2. Our fraud support services are better, cheaper, and faster than spreadsheet input.

3. We use high speed scanners, Optical Character Recognition, templates, sophisticated software and all done with the skill, knowledge, education, experienced and training that was gained as a Special Agent working financial crime cases.

4. We leverage proprietary database technology developed over the past seven years and proven through investigations.

5. We employ artificial intelligence to identify transfers between accounts.

6. We offer trained and experienced staff that will build your confidence in the data and in our ability maintain the confidentiality of the data.

7. We document each transaction by appending electronically the evidence you develop to the related transactions.

8. We help you improve the delivery of analyzed data to help your client – plaintiff or defendant. (Civil or Criminal)

9. Our reporting can be in the standard Source and Application of funds or in the indirect methods (criminal tax cases.)

10. We can import accounting software data to compare against bank account data.

We believe that our service will be a win – win that will aid you in your investigations.

We are offering to 10 qualified firms the opportunity to partner with us and we will waive the onetime $1,500 initiation fee.

We can help you and your firm!

CALL 1-800-286-8140 if you are interested. We have already had a number of calls from interested investigators, CFEs, CPA, and financial investigators to further discuss our services.

Call us NOW 1-800-286-8140 for an appointment and let us help you “Shed light on the Truth!!”

Preparation for hiring a PI to locate a person or conduct surveillance.

1. Determine who, what, when, why and your budget

2. Seek a cost estimate.

3. Secure a written contract from the PI

4. Your attorney in the matter should hire the PI.

5. Be prepared to provide detailed information to the PI and pictures.

6. Rely on you instincts and be comfortable with your PI.

Examining Book & Witnesses by IRS

With the increase in the use of automated accounting systems and tax preparation software such as Quicken, QuickBooks, MS Money, and other prominent software, including TurboTax, Tax Cut, Tax Works, etc., IRS is stepping up its scrutiny of the contents of electronic data.

In a Private Ruling: Chief Council Advice Memorandum UIL No. 7602.00-00 dated October 14, 2011, IRS issued an advice memorandum regarding six issues:

Issues:
1. May an examiner summon the taxpayer’s original electronic data files (or the backup files):
a. To obtain the associated metadata if the taxpayer offers to provide paper printouts of these data files (or spreadsheets created from the data files) that do not contain the metadata?
Metadata is defined herein as, information that describes how, when, and by whom a particular item or set of electronic information was collected, created, accessed, modified, and formatted. The Service’s examinations would be advanced by accessing metadata that identifies the original date a transaction was entered in the electronic records, the dates of any changes to the entries, and the username of the person who made the entries. The value inherent in an examiner’s ability to obtain the date and source of recorded entries is self evident; the information tends to support or undermine the credibility of the entries in the business records. (QuickBooks refers to this metadata in an Audit Report file.)

b. To obtain the associated metadata if the taxpayer offers to provide a truncated or an altered copy of the original files in which the original metadata was removed or changed when the altered copy was created?

c. to obtain the recorded entries and associated, unaltered metadata for transactions that occurred before or after the periods being examined if the taxpayer offers to provide a copy of the data file showing only the recorded entries without the metadata for transactions that occurred during the periods being examined?

d. From the taxpayer’s accountant (third party) if the accountant recorded entries of the business transactions into the electronic file and possesses the records?

2. If a taxpayer provides the Service with an electronic data file on a CD or a thumb drive, must the examiner retain the original CD or thumb drive in the examination case file? Alternatively, may the examiner make an electronic copy of that file and include it in the examination file if the case is closed “unagreed” and the data file supports the examiner’s conclusions (or the data file contains information that may be relevant to a separate criminal investigation)?

3. Do the Federal Rules of Civil Procedure and the case law thereunder offer analogous support for summoning electronic records with intact metadata?

Conclusions:
The key to Item 1.a. and b., above is governed by the statutory authority of IRC Sec. 7602 (a)(2) including the determination if a return is correct. The Service may properly summon the taxpayer’s original electronic data files containing the unaltered metadata, because it “may be relevant” to the determination. If the taxpayer’s offer to provide copies that omit the metadata or actual production thereof does not restrict the Service’s authority to summon the original, unaltered metadata. This item is supported by US Supreme Court case, U.S. v. Powell, 379 U.S. 48, 57 (1694).

The key to Item 1.c., above is governed by IRC Sec. 7602 (a)(2) and the Service may summons information, including metadata, concerning transactions and events that occurred before and after the periods under examination so long as that information

The Internal Revenue Service sets the bar high for individuals to meet the Innocent Spouse guidelines.

