In this series of blogs, we are looking at the practice of using a fraud audit to detect shell company schemes occurring in an accounts payable file. Because the practice of effective fraud auditing is grounded in knowledge, we will start with a knowledge section and then delve into a demonstration of the fraud audit process.
Fraud Trivia, per the National Council of Aging (remember these are US statistics.)
In 2021, how many older victims were scammed out of their money? 92,371 were reported to the FBI alone.
In 2021 it is estimated that seniors lost how much money to fraud schemes? $1.7 Billion dollars.
What are some of the most common scams perpetrated on seniors? Government impersonation, sweepstakes and robocall scams.
How much money did seniors lose to romance schemes? 304 million dollars
Have you talked to the seniors in your life regarding these scams? What are you waiting for?
Knowledge Section
If you are going to write a forensic investigation report, there are certain rules you must know. A word of caution: the rules surrounding a forensic report are different from the rules for an internal audit report.
In court cases, Federal Rule of Evidence 703 allows experts to give their opinion even if that opinion is based on inadmissible facts or data, That means, experts can state testimony based on personal knowledge, evidence admitted at trial, or evidence not admitted so long as it supplies the kind of facts or data that experts in the field “reasonably rely” on in forming an opinion. As you might expect, there are other rules you should be familiar with before you write an expert witness report.
There are nine basic requirements for the expert’s report:
- The report contains a complete statement of the expert’s opinions.
- The report must be written.
- The expert must sign and date the report.
- The report must contain the basis and reasons for an expert’s opinion.
- The report must contain a listing and all exhibits to be used by the expert.
- The expert’s qualifications.
- All publications authored by the expert in the past ten years should be listed.
- The expert’s compensation for his investigation and testimony should be disclosed.
- A list of all other cases in which the expert has testified or provided deposition in the last four years should be included.
The landscape of expert testimony was transformed in 1993 through the ruling of the U.S. Supreme Court in the cae of Daubert v. Merrell Dow Pharmaceuticals, Inc. The ruling set a new standard, referred to as the Daubert Standard, that requires trial judges to act as “gatekeepers” of scientific evidence.
Under the Daubert Standard, judges must scrutinize not only the expert's methodology but also the underlying scientific principles. This shift aimed to curtail the admission of pseudoscientific or unreliable expert testimony. Judges must assess the methodology and reasoning behind an expert's opinions, rather than simply relying on the expert's credentials or reputation.
Under the Daubert Standard, the trial court considers the following factors to determine whether the expert’s methodology is valid:
- Whether the technique or theory in question can be and has been tested.
- Whether it has been subjected to publication and peer review.
- Its known or potential error rate.
- The existence and maintenance of standards controlling its operation; and
- Whether it has attracted widespread acceptance within a relevant scientific community.
The Daubert Standard supplanted the Frye Standard, which focused primarily on the general acceptance of scientific evidence within a particular field. See Frye v. United States, 293 F. 1013 (D.C. Cir. 1923). While some state courts still adhere to the Frye Standard, the Daubert Standard is used in all federal courts.
Subsequent U.S. Supreme Court cases have clarified the Daubert Standard. In General Electric Co. v. Joiner, 522 U.S. 136 (1997), the Supreme Court ruled that an appellate court may still review whether a trial court abused its discretion to admit or exclude expert testimony.
In Kumho Tire Co. v. Carmichael 526 U.S. 137 (1999), the Supreme Court ruled that the Daubert Standard may apply to non-scientific testimony, meaning "the testimony of engineers and other experts who are not scientists." Along with Daubert, these cases are often referred to as the “Daubert Trilogy.” Federal Rule of Evidence 702 was modified based on these cases. Source Cornell Law School.
For my NON-USA readers, while I have not read every civil and criminal procedure in the world, it would be my guess that your country’s legal system has something similar to what I have listed. FYI, if you are in a USA state court, each state has its own rules.
Writing a report of the facts and circumstances that is the basis of your opinion.
Practical Section
In writing a fraud audit report, the format of my report follows the rules of evidence to the extent that I believe is necessary. I always list my opinions and the facts supporting my opinion.
My recommendation is to:
- State your opinions. If you prefer, state your conclusions.
- Next, state the facts and circumstances that are the basis of your opinions.
- Lastly, explain the necessary procedures that will be required to perform a forensic investigation.
In my opinion, writing is a matter of style. However, as a matter of style, your report must have sufficient information to allow management to formulate an opinion on the need for a forensic investigation. As a matter of style, I recommend that you build your fraud audit report around the expert witness requirements in your country. Remember, write to your audience. Keep in mind that those in the legal department will most likely have a major influence on whether to proceed with a forensic investigation.
Your report should have a minimum of two opinions. The first is your opinion on the shell company and the second is on the fraud statement
I would suggest that you start your report with your opinion as to whether the vendor is a shell company. As a matter of style, I will offer you three approaches. You can choose based on your audience. For all, my preference is to use simple and direct statements.
1. State what you think it is:
In our opinion, ABC Company has the attributes of a shell company.
2. State what you think it is not:
In our opinion, the ABC Company does not have the attributes of a company operating in the marketplace.
3. Break it down into smaller steps:In our opinion, the ABC was legally created on July 24, 2023.
In our opinion, the ABC company does not have a physical office in the marketplace.
In our opinion, the ABC company infrastructure is not consistent with a real company operating in the marketplace.
In our opinion, etc.
In our example, the action statement would be either a false billing statement, a pass-through statement, or a conflict-of-interest statement.
Facts and Circumstances
To illustrate the writing style of stating the opinion and then listing the facts that support your opinion:
In our opinion, the ABC Company does have the attributes of a company operating in the marketplace.
In our opinion, the services described on ABC invoices were not provided.
In our opinion, the ABC Company does not have the attributes of a company operating in the marketplace.
- ABC Company was incorporated on April 1, 2023.
- ABC Company address is a mailbox service address.
- The Corporate Registrar is an individual, and the address is a personal residence.
- ABC Company does not have workers’ compensation insurance, which means the company has no employees other than a statutory employee.
- The ABC Company has no secured debt.
- The ABC company does not belong to any logical trade shows or entitites, including the Chamber of Commerce.
- The ABC company has no public advertisement.
- In three attempts to contact the ABC company via telephone, in each attempt we went to voice mail.
- The ABC company web site has limited information.
Explain the necessary procedures to perform a forensic investigation.
Do not assume that management understands what a forensic investigation entails or the intended purpose of a forensic investigation. Remember, in the fraud audit phase, much of our work was performed in a covert manner. That means the the ABC company most likely did not understand that it was a potential target. You need to be very clear as to what procedures will be necessary to gather the information for a successful legal action. To illustrate the type of procedures.
- Contact the ABC company and request a meeting at their offices.
- Contact the ABC company and request records supporting their invoices.
- Contact the ABC company and request certain bank records.
No, the ABC company can say no. Then the question is will your company consider initiating legal action to obtain such records? In my opinion, issues such as under what circumstances legal action might be taken should be discussed before you initiate overt investigation procedures.
Fraud Trivia
Okay, I am going to take a chance, here is my email, lvona@leonardvona.com If you have an idea for fraud trivia, I will list your fraud trivia, give your credit, if you want credit or I will list the source as anonymous. All I ask is that you provide a source of the information.
