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The expert often will start with the couple's tax return to understand the trail that needs to be established regarding income and expenditures. In addition, he or she will access bank account and other investment account activities. Because often it is uncertain when a party to a matrimonial dispute initially considered terminating the marriage, a forensic accountant may need to go back several years before the date of separation to understand the financial implications of the marriage and the assets that may be subject to equitable distribution.
A review of several years' tax returns will reveal whether the initial listing of assets and liabilities has been manipulated. One tool is a "source and application of funds," also known as comparative balance sheets. In this exercise, the accountant will gain an understanding of the couple's assets and liabilities at a particular point in time, usually several years before the divorce action was initiated, to gain an understanding of the various sources of income and expenditures reflected on the tax return. The forensic accountant also will talk with the party to find out about other lifestyle and related income and expenditures that may not be reflected on the tax return.
By starting with the balance sheet (assets and liabilities) and adding all income shown on the tax return (as well as nontaxable income and return of capital) and then deducting expenditures, whether tax deductible or not, the forensic account will ascertain whether the balance sheet at the beginning of the year and at the end of the year are supported by transactions known to have occurred. In addition to documentation, an interview with the client often is helpful in understanding whether other transactions may not be reflected on the tax return, including those that may constitute tax fraud.
This comparison of balance sheet to cash flow is the first step in understanding whether hidden assets are likely. A review of bank statements and all other types of financial assets (brokerage accounts, mutual funds, pension plans, and partnerships of any sort) will be used to understand actual transactions that have occurred during the year.
A review of cancelled checks and bank statements will show whether income is being "siphoned off" from marital/household accounts for other purposes. For example, in reviewing bank statements for two years before a marital separation, one forensic accountant noted checks being written to cash. In denominations of $7,500 each, these were being negotiated at a bank on Grand Cayman Island. A review of the other spouse's passport indicated that he was taking scuba-diving vacations to the Cayman Islands simultaneous with these transactions. Over the course of two years, $75,000 had been withdrawn from marital bank accounts and deposited in Cayman Island accounts.
In many cases, the expert will review tax returns and related financial information from an underlying business. Businesses that borrow money are routinely required to complete financial disclosure information in connection with those loans, whether with a bank or other institution. Ascertaining what information a business has provided to such institutions is frequently part of the discovery process.
The forensic accountant compares information provided to such banks with financial statements presented in discovery and tax returns filed with the government. This analysis may give rise to additional assets or expenditures beyond normal business requirements or provide grist for cross-examination to impugn the credibility of one of the spouses. The forensic accountant will attempt to gain access to all financial statements prepared for the couple as well as those for business entities to which either spouse has a ?nancial interest, especially a controlling interest. Although control normally requires more than 50-percent ownership in an entity, in many circumstances an individual can have effective control or significantly influence control with less than 50-percent ownership. Sometimes owners with as little as 10 to 20 percent of an equity interest in the business may, in fact, control business operations.
All of the couple's financial statements for the period must be made available to the accountant. By reviewing bills paid to an accounting firm, the expert will find out what work has been undertaken on behalf of the couple or the business, which may lead to further analysis and discovery of additional assets (as well as income).
In addition to assets that are being "hidden," other income may be undisclosed. Issues regarding income will often fall into two categories: the first is gross business income that is not reported on tax returns, and the second is expenses of a personal nature being deducted on a business tax return.
To ascertain whether all income is being reported, the forensic accountant must understand the business as well as business records. Looking at internal business controls and the role of the spouse on a day-to-day basis will reveal whether hidden income is likely.
For example, consider the owner of a large diner who spends 12 to 14 hours behind the counter each day. There are no other "partners" in the business. When the spouse is not at the cash register, one of two other family members is there. The restaurant is open 18 hours a day. The cash register does not have an imbedded tape, and daily deposits to the bank consist primarily of credit card receipts and a nominal amount of cash. The proprietor is likely "skimming" money from the business and underreporting income to the taxing agencies and the nonworking spouse.
