34 July 2012

Illustrations by Tree Tree Tes

Financial fraud and counter measures by regulators have created a boom for forensic accountants in Hong Kong. George W. Russell reports

Forensic accounting

TRUSTBUT VERIFY

July 2012 35

decade ago, when Wilson Cheng was investigating alle-gations of financial fraud in the mainland, collecting evidence could be a fairly simple affair. An obviously hastily handwritten piece of paper would be proffered as a re-ceipt for a large corporate transaction. “It was so easy to tell it was fraudulent,” he says.

Today, fraud is more sophisticated, but so are the techniques for investigating it. Cheng, as a managing director at FTI Consulting and a Hong Kong Institute of CPAs member, says his specialty is one of the fastest growing sec-tors of the profession. “Forensic accounting is hot,” he says.

Financial irregularities connected with so-called Chinese reverse takeovers has put the skills of forensic accountants in the spotlight. And multinational corporations are hiring forensic accountants as compa-

nies seek to comply with heavy duty local and international regulations. The Hong Kong Anti-Money Laundering Ordinance becomes effective on 1 August, joining the United States Foreign Corrupt Practices Act of 1977 and United Kingdom Bribery Act 2010. These acts can cause serious problems for companies that do not comply.

As a result, companies are competing with accounting, consulting and investiga-tion firms to hire more forensic accountants. Regulators, too, are boosting their ranks of forensic investigators, including those with CPA qualifications. “Accountants are abso-lutely crucial to us,” says Ashley Alder, chief executive officer of the Hong Kong Securities and Futures Commission. “When it comes to potential misconduct it is always the case that you need financially savvy and literate accountants and analysts on your team.”

Meanwhile, Hong Kong’s graft busting Independent Commission Against Corrup-tion is hoping to recruit three more CPAs this year for its rapidly expanding forensic ac-counting group set up last year. (See “Hard graft” on page 38.)

Global crime scenesThe demand for forensic accountants is a worldwide phenomenon. “I have definitely noticed an increase in accountants and accounting students interested in the field,” says Kelly Richmond Pope, associate professor of accounting at DePaul University in Chicago and an American Institute of CPAs member. “I like to describe it as the perfect blend of accounting, law, psychology and criminology.”

In the U.S., forensic accounting is often deployed as part of litigation. “Many of our

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36 July 2012

Forensic accounting

cases involve the defence of other CPAs who have had a lawsuit brought against them,” says Robert R. Harris, managing director of Harris Cotherman Jones Price & Associates in Vero Beach, Florida, and a past chairman of the American Institute of CPAs.

Meanwhile, in Australia, much of the work lately has been independent reviews and investigations into boardrooms following cases in which directors were found liable for not adequately discharging their duties. “We are also seeing more proactive and preventative anti-bribery and corruption risk reviews,” adds Dawna Wright, a partner at the McGrathNicol financial advisory practice in Melbourne.

In Hong Kong, forensic accountants say their workloads are building due to a simple reason: a rising incidence of financial misconduct. “Fraud is trending up,” says

Richard Yung, the Asia Pacific regional anti-money laundering, sanctions, anti-bribery and anti-corruption head at the Royal Bank of Canada in Hong Kong and an Institute member.

Most fraud cases follow the same pattern, say experts. “Fraud can take many forms but the substance is almost identical,” says Rio C. K. Lam, a principal with the forensic and investigation service at BDO in Hong Kong and an Institute fellow. “It almost always happens in a way where someone has taken something that he doesn’t own, or isn’t entitled to, or deceives another for personal gain.”

Evolving fraudAccountants say the nature of fraud has shifted over the past decade. “In the early 2000s, we used to see an awful lot of cases

that revolved around the use of documen-tary credit,” says Chris Fordham, Asia Pa-cific managing partner of fraud investiga-tion and dispute services at Ernst & Young in Hong Kong. “We saw these companies essentially round-tripping funds around their organization.”

