White collar crime – an inside job

Six former executives from Time Warner’s America Online unit and the now defunct were recently charged with federal fraud offences for allegedly participating in a scheme to falsely inflate their earnings. Sadly, it is just the latest high-profile accounting scandal to hit the headlines.

Despite increasing investment in fraud prevention measures, the sophistication of the fraudsters is such that some misdemeanours will only come to light once the damage is done. In such circumstances, companies need to act quickly and efficiently to investigate the fraud and deal with its consequences.

The size and scope of an internal investigation will vary according to the size of the company, the extent of the alleged fraud and the commercial objective of the investigation. For example, a business that discovers fraud in a recently acquired company will want to know quickly how the acquired company’s value will be affected by the fraud and whether the problem should be dealt with through a completion accounts exercise or through litigation.

When ING bought Barings following the collapse brought about by Nick Leeson’s rogue trading, it needed to find out as quickly as possible whether the trading losses in Singapore were a one-off incident or part of a wider problem.

The first step in any investigation is to put together an appropriate team. Depending on the size and scope of the investigation, this could comprise a member of the board, a member of the internal audit team, a human resources representative, both in-house and external lawyers, forensic accountants, public relations advisers, private investigators and other experts.

The core team must be small enough to be effective and cohesive. When choosing the team, it is important to consider their independence. What is their relationship with the suspected fraudsters? Are they likely to be subjected to criticism themselves?

The decision whether to appoint external lawyers or accountants will depend on the size of the investigation, the complexity of the issues involved and the level of in-house expertise. It is worth bearing in mind, however, that the expertise of specialist lawyers and accountants in this area is not just confined to legal and accounting issues. Their experience will also enable them to give practical advice to the company on strategy, document management and reporting procedures.

The order in which witnesses are interviewed, for example, will be crucial. You might be tempted to interview the alleged fraudster as early as possible, but it’s often better to speak to other employees first and then compare the information obtained in those interviews with the version of events given by the person under suspicion.

Internal investigations will usually require computer forensics to retrieve and examine the emails of the alleged fraudsters. This exercise raises a wide range of practical and legal issues, such as whose emails can be retrieved, which emails can be retrieved and how the information in the emails can be used.

If the company in question has groups in other jurisdictions, data protection, human rights and employment law advice will often be required from foreign lawyers.

In larger investigations, an electronic database may often be required to store the documents retrieved as part of the investigation. The explosion of email use means that significant time and money is spent reducing the volume of electronic documents retrieved into a collection of documents that are relevant, manageable and searchable.

There is now a range of software to aid forensic accountants and lawyers in their investigation. A number of accountancy firms are developing their own products. But it is important that the most appropriate software for a particular job is used, especially if litigation is likely to ensue from the investigation. Lawyers should be consulted on the choice of software at an early stage.

While the focus of a fraud investigation is often the missing monies, there is also the matter of how to deal with the offending employees. If staff who are accused of fraud are not dealt with sensitively and fairly, the consequences can be both embarrassing and financially damaging.

Most large companies have procedures in place for dealing with investigations into employee misconduct. It is important that these procedures are not ignored in the pressure-cooker environment of an investigation, especially if shareholders or the media are expecting heads to roll. Take a recent investigation into the conduct of certain employees at Severn Trent. Although it found that the issues had no effect on the integrity of the group’s accounts, disciplinary action was still taken against employees whose actions had fallen short of the required standards in order to reassure customers and shareholders.

The way documents are collected, organised and used needs careful consideration at the outset of any fraud investigation. In particular, the investigation team must have a good understanding of the law of privilege and how it relates to both contemporaneous documents and the work product of the investigation.

There may be correspondence between the client, lawyers and accountants that is intended to be confidential. But if an employee is dismissed, and requests those documents as part of a claim for unfair dismissal, the company may not be able to rely on litigation privilege if it cannot show the documents were created for the purpose of potential litigation.

The work of non-lawyers does not generally attract the same privilege as the work of lawyers. Thought should, therefore, be given as to who is the most appropriate adviser to prepare written advice on certain issues and produce the final written report on the investigation. The chain of communication in the investigation will also be important.

Last, but not least, at the outset you need to consider whether any public authorities should be involved. Alerting the police or a regulatory body may not be in the company’s interests, but if it is necessary, assistance must be provided in a controlled way and steps must be taken to safeguard key documents.

Communication between the various members of the investigation team is key. From day one, a detailed action plan should be devised and maintained to ensure that each member is absolutely clear as to who has responsibility for each task and what the agreed strategy is for each of the various elements of the investigation.

Crispin Rapinet is a partner and Ashley Hurst is a lawyer in the insolvency, fraud and asset recovery group of law firm Lovells.

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