Important: Form 8857 Summary of Instructions:

The IRS says must complete your paper work, Form 8857, attachments, and exhibits “as soon as you become aware of a tax liability for which you believe only your spouse should be held responsible.” You must be brave in this process because the IRS will contact your spouse and inform him/her of the filing to allow him/her to participate and will advise him/her of their determination.

Awareness includes the following
1. IRS is examining our tax return & proposing to increase your tax liability.
2. IRS sent a notice. (Note: You must submit your Form 8857 within two years of the first attempt (notice) from the IRS or your request could be rejected. Do not delay, get your information together to complete the Form 8857.)
3. IRS Collection activities start the two year clock ticking after any of the following:
a. IRS offsets your income tax refund against the liability owed.
b. IRS could file a proof of claim in bankruptcy proceeding.
c. IRS could file suit to collect a joint liability.
d. IRS issues a Notice of Intent to Levy and notifies you of your rights.

Types of Relief:
1. Innocent Spouse Relief
2. Separation of Liability Relief
3. Equitable Relief
4. Relief from Liability arising from community property laws.

We will only discuss Innocent Spouse and Equitable Relief herein: Note that all the following must apply.
1. You filed a joint return(s) for the years for the relief requested.
2. The understatement of tax on the return(s) that is due to erroneous items (income, deductions, credits, or basis) of your spouse with whom you filed the return.
3. You can show (demonstrate through statements and actions) when you signed the return(s) you did not know and “had no reason to know” that the understatement existed or the extent to which it existed.

Equitable Relief: You may be allowed equitable relief if both of the following conditions apply.
1) You have an understated tax or underpaid tax (tax properly shown on your return but has not been paid.)
2) Taking into account all the facts and circumstances the IRS determines it would be unfair to hold you liable for the understatement or underpaid tax.
a) Note: Equitable relief is the only type of relief available for underpaid tax.

Good news if you do not qualify for innocent spouse relief but your circumstances are right, IRS will consider equitable relief without completing additional forms.

Two scenarios that should be explained in the Form 8857 and attachments:
1) If your spouse was self-employed; controlling; handled the bank accounts; gave you a debit card or an allowance in a separate bank account to pay bills; kept the personal and business records on password protected QuickBooks; received the US Mail; made every major purchase decision in your life and threatened or coerced you into signed the tax return not knowing that he did not make estimated tax payments, then you may qualify for relief. If your spouse forged your name to the return then you may qualify for relief.

2) If you are in a second marriage and your spouse did all the above items and his adult children were held by him/her to be superior to you then include that information in the attachments to explain what happened to you. If there are police reports that reveal abuse by your spouse or his children get copies for the IRS. If you have witnesses to events that show abuse have them prepare affidavits and include them with you Form 8857.

It will be best for you to be separated or divorced from your spouse when the Form 8857 is filed.

Also, remember just like any other IRS document you submit to them are signing under penalties of perjury thus the contents of your Form 8857 must be truthful and well documented.

To learn more contact Fraud Expert Ed Martin, CFE, TCI, at Sage Investigations, LLC, e-mail: edmartin@sageinvestigations.com

With continuous construction in Austin, Texas you may be hired to investigate the misappropriation of construction funds by their contractor. The investigator will ask himself / herself, where do I start? The following will act as a checklist of things to do if faced with this type of investigation.

Meet with the Client:
Remember to take care of yourself by securing a signed contract with the client defining the scope of your investigation and secure a retainer. Thoroughly interview the client and any secretary or bookkeeper about what they suspect and why.

Records are everything:
Obtain the contract between the partners and the contractor to determine the terms and conditions, including the required periodic financial reporting and the accessibility of financial records by the member. Determine how many properties are being constructed and the estimated cost of each. Most of the time contractors get in trouble by failing to allocate materials and labor per job. This scenario is dangerous for the client. Secure any reports made by the contractor to the client and if none, determine why. Most contractors tell their employers that they are too busy to maintain an accounting. Obtain from the client all the written information possible.

Determine what are the funding sources?
Generally, the funding sources are received from invested capital contributed by the members of the entity, and / or bank construction loans. Secure records that show how much and when funds were contributed or loaned and where they were deposited.

Gather the available records:
Initially secure the records of the members including canceled checks or evidence of wire transfers; this will give the investigator a lead to the contractor’s bank account. Ask the contractor for his records, obtain a power of attorney from the contractor to obtain the records or if necessary, the client will have his attorney file a lawsuit. Have the attorney subpoena records from all known banks. This will allow you to determine the amount received and disposition of the funds and secondarily will allow you to identify leads to other bank accounts and to the ultimate disposition of the money. Subpoena the contractor for invoices for construction materials in an attempt to determine the particular job to which the materials were delivered.

