Business Forensics– Untangling the Mysteries of Financial Shenanigan: Unmask the Illusions– Art of Following Money…

Business forensics stems from the need to– curtail, suppress, manage… the increasing numbers of corporate financial crimes… More than ever, companies are operating in a complex global business environment: They are drowning in a sea of digital financial data, adapting to perils of doing business in new markets, struggling to comply with increased regulation and trying to avoid costly enforcement actions, litigation…

Managing the risk of financial shenanigans and misconduct has never been more challenging… The effects of fraudulent activities through financial manipulations can seriously impact the financial welfare of the business, as well as; investors, suppliers, partners… Corporate financial scandals have given rise to outcries for improved transparency, honesty… in financial reporting, and untangling of complicated financial maneuvers that obfuscate ‘transparent’ financial reporting…

The sophistication of cleverly schemed financial crimes is eroding the security of vital business sectors, particularly– banking, financial institutions… Financial forensic is a blend of traditional accounting, auditing, financial detective work, computer technologies… and the typical financial forensic investigator is experienced in determining if and when there is financial criminal activities, mismanaged funds… and whether these activities are the result of deliberate fraud or simply due to inexperienced or uneducated employees, executives…

A financial forensic investigator can also be engaged to examine the financial impact, on a business, from– product liability claims or infringement on an existing patent… According to Timothy Sexton; the purpose of forensics is to assemble a sequence of evidence that act as facts to support investigative theories. This sequence of evidence is offered as part of the judicial process that either clears a suspect of a charge or confirms their guilt…

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In the article What Is Financial Forensics? by Tom Lutzenberger writes: Financial   forensics investigations frequently follows the principles of financial auditing to uncover evidence… Using the tried-and-true principle of– ‘follow the money’; auditing traces back the paper trail of transactions to their original starting point to verify funds– amounts, movement, purpose… However, unlike auditing, financial forensics involves much more intensive review– it looks at all documents available rather than just using spot samples on large amounts of data. As a result, large cases can involve multiple-person teams for reviewing the same set of files to find evidence in a timely manner…

Corporate financial forensics teams are often an assemblage of financial business experts– auditors, analysts, accountants… and even, lawyers… Financial forensics are engaged in cases ranging from pursuing financing of terrorism, money laundering… and, as mundane as tax evasion, charity scams… All of these fraudulent activities generally have the same type of financial crime occurring, e.g., misrepresenting, misappropriating funds, including; their sources, amounts, locations…

A typical case can involve falsifying sources of revenue, hiding the fact that the funds actually come from illegal sources (e.g., false contracts, falsified sales receipts, fake donations…), or it can be an investigation into why less revenue is being reported than should be for tax purposes (e.g., hiding gross profits, representing expenses that never occurred for fake deductions, taking tax credits that are not valid)…

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In the article Advanced Forensics Financial Analysis by Michael F. Rosplock writes: Corporate financial fraudsters are committing more devious forms of financial statement fraud by concealing, suppressing… the true worth of– assets, liabilities, cash flows, sales, profitability… Financial forensics examiners are trying to stay one step ahead of the bad guys by using advanced analytical processes to detect illegal activities, for example:

  • Perform a subjective analysis of history and operations of the company. Obtain credit and bank reference information to determine– changes in payment habits, relationship with banks, savings account balances, short- and long-term credit line exposures, and bank compliance…
  • Analyze the financial condition by performing a horizontal and vertical analysis of the balance sheet and income statement. The use of industry standard statistics is essential in the analytical process, as a means of verifying the condition of ratios and financials in relation to standards…
  • Once the conditions of ratios and statistics have been determined, trending analysis is the next step in the analysis process. This process assists in detecting inconsistent patterns in the ratios and statistics, which should be regarded as a red flag…
  • The detection of trending inconsistencies requires further analysis to determine the factors that impacted the changes in condition of ratios or financial statistics. The detection of imperfections or inaccurate statistics is essential during this analytical      process…
  • When analyzing the condition and trend of the income statement and balance sheet, it’s important to evaluate the gross margin, operating margin, and net profit margin as a percent of sales. This determines if the changes in condition of the income statement and balance sheet were accordant…
  • In-depth knowledge of the balance sheet, income statement, and statement of cash flow requires an understanding of how  changes of consistent or inconsistent trending patterns impact the income statement and cash flow… The ability to determine inconsistencies, or unexplainable changes in the income statement and balance sheet assists in the beginning stage of forensic financial analysis. The ability to acquire an investigative perseverance requires– an ability to analyze below the surface…