Fordham, who is also the steering group convenor of the Institute’s forensics forum, says this is in decline. “What we tend to see now is a number of companies cooking their books by either inflating their revenues or keeping their liabilities off their books.”

Now, it’s the Chinese reverse takeover scandals, he adds. “Both my firm and my competitors have seen these from about two and a half years ago and we’ve been working fairly solidly on these kinds of issues,” says Fordham.

Mainland fraud is keeping many forensic

July 2012 37

accounting practices in business and shows no signs of abating. “Financial crime is per-haps the fastest growing area of the market,” says Aaron Liddelow, forensic investigations and dispute services manager at Briscoe Wong Ferrier in Hong Kong and an Institute member. “One of the most interesting re-cent engagements involved the analysis of kickback payments taken by employees of a mainland company.”

Indeed, Chinese business practices offer temptations. “A lot of business [in China] is done around relationships and individu-als will conduct business with people that they know and trust outside the organiza-tion,” notes John Donker, China and Hong Kong forensic services leader at Pricewater-houseCoopers in Beijing and another foren-sics forum steering group member. “That can be fine and work in the interests of the

company, but we also see that can be abused from time to time with people doing busi-ness to the detriment of their company.”

The other issue that accountants see in China – and in Asia broadly – is manage-ment override of internal controls. “There is a very strong boss-subordinate relationship in most Asian economies, so it is that much easier for someone in a position of authority within an organization to subvert tradition-al controls,” Donker points out.

Detective controlsMuch of the work of a forensic accountant these days is prevention, echoing the foren-sic accountant’s mantra of “Trust but veri-fy,” a sentiment ascribed to a Russian prov-erb. “Until recently, forensic practitioners were brought into companies only when something had gone wrong and in order to

“I like to describe it as the perfect blend of accounting, law, psychology and criminology.”

38 July 2012

identify the extent of the problem and its perpetrators,” says Barry Tong, an advisory partner at Grant Thornton and an Institute member. “Now they are beginning to be brought in before a problem occurs.”

Forensic accountants have also broad-ened their capabilities to investigate disputes that do not necessarily involve fraud. “I have seen an increase of family disputes cases…,” says Kenneth Chen, a partner with Shine-Wing in Hong Kong and an Institute member.

“Forensic accounting can include asset tracing, business valuations, calculating lost profits and performing other quantum assessments,” says Colum Bancroft, Greater China managing director at Kroll Advisory Solutions and an Institute member.

Another factor behind the boom in foren-sic accounting is an increasing recognition by

the Hong Kong judicial system of the impor-tance of involving forensic accounting exper-tise. “The courts and the counsel value the assistance from forensic accountants in the financial and accounting aspects of legal cas-es,” says Johnathan Lai, director of corporate advisory services at RSM Nelson Wheeler.

Lawyers foresee a further use for foren-sic accounting in quantifying damages in personal injury cases that involve claims of substantial business losses of the injured person. Until recently, courts have been re-luctant to use such evidence, but a recent Privy Council judgment admitted forensic accounting evidence for the first time, re-sulting in a much higher award of damages.

The judgment related to a Guernsey case but lawyers say Hong Kong courts could adopt this precedent. “There is a possibility

[of allowing] the parties to adduce actuarial or accounting expert evidence to project fu-ture losses,” says Angela Yim, a partner at the MayerBrown JSM law firm.

Evidence gatheringThe pick-and-shovel work of forensic ac-counting is data collection, which nowadays is assisted by technology. Some firms use Encase, a computer investigation package made by Guidance Software in California. “Encase is a tool to collect or image the hard drive and conserve every single bit with-out altering or affecting it in any way,” says Y.L. Cheung, a forensic and dispute services group partner at Deloitte in Hong Kong and an Institute member. “We need tools that narrow down millions of files to a manage-able number of the really relevant files.”

Forensic accounting

The Securities and Futures Commission is not the only public sector group in Hong Kong on the lookout for forensic

accountants. The graft busting Independent Commission Against Corruption is also bolstering its ranks of professional financial investigators.

