The interview before the fraud interview

When Anna, the CEO of a small manufacturing company, received an anonymous report about fraud in the accounting department, she wasn’t sure how to act. After all, the complaint could be accurate, but there was also a chance that it wasn’t. She called her company’s attorney, who recommended a forensic accountant to investigate. He also suggested that she perform some preliminary interviews to gather facts — but to be careful not to interrogate employees.

If you’re in a position similar to Anna’s, here’s how to conduct interviews before a fraud expert comes on the case. 

Investigation prep

In advance of requesting any interviews, decide what information you’re looking for. Knowing what you want helps you get to the truth of the matter quickly and avoid getting sidetracked by extraneous information. Then, identify who’s best able to supply that information.

Say, for example, you suspect an accounts receivable employee of siphoning money. You may want to talk to that person’s supervisor and a member of your IT department to get information on work habits, unusual behavior or signs of file tampering. Remember, though, that people may be reluctant to share information if they feel it reflects poorly on them or if it might land someone else in hot water.

Restraint is critical

When you sit down for an interview, set the tone with some introductory questions and ask the interviewee to agree to cooperate. In most cases, you’ll be looking for information that helps prove or disprove your suspicions, and the interview will be fact-finding in nature. It should last long enough for you to obtain all the information the subject has to offer. But don’t prolong sessions unnecessarily.

Aim for an informal, relaxed conversation and be sure to remain professional, calm and nonthreatening. Don’t interrupt unnecessarily, suggest that you have preconceived ideas about who did what, or assert your authority unnecessarily. If you suspect someone is withholding information, try asking more detailed questions. And if someone says something you believe is untrue, ask for clarification. You might suggest that your question was misunderstood or that the employee didn’t give it enough thought before answering.

Finally, never make threats or promises to encourage an employee to change a statement or confess. If the case ends up in court, such tactics could make the evidence you collect inadmissible. If someone persists in lying, ask them to put their statement in writing and sign it. Then turn the statement — and your suspicions — over to fraud experts.  

Give it to the experts

If you decide there’s evidence that fraud has occurred, engage a forensic accountant to investigate further. This expert will interview potential suspects and witnesses to get to the bottom of the matter while gathering critical evidence of a crime. Contact us for help and more information.

© 2021 Covenant CPA

Dividing a marital estate is rarely easy. But it’s made much harder if a divorcing spouse owns a private business and attempts to artificially deflate its profits or hide assets. If you or your attorney suspects this type of deception, engage a forensic accountant to investigate.

Key questions

When working on divorce cases, fraud experts ask several questions about private business interests. For example, does a spouse own a cash business that may have unreported income? Does the owner receive special (or excessive) perks or tax write-offs that affect the business’s profitability? Are numbers intentionally reported incorrectly to affect the business’s value?

n addition, experts investigate whether the company has any subsidiaries or is part of any other business ventures. Sometimes, a business owner may be a silent partner in an entity where ownership isn’t obvious.

Readily transferable.

Anomalies in a business’s income statements may reveal possible deception, particularly:

  • Excessive write-offs,
  • Withheld revenue deposits,
  • A large one-time expense, or
  • A decrease in revenue with no related decrease in variable expenses.

Sudden changes that occur when a spouse is contemplating divorce may suggest unreported income or overstated expenses. However, these changes could also be due to external forces, such as the loss of a major salesperson or adverse market conditions.

When evaluating expenses, experts often focus on the amounts paid to owners and other related parties. These may include payments for compensation, benefits, rent, management fees, and company vehicles and other perks. The owner-spouse also might try to flush personal expenses through the business.  

Balance sheet secrets

Balance sheets may reveal whether an owner is trying to hide assets (for example, in an offshore account) or transfer them to a related party for less than market value. Inventory is particularly susceptible to manipulation. Although notes payable to shareholders can be legitimate transactions, they also may be used to conceal income being distributed to an owner.

Experts review the equity section for any changes in the business’s ownership after the parties filed for divorce. They also search for suspicious withdrawals or distributions from capital accounts. Controlling owners may sometimes attempt to transfer ownership of business interests to close friends or associates to deprive their spouses of portions of the assets or portions of the business income.

Distorted value

Although divorce can give rise to angry actions, most business owners would never stoop to falsifying financial records simply to deprive their ex-spouses of a fair division of marital assets. But if the value of a business seems distorted, contact us for help identifying the causes and to suggest reasonable adjustments.

