Since Sarbanes-Oxley was enacted, the Securities Exchange Commission (SEC) and the Department of Justice (DOJ) have increased the number of their accounting investigations and related enforcement actions. During this time, public companies have also been initiating their own investigations due to internal audit findings, whistleblower allegations or proactively after news reports of accounting improprieties at other entities. Generally, the objectives of these accounting investigations are threefold: (1) to determine whether the company's financial statements were materially misstated; (2) to determine whether any misstatements arose from mistakes or intentional conduct; and (3) to determine what remedial measures are required. This article describes some of the various types of accounting investigations performed by SEC, DOJ, public companies, and other parties and the role that CPAs and forensic accountants play in these investigations.
Taking a Closer Look
To better understand the investigative processes in connection with an accounting investigation, consider this hypothetical example. An accounting clerk at XYZ public company sends an anonymous letter to the company's Office of General Counsel (OGC) alleging that the CFO and Controller have been materially overstating revenue during the past several quarters to meet the company's earnings guidance. The letter alleges that the supervisors instructed an employee to artificially inflate revenue by shipping merchandise to company-owned warehouses and by keeping the accounting books open after the quarter had ended.
These allegations would likely prompt the OGC to take certain fact-finding actions that could employ CPAs and forensic accounting specialists for months, even if the allegations turn out to be unfounded. Such efforts by the company, its lawyers, and CPAs are necessary so management can prepare, certify, and disseminate accurate financial information to investors. Each situation, however, will be different and the specific courses of action will depend on the underlying facts and circumstances. Nonetheless, events are likely to unfold as described below.
First, the company's OGC would conduct a preliminary due diligence, often with the help of in-house CPAs, to assess the credibility of the allegations and materiality to the financial statements. If warranted, the OGC would likely inform the audit committee and assess the need to suspend or terminate any personnel suspected of wrongdoing. The audit committee would then decide its course of action and inform the independent auditors. Depending on the circumstances, the OGC along with the Company's internal audit department may conduct the investigation. This approach, for example, may be appropriate if no senior level officials are implicated or are no longer with the company. If deemed serious enough, the OGC may seek assistance from the company's outside counsel. In situations like the whistleblower letter described above, in which a restatement of financial statements seems likely or government prosecution is possible, the audit committee may authorize an independent investigation to be conducted by outside lawyers and forensic accountants who have no previous affiliations with the company.
Regardless of the form of investigation, counsel would typically hire CPAs and forensic accountants to assist them. Forensic accountants are specialists with training and experience in fraud investigations (and may have a Certified Fraud Examiner - CFE designation) and often have past experience as corporate accountants, internal auditors, independent auditors, or law enforcement investigators. Forensic accountants also frequently have significant experience in reconstructing financial transactions, assessing internal controls, applying accounting principles to factual issues, conducting witness interviews, and evaluating potentially incriminating evidence uncovered through reviews of documents and emails.
Accounting Investigations Conducted by the Company's Accountants
Accounting investigations are generally conducted by internal auditors when the allegations are not likely to cause a restatement or government investigation. A typical situation would relate to an allegation of misappropriation of assets by company employees. Another scenario could involve immaterial accounting errors that may have resulted from processing mistakes, misunderstandings of the facts, or good-faith errors in judgment.
The company accountants have an important role throughout an investigation irrespective of its size or complexity. As discussed above, they may be called upon as soon as the OGC receives a whistleblower allegation because they are likely to possess better knowledge of the company's accounting, operating, and internal control systems. The legal department should only seek assistance from internal accounting personnel who are not implicated in the alleged shenanigans. In this role, company accountants may be able to quickly gather evidence and possibly demonstrate that the allegations are inaccurate. If the allegations are corroborated, the internal accountants can also help the OGC assess the scope of the issues and help evaluate quantitative materiality, the time period in which the conduct occurred, and whether the conduct seems to be widespread or limited to a particular subsidiary, customer, or employee.
If an audit committee investigation is warranted, the company accountants' role may still go beyond the initial due diligence phase. However, because SEC and criminal prosecutors (and possibly the independent auditors), may not view an investigation performed by company accountants as an independent investigation, it is probable that company accountant activities would be limited to preparation of corrected financial statements and acting as liaisons between the various parties involved in accounting investigations (i.e., management, audit committees, independent auditors, and all of their respective forensic specialists).
Audit Committee Investigations
As indicated above, the audit committee or a special committee of the Board of Directors will usually be involved when the company is confronting the most serious accounting allegations and the likelihood of restatement or enforcement action is high. In virtually all high-profile cases reported by the press in recent years, including recent stock options backdating matters, outside forensic accountants have been engaged by special committees and through counsel to such committees. The reasons for engaging forensic accounting specialists are manifold, but one of the most important reasons is the significant training and experience that forensic accountants have in investigating complex accounting matters.
