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When reviewing a financial statement, how do you know if the numbers it contains are truthful and based on objective factual information or if it is a work of fiction? The short answer is you don’t know without digging. When viewing financial statements, Benjamin Disraeli’s famous quote should always be kept in mind. He said, ‘There are three kinds of lies: lies, damned lies and statistics.” And, that my friends, is the level of skepticism that should guide you when analyzing financial statements. Given today’s computerized environment, any financial statement and its supporting documents can be manipulated to change an ugly duckling into a swan.

In my 35 years of practice, I’ve observed that most members of the legal profession are not qualified by training and experience to determine whether a financial statement, on its face, reflects the real world status of a company or an individual. This is the realm of accountants.

So how do the uninitiated review financial statements? First, you need to consider a company’s or individual’s financial history over more than one fiscal period. By reviewing a financial history for multiple fiscal periods, you are more likely to spot trends and anomalies. Each industry and activity has its unique genetic markers. The financial statements of a law firm will differ considerably from the financial statements of an auto parts manufacturing firm. Capable financial analysis requires in-depth knowledge of the economic idiosyncrasies of each industry before being able to issue a reliable report. This applies to every area of legal practice involving financial statements, tax returns, securities and insurance, just to name a few.

Trends and anomalies are an initial starting point for confirming a financial statement’s veracity. This may be as simple as understanding the relationships between certain balance sheet or income statement accounts. If, for example, over a period of three years the accounts receivable of a company are at least twice as large as the company’s accounts payable, and in the fourth year that ratio materially changes, there is an anomaly that ought to be investigated.

The financial condition of a company or an individual for a given period should not be viewed in a vacuum. Whenever possible, it must be viewed over a series of comparable time periods. Numbers are the result of circumstances that are not always reflected by the numbers themselves. Amounts must necessarily be considered in the context from which they arise.

Combining panoramic and vertical perspectives are also necessary for effective analysis.

Using vertical thinking simply means drilling down to determine whether everything classified in a particular category belongs there. By itself, vertical thinking doesn’t require looking beyond the obvious. For example, if an individual’s financial records show that he or she has been receiving and depositing $5,000 per month into a bank account. The person’s submitted personal income tax return reflects a total of $60,000 as annual revenue. The individual’s monthly bank deposits and reported annual income match. Under the vertical thinking scenario, the monthly income of $5,000 is presumed to be correctly classified in the financial statements.

Panoramic thinking involves the connecting and disconnecting of information depending on how it relates to the numbers in the financial statements. That means searching out logical sequiturs and non-sequiturs, which are all parts of the context from which financial information arises. This kind of thinking could be considered looking at the big picture of a narrow area in a financial statement.

Panoramic thinking requires examining one piece at a time in the context of the entire financial picture presented, thereby obtaining an unobstructed view of the financial statement from all angles.

Using the same example as above, a completely different conclusion could be drawn. You may discover that the tax return on file with the United States government, showing $60,000 of income, is materially different than the one provided to a bank. The annual income included in the financial statement may be $60,000, but that $60,000 may in fact be loans or gifts instead of actual income. Any of these new facts will change the thinking of someone who is considering lending money based on the reported income.

South Florida’s case of Gus Boulis and SunCruz Casinos shows the necessity of forensically scrutinizing financial statements and their supporting documents. SunCruz was a fleet of 11 gambling ships. At the time of its sale to Jack Abramoff and Adam Kidan, the financing package included a counterfeited wire transfer document purportedly demonstrating a down payment of $23 million. On Sept. 22, 2000, Abramoff and Kidan convinced Boulis to accept undisclosed promissory notes for $20 million in exchange for a secret 10 percent interest in the newly reorganized SunCruz Casinos.

The deal was illegal in two ways. Abramoff and Kidan were violating the terms of their purchase agreement with their financiers, which required that they make a down payment of $23 million of their own money, and Boulis was violating the terms of his settlement with the government, which required that he separate himself entirely from his company. The sale of SunCruz Casinos was forced by the U.S. government because a non-U.S. citizen is not permitted to own U.S. commercial vessels. Boulis was not a U.S. citizen.

In early 2001, Boulis was murdered. His killing appears to have resulted from a dispute over the counterfeiting of the $23 million wire transfer down payment along with a clash over his retained undisclosed illegal 10 percent ownership of SunCruz. During the subsequent murder investigation, Abramoff and Kidan admitted their falsification of the $23 million wire transfer and failure to disclose that a condition of their purchase was Boulis retaining an unlawful interest in SunCruz.

Based on the falsified $23 million wire transfer documents. Kidan and Abramoff were able to dupe their lenders into providing 100 percent of the funds required to close on the purchase.

Simply requiring the production of banking documents and records proving Boulis’ receipt and retention of $23 million and directly contacting the remitting and receiving banks, would have been enough to prevent the implementation of this lending fraud and may have prevented the subsequent murder of Mr. Boulis.

The case of SunCruz Casinos is by no means unique. The IRS, FBI and other federal and state agencies routinely investigate various forms of lending fraud that are the result of falsified financial statements and documents.

Failing to review the documentation that allegedly provides the support for the numbers in the financial statements can be unfortunate. While taking a closer look may pleasantly or unpleasantly surprise you, not doing so may prove disastrous.

Stanley l. Foodman is a former auxiliary special agent for the Florida Department of Law Enforcement and has worked as a consultant to the Miami office of the U.S. attorney in the area of civil RICO money-laundering recoveries.

Wednesday, November 15, 2006