Investigating a Compliance Failure

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How to determine the right mix of expertise for a fraud investigation.

Tracy L. Coenen – CFO Magazine

It’s every CFO’s worst nightmare: despite your best efforts, your company’s compliance program has failed. There are credible reports of fraud and corruption inside the company, and an initial analysis of the situation confirms a problem. An internal investigation is necessary to determine the magnitude of the fraud, the parties involved, and the company’s financial and reputational exposure under government regulations.

How should you proceed? These investigations are often high stakes, so it is important to do things the right way from the start. In-house counsel should be involved in any situation involving allegations or evidence of fraud. Once executives have sufficient reason to believe the allegations are credible, they should involve outside counsel as well. Executives’ responsibilities don’t end there: they can help find the proper consultants to investigate the fraud, influence the fee schedule of the outside work, and keep the investigators informed. Most important, executives can see to it that employees cooperate with the investigators and provide access to all relevant data and documents.

One group they will need to converse with regularly is outside counsel. These lawyers are more likely to have broad experience with fraud issues and related government regulations than lawyers who have worked for only one company at a time. A more important distinction is the clear attorney-client privilege between the company and outside counsel. This privilege will protect the investigation and its findings, at least to some extent.

Even when a company has done nothing wrong, the details of its internal investigation should be kept close to the vest. Depending on the approach government officials take to their investigation, the company may wish to hold back the results of its own investigation. The attorney-client privilege can provide a perfectly legal and ethical way to do so.

In-House or Independent?
Companies are often inclined to have employees handle their fraud investigations. The advantage to using employees is the relatively low cost to investigate, the benefit of the employees’ knowledge of the company and its operations, and the ability to carefully control the investigation.

However, companies are often better off using independent investigators. Although the investigation will cost the company more in dollars, the independence that an outsider brings to the situation may impart more credibility to the findings, especially in the eyes of government investigators. In addition, outside investigators may have more experience and specialized knowledge in the area of fraud, making the investigation more effective.

Outside counsel should make this decision, although input from the board of directors may be important. The lawyers know the risks related to government actions and court activity, and will be in the best position to determine if an independent investigation is necessary.

Some of the best internal investigations I’ve seen have had the best of both worlds. An independent investigator with a fresh set of eyes led the investigation, while employees of the company were liberally available to provide documentation, answer questions, and analyze the work for additional areas of risk.

Further outside help may be needed if the apparent fraud involves specialized issues. For example, cases involving computer forensics should be handled by outside firms with the requisite expertise. Other specialized needs might include familiarity with a particular foreign jurisdiction, regulatory expertise, or knowledge of complicated accounting or tax rules.

I have seen companies try to do their own work, particularly in the area of computer forensics. Management assumes that someone from the IT department will know what to do, and calls the employee down to look at the computers. But it is easy to unintentionally damage and alter digital evidence. I have seen this happen when people unfamiliar with the specialty of computer forensics start poking around. The digital component of investigations keeps growing as technology and business evolve at a rapid pace, and companies are best off calling in specialists at the very beginning of a case to preserve digital evidence.

Leave Some Stones Unturned
Part of the art of working with outside consultants is controlling their fees. While outside counsel will likely be in charge of the scope of the investigation, the board of directors or company executives will also have some say over how the investigation progresses. The company does not need to write a blank check to consultants. The best consultants are those who analyze the company’s situation and offer a measured approach to their work.

It is too easy for a consultant to map out a gigantic project with equally large fees. That is usually not the best way to approach a fraud investigation, even if the case is large and has a wide-scale impact on the company. The investigator should instead map out a logical progression of the investigation, starting with the most critical areas or most immediate concerns. As the results come in from those parts of the projects, better decisions can be made on expanding the scope of the investigation. Additional work can be done when it makes sense. At some point, it will become apparent that all (or nearly all) of the stones have been turned over, and further investigation is unlikely to yield any valuable results.

Many times a measured approach to an internal investigation seems impossible. Managers want to quickly get their arms around all the information available, and that is understandable. But “measured” doesn’t mean the same thing as “slow.”

Ask for a firm proposal on scope and fees. This might be difficult for the investigators, particularly if they do not know how wide they need to take the investigation. However, the experts should be able to offer a somewhat-detailed outline of the initial work that is needed, a less-detailed description of additional work that might be needed, and a range of fees for each step of the investigation.

Be wary of fee budgets. Consultants are reluctant to cap their fees or otherwise commit to a certain dollar figure. If this is the case, does that make the budget essentially meaningless? Insist on a cap to the fees for each part of the investigation, if you can, and strongly consider utilizing an investigator who offers flat fees for each step of an investigation. This limits the company’s exposure to runaway billings. Your agreement with the investigator can allow for a change of scope, along with a change in fees, so long as both parties agree to the changes.

Beyond fees, though, your company’s relationship with a consultant or investigator should be built on trust. With the help of in-house and outside counsel, look for recommendations from colleagues and plan on interviewing more than one firm. Ask the consultants to talk about some of the investigations they’ve worked on so that you can get a feel for the issues they’ve handled and the approach they’ve taken. Do you know enough about this firm and the person in charge of your investigation to feel comfortable proceeding?

You must trust the investigator to have the requisite skills and experience to complete your investigation, the tenacity to pursue difficult issues, and the integrity to control billings for your best interest. If you don’t trust a consultant, move on. Time may be of the essence in your situation, but taking a few extra days or weeks to select the right investigator will usually not harm the investigation.

Tracy L. Coenen, CPA, CFF, is a forensic accountant and fraud investigator with Sequence Inc. in Milwaukee and Chicago. She has conducted hundreds of high-stakes investigations involving corporate embezzlement, financial-statement fraud, securities fraud, investment fraud, tax fraud, and criminal defense. Tracy is the author of Expert Fraud Investigation: A Step-by-Step Guide and Essentials of Corporate Fraud, and has been qualified as an expert witness in both state and federal courts.

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