Secure the settlement statements for the purchase of the land reflecting the property loan; secure bank loan documents, a bank loan history reflecting loan advances and payments. Also, review the construction draw requests, and determine the allocation of the funds expended. (Review the allocations on the draw requests and compare to the checks drawn during the draw period. This will allow you to determine if the money went for the stated purpose or if the contractor used the funds in another way.) Also obtain the checks or Electronic Funds Transfers (EFTs) notice to determine when the funds were transfers or deposited. Determine the name of the bank officer that signed off on the draw requests. Interview the officer, he / she could become an important witness. He / she may have further records of the allocation of expenditures for the construction project as represented in the draw requests and a computation of the percentage of completion.

How to solve the financial puzzle and determine if the contractor really absconded with the funds:
Analyze the bank loan records and the bank account records on spreadsheets. Be aware of transfers between accounts. Generally, the lending bank will require that the loan funds be transferred to a bank account within their bank. Unfortunately, funds are then transferred to other bank accounts and expended, possibly for the purpose on the draw requests and at times not. The analysis of the bank loan records and bank account records will allow the purification of the records and the elimination of the transferred funds to allow a focus on the actual disposition of the funds. At times, it will be determined that the funds were transferred to the account of the contractor and the check notated as “Supervisor Draw.” A review of the contract will clarify if this is authorized or not. Therefore the money has been traced to the contractor and ends there. At times, it will be determined that the funds were used to pay for materials and labor cost on other properties of the partners or of other jobs the contractor has in progress for another group of partners. These funds must also be considered as traced to the contractor and due by the contractor to the client’s job. The goal of any analysis is to determine how much money was received overall from contributed funds or bank loans, how much was expended for construction, and how much money did the contractor receive directly or to his benefit. Once the analysis it complete, the burden of proof will be on the contractor to clarify the amount he received. With a competent business litigation attorney and a prepared investigator, the contractor will have to reach a compromise to benefit your client. At that point the investigator has done his or her job.

Recommendations to Client:
Unfortunately, in my experience a number of contractors are good with their hands but lack the skill it takes to maintain financial records and the cash management skills to timely complete a job at the estimated cost. When the money starts to run out, they resort to “Robbing Peter to pay Paul.” Poor recordkeeping starts with the lack of an accounting system, a lack of notations as to the allocation of the expenditures, lost invoices, commingling of funds received and expenditures, and the payment of materials and labor on another job. With the assistance of an active member of the entity, the investigator can put together a timeline for expenditures and can be established the normal construction sequence during the construction period. This sequence will allow a reasonable allocation of expenditures if none is available.

With today’s internet access to bank accounts, individuals that employ contractors should require all funds to be deposited in the construction account and paid out of the account directly for materials and labor. They should require that they be allowed access to view the account activity over the Internet. This would allow the partners to monitor the funds received from the draw requests from the bank, the use of the funds in the bank account and would act as a deterrent to any “hanky-panky” by the contractor.

In today’s global economy the importance of data organization and classification has become the cornerstone on which a financial investigation relies.Everything from converting to digital data to searching information for classification has become an arduous task as fraud cases have become more and more complicated. To address this increase in data complexity, a few standardizations of technique and technology can make a huge difference in the number of hours needed to take a fraud investigation from start to finish. In this article I will discuss the various techniques and processes for building financial fraud cases using computer technology. From data entry and conversion to advanced search algorithms that aid in classification, managing a financial fraud case has never been easier, if you know the right techniques and tools to use.

Since this article is written for the average fraud investigator, it is important to clarify some of the more advanced technical words I am going to be using.

Important Definitions

OPTICAL CHARACTER RECOGNITION, abbreviated as OCR, is the mechanical or electronic translation of images of handwritten, typewritten or printed text into machine-editable text.

DATA OBJECT is a digital representation of a real-world object’s state and characteristics.

DATA MINING is the process of searching and sorting through large amounts of data and picking out relevant information.

An ALGORITHM is a sequence of instructions often used for calculation and data processing.

Now I know you are saying to yourself, “oh no, I cannot learn advanced computer terminology” or “I better let my computer guy read this”, but stick with me and I will clarify the importance of a basic understanding of these terms. Even if you use someone or some software that has these features hidden from you in a nice user-interface, it is always good to understand the concepts that make the computer work for the modern-day investigator.

Data Entry and Data Conversion

With the advent of technology, the data entry process has become the most important step in building a financial fraud case that is both accurate and complete. Whether the data entry process is manual or computer-aided, precise information is of the utmost importance.In this section, I will discuss the various data entry techniques that will be available to the modern financial investigation team.

