Top Ten Red Flags: When it s Time to Engage a Forensic Accountant in Divorce Litigation

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1 Top Ten Red Flags: When it s Time to Engage a Forensic Accountant in Divorce Litigation Selecting a forensic accountant in a family law case can be a difficult decision and their role will vary from case to case. A forensic professional may be engaged either as a court ordered neutral expert, a consultant to an attorney, or an expert witness. To assist family lawyers with making the decision to hire, here are the top reasons, based on my years in the family law realm, I believe a forensic accountant should be hired: 1. When a spouse has assumed the money management role, while the client spouse has less knowledge of the couple s financial affairs. 2. If a client has significant separate assets that may have been commingled or expended over time for the benefit of the community, or spouse is claiming community property as separate property. 3. Any time there is an interest in a closely held business, whether or not the spouse is actively involved in its management. 4. When a spouse refuses to provide information related to the business entity, and/or is receiving major perquisites and benefits through the business. 5. When multiple checking accounts and loans are involved both personal and business. 6. If a spouse has transferred money from personal accounts to business accounts. 7. If the IRS has contacted client regarding delinquent or unpaid taxes. 8. When W 2 wages or distributions suddenly drop, or there is reason to suspect significant under reported income (URI). 9. If a client has received notice of outstanding credit cards balances/excessive credit card balances, or the business credit cards just don t make sense. 10. If a client receives notice of delinquent loans, or spouse has recently taken out new loans. A Forensic CPA is uniquely qualified to assist the divorcing spouse and their attorney. Forensic CPA services include, but are not limited to, the following: 1. Identifying, valuing, and dividing marital assets and liabilities between divorcing spouses. 2. Calculating amount that should be paid in alimony and/or child support.

2 3. Applying forensic examination procedures that are designed to find assets and/or income that have not been disclosed by the opposing spouse Assisting in preparation of deposition questions, interrogatories, or other discovery requests. 5. Assisting in answering interrogatories and requests for production. 6. Analyzing reports of the court appointed or opposing spouse s financial expert in preparation for cross examination. 7. Preparing required financial disclosure forms. 8. Assisting in the preparation of alternative financial scenarios for mediation. 9. Conducting business valuations. In cases in which a forensic accountant s expertise is warranted, it is critical that they be brought in as quickly as possible, particularly when a closely held business in involved in the divorce. This early involvement serves three valuable purposes the accountant s investigation prevents the continuation of deceptive financial practices, the accountant will likely be able to make a preliminary determination as to the merits of the litigation and a list of necessary financial records can be compiles and requested. Once the engagement letter is signed and a retainer received, the forensic accountant can begin the investigation. At the outset, the accountant will obtain preliminary information such as the other spouse s education and employment history, a list of all known accounts with various financial institutions, all sources of income, expenditures, and detailed information on personal and business relationships. Once this foundational information has been gathered, the accountant can utilize a number of different methods to locate hidden assets, characterize property as either separate or community, conduct business valuations, etc. When an interest in a closely held business ( target company ) is involved, a forensic examination is almost always necessary. The forensic accountant s investigation into the business will serve to identify unreported business income, determine the value of any ownership interests, and determine whether the other spouse has used business funds to acquire personal assets or pay personal expenses. Each of these can have a direct effect on the client s divorce settlement, potential child support, and potential alimony payments. 1 PPC s Guide to Litigation Support Service, 2014 Thomas Reuters/Tax & Accounting, Pg17 1

