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The Fraud Report, Litigation, and the Recovery Process McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

12-3 Fraud Investigation Reports The fraud report plus expert opinions and testimony are then used as needed to support the resolution of any issues that may relate to taxes, employment, regulatory reporting, litigation (civil and criminal), and insurance claims. Because the report is used for such important purposes, it must be constructed under the assumption that it will be challenged in court.

12-4 Uses of Fraud Reports Taxes A fraud report may be useful in defending against a trust fund recovery penalty. A fraud report may help estimate losses for tax deductibility. Employment Incomplete investigations may face unemployment compensation issues. Regulatory Reporting of Fraud Litigation May be helpful in litigation, but police might not investigate. Insurance claims A business could run out of funds during the investigation.

12-5 Elements of a Fraud Report Address section - whom the report is addressed to. Background information - what triggered the investigation. Executive summary - briefly summarizes the investigation. Scope and objectives - what the investigation sought to accomplish. Approach - the fraud investigation team, the procedures and methods used, the tests performed, and the evidence collected. Findings - details regarding the methods used,tests performed, and the evidence collected, and a one- or two-sentence summary of the findings of the investigation. Recommendations – e.g., suggestions to improve controls Exhibits - copies of documents, interview transcripts, a brief résumé of the fraud investigator, and so on.

12-6 The Investigator’s Liability in Writing a Fraud Report There is some risk that a suspect may sue the investigator. Avoid any inferences relating to a suspect’s guilt. State facts, and opinions on things other than guilt. Use the word “consistent” but very carefully. Ask your professional liability insurer to check the wording in your report.

12-7 Fraud Loss Recovery The fraud loss recovery process includes the actions taken to make the victim whole again to the extent possible. Fraud loss recovery options include the following: Accept the loss Sometimes this is the best business decision. Collect insurance Business policies can include coverage for proof of loss, embezzlement losses, loss of income due to embezzlement, and loss of valuable papers and records. Proof of loss and cooperation are required. Payment can come too late. Litigate Fraudsters can be judgment proof, and the police may not help.

12-8 Expert Witnesses Expert witnesses are granted a privileged status in court trials: They are permitted to render opinions or conclusions based on facts admitted into evidence and other information on which they choose to reasonably rely. The expert’s privilege is a major exception to the “personal knowledge rule.” which normally limits witness testimony to matters of personal knowledge. Being able to testify on anything on which they can reasonably rely permits experts to base their conclusions on their own experience, their technical knowledge, and sometimes even hearsay evidence that would not directly be admitted into evidence. This makes experts a powerful force in the courtroom.

12-9 Admission of Expert Testimony into Evidence Before experts can testify in trials as experts, they must first demonstrate their expert qualifications. Education, including degrees, specialized training, and professional certifications. Experience in the subject area of testimony. Publication of books, proceedings, technical papers, etc. Special awards and recognition in the field of expertise. Memberships in professional organizations. Professional speaking engagements. Professional certifications are especially important. Before someone is permitted to testify as an expert, the opposing side is permitted to examine and challenge that expert’s background and credentials.

12-10 Rule 702 (Testimony by Experts) The federal court system is governed by Rule 702 (Testimony by Experts), which states the following: If scientific, technical, or other specialized knowledge will assist the trier of fact to understand the evidence or to determine a fact in issue, a witness qualified as an expert by knowledge, skill, experience, training, or education, may testify thereto in the form of an opinion or otherwise, if the testimony is based upon sufficient facts or data, the testimony is the product of reliable principles and methods, and the witness has applied the principles and methods reliably to the facts of the case.

12-11 The Daubert Test The key phrase in Rule 702 rule is “reliable principles and methods,” which sets the general standard for what is admitted as expert testimony. In the Daubert case, the U.S. Supreme Court interpreted this to mean that the following conditions hold: The technique or theory has been subjected to scientific testing. The technique or theory has been published in peer-reviewed scientific journals. The error rate for the technique is reasonably estimated or known. The technique or theory is accepted in the relevant scientific community. The Supreme Court intended that these requirements be applied as relevant on a case-by-case basis.

12-12 The Frye Test The Frye test preceded the Daubert test and is still applicable in some state courts. The Frye test merely requires that the expert testimony be based on principles and methods that are generally accepted in the scientific community. The application of the Daubert and Frye tests varies from one jurisdiction to the next. All federal courts and some state courts use the Daubert test, but other state courts use the Frye test, a combination of the Daubert and Frye tests, or some other test. Furthermore, the way the particular test is applied can vary from one court to the next, even within the same jurisdiction.

12-13 Daubert Versus Frye Test

12-14 The Kumho Tire Co. v. Carmichael Case Although the Daubert conditions are defined in scientific terms, the Supreme Court in the Kumho Tire Co. v. Carmichael case ruled that the four Daubert conditions were merely illustrative and applied to nonscientific expert testimony as well. Although the high court did not give illustrative conditions for nonscientific expert testimony, the general import of the decision is that all types of expert testimony are subject to Daubert-type testing. The two Supreme Court decisions suggest that the forensic accounting expert witness must be prepared do more than simply defend her methods based on their being generally accepted in the academic and professional area of testimony.

12-15 Pretrial Reports for Expert Witnesses The forensic accountant expert witnesses could be asked to prepare written pretrial reports. The following are relevant components of the report: The scope of the report, including the matters covered. Any conclusions drawn by the forensic expert. The information, observations, and rationale used by the forensic accountant to support any conclusions made in the report. The report should not include any extra information or comments. Extra information unnecessarily increases the “target area” that can be used to attack the report.

12-16 Depositions Expert witnesses are generally subject to depositions. It is generally best for expert witnesses to testify in a deposition or at trial only if ordered to do so by a court or a subpoena. As a general rule, the expert forensic accountant should bring to the deposition or trial only documents or files that are specifically named in the subpoena or court order. In most jurisdictions, the two opposing sides must give each other lists of anticipated witnesses.

12-17 Expert Witness Preparation for Testimony The expert witness should review the credentials of any opposing witnesses. An expert witness must be well prepared for testimony. Mistakes or omissions can damage the expert’s credibility in the negotiations or trial. That in turn can do major damage to the client’s case and the forensic accountant’s future as an expert witness.

12-18 Trial Strategy and Expert Testimony As mentioned, expert witnesses are generally subject to pretrial depositions. For this reason, attorneys often use both non-testifying experts and testifying experts so that only the testifying experts are subject to discovery. Depositions can serve multiple purposes. It is generally not in the best interest of the opposing counsel to attack the expert witness during depositions. Attorneys often shy away from hiring more than one expert witness in the same area. In some cases, courts may permit opposing counsel to put an expert on the stand without prior notice to the side the expert witness represents. When this happens, counsel should insist on very carefully and slowly qualifying the surprise expert.

12-19 Trial Tactics and Principles Concerning Experts The most important considerations at trial for experts are credibility, demeanor, understandability, and accuracy. Experts should follow these guidelines: Answer questions in plain language Answer only what is asked Maintain a steady demeanor Be friendly and smile at appropriate times Remain silent when there is an objection by one of the attorneys. Tell the truth Control the pace