Whether you are an old-pro or new to the business, everyone is familiar with the discovery that is important to any fraud case. Bank records, credit card statements and receipts make up most of the information, translating this information into a form which is usable by the computer can be a daunting task. The computer is not yet smart enough to show it a piece of paper and have it recognize the type of document, then enter the data and organize it. This is where the data entry group and the “eyeballs” of humans play the most important role.You must have people verify all information that is inputted into the computer is accurate. There is no point for a fraud examiner to even analyze data if it is incorrect. The case is only as good as the information obtained. Having a person who can validate the integrity of data entered whether manual or using Optical Character Recognition is important. Humans and computers can mistakenly enter 5’s for S’s and commas for periods; which makes for errors in the case management process. Catching any problem is the job of the data entry group and there are many tools available to assist in this process.

The tried and true methods of manual data entry have been overtaken by the advances OPTICAL CHARACTER RECOGNITION, referred to as OCR. While it can take up to two minutes for a human to enter one bank transaction, the computer can read a scanned document and translate the image to text in seconds. There are many applications such as Nuance OmniPage, Abbyy FineReader and Adobe Acrobat that work well at character recognition, finding one that is useful for you is important. How they work is simple. If you do not have a PDF or any other image type of the document, you must first get the information into a digital image, using a scanner is the best method. Most scanners work easily with programs such as Adobe Acrobat or Microsoft Word for making useable images of documents. The most important setting during scanning is quality of image; I try and have at least 300 dpi setting (dots per inch) for any scanned document. The higher the resolution the better chance the software has for accurate translation. Once you have the image of the document, use your OCR application to translate or recognize the characters, then save the data in whichever text or file format you plan on using. Most OCR programs can work with Word, Excel and other file types and have the ability to export the data as a text file using comma or tab delimited values. Using some sort of delimiter gives the data a consistent marker that aids with data separation and organization, while maintaining an application neutral data file. Open the file in something such as Notepad or other simple text editor; from here you can use the features of copy and paste to further organize the data. What you are looking for is consistency of information layout and one line of data per transaction. Make sure word wrap is turned off for the application and verify each transaction has the same number of entries.

datetime1amount1

datetime2amount2

datetime3amount3

In this example the transaction can be either debit or credit depending on whether the value is positive (credit) or negative (debit). I understand you cannot see it, but hidden in the code that separates the datetime from amount is a t which means tab. The computer can now read the example and be instructed to separate the two values from each other using the tab as the delimiter. By creating patterned data, the amount of manual data manipulation is decreased through consistency. In fact, there are many occasions where the time of OCRing just a few transactions is slower than manual data entry so being consistent with your delimiters is the key. Hint: Try and create delimiters that are unique and have almost no chance of being in the text you are working with

Example 2 of simple bank transactions that are custom text delimiter of %$%

datetime1%#%amount1

datetime2%#%amount2

Either way the data has to be verified as correct and laid out in such a way to be useful for the investigator. Using tools like Microsoft Excel or most any spreadsheet program, you can import the delimited text easily with all data going into their respective columns. Some applications like Excel allow the programming of macros and algorithms that can be used to calculate the running balance of transactions as they apply to the bank or credit card statements. There are many features embedded into spreadsheet programs, like sum total, that perform these calculations quickly. As an example, a bank statement has a daily balance included on the statement. Using the sum of the transactions, a person can compare the digital data with what the statement says. If you are missing any information or there is an error in typing like extra numbers (50.00 instead of 5.00), the error will be noticeable because of the deviation from the statement or failure of the application to perform as intended.

Data Objects and the Financial Investigator

Data Objects are not an easy concept to grasp for some, but it is important to have a small knowledge of them to understand how computers handle data efficiently. From the previous definition given, a Data Object is a digital representation of a real-world item. What does this mean? In the case of a bank account, this means that a Bank Account Data Object has certain properties and associations that are universal to every bank account. Bank accounts always have an account number and opened date. Bank Accounts also can contain other data objects within them, like bank transactions. Bank Transaction Data Objects have their own properties such as datetime of transaction, whether the type is a debit or credit, and the amount of the transaction. By creating Data Objects for every possible financial transaction, we can build a set of rules that the computer can interpret and aid the investigator in case management.

With Data Objects the computer can determine whether a field must meet some type of parameter or criteria, like the date being in a particular format like mm/dd/yyyy or amount of transaction being of the money type. This allows for the computer to warn the person, or a computer application, of data entry errors that need to be addressed. We can guarantee that check amounts are money fields and names need to exist for our case’s subjects. By using Data Objects we can maintain minimum standards of data that guarantee our search algorithms and association techniques will function correctly.