© 2021 Covenant CPA

All that glitters isn’t gold. This includes gold — and other precious metals, stones and jewels that are sometimes used to launder the “dirty” proceeds of criminal activities such as drug trafficking and terrorism. But several U.S. laws and regulations target these international money-laundering operations.

Good as gold

Precious metals, stones and jewels make ideal vehicles for money laundering for several reasons:

Ownership and control. Precious metals are bearer instruments, meaning that like cash, the individual in possession of the precious metal owns and controls it.

Readily transferable. There’s an active, global market that enables criminals to trade them. Because precious metals have many legitimate uses, criminals often can move them without attracting attention.

Relatively stable. Although the price of precious metals fluctuates like those of any commodity, the value of precious metals tends to remain reasonably steady.

Easy to smuggle. Money launderers may use private jets to bypass major airports and cross international lines. Diamonds and other precious stones are small enough to smuggle in someone’s pocket.

Difficult to track. Criminals can manipulate these goods to disguise their source or create a fake document trail to prove their authenticity.  

Defining the dealers

Most precious metals dealers must comply with the U.S. Bank Secrecy Act, which requires that they create and follow an anti-money laundering (AML) program. Certain AML provisions of the U.S. Patriot Act and rules of the Office of Foreign Assets Control also apply to precious metal dealers.

The Financial Crimes Enforcement Network (FinCEN) defines a dealer as someone who isn’t a retailer and who both buys and sells covered goods (as described by FinCEN). A dealer must have bought at least $50,000 and sold at least $50,000 of goods in the previous year. Note that there are exceptions. For example, pawnbrokers generally aren’t considered dealers, but in some circumstances they can be. If you’re not sure about your business, talk with an attorney with AML experience.

AML program

But if you do qualify as a dealer, your AML program must have the following:

  • Written policies, procedures and a robust set of internal controls,
  • A designated compliance officer,
  • Training for employees, and
  • Frequent third-party testing.

Other businesses also should be aware of potential criminal activity. For example, if your company is involved in a transaction involving gold coins, be sure to assess the dealer’s compliance efforts.

Contact us for more information, particularly if you aren’t a precious metals dealer but are contemplating a transaction that involves precious metals or stones. 

© 2021 Covenant CPA

Deepfakes: The newest frontier in fraud

Fraud perpetrators are constantly altering their methods to evade detection. Nimble cybercriminals, for example, are why IT security companies update their software so frequently. The use of deepfakes (a word derived from “deep learning” and “fake”) is one of the latest threats to emerge. Deepfakes are enabled by artificial intelligence (AI) and they’re something your company needs to have on its radar because if you haven’t seen a deepfake yet, you will.

Spotting an imposter

A deepfake involves the use of AI to create video, audio or static images that seem real. You may have seen them in viral videos of famous people, such as one in which Facebook’s Mark Zuckerberg is shown saying he has “total control of billions of people’s stolen data.” As realistic as it looked and sounded, the video depicted something that never happened.

Aside from manipulating public opinion and generating outrage, deepfakes can be used to steal. Employing an expertly altered audio file, someone can trick a bank’s voice authentication tools to grant access to funds. Or a deepfake using audio and video files could convince a company to open a customer account to buy goods on credit. In such cases, the nonpaying customers are untraceable.

Proving what’s real

Since deepfakes use emerging technology, detecting them can be challenging. But depending on a deepfake’s format, some third-party detection solutions are available.

Software designed to detect video deepfakes can use a “liveness” detector, which analyzes a person’s face for natural movements. Computers also can analyze images at the pixel level for manipulation. Deepfake audio software is capable of discerning almost-imperceptible sounds that aren’t human generated.

Keeping current

You can protect your business from deepfake-related fraud by updating your current internal controls. For example, if your company operates a call center, make sure you have procedures that prevent audio deepfakes from gaining unauthorized account access. In addition, keep current on deepfake developments. You might, for example, establish a Google Alert to provide you with articles relevant to your industry and particular vulnerabilities.

Contact us for more information about emerging fraud schemes and for help updating your internal controls.

© 2021 Covenant CPA

The COVID-19 pandemic has often made the due diligence process for business acquisitions more complex and time-consuming. But if you’re buying a company, it’s critical to dedicate your full attention to this part of the M&A process — not only to confirm that the selling business is as valuable as you believe it to be, but to protect against fraud. Plan early to engage a fraud expert to review financial statements and other documents for signs that you could be dealing with a dishonest seller.

