ACFE training has long told us that a prudently crafted final examination report can have a variety of important uses. As we know, when the fraud investigation has been completed, the investigator writes a formal report. The report itself plus expert opinions and testimony are then used as needed to support the resolution of issues that can relate to a whole host of matters potentially concerning taxes, employment, regulatory reporting, litigation (civil and criminal), and insurance claims.
Because the report can be used for such varied purposes, it should always be constructed under the assumption that it will be challenged in court. This requires that the report meet very high standards; any errors or misstatements in it may be used to undermine the credibility of both the report and of the investigator who wrote it.
Frauds typically result in business losses. For income tax purposes, such losses may be classified as either deductions or offsets to reportable revenues depending on the type of loss and the taxing authority. In cases of misappropriation, almost any type of asset can be fraudulently converted, and in some cases, a valuation expert might be needed to determine the dollar amount of the loss.
In cases of occupational fraud, the financial records can be so damaged from the fraud scheme that an exact determination of the loss is impossible. In such cases, the report may attempt to estimate the loss using any reasonable means available because taxing authorities often permit estimation of losses in cases of destroyed records.
Some occupational fraud schemes result in so much damage to the financial records that the entity will not have enough information to file tax returns. This can happen, for example, if the revenue records are either destroyed or rendered unreliable as a result of fraudulent transactions and journal entries. In such cases, it might be necessary to conduct a major reconstruction of the accounting records before losses can be determined, reliable financial statements can be generated, and tax returns can be filed. In fact, in some cases, the fraud investigator’s report might need to focus on the loss due to destruction of the financial records and leave open the issue of misappropriation pending reconstruction of the financial records. Of course, depending on the scope of the investigation and the available information, the investigator might both reconstruct the financial records and report on any misappropriation losses.
Another tax-related issue involves the embezzlement of funds set aside to pay payroll taxes. The U.S. federal tax system sometimes refers to such funds as trust fund taxes because under tax law, these funds belong to the Internal Revenue Service (IRS) from the moment they are collected. The business and the owners merely serve as trustees in collecting the taxes on behalf of the IRS.
Employers who terminate an employee for committing fraud can eventually battle the employee in litigation. In some cases, the former employee may sue for wrongful termination of employment, defamation, or discrimination. In other cases, an employee who is to be fired might have collective bargaining rights that require an arbitration process with a right of appeal. Fired employees may also attempt to claim government unemployment compensation benefits.
As a general rule, employees who are fired for serious misconduct (e.g., fraud) are not entitled to benefits. However, employees may argue that their termination was not deserved and may request a hearing to argue their side of the story. If this occurs, a fraud investigation report could serve as important evidence.
Whether a fired employee receives unemployment benefits may be important in determining the amount the company is required to pay for unemployment insurance. As a result, an employer who routinely fires employees runs the risk of incurring considerable increases in the cost of unemployment insurance. To make things even worse, if a fired employee was the one in charge of making unemployment insurance contributions but did not make them on time, a penalty rate of 150 percent could be applied to the employer’s future contributions. The exact consequences depend on the particular state involved because rules for unemployment insurance for state and federal governments differ. As a result of the possible tax and legal consequences as well as of possibly embarrassing publicity, employers are frequently reluctant to fire dishonest employees. Instead, they do things to encourage dishonest employees to leave voluntarily after taking measures to prevent them from continuing the fraud. In some cases, employers actually give dishonest employees favorable recommendations for future jobs.
Sometimes, a fraud investigation report may trigger mandatory reporting of the fraud to a government agency. For example, §1233.3 (a) of Title 12 (Banks and Banking) of the U.S. Electronic Code of Federal Regulations states the following:
‘A regulated entity shall submit to the Director a timely written report upon discovery by the regulated entity that it has purchased or sold a fraudulent loan or financial instrument, or suspects a possible fraud relating to the purchase or sale of any loan or financial instrument.’
A fraud investigation report can sometimes be more helpful in ruling out fraud than in ruling it in. For example, a report might read, “A detailed examination of the financial records did not reveal any intentional irregularities or evidence of fraud or misappropriation.” On the other hand, when there is fraud, the report might read something like, “There was a series of irregular computerized journal entries made in the accounts receivables ledgers and corresponding shortages in the cash account. The employee in charge of the computerized journal entries left the company before this investigation began and was not available for an interview. The owner states that only she and the former employee had access to the journal in question.”
The wording in this report suggests that the former employee may have embezzled funds from collections on account by making irregular journal entries. But the report cannot guarantee that s/he did so, nor can it definitively conclude that a fraud occurred. As a general rule in advance of an occupational fraud investigation, interested parties should not assume that the investigation will result in a report that gives a definitive answer to whether a fraud occurred. A more reasonable outcome is a report that identifies missed or damaging records or missing assets.
Fraud reports can be very helpful in both criminal and civil litigation. However, they can be less than satisfying in trying to persuade authorities to prosecute a suspect. What happens too often is that police or prosecutors browse through a fraud investigation report looking for a clear statement that identifies the guilty person. But, of course, such statements don’t appear in independent fraud investigation reports written by CFEs.
In many cases, a fraud investigation report is enough to at least persuade authorities to look at a case, especially with the hope of getting a quick confession. But if the suspect denies everything or lawyers up, law enforcement quickly realizes that they will need to hire a forensic accountant (because it is unlikely that they have one of their own) and will be forced to try to understand what they consider to be arcane and obscure accounting concepts.
The saying in law enforcement circles (as with the news media) is “if it bleeds, it leads.” In a metropolitan area, police quickly send a dozen squad cars, a SWAT team, and a helicopter to pursue someone who robs a liquor store of $100 with a penknife. But the same police respond with glassy eyes if the owner of the same liquor store reports that his accountant has robbed the business of $100,000 using a computer to manipulate the accounting records.
Although it does happen, most victims do not sue their fraudsters, primarily because fraudsters are typically judgment proof, meaning they do not have sufficient assets to repay their victims. However, criminal courts can and do order restitution, which can provide a strong motive for the victim to prosecute the perpetrator. In some jurisdictions, courts order convicted fraudsters to make regular restitution payments directly to the court, which then distributes them to the victim.
Finally, many companies have insurance with coverage for losses related to fraud. This coverage can include losses such as those due to the costs of preparing a proof of loss, losses due to embezzlement, losses of valuable papers and records, and loss of income. Independent fraud investigation reports can be very helpful in supporting insurance claims. Furthermore, one nice thing about embezzlement coverage is that some polices are written so that it is necessary only to prove that a loss has occurred, not who the guilty party is. The usefulness of a fraud investigation report with respect to losses of valuable papers and records, and loss of income, depends on the scope of the investigation. In many cases, the scope does not include determining the amount of losses of income or damage to valuable papers and records.