A forensic accountant can understand income being generated in a variety of ways. Using the restaurant's food purchases and his or her knowledge of the relationship between retail price and material costs will often lead to a fairly sophisticated understanding of unreported sales. In addition, surveillance can be used to ascertain the number of customers for any given period from which average revenue per customer can be extrapolated. A comparison of this figure to reported income for that same time period would reveal unreported income.
As another example, a physician's office is reporting $450,000 a year in gross revenue to the taxing agencies as well as to legal counsel for the other party in a divorce. The physician is performing a variety of services, among them cosmetic procedures for which insurance reimbursement generally is not available. Most of the payments for cosmetic procedures are made in advance and, in some cases in "cash."
The forensic expert may use business records to ascertain whether all cash is being reported, both on the tax return and in the legal matter at hand. The expert then assists legal counsel in understanding the type and size of practice and the potential unreported income to determine whether digging further may be worthwhile.
An area where manipulation of financial information may be likely is with regard to nonbusiness-related expenses incurred by the business. Although generally an issue between the business owner and the Internal Revenue Service, such transactions affect income available for equitable distribution, alimony, and child support. The forensic accountant will search tax returns and other financial statements for questionable items or items that are outright personal in nature. He or she will gain access to underlying accounting information, often the general ledger, cash disbursement records, purchase records, and invoices to produce a report and come up with ultimate findings and an opinion. Insight into the nature of the business and a detailed analysis of data often will allow the forensic accountant to identify personal expenditures being run through the business. Paper as well as digital records will be required to effectively and efficiently itemize those expenses.
Several types of valuations may be performed. A full appraisal is an unambiguous opinion of value. All relevant information is considered, collected, analyzed, and reviewed. All conceptual approaches deemed relevant are considered. Generally, this is done for any valuation engagement in which all information considered by the business appraiser needs to be presented for future consideration.
The limited appraisal report is an estimate of value and includes procedures that are applied to collection, analysis, and consideration of relevant information on a limited basis. Only the conceptual approaches deemed most relevant are considered. Generally, this is used for buy-sell agreements and other strategic business issues. The limited appraisal would not be used where the lawyer requires a full understanding of the report and all of the issues thought through by the business valuation professional.
The third type of valuation is a calculation. This is an approximation or indication of value. Limited procedures are applied to the collection, analysis, and consideration of relevant information (usually only financial statements or tax returns). Approaches are limited to those agreed to by the valuation professional and the client. This approach is used for initial stage companies or strategic planning and is not appropriate when the client requires a thorough understanding of the issues considered by the appraiser.
In a litigation context, the attorney and valuation professional must determine which type of report is appropriate, based on the rules of evidence. When the "four-corner" rules are appropriate, a full valuation appraisal is required. More limited appraisals will give the ultimate result, but not the thinking of the valuation professional. A more limited appraisal would be appropriate when cross-examination of the expert is deemed to be the best means of understanding the valuation professional's thoughts and methods. In most litigation circumstances, unless there are specific local court rules to the contrary, a full valuation is the best means to prevent a challenge to the report under local Daubert or Frye standards.
In most cases, retaining the valuation expert early in the case will assist counsel in gaining a full understanding of discovery issues to be explored. In some jurisdictions, the attorney may only get one "bite at the apple" to make a full set of discovery requests for documents and/or admissions. In several circumstances, courts have denied discovery requests based on a later retention of a forensic accountant, precluding the admission of compelling information that would have been quite helpful to the case.
Early retention also aids a lawyer's full understanding of the various business aspects to be reviewed. Although it would never be considered an "opinion," sufficient information early in the case may accommodate a "ball-park" opinion (off the record) to move negotiations forward.
At the initial consult with the expert, the lawyer must determine who will retain the forensic accountant. In most cases, the attorney should retain the expert. Although attorney-client privilege may not become an issue in most divorce matters, we have found sufficient basis to prefer retention by legal counsel. If the forensic accountant or valuation expert gathers information that is damaging to the client or issues an opinion that is not completely in line with the lawyer's theory of the case, retention by legal counsel allows the expert to serve as a "consulting expert" and thus the report is not subject to discovery. In such a case, the attorney-client privilege or work-product privilege will be in place. Obviously, once the expert testifies, most privileges are no longer in place.
