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Forensic Accounting in Divorce

FORENSIC ACCOUNTING IN DIVORCE

To direct your own expert you should always have an understanding of the subject matter in which your expert will speak upon. When it comes to cross examination I think this is even more important. If you don't understand the subject matter you can expect a hostile expert witness to make a fool of you on cross. Thus good lawyering requires understanding your subject matter. Not only do you need to understand the subject matter itself but you should also understand the techniques used by experts in reaching their conclusions. It is difficult for you to pick apart an experts line of reasoning if you don't have any idea of what techniques the expert used in reaching his or her opinions. This isn't the type of thing you should try to do in the midst of your cross examination. You should have an understanding of what techniques were employed while preparing your cross examination. If you know the expert's methodologies you can exploit the weaknesses employed by that expert.

In the high asset divorce context the expert you will often come up against or otherwise have to employ yourself is the forensic accountant. Thus you should have a basic understanding of techniques regularly employed by these forensic accountants in divorce. Know that CPAs are not required to possess any specific credentials in order to be able to testify as experts. Though there are certain heightened credentials which do exist within the CPA field.

Although there is no one theory which CPA's are required to follow when conducting a forensic analysis in divorce, there are some basic tenants which apply in most cases. Darrell Dorrell, one of the foremost experts in the area has created a method which he calls Forensic Accounting/Investigation Methodology (FA/IM). Within this methodology Darrell describes a total of four phases in which the expert travels through in his investigation. Within these four phases there are then 13 specific stages which each fall under the canopy of one of these four phases.

As a high asset divorce practitioner it is an advantage to have an understanding of this methodology. A strong understanding of this methodology will allow you to direct your own expert well both in and out of the courtroom and of course will make your cross examination, as a divorce attorney, considerably more powerful.

The first phase described by Darrell is the Foundational Phase. Within this phase a couple of stages occur. First of all the assignment is developed. The assignment describes what exactly the expert will be doing. Thus as a high asset divorce attorney you normally wouldn't just turn over your client's entire file and tell the expert to go to work without limitation. Generally you will first outline what assignments you wish for your expert to do. For instance you may only want you expert to compare and contrast various statements of one of the parties' businesses. Related to this assignment stage is the scope stage. Within the scope stage, you as counsel, will advise the expert as to the scope of the investigation. So given the example above, if you advise your expert to compare the financials of the business you may then go on to advise that you only want your expert to compare the last four years for example. In this way you limit the amount of work done. You as the lawyer should have some idea of what time frames will be important. You will typically want to go back at least a couple years before the beginning of marital strife. Budgetary considerations are going to be your guiding principle in this phase. Forensic accountants can be expensive. You don't want to spend $20,000 on a forensic accountant if the potential amount of financial misconduct is small. You have to balance the interests of your client here.

The next Phase outlined by Dorell is the Interpersonal Communications Phase. In this phase the CPA will begin talking to people in the know. Potential witnesses will include anyone who handles financial matters within a business. These individuals will be interviewed by the CPA. After these interviews take place the CPA can continue on to conduct background research. This research is intended to verify the information obtained in these interviews. The CPA can find substantial information in public and private databases which can verify the validity of statements recorded in interviews.

Your forensic accountant will then move on to the third phase, the Data Collection and Analysis Phase. In this phase the accountant will collect data. This information will come from your client followed by discovery including requests for production and depositions. This data collection may be followed up with surveillance, both electronic and physical. The reason for the surveillance is to get an understanding of a certain human's behavior. If you can understand their behavior you can then anticipate various motives and timing of spending patterns. This phase also includes the use of confidential informants as well as undercover private investigators. Finally this phase concludes with laboratory analysis and analysis of transactions. This includes the use of statistical analysis which can be used to spot trends indicative of certain assumptions and conclusions.

The final phase is the trial phase. In this phase the expert will need to be preparing reports. Reports, opinions and summaries presented well can be exceedingly powerful. These reports can be used any time prior to trial as a method for pushing settlement. Alternatively these reports can be used in deposition and should always be used in trial. As divorce counsel be sure to put these exhibits up in court. Have your expert walk you through his or her analysis on direct examination. These matters are complex so visual aids along with explanations of well-spoken experts can make the difference in your case. Additionally, these exhibits can be powerful tools on cross-examination. Walk your hostile witness through his or her fraudulent transfers. Walk the opposing party through his personal expenditures written out of the business account one by one.

