Tag Archives: conducting internal examinations

Better Call Saul

As reported so often in the press these last few years, even when well-intentioned employees feel they’re doing the right thing by reporting acts of wrongdoing, their reports aren’t always well received. Numerous studies conducted by the ACFE strikingly bear this out.  And this is so much the case that any employee (public or private) who witnesses acts of wrongdoing and decides to report them is well advised to seek legal counsel before doing so.  When a whistle-blower also happens to be a CFE, the same advice applies. Every CFE should learn just when, where, and how to report fraudulent acts before blowing the whistle, if only so they can comply with the often complex procedures required to receive any available protections against retaliation.

All the U.S. states have laws to protect public sector employees from retaliation for whistle-blowing. Indeed, most of the state whistle-blowing laws were enacted specifically to actively encourage public sector employees to report fraud, waste, and abuse both in and without government agencies. Some state laws protect only public employees; others include government contractors and private-sector employees as well.  Many of the laws protecting private sector employees involve workplace safety. They were designed and enacted decades ago to protect employees from retaliation when reporting occupational safety issues. Public and private employees can use them, but they might not apply in all situations. Over the years, reporting in some other specific situations has also received protection.

Facts to keep in mind. Whistle-blowing, as it relates to fraud, is the act of reporting fraud, waste, and abuse. Reporting any act of wrongdoing is considered whistle-blowing, regardless if it’s reported by a public or private employee or to persons inside or outside of the victim organization.  Anyone can report wrongdoing, but the subsequent level of protection against retaliation an employee will receive will differ depending on whether they’re public or private, to whom they report, the manner in which they report, the type of wrongdoing they report, and the law(s) under which they report.  The ACFE tells us that a majority of unprotected whistle-blowers end up being terminated.  Among those unterminated, some are suspended, some transferred against their wishes and some are given poor performance evaluations, demoted or harassed.  To address their situation, some choose recourse to the courts.  The rub here is that to prevail, the employee will probably have to link their whistleblowing directly to the retaliation. This can be difficult for the employee experiencing any kind of current problem in the workplace because employers will claim their adverse personnel actions were based on the employees’ poor performance and not on the employees’ decision to blow the whistle. It’s especially easy for employers to assert this claim if the person who conducted the retaliation claims no knowledge of the whistle-blowing, which is very frequently the case.

Additionally, many whistle-blowers lose their cases because they didn’t comply with some technicality in the laws. Protection laws are very specific on how whistle-blowers must report the wrongdoing. Failing to comply with any aspect of the law will result in a loss of protection. Some examples:

  • Subject Matter Jurisdiction – the court must have the power to hear the kind of issue in the whistle-blower’s suit. Subject matter jurisdiction is based on the law the whistle-blower plans to use. Generally speaking, federal courts hear violations of federal laws and state courts hear violations of state laws, although this isn’t always the case. Employees can file alleged violations of their civil rights in state or federal courts under Section 1983 of Title 42 of the U.S. Code of

Federal Regulations. While rarely used in the past, today Section 1983 is part of the Civil Rights Act and the primary means of enforcing all Constitutional rights. Subject Matter Jurisdiction can help employees decide to file in federal or state court. Of course, the employer might ask to have the case moved to another court.

  • Personal Jurisdiction – the employee should make sure the court has power over the party s/he wants to sue. A court must have personal jurisdiction over the defendant to hear a case. Courts usually have personal jurisdiction over the people and organizations residing or doing business in their jurisdiction.
  • Venue – venue refers to the court that will hear the employee’s case. The proper venue is the jurisdiction in which the defendant lives or does business, where the contract was signed or carried out, or the incident took place. More than one court can have jurisdiction over the case. The employee should pick the venue most convenient for her.

As I said above, most whistle-blower laws were written and are intended to protect public-sector employees who report violations affecting public health and safety. Proving public interest is easy for public-sector employees because their work involves public protection. It’s not as easy for private-sector employees.  A goodly percentage of private-sector whistle-blowers lose their cases because the matters didn’t involve public policy.   Whistle-blowers can improve their chances of success by preparing early and reading the whistle-blowing laws of their state of jurisdiction. The case law is also important because it shows the precedent already set by the courts. The better prepared the employee is, the less likely s/he will make avoidable mistakes.  An evolving issue is the extent to which whistle-blowers must be certain of violations. Many laws already require the employee to state the specific law that was broken. Some courts require whistle-blowers to be certain of their allegations. Trends requiring certainty will make it increasingly difficult for whistle-blowers to receive protection.

As a final point.  A goodly percentage of whistle-blowers fail to achieve protection each year because of their own improper conduct. Some of these whistle-blowers misused their employers’ property; some of them stole it. Employees must ensure their conduct is above scrutiny because some courts will apply the “doctrine of unclean hands” and bar whistle-blowers from protection, if they’ve engaged in misconduct directly related to their complaints. The doctrine of unclean hands can work against employers, just as it does employees. In Virginia not too long ago, a Medicaid provider submitted documents containing incorrect claims information to the court. The whistle-blower proved the information was false and won his case on those grounds alone. Thus, it’s important for employers and employees to comport themselves with integrity.

Whistle-blowers who commit unlawful acts to advance their cases don’t do well in court, but neither do whistle-blowers who refuse to commit unlawful acts on behalf of their employers. Most state whistle-blower laws are designed to protect employees that refuse to commit unlawful acts, but it can be difficult to receive even that protection.

