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It takes a team to uncover a fraud

Legal Report: Forensics & Criminal Law
|Written By Gretchen Drummie
It takes a team to uncover a fraud
Illustration: Enrico Varrasso

An allegation of fraud within a company used to be handled something like this: a mid-level supervisor would go off like a gunslinger on his own to nail the bad apple that breached the company’s trust.

These days, a savvy in-house counsel knows the rules of an internal investigation have evolved; that a troubled economic environment, a changing regulatory climate, and dramatic technological advancements are conspiring with the usual factors to create a perfect storm when there’s a potential fraud blowing up. So now, instead of simply locking down the filing cabinet, the best course of action is to have a plan that revolves around a tight team of specialists — including outside experts — that can land on the investigation running, advises forensic accountant Peter Steger, principal at Cohen Hamilton Steger & Co. Inc.

“In-house counsel are wise to bring in the specialized resources that can come in and handle it in a nice, compact way, hitting all of the buttons they need to hit, rather than trying to deal with it from scratch,” says Steger. He compares what he’s suggesting to a wheel with a hub and spokes, with the in-house lawyer quarterbacking, or appointing, external counsel to the role. Adopting the team-like approach helps avoid the “traps and pitfalls, for example, of a neophyte in-house counsel who perhaps hasn’t tackled an internal fraud and can get easily overwhelmed with the extensiveness of it,” he says.

Steger says an allegation of fraud should be handled like this: pull together a finite team drawing initially from inside the company including the in-house lawyer, the human resources leader, a manager from the business and accounting sides, and put internal IT on notice. Then, reach out to specialized resources like external lawyers with their areas of expertise depending on the case, forensic accountants, external IT, and even public relations professionals in some instances.

He likens it to a detective mindset “embarking on unbiased fact finding.”

Mary Jane Stitt, a partner in the litigation group at Blake Cassels & Graydon LLP, agrees with Steger that the team approach is the way to go in these circumstances. She says most larger companies now have a plan in place that includes bringing in people like her to join the investigative team. And she advises what in-house counsel at smaller firms who have yet to embrace the concept should do is, “learn from the best practices and know that if there’s a fraud or suspected fraud in their workplace, this is a team that you should put in place.”

She says it’s part of risk management for those in-house lawyers who have policies in place outlining what will occur in the event of a suspected fraud. “They go out, they buy insurance, they have audits done and try and put controls in place to prevent fraud and this is the next aspect of it, what do you do if there is a problem. This is a type of disaster planning. Instead of your plant burning down, you’ve got somebody stealing money out of your bank account and you’ve got to move quickly to mitigate your loss, to investigate and contain it,” she notes.

Says Stitt: “I think in-house counsel have to understand that [an internal investigation] is legally more complex. They have an important role to play as the client and in giving the direction, but there really is the need to reach out to experienced external legal advisers.”

For his part, Steger adds that even large public companies still struggle when something like an internal fraud strikes and “they reach out to experts in the field for help and guidance to get them through it, because there are a lot of potential risks of unintended consequences when you don’t think about everything you need to be thinking about.”

In fact, one of the aspects that should be top of mind is for the in-house counsel not to underestimate how far-reaching the fraud may be and the number of stakeholders affected. Steger says the list of constituents may be “longer than you think and includes the company’s customers, suppliers, staff, auditors, insurance company, joint venture partners, the public, lenders, and shareholders.”

Steger says that when a fraud is first alleged, the first hope of most companies is that it’s a small issue, that it only affects one person, and is an isolated incident. “However, what’s incumbent upon the company — its fiduciary duty to both the internal constituents as well as shareholders and their customers and suppliers — is to get to the bottom of it and to understand how extensive this potential fraud is. Is it just the one guy in purchasing or is it the entire department going all the way up to the senior vice president or even the CFO or CEO? And from the external side of things, if there are colluding vendors you need to be sure that you’ve cast out the net wide and far enough that you’ve stopped the bleeding, you’ve plugged the hole, and that you’ve caught everyone that was involved.”

A large part of the quarterback’s job, says Steger, deals with communication to external parties, a portion of it obviously deals with the legal rights of the company, the suspect, potential colluding outside parties, and other parties that need to be directed and managed. Steger says the forensic accountants are the ones to help determine how it was done, when it was done, who it was done by, how much is involved, and figuring out all the parties and their relationships. Another key question is to determine if this is really fraud as opposed to mismanagement. “Once you know, or at least have a good feel for what happened, there’s no point candy coating it or backing away from it. It is what it is.”

Stitt advises that once an allegation is made, a number of wheels are set in motion. She says if loss is occurring, it has to be stopped. There is the need to preserve evidence and do timely interviews so that recollections are captured while the events are fresh. And there is the need to deal with reputational concerns. In addition, the outside lawyer can set up the appropriate claims for solicitor-client privilege so the confidentiality of the investigation is maintained. “Having an external counsel involved and having information flowing to them and getting their advice as you go along is quite critical to setting up a claim for solicitor-client privilege right from the outset. It has a very high level of protection in Canada,” she says.

The other thing that an external legal counsel brings to the table, says Stitt, is they will have experience in actually litigating these types of cases and have an understanding of just how careful you need to be in the collection of the evidence, organization, and eventual presentation. “We work hand-in-hand with forensic accountants, yet it’s being able to stand back as you go along and understanding how what you’re finding is going to fit into different theories of recovery.”

Steger and Stitt both note the big change in the last 10 years is in the IT area. The use of e-mail and electronic documents and the number of records that may be generated and must be preserved and examined, has grown exponentially, says Stitt. And so while Steger says notification of the internal IT head is critical at the outset, marshalling external IT experts as part of the team approach is also key.

Steger says it’s important to get a forensic image of hard drives, servers, and e-mails in order to preserve the evidence. “If that’s not done properly and immediately up at the front, that can compromise the investigation and the evidence that’s available.”

Focusing on specialization is important because, using “IT as an example, the lawyers and even the accountants should not be the ones tasked with getting the forensic images of the e-mails and hard drives and servers because technically, the way it is today you need somebody who knows what they’re doing and isn’t going to accidentally press the wrong button and delete or alter all the evidence,” says Steger. That’s particularly true if internal IT doesn’t have experience with this type of probe, he adds.

Finally, Steger says the state of the unpredictable economy helps bring to light past frauds that may have gone unnoticed in better times and heightens the risk for new ones occurring. “The potential for fraud, I think, is becoming greater,” says Stitt. “We’re trying to do more with fewer people. I think there’s a change in the psychology of the workplace. It’s a confluence of factors, but as times are getting tighter, people will be more tempted. Be proactive; don’t be caught scrambling if it happens.”

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