Data Mining and Classification

A very important feature that an investigator needs is the ability to search, sort and classify the data. Without searching and sorting features, the classification of financial transactions can be a laborious. The investigator needs to be able to classify transactions as business expenses, income, investments, etc. efficiently and consistently. In this section I will discuss the various methodologies available to the investigator that assist with data organization and classification.

The first thing a financial investigator needs to do with classification is to organize the recurring items, whether they are expenses or incomes. For example, a business might have an office with a rent payment, electricity, phones and internet that are due and paid every month. These transactions have a tendency to be paid from the same account or even in the same manner consistently, like always by check or using a debit card. These transactions usually always have the same information profile, like notations in the bank statements. An example of this is transactions for the cable tv/internet might always have a check being written to Time Warner; by using the name of the company in a simple search we can easily find every transaction that has a reference to that name. Simple search is just typing a word or words in exactly as you expect them to appear from within some text. Simple search and sorting techniques help by narrowing the data set of available financial objects that require more classification by categorizing repeating data more effectively. If there are on average ten checks written by a company every month and six of those checks are for company bills, we have limited the unorganized data set by 60%. This greatly reduces the size of the unorganized data and can effectively aid the investigator in more quickly recognizing patterns of fraud or uncharacteristic spending habits.

The second pass on the data needs to determine the movement or transfer of money between accounts. Sometimes the transfer of money is easy to spot because there is a direct one-to-one correlation between the values, e.g. a $1000 debit from one account becoming a $1000 credit in another account. These transfers sometimes can be hard for an investigator to spot with many accounts. This is where a simple search on the amount fields can show just the transactions with that particular amount. Other times searching is more difficult. As an example some of the money was transferred to an asset like a car or even put in their pocket as cash. Anytime that funds are taken out of a bank account and spent as cash, a transfer of money needs to be made to a virtual transaction in the subject’s cash account. A virtual transaction is a representation of an assumed value or item that needs to be accounted for. An example of this is if the person says they paid cash for a $2000 tv, the investigation needs to show a debit from the cash account for the money. Sometimes money is split up, like a $1000 debit going to pay a $500 company expense while the other $500 went into the person’s pocket. By sorting out all of these account transfers we have reduced the chance of tabulating the transactions more than once.

By time we reach the third pass we should have about 80% of all data organized and need to apply only few more advanced searching techniques to further organize the case. There are many different methods for searching that can be applied to financial objects; we are only going to discuss a few. The math and computer science behind these search techniques are a bit technical for this article, but I feel it is important to mention them. Fuzzy searching is the names given to finding strings of text that have an approximate match, like finding ball when looking for bill. Soundex searching is looking for words that sound similar in the English language, such as pelt and belt. Wildcard searching uses a character that can be substituted for any subset of a string; wildcards are usually represented by the * key (star). An example of this is searching for fra* should reveal results like France, fray, Frank, frazzle, etc. Fuzzy and Soundex searching are good tools for finding data where typing errors have occurred. Just because we have built our data objects properly does not mean that errors in data entry did not occur. A data object value that is a text field will accept ‘5+3ve’ just as it will ‘Steve’; if you find several errors like this there could be a breakdown in your data entry process somewhere that needs to beaddressed.

The rest of the investigation after the third pass just comes down to solid fraud investigator work, mental data mining if you will. Remember what you might be looking for could have been categorized or sorted in the data mining process. Smart criminals try to hide fraud through fake businesses, employees and other methods. If you have organized your data correctly, when you make that connection every related transaction is already at your fingertips.

THE TRUTH ABOUT FRIVOLOUS TAX ARGUMENTS

From www.irs.gov

I. The Voluntary Nature of the Federal Income Tax System

A.Contention: The filing of a tax return is voluntary

B.Contention: Payment of tax is voluntary

C.Contention: The IRS must prepare federal tax returns for a person who fails to file

II. The Meaning of Income: Taxable Income and Gross Income

A.Contention:Wages, tips, and other compensation received for personal services are not income

B.Contention:Only foreign-source income is taxable

C.Contention:Federal Reserve Notes are not income

III.

When do people embezzle or abuse the company? Generally, three things have to be present before someone commits fraud or embezzles: need, opportunity, and rationalization. This is known as the “triangle of fraud.”

Need – Direct need is stealing to fund cash needs and is often driven by an addiction – drugs, alcohol, gambling, or an extramarital affair.  Therefore, the next time someone brags about an affair, a warning flags should go up if the handle your company funds.

Opportunity– Defined as the perception that there is a low probability of being detected.  In accounting, we call this “poor internal controls.”  Note:  Management sets the tone.

Rationalization – The employees’ mental process of making the action fit within their personal code of conduct.  In other words, the employees must be able to “talk themselves into the action” — “the ends justify the means.”

