross-examination, the expert’s stature is likely to grow significantly and opposing counsel’s stature is likely to diminish. Steven Babitsky and J.J. Mangrauiti, Cross-Examination, Seak, Inc. 2003, p.392

Random Process “ Further, even though Gage and Terell hadn’t gotten them any points, neither had they put too many on the boards for Powell. That, though, could change in an instant. One false move now could turn the momentum of the entire trial. It was a time to be conservative in the literal sense- conserve what you’ve already got. Don’t let the other side score.” Source: J.T. Lescroart, The 13th Juror, New York: Dell Publishing, 1994, pp

Three Communication Techniques
Central – focus on what you say. Peripheral – focus on how you say things. Amount of evidence presented. Number of points you make. Length of your testimony. Your qualifications. Trustworthiness. Likeability. Combination. Source: D.S. Scott and R. Laguzza, “Communication With The Jury,” Litigation Services Handbook, John Wiley, 2001, p

Ross Davis and Ross Laguzza Say
At least one of the jurors will not listen to you. Those that listen to you must understand you (e.g., Accounting/Taxation/Valuation issues are not easy). Jurors need to understand why you say what you say. You must persuade the jurors that what you say is correct, despite the cross-examination. Source: D.S. Scott and R. Laguzza, “Communication With The Jury,” Litigation Services Handbook, John Wiley, 2001, p

Why Financial Experts Fail
The financial expert does not know the case story (e.g., the strategic messages). Expert never develops home base messages, or develop the wrong ones (short simple messages). Inconsistencies between direct and cross-examination. Unnecessary use of jargon and terms or art. Insufficient meaningful practice. Source: D.S. Scott and R. Laguzza, “Communication With The Jury,” Litigation Services Handbook, John Wiley, 2001, pp and

Turning Jurors Off Over-rehearsed testimony. Unenthusiastic testimony.
No directly examining relevant evidence. Overly technical presentation. Rambling and irrelevant testimony. Mistaken and contradictory testimony. Evasive or combative responses. Indirect eye contact. Ill at ease or nervous. Crossing arms across chest. Drinking a lot of water. Looking toward your attorney for help on cross. Source: Sarah E. Murray, “How Experts Can Win Jurors and Influence Outcome,” NACVA, June 3, 2004.

Dines’ Potpourri of Advice
Read your client-lawyer’s entire case file, including the narrative, thoroughly and as often as necessary to understand all the known facts. Ask for more information from your client-attorney if needed. Prepare a list of questions (with answers) for your attorney that he can ask you during the qualification phase as an expert witness. Address your findings in a professional and business like manner. Be eloquent, clear and precise. Your demeanor should be proper. Obtain a predetermined retainer. Your attorney may request a retainer agreement. This is okay. But get you initial retainer up-front. Remember the slogan of small general stores throughout the country in the late 19th century: “ Cash makes no enemies.” Never become an advocate or hired gun. Your mission is to determine certain facts within your expertise, and testify about them. That’s all.

Educate your attorney in simple lay terms so that he understands all the aspects of of your testimony related to your expertise. Sure, he may have graduated at the top of his class at Yale or Harvard, but what does he know about intangible assets or retained earnings? Offer suggestions that will help your client-attorney in the trial. Explain whatever test procedures you intend to use. Yes, you’re the expert in these procedures, but the lawyer is the expert in how juries will respond to your explanations. Request additional information that you may need to conduct further research tests in order to formulate your evaluation. Provide your client attorney with an estimate of additional costs, if any. Help your attorney draft interrogatories and interpret those of the opposition.

Help your attorney interpret numbered exhibits and demonstrative evidence and explain how you intend to use them. Also determine the estimated cost of these. Fully review your CV and fee schedule. Be assured the opposing attorney will scrutinize it and attempt to discredit you during the qualifying phase. Request a copy of the complaint, including all of the known evidence pertaining to your expertise, as well as the existing documents and photographs. Be cognizant of the current research and literature pertinent to the case that is available in the field of your expertise. You don’t want to build your opinion on a protocol that has been in use for fifty years-but was discredited within the past ninety years. You should not exaggerate the strengths of the case. Sometimes it is more valuable to point out any weakness and voice more conservative opinions.

Discuss with your attorney any weak (as well as strong) points your opinion may possess, especially if you have not testified before, and how to handle questions relating to it. Have your attorney bring these points out immediately during cross-examination. Although the opposing attorney will doubtless make an issue out of these issues, his attack will have been blunted. Focus on only the scientific, technical, or objective portions of the case. Avoid extraneous or unrelated issues. Practice a mock trial at least once: more is better. You can never practice enough. Your attorneys can save you the embarrassment of not being qualified. Also, this will prevent misunderstanding and any apparent contradictions. Be prepared to attend a settlement or arbitration conference that includes you and the opposing attorneys.

