White Collar Crime Hits Hawaii Firm

The beautiful island city of Honolulu, Hawaii is home to sand, surf, shopping and scenic views.  The nearly 1,000,000 people living in or near Honolulu also have many professional service firms to choose from – one of them being PKF Pacific Hawaii (PKF Pacific), a member firm of PKF International.  Patrick Oki, the managing partner of the firm has recently been arrested under charges of embezzlement of firm funds.  13 felony counts surrounding the alleged theft have been made against Mr. Oki.

The embezzlement investigation centers on Mr. Oki reimbursing himself for business expenses he claimed were paid for by him personally.  Mr. Oki also is being claimed to have created false records to give legitimacy to these charges.  Fake people, entities, contracts and even falsified IRS forms may have been created.  Mr. Oki also forged various signatures to allow the expenses to pass inspection by his co-partners at the firm.  $500,000 is being claimed as lost by the firm, who said in a statement that they are making plans to move ahead with the future of the firm.

Theft by employees at a company is nothing new.  White collar crime makes headlines every year and accounting firms need to know how to address the risks.  This type of risk at an accounting firm can be specifically be covered by a crime insurance policy, otherwise known as fidelity insurance.  Fidelity insurance covers theft by employee of company funds.  It can also cover loss of client funds, or theft by robbers while money is in transit to the bank.

Owners and partners of firms are typically excluded from being covered by this type of insurance, however.  The reason for this is simple – an owner of a company can’t steal their own money.  So in this particular matter, PKF Pacific may not have coverage for the potential half a million dollar theft.  This speaks of the need for good prevention and detection of embezzlement to be highlighted at a firm – not just insurance to handle incidents after they happen.

We find that a number of simple risk management protocols can help firms avoid this type of loss:

  • Countersignatures – A firm should require two signatures on all checks above a certain amount.
  • Reconciliation of Funds – Firms who have the same person reconcile the bank statements and withdraw/deposit funds are in a precarious situation.
  • Oversight – Periodic financial audits or inspections can help uncover fraud.  Having an independent party review the firm’s books for suspicious accounts and transactions can also be helpful.
  • Personnel Lifestyle – If an employee suddenly begins living above their means with no apparent explanation, it may be because they are defrauding the company.
  • Personnel Never Accept Promotions – A talented person who turns down promotions and instead requests to stay in the same position in the finance department may be using their influence to set up an embezzlement scheme.

Protecting your accounting firm from client lawsuits and employee fraud can be daunting.  Contact us to learn more about our services and how Calculated Risk Advisors can help protect your firm through insurance and risk management solutions.

$88M Restatement by an Audit Firm of 34 Years

KPMG served as the auditor for Singing River Health System for 34 years.  This Mississippi based hospital had continued to renew the audit engagement with the accounting firm for many years and also used them on the audit of the defined benefit pension plan the hospital carried.  Recently, it was discovered that the work product may not have been accurate and the audits may be in need of restatement.

A change of the auditing firm in 2013 occurred in order to save money.   According to this new firm’s research at the time of the transition, the hospital’s pension plan was underfunded by $150M and the hospital was in violation of certain debt covenants on their bonds due to the newly revealed financial condition of the hospital.

Singing River is calling the audits flagrantly erroneous and asking for a jury trial so the true damages would be taken into consideration.  The lawsuit is asking for the audits to be restated and damages to be paid.

While the accuracy of the audits is still in question, there are many take-aways for accounting firms to learn.  Building a solid risk management program for a firm should include as much real-life lesson as possible.  Here are a few from this scenario:

  • Repeat business is great, but it requires extra diligence to assure that the work does not get rolled-over each year or looked at with a lower degree of scrutiny.  Second partner reviews become key during engagements such as these.  Audits are especially important to maintain independence from the client.
  • As the duration and relationship lengthens, maintaining proper independence requires more effort.
  • Audits continue to be high risk because of large amounts like this.  Our firm has seen many claims revolve around auditing work that did not take into account the full situation or were not reviewed adequately by the partners.
  • Pension audits have historically been troublesome as well.  The assets in the plans were reduced during the Great Recession, leading to a slew of claims against auditors, investors, fiduciaries and the firm that sponsor the plans.  These engagements need special expertise and monitoring.
  • An accounting firm cannot get away from long-time clients or taking on higher risk work at times.  It can, however, employ proper risk management techniques and be sure to purchase accountant’s malpractice insurance.