Forensic accountants each have their own favorite methodologies. Some of these methodologies and techniques may be specific to a particular forensic accountant such that you could say the technique is more art than science. That being said, there are some standard techniques that are well known and commonly used in whole or in part by forensic accountants.

An important principle to keep in mind is that you want to have at least one individual review all of the documents. This is better practice than having multiple individuals divide up the work and review various segments. I prefer to always review everything myself, however if the material is dense and complicated you may want to delegate this task to your forensic accountant who deals with material such as this every day and thus will be able to analyze larger volumes of data faster.

This individual who takes on the task of reviewing all documents can break his or her tasks down into specific segments. For instance, you may want to start by determining all income and earnings for each party. Then you can go on and look for all assets followed by all debts. Follow this up by reviewing what assets are marital and what are separate. Then look for comingling or transmutation issues. These are examples of various tasks that can be compartmentalized so as to make the effort attainable. If you do this work yourself where you review the entirety of the financials, which I suggest you do as counsel, once you see something that looks fishy you should hand that portion off to your forensic accountant to get an opinion on the matter. The accountant should be able to quickly tell you of any issues or further material you are going to want to get your hands on.

A strong technique used by forensic accountants is that of creating detailed transaction reports. In these spreadsheets the accountant can categorize data relevant to transactions. This data can include the account name, thus amount of each transaction, the timing of each transaction, who was the payee and so forth. In this way a spreadsheet of the data can group and illuminate relevant data. This spreadsheet can then be a powerful demonstrative for the divorce attorney in trial. You can walk your hostile witness through all notable transactions and events.

Another solid technique employed by forensic accountants and/or divorce lawyers is that of reconciling tax returns with financial statements. These two statements will often tell different stories the goal of the prior to show reduced earning and high expenses while the goal of the financial statements will often be the exact opposite, to show high earnings and low liabilities. If your CPA can uncover unsavory accounting practices this should be used as a tool to exploit the other side's lack of credibility. If there are major differences between the two argue for adjustments to be made in favor of your client.

The Proof of Cash method is a method employed by forensic accountants where they reconcile bank statements with the books of the business. The point of this method is to fish out any manipulation which may have occurred to the parties' books. The bank statements won't lie. So if the two can't be reconciled then you can assume that the books are incorrect by intent or mistake.

If you or your client can get your hands on the business's accounting software then do so as soon as you can. These programs can be recorded as such that you can make an exact replica and hand that replica over to the forensic accountant. These accounting software typically have built in audit functions. These audit functions can tell you if specific transactions or items have been deleted. This may be your smoking gun. If the family or business tracks all transactions with this software and then it was deleted, there is typically a dishonorable reason for the deletion. Find this deletion and you find gold.

Horizontal analysis is one of the lesser complicated methods of analysis. In this method we gather account data from various time periods. We then compare the date across the various time periods whether that be by quarters or years. We can look at various types of data including gross revenue, officer compensating and the like. Horizontal data is easy for laypeople to understand. Other methods such as ratio analysis are effective as well and can be used to compare ratios over various time periods within the horizontal analysis. Unfortunately, most judges are not CPAs and thus ratios are more difficult to digest for judges than just raw data on a graph.

If you can obtain various reports from the opposing party or business do so. Particularly try to obtain some reports meant for in house use and some used for external use such as for the IRS. Look at the differences in data between these various reports. Then look to explain the differences. This may uncover manipulation in anticipation of divorce.

These methods mentioned above are just a samples of the various techniques employed by forensic accountants. Other important methods include SCORE and Transaction Sampling and Testing. SCORE looks to track the flow of money from sources to recipients. Transaction Sampling and Testing is similar in that you look to particular transactions and you test them. This is also where your forensic accountant can test the strength of internal controls within the organization. Remember, it is typically easier for the business owner spouse to defraud the marital estate in a smaller organization than in a larger one. In larger organizations there are typically more checks and balances and more people involved in the process who don't include the business owner spouse. When you are dealing with a large business look to the weakest points of internal control. These are the points where you will typically find your foul play.

Categories: Family Law