Accounting has existed for as long as trading and certainly currency have. Early merchants used it to keep track of their assets and liabilities. As trading became more complex, through the Renaissance and then especially with the onset of the Industrial Revolution, so the need to record and ‘account’ for assets and liabilities became more important.
From the moment accounting was invented so developed the need for auditors to review and check accounts. This was important initially to support money lenders and regulators. The advent of limited liability companies following the establishment of the Limited Liability Act in the UK in 1855 increased business risk and the need for auditors yet further.
Accounting scandals and frauds became commonplace through the Industrial Revolution, and accountants soon became drawn in to support companies, the courts and regulators to investigate alleged fraud and mismanagement.
One of the most famous early examples of forensic accounting was the investigation and ultimate imprisonment of the US gangster Al Capone for non-payment of his federal taxes in the 1940s.
Auditing v forensic accounting
There is currently a large public expectation gap with respect to the role of auditors in finding fraud.
In the 1896 case of The Kingston Cotton Mills Co, Judge Lopes coined the phrase that “the auditor is a watchdog, not a bloodhound”.
The latest audit guidance in the UK is enshrined in ISA 240 (revised June 2016) which requires the auditor to obtain reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error. The standard goes on to say: “Owing to the inherent limitations of an audit, there is an unavoidable risk that some material misstatements of the financial statements may not be detected, even though the audit is properly planned and performed in accordance with the ISAs (UK).”
Forensic accountants, by contrast, are nearer to the role of bloodhounds, as opposed to the role of watchdogs. Rather than reviewing accounts before fraud may be discovered, they are usually employed after the suspicion of fraud has arisen. They tend to be reactive as opposed to proactive, although organisations are intervening earlier, when they have suspicions or concerns, by asking for forensic analytics or forensic audits to be performed.
Forensic accounting definition
Forensic accounting will mean different things to different people, and indeed will be influenced by the type of work itself. Investopedia defines Forensic Accounting as follows:
“Forensic accountants analyze, interpret and summarize complex financial and business matters. They may be employed by insurance companies, banks, police forces, government agencies or public accounting firms. Forensic accountants compile financial evidence, develop computer applications to manage the information collected and communicate their findings in the form of reports or presentation.”
In my opinion, the best forensic accountants are able to see the big picture, while at the same time paying close attention to detail.
Categorisation of forensic accounting
Forensic accounting today can be divided broadly into three sub-disciplines:
1. Investigation services
2. Digital forensic services
3. Expert witness services
It is important to consider each of these not in isolation, but instead as a continuum. The facts around transactions reside in the data but need to be extracted properly and then understood. Once understood, the legal case can be advanced, which may require an expert’s opinion.
This is the longest established of the three sub-disciplines. Regulators and organisations facing critical issues have long used forensic accountants to get to the bottom of transactions with complex fact sets. Typical services could include:
1. Financial crime issues. Fraud as an issue now sits alongside bribery and corruption, money laundering and sanctions as risk issues for reputational damage and legal/regulatory impacts
2. Company accounting ‘black hole’ investigations, particularly with increased scrutiny by the Financial Reporting Council
3. Tax investigations. We are waiting for the impacts of HMRC’s enforcement of the Criminal Finances Act
4. Asset tracing, which may be in support of an insolvency or other court appointment process
5. Money laundering and financial crime investigations generally
Corporate intelligence (which is the gathering of public records information from public records and human source enquiries) is used by the modern investigator as part of a corporate compliance programme. This category is separately analysed by Chambers and Partners but is nonetheless important for the forensic process.
Digital forensic services
Digital forensic services have been used to complement investigations and forensic expert witness services alike. The explosion of big data (both structured and unstructured) since the Millennium has changed how businesses operate and where the facts reside. Unstructured data is typically what we say in emails and other communications, and we can track growth back to the first smartphones and tablets. Structured data is what comes from accounting and ERP systems, and growth has also been seismic. Botched data handling undermines any legal or regulatory matter. Therefore, it has never been more important to identify, preserve, collect and analyse data quickly and accurately.
