The Evolution Of Forensic Accounting

Friday, October 1, 2004 - 01:00

Tedd Avey
Kroll Consulting Services Group

The ongoing Commission of Inquiry into the Sponsorship Program and Advertising Activities, better known as the Gomery Commission (named after inquiry head, Mr. Justice John H. Gomery), is arguably the most important investigation taking place in Canada. The Commission, which was established in February 2004 by order-in-council, began public hearings in early September. During the next year or so, this government-appointed commission will hold televised public hearings to examine the findings of Canada's Auditor General, Sheila Fraser, that there was widespread non-compliance with the contracting rules in the management of the Sponsorship Program that consumed $250 million of taxpayers' money. She found that over $100 million of that amount went to private communications agencies as fees and commissions. The commission also has a mandate to recommend ways to prevent mismanagement of sponsorship programs and advertising activities in the future.

It is a politically charged inquiry that has already, and likely will continue to, make front-page news in Canada for quite some time. It is also a current engagement of Kroll Lindquist Avey (KLA), the forensic accounting firm that I co-founded almost 30 years ago. Little did I guess those many years ago that one day our firm would be assisting such a highly sensitive and complex investigation involving literally millions of documents

It is perhaps not well known that forensic accounting originated in Canada and existed here long before it gained the international prominence it now has. In 1975, Bob Lindquist, Don Holmes (now deceased) and myself, all Chartered Accountants, left the relative security of the major accounting firm Touche Ross (now Deloitte Touche) in search of a new, and we hoped, more exciting career as financial investigators. We called ourselves forensic accountants, since our work had to meet the standards of a court of law (the definition of "forensic"). A popular TV show of the time, called "Quincy," featured Jack Klugman as a crusading coroner who solved crimes conducting forensic examinations of murder victims. As a result, we often had to distinguish our newly developed discipline of forensic accounting from the work of the then-famous coroner.

On reflection, what we actually did was quite radical at the time. We combined our knowledge of accounting techniques and principles with an investigative mindset to assist the Ontario Attorney General and the police with investigations that had a financial component to them. White-collar crimes such as fraud and corruption were on the rise - or, at least, were becoming more apparent to the authorities and the public. The authorities realized they needed help in understanding, investigating and explaining to the court the financial aspects of these matters, so they turned to us for help.

One of my first cases was to assist the police with the investigation of the theft of a very significant number of auto parts from one of the major carmakers. One aspect of the assignment was to help the police develop the wording for search warrants to obtain financial information to prove that wholesalers of the stolen parts had no legitimate source of supply. The use of financial information to prove a crime was in its infancy and the investigators had no prior experience. We needed financial evidence that the suppliers' invoices and purchase orders were false. We worked very closely with the police in a way that doesn't occur any more, even to a point of being present at many of the searches.

In another interesting engagement, we assisted police with the investigation of Brian Molony, the assistant bank manager at a major Canadian bank. A compulsive gambler at casinos in Las Vegas and Atlantic City, he stole $10.2 million from the bank to fund his habit, which ultimately cost him six years in prison. As a footnote, his life story was recently the subject of a Hollywood film starring Philip Seymour Hoffman.

For about five years, we were the only group of forensic accountants in Canada; and we worked almost exclusively for the Attorney General to assist the police. By the mid 1980s, the major accounting firms in Canada began to offer this service as well. Over the next decade, government budgets in Canada were cut back. There was also a change in government priorities, which reduced the availability of funds to investigate white-collar crime, in particular as it related to internal fraud within companies. Although the focus of our work did not change, our clientele shifted from governments to corporations that had been victimized by fraud.

In the early '90s, a downturn in the economy not only further affected the funding for white-collar crime investigations initiated by government authorities, it also resulted in layoffs in the private sector. These contributed, through reduced layers of control and an increase in desperate employees and managers, to more white-collar crime and other forms of financial wrongdoing. Managers were under pressure to meet goals and objectives. Do what it takes was the order of the day. The same applied to many businesses. Facing collapse or bankruptcy, some companies even turned to fraud to survive.

As white-collar crime escalated, and many of the schemes became more complex, our firm realized forensic accounting had to evolve to keep up. Police openly told victims that the onus was on them to find a solution and they often encouraged victims to engage forensic accountants. We soon realized that many of the cases required investigative expertise beyond our experience, so we began to bring former senior law enforcement officers, such as Jim Szarka, who had been Deputy Commissioner of the Ontario Provincial Police, into our practice as partners. Today, almost all forensic accounting firms employ former investigators to work in tandem with the CAs and CPAs.

