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Josh Howard
Common mistakes to avoid in fraud investigations

These four suggestions can help prevent companies from becoming a statistic in federal court sentencing records.

July 24, 2013
by Josh Howard, J.D.

If you and your forensic accounting colleagues have felt busier recently, there’s a good reason. The United States Sentencing Commission tracked roughly 84,000 federal criminal cases in 2012. The raw number of fraud cases totaled 8,634 in 2012, a number that has steadily increased over the past five years.

Yet only 26 organizations—as opposed to individuals—were sentenced for fraud in 2012. Why is that number relatively low? One reason is that corporations often strike settlement agreements with prosecutors. But there’s another reason as well: Properly handling allegations of fraud or other financial misconduct can make it much easier for an organization to stay out of federal court in the first place.

Organizations are sentenced under Chapter 8 of the federal sentencing guidelines. The guidelines require judges to determine whether the organization handled the case appropriately and if it had an effective ethics and compliance program. So how should companies go about handling these types of investigations?

I have a few suggestions that are based on years of dealing with these types of issues. I spent roughly 10 years as a federal prosecutor, ultimately serving as the white collar crime section chief for a U.S. Attorney's Office. I then worked as the chief ethics officer at a multinational government contractor in Research Triangle Park, N.C., where I ran internal investigations into allegations of fraud and abuse in corporate and federal funds. Now I work as a defense lawyer focused on internal investigations and white collar defense.

My experience has taught me that companies make four common mistakes in handling fraud allegations. They are: (1) not investigating, (2) not shrouding the investigation under the attorney-client privilege, (3) not using independent investigators, and (4) not disclosing the investigation to clients, shareholders, and government officials as necessary. Let’s take a closer look at each error in turn.

A total failure to investigate

Investigative inaction can be the result of sheer negligence or a more cynical, deliberate decision. In some instances, closely held or public-minded organizations are staffed by people who just can't believe someone on staff might glean personal benefit from their shared, broader cause. In other instances, personalities and corporate politics stand in the way: No aspiring executive wants to answer for fraud that went on under his or her watch.

This is why companies should have anonymous ethics hotlines and active audit committees; a key lesson of the Enron scandal was that people within the company knew about the fraud but did not have the ability to raise it with appropriate corporate officials. Lawmakers and regulators, in passing Sarbanes-Oxley and similar corporate behavior mandates, made clear that companies can no longer stick their heads in the sand and expect to avoid ruinous civil and criminal liability.

Remember attorney client privilege

Accountants make outstanding fraud investigators. Unfortunately, the law does not readily protect their findings from unnecessary disclosure. The best way to protect findings from unnecessary disclosure to trolling media outlets, opportunistic plaintiffs, and even government agencies is to shroud the effort in the attorney-client privilege. This is accomplished by having a lawyer lead the investigation. Forensic accountants involved in the investigation would report to the lawyer.

In a privileged environment, management can be confident it will have appropriate time to digest the sometimes dramatic findings of forensic accountants. Similarly, forensic accountants may identify issues beyond the scope of the original investigation; if they operate in a privileged environment, companies can address unexpected and unrelated findings in private. Major management decisions that flow from investigations, such as disciplining staff, installing new internal controls, and addressing financial consequences, can be more thoughtfully considered when educated by privileged findings. Finally, a privileged investigation best empowers the one-time release of all findings at a time of the company’s choosing rather than a steady drip of problems directly into the public eye. The attorney-client privilege offers investigative findings by all types of investigators maximum protection.

Lack of independence in the investigation

Problems can arise if the investigators are not sufficiently insulated from corporate politics. Federal prosecutors evaluating the credibility of an internal investigation routinely assign more credibility to those led by outside counsel rather than those conducted by less expensive, and more vulnerable, in-house counsel. Given that the mean fine and restitution order imposed on organizations sentenced for fraud in 2012 was $343,579, legal fees on outside counsel are dollars well spent.

Failure to make appropriate disclosures

Finding the truth often means airing the truth. Sometimes the law requires disclosure to law enforcement, clients, shareholders, or even the media. Companies in the public eye face the ominous risk of adverse media coverage through a drip, drip series of disclosures and leaks. Savvy companies promise a full investigation, bring in credible outside investigators, and, where necessary, make full and total disclosures that make clear to the public and law enforcement that the company is an ally rather than a stumbling block in detecting and prosecuting fraud.

Internal fraud investigations can be embarrassing and expensive in the short term. But avoiding these mistakes will help you make sure that your company or client never makes a far more costly and embarrassing appearance in federal criminal sentencing statistics.

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Josh Howard, J.D., is a partner at the law firm of Gammon, Howard & Zeszotarski PLLC in Raleigh, N.C. He has served as the white collar crime section chief in a U.S. Attorney’s Office and as the chief ethics officer for a multinational research institute in Research Triangle Park, N.C.