As noted above, three general types of opinions can be provided. The attorney and the valuation professional must discuss ahead of time the type of report to be generated and local rules of evidence. One of the worst things that can happen is that the report can be eliminated from consideration due to a failure to provide suf?cient information to opposing counsel. For this reason, it is imperative that the valuation professional has experience in the state. If he or she has not previously testi?ed in a local state court, the lawyer must explain fully what must be included in the report.
This discussion should include at minimum a full description of the fee arrangement (as per federal rules of evidence); a list of all documents "having been considered;" and in some jurisdictions, a complete list of documents consulted in any fashion, whether used or not. Other jurisdictions require only those documents used by a professional in arriving at the ultimate opinion. A motion in limine can be at the least troublesome and, at worst, extraordinarily problematic if the report is then excluded.
Reports from forensic accountants are even more complex. There is no simple, standard format for a forensic accounting report. The attorney must make certain that the forensic accountant fully understands the issues to be addressed in the report. In addition, clarify any items that should not be addressed in the report. For example, findings of "cash" in a business may or may not be appropriately disclosed and discussed in the forensic accounting report.
A full understanding of the civil and criminal implications of such disclosures can be quite problematic. In some circumstances, such a disclosure may require matrimonial counsel to consult with special counsel, tax or criminal, in concert with the forensic accountant, to ascertain how to treat such subjects. Additional information regarding the findings of the forensic accountant must be fully documented if used in the proceedings. In most cases, the opposing party will dispute findings, and cross-examination of the forensic accountant will be conducted at the highest level.
Providing testimony in matrimonial matters may differ from other litigation contexts. In some jurisdictions, the testimony of a forensic accountant or valuation expert will be limited, especially when presented before a master or special master. In addition, rules governing depositions of experts will vary from court to court. Understanding such differences upfront is important because they will affect how the expert drafts the report, i.e., depending on whether he or she will be deposed and how local rules of evidence govern what is included in the report. The expert should be well prepared to testify in advance of the trial date and, when appropriate, in advance of the deposition date so that he or she can anticipate the types of questions allowed by local rules of evidence as well as opposing counsel's methods and techniques.
If the expert has already testified in the initial case and new matters come up during the opposing expert's testimony, rebuttal may be appropriate. This may require relatively brief preparation of the expert and generally will be limited to those items that are specifically subject to rebuttal. Most courts will not allow the expert to repeat his or her initial report, nor is that necessary or appropriate.
In some cases, the testimony of a forensic accountant or valuation expert will be held for rebuttal. This may be the case when the expert initially is a consulting expert and is used solely for the purpose of analyzing the initial expert's report, which has been placed before the court. In many circumstances an expert is used to critique another expert's report to allow legal counsel to attack the report and the credibility of the testifying expert. If at the end of the case in chief the attorney believes other issues need to be addressed by a rebuttal expert, the attorney must determine whether it is appropriate to use the consulting expert in this role.
In summary, the forensic accountant can provide a significant range and breadth of capabilities in matrimonial matters. Some experts have valuation capabilities, whereas others do not. In some circumstances, one forensic accountant may trace funds and conduct similar activities, and another expert may be hired to value the business.
David H. Glusman is a CPA, DABFA, CFS, Cr. FA with Margolis & Company in Balla Cynwyd, Pennsylvania. Mr. Glusman has more than 36 years in public accounting and consulting experience and provides forensic and litigation support and expert witness testimony in matters involving assets and income in divorce cases, hidden assets, and business valuation issues. He has authored more than 100 publications and spoken extensively on valuation and forensic accounting topics. He holds designations of Diplomat and Fellow of the American Board of Forensic Accountants, Certified Fraud Specialist, and Certified Forensic Accountant. Mr. Glusman is the lead author of the CCH Publication Fiduciary Duties and Liabilities: Tax and Trust Accountant's Guide.
Published in Family Advocate, Volume 29, No. 4, Spring 2007. © 2007 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.