Last year, the ICAC set up a dedicated group led by Melissa Tang, the commission’s chief forensic accountant. The commission will have 11 forensic accountants at full strength – all Institute members – and is actively recruiting to fill three positions.

“In recent years there has been an upsurge of corruption related financial fraud cases and many of them involve complex business transactions in financial markets, global flows of funds, and cross-border money laundering,” says Tang. “In some cases, a large number of parties are involved, including offshore companies, and some innovative and aggressive accounting techniques.”

The growing sophistication of fraud cases prompted the commission to restructure. “In August 2011, we restructured our financial investigation section to deploy additional resources to forensic accounting and enhance our professional capability,” says Tang.

Tang, an Institute member, is confident the ICAC can attract the right people despite the surging demand for forensic accountants in the city.

The commission expects to hire from accounting and consulting firms. Would-be employees must be experienced in forensic accounting and fluent in

written and spoken Chinese. “We have that China element in our cases,” Tang notes.

The ICAC puts its accountants through the same training programme as its investigators, including knowledge of the statutes, such as the ICAC, Prevention of Bribery, Anti-Money Laundering and Theft Ordinances, as well as judicial procedures.

Accountants also have to meet the ICAC standards on professional conduct and discipline. “Our accountants need to know what our frontline investigators know,” says Tang.

Much of the work involves data collection and analysis, but ICAC forensic accountants are also expected to assist investigators in the operational and investigative aspects of cases, including the questioning of suspects and witnesses, and participation in search-and-seizure operations that make for so many dramatic headlines.

The ICAC push into forensic accounting echoes that of counterpart organizations elsewhere in Asia Pacific, such as in Malaysia and Singapore, that also have boosted their accounting ranks.

Private sector forensic specialists say they welcome the strengthening of anti-graft agencies.

“Those who might consider committing fraud and other corrupt acts may think twice if the probability of being caught is higher through the deployment of more skilled investigators to catch them,” says Peter Coleman, executive director of Deloitte Forensic in Singapore. “It can only be a good thing.”

Hard graft

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FTI Consulting, meanwhile, deploys its own proprietary software, Ringtail, devel-oped by Ringtail Solutions in Melbourne and acquired for US$35 million in 2005. “The toughest thing is always the language barrier,” adds Cheng. “Chinese and Korean are the most difficult for computers as one dot or one stroke can make a difference.”

Some labour-intensive areas of forensic accounting investigations can be outsourced and a cottage industry has emerged to sup-port these functions. “Initially, our forensic accounting was limited to litigation sup-port,” says Mayur Joshi, director of Riskpro, a forensic accounting services company in Pune, India, which has worked on inter-national fraud cases such as Olympus, the Japanese optical company. Now, he says, the firm can be called on to analyse financial

statements “anywhere across the globe” to look for warning signals.

However, much of forensic investigation still requires one-on-one interaction. “We need specialist training such as interviewing skills,” says Cheung at Deloitte. “We need to know how to read body language and how to interpret what we call micro-expressions.”

The increasing popularity of forensic ac-counting has led some to consider whether there should be a specialist qualification in the field. “We’ve had talks within the Institute’s forensic forum to roll out addi-tional training and perhaps eventually an additional designation for forensic accoun-tants,” says Donker at PwC. “At the moment we’re trying to achieve some of that training through seminars we’re running.”

Few firms in Hong Kong expect to be able

to hire forensic accountants from overseas as the mainland requires fluent Putonghua and familiarity with Chinese business cul-ture. “In Hong Kong there are not too many people who are specialized in this area,” points out Annie Chan, managing director of corporate recovery and forensic services at Mazars. “They are in high demand and the pool is scarce.”

In China, the days of fake handwrit-ten receipts are over. Cheng at FTI says forged documents look like the real thing these days but, fortunately, a computer data search can recreate the steps used to make them. “In five years they will be much smarter and we will not be able to see that in the computer,” he warns. The challenge for forensic accounting, Cheng adds, is to stay a step ahead of the criminals.