Building the Case with Forensic Accounting 

A.    Choosing the Right Forensic-Accounting Professional

Fraud prosecutors who have no formal training in accounting principles may need to understand complex accounting issues during the investigation of a securities or financial fraud case. While most forensic accountants—whether employed directly by the government or as contractors—will have the investigative skills to trace funds or locate assets, consider whether your case may require additional specialized expertise. For example, during the investigation of a securities fraud case involving a public company, it may help to consult with a forensic accountant who also holds a license as a Certified Public Accountant, and thus, is qualified to explain relevant accounting standards and their potential application

to the investigative team. In other cases, such as an investigation into a potential Ponzi scheme involving a small group of perpetrators, nothing more may be required than a forensic accountant with the skills to build and manage a database containing bank records and other financial information and the ability to trace proceeds through multiple accounts. While most securities and financial fraud cases will benefit from using at least some forensic-accounting techniques, there will be cases where the specialized expertise of the forensic accountant also can be leveraged to advance the investigation.

B.    Types of Analyses

In securities fraud prosecutions involving Ponzi schemes or misrepresentations in the sale of unregistered securities, forensic accounting techniques can build and maintain databases to hold the voluminous financial records gathered during the investigation, including bank statements, brokerage statements, and information provided by individual investors. As the database is populated with the evidence, forensic accountants can draw conclusions about the nature and extent of the scheme and resolve key questions in the case. The central issue in many Ponzi scheme cases is the extent to which the targets of the investigation used investor proceeds to pay off other investors, in violation of the terms of the investment. In very complex Ponzi schemes involving hundreds of accounts and multiple operating entities, forensic accountants may need to create a database with the financial records and collapse the transactions to show only inflows and outflows from the “system” that comprises the accounts linked to the scheme. This technique was used by the government with success in United States v. Timothy Durham et al., No. 1:11-CR-42 (S.D. Ind. 2012). In Durham, the defendants were charged with defrauding over 5,000 investors out of approximately $200 million after a financial services company collapsed with little or no assets available for recovery. The evidence at trial proved that the defendants had purchased an existing financial services company and stripped the compa provide an opinion on whether the financial statements were presented in accordance with relevant accounting principles, and to quantify the impact of the scheme upon the financial statements, in order to establish the materiality of the misrepresentations. See United States v. Cuti, 720 F.3d 453, 458 (2d Cir. 2013) (appropriate for the government to elicit testimony on materiality from “certified and experienced accountant[s] personally familiar with the accounting of the transactions at issue”); United States v. Orr, 692 F.3d 1079 (10th Cir. 2012) (noting government has broad discretion to prove materiality, including through posing hypothetical questions);

United States v. Ranney, 719 F.2d 1183 (1st Cir. 1983). Forensic accountants who have specialized expertise in registered securities or Generally Accepted Accounting Principles can also assist in the investigation by explaining where the accounting records fit in with the scheme and the best way to examine the records, given the government’s theory. ny of its assets and liquidity through hundreds of related-party loans and lines of credit. Then, they used the proceeds from the loans to pay other investors, keep other failing businesses afloat, and sustain their lifestyle.  Because the defendants used a complex system of accounts to siphon investor proceeds through more than a hundred related businesses, the government relied upon forensic-accounting techniques to collapse all of the accounts controlled by the defendants so that the entire universe of cash flows into and out of the accounts was captured. This analysis showed that despite the defendants’ glamorous lifestyle, the reality was that they were broke and their businesses were essentially insolvent. Nevertheless, at trial the defendants still argued that the value of their businesses was destroyed by the government’s execution of a search warrant rather than by the fraud.

The government was able to successfully counter that defense by relying upon the forensic accounting analysis to show that the only cash entering the defendants’ system of accounts was investor proceeds. After a two-week trial, all defendants were convicted. Ultimately, the Chief Executive Officer of the collapsed financial services company received a 50-year sentence. In contrast to securities fraud prosecutions involving the sale of unregistered notes, investigations into public companies often involve complex accounting issues. In many of these cases, the government will focus upon potential misrepresentations in the financial statements that the issuer has filed with the securities regulator, such as the Securities and Exchange Commission (“SEC”). The government often uses forensic accountants in these types of cases to help review the relevant papers from the company’s outside auditors and establish what was known by the auditors about the transactions at that time. In addition, in a true accounting fraud case, the government also may ask the forensic accounting team to