All this by way of saying that the laws governing whistle-blower protection are many and varied.  As fraud examiners and auditors it behooves us to be as familiar with these laws in the jurisdictions in which we practice as we reasonably can be.  But always, when confronted with such cases, always consult counsel.  As my father told me so long ago, the man or women who acts as their own attorney has a fool for a client.

And the Cash Flows On

As a fraud examiner and information systems auditor, I’ve always been a big fan of the cash flow statement and I think you should be too. For the non-accountant investigators among you, the cash flow statement reveals what happened to the client’s cash during the reporting period. It’s very much like your bank account statement: You have a beginning balance of cash at the start of the month, you deposit your paycheck, you write some checks for your mortgage and groceries, and then you end the month with a new cash balance. This is what a cash flow statement is: simply a beginning balance of cash, plus or minus some cash transactions, to arrive at an ending cash balance.

Another way to view the cash flow statement is as an income statement that is adjusted for non-cash transactions and transactions that have not yet impacted cash. Non-cash transactions are transactions that affect the income statement but will never affect cash. Depreciation is a non-cash transaction that is added back to profits on the cash flow statement since cash is never paid out or collected when an asset is depreciated. The cash flow statement also clarifies transactions that immediately impact cash. A company can make a sale but not collect on it, or incur an expense and not immediately pay for it in cash. These are called accounts receivable and accounts payable, respectively. Revenues that are earned but not received and expenses that are incurred but not paid would show up on the income statement, but not on the cash flow statement. So the formula for the statement is simply …

Beginning Cash Balance
+I- Net Cash Flows from Operating Activities
+I- Net Cash Flows from Investing Activities
+I- Net Cash Flows from Financing Activities
= Ending Cash Balance

There are two methods of reporting cash flows from operations; in the direct method, the sources of operating cash flows are listed along with the uses of operating cash flows, with the difference between them being the net cash flow from operating activities. In contrast, the indirect method reconciles net income per the income statement with net cash flows from operating activities; that is, accrual-basis net income is adjusted for non-cash revenues and expenses to arrive at net cash flows from operations. The net cash flows from operating activities is the same amount regardless of which method is used. The indirect method is usually easier to compute and provides a comparison of the company’s operating results under the accrual and cash methods of accounting. As a result, most companies choose to use the indirect method, but either method is acceptable.

So what does all this provide as a tool for the fraud examiner? Simply, the cash flow statement provides any CFE with lots of neat information for further analysis in a very compact form. First of all, the statement tells you what the company’s cash receipts and cash payments were for the period. Remember that it’s unlike the income statement in that the income statement takes into account all revenue and expense transactions, whether or not they affected cash. The cash flow statement only considers transactions that involve cash.

The cash flow statement divides the company’s cash transactions into three categories:

• Operating activities, which include all cash received and paid out in connection with the company’s normal business operations, such as cash received from customers and funds paid to vendors. This category essentially encompasses any cash transactions that affect items on the income statement.
• Investing activities, which are cash flows related to the sale or purchase of non-current assets, such as fixed assets, intangible assets, and investments. This category generally covers those cash transactions that affect the asset side of the balance sheet.
• Financing activities, which are all cash inflows and outflows pertaining to the company’s debt and equity financing. Inflows include the proceeds received from issuing stocks and bonds and from borrowing money from a bank. Outflows include debt repayments and cash dividends paid to shareholders. In general, this category includes the cash transactions that affect the liabilities and owners’ equity side of the balance sheet.

In a perfect world, a company should only need loans when it has a timing problem between collecting and spending money or when it’s expanding. However, if a company expends more money than it will ever make, it will eventually go out of business. This is where the cash flow statement is so useful to the fraud examiner. You will want to get an idea of the cash flow necessary to run the business so that you will be able to tell whether the company is generating enough cash from operations to continue to do business. The examiner can also evaluate the relationship between total cash generated from financing and investing activities and the amount generated by operating activities.

Some things you will want to note from the cash flow statement in connection with any suspected financial fraud:
• Does the company have heavy demands on its operating cash each period?
• Do the inflows equal or exceed the outflows?
• Is the cash balance increasing or decreasing over time?
• Is the company making smart decisions about sources and uses of cash given its apparent financial condition?

This is information pertinent to the investigation of a wide range of fraud scenarios, the successful investigation of which involves different data than that commonly available in the income statement. The income statement alone does not reveal a complete picture of the company’s financial health, necessary for a full investigation of so many types of fraud. Evaluating income and cash flows includes considering the timing of items, such as collections of accounts receivable. In the end, a company might have a fabulous looking income statement, but might not have any cash available for operations. This may occur because the revenues recorded on the income statement have not been collected. Remember, as part of doing business, companies usually allow customers to make purchases on credit; this means the companies will collect the cash subsequent to the actual recording of the revenues. For example, a small high-tech manufacturer might have a healthy looking profit on its income statement, but not be able to pay its employees’ salaries. However, the entrepreneurial owners of the company expect all is well, since they think the net income on the income statement to be equal to the amount of cash in the company’s bank account. But, as is often the case, there’s a timing difference between when the company records a sale and when it actually receives the cash from its customers. As a result, the cash balance seldom, if ever, will match the income on the income statement. Other transactions – such as accrued or prepaid expenses, depreciation, and inventory purchases – will also cause a disparity between an organization’s net income and its net cash flows.

The statement of cash flows represents a trove of invaluable information that can cast light on virtually every aspect of a client’s financial health and, thus inform any investigation. Use it to your advantage.