Do not drink any carbonated drinks or alcohol at least twenty-four hours prior to the trial. Drink water without ice at room temperature. Eat light, healthful meals. If you are on medication, explain it to your attorney. Do not be late to court for any reason (outside a terrorist attack). “Stuck in traffic” is not an excuse, nor is “I couldn’t find parking space.” Being on time is one reason you charge by the half-day for your in-court testimony. Your attorney will tell you whether or not you should sit in the spectator section of the court or be sequestered outside the courtroom until you are called to testify. This is determined by the judge. Consider taking as aspirin or diarrhea preventive prior giving a deposition or testifying in open court. Ask your client-attorney which files you should take to court. Keep in mind these files are considered discoverable and must be shown to the

opposing attorney if he requests it. Privileged files should not be taken to court. Before reading from your notes, obtain the judge’s permission. The opposing attorney may raise an objection. You should also take several copies of your CV, and be prepared to provide them to the jurors if requested. Business cards must not be used for solicitation. However, it is generally permissible to give the court reporter one to provide your full name, address, and so forth. When appearing in state or municipal courts, learn beforehand whether or not you will be allowed to take pen and pad with you to the witness stand. (In federal court, you are allowed to take a pen and pad to the witness stand.)

Maintain close contact with your attorney throughout the proceedings as to the status of the case, even though you may not be in court. Your calendar will help him provide dates on which to schedule a deposition or trial appearances. Source: J.E. Dines, Expert Witness Manual, Irvine, CA: Pantex International, 2004, Chapter 14

Investigative Techniques and Evidence
Documentary evidence – written evidence on paper or computer medium. Testimonial evidence – testimony of individuals. Observational evidence – evidence, actions, or observations seen by an investigator. Physical examination of evidence (e.g., counts or inspections). Fixed point observations of activities (e.g., watching a scene and recording). Moving observations. Invigilation – strict temporary controls are imposed so that fraud virtually impossible. Keep detailed records. Covert observations. Forensic document examination. Source: D.R. Carmichael et.al., Fraud Detection, Vol. I, Practitioners Publishing Co., 2002, pp. 3-1 to 3-4

Evidence Best evidence rule: Demonstrative evidence (the chalks)
original documents to be produced rather than secondary evidence (including oral testimony) Many exceptions: Computer print-out – now admissible if a foundation of accuracy is laid. Copies admitted if lost. Generally can get around the best evidence rule. Demonstrative evidence (the chalks) objects – the gun. models. photographs. videos. charts. exhibits Do they have the tendency to “assist the trier of the facts”?

Authentication Requirement
To be admissible as evidence in a legal proceeding, a document or other material usually must be authenticated or identified as to what its proponent claims it to be.

Authentication Concept
Authentication Concept: The writing or object must be proven to be what it purports to be direct testimony / chain of custody. content. other circumstances. e.g., computer records may be used in the courtroom by showing that they were prepared by an accurate process.

Criminal Proceedings No plaintiff, but a prosecutor.
A criminal defendant. Due process is stronger. Burden of proof beyond a reasonable doubt. 4th Amendment, search and seizures. 5th Amendment, right against self-incrimination. Obtaining information from defendant more difficult. Case dismissed if prosecutorial misconduct. Double jeopardy applies. Fewer depositions. Original documentation and chain of custody important. Normally jury must be unanimous.

Criminal Investigations Differ
Different mentality – look for the financial evidence to support or refute an allegation. Different skill set (an investigative competency) – inquiring, observant, professional skepticism, and attention to detail . Your job is not to determine guilt or innocence. Strategy – team approach – requires obtaining witnesses, collecting evidence, and proving fraudulent intent. Source: Laura J. East, “The Role of the Forensic Accountants In a Criminal Investigation.” Journal of Forensic Accounting, Vol. IV, 2003, pp

Common Problems In Criminal Investigation
Identifying the criminal activity and the violation. Locating witnesses who have moved. Gaining the cooperation of witnesses. Establishing fraudulent intent. Organizing and maintaining documents and other evidence. Responding to defense motions and anticipating defenses. Completing investigations within the statute of limitations. Investigators and prosecutors being reassigned over the life of the case. Criminals adapting their schemes to new technology. Competing for a prosecutor’s time. Source: Laura J. East, “The Role of the Forensic Accountants In a Criminal Investigations.” Journal of Forensic Accounting.