3 To begin an investigation into the target company, the accountant will issue a document request list either directly to the opposing spouse or through their attorney. The documents typically requested as detailed in Investigating Accounting in Divorce by Kalman A. Barson, CPA/ABV, CFE, CVA include copies of any financial statements, income tax information, books of original entry, employment contracts, payroll information, bank statements, purchase and expense invoices, loan documents, lists of intangible assets (patents, trademarks, copyrights), prior business valuation reports, etc. If electronic copies of financial program such as Quickbooks or Peachtree are available, this eliminates the need to request several of these documents and allows the forensic accountant an intimate look into the historical finances of the target company. Once these documents are obtained, the accountant will conduct a methodical review of all business tax returns. A wealth of basic information about the business can be gleaned from tax returns such as business structure, partners and percentage of ownership, shares of stock, etc. Tax returns also include information on distributions, profit and loss, and balance sheet items. Next, if an electronic accounting file is available, accrual basis financial statements are reviewed in order to evaluate the target company s operations. A comparative spreadsheet of the last five years of profit and loss and balance sheet accounts should be prepared in order to pinpoint unusual fluctuations between accounts and mark these anomalies for further investigation. Although physical access to the target company may be difficult to obtain, a site visit can prove to be incredibly valuable for the investigation. During the site visit, the forensic accountant is in a position to evaluate the overall condition of the business, view inventory, observe how sales are made and recorded, note the process for collecting and depositing cash, etc. If possible, the forensic accountant will also conduct an interview with the target company s bookkeeper/controller. If the other spouse is purposely minimizing the value of a closely held business, this will directly impact the value of the marital assets and thus affect the client s eventual settlement. A business valuation performed in conjunction with the divorce proceedings will involve an extensive analytical review of the significant accounts (both balance sheet and profit and loss statement). In addition to providing an accurate value of the business, this analytical process can also serve to identify accounts that may warrant further investigation.

4 As noted by Jeff Landers of Forbes Magazine, forensic CPA s are trained to examine personal and business financial records with an eye not only for what they show, but for what is being withheld. As Miles Mason, writes in his book The Forensic Accounting Deskbook, forensic accountants can smell problems. For example, a forensic accountant can analyze trends from tax returns by spreading numbers from multiple corporate tax returns. Red flags are raised when gross profits decline as gross revenues increase over multiple periods. When presented with a reason, a forensic accountant will generally have a good idea whether the explanation is credible or contrived for the divorce. 2 Accusation of fraud by a spouse in a divorce situation is common. When fraud is alleged and initial evaluation of the claim is difficult but necessary. Fraud investigations are expensive and often times difficult to prove. The wild goose chase also arises. In a wild goose chase, it is possible to find the goose but not possible to conclusively prove there is no goose to find. 3 Attorneys and experts should be a team. Attorney s build styles and strategies of their own that they apply to each case. Experts are often hired for their personality and background as much for their professional expertise. Attorneys may look for a bulldog, or aggressive, expert to pressure the other side. Or they could be looking for a good old boy (or girl) to keep the peace and settle the case. Others may be looking for an experienced testifying expert because they know their case will not settle. 4 CPAs are uniquely qualified to conduct the type of in depth analysis that can protect your client s settlement in a financially complex divorce. Their expertise in tax, accounting, and auditing allows them to understand the long term financial and tax impact of divorce settlement options, and provide information that is critical to your client s financial future. 2 Landers, Jeff Why A Forensic Accountant Belongs On Your Divorce Team. Forbes Magazine. September 4, 2014:3 3 Donald, G. A., Burrgae, T. F., DeGrazia, D. J., Stewart, W. B. (2011)Family Law Services Handbook Hoboken, NJ: John Wiley & Sons. 4 Donald, G. A., Burrgae, T. F., DeGrazia, D. J., Stewart, W. B. (2011)Family Law Services Handbook Hoboken, NJ: John Wiley & Sons.

5 Stephanie Halphen serves as Manager I for the leading regional accounting firm, Wegmann Dazet and Company, practicing in the firm s litigation and business valuation group. She current carries the credentials as Certified Public Accountant (licensed in LA and MS), Certified Valuation Analyst, Certified in Financial Forensics, and Master Analyst in Financial Forensic. In litigation services, Ms. Halphen's experience includes fraud and forensic accounting, expert reports and testimony in accounting and financial business issues. In addition, drafting and answering interrogatories, drafting questions for trial, critique of expert witness reports, reviewing, organizing and analyzing documents received in response to discovery, preparing discovery responses, preparing required financial disclosures. Additionally, Ms. Halphen has provided business valuation services for various purposes from estate tax and gift tax planning to mergers and acquisitions, buy/sell agreements, marital dissolutions, shareholder disputes, and other litigated/nonlitigated matters. Businesses she has valued include: manufacturing, timber, restaurant, utility contract services, health care, professional services, retail, real estate. shalphen@wdco.biz