Subtle warning signs

When reviewing a seller’s financial statements, forensic experts look for subtle warning signs of fraud. These include excess inventory, a large number of write-offs, an unusually high number of voided discounts for returns, insufficient documentation of sales and increased purchases from new vendors. Another suspicious sign is increased accounts payable and receivable combined with dropping or stagnant revenues and income.

Fishy revenue, cash flow and expense numbers and unreasonable-seeming growth projections warrant further investigation to determine whether financial statements represent fraud or they’re evidence of unintentional errors or mismanagement. The latter is common in smaller companies that don’t have their statements audited by outside experts or that may not have adequate internal financial expertise.

Systematic manipulation

To determine whether unusual income numbers indicate systematic manipulation, experts often consider whether owners or executives had the opportunity to commit fraud. A lack of solid internal controls makes financial statement fraud more likely. Regulatory disapproval, customer complaints and suspicious supplier relationships can also raise red flags. If warranted, a forensic expert may perform background checks on your target company’s principals.

It’s important to note that some accounting practices adopted to present a business in the best light may be perfectly legal. However, if your expert finds evidence of intentional fraud — particularly at the executive level — you’ll probably want to rescind your acquisition offer. In less serious cases, you may simply need to make purchase price adjustments or even change the deal’s structure.

Negotiating protection

An indemnification clause written into the purchase agreement can protect you if a seller lies about matters that affect your acquisition, such as fraud. But negotiating these clauses can be tricky since sellers tend to push for a narrow definition of “fraud” and for limits on liability. The fact remains that if a seller has committed fraud, it’s better to uncover it before the M&A transaction goes through.

Contact us with your questions about M&A fraud and for help evaluating your potential business acquisition.

© 2021 Covenant CPA

If you have an estate plan and also have creditors, you could be a fraud perpetrator — without knowing it or intending to defraud anyone. In some circumstances, creditors can challenge gifts, trusts and other strategies for leaving assets to heirs as fraudulent transfers. Here’s how to keep your estate plan from running into trouble.

2 types

Most states have adopted the Uniform Fraudulent Transfer Act (UFTA). The law allows creditors to challenge transfers involving two types of fraud:

  1. Actual fraud. This means making a transfer or incurring an obligation “with actual intent to hinder, delay or defraud any creditor,” including current creditors and probable future creditors.
  2. Constructive fraud. This is a more significant threat for most people because it doesn’t involve intent to defraud. Under UFTA, a transfer or obligation is constructively fraudulent if you made it without receiving a reasonably equivalent value in exchange for the transfer or obligation and you either were insolvent at the time or became insolvent as a result of the transfer or obligation.

“Insolvent” means that the sum of your debts is greater than all of your assets, at a fair valuation. You’re presumed to be insolvent if you’re not paying debts as they become due. Generally, constructive fraud rules protect only present creditors or those whose claims arose before the transfer was made or obligation incurred.

Know your net worth

When it comes to actual fraud, you may not be safe just because you weren’t purposefully trying to defraud creditors. A court can’t read your mind, and it will consider the surrounding facts and circumstances to determine whether a transfer involves fraudulent intent. So before you make gifts or place assets in a trust, consider how a court might view the transfer.

Constructive fraud is a greater risk because of how insolvency is defined and gifts are made. When you make a gift, either outright or in trust, you don’t receive reasonably equivalent value in exchange. If you’re insolvent at the time, or the gift you make renders you insolvent, you’ve made a constructively fraudulent transfer. This means a creditor could potentially undo the transfer.

To avoid this risk, calculate your net worth carefully before making substantial gifts. Even if you’re not having trouble paying your debts, it’s possible you might meet the technical definition of insolvency. Also keep in mind that fraudulent transfer laws vary from state to state. Therefore, you should consult an attorney about the law where you live.

Build a better plan

Besides knowing the law, you can protect your estate plan in several ways. Work with a professional estate planner and be sure to reveal everything about your financial situation that might be relevant to building a creditor-resistant plan. Also manage any debts by working with creditors to negotiate reasonable repayment plans. We can help if you’re still having trouble balancing your budget or managing your assets.

© 2021 Covenant CPA

Put employees to work fighting fraud

You may have the best internal controls in the business world, but if your employees don’t follow them, your company is at serious risk for fraud. The same is true if workers aren’t aware of your company’s risks and can’t recognize red flags. The solution? Educate them.