Criminal Grand Jury (e.g. Fraud)
Arrest or grand jury. 16 – 23 sworn jurors; meet bi-weekly or monthly. Indictment if at least 12 votes (without prosecutor present). Accused has no right to be informed. Have power to accuse, not to convict. Can subpoena witnesses and documents. If accused attends, no right to an attorney. A witness may be compelled to testify under a grant of immunity. If immunized witness refuses, can be found in contempt, jailed. Arraignment: reading of the indictment in open court. Burden of proof much higher: beyond a reasonable doubt. Innocent until proven guilty (U.S. constitution).

Criminal Expert’s Report
After a suspect has been indicted but before the trail, an expert testifying in a criminal trial may be asked to prepare a written summary of the testimony expected to be given. Under Federal Rule of Criminal Procedures 16(a)(1)(E), a defendant has a right to request that the government provide a written summary of the testimony expected to be given by the government’s expert if prepared, the government’s summary report should include the information listed above. Once the government provides the defendant with this summary information, the government is entitled under Rule of Criminal Procedures 16(b)(1)( C ) to reciprocal discovery of the same information from the defendant’s expert.

AICPA Consulting Aids AICPA Consulting Services Report 93-1 (superseded by AICPA Consulting Services Special Report 03-1, March 2003) AICPA Consulting Services Special Report 93-2 CPA serving as an expert witness for a client is not an advocate. Trier of fact. AICPA Consulting Services Practice Aid 95-2 If a CPA acts as an expert witness, engagement letter discoverable. Detailed engagement letter can be a roadmap for opposing attorney. May wish to restrict services to a broad statement. CPA work product not protected.

AICPA Consulting Aids AICPA Consulting Services Report Practice Aid 96-3 Minimum elements to be included in your report. Table of contents, executive summary,introduction and background, objectives of the engagement, assumptions, and references. Does not require a report. Sampling less useful for off-the-book fraud. AICPA Consulting Services Report Practice Aid 97-1 List of selected badges of fraud. Description of fraud schemes. Legal references. Illustrative engagement letter scope paragraph. A short letter or memorandum. Statement of prediction, list of interviews conducted, and summary of interview information. Avoid stating any conclusions about the presence and absence of fraud. Avoid editorial content or judgments. Opinion on guilt or innocence left to judge or jury. (CFE has similar directive).

AICPA Consulting Aids Statement on Standards for Consulting Services No.1 – Consulting Services Definitions and Standards. These standards apply. Professional competence. Exercise Due professional care. Adequate Planning and supervision. Obtain Sufficient relevant data. Client interest [accomplish client objectives while maintaining integrity and objectivity]. Understanding with client [written or oral]. Communication with the client. A. Conflicts of interest. B. Significant reservations. C. Significant engagement findings or events.

Understanding With The Attorney
Identification of the attorney’s client The title of the litigation, including the litigants’ names, the court, and docket number A description of the nature of the litigation services to be provided or a statement that the services will be as the attorney may direct An identification of the expert witness or the willingness of the person who will be the expert witness if necessary Reference to the absence or existence of conflicts of interest The absence or existence of the attorney’s work product privilege Restrictions of the use or exposure of the CPA’s work The CPA’s right to withdraw from and terminate the engagement in certain circumstances Source: AICPA Proposed Statement on Responsibilities for Litigation Services No. 1, December 1, 2001.

Cash Receipts Statement?
The receiver, Thomas F. Lennon, hired a CPA, William Ling, from San Diego. The receiver’s November 6, 1997 “cash receipt statement” prepared by Mr. Ling appeared as follows: Beginning Balance $268,439 Money Distributed to Investors $2,281,255 Money Raised From Investors 6,704,320 Employees / Principals / Overhead $2,332,066 Oil and Gas Production 394,575 Oil Field Operations $1,616,000 Other 194,575 Attorney’s Fees 1,027,984 158,626 $145,978

The End Is Here

Sample Engagement Letter 1—Litigation Services
Exhibit 70A-1 Sample Engagement Letter 1—Litigation Services CPA & Company Anytown, USA September 4, 200X John A. Smith, Esq. Smith, Smith & Jones 100 Courthouse Way Dear Mr. Smith: You have asked me to read and analyze certain documents relating to a lawsuit brought against your client, XYZ Company. You have also asked that I be available to testify at the time of trial should you decide to use me as an expert witness. Any written reports or other documents that I prepare are to be used only for the purpose of this litigation and may not be published or used for any other purpose without my written consent. Irrespective of the outcome of this matter, I understand that you will compensate me at my standard hourly rate (currently $___) for all time spent, including travel, whether or not the engagement is completed or its results are used. You will also compensate me for any out-of-pocket costs that I may incur. I will submit bills monthly, which are due and payable on receipt and in all events prior to the commencement of my testimony. [Optional sentence: Before commencing work on this engagement, I would like a retainer of $___ which will be applied to final billing on this engagement or refunded to the extent that it exceeds such billing.] Any controversy or claim arising out of or relating to this contract, or the breach thereof, shall be settled by binding arbitration, in [insert desired venue], in accordance with the Commercial Arbitration Rules of the American Arbitration Association, and judgment upon the award rendered by the arbitrator may be entered in any court having jurisdiction thereof. I look forward to assisting you in this matter and hope that my services will be beneficial. If you approve of the engagement terms described above, I would appreciate your signing the enclosed copy of this letter and returning it to me. Sincerely yours, Accepted: John Jones, CPA Name of attorney's firm

