Article, Solicitors Journal – June 2010
Legal / Disputes
While forensic accountants often work on high-profile fraud investigations, their skills can also be used in a wide range of civil actions, say James Stanbury and Mark Jennings of RGL’s London office.
In terms of public perception, the term “forensics” can yield a wide-ranging definition – from the bloodless to the bloody! Whereas the latter should be ascribed to the realm of science, the former is the preserve of other forensic specialists, including forensic accountants. In turn, the public perception of the forensic accountancy profession is usually limited to that of fraud investigation -indeed, that is the focus of most commentary presented by the national press. However, as with most professions, the scope of expertise is much broader than initial perception.
Forensic accountants are broadly involved in the investigative or dispute resolution arenas – hence the strapline adopted by many accountancy firms to describe their services in this arena. The high profile work in which forensic accountants are used is generally in the realm of corporate fraud investigations that forensic accountants are used – think Enron, WorldCom and Madoff. But these same skills can be applied in a variety of other areas. In the civil realm of dispute resolution, the main focus is on quantum – establishing what a party has lost. This requirement to evaluate compensation can arise in a broad range of actions that will be familiar to lawyers – from compulsory purchase orders to breach of contract claims, shareholder disputes, marital dissolution actions, business interruption/loss of profit claims, subrogation claims, product liability claims, personal injury/fatal accident claims to name a few.
Part 35 of the CPR gives guidance to lawyers as to the protocols for instructing experts, be they appointed as a party-expert, a single joint expert or as an assessor. However, not all financial disputes require expert evidence; a lawyer must think carefully as to whether appointment is appropriate or not. An obvious area where such a question may arise is that of personal injury claims. Cases where the injured party is an employee on a steady career path with a straightforward earning stream do not, I think, require expert evidence to establish quantum. This should be contrasted with claims involving an individual who is a high earner (with a complex earnings pattern) or a self-employed claimant, which may require such expertise.
Why instruct a forensic accountant?
So what drives a lawyer to engage a forensic accountancy expert? Of course, each case will define its own requirements but factors that we regularly see come to the fore include where:
- a claim may be monetarily significant
- a claim is complex
- the “other” party has one (and there is a need to match expert evidence with expert evidence)
- there is a deadlock in negotiations; or
- there are incomplete records.
Once instructed, what does an expert need to perform its work and how does it go about its work? Section 8 of the CPR Protocol for instructing experts provides the starting point and sets out the guidelines – these focus on the basic requirements of scope of instructions, the provision of statements of case, disclosed documents and witness statements and procedural timetable.
In a litigation environment, the evidence that a forensic accountant will rely upon will inevitably be largely document-based. Therefore, it is usually necessary to make a tailored request for further documents - indeed, such a request communicates to the other party an understanding of the significance of the documents to the underlying claim. Indeed, we have had claims where a request for documents - that should have existed for legal and regulatory reasons but which did not – has effectively brought an end to the claim process, such was the consequence of their non-presentation.
Analysing financial records
Inevitably, the financial records become the main source of attention and critical to evaluating quantum. For a claim involving a business, management accounts (which will give monthly data, not annual as with audited accounts), budgets/forecasts, order books, contracts, production records are fairly standard to request, notwithstanding the overall need to tailor those requests to the specific case. As an example, let us take a loss of profit case involving Father Christmas – now you don’t think he gives out presents for free, do you?!
Readers will have no doubt have noticed the trend in recent years around Christmas for commercial “winter wonderland” experiences to pop up, attempting to bring an authentic “Christmas” experience with the usual enticement of Santa in person. At one such site, due to the collapse of some scenery, various members of the public were injured which resulted in closure in early December - the critical period. The claim – for multiple millions – focused on loss of profit not just for that season but also subsequent seasons; in addition, losses were claimed from the inability to franchise the operation in other territories worldwide over a time horizon of some 5 years. As the site had reopened a few days after the incident, the claim therefore rested on the effects of the ensuing poor publicity.
The key to any loss evaluation is understanding:
- the drivers of business value – in our case, ticket sales and income they generated; and
- the cause and effect of the subject incident on those drivers.
It is essential the two are related – the losses have to flow directly from the incident; losses imputed to other reasons will only serve to overstate the claim. Therefore, on this case, it was important to understand the ticketing and sales income profile not only of this season but also prior seasons.
Analysis of corporate records revealed:
- ticket sales in the season of incident were far slower than in previous years and the incidence of pre-event selling had also waned;
- publicity from the incident had been restricted to a few local papers overnight – the reputational damage had been minimal;
- the loss-making of a sister venture, said to have failed because of bad publicity of this incident, had failed due to unrelated ticketing-process problems; and
- there were no documents to support the potential franchising into other territories.
The venture was doomed to be loss-making in any event and had not been affected by the incident and attendant publicity apart from a few lost ticket sales in the subject season.
However, not all cases turn on a review of the financial records – the non-financial records are equally important. For example, where a loss arises from the non-completion of the sale of a business, it is important to establish the parties’ intentions – this can only be established by corporate non-financial records such as minutes of meetings (internal to the company and external with financiers and advisors) and correspondence between the parties.
Non-financial information in terms of external research can be equally important – be it on a business or individual. A few years’ ago, we were instructed to review a personal injury claim arising from a light aircraft accident. The claim for loss of earnings was valued at close to £1m. Review of the witness statements revealed that the Claimant had, earlier in his life, been a professional football player for Plymouth, Argyle. Googling him revealed, critically, that the Claimant, an enthusiastic golfer, had entered and won, post-incident, an amateur pairs golf championship – contrary to the poor physical abilities he claimed to have been left with after the accident. Given the consequent impact on his credibility and the so-called “facts” of his injury, the claim settled for a minimal value.
Making use of technology
Financial records retain importance in any review or investigation. What has changed over the years is the way financial information is stored and organised – technology has been the leader. The amount of electronically-stored financial information held can be vast. Thus, finding the relevant information is important. Forensic Technologists, who are used to interrogate computer systems, can assist not only with extracting the information from accounting systems but also in managing, organizing and streamlining large volumes of data. For example, we were recently instructed to value retail stock in a Russian warehouse damaged from a fire. The company’s accounts and stock ledgers were held across 24 spreadsheets with over 30,000 records in each. With the use of specialist software, we were able to clean and import all of the data into one database of over 1.1 million transactions. This allowed us to analyze the ageing, pricing and obsolescence of the stock to arrive at a proper valuation. The humble Excel spreadsheet, our stock-in-trade, can have a limited usage.
In an investigation, deployment of technology can save a huge amount of time – for example in providing search tools for key words. An unusual case we dealt with was reviewing claims arising from failed bail bonds in the US: where an alleged criminal is required to “post bail”, agencies provide bonds for the same value subject to payment of a premium (and therefore at an affordable (to the bailee) fraction of the value) and security from other sources. If a criminal absconds, the bond may default and, where there is insufficient security, a claim may arise. We reviewed such claims – of which there were hundreds – but needed, inter alia, to match criminal records to specific bonds before establishing quantum. A paper trawl through hundreds of disorganized files would have required significant manpower; however, through a scanning/OCR process, records could be identified and significant time and cost savings arose.
The role of the forensic accountant is extremely varied. Each case presents its own facts and foibles and has its own personality – indeed, it should not be forgotten that even corporate claims are driven by individuals. What is important to understand is that the forensic accountant’s focus is not just on the financial records. The non-financial records can be equally important and thus ensure that no blood is spilt in final resolution.
As appeared in Solicitors Journal, June 2010.