Larger accounting firms that have significant forensic capabilities can help accurately and efficiently conduct accounting investigations. These tasks include the preservation of electronic evidence (e.g., e-mail, memoranda, and spreadsheets), and performing e-discovery on the captured data, including reviewing e-mail for accounting implications. Such exercises are complicated and involve obtaining massive electronic databases of e-mails and attachments residing on company servers, laptops, desktops, and various types of storage media. Many forensic accounting firms employ staff members both in the United States and abroad who are specifically trained to perform these computer forensic tasks and follow protocols for using the evidence in subsequent proceedings. Finally, certain audit committee investigations require the deployment of numerous forensic accountants and CPAs simultaneously at several locations all over the world. The largest forensic firms are generally better equipped to deploy the required resources quickly and efficiently.
Forensic Accountants Assisting Independent Auditors
The independent auditors, once they become aware of allegations that a company's financial statements may have been materially misstated, may decide to deploy their own forensic accounting specialists (often called a shadow team ) to monitor the investigation. The objective of the shadow team is to assess the scope and adequacy of the investigative procedures being performed by the company and/or audit committee. The forensic team can also help the audit engagement team obtain sufficient evidence from company investigators to assess management's credibility, whether previously issued audit reports need to be withdrawn, or whether an upcoming audit opinion needs to be delayed. In these situations, shadow teams may need to act swiftly because the company typically would avoid postponing its earnings releases and making late SEC filings. In this role, the auditors and their forensic team can help the company make sure that it does not rush through an investigation and cut corners, which could prove harmful later on if SEC or government prosecutors uncover facts that are not favorable to the company.
Investigations Conducted by SEC Accountants
The SEC's Division of Enforcement initiates accounting investigations for many reasons, including self-reporting by companies, press reports about accounting irregularities, whistleblower complaints, and analysts' concerns. These accounting investigations may have a criminal aspect leading to a parallel investigation by Assistant United States Attorney or a State Attorney General. The objectives of these investigations are generally to determine whether the company filed materially misstated financial statements causing violations of federal securities laws.
A typical investigative team for these SEC investigations would include SEC employees who are CPAs and former auditors. They can help SEC counsel understand the company's accounting records and internal controls relating to the matters being investigated. They can also assist in gathering relevant facts including taking investigative testimony of various company personnel. SEC accountants also participate in reaching conclusions on whether the financial statements included in the SEC filings are materially misstated and whether such misstatements resulted from gross negligence or fraud.
Forensic Accountants Assisting Defense Counsel
Generally, as soon as the SEC sends an informal investigation notice, the company's OGC engages external counsel to help prepare its defense. Defense counsel - who may be from a different law firm than the one hired by the audit committee - often seeks help from forensic accountants early on to understand the accounting rules and to uncover the relevant facts and circumstances.
During the company's internal investigation and the government's investigation, current and former employees of the company may become implicated in accounting issues. In some cases, CFOs and Controllers may decide to resign, or may be suspended or terminated due to preliminary investigation findings. As a result, these individuals may hire personal defense counsel who would also likely hire forensic accountants to help prepare the defense strategy.
Forensic accountants also may assist the defense counsel in writing a Wells submission" - a document that explains to the SEC why an enforcement action should not be pursued against them. The submission may explain how the company's accounting complied with GAAP, or if it did not, why the error was immaterial or occurred due to good-faith errors in judgment. Following the Wells submission, forensic accountants may attend settlement meetings with the SEC, or if the case is litigated, testify as an expert witness in depositions or at trial.
CPAs and forensic accountants play a critical role in accounting investigations and serve the public interest by helping companies get their financial reporting accurate. It is important to point out that in an investigation, the various teams of CPAs and forensic accountants working for different parties are concurrently investigating the same allegations and transactions. As a result, CPAs will likely be examining the same evidence and conducting similar kinds of investigative work. However, because each team is working for a different party, each may potentially view the facts and circumstances differently and could draw different conclusions. This dynamic highlights a reality about corporate accounting investigations that there may be no clear answers concerning the allegations and transactions giving rise to many resolution possibilities.
By Howard Scheck and Sachin Verma
About the authors
Howard Scheck is a partner and Sachin Verma is a senior manager in the Forensic & Dispute Services practice of Deloitte Financial Advisory Services LLP.
The views expressed in this article are those of the authors, and do not necessarily reflect the views of Deloitte Financial Advisory Services LLP.