Rationalization often results in “situational fraud”

Employees’ propensity to steal or embezzle can be described as a normal distribution curve.  (Do you remember statistics from college?)

1. About 5% to 10% of employees would never—ever—do anything wrong.
2. About 5% to 10% of employees are always scheming.  (I hope you don’t have many such folks working for you.)
3. The real problem is that 80% to 90% of employees who will commit “situational fraud.”
   1. a.     Remember: Who are the only employees who can steal from you?  
   2. Employees you trust.
   3. This isn’t meant to imply you shouldn’t trust your employees, but remain skeptical.  Do not go soft on internal controls because you trust employees.

Here are some warning signs and risks to watch for, especially if they handle company money or assets:

• Employees who are being downsized;
• Employees who are bored and may steal for excitement;
• Employees who make an honest mistake, discover a hole in internal controls, benefit from it, and who intend to “pay it back”;
• Thrill seekers who like bending the rules;
• Employees who are under personal stress: money, divorce, illness (especially spouse or children);
• Employees whose financial problems suddenly disappear;
• Employees with addictions: drugs, alcohol, extramarital affairs, gambling;
• Employees who always have to be number 1 and/or can’t stand not being the center of attention.

Tips on Minimizing Fraud

Minimize risks with a little creativity and by being proactive.

You must segregate duties as much as possible.  Do not allow those who handle money to make deposits, to make entries to the books, to issue and sign checks and to reconcile bank accounts.

As a small business owner, your business generally does not have segregation of duties but you can still be involved:

1. You can have the bank statement sent to your home, not to the company.  This demonstrates that you are paying attention to the statements.  Learn to access you account online and periodically review the balance and checks and deposit slips.
2. I know you are busy, but it won’t take more than 5 or 10 minutes for a review of the bank statement.”
3. When you return to the office – asks questions about several items in each statement.
4. This procedure creates the perception that a theft will probably be detected, thus reducing the “opportunity” and increasing the risk of being caught.
5. Upsetting either side of the Fraud Triangle will help minimizing the opportunity for theft and embezzlement to take place because the perpetrator might “get caught.”
6. To make a change palatable to your long-term employee, have a third party, your accountant, auditor, or CFE, suggest this change.  This will avoid sending the message to the long-time employee that he or she isn’t trusted anymore.

• You need to get the employee (probably a bookkeeper or controller) to ask for the change.
• The third party can say, “You know, you have complete control of everything.  You pay the bills, you make the bank deposits, you reconcile the accounts, and you make entries to the books.  If any money is missing, whom do you think the owner will suspect?  For your own protection, you should get the owner to look at the bank statements and initial the envelope every month.

1. Separate the cash/banking function from the recordkeeping function.  If not possible, then rotate personnel or functions in critical financial areas on a regular basis.
2. Review hiring policies to keep people of questionable background from making it to the payroll.  (Consider employee background checks for employees that handle money and assets.)
3. Restrict access to employee master files to prevent “ghost employees” and improper pay rates.  The owner should review the payroll report.
4. Restrict access to vendor master files with strict procedures for additions and modifications.
5. Protect all check stock (under lock and key) and destroy obsolete stock.

How to react if your suspect fraud and embezzlement

No. 1 Contact the Insurer

The employer’s insurance company should be contacted immediately and your insurance policy reviewed.

No. 2 Contact Legal Counsel

The employer should immediately contact a competent employment lawyer to discuss the situation.

(Consider having your Attorney hire a Forensic Accountant, preferably a Certified Fraud Examiner (Ed Martin, CFE @ 512-659-3179) to help review the detail and preserve evidence (testimonial, documentary and electronic) which will be necessary for your insurance claim, confronting the employee, or presenting to the District Attorney.)

No. 3 Deal with “Alleged” Perpetrator

Once an employee is suspected of embezzlement or even caught, at least three courses of action are possible:

1. Place the employee on administrative leave with pay;

• Do not confront the employee but escort the employee out of the office.
• Limit the employee’s access to the computer network.

1. Proceed to develop evidence by gathering bank records, business records, electronic records, and securing testimony.

• Consider having their computer forensically imaged.
  • Don’t use their computer until the computer is forensically imaged by a qualified computer forensic specialist.
  • The forensic image of their computer will preserve existing evidence and allow the computer to be returned to business use.

1. If evidence of theft is developed then terminate the employee immediately.

Note: Before you contact the Police Department or DA for charges get the evidence and be able to articulate what happened.  The Police have lots of work and embezzlement of your company will not get top priority.

No. 4 Prepare Action Plan

This is a dangerous situation.  Although Texas is an “at will state.”  Meaning that an employer can fire a person at will, wrongful termination lawsuits can result.  Contact an employment lawyer to avoid a mistake.

