March, 2009 THE CHAMPION (National Association of Criminal Defense Lawyers

March 2009

BY Stanley I. Foodman and Dennis G. Kainen

A plaintiff’s allegation of fraud or monies owed in a charging document or complaint might not be true. An accurate analysis and interpretation of numbers in a financial case might be the difference between winning and losing. For years, the courts have recognized the importance of forensic accountants. The effectiveness of a forensic accountant may depend upon the breadth and depth of his or her experience.

A Legal and Number-Crunching Team

In many legal proceedings, lawyers often need to solve complex mathematical riddles. Adversaries in a case may differ on issues such as calculation of damages, lost revenue, taxes, and other key amounts. The stakes may be high in complex commercial and criminal cases. The evidence — incriminating, exonerating, or both — is usually present, but elusive or incomplete.

Because victory often hinges on interpreting “the numbers” and their connection to other documents, there is a growing trend among lawyers working on complex cases to partner with a forensic accountant.

Code of Conduct

Typically, forensic accountants are retained in civil and criminal cases as either non-testifying or testifying consultants.

When hired as non-testifying consultants, forensic accountants have the freedom of assisting counsel in an advocacy role. When retained as testifying consultants, forensic accountants do not have that freedom. This raises the question of why anyone would want to retain a forensic accountant as a testifying consultant. The answer lies in the traditional role of the independent accountant.

The American Institute of Certified Public Accountants’ (AI CPA) code of professional conduct governing CPA behavior and the rules of conduct governing local, state, and federal courts prohibit conflicts of interest and professional accountant/client behavior that could be interpreted as less than objective. This same code of conduct applies to all accountant/client engagements, including those involving professional forensic consultants (unless specifically carved out as an exception). This requirement for objective thinking and behavior requires forensic accountants to act as “truth sayers” during forensic accounting engagements whether or not they have been hired to testify.

As a result of the requirement to act as “truth sayers;’ occasions arise when retaining more than one forensic accountant firm for the same matter may be desirable. It may be beneficial to limit the information made available to a forensic accountant during an engagement when trying to limit the scope of the accountant’s testimony.

Some states have passed legislation that requires accountants to provide unbiased opinions. In Florida, for example, a certified public accountant cannot express an opinion on the financial statements of an enterprise unless the accountant and her Of his firm are independent with respect to such enterprise.’ Additionally, a certified public accountant must not knowingly misrepresent facts, and when engaged in the practice of public accounting, must not subordinate his judgment to others — including clients, employers, or other third parties.’

When considering engaging a forensic accountant for a civil, commercial, or criminal defense matter, understanding that all three arenas require the same forensic skills is helpful. For example, calculating financial damages using compound interest and present value calculations is often required. This is true whether calculating victim loss in economic crime cases, the present value of a future lost income stream in a personal injury matter, or the calculation of the value of a business during the dissolution of a marriage.

Get in Early

Qualified forensic accountants are usually professionals with a broad range of skills and experience. In addition to being a CPA, a forensic accountant should have auditing and investigating capabilities that would be used to illuminate the complex economic details of litigation. Forensic accountants are particularly helpful with investigative accounting and analysis involving voluminous ledger sheets, bank statements, receipts, and other financial documents. Forensic accountants should take seemingly needle-in-a-haystack piles of financial information and distill them into the important elements required for clear and concise courtroom testimony.

For maximum benefit, a forensic accountant should be engaged early in any case in which an accountant’s expertise is needed. He or she should begin reviewing all documents as early as possible to be most effective in analyzing and calculating damages or helping with settlement negotiations.

Joining a case in its early stages may result in lowering litigation fees by identifying potential problems before they make a surprise appearance. The forensic accountant should also help a lawyer in formulating a theory of defense or prosecution. This early analysis protects the lawyer and obviously the client from miscomprehending the impact of the facts of the case.

Do not wait until after completion of discovery to bring in forensic accountants. This might result in greater case complexity. Instead, counsel should use forensic accountants to assist in requesting production of needed financial discovery.

Look Beyond the Resume

Not all forensic accountants have the same experience, and locating an appropriate forensic accountant is not always easy. Locating a forensic accountant with an investigative or law enforcement background is a good starting point. Because a resume is no better than the character of the person whom it portrays, asking for and checking references is paramount. After locating a forensic accountant and verifying the accountant’s background, deciding the suitable moment during litigation to retain him or her may ultimately determine success or failure.

When seeking the support of a forensic accountant, look for personal characteristics beyond experience. Is the accountant able to make evidential connections not readily discernable, or does he or she simply wait for counsel to drive the forensic investigation? A good forensic accountant, possessing a sense of creativity and organization, will be able to distill financial material into understandable terms that will not put a judge or jury to sleep. Even if the forensic accountant will not be testifying, the knowledge gleaned from his or her expertise may assist the attorney in the examination of witnesses at trial or in a pretrial matter. Finally, a forensic account should have the professional judgment and sense of discretion necessary in any litigation.

