Family lawyers should always consider engaging an experienced forensic accountant or fraud examiner in any matter where one person is managing significant assets belonging to another. This is crucial if counsel has reason to believe that the fiduciary has breached their duty by not acting in the best interest of the beneficiary.
By Stephan C. Chait and Charles Rabeno, Forensic Accountants
Donald Cressey’s Fraud Triangle
While judgement of the proper performance of fiduciary duty falls into an area of legal expertise, there are many factors attorneys should consider when deciding whether to use a forensic accounting expert when administering any litigation case where one individual has control over the assets of another. Unfortunately, matters of estates, wards, or guardianship often provide the opportunity for financial fraud and abuse by dishonest individuals.
According to Donald Cressey, financial fraud persists by trusted persons when they have a financial need, are in a position that can satisfy this need (albeit through a violation of their trust), and can rationalize that behavior as a means to an end (Cressey, 1973, as cited in Association of Certified Fraud Examiners [ACFE], 20141). This perfect storm is what is referred to as the “Fraud Triangle.”
According to the ACFE, “The fraud triangle is a model for explaining the factors that cause someone to commit occupational fraud. It consists of three components which, together, lead to fraudulent behavior.”2
We would like to assume that in all cases, fiduciaries use good faith and ethical conduct when controlling the funds with which they are entrusted. Unfortunately, we have seen many cases where temptation, lack of controls, and a perceived need set the stage for misappropriation and self-interest. Following are some key indicators that might demonstrate the need to engage a forensic accountant or fraud examiner.
Forensic Accounting Considerations in a Fiduciary Setting
Ask “What is the Nature of the Fiduciary Relationship”
The first question to ask is, “What is the relationship between the fiduciary and the principal?” Frequently, when a principal is unable to manage his or her own financial affairs, a trusted relative or close friend acts as the de facto money manager, especially for an elderly parent or grandparent.
What happens when the fiduciary is someone with a distant, obscure, or new relationship to the principal? Perhaps it is totally legitimate, but in the totality of circumstance, it should at least raise a question. Counsel should inquire about any suspicious dealings in such a situation, such as recent changes in bank account signatory, change of banking relationship, appointment as power of attorney, beneficiary, or other similar activity.
Another potentially glaring issue, and the most common indicator of corporate fraud, according to the ACFE (2020)3 is if the fiduciary is known to be experiencing financial difficulties or is living beyond their means.
Obfuscation and Commingling
Frequently, individuals who commit fraud make transactions more complex and convoluted than necessary, with the intent of making the examination of those transactions more difficult.
Segregation of funds is a hallmark of good fiscal control. The opposite is when a fiduciary mixes his or her personal funds with those of the principal. Commingling of assets can take several forms, all of which raise serious concerns.
It may be common for inter-account transfers between the principal’s accounts. For example, it may be necessary to move funds from an investment account to a checking account in order to satisfy legitimate expenses. However, transfers of funds between the principal’s and fiduciary’s accounts should always be investigated thoroughly. While there might be a rare instance where this is acceptable, frequent or unexplained transactions of this nature are definitely not a good sign.
Typically, sound financial practice dictates paying for goods and services directly. When a fiduciary pays expenses from their personal funds, and is then reimbursed by the principal, the clear audit trail is lost. Except when used for small incidental expenses, this behavior should be very concerning. Without having the fiduciary’s financial records (which in reality is likely), it will be impossible to verify the legitimacy of those transactions.
Documentation for Disbursements While Acting in the Fiduciary Capacity
We understand when commencing an engagement that not everyone who is in the position as a financial fiduciary is a trained accountant. As such, we find that a logical and reasonable method of record-keeping is paramount. This methodology should include sufficient justification and documentation for all expenses paid while acting in the fiduciary capacity. Given the advancement of technology, electronic documentation has become easy, if executed properly.
In a perfect world, when conducting a forensic review, we hope to find clear receipts, notes, and explanations that agree to all disbursements made. Likewise, all deposits into the principal’s accounts are explained as to their source. Unfortunately, we are often provided with inaccurate or incomplete records at best.
Depending on the individual circumstance, such as whether information could be otherwise corroborated, the forensic accountant and counsel should discuss the impact of the absence of adequate records on the case and immediately seek getting discovery directly from the financial institution. Furthermore, the volume of records provided does not necessarily equal their usefulness. In some instances, it may be possible to reasonably quantify damages, despite missing documentation.
