This last Thursday Eric Lee from Grant Thornton came and gave us a deeper look at forensic accounting and fraud. In case you were not able to come to both meetings about this subject, forensic accounting is the identification, gathering, and interpretation of financial information suitable for use in a court of law. Eric had spent time with the FBI and then made the change to a firm. He enjoyed his old job, kicking in doors, arresting people, infiltrating drug gangs and performing interrogations with the FBI. He told us that it was hard to pretend to be a dirt bag to get into a drug gang, and raise a family. He also enjoys that people are not trying to kill him daily, he also enjoys the opportunity he has to build up networking relations with law firms, go golfing with lawyers and other events, and giving back to the community with his career at Grant Thornton.

 

Eric explained to us that as a forensic accountant there are two main areas that you are involved in. Investigations are the first area. Subjects like fraud, embezzlement, financial statement fraud, foreign corrupt practices act, shadow investigations, and anti-corruption consulting fall under this category. Under the foreign corrupt practices act Eric has gone out to other countries to see if any companies that do business in the United States bribe officials in other governments to get preferential treatment. Eric has been all over the world looking at other companies where one of their employees had blown the whistle on the company. Shadow investigations are where auditors shadow investigators to make sure that the auditors have all the information they need to make a decision on whether the auditors want to issue an opinion or drop the client.

The second area is Dispute Services. This has a lot to do with coming up with numbers to present in a court case or for lawyers to know how much to sue for. Damage valuation, expert testimony, litigation consulting, neutral arbitration, and post-acquisition disputes are covered by dispute services. Attorneys frequently hire forensic accountants to find out what happened to the money, and then the accountants usually give testimony in court.

There are many ways that you can get into a forensic accounting career. Eric suggested that since we are already in the accounting field, that we can try to get on as many shadow investigations as possible when we are in a firm. We have exceptional resources available to us right now as well. We have Professor Albrecht and Zimblemann that would be happy to talk about fraud any time they are free, as well as a Fraud club that can also help you find out more.

Mortgaged backed securitizations. The very name of these financial instruments most likely brings up bad memories for the average citizen in the United States. This last week we were visited by Peter Christensen, a VP in Goldman's BHC Regulatory Capital Group, and we learned more about what structured finance is all about.

A structured finance is a bond that is backed by cash flows made by a specific asset. You can securitize anything with a cash flow, residential and commercial mortgages, credit card receivables, and auto loans. You can choose how risky or reserved the structured finance bonds are by what you decide to securitize to make the structured bonds. A more advances form of a structured finance is called a collateralized debt obligation (CDO). This is where you take a lot of securitization bonds and securitize them into one bond.

The reason why it is possible to make a structured finance bond is a principle called “bankruptcy remote.” To achieve this, banks created special purpose vehicles to buy the loans from the banks to keep the assets safe from the chance that the banks go bankrupt before the bond is matured. This also allows the investors to focus on the bond risk alone, and not the risk that is tied to the bank.

Securitization is a way for the banks to raise capital for banks without issuing new debt or equity. This allowed the banks to be able to make more loans with cash that was on hand. In 2006 banks had been securitizing tons of home mortgages into these bonds. Most of these bonds held mortgages in California, Arizona, and Florida, where the economy of the state relied heavily on the health of the housing industry. When the bubble burst in 2007 the bonds started to go bad. No one was able to pay their mortgages, so the bonds did not receive the cash flow that was required.

The reason why the securitization bonds were so popular is because to the banks they seemed like a good investment to reinvest their money in. They felt like they understood the risks associated with the mortgage backed securities. Due to the traunching of securities, where there is a rating level to the risk you are taking, banks were able to make huge returns by reinvesting in the riskiest unrated class. Traunching is a rating system, the highest grade is the AAA ranking, followed by AA, A, BBB, BB, B, Unrated Class, where the AAA rating gets paid a lower interest rate for the money invested. The unrated class gets the highest interest rate, but when the cash flow starts to fail, their investment is the first to go. When people do not pay their mortgage or auto loan, then the unrated class, does not get paid, then B, BB, BBB, and so on until no one gets a return on their investment. In 2007 so many loans were defaulting that AAA investments were starting to drop off, it did not help that most investors had an AAA rating. Businesses that had investments in these securities were required by law to sell the investment. With the saturation of securities, and the declining price, a perfect storm was created in the economy.

There were a few companies that saw the storm on the horizon. A man at Deutsche bank was able to get on the other side of the transactions and made millions of dollars for his company. Also at Goldman – Sachs, who fair values all of their assets, they were able to see trouble and make money through the bursting bubble.

Securitizations today are more diverse and hopefully will not run into the same problems that were seen five years ago. Peter Christensen feels that to keep bank interest rates low, it is important that banks start using securitized bonds again. “The Fed cannot keep their interest rates at a minimum forever.”

This Thursday professional meeting was awesome! We learned about Forensic Accounting from
Angela S. Mennitt, a FBI agent from Minnesota. She graduated in Economics and through her career
choices got into the accounting field and auditing. She is now part of the Utah branch of the FBI, and
she gave us some insights on what the FBI accountants do.

As an FBI agent, accountants are mostly involved in “White Collar” crime, which entails fraud,
deceit, manipulation, etc. Sometimes they get called in to the spy side of the agency, to fight against
corrupt corporations or mob organizations with money laundering operations. With most cases it is the
job of the forensic accountants to follow the money and prove the purpose of intent.

She described the different crimes that she has seen and dealt with. One group of crimes is
called Affinity Fraud, a case of fraud where the victims have some sort of commonality between them
and the perpetrator. The perpetrator uses this connection to get victims to buy into the scam. An
example of this is Bernie Madoff, whose victims were mostly Jewish. A case that she had data on was
one that involved the “Tiger Woods of foreign exchange” right here in Utah valley. The perpetrator got
his family and neighbors to let him invest money for them in foreign exchanges. It is no crime to lose
money or gain money in exchanges, the crime was when he lied to his relatives about the gains he was
receiving to get more money to cover the losses on old investments.



Another class of cases we looked at was health care fraud. Health care fraud costs the
government around 80 billion dollars a year! She talked about how this will not be fixed in the current
Medicaid system that we have because the FBI is always chasing the money. We need preventative
actions to solve the problem. The FBI is able to recover about 200 million each year, there is a big
difference; the other money just disappears.

The reason that it is such a problem in the United States is that there is such a low barrier of
entry into starting a medical equipment store. After one is set up, the owners go out to doctors and
perspective patients to get more orders for their goods. Then the bill gets put in the taxpayers lap when
the Medicaid program pays for the equipment. Angela showed us a case from Florida that involved a
family that set up three different supply stores. She showed us data on how the money of the
businesses was distributed. There were costs for purchasing the equipment, other business costs, and
then cash disbursements to the family and conspiring marketing company, which was also owned by the
family. It seemed blatantly obvious that these stores were a scam even though in criminal accounting
you have to be conservative with what is labeled other business expense. Most of the time these kinds
of frauds are pointed out to the FBI by other supply stores in the area, patient recruiting, and
advertisements that offer medical equipment for free.

Angela really enjoys her work. It can be tedious at times; scanning information into a computer,
cleaning data, and going through bank statements, but being an agent can take you exotic places. She
has been all over the world with her work. She has gone to Istanbul, to Beijing, and many other places
in Europe, and South America.

On Thursday we got to look into the world of fair value.  David Larson, a fair value expert from Duff and Phelps came and showed us how complicated and exciting the world of fair value can be.  The reason that there is such a big push to value more line items at fair value is because fair market value gives a better “apples to apples” comparison between different companies.