Forensic Accounting September 21, 2010 James Hyden, Manager Erin Lentz, Manager

1. Forensic AccountingSeptember 21, 2010James Hyden, ManagerErin Lentz, Manager

2. Forensic, investigative and litigation Information technology Valuation Governance risk and compliance Advisory Services Business strategy Restructuring and turnaround Performance improvement Transaction support Advisory Services Practice

3. What do we do? Investigations • financial statement fraud • embezzlement • third-party fraud (vendors/customers)

4. What do we do? (cont’d) Litigation • calculate damages in commercial litigation cases (lost profits, liquidated damages, diminution of value) • electronic discovery consulting • expert testimony/reports • consult in post-acquisition (purchase price) disputes • serve as an arbitrator

5. What do we do? (cont’d) Forensics • royalty audits/vendor audits • insurance claims • business interruption • property claims • assess distressed business for lenders/investors • fraud risk assessments • support audit teams (both internal and external)

6. Association of Certified Fraud Examiners2008 Report to the NationHighlights or “Lowlights” Study is based upon data compiled from 959 cases of occupational fraud that were investigated between January 2006 and February 2008. All information was provided by the Certified Fraud Examiners (CFE's) who investigated those cases.

7. Association of Certified Fraud Examiners2008 Report to the NationHighlights or “Lowlights” • Occupational fraud schemes tend to be extremely costly. • The median loss caused by the occupational frauds in the study was $175,000. • More than a quarter of the frauds involved losses of more than $1 million. • Occupational fraud schemes frequently continue for years before they are detected. • The typical fraud in the study lasted two years from the time it began until the time it was caught by the victim organization.

8. Association of Certified Fraud Examiners2008 Report to the NationHighlights or “Lowlights” • Despite increased focus on anti-fraud controls due to SOX and other professional standards (SAS 99), occupational frauds are much more likely to be detected by a tip more than any other means (audits, controls, accident, etc). • 46% of the cases in the Report to the Nation were detected by tips. • Tips were also the most common means of detection in 2002, 2004 and 2006.

9. Association of Certified Fraud Examiners2008 Report to the NationHighlights or “Lowlights” • However, the implementation of anti-fraud controls appears to have had a measurable impact on an organization's exposure to fraud. • 15 specific anti-fraud controls were examined. • The median loss in each fraud case was measured depending on whether the organization did or did not have a given control at the time of the fraud. • In each comparison, there were significantly lower losses when the control had been implemented.

10. Association of Certified Fraud Examiners2008 Report to the NationHighlights or “Lowlights” • Small businesses are especially vulnerable to occupational fraud • The median loss suffered by organizations with fewer than 100 employees was $200,000. • This was higher than the median loss in any other category including the largest organizations. • These findings are consistent with the 2006 report as well.

11. Financialpressure Rationalization Perception ofopportunity Fraud triangle Why do people commit fraud? • financial pressure • perception of opportunity • rationalization

12. Fraud triangle defined – Financial pressure • Management/employees have an incentive or are under pressure, which provides the underlying reason to commit fraud

13. Fraud triangle defined – Opportunity • Absence of controls, ineffective controls and/or ability for management to override controls

14. Fraud triangle defined – Rationalization • Attitude, character or set of unethical values that allow them to knowingly and intentionally commit dishonest act.

15. Top Indicators of Fraud Employees that work too hard! No vacations First one in, last one out According to the ACFE’s 2008 Report to the Nation 20.0% of frauds were discovered by accident

16. Top Indicators of Fraud Bad accounting records Unreconciled bank accounts Numerous correcting journal entries Corrected/altered source records

17. Top Indicators of Fraud Doing well when the industry is down Is the Company’s sales target reasonable? Is their an undue emphasis on short term profitability? Does the accounting staff focus on making budget or accurately (conservatively) preparing the financial statements?

18. Top Indicators of Fraud Continuous crisis mode/fire drill mode of operation Late night or weekend journal entries Emergency payment to vendors

19. Top Indicators of Fraud Management performing clerical tasks Override of controls Accounting staff out of the know

20. Top Indicators of Fraud Lack of segregation of duties High turnover Controlling individual

21. Top Indicators of Fraud Inherent risk factors Related party transactions Remote operations Operations in high risk countries

22. Top Indicators of Fraud Lack of Ethical Tone from the Top Does the Company have an employee tip line? Vendor tip line? Fraud ethics policies and training? Code of conduct?

23. Top Indicators of Fraud Change of lifestyle Is the parking lot full of BMWs? Spending on health care for elderly parents or children with drug problems is a common reason people start to commit fraud.

