Experienced family lawyers are familiar with the common ways spouses attempt to commit financial fraud in divorce: hiding or undervaluing assets, overstating debts, concealing income, and inflating or fabricating expenses. All of these are done in an attempt to get more than the spouse’s fair share in the property division, and to influence the amount of support that will be paid or received.
Successfully advocating for your client involves more than just knowing that these things occur during the divorce process. You must also be able to identify the red flags that indicate the financial issue(s) must be investigated further. Some are easier to spot than others, but once you have identified two or three red flags, it is time to get a forensic accountant involved. The financial analyst’s experience with fraud and deception will be invaluable in evaluating the red flags and determining if there is something of substance to investigate further.
The most straightforward red flag is the discovery of undisclosed accounts. This could be direct evidence of a spouse attempting to conceal assets. However, the nature of the undisclosed account should be examined. Is it an old account that hasn’t been used in a long time? Is there little to no activity in the account? Is the balance in the account insignificant? In these situations, little weight should be given to the non-disclosure, since it is more likely an oversight.
However, if the undisclosed accounts have substantial activity or balances, appear to be recently used, or show signs of an attempt to actively conceal their existence, the situation is more serious and should be considered an important red flag.
Making Cash Withdrawals
Look for evidence of cash withdrawals from bank and brokerage accounts. Failure to deposit full paychecks or other known sources of funds can also be a sign of siphoning cash. This cash may be used to fund non-marital expenses, purchase hidden assets, or add funds to undisclosed accounts. It could also be used to purchase cashier’s checks or money orders that are hidden, to be converted to cash after the divorce is finalized.
Manipulation of Business Assets
The manipulation of business assets could include not recording valuable hard assets (land, equipment, buildings, etc.) or intangible assets (goodwill, patents, etc.). It may also include improperly valuing accounts receivable or inventory, which can have substantial value to the business. Unusual fluctuations in the reported value of assets, particularly around the time of separation, may be a red flag and should be investigated.
Diverting or Not Recording Business Revenues
If the revenue of a closely held business owned partially or wholly by one of the spouses dips in the period leading up to and following the separation, it could indicate that revenue is being diverted or unrecorded. The business owner may fail to record revenue to reduce the apparent value of the business or to make it appear that the business is failing. The owner may also set up new, undisclosed entities to which customers and revenue are diverted in order to conceal value from the spouse. Again, unusual fluctuations in business revenue should be investigated to determine the reason behind the variances.
Paying Phony Vendors with Business Funds
Similar to the creation of entities used to divert revenue, a business owner may also create phony vendors or entities that are subsequently paid with company funds. These increase the expenses reported by the company, and therefore decrease the profits. It is again done to divert cash away from the business and make the business appear less successful (and therefore less valuable).
Unusual increases in expenses can be a red flag, and therefore should be evaluated. It may also be helpful to examine the known vendors of the company, looking specifically for new vendors being paid substantial sums of money.
Paying Personal Expenses with Business Funds
Business owners sometimes use business funds to pay their personal expenses, while recording them as business expenses in the accounting records. This again increases the expenses and decreases the profits of the company. It also decreases the owner’s need for a paycheck, because there are fewer personal expenses for the owner to pay out of his own funds. The “income” of the owner may subsequently be decreased, which can unfairly impact support calculations.
Paying personal expenses with business funds may also decrease the personal expenses that the business owner reports during the divorce. He or she may therefore appear to have a smaller or more reasonable budget than the spouse, which could also improperly influence support calculations.
Note that the flip side could impact support calculations too. If one spouse is overstating personal expenses, it may make it appear that less money is “available” for support. Conversely, if the spouse receiving support overstates personal expenses, it could falsely create a greater need for support.
Inflating or Fabricating Debts
Higher debts mean that assets such as businesses, homes, and other leveraged property are less valuable on a net basis. When dividing property in a divorce, the spouse in possession of an asset may therefore be inclined to overstate the debt (or even purposely incur additional debt) related to the asset.
A spouse may also fabricate debts, “loaning” money to a friend or family member to deplete assets and cash reserves. These “loans” may be undisclosed, or they may be reported but represented as uncollectible. Either way, the intent is to deprive the other spouse of assets, so any loans between friends, family, and business associates should be investigated to determine the substance of the transactions. The same advice applies to transactions that are reported as “gifts.”
Creating Trusts or Business Entities to Divert Assets
A party to a divorce may create trusts or business entities that are nothing more than vehicles for the diversion of cash and other valuable assets. Any new entity formed in the period leading up to the separation and after the separation should be carefully evaluated. Are legitimate business activities being carried out? How was the entity funded? Is there true economic substance to the transfer of assets? Was the transfer reasonable and necessary? Is there any indication that the transfer or other transactions were shams intended to deprive the spouse of a share of assets?
Should You Investigate?
If a few red flags of minor importance or value are discovered, it may not warrant further investigation. However, if several red flags are uncovered, and they relate to significant issues or substantial value, it is advisable to seek assistance from a financial investigator. The greater the issues, the more likely there are other red flags that you simply are not seeing yet. An investigation can be limited in scope initially, and expanded accordingly as more red flags are uncovered.
Tracy L. Coenen, CPA, CFF is a forensic accountant and fraud investigator with Sequence Inc. She specializes in cases of embezzlement, financial statement fraud, white collar crime, securities fraud, and family law. She can be reached at 312.498.3661 or [email protected]