Analyse this - Forensic auditing

by Hilton Tarrant
Once a mysterious subculture of the accounting fraternity, forensic auditing has become a familiar scene in the contemporary business world.

Forensic accounting conjures up images of lengthy, intricate investigations into complicated transactions by teams of senior auditors. In a post-Kebble, post-Enron, post-Tannenbaum, post-Madoff, post-Stanford world, we have become used to the notion of forensic auditors making evening news reports.

Peter Goss, head of Forensic Investigations and Fraud Risk Consulting at PricewaterhouseCoopers (PwC) Gauteng, says: “Simply put, we’re in the business of forensic investigation into financial crime and fraud.” He explains that forensic auditing is used to investigate suspected fraud in businesses, both in the public and private sectors, as well as in matters affecting civil society.

Forensic auditing is really big business, but overall forms only a small portion of what the big four accounting firms offer in terms of services.

The terms ‘forensic auditing’ and ‘forensic accounting’ are largely synonymous, according to Graham Dawes, director of Risk Advisory at Deloitte.

Dawes says the notion of ‘forensic’ as a term is about being able to unpack financial records for court purposes. He argues that the major use of forensic auditing is for the purposes of court process. “That is where it lands in most cases,” he explains, “with auditors able to give testimony, and detail what they have uncovered. Any forensic engagement is able to uncover a huge range of irregularities, from financial statement fraud to fraud within procurement.”

Undertaking any forensic investigation with the intention of it heading to trial is a reactive process.

There are proactive uses for forensic auditing as well, but Dawes argues that most inquiries are reactive. A reactive audit comes about as the result of allegations of fraud and corruption. These are commonplace, particularly in the SA public sector. A forensic team would then investigate these types of allegations.

PwC’s Goss explains that a typical forensic audit spans a period of time subject to the complexity of the concern. “On reactive issues, somebody raises allegations about fraud or corruption in a business or government process. We go in, secure an understanding of that process, gather documentation supporting the irregularity, interview witnesses, conduct certain analyses and put together a report.”

Obtaining evidence and the actual analysis is the time-consuming part of the investigation, and this is dependent on the assignment. Tracking evidence involves locating documents, economic information, assets, a person or company, any requisite experts or proof of the occurrence of an event.

Dawes says the difference between a forensic investigation and a normal audit, is that in a traditional audit, auditors sample transactions and provide some level of assurance. “Generally, in a forensic process, you’re actually going through all of the transactions to uncover irregularities.”

During a forensic audit, it may be necessary to reconstruct transactions, where financial statements and evidence are used to reconstitute missing ones. The analysis could involve the calculation of economic damages, summarising a volume of transactions or even tracing assets.

Goss says that the report may suggest corrective action against people or in relation to systems, and that corrective action against people can include disciplinary action or prosecution. “There’s a second leg to this, which of course is outside the forensic auditor’s hands, as it falls to the hands of law enforcement.”

Forensics not only relates to investigations into accounting. PwC’s forensics practice, for example, also provides dispute support services where there is a threat of litigation or arbitration.

It’s also able to deal with investigations into any “suspicions of white-collar crime”. This could mean reacting quickly and confidentially to any crisis situation, like asset misappropriation, money-laundering activities, corruption and bribery, or regulatory investigations.

Increasingly, there is a need for forensic expertise in the area of information technology. Specialists are able to identify, seize and analyse information located on a company’s IT assets.

On the proactive side, explains Goss, a forensic audit means going into known systems that have problems and reviewing those systems for actual evidence of corruption and fraud.

“For example, you may find that procurement fraud is rife in a specific sector. You may have no specific allegations but you want to assure yourself that it’s just a rumour. So you conduct a proactive review of systems, policies and procedures.”

There’s another side to proactive investigations too: developing anti-fraud systems. “In the public service, I’ve probably developed in excess of 300 anti-fraud plans which are part of forensic auditing’s proactive output. Forensic auditing and governance go hand in hand; it’s absolutely integral to governance and transparency and is a very material component.”

Incidentally, Goss is busy writing a paper titled Fraud Risk Governance for the Institute of Directors, which specifically links forensic accounting to corporate governance as suggested in the new King III report.

“Forensic auditing is tied in by means of its proactive outputs which include fraud risk management and good governance,” he says. The latter also includes good ethical systems and responses to ethical breaches; and forensic auditors are the people who respond to those ethical breaches.

Dawes believes it almost goes without saying that the staff responsible for forensic audits are typically senior. “You need experienced individuals. We might have younger staff learning, but they would be leveraging off senior staff.”

He says that in SA there are only about four or five really good forensic accountants who could stand up in a significant court matter.

Locally, we’ve seen forensic accounting used in very public investigations, notably by author and journalist Barry Sergeant in his reconstruction of Brett Kebble’s financial engineering and the accounts of the collapsed Fidentia group.

Concerned shareholders of Kebble companies, for example, took to the internet and published a number of findings following investigation into the accounts.

Specialised Services Group (SSG) shot to prominence after its investigation and publicising of the Ponzi scheme (Frankel Investment Scheme), allegedly operated by Barry Tannenbaum and associate Dean Rees.

After being approached by investors in the scheme, SSG forensic consultants discovered that purchase orders Tannenbaum presented to prospective investors were forged. Some of the items indicated were not used by the respective pharmaceutical companies and the “value of the orders were nowhere near the amount Tannenbaum claimed”. SSG says the investigation into Frankel
Investments came about when the organisation failed to pay investors for over a year.

Bernard Madoff’s Ponzi scheme, which lost 4 800 clients $65 billion, also thrust forensic investigations into the global mainstream media spotlight. Regulators in the US were lambasted for not investigating allegations against Madoff more thoroughly over the past 16 years.

In SA, state departments as well as entities such as the SABC, Transnet, SAA and the Land Bank are in the news regularly for procurement policy breaches and the ensuing forensic investigations.

Last year, Transnet Freight Rail cancelled the order of 212 diesel locomotives in a multibillion-rand tender after uncovering a number of irregularities, and as a result, suspended senior staff. Transnet says that it made the decision following advice from two leading senior counsellors and the findings of forensic advisers Ernst & Young.

It adds that the decision was also part of a series of corrective steps, including a review of its procurement processes, that it took in a bid to prevent similar occurrences. Further recommendations of the forensic advisers arising out of the probe are being implemented.

Forensic investigator Andre Prakke says that Finance Minister Pravin Gordhan’s intention to overhaul the way the state procures goods and services in order to clamp down on tender fraud and corruption is a noble aim. However, he believes it will “take a long time”, and adds that problems plaguing the public sector are procedural, systemic, and skills-related.

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