As a corollary to this case, the International Forum of Independent Audit Regulators (IFIAR) released a report outlining a number of deficiencies of audit firms in 2014.  The IAFAR assessed 29 firm’s audit work and came out with findings that line up with similar studies of the PCAOB and other entities.  The IFIAR findings show room for improvement in three key areas.  Internal control testing (24%), Fair value measurement (20%) and Revenue recognition (14%).  These are key areas of an audit firm’s practice and a good list of items to assess in 2015 at your own firm.

Contact us to discuss ways to best protect your firm in today’s litigious times.

SEC and PCAOB Discipline Firms that Lack Auditor Independence

Last month the Securities and Exchange Commission (SEC) found that eight accounting firms lacked the adequate independence during their audits.  The Public Accounting Oversight Board (PCAOB) found seven other firms that lacked independence during their audits of broker-dealers.

These firms all consented and settled the disciplinary matters with these regulatory bodies – without admitting or denying the findings.  The fifteen firms ranged in size and location.  In general, the findings revolved around the rules limiting auditors from providing other non-attest services that could jeopardize their impartiality.  Specifically, these firms were found to have prepared the financial statements through the year prior to the audit – in essence auditing their own work.

Each firm paid a small monetary fine and agreed to remediation and training to address the issues.

This matter shows the importance of maintaining independence in all services – whether working for a public company or the neighborhood grocers. A lack of independence may lead to an accountant’s malpractice claim, a regulatory investigation or to an upset client when they feel the work was slanted.

This also highlights the need for a firm to have accountant’s professional liability insurance.  Some policies provide coverage for regulatory investigations – like the kind noted above.  Other policies would not provide such protection.  Since no insurance policy is exactly the same, these seemingly minor differences on paper could turn into large and important issues in practice.  Having an experienced insurance broker is necessary to make sure that a firm is obtaining all the coverage it needs.

Emmy-Award Winning Actor Sues Accounting Firm

In another matter that developed towards the end of 2014, Edward Herrmann sued his accountant for malpractice.  The Emmy-award winning actor explained in the suit papers that he and his wife had granted full power of attorney to CohnReznick and its predecessor firms for years – giving the firm full range of authority to pay bills, open bank accounts and represent them to the IRS.  Herrmann recently discovered that the firm had not presented an IRS investigation to them appropriately which, the suit explains, was larger than initially thought.  This also led Mr. Herrmann to uncover erros that had been ongoing for years on his tax returns.  $1.2M is being sought.

The need for accounting firms to carry professional liability insurance is by no means diminishing as we enter 2015.  If anything, the world is getting increasingly complex and the litigious nature of business only seems to be increasing.

Contact us for a review of the insurance plans your firm carries or to discuss ways to better protect your firm in the New Year.

Court Says Insurance Companies can Clawback Defense Costs

A little over a month ago, a decision was handed down by the 3rd Circuit Court of Appeals on a particular coverage dispute in an accountant’s professional liability insurance policy.  The matter arose while CAMICO – a California based insurer of accounting firms – defended Heffler, Radetich & Saitta, LLP (Heffler) in a professional malpractice claim.

In the underlying case against Heffler, the accounting firm was acting as an administrator of class action funds for a number of class action settlements.  It was discovered that one of the firm’s employees in charge of disbursing the funds to appropriate parties was working to embezzle funds to their own friends.  He worked with others to create fake businesses that would later apply for thesesettlement funds.  The employee would then approve the disbursement and receive a kick-back.  Heffler was sued as soon as this was discovered.

The insurance company – CAMICO – defended the firm but said that they would only defend up to the $100,000 sublimit because of the fact that the claim revolved around misappropriating funds.  The lawsuit defense costs exceeded this $100,000 limit and CAMICO sued for the return of money that they spent about this limit.

The court agreed that the insurance company could ask and receive these funds back since the insurance policy was enforceable in this area.  While Heffler argued that the rogue employee was not engaged in professional services on behalf of the firm when they acted in this manner, the court disagreed.

There are two take-aways from this case.