Consider hiring a forensic accountant / investigator.  Before he jumps into an assignment on embezzlement, he will require preparation and planning.  An embezzlement fraud examination can be complex so organization of documentation is necessary.  Establish a budget for what you will spend on the matter.

A proper plan does the following:

• Identify suspect, co-conspirators, witnesses;
• Preserve evidence both documentary and electronic.
• Prepare for timely interview of the suspect and / or co-conspirator.
• Prepare for timely interview of witnesses
• Unidentified suspected perpetrator – some times the investigation will require “the casting of a wider net” and bring in all individuals who may have had the opportunities and access to commit the fraud.

No. 5 Act Quickly to Stop the Damage

Direct observation rarely catches employee theft.  Usually a tip or specialized audit procedure uncovers embezzlement.

Initially you will be seeing the tip of the iceberg.  The perpetrator’s scheme or schemes likely have been ongoing for months.

No. 6 Know Employer’s Rights and Responsibilities

The employer has a right to conduct a fraud examination and a responsibility to the owners and stockholders to investigate and seek to recover losses by theft.

The complex series of laws dealing with employee rights in the workplace does not necessarily have to hamper the examination.  The rules must simply be followed.  However, the employer must treat all employees consistently.  Inconsistent treatment or an inconsistent track record can later be used against the employer.

No. 7 Know Employee’s Rights and Responsibilities

Review the employee handbook.

Does it outline the employee’s rights in such situations and his or her responsibilities?  Generally, an employee has a fiduciary duty to comply with the employer’s investigation of their possible fraudulent acts.  Failure to do so can lead to termination of employment.

No. 8 Secure Data

The employer must take immediate steps to preserve data.

Fraud deals with issues of “intent” and proving intent is generally through circumstantial evidence.  Evidence that goes to the issue of intent must be gathered and preserved.  Once an employee is notified that he or she is the subject of the investigation:

1. the employee should not be allowed to touch computers or
2. remove anything other than personal items from the office.
3. The employee should be accompanied while in the office and
4. walked from the premises.
5. The timing of such notification is a separate issue.

Do not overlook the employee’s home computer ask for a consent search of the computer and have the employee sign and date the consent.  This consent to search can be executed by a competent private investigator hired by your attorney.  Depending on the matter being investigated, the home computer may be imaged.

No. 9 Perform Background Check of Suspect

Background and credit checks allow the identification of “need” and “greed” as possible motivations for the fraudster.

Provisions of the U.S. Fair Credit Reporting Act require notifying the employee that a check of their credit is being made.  The employee manual should notify all employees that the company may be performing background checks and advise them they have a right to receive copies.

No. 10 Remember Iceberg Principle

Fraud is like an iceberg.

1. What is seen may only be a small part of the whole.
2. Many others may have been involved in the fraud scheme.
3. Often, the toughest frauds to detect are those involving collusion with others within or outside the entity.  For example, a common embezzlement scheme involves the use of fictitious vendors or consultants.  Any employee with the authority to approve payment of an invoice can perpetrate such a scheme.

An admission to the fraud committed follows the 10 percent rule:

A fraudster’s first admission is only a small part of the whole story.  The true fraud (the other 90 percent) may be greater, broader, and longer than you originally envisioned.

If you are unfortunate enough to have IRS Criminal Investigation (CI) target you and execute a search warrant on your residence, cars, and small business here is what to expect. An IRS Special Agent with information sufficient to establish probable cause for a search warrant has filed an affidavit with a US Magistrate and obtains a search warrant.

The affidavit will be “sealed” to prevent access to the contents.  The agent (armed with guns, bullet proof vests and badges) will marshal forces with his fellow agents and possibly the local police department and to systematically execute the warrant with a team of investigators.  They will take all of your business and personal records.  If you maintain a “cash hoard” in a shoe box or safe deposit box, they may seize it as evidence of the crime of Income Tax Evasion (Title 26 USC 7201) or income Tax Fraud (Title 26 USC 7206(1)).  For those involved in illegal activities, there may be Money Laundering charges under Title 18 USC, 1956 and 1957.  This is the start of a long “Grand Jury” investigative process that will be unsettling and confusing to most individuals and inexperienced attorneys.  The services of an expert private investigator are required to assist your attorney in the defense of a criminal income tax investigation (Pg 2) conducted through this “Grand Jury” or “Administrative” Investigation.

There are two type of investigation conducted by IRS Criminal Investigation they are the “Grand Jury” investigation which with the assistance of an Assistant US Attorney (AUSA) allows the use of Grand Jury Subpoena, governed by Federal Rules of Criminal Procedure Rule 17, such as a Subpoena Duces Tecum (Bring with you records.) to gather evidence of the crime.  The second is the “Administrative Investigations” conducted through the use of IRS Summons which are similar to a Federal Grand Jury Subpoenas or Trial Subpoena and require the production of records, but are more cumbersome than the Grand Jury Subpoena.