24. How is fraud detected? • external audit - 10% • internal audit - 19% • whistleblower - 46% • accident - 20% • other - 5%

25. How is fraud prevented? • understand the inherent risks • pay attention to recent fraud trends • understand the regulatory environment • look for red flag indicators

26. The Credit Crisis of 2008 • Enron and WorldCom brought you Sarbanes Oxley. • What will the credit crisis of 2008 bring??? • Increased regulation • Increased scrutiny from lenders • Higher fraud risk profile for everyone

27. Fraud Schemes Asset misappropriation Ponzi schemes Other acts of madness

28. Fraud SchemesAsset misappropriation • Company profile - Privately owned manufacturer in a small town; over $25 million in annual revenue; 150 employees • Former accounting manager accused of embezzling more than $8.0 million in cash

29. Fraud SchemesAsset misappropriation, cont. • Cash was embezzled from the Company via wire transfer, check and debit memo; many of the checks contained forged signatures and forged endorsements; payees on the checks and wire transfers did not correspond to the payee per the GL • The initial accounting for a majority of the inappropriate transactions was to debit inventory and credit cash

30. Fraud SchemesAsset misappropriation, cont. Fun facts • The accounting manager had 52 automobiles, a small fleet of boats, a 7,000 sq. ft. house with a tanning bed and a rock climbing wall in the backyard, a camper, a lake house with an in-ground pool and a home in Florida…all on a $40,000 annual salary! She claimed all this was a result of a common law marriage to a member of the Gotti family in NY

31. Fraud SchemesAsset misappropriation, cont. Not so fun facts • The owner and senior management of the Company did not have a clue they were being embezzled from • The fraud occurred over at least a 7-year period • The Company was audited by a Big Four accounting firm that issued unqualified audit reports for all of the affected years • The owner of the Company found out about the fraud via an early morning phone call from the IRS shortly before the fraudster was arrested

32. Fraud SchemesAsset misappropriation, cont. • The owner of the Company almost went to prison for non-payment of back payroll taxes • The fraudster was sentenced to 6 years in federal prison • The Company was almost forced into bankruptcy, as it was unable to refinance its debt until the fraud investigation was completed and the financial statements were restated

33. Fraud SchemesPonzi • “Ponzi” scheme is name for Charles Ponzi who, in the early 1920’s, persuaded tens of thousands of Bostonians to invest over $10 million in postal reply coupons even though only a few hundred thousand dollars worth existed. • Ponzi claimed these coupons, bought at a discount, could then be redeemed at full face value, yielding a substantial profit. • 2008 Fraud Examiners Manual • “A true Ponzi scheme has to do something to lure the investor, and the best way is by paying excessive returns” • James D. Ratley, ACFE President • Ponzi schemes rely on new investors to pay returns to earlier investors • Once the scheme collapses there is very little money left

34. Fraud SchemesPonzi - Bernard Madoff • Ponzi Scheme which took an estimated $50 billion in personal and institutional wealth from around the world • Offered an “investment” that provided a steady return and was protected against market downturns • “Holy Grail of investment products” – Harry Markopolos • Similar to other large CEO-fraudsters, Madoff’s resume was impeccable • Former Chairman of NASDAQ • At times his legitimate firm traded 5 – 10% of the volume for listed stocks

35. Fraud SchemesPonzi - Bernard Madoff, cont. • Auditor of Madoff’s Funds • Three-person accounting firm with one CPA • Told AICPA it has not audited in 15 years • Investors • Used the veil of exclusivity to overcome victims’ hesitancy to invest • Investors were blinded by the resume, his perceived wealth, and community status • Investor’s who asked too many questions were told not to invest

36. Fraud SchemesPonzi - Bernard Madoff, cont. • Clients / Victims – Court Filing shows 165 page list • HSBC Bank - Lost approximately $1 Billion • New York University • Kevin Bacon - Actor • John Malkovich – Actor • Jeffrey Katzenberg - CEO of Dreamworks • Steven Spielberg's charity, Wunderkinder Foundation • Eliot Spitzer - Former New York Gov. • International Olympic Committee

37. Fraud SchemesPonzi - Bernard Madoff, cont. • Downfall – Financial Crisis of 2008 • Everyone wanted their cash, even the most trusting clients • Institutional investors began to demand redemptions • Madoff did not have the cash to cover the redemptions • Sentenced to 150 years in prison • Life Style • Prestige • Manhattan apartment • Beachfront mansion in the Hamptons • Villa in French Rivera • Yachts in New York, Florida, and Mediterranean

38. Fraud SchemesPonzi – Sir Allen Stanford • Estimated $8 billion ponzi scheme and potential money laundering operation with drug cartel • Stanford Financial offered many products, but main investment opportunity was Certificate of Deposits that offered 2% above American bank rates • “Its unbelievable. People are so stupid, they will risk all their money, give it to someone they don’t even know, for two points.” • Allen Stanford to Bank Employee • Stanford Financial had 30,000 customers in 131 countries • Based in Caribbean Island of Antigua • Offices around the world