  • First, it is important to note that this happened on multiple class action settlements.  There was trust placed in the employee and a lack of oversight that allowed this happen on more than one occasion.  It is important for accounting firms to be aware of the areas that are ripe for fraud or theft and place safeguards over these areas.  Rotating personnel, or having a partner oversee and audit the work are simple steps that can be taken to prevent wrongdoing.
  • The second aspect this case raises is the importance of knowing your insurance policy.  Few firms carefully read the policy and all its components, but this is important since no professional liability insurance policy is written exactly the same.  There is no standardized policy form as there is in auto insurance or even general liability insurance.  Each insurance company drafts their own E&O policy for their clients.

Engaging a generalist insurance broker who does not understand this aspect of risk transfer can be costly for firms.  Often a less expensive product may lack an important coverage grant or perhaps exclude some work done by a firm.  It is important to have a broker who is able to compare the policy forms and offer feedback on each one.  Contact us to discuss whether your accountant’s professional liability form is proper for your firm.

Accountant Misses $3.4M Embezzlement in Audit

Cuyahoga Heights Local School District – a school district located in Cleveland, OH – has sued a former accountant for missing an embezzlement which eventually led to the theft of over $3M.  The embezzlement was discovered by the state during an oversight audit in 2011.

Joe Palazzo worked for the District and was in charge of technology services.  It was discovered that from 2007 to 2011, Palazzo would create fake invoices for work or products that were never done.  Ther invoices were paid to shell companies and Palazzo would then receive kick-backs from the people who owned these shell companies.  Joe Palazzo was sentenced in 2013 to 11 years in prison for the embezzlement.  While the accounting firm of Rea & Associates was only the auditor for the school during the 2008 fiscal year, the school is bringing suit against them.  They claim that if Rea had done their audit correctly, it would have discovered the early embezzlement and prevented it from going on for another 3 years.  The school district explains that the accounting firm’s malpractice stemmed from the fact that they “failed to obtain a sufficient understanding of the School District and its environment, including its internal controls, in order to assess the risk of material misstatements due to error or fraud and to design further audit procedures.”

The school is trying to place the blame for the entire embezzlement on the auditors, despite the fact that they only audited the books for one year.

This scenario highlights a few important accounting firm risk management and insurance practices:

  • Claims Made – Accountant’s professional liability insurance is written on a claims made basis.  This means that the insurance must be active and currently in place in order for coverage to be afforded for past actions.  Many firms are tempted to drop their insurance once they feel their risks have diminished or their practice is winding down.  However, in the case noted above, a firm was sued for work done nearly 6 years ago.  Firms need to be careful before they drop insurance coverage for this very reason – lawsuits often take years before filed.
  • Retro Date – Accountant’s malpractice insurance policies also contain a “prior acts” date.  Any work done prior to that date is not covered under the insurance.  Before engaging with a high-risk client or before beginning a firm’s practice, accountants need to secure this type of insurance.  Waiting until the firm is more established or has more revenue simply means that the firm’s early work has no coverage once insurance is purchased.
  • High Risk Engagements – Audits are historically the highest risk work an accountant can perform.  It is important to have robust procedures for handling audits and for following up on any red flags in the engagements.  A second partner review of the work is also prudent to catch anything previously overlooked.

Contact us to discuss ways to further protect your accounting practice.

Circular 230 Changes Finalized by Treasury

The revamping of Circular 230 has been a year in the making, but is now final.  Of the changes, it seems that the famous “Circular 230 disclaimer” comment is garnering the most attention.  The Treasury noted that it will take action against accountants who use the disclaimer, but who also note that the disclaimer is required by Circular 230.  The disclaimer can (and should) be left in the written correspondence, however.

Beyond this, there are additional changes that are also note-worthy.  Many commenters explain the changes as going from a rules-based regulation to a principles-based regulation.  It is important to note the new principles when forming risk management guidelines for accounting firms.  Here is a quick look at some of the changes that may impact the risk profile of accounting firm’s engagements:

  • Competency – The Treasury explains that tax work must be performed by accountants that are “competent” to give the advice and do the work.  However, there is no definition of what makes a firm or an accountant competent.  The Treasury does give some clarity when it explains that the accountant can perform research on a particular matter to become competent.  They can also consult with an expert when the accountant’s background is not adequate to handle a particular tax situation.  These are best practices that firms should employ on all engagements – not simply tax engagements.
  • Compliance Responsibility – Circular 230 places the burden of compliance on the person at a firm who maintains principal authority.  This person must form procedures that ensure that the firm complies with Circular 230 and also spearhead the implementation of those procedures.  Failure to do so could result in this person being held accountable if their firm is found to have violated the regulations.
  • Reliance on Another’s Work – The “Diligence as to Accuracy” section of the Circular has also been amended to enforce accuracy when one accountant relies on the work of another.  Each accountant has the responsibility to be assured that all information going to the IRS is accurate.  This even extends to the use of another accountant’s work product.  The accountant does not need to re-hash the work, but should consider the competency and expertise of the person whose work they are using.  This is also a best practice for firms and even speaks to the importance of a second partner review to ensure that work is done accurately for each engagement.