Training is critical

A forensic accountant can conduct on-site, broad-based training for employees in the form of live or virtual presentations. This expert might use role-playing to help staff understand the various forms fraud can take, as well as how perpetrators think and identify their victims’ vulnerabilities and weaknesses.

Enlisting the help of external experts is particularly important for smaller businesses. Not only are they more vulnerable to fraud, but they’re less likely to have in-house fraud expertise. Small-business training can focus on the most common schemes for companies with fewer than 100 employees, such as billing fraud and check-tampering schemes.

Threats that require employee attention

In general, your company’s specific needs should dictate the content of your training program. But most businesses need to spread the word about certain threats. For instance, employees should be trained to observe coworkers who appear to be living beyond their means or who might have addiction issues. Both increase the likelihood that an employee will attempt to commit fraud. If these workers have easy access to payroll or other accounting functions, the risk increases. Provide stakeholders with a confidential fraud reporting hotline or web portal to report their suspicious.

Cybercrime is another risk every employee needs to know about. Phishing, social engineering and other techniques are designed to trick them into revealing company, customer and other confidential data or providing access to your business’s network. Workers need to learn how to keep information safe by handling email carefully, changing passwords often and updating security software as soon as required.

Optional training

Depending on your industry, you might want to train employees to spot other risks. Construction and manufacturing businesses, where on-the-job injury rates are high, should prioritize workers compensation fraud training. Retailers and other cash-dependent businesses need to educate workers about potential skimming schemes.

Also train employees to mitigate risks related to specific responsibilities. For example, those who authorize charitable donations should be taught to verify charities with the IRS to ensure they’re legitimate and tax-exempt. Hiring managers and HR employees — as well as those who vet potential vendors — must follow background check procedures.

Empower fraud watchdogs 

Rank-and-file employees usually are the first ones to spot fraud perpetrated by coworkers or managers. So give them the tools they need to succeed in their role as fraud watchdogs. Contact us for help with fraud training.

© 2021 Covenant CPA

Many startup companies require access to large sums of investment capital to take on well-established competitors. The need to raise such funding may encourage a startup’s founder to paint an overly optimistic picture of the business and exaggerate its ability to succeed. In some extreme circumstances, founders may resort to deception to convince investors to back their ventures. That’s fraud.

Silicon Valley warning

A medical testing startup provides a cautionary tale of what can happen when an aggressive entrepreneur plays fast and loose with the truth. Based on the extravagant claims of the Silicon Valley company’s founder, the startup raised more than $700 million and secured a $10 billion valuation. When evidence emerged that it couldn’t conduct extensive medical tests on tiny amounts of blood as it had claimed, the company collapsed.

Its founder has denied allegations that she made false claims. She and the startup’s former president currently are defending themselves against criminal charges leveled by the U.S. Attorney’s Office (a trial is scheduled for this spring). The founder has already settled a lawsuit alleging fraud filed by the Securities and Exchange Commission.

Getting adequate information

So how can you avoid fraudulent investments? The simple answer is that you must investigate any claims that sound too good to be true and closely scrutinize new investment opportunities — and the entrepreneurs behind them.

The founder of the medical testing company deflected requests for information about its inner workings. She often cited the need to protect intellectual property. Protecting proprietary information is a valid concern. But before investors inject capital into a project, they need to have an intimate understanding of the company and its products and services. If a startup refuses to provide adequate information, you’re better off walking away.

The startup also lacked an audited set of financial statements. This is another glaring red flag that investors should have heeded. According to MarketWatch, none of its investors requested access to the company’s financial statements.

In addition to developing a detailed understanding of a company’s operations, set aside time to conduct background checks on its founders and key executives. A founder’s so-called stellar business track record may not jive with public records that show a history of failed ventures. Or you may find that a programming “prodigy” enjoys little respect or confidence in the tech community. Ask direct questions of the business’s owner to resolve issues.

Reduce your risk 

Startups have a strong incentive to provide potential investors with overly optimistic financials and hyperbolic growth claims. Most startup founders aren’t involved in promulgating fraud. Nevertheless, you should work with experienced financial advisors when investing in a new company.

© 2021 Covenant CPA

Over the past year, most businesses have been forced to contend with multiple crises, including COVID-19, social unrest and financial challenges. The last thing you need right now is a fraud incident. But if your company is defrauded, you can help mitigate the damage with a fraud contingency plan.

