Whistleblowers, Accounting Fraud, and Internal Investigations (A Case Study)

Compliance professionals can talk at length about the importance of conducting internal investigations when there are whistleblower reports of fraud, corruption, and other questionable behavior. But what actually matters is doing something when the time comes. This case study  illustrates how one public company did it right to head off big trouble when the SEC came knocking.

A supervisory employee in the company’s accounting department was having performance problems. She was counseled repeatedly, and management decided that one final warning was in order. The employee had a “last chance” meeting with management, in which she was told that the next step would be termination if her she did not meet certain performance expectations.

The employee went into action immediately, stealing confidential company accounting information and deleting documents from her computer. She wrote a whistleblower letter to the Securities and Exchange commission, the board of directors, and the independent auditors. She claimed that because management was engaging in accounting shenanigans, she could no longer remain employed, and she quit.

The whistleblower letter was taken seriously immediately. Management quickly looked at the list of allegations, evaluated them one-by-one, and determined that they were without merit.  They were able to make this determination so quickly because the issues were all things that the company was aware of and actively working on. Simply put, there was nothing new in this letter.

The board of directors decided almost immediately that an independent investigation should be done so that an unbiased analysis of the issues would be completed. They determined that because the allegations all related to the accounting function and financial disclosures to the SEC,  a forensic accountant was the right person to investigate. I was engaged to conduct the independent accounting investigation, and work began.

Management immediately began gathering internal documentation related to the allegations including internal communications, accounting system data, reconciliations, appraisals, and documents filed with the SEC. I was given access to all employees so that I could interview anyone I thought might have relevant information.

I interviewed members of management and evaluated the documentation gathered. I asked for additional documentation that I deemed necessary to fully analyze the issues. I attempted to interview the whistleblower on numerous occasions, telling her via email, voicemail, and telephone conversations that I was completing an independent investigation and was interested in any information or documentation she had in her possession regarding the issues she raised.

Ultimately, the whisteblower would not provide any additional information. She claimed to have knowledge and documents that would prove her allegations true, but would not provide me with anything. All the while, company personnel remained cooperative and offered me unlimited access to anything necessary to fully investigate.

This case was unusual because the allegations were made about issues that the company had already identified as material weaknesses. That is, the company had already disclosed in SEC filings that there were certain accounting and control problems, and action had been taken to resolve those issues. Write-downs and adjustments had already been made in prior periods, and proactive steps had been taken to remediate the problems.

Ultimately, I determined that all issues raised by the whistleblower had been properly handled, even before the former employee wrote her letter. I found nothing to indicate that the company was engaging in accounting irregularities.

One difficulty in investigations like this is looking for that which is concealed. If the investigator doesn’t know about an issue or a document, how can the investigator find it? An argument could be made that the company is hiding its shenanigans well and not providing full information, making it impossible for the investigator to find the smoking gun. That is always an issue, and it is a legitimate concern.

In this type of situation I rely on my gut instinct. Is there anything in my investigation that gives me pause? Was there any sort of irregularity or hint of a cover-up that signals the need for more investigation? In this case, there was not. I could not find even one instance of an apparent cover-up or manipulation that causes further investigation.

What if the whistleblower had come forward with new information or additional documentation? I certainly would have carefully evaluated it and expanded the scope of my investigation. The fact that she was unwilling to provide additional information indicated that there was likely no other evidence of wrongdoing.

Could there have been other reasons why she didn’t provide additional information? Of course. But there was nothing I could do to elicit additional information from her, and I had to make a decision about continuing the investigation, or issuing an opinion based on what I had already seen. Because I was comfortable with everything I had seen and had no reservations whatsoever about any of the issues, I wrote my report on the investigation.

Within a week of issuing my report to the board of directors, the SEC made contact with the company and began an informal investigation into the issues.

This public company handled this situation the right way. They were in an excellent position from the start of the SEC inquiry for several reasons:

• The company was aware of the issues long before the whistleblower letter was written, and already had taken substantial action to correct the problems.
• Management investigated issues as they were raised in the course of business, and made changes based on their findings.
• They hired outside firms, as appropriate, to provide opinions and valuations to ensure that their financial statements and disclosures were complete and accurate.
• Substantive changes were made to the accounting function so that transactions would be recorded correctly on an ongoing basis.
• Documentation related to the corrective actions was maintained, which demonstrated that management was thorough in examining the issues, following authoritative guidance, and making proper disclosures to the SEC.
• Management allowed me unlimited access to people and documentation so that I could complete my independent investigation on my own terms.
• The board of directors and management did not attempt to influence my investigation or my report, never suggesting findings or impeding my ability to seek out necessary information or documentation.

Probably the most important “right” decision the company made, however, was to immediately begin an independent internal investigation. By starting quickly, the investigation was able to be completed before the SEC contacted management, giving more credibility to the findings. If the investigation had been completed after the SEC became officially involved, the findings may have been regarded only as an attempt to sway the SEC in their investigation.

This situation has been costly for the company, both to complete the independent investigation and to comply with requests from the SEC. However, this cost is a hazard of being publicly traded and subject to regulations which require such actions.

The case demonstrates the need to take whistleblower allegations seriously, even when management has substantial knowledge that the allegations are false. Management knew that the whistleblower letter had sufficient detail that it could be considered credible by the SEC, and they were right. They took no chances and quickly engaged a forensic accountant to independently evaluate the allegations and report the findings to the board of directors. The company handled this whistleblower case the right way, and as a result, they are in an excellent position relative to the SEC’s inquiry.

Related posts:

1. Whistleblower Case Study: Independent Internal Investigations
2. Books, Crooks & Rooks: Internal Corporate Fraud Investigations
3. Whistleblowers under Sarbanes-Oxley
4. The Case for Independent Internal Investigations
5. Whistleblower Complaints: Fast Action Required