While these changes are significant, they can also help firms institute sound risk management protocols on engagements.  It is also important to note that there are two risks when a firm does not comply with Circular 230 – or any other regulation.  The first risk is a regulatory investigation from the governing body.  Many insurance policies can be structured to provide coverage for regulatory investigations, but typically they will not insure the penalties for non-compliance.  Secondly, if a client were to sue and it was discovered that the engagement did not comply with Circular 230, the plaintiff would have all the more fodder with which to sue.

Contact us to learn how your firm’s insurance would respond to allegations of accountant’s professional malpractice or to a regulatory investigation.

KPGM Faces Potential Discrimination Class Action

KPMG is facing a potential 9,000 person class action lawsuit now that a U.S. District Court has allowed the class to move forward.  The lawsuit stems from allegations that women were systematically paid less than men in comparable roles and experience levels.

Initially filed in 2011, the plaintiff lawyer was given authorization from the court to send a letter to 9,000 women who worked at KPMG from 2008 onward.  The plaintiff used statistical analysis to show the judge that the lawsuit has merit.  The plaintiff showed evidence that suggested that salary differences were statistically different and could only be accounted for by the gender of the employee. KPMG denies wrongdoing and will defend the matter in court.  The lawsuit is being brought as a violation of the Equal Pay Act.

Large scale gender discrimination lawsuits are rare and even more infrequent in the accounting space.  However, this case does highlight the need for accounting firms to be cognizant of how their actions may impact various groups.  Discrimination can take many forms – whether intentional or not.  Firms should take all precautions when setting rules and making changes to company policies even if those changes do not deal with salaries.  One tool being used by firms is a disparate impact study.  This type of study can be performed to address whether a particular action is having an undue effect on a particular class of personnel.  If a particular action is bring found to have an adverse effect it can be remedied quickly and often prevents lawsuits from coming later.

Beyond risk management, this case also addresses the need for accounting firms to carry adequate insurance to protect themselves.  The insurance policy that would address discrimination and a violation of the Equal Pay Act is called Employment Practices Liability (EPL).  EPL insurance specifically protects firms from allegations of a “wrongful employment practice.”  A “wrongful employment practice” is commonly defined in the insurance policy as discrimination, retaliation, harassment, wrongful termination, violations of various employment laws and a number of other potential employment related risks.  Most EPL policies specifically mention the Equal Pay Act as something that the policy covers or as something the policy excludes.

Since each insurance company offers their own version – and wording – to an accountant’s Employment Practices Liability policy, it is vital to review your coverage and have an experienced broker negotiating coverage on your behalf.  Using an inexperienced broker, making assumptions about the coverage you have in place or misreading the policy can be an error that could cost the firm tens of thousands of dollars.

Contact us for a policy review or to discuss whether employment practices liability insurance is right for your firm.

Ponzi Scheme’s Accounting Firm Liable for $1.8M

DeWitt & Shrader, an Indianapolis, IN accounting firm, has been found liable for $1.8M for serving as the accountant for a Ponzi scheme.  The case was brought by the Indiana Secretary of State in their efforts to recover some of the $9M stolen from investors in the Ponzi scheme.

The Ponzi scheme was run by now-jailed Keenan Hauke.  Keenan’s firm – Samex Capital Partners (Samex) was discovered to be an illegal investment company and convicted of securities fraud in 2011.  In an effort to return money to investors, assets have been liquidated, profits clawed back and related parties to the firm have been sued.

DeWitt & Shrader acted as the accounting firm to Samex and issued investors their account statements and tax documentation.  The firm’s conviction came based on the premise that their independence gave the scheme credibility.  Neglecting their duty to accurately portray the investment situation was their mistake and their responsibility.  Their lack of observation, inspection and professional curiosity led to their indictment.