The mere existence of a receipt does not in itself legitimize an expense. As discussed below, the nature of the expense should be considered when deciding its veracity. While certainly valuable, receipts show, when, where, and how much was spent. They do not explain why. Therefore, the extra evaluative step beyond comparing an amount on a receipt with a disbursement is a crucial part of a forensic examination, as it may help to uncover instances of commingling and misappropriation.
Amounts of Expenditures
Often the focus of a forensic analysis revolves around the aggregate amount of the suspected fraud or defalcation. It is important to consider, in addition to the gross amount of expenses, the propriety of individual expenses. What we mean is that we should consider whether individual expense amounts are commensurate with what is reasonable and customary. Of course, we should analyze material transactions. But it is not enough to analyze only large transactions, but to consider the cumulative effect of multiple smaller potential misappropriations. For example, are there recurring expenses for meals that, while not material individually, are frequent and for amounts in excess of what makes sense in the circumstances?
It may be necessary to consult other specialists to determine the reasonableness of expense amounts. For example, is an expenditure of $10,000 to fix a roof on the principal’s house appropriate? It would depend on exactly what work was done. A reputable licensed contractor can look at the work performed for the cost and render an opinion as to whether such costs were reasonable.
Qualitative Review of Expenditures
While naturally the materiality and amount of expenditures is always a part of a forensic analysis, we should also be concerned about the nature of such expenses. Do purchases appear to be reasonable and necessary, and for the benefit of the principal? To use the example of meal purchases above, we would question the propriety of frequent, large meal purchases by the fiduciary (or by others and reimbursed by the fiduciary) made miles from where the principal lives.
Were expenditures made that are outside the scope of the fiduciary’s authority? Though this may be a legal judgement, it certainly would be part of a financial examination in concert with counsel’s guidance. Too often, fiduciaries exceed their legal authority and disburse funds improperly.
Finally, has the documentation been examined to determine whether expenses were paid to legitimate parties and for the benefit of the beneficiary? We have seen expenses paid on behalf of third parties without even an attempt to conceal the expense.
Forensic Accounting Considerations in a Fiduciary Setting: Conclusion
Engagement of a trained and experienced forensic accountant or fraud examiner should always be considered in any matter where there are significant assets of one person managed by another. This is especially important if counsel has reason to believe that the fiduciary has breached their duty and not acted completely in the best interest of the beneficiary.
For any estate/trust with assets greater than $1 million dollars and where the fiduciary controls more than 50% of the estate/trust assets, we recommend that counsel establish the following three conditions:
- Have the fiduciary bonded. The costs are minimal in comparison to the risks.
- Have the fiduciary produce quarterly financial reports. There are many inexpensive software programs that will make this reporting easy.
- Have a co-fiduciary with oversight rights appointed.
A forensic accountant can be a valuable member of the litigation team when it comes to family law, matters of estates, trusts, and other cases involving a fiduciary.
1 “Iconic Fraud Triangle Endures” by W. Steve Albrecht, Ph.D., CFE, CPA, CIA (Fraud Magazine, July/August 2014).
2 “The Fraud Triangle” (Association of Certified Fraud Examiners, October 22, 2020).
3 “Report to the Nations: 2020 Global Study on Occupational Fraud and Abuse” (Association of Certified Fraud Examiners, October 22, 2020).
Key Findings from the Report to the Nations: 2020 (Association of Certified Fraud Examiners, October 22, 2020).
Stephan C. Chait (CPA/ABV/CFF) has over three decades’ experience in public accounting, specializing in forensic accounting, complex litigation, estate, business valuation, matrimonial matters, and due diligence in mergers/acquisitions. He has often testified as an expert witness in courts both in New York and New Jersey, and has been named as the Administrator of a charitable trust.
Dr. Charles Rabeno (EdD/CFE) is a forensic accountant, instructor, and Certified Fraud Examiner. Prior to joining the private sector, he spent over 20 years as a federal criminal investigator with the US Department of Homeland Security. His expertise is in white collar crime, including cybercrimes, financial investigations, fraud, and money laundering. www.mmbllp.biz
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