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Securities fraud cases often hinge on the tiniest accounting details.
Lucky, then, that Van Khang and Robert Francis thrive on minutiae. They are the accounting equivalent of crime scene investigators, searching for clues to corporate crime in balance sheets, income statements, public disclosures, shipping documents and auditor work papers.
Together, the two comprise the forensic accounting team at Berman DeValerio, one of a handful of plaintiffs’ firms with such a department in-house. Berman DeValerio was one of the first firms to hire an investigative accountant full-time, beginning in 2001. Francis joined in 2003, followed by Khang a year later.
The two can cite obscure details from GAAP and GAAS (Generally Accepted Accounting Principles and Generally Accepted Auditing Standards, respectively) in the same way an English scholar recites verses of Chaucer. And, by all accounts, they actually like this stuff.
There’s certainly plenty to keep them happily occupied.
Accounting irregularities represent the vast majority of securities fraud cases. Last year, 89% of cases alleged misrepresentations in financial reporting and 82% alleged false forward-looking statements, according to the Stanford Law School Securities Class Action Clearinghouse, which analyzes filings annually.
The two accountants – both Certified Public Accountants – have more than 20 years of combined experience. Khang and Francis spent much of their careers at Big Four firms – Francis with KPMG and what is now PricewaterhouseCoopers, Khang with Ernst & Young.
“The accounting expertise of these two individuals has been invaluable to our attorneys and to our clients,” said Jeffrey Block, a Berman DeValerio partner. “We rely on Bob and Van in all phases of a case’s development. They consistently impress us with their abilities to decipher the numbers and pinpoint what is often a critical element of any given fraud.”
In the earliest stages of a potential securities lawsuit, the accountants help the attorneys evaluate the merits of a case. When a company restates earnings – frequently an indicator of fraud – the accountants will review corporate financials to gauge whether it was a simple mistake, a case of book-cookery or something in-between.
“We can usually tell very quickly,” Khang said. “If there were no huge impacts to profits and losses, and if their accounting changes appear reasonable, I might suggest that we shouldn’t bother to take the case.”
Of course, they could also determine that it is a strong case with accounting irregularities written all over it.
The accountants frequently collaborate with Berman DeValerio’s in-house team of investigators to make these determinations. (See our Fall 2004 issue for more on the firm’s investigators.)
Once a case has been filed, the accountants assist with any number of key tasks in the litigation: drafting complaints and document requests; analyzing public financial statements; preparing attorneys to take depositions; helping choose expert witnesses; and preparing for trial.
Khang is particularly suited to these efforts. At Berman DeValerio, she searches for buried bodies, an extension of what she did at Ernst & Young. In that job, Khang was part of a team of forensic accountants hired by corporate defense attorneys. Their mission: finding problems and correcting the books at companies where fraud occurred.
“I used to work for defendant companies to find the fraud,” she said. “I would sit down with defense counsel and say, ‘This is how we need to package this to the market.’ I’ve seen all the frauds and how they can be hidden.”
For example, she said, fraudulent record keeping at a company might be packaged to Wall Street as a “breakdown of internal controls.”
“The problem with the industry is that many CEOs and CFOs were CPAs from Big Four firms, so they know how to hide things from auditors,” Khang said. “A first-year auditor would never catch many of the tricks because they lack the experience necessary to understand the impact to the bottom line. The company executives are much more knowledgeable and able to pull the wool over the eyes of the inexperienced staff auditors.”
Adding to the systemic problem is the fact that more experienced auditors spend very little time training and monitoring their inexperienced counterparts. This lack of guidance and oversight helps to enable fraudsters, Khang said.
“If you’re not trained, you’re going to miss a document that’s really hot and could make the case,” Khang said.
At E&Y, Khang saw it all, so she wasn’t surprised by the fraud cases she has explored since joining Berman DeValerio. Francis, by contrast, was stunned, both by the depth of the accounting shenanigans at corporations and by the shoddy work of the auditors who were supposedly monitoring them.
“I was astonished at how bad the accounting work was, and how the auditing company found continuous patterns of revenue problems and ignored them,” Francis said of McKesson HBOC, one of his first assignments.
The two accountants bring different skills to the firm, and cases are assigned with their backgrounds in mind.
Francis’ knowledge of the mutual fund industry, for example, helped Berman DeValerio successfully prosecute the Heartland Advisors case. (The firm recently reached an $8.25 million settlement with PWC over its auditing of two Heartland funds. See related story on p. 5.) When working at the former Coopers & Lybrand, Francis specialized in investment management audits, so he knew precisely which documents the firm’s attorneys would need to prepare their arguments.
While the names and players in the securities cases change, the accounting frauds typically stay relatively constant. After all, there are only a handful of accounts that a fraudster can play around with: revenu recognition, restructuring reserves, allowances for different accounts, and capitalization of costs that should have been expensed. Such manipulations are usually attempts to increase sales, decrease expenses and, ultimately, increase the bottom line.
“You see the same thing over and over again,” Francis said. “You would think they would learn from their mistakes.” only if – businesses interpret the lessons of past failures.
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