During the 1990s, forensic accounting experienced more changes. Traditionally, forensic accountants had been retained after the fact - money was missing, kickbacks to suppliers had been discovered, a sure-fire deal turned out to be too good to be true. Gradually, clients began calling forensic accountants in before the fact; for example, to design fraud prevention controls and, especially, to conduct due diligence.

Financial due diligence had traditionally been the exclusive domain of the traditional accounting firms with an audit focus, and who still dominate the field. But it was no longer exclusive. Forensic accountants were being retained to apply their expertise to deals before they were made. They examined questions such as: is the company being acquired as financially healthy as it claims? Are there issues to be uncovered that could alter or break a deal?

One case example was on behalf of a client that considered purchasing a manufacturer of transportation equipment. The manufacturer showed budgeted sales volume growth of 32% in the year following acquisition. The projections strongly hinged on the launch of new products late in the post-acquisition year.

An analysis of previous project launches determined that achieving significant sales volumes required a longer lead time than budgeted. Our adjusted projections identified 12% as a more realistic figure. The deal went ahead but was restructured to tie a portion of the purchase price to future performance.

This was a long way from helping to unravel frauds and solve financial crimes. It was also symbolic of one of the most significant shifts in forensic accounting. Fraud investigations were no longer our mainstay. For Kroll Lindquist Avey it had become, and remains, an important part of our business; but it is now less than 50%.

In the past decade or so, the legal and corporate communities have begun to see a greater need for the assistance of accountants trained with an investigative mentality. Our new services include litigation consulting, business valuation, business intelligence and investigations, corporate advisory and restructuring -Kroll runs Enron, for example - background screening and computer forensics, such as data recovery and e-discovery. This is just a partial list of the interrelated services that a firm such as Kroll Lindquist Avey provides.

Why the somewhat sudden diversity in services? One reason is the globalization of white-collar crime, as technology, especially, allows fraudsters to move money around the world electronically, regardless of borders, as well as entice victims in one country while operating perhaps thousands of kilometers away. Another reason is the proliferation of crimes and problems that have a financial component of some degree or another. Criminals have discovered that it's a lot easier, safer and more profitable to commit fraud than, say, rob a bank. And the penalties if caught are usually far less severe, although that has recently begun to change, especially in the United States.

While decades ago we worked almost exclusively in Ontario, we are now retained on engagements all over the world. One example was Kroll Lindquist Avey's work, on behalf of the Jamaican government, on an investigation involving the collapse of three financial institutions in that country, apparently through self-dealing and fraud. The loss to the Jamaican government was in the hundreds of millions of dollars. As the head of a large team of financial investigators from various KLA offices, I provided expert testimony in Jamaica on this challenging matter.

Following the collapse of Enron and other major financial scandals, the attitude towards white-collar wrongdoing dramatically changed. The new corporate governance requirements, in the U.S. and Canada in particular, have been well documented, and some white-collar defendants have received sentences in the U.S. that are equal or greater to those for violent offences. A new emphasis on prevention and corporate accountability has also resulted, so that corporate governance support has become an additional service offered by forensic accountants.

Four years into the new millennium, forensic accounting has again responded to the new realities of our world. When we began our practice in 1975, we operated at first out of our cars until we could afford a small office in Toronto. Now we are part of a large international risk consulting firm, Kroll Inc., which offers clients a considerable array of related services, from forensic accounting to business intelligence. We joined Kroll in 1998 because we perceived that being part of a large, global investigative firm was the future for our discipline. If many of the sophisticated criminal minds are operating on a large, international scale, we had to as well.

As I look around Victoria Hall in Ottawa's old City Hall, where the Gomery Commission takes place, I am proud that forensic accounting began in Canada, and of the role our firm played. Canada continues to lead the way in the evolution of the discipline, through such advancements as the Diploma in Investigative and Forensic Accounting, a professional accreditation program developed and managed by the Canadian Institute of Chartered Accountants. Also noteworthy is the work of the U.S.-based Association of Certified Fraud Examiners, which offers a Certified Fraud Examiner program. As well, in the past few years, a significant number of universities in North America have added courses in forensic accounting and fraud detection.

What is the future of forensic accounting? I believe it's a discipline that will continue to respond to the changing business and government environments, and will always strive to improve the professional standards of its practitioners. It's probably unwise to predict much beyond that, as recent events have shown how quickly the world changes these days. But there is one prediction that can be made - the need for forensic accountants is not going to decrease. Fraud is a growth industry, as Joseph Wells, the founder of the ACFE, recently told an international conference. Sadly, that is all too true.

Tedd Avey (tavey@krollworldwide.com), CA·IFA, CPA (Texas), CFE is President, Kroll Consulting Services Group (www.krollworldwide.com).