The Check-Cashing Case

An example of how critical the role of a forensic accountant can be is exemplified by United States v. Armadoros.’ A couple in South Florida, Demetrios and Florynda Armadoros, were charged in a IS-count indictment that included five violations of 26 U.S.c. § 7201 (tax evasion). Florynda Armadoros was separately charged in the indictment with 10 counts of 26 U.S.c. § 7206(1) (false statements) and 18 U.S.c. § 2 (principal participant). The period of the alleged crimes was 1997-2001.

The indictment did not detail a specific amount of tax loss. Rather, the indictment simply stated that the amount of annual taxable income reported by the defendants was substantially underreported between 1997 and 2001. Furthermore, included with the 15 counts in the indictment was a claim that Florynda Armadoros substantially underreported the income of three S Corporations whose returns she signed as an officer and responsible party. The government’s position at trial was that Demetrios and Florynda Armadoros underreported their income by $10.1 million.

The Internal Revenue Service (IRS) investigation triggering the indictment originated from its investigation of a check-cashing store in South Florida. Checks totaling approximately $8.2 million made to the defendants’ controlled S Corporations were cashed at the check-cashing store.

The IRS financial investigation was not thorough enough to reveal how the cash received from the store was actually spent. Nor were the government’s agents technically familiar with the painting and maintenance industry in which the controlled S Corporations conducted business.

Counsel for the defendants engaged two forensic accounting firms that assisted each other with the analysis of the books, records, and taxable income of the defendants. The results of the forensic accounting investigation into their financial history revealed that in years pre-dating the period of the indictment, the reportable revenue and taxable income of the defendants and their S Corporations were substantially over-stated. Furthermore, it became evident that the government’s investigation was flawed. The government did not make any effort to understand the industry, economy, and geographic environment in which the defendants’ controlled S Corporations conducted business.

The forensic accounting investigation revealed information critical to the defense.

  • The segment of the painting industry in which the defendants operated their S Corporations (low income housing) had a history of not timely paying its contractors. This compelled the defendants, during years prior to the period in the indictment, to lend large sums of money to their companies, which was erroneously treated as revenue to the S Corporations by their independent tax return preparer, a certified public accountant (CPA). The defendants’ return preparer never asked them whether all of the money being deposited into their S Corporation bank accounts was revenue.
  • The defendants’ return preparer never asked them whether they were personally paying expenses of their controlled S Corporations.
  • The combined amount of personal funds loaned by the defendants to their controlled S Corporations and expenses paid by the defendants on behalf of their controlled S Corporations and not deducted by the controlled S Corporations was approximately $1.9 million.
  • During the period of the indictment, the defendants, when paid by customers, repaid themselves the approximately $1.9 million they had previously loaned to their controlled S Corporations. This repayment of a loan was not income to them. This was an issue proven by the forensic accountants.
  • Economic and social conditions peculiar to the geographic area in which the S Corporations conducted business necessitated them paying laborers in cash. Cash received from checks cashed at the South Florida check-cashing store was spent for painting labor and painting materials and other costs of doing business.
  • Financial data compiled by both the IRS and the industry involved revealed an average cost of goods sold and operating expense burden common to its businesses. This data permitted the forensic accounting team to calculate the costs of labor, materials, and other operating expenses attributable to the production of the $8.2 million of revenue received and cashed at the South Florida check-cashing store.

At trial, counsel for the defendants made full use of the evidence produced by the forensic accounting team. They combined the effects of IRC Section 1341 (computation of tax where taxpayer restores substantial amount held under claim of right). This code section allows a deduction in a current year for an item included in gross income for a prior taxable year, or years, because it appeared that the taxpayer had an unrestricted right to such item. This allowed the defendants to reduce their income in the years alleged in the indictment by the amount of income over-reported in earlier years and by the allowable costs associated with the $8.2 million of revenue checks cashed at the South Florida check-cashing store. The jury returned a verdict of not guilty on all counts as to both defendants.
Without the hiring of a forensic accounting team to flesh out the critical elements of the defense strategy, it is likely that the defendants would have been convicted.

Notes

1.Fla. Stat. Ann. § 473.315 (2009).
2. See 61Hl-21.002 of the Florida Administrative Code.
3. United States v. Armadoros, No. 1:04-CR-20 19O-CMA (S.D. Fla. June 21, 2004). II

About the Authors

CPA and forensic accountant Stanley I. Foodman has worked extensively as an expert witness in tax cases in the federal district courts. He has also worked as a consultant to the Miami office of the U.s. Attorney in the area of civil RICO money laundering recoveries. Foodman is a member of the Association of Certified Fraud Examiners and a member of the Supreme Court of Florida Circuit Grievance Committees on the Unlicensed Practice of law.

Stanley I. Foodman
1201 Brickell Ave., Ste. 610
Miami, Fl 33131
305-365-1111
Fax 305-365-2244
stanley@stanleyfoodman.com

Miami-based attorney Dennis G. Kainen has an extensive tax controversy and criminal defense practice that includes criminal and civil tax matters. He is a past president of the Dade County Bar Association. In private practice over 20 years, he is a former assistant federal public defender for the Southern District of Florida.

Dennis G. Kalnen
Weisberg and Kainen
1401 Brickell Ave., Ste. 800
Miami, F133131
305-374-5544
Fax 305-358-8565
attorneys@weisb.com