In the article Art of Illusion by Bruce G Dubinsky and Tiffany Gdowik write: It’s not what’s on the page that matters; it’s what’s not on the page that matters… Forensics examiners have been taught to gather documents, review information, interview people and then draw conclusions… While this approach will detect the simplest of frauds, it won’t detect the type of complex financial frauds that are increasingly making headline news– where companies use ‘accounting gymnastics’ to manipulate financial statements… For example; in 2008, Lehman Brothers’ shaky balance sheet and falling profits left the firm in dire financial peril. It desperately needed to create an ‘illusion’ that it was healthier than it actually was.

Lehman used what appeared to be a normal financial instrument in the banking world; repurchase agreement (repo)– to book billions of dollars of transactions… A repurchase agreement is a form of short-term borrowing for banks and other dealers typically using government securities. The bank sells the government securities to an investor (often it’s another bank), usually on an overnight basis, and buys them back the following day.

In Lehman’s case, the company did it to exploit an accounting rule that was meant to give principled guidance to determine when ‘repo’ was a true short-term finance method versus a sale of a financial instrument. The latter desired treatment as a ‘sale’, and that allowed Lehman to slyly portray its financial condition as rosy when, in fact, it wasn’t.

Interestingly, investigators didn’t discover the ‘illusion’ created by Lehman by looking at what was on the page (i.e. the entries in the accounting system). The accounting entries, which seemed straight forward generated little-to-no alarm. The debits and credits were in the proper accounts. The explanation accompanying the entries also seemed normal. In fact, a review by even the most skilled auditor would, in and of itself, had revealed nothing. Rather, investigators exposed the company’s deceptive behavior by looking at what was literally– not on the page.

The key to uncovering the ploy was– first to understand what Lehman’s financial perils were at that time… So, the first ‘red flag’ came in the form of a question: Why was Lehman spending so much time focused on de-leveraging its balance sheets? Its access to public capital was critical to its continued survival. During this time period, in the stock market, investor panic was running rampant, so Lehman had to create an illusion that it was a solid financial institution with sound balance sheet…

So how did Lehman create the delusion? It simply used the chameleon approach: Make something that’s really one thing look like something else… Lehman took ‘repos’ that were really short-term loan transactions and made them look like they were sales of financial product inventory (e.g., treasuries, certain equities…). By knowingly exploiting that accounting rule and specifically structuring the ‘repos’, Lehman was able to disguise itself as a financially healthier institution…

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The term forensics stirs up vivid images: Crime scenes littered with obvious and equally less obvious evidence. Law enforcement investigators toiling to bring heartless criminals to justice… Unfortunately, the popular view of forensics is often in stark contrast with reality… According to Tom Kopchak; corporate forensics requires significant quantities of tedious, detail-oriented work, sifting through huge amounts of data looking for pertinent details… And, when the guilt or innocence of a defendant lies in the hands of a forensics investigator, a single mistake can corrupt or cost the prosecution its case…

It happens to almost every company; an anonymous letter, phone call, perhaps an audit– tips the firm off to serious employee wrongdoing… Frequently, wrongdoing involves theft of company assets, including; proprietary or confidential information critical to company’s financial well-being. In either event, company must investigate allegations… All forensics analyses have four common ‘core’ duties that consist of: • Data collection • Data preparation • Data analyses • Reporting… The potential for fraud, misconduct… can reach far, wide within an organization, including; procurement, sales, marketing, accounting, operations… foreign and domestic subsidiaries, portfolio companies, joint ventures, merger and acquisition targets…

According to amymatt; ‘cooking the books’ is an accounting phrase to describe a rewriting of past financial mistakes to justify fraudulent transactions or use of funds… Some companies can do it right, while others stay under the radar… the acts of ‘cooking’ are like a disease leading ultimately to the company’s demise… Managing risk of financial fraud, misconduct… has never been more challenging…