Don't Blame Madoff

Here's why.

February 5, 2009
by Sukanya Mitra

First it was Enron and WorldCom. Then it was the avalanche at Wall Street and falling or rather the failing of Bear Stearns and Merrill Lynch. Surely, Bernie Madoff was a catalyst somewhere in all this, right? Wrong!

There has been a sudden surge for forensic accountants. More than half (54%) of AICPA’s 5,400 Forensic Section members say business has grown over the past year, while 75 percent of top accounting 100 firms have reported that business in forensics and fraud has increased. And apparently Madoff is not to blame.

“The regulatory audits that Madoff went through were not full-scale audits; they weren’t complete audits,” said William Barrett, III, CPA, ABV, CFF, at a recent Webinar. Barrett, who was recently voted by his peers as one of Virginia’s “Best Valuation and Litigation Support Specialists,” has more than 20 years of public-accounting experience and provides accounting and economic damage assessment services to clients in financial institutions, professional-service firms, federal, state and local government as well as high-tech and not-for-profit industries among others.

He continued to say that since Madoff was a money manager, he — as do all money managers — went through broker-dealers and investors. In the financial industry, this is considered an “omnibus arrangement,” and so money managers, such as Madoff, fall through the cracks because regulators do not look at him, but at the investors, clearing houses and broker-dealers to make sure they are following regulations properly. Barrett went on to say that regulators have a lot of contact with the firms that they regulate, but none with the investors, money managers and consumers. “There’s a disconnect here, and that’s how it [will] continue to be,” Barrett added.

Still, thanks to Madoff, several firms such as Eisner LLP, J.H. Cohn and Habif, Arogeti & Wynne among others, have created economic crisis teams to handle such crises.

Basics of Forensic Accountants

So what do forensic accountants do? Barrett said to understand what they do, one must first understand what fraud is. He likened forensic accountants and fraud to locks, keys and locksmiths. “For every lock that is created, there’s infinity of keys” some of which the locksmith knows about and prevents locks from being opened, while there are locks that are allowed to be opened. Continuing his example, Barrett said that with time, an industrious individual may come up with a way to unlock a lock that was not supposed to be unlocked. In the same way, forensic accountants are expected to rummage through and find sense in the barrage of information that is out there, and define what can and cannot be considered in a court of law.

Barrett explained that forensic accounting “is not a destination or a designation, but is a continual path” and should be looked at as two different fields. “Forensic is defined as of or belonging to the courts of justice,” said Barrett, and as most already know, accounting can be defined as the “methodology for organizing, preserving and reporting of business transactions,” he added. He went on to define some terms that are closely-related to the industry:

  • Forensic Investigation. This is an inquiry that is applicable in the court of law and grounded in that discipline.
  • Forensic Audit. This is when forensic accountants are invited in to see what has happened and to determine if the information can be used in a court of law, such as in cases of fraud. “Proving causes of intent,” said Barrett is one of the most important decisions made by forensic accountants and proving that information is admissible in court.
  • Internal Audit. Internal auditors in the past were expected to see “whether prescribed operating procedures have been followed in business practice,” said Barrett. This is changing because internal auditors are not generally expected to audit fraud.
So, what does it take to be a forensic accountant? You do start with the basic knowledge of accounting. But as a forensic accountant, you need to delve further and dig a little deeper and start by asking questions both internally and externally. To be a successful forensic accountant, you need to have the right personal background and integrity, the strategic knowledge and expertise and the education and professional designations. “Education is like a two-way sword,” said Barrett. “You the person who is being educated and you, the person, who must have an affinity and a desire to be a specialist in this. It’s no longer that you are a firm or an individual who can be specialized in anything and everything that walks in the door,” he added. Much like law firms, accounting firms now create strategic alliances instead of handling everything by themselves.

Path to Designation

The Certified in Financial Forensic (CFF) designation is provided exclusively by the AICPA. To qualify for this designation, you need to:

  1. Be a CPA member in good standing of the AICPA
  2. Hold a valid and unrevoked CPA certificate issued by a legally constituted state authority
  3. Have at least five years of experience in practicing accounting
  4. Complete a CFF application and meet the 100-point requirement 
  5. Sign a Declaration of Intent to comply with the requirements of CFF recertification

Firm Considerations

What if you already have an existing accounting firm and want to add forensic accounting as a service? What are some of things you should consider?

  • Liability should be foremost in your mind according to Barrett. “Dissatisfaction is very high in any type of litigation, and forensic accounting is one of them.”
  • Barrett also said that your firm needs to consider time allocation. This is because often you can be involved in several cases that can stretch over two years. People often want you to hurry up and finish the case. But it is not always in your hands because either you’re in the waiting period or you are intensely involved in a case that has a “rigorous process with a very finite window to it.”
  • Staffing. Just because your firm has done taxes and knows how to do audits, does not necessarily mean they can sniff out a case on tax fraud like forensic accountants. “Discovery sampling is when forensic accountants go about looking for something that shouldn’t be in statements,” said Barrett as he exemplified this with a case in which he was involved in a tax fraud and gave an auditor five years’ worth of statements to look through. Unfortunately, the auditor was viewing it as an audit and not with the trained eyes of a forensic accountant and could not find anything wrong. It is very important for firms to distinguish between regular accountants and auditors and trained forensic accountants.
  • Partner participation. Barrett said this is an area that you need to watch out for. Often older partners who cannot handle their normal tasks, want to foray into litigation and forensic accounting, but they may not have the expertise to do so, but they believe they do.
  • Re-training. As with CPE courses, time to time, Barrett advises that accountants get re-trained in courses for the forensic accountant.
  • Personal harm. All it takes is one fraudster or suspected fraudster to fire a gun at you.

While the above list is important, Barrett advises accounting firms that want to get into strategic areas, to form strategic alliances in which they can manage the process and have the authority in the eyes of the client.

If your firm wants to start a forensic accounting division, Barrett suggests bringing ex-regulators on board and even IRS agents, many of whom have spun off into different services.

Last Thoughts

Today, forensic accountants and CPA firms are charged with looking for fraud in day-to-day practices. As Barrett quips, to be a forensic accountant, you can’t take yes for an answer. “You should be able to go out there and take on all the Madoffs and hold their feet to the fire and tell them that ‘I want this and I want it now,’” says Barrett.

Intrigued? Want to learn more about the designation, its application process and how you can grow your business? Visit AICPA’s Web site on CFF.

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Sukanya Mitra is Managing Editor of the Insider™ e-newsletter group.