The Securities Commissioner was quoted as saying that a firm has a responsibility to take action if they suspect securities fraud.  She went on to say that DeWitt & Shrader turned a blind eye and did nothing.

There are important risk management considerations as a result of this case.

  • It is important for firms to know their clients.  Simply doing work blindly may result in poor client retention ratios at best – and a lawsuit at worst.
  • Firms should investigate and follow up on suspicious behavior.  If fraud is going on in a client’s business, the accountant should disengage to avoid being part of the activity.
  • Firms should keep an eye out for fraud.  The accounting profession is respected and relied on by many third parties that the firm may not see.  There is an ethical duty to present a client in an accurate manner through all work products.

 Contact us to discuss ways to better protect your accounting firm.

Importance of the Statute of Repose

The statute of repose is an often overlooked piece of law.  When it comes to claims of malpractice, it can have some serious implications.  This past legislative session, the Tennessee General Assembly changed the statute of repose.  The new legislation impacts the time frame to file lawsuits against lawyers and accountants.  This change brings to mind the importance of such dates.

The law, which impacts work done after July 1st, 2014, enacts a five year statute of repose for malpractice suits.  The law’s text explains that “if a plaintiff discovers that a cause of action exists after five years from the date on which the act or omission giving rising to the claim occurred, the plaintiff will be barred from bringing her cause of action. The statute of repose, however, will not apply in situations where the defendant engages in fraudulent concealment. Id.  When a plaintiff establishes fraudulent concealment, the suit shall commence “within one (1) year after discovery that the cause of action exists.” 2014 Tenn. Pub. Ch. No. 618. 

This law has many important implications.  Many accountants don’t sleep well at night until this time passes.  More importantly, it impacts the insurance purchasing of a firm.  Mergers and acquisitions are common.  So are sole practitioners retiring, joining a larger group, or even dropping their insurance because it becomes too expensive.

The statute of repose tells a firm that the work done in the past needs to be considered when an event necessitates a change in the insurance.  Dropping insurance altogether is dangerous, as lawsuits can be brought on work done years ago.  Even if a firm has done little to no work in the recent months, claims for past engagements can still surface.

When a firm shuts a practice down, the statute of repose impacts how long of a “tail” needs to be purchased.  A “tail” is a term for an option that allows a policy holder to report claims to the insurance company in the future even though a policy is no longer being purchased.  the “tail” only covers work done prior to the date the “tail” is purchased, however.  Since a “tail” costs more the longer the firm is allowed to report malpractice lawsuits, the duration of the tail should match the statute of repose.

While Tennessee just ruled on their statute, it is outside the scope of this post to explain all the states and their laws.  We encourage each firm to engage with a lawyer who can explain the statutes in each of the jurisdictions the accounting firm practices in.  This will allow each firm to make decisions based on their exact situations.

As a firm considers how to best run their practice and mitigate their risks, it is important to implement a comprehensive risk management structure.  Contact us to discuss items to include in that structure

Crocodile-Crushing Accountant Highlights Need for Insurance

In what could have been a tragic encounter between a crocodile, a Russian circus and an accountant, everyone appears to be doing fine.

Fedya, a six foot long crocodile, was traveling in Northern Russia with the circus that the crocodile was part of.  The staff accountant for the circus rode in the same bus as Fedya during this portion of the trip.  The bus took a sharp and unexpected turn which caused the accountant to fall on top of the crocodile.  Fedya was reported as vomiting for three hours after the incident, while the accountant was unharmed.  Fearing the worst, the animal was sent for monitoring as it was sceduled to become a star for a Russian television program in the near future.  According to the Soviet Circus director, Vassili Kolos, the crocodile has recovered.

While the story itself is incredible and the events extremely rare, this scenario does highlight the need for accounting firms to consider the breadth of their insurance program.  Accountants are often out on the road, visiting client and in client’s offices or worksites.  Most accountants also have office space where clients can come to discuss financial matters and drop off documents.

Whenever accountants are with others, there is an opportunity for bodily injury or property damage to occur.  When this injury occurs in the course of work, the Business Owners Policy (BOP) will respond.  It is important to make sure that general liability is included in the BOP and that it extends to injury done to clients whether at firm’s place of business or while visiting client off-site.

A BOP that includes robust general liability coverage, coverage for property damage and other enhancements can be obtained for as little as $500.  Contact us to discuss whether your firm’s insurance is adequate or to obtain an option for consideration at your next renewal.