Your reaction to the search warrant is critical at this time because, during the execution of the search warrant, you will be anxious to tell your side of the story.  You are and honest person but you should stop and tell the agent you wish to speak to an attorney.  In a “Grand Jury” investigation, you will not be read your rights as is required during an “Administrative” Investigation where the Internal Revenue Manual (IRM) requires that a non-custodial Miranda warning be read to the target.  Even though you are confused and do not have a criminal law attorney that practices in the Federal Courts ask to speak to one before further responding.  The agent is required by case law and procedure to stop asking you questions.  Do not be tempted to continue answering questions no matter what the agent says, statements you make are being witnessed and will be documented in writing and used against you later.  Do not be afraid to stop the questioning and “lawyering up,” this is your right under the Constitution of the United States.

During the search the agents will present a copy of the Search Warrant which sites the charges that are alleged and provides other information; including the name of the Special Agent that signed the Warrant.  This information should be provided to the defense attorney.  Generally, the agent will not talk to the attorney during the search and until a Form 2848 Power of Attorney is prepared for the individuals and all entities, signed by the client, and delivered to the IRS CI office.  The Special Agent will leave a computer generated inventory of the items seized from the premises.

Here are eight steps to help you get organized

1. Contact your business attorney and ask for a referral to a criminal attorney that has experience in the Federal Court System.  Former Assistant US Attorneys in private practice are generally excellent in these cases.  They know the system and are generally respected by the AUSA.
2. The criminal defense attorney should prepare a letter of representation to the AUSA on the case to allow dialogue.
3. The criminal defense attorney should hire an expert private investigator trained in investigation by the IRS and US Treasury Department (Pg1).  The investigator should receive an engagement letter that will allow the investigator to be covered by the attorney client privilege.  Generally a CPA is not necessary but a retired IRS Special Agent with a CPA or CFE would be beneficial to the case.
4. The criminal defense attorney prepare Forms 2848 IRS Power of Attorney (available at www.IRS.gov/pub/irs-pdf/f2848.pdf) for each individual and entity involved (corporation, partnership, LLC, etc.)  The investigator should also be included on the IRS Power of Attorney.  The investigator will be dealing directly with the IRS Criminal Investigation Special Agent to secure access to the records and will determine the method of proof that the agents will pursue to prove their case.
5. The expert private investigator will secure a copy of the search warrant inventory to determine the evidence that has been seized.
6. The criminal attorney and the investigator will meet with the client and target of the investigation and discuss the matter, receive information necessary for the defense of the case, discuss the various methods of proof and what is involved and advise the client of what the future holds.
7. The criminal defense attorney with the investigator will interview current employees to determine what has transpired with in the business and to determine if there are former disgruntled employees that may have gone to the IRS seeking a reward.  The new IRS tax Whistleblower statute (Title 26, USC 7623) gives anyone with information about large-scale tax underpayments, including accounting errors or tax fraud, a significant financial incentive to report it.  IRS will give up to 30% of the money collected base on the information.
8. The defense begins.

6 Tips to minimize fraud risk:

1. Protect your money:  Have company bank statements sent to the home of the business owner, not directly to the office, to demonstrate that you are paying attention to the company finances.
2. Review the statement and ask questions about several items on the statements to ensure the employee knows you are watching, which will reduce the opportunity and increase the risk of being caught.  Require monthly reconciliations and review them monthly looking for checks that cleared and those outstanding. 
3. Have a third party, perhaps an accountant, or forensic accountant review internal controls, segregation of duties, and suggest changes.
4. Segregate Duties:  Separate the cash / banking function from the recordkeeping function.  If not possible, then cross-train employees and on a regular basis rotate personnel in critical functions.  The owner should review the list of payables before payment.  Invoices and supporting documents must be reviewed and they must be initialed and dated prior to authorizing checks to be printed.
5. Restrict access to Payroll Master Files to prevent “ghost employees” from being inserted and improper pay rates.  The owner should sign the payroll checks and / or review the Payroll Journal to understand who receives payments from the company.  Also, restrict access to Vendor Master Files and create procedures to control additions and modifications.
6. Use background checks and review hiring policies to keep people of questionable backgrounds from being hired.  A Reputable Private Investigator can provide criminal and civil background checks including tax liens, judgments, and bankruptcy.

To learn more contact Fraud Expert Ed Martin, CFE, TCI, at Sage Investigations, LLC, e-mail: edmartin@sageinvestigations.com