Identifying likely scenarios

No contingency plan can cover every possibility, but yours should be as wide-ranging as possible. Work with your senior management team and financial advisors to devise as many fraud scenarios as you can dream up. Consider how your internal controls could be breached — whether the perpetrator is a relatively new hire, an experienced department manager, a high-ranking executive or an outside party.

Next, decide which scenarios are most likely to occur given such factors as your industry and size. For example, retailers are particularly vulnerable to skimming. And small businesses without adequate segregation of duties may be at greater risk for theft in accounts payable. Also identify the schemes that would be most damaging to your business. Consider this from both a financial and a public relations standpoint.

Assigning responsibility

As you write your plan, assign responsibilities to specific individuals. When fraud is suspected, one person should lead the investigation and coordinate with staff and any third-party investigators. Put other employees to work where they can be most effective. For example, your IT manager may be tasked with preventing loss of electronic records and your head of human resources may be responsible for maintaining employee morale.

You’ll also want to define the objectives of any fraud investigation. Some companies want only to fire the person responsible, mitigate the damage and keep news of the incident from leaking. Others may want to seek prosecution of offenders as examples to others or to recover stolen funds. Your fraud contingency plan should include information on who will work with law enforcement and how they will do so.

Releasing information

Employee communications are particularly important during a fraud investigation. Staff members who don’t know what’s going on will speculate. Although you should consult legal and financial advisors before releasing any information, aim to be as honest with your employees as you can. It’s equally important to make your response visible so that employees know you take fraud seriously.

Also designate someone to manage external communications. This person should be prepared to deflect criticism and defend your company’s stability, as well as control the flow of information to the outside world.

Taking swift action 

A fraud contingency plan isn’t designed to prevent fraud. Instead, it’s a blueprint for taking swift and effective action should fraud occur. To reduce the risk of theft, you’ll need to ensure that you have strong internal controls. Contact us for help with both plans.

© 2021 Covenant CPA

New year, new fraud to watch out for

Whew, you made it through 2020! But don’t rest easy yet. Unfortunately, fraud perpetrators enjoyed a profitable year, and there are signs they may continue to feed off Americans as long as the pandemic is active. Here are several scams to watch for in 2021.

PPP fraud

Struggling small-business owners have welcomed last month’s 11th hour extension of the Paycheck Protection Program (PPP). They aren’t alone: Fraudsters skilled at falsifying loan applications are also likely rubbing their hands in anticipation.

The Justice Department has brought charges against at least 80 individuals for stealing $127 million from the first PPP. Law enforcement expects to charge more (likely many more) con artists as evidence is uncovered. Indeed, the House Select Subcommittee on the Coronavirus Crisis claims that at least $14 billion in PPP loans were improper. Not all of these cases were outright fraud, but there’s evidence that some business owners and lenders ignored PPP guidelines.

To help prevent further misuse of these loans, $50 million has been allocated to the Small Business Administration for PPP fraud prevention and audits. To avoid unnecessary scrutiny or legal trouble, business borrowers should make sure they understand all eligibility requirements for PPP loans and are qualified before applying.

Vaccine cons 

Consumer scams related to the pandemic also are still going strong. Even before COVID-19 vaccinations gained FDA approval, fraudsters conned many Americans (primarily via email and online ads) into paying for nonexistent cures and preventive treatments.

This past month, the FBI and several other federal agencies warned that perpetrators are now advertising COVID-19 vaccine “early access” for those willing to pay a fee or submit medical and other personal information. Make no mistake: These are fraud schemes. To receive a vaccine, visit the Food and Drug Administration (fda.gov) or Centers for Disease Control and Prevention (cdc.gov) websites or consult your physician to learn when you will be eligible.

Pet scams

Fraudsters took note when many Americans adopted pets to provide companionship during the pandemic. The Federal Trade Commission is warning about fake ads picturing puppies, kittens and other pets for sale or adoption. The fraudsters typically first request an amount that sounds reasonable up front. Once they receive that, they ask for more and more … for vet bills, health certificates, shipping and anything else they can come up with. Needless to say, there are no actual pets.

You can avoid falling for such scams by performing extensive due diligence. For example, get the name and address of the seller (and verify them) and arrange for a videoconference to see the pet in the possession of the seller. Even better, adopt an animal from a shelter you can visit in person.

Staying safe 

There are a lot of fraud threats out there these days. For help combating consumer and business fraud, contact us.

© 2021 Covenant CPA