This is significantly the domain of the E-Disclosure/E-Discovery experts (separately analysed by Chambers and Partners), but the frontiers are moving and changing very quickly. We are now seeing further specialisation into:
1. Data capture
2. Data cleansing and data analytics
3. Cyber analysts
Expert witness services
Courts increasingly rely on expert forensic accountants to help quantify damages caused by breach of contract or tort, or to value assets and liabilities to support court procedures, e.g. insolvency proceedings and restructurings, or for the purpose of divorces (through the family courts). Typical matters could also include:
1. Company sale and purchase disputes
2. Valuation of shares for the purpose of s.994 Companies Act 2006 shareholder disputes
3. Assessment of damages for the purpose of international arbitration disputes
4. Security for cost applications
5. Assessment of losses caused by breach of contract or tort disputes
6. Assessment of losses caused by alleged professional negligence and malpractice
What are the key macro issues that have supported the growth of forensic accounting?
There have been three key macro factors:
Warren Buffett is quoted as saying that it is only when the tide goes out that you learn who has been swimming without their trunks. The credit crunch from 2008 launched a huge amount of forensic investigation into banks and financial institutions and thereafter related litigation. Furthermore, there is a regulatory backlash which again tends to involve forensic accountants in monitoring and supporting remediations.
Madoff and Stanford entered the common vernacular as fraudsters. Lehman Brothers will again be long remembered for its failure. And huge court cases such as Deutsche Bank AG v Sebastian Holdings, Inc and the SAAD Group failure will be remembered for their sheer complexity and size. Most of these matters involved Grant Thornton forensic accountants supporting the investigation, delivering evidence into court, and gathering and collating digital information.
The world’s economy is speeding up (particularly in developing markets), and the world is becoming a smaller place. It is therefore inevitable that globalisation will create a large number of international disputes. There is no clearer example than through the huge growth of international arbitration over the past ten years. Here you may often see differences play out between languages, laws, cultures and accounting rules, overlaid with large and volatile commodity price fluctuation. A practical perfect storm, and forensic accountants have played a large part in both investigating and quantifying the impacts.
We have seen an explosion in the volume of data since the Millennium. As discussed, it has never been more important that data, particularly through the Internet of Things, is understood and the right skills brought to support forensic cases.
Each of the above three factors will continue to have an impact in the years to come. I think we will see increasing complexity:
Complexity of data
I suggest the role of data scientist will become increasingly prominent. The ability to see the signal through the noise will be increasingly valued as complexity increases.
Complexity of subject area
As the world drills deeper specialist bunkers, the ability of the forensic accountant to bridge sectors and work with different professionals and subject matter experts (SMEs) will never be more greatly valued.
What to look for in a forensic accounting team
This will depend on the needs of each matter, but a well-functioning team should be able to demonstrate:
- Close collaboration and integration between Investigation, Expert and Digital Forensic functions
- Global connectivity and reach
- Connectivity with SMEs
What makes a good forensic accountant?
This again will depend upon the needs of the case, but I suggest the following attributes will carry a premium:
1. Experience. I have given evidence in court over 30 times. Each time presents learning opportunities. The adage that you rarely see old, incompetent bullfighters applies equally to forensic accountants. As in the bull ring, there is no hiding place for forensic accountants.
2. Understanding of the law. Forensic accountants need not be lawyers, but do need to have a good understanding of the area of law where they are asked to support, be it, for example:
a. For an Expert: the different way to quantify damages through breach of contract as opposed to tort
b. For an Investigator: the rules of evidence gathering
c. For a Digital Forensic practitioner: the rules surrounding GDPR and data capture
3. Know your place. A good forensic accountant should understand their role with respect to the court, counsel, and other experts.
4. Report writing and evidence presenting. Simplicity is the ultimate sophistication. I used to judge whether I understood a matter sufficiently by whether I could explain it to my children (not that I did of course). But it was a good check!
Will Davies is Managing Partner with Grant Thornton UK LLP and co-leader of Forensic Services with Grant Thornton International. He specialises in corporate investigations, valuations and commercial disputes. He has given evidence at court or tribunal on over 30 occasions. He has acted on some of the largest and most complex forensic accounting matters of recent years including Deutsche Bank AG v Sebastian Holdings Inc. (2013) and Ahmad Hamad Algosaibi and Brothers Company v Saad Investments Company Limited (in official liquidation) (2017).