39. Fraud SchemesPonzi – Sir Allen Stanford, cont. • Stanford Financial popularized its brand • Sponsored Vijay Singh and two golf tournaments • Gave millions to hospitals, charities, and museums in Memphis, Houston, and Miami • Stanford built expensive and large buildings in Antigua and in the U.S. • Focused on appearance of success • Allen Stanford gave so much money to the government of Antigua, they awarded him a knighthood

40. Fraud SchemesPonzi – Sir Allen Stanford, cont. • Auditors of Stanford Financial • 14 person firm in Antigua • Downfall • Despite being investigated by the SEC, FBI and DEA for over 10 years, Stanford Financial remained in business • Multiple insiders stated, nobody knew how the business provided high returns on its investments or how it made its money • “He paid very well. So the questions stopped.” • Brought down by independent financial analyst and a blog

41. Fraud SchemesPonzi – Sir Allen Stanford, cont. • Life Style • Respect • Mansions around the world • Fleet of private jets and helicopters • Owner of cricket team and field complex • Women • Wife and daughter in Texas • Girlfriend and two kids in South Florida • Girlfriend and two kids in Kent, England • Girlfriend (cocktail waitress) in Antigua

42. Fraud SchemesPonzi – Marc Dreier • Four year ponzi scheme that stole $380 million from 13 Hedge Funds • Dreier LLP occupied 11 floors in a Park Avenue building • Employed 270 attorneys • Had famous clients – Bill Cosby, Maria Sharapova, Wilco • Sold multi-million dollar debt notes for a Solow Reality, a client’s company, without the client’s knowledge • Forged financial statements and auditor letterhead • Created a fake debt note

43. Fraud SchemesPonzi – Marc Dreier • Hired people to impersonate Solow Reality management in a conference room inside Solow’s actual offices • Dreier impersonated an attorney with Ontario Teacher’s Pension fund inside the Pension funds offices in order to sell debt notes to a Hedge Fund • Downfall • Financial crisis of 2008 – client’s demanded money • Arrested at Ontario Teacher’s Pension Fund during impersonation • 20 years in prison

44. Fraud SchemesPonzi – Marc Dreier • “I needed to give people the idea I was doing very well…That was the first step in a pattern toward living above my means.” • Life Style • 2 Waterfront homes in the Hamptons • Caribbean condo • 120-ft Yacht in St. Martin • Aston Martin • Santa Monica condo • Sushi restaurant in LA • Art – Warhol, Picasso, Matisse

45. Fraud SchemesJerome Kerviel • Jerome Kerviel is a young trader at French bank Societe Generale who is accused of making unauthorized bets on stock markets that cost the bank nearly $7.2 billion but may not have netted him a cent. • The bank called the fraud "exceptional in its size and nature," and said it apparently went undetected for more than a year by its own multilayered security systems.

46. Fraud SchemesJerome Kerviel, cont. • Kerviel worked on the glamorous futures desk, where he invested the bank's own money by hedging on European equity market indices - making bets on the future performance of the markets. • Kerviel was involved in what the bank calls "plain vanilla," or the more basic forms of hedging, with limited authority. • The bank said he went far beyond his role - taking "massive fraudulent directional positions" in various futures contracts, betting that stock markets would rise.

47. Fraud SchemesJerome Kerviel, cont. • He apparently escaped detection by using knowledge of the bank's control systems gleaned in his earlier monitoring job. • He got caught when markets dropped, exposing him in contracts where he had bet on a rise. • Three union officials representing Societe Generale employees said managers at the bank told them Kerviel was having "family problems."

48. Fraud SchemesSamuel Israel • Samuel Israel pleaded guilty to conspiracy, wire fraud and investment advisory fraud in September 2005 and was given a 20-year sentence for bilking his investors of more than $400 million. Israel’s lawyer had convinced authorities that Israel was not a flight risk and they allowed him to drive himself to prison. • But in June 2008, he tried to avoid prison by faking his suicide. He abandoned his car near the Bear Mountain Bridge in New York with the message “Suicide is Painless” written on the windshield.

49. Fraud SchemesSamuel Israel, cont. • Following Israel’s mysterious disappearance, police aircraft and boats began searching the river for his body. When they could not find his body or any witnesses who saw a man jump, they determined that the suicide was a hoax. • Israel turned himself in to Massachusetts police in July 2008.

50. Fraud SchemesMarcus Shrenker • Marcus Shrenker is an Indiana money manager who tried to fake his own death in a plane crash in December 2008 to avoid financial ruin. He had built his investment businesses on the backs of people he knew — acquaintances, a friend of 10 years and even his own aunt. • His clients didn’t know he had sold them a nonexistent foreign currency fund, created false account information and used their money for personal expenses.