Exhibit 70A-2 Sample Engagement Letter 2—Litigation Services [Optional additions are bracketed] CPA & Company Anytown, USA September 4, 200X John A. Smith, Esq. Smith, Smith & Jones 100 Courthouse Way Dear Mr. Smith: The purpose of this letter is to summarize our understanding of the assistance that CPA & Company will provide to you and your client, XYZ, Inc. in the matter of XYZ, Inc. v. ABC Corporation et al. before the Superior Court of the State of California, County of Los Angeles, which matter is Case. No. XXXXXX. You have requested that we assist you with analysis and consultation with regard to the XYZ litigation matter as you may direct. I would also be prepared to provide testimony at deposition and trial should you decide that to be appropriate. I will be responsible for the performance of our engagement with you and your client. My hourly billing rate is $XXX. From time to time, if necessary, other professionals may also assist when appropriate and needed. The hourly rates for our professionals are in the following ranges: Senior managers and managers — $XXX to $XXX; senior accountants and senior consultants — $XXX to $XXX; and consultants — $XXX to $XXX. [Our hourly rates are subject to change from time to time. We will advise you immediately if the rates are being adjusted by our firm.] Fees for our services are based upon the actual time expended on the engagement at the standard hourly rates for the individuals assigned. In addition to our professional fees, we are reimbursed at cost for any travel and out-of-pocket expenses. Bills are rendered and are payable monthly as work progresses. [We reserve the right to defer rendering further services until payment is received on past due invoices.] [Our normal practice is to obtain a retainer, and we herewith request such a retainer in the amount of $XX,XXX. This retainer is not intended to represent an estimate of the total cost of the work to be performed. The retainer will be held against the final invoice for the engagement; any unused retainer will be refunded.]

Exhibit 70A-2 Sample Engagement Letter 2—Litigation Services We are certain that you recognize that it is difficult to estimate the amount of time that this engagement may require. The time involved depends upon the extent and nature of available information, as well as the developments that may occur as work progresses. It is our intention to work closely with you to structure our work so that the appropriate personnel from our staff are assigned to the various tasks in order to keep fees at a minimum. [Furthermore, you, your client and I, all agree that any dispute over fees charged by our firm in this engagement will be submitted for resolution by arbitration in accordance with the rules of the American Arbitration Association. Such arbitration is limited only to the issue of fees charged and shall be binding and final. In agreeing to arbitration, we each acknowledge that in the event of a dispute over fees, each of us is giving up the right to have the dispute decided in a court of law before a judge or jury and instead are accepting the use of arbitration for resolution.] [You or your law firm or the court itself will advise us (with sufficient notice) of the work to be performed by us and the requirement for appearance in court. If there is a substitution or change in the association of attorneys involved in this litigation, we reserve the right to withdraw from this engagement.] If the arrangements described in this letter are acceptable to you and the services outlined are in accordance with your requirements, please sign and return a copy of this letter. We look forward to working with you in this matter. If I can provide you with any additional information, please do not hesitate to call me at (555) The proposed terms of this letter are subject to change if not accepted within 60 days of the date of this letter. Very truly yours, _______________________ (Name and Title) CPA & Company The services described in this letter are in accordance with our requirements and are acceptable to me and my client. Accepted: John A. Smith, Esq. Date Smith, Smith & Jones

Forensic Accounting: Strategies for Detecting and Controlling Fraud Intermediate D. Larry Crumbley, CPA, Cr.FA, CFFA, FCPA KPMG Endowed Professor Department.

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Forensic Accounting: Strategies for Detecting and Controlling Fraud Intermediate D. Larry Crumbley, CPA, Cr.FA, CFFA, FCPA KPMG Endowed Professor Department.

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Presentation on theme: "Forensic Accounting: Strategies for Detecting and Controlling Fraud Intermediate D. Larry Crumbley, CPA, Cr.FA, CFFA, FCPA KPMG Endowed Professor Department."— Presentation transcript:

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