Special Investigations: Managing the Process Bob Gray

1. Special Investigations: Managing the Process Bob Gray Managing Director, UHY Mann Frankfort Stein & Lipp Advisors David McAtee Partner, Haynes and Boone, LLP Bill Powers Dean, The University of Texas School of Law

2. Financial Statement Fraud • Who is Responsible • What is the Trend in Restatements • Explore Methods Employed to Distort Reported Results • Discuss Some Fraud “Warning Signs”/ “Red Flags”

3. Responsible Parties Include…

4. And The Winner Is…

5. Restatements Resulting From Errors & Irregularities 28% Increase In 2004 414 restated in 2004 330 restated in 2002 323 restated in 2002 270 restated in 2001 223 restated in 2000 216 restated in 1999 158 restated in 1998

6. Irregularities Involve: Manipulating, altering or falsifying records Intentional omission of events, transactions or significant events Misapplication of accounting principles with intent to deceive Errors Involve: Mistakes in gathering and processing data Incorrect use of estimates Certain mistakes in applying accounting principles Errors vs. Irregularities

7. The Trajectory of Fraud • Fraud starts out small • Increases in complexity and aggressiveness • Grows in magnitude and number of participants • No way out

8. The Slippery Slope A. Utilize aggressive reserves B. Delay/alter expense recognition C. Accelerate revenue recognition

9. General & Administrative Costs Accounting 417,845 0.3% Acquisition Costs 254,050 0.2% Advertising 411,240 0.3% Automobile 913,670 0.7% Depreciation 4,636,470 3.5% Insurance 3,212,843 2.4% Insurance - G/L & Property 972,570 0.7% Insurance - Workers Comp 1,697,912 1.3% Interest 603,886 0.5% Legal 871,393 0.7% Office 624,602 0.5% Payroll Tax 2,683,565 2.0% Rent 6,025,808 4.6% Rent - Equipment 368,475 0.3% Repairs & Maintenance 4,763,189 3.6% Taxes 346,746 0.3% Telephone 367,156 0.3% Travel & Entertainment 475,634 0.4% Utilities 939,418 0.7% Wages 15,987,880 12.2% Total Expenses 46,574,352 35.4% Capitalize Operating Expenses Reduce G&A by shifting $3mm in “Repairs & Maintenance” expense to the Balance Sheet

10. Capitalize Operating Expenses Bury the $3mm of G&A expense in Prepaid Assets and PP&E Increase operating income by $3mm less annual depreciation

11. The Slippery Slope A. Utilize aggressive reserves B. Delay/alter expense recognition C. Accelerate revenue recognition D. Make unsupportable entries E. Exploit acquisition reserves F. Fabricate additional revenues

12. Potential Warning Signs / Red Flags • Undue Emphasis on Meeting Earnings Projections or Other Targets • Control Environment Within the Company is Weak • Management Compensation depends on Meeting Unreasonable Targets Set by Others

13. Potential Warning Signs / Red Flags • Continuing Lag Between Cash Flow and Reported Earnings • Conditions in Subject’s Industry are not positive for the long-term • Participation in Several Period End Transactions • Period of Rapid Growth • Growth Fueled by Continuous Acquisitions

14. “Internal or special investigations in the business world are like brain surgeries in the world of medical trauma- delicate, fraught with unsuspected complications, and even when quite successful, serious aftereffects may remain.”

15. 12 Steps to Conducting Internal Investigations Step 1: Admit that you don’t know where this investigation might lead. Step 2: Visualize the goal vis-à-vis the Government. Step 3: Understand that the Government expects your cooperation.

16. “Thompson Memo”Larry D. Thompson, Deputy Attorney General (Jan. 2003) “The main focus of the revisions is increased emphasis on and scrutiny of the authenticity of a corporation’s cooperation. Too often business organizations, while purporting to cooperate with a Department investigation, in fact take steps to impede the quick and effective exposure of the complete scope of wrongdoing under investigation. The revisions make clear that such conduct should weigh in favor of a corporate prosecution.”

17. “Comey Interview”James B. Comey (Nov. 2003), now Deputy Attorney General “When misconduct is discovered, the Department expects corporations to self-report to law enforcement, including any regulators, to investigate the misconduct, to discipline any wrongdoers, and to cooperate fully with government investigations.” - United States Attorneys’ Bulletin, Nov. 2003

18. “Comey Interview”James B. Comey (Nov. 2003), now Deputy Attorney General “Cooperation doesn’t just mean complying with subpoenas. It means … telling the Government what the corporation knows about what happened, who did it, and how they did it. In short,we expect cooperating corporations to help us catch the bad guys.” - United States Attorneys’ Bulletin, Nov. 2003

19. 12 Steps to Conducting Internal Investigations Step 4: Hire independent counsel Step 5: Establish a chain of command or, even better, review and adopt a pre-determined chain of command. Step 6: Disclose the investigation to the Government and, if appropriate, the press.

20. 12 Steps to Conducting Internal Investigations Step 7: Inform employees of the investigation. Step 8: Collect relevant documents. Step 9: Interview witnesses. Step 10: Decide whether to waive privilege (your presumption has been that you will).

21. “Comey Interview”James B. Comey (Nov. 2003), now Deputy Attorney General “The Principles do not require waiver, and do not even require cooperation. … Should the Government request the results of interviews conducted under the pain of dismissal? Yes, of course… It is obviously up to the corporation to decide whether to wants to cooperate or supply the details of the interviews.” - United States Attorneys’ Bulletin, Nov. 2003

22. 12 Steps to Conducting Internal Investigations Step 11: Decide whether to create a written report. Step 12: Take remedial action.

23. Thank you! For more information, please contact: David McAtee Haynes & Boone, LLP 901 Main St.Suite 3100Dallas, TX 75202ph: 214.651.5374 david.mcatee@haynesboone.com Robert Gray UHY Mann Frankfort Stein & Lipp Advisors 2320 Thanksgiving Tower 1601 Elm Street Dallas, TX 75201 214-999-4491 rgray@uhy-us.com