FORENSIC AUDITING (DOC)

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					       FORENSIC AUDITING
21st Century Challenge to Supreme Audit Institutions

                 A presentation by
           James P. Wesberry, Jr., CPA
  Principal Adviser on Accounting & Auditing for
         Latin America and the Caribbean
                 The World Bank

                       at the
           4th Triennial Congress of the
Caribbean Organization of Supreme Audit Institutions
                   (CAROSAI)

               Georgetown, Guyana
                 March 18, 1997

 "More cases of insolvency are to be attributed
 to Frauds than shrewd business men are aware
 of, and though the advice is almost universally
 unpopular, it is urged on merchants to
 overcome their disinclination for this species of
 labor, and give a little time to a thorough
 investigation of their accounts....Newspapers
 daily chronicle the detection of new cases of
 embezzlement, and still our merchants shut
 their eyes and believe all servants dishonest but
 their own. While they admit the shrewdness of
 their accountants in other matters, they blindly
 imagine them too trustworthy, or too fearful of
 consequences to deceive them in regard to the
 manipulation of their finances; yet in case of
 the death of an old favorite bookkeeper, or even
 of a partner, who has had the management of
 the cash, how often do we find that their
 apparently beautifully balanced accounts are
 teeming with a succession of fraudulent entries
 that had been continued through years."

                                     H. J. Mettenheimer,
                                     AUDITOR's GUIDE, Being
                                     a Complete Exposition of
                                     Bookkeeper's Frauds, 1869
                                     (The United States of
                                     America's first known book
                                     on auditing).




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In the Beginning...

In its beginnings auditing was intended to detect and expose fraud,
embezzlement and corruption in accounting records. It was developed to serve
the interests of absentee owners/investors who needed assurance they were not
being robbed by their own employees. During the 19th Century many auditors,
in fact, are reported to have carried arms. But the auditing profession's
objectives evolved quickly to focus upon the certification of accounts and
financial statements. Fraud detection was a risky business.

Twenty-three years after publication of Mettenheimer's small Auditor's Guide
audit objectives began to change as George Soule's Manual of Auditing, the
second oldest known American book on auditing, states that "...the Auditor must
not certify Statements of Account as correct, of his own knowledge, until he has
investigated them from the source to the final exhibit."

Not much more time passed until auditors found that even "certifying" was risky
and began to emit "opinions" on the "fairness" of presentation and the auditor's
"certificate" was abandoned in favor of language less vulnerable to getting the
auditor into trouble.

But in the late 20th Century auditors began getting into another kind of trouble.
Stockholders, creditors and others began to sue auditors alleging they had been
misled after "fairly presented" financial statements were found with fraudulent
content. Despite the auditors' contention that they were not responsible for
detecting fraud, many juries and courts began to suggest that in fact they did.

Thus as we approach the 21st Century, auditors are again becoming more and
more interested once again in the detection of fraud...and a new adjective is
being used to describe their work.

"Forensic" accounting and "forensic" auditing are now frequently mentioned as
fields of expertise offered by auditing firms. And these "new" specialties are
much more common that one like myself who has practiced accountancy during
the mid and latter parts of the 20th Century, seeing financial audits lose
popularity to operational or performance audits, might have thought.

In preparing this paper, I did a search of the InterNet on the two terms. I found
4,726 matches for "forensic accounting" and 1,212 matches for "forensic
auditing." Most of these are not references to articles in professional journals
but rather citations of talents offered on Home Pages of accounting/auditing
firms offering their services to the public. Forensic accounting/auditing is now a
commonly offered service of many accounting firms in the United States and
Canada and many other industrialized countries.

I have concluded that "forensic" accounting or auditing or just plain fraud or
investigative auditing (terms now used interchangeably) basically refers to the




                                        2
kind of auditing 19th Century auditors used to do and stopped doing because it
was too risky. Now due to the clamor from a public which seems to have always
felt that auditors should have been protecting them against fraud and the very
large judgements against auditing firms perceived by juries not to have been
doing so, it has become risky for auditors not to do this kind of work. But,
careful as always, auditors are now diligently differentiating between financial
statement (and other assurance service) audits and forensic (or fraud
detection/substantiation) audits.


What is Forensic Accounting/Auditing?

Here's what one firm says about forensic accounting on the InterNet:

       "The synthesis of accounting, auditing and investigative skills
       yields the specialty known as forensic accounting.

       `Forensic,' according to the Webster's Dictionary means,
       `Belonging to, used in or suitable to courts of judicature or to
       public discussion and debate'

       `Forensic Accounting' provides an accounting analysis that is
       suitable to the court which will form the basis for discussion,
       debate and ultimately dispute resolution. It is often referred to as
       `Investigative Accounting' and is often associated with
       investigations of criminal matters. A typical forensic accounting
       assignment would be the investigation of employee theft.
       (emphasis added).

                              (see - http://www.forensicaccounting.com)

Forensic accounting (or auditing as some call it) is growing rapidly as a service
offered by Chartered or Certified Public Accountants. Some firms specialize
exclusively in this area. In addition, the fastest growing new professional
organization in the United States of America is the Association of Certified
Fraud Examiners (ACFE). Started less than ten years ago ACFE is now nearly
as big as the Institute of Internal Auditors and is now expanding internationally,
having just announced the opening of a European Regional Office in the
Netherlands which seems to be a center of growing interest in fraud examination
and forensic accounting. The CFE credential based upon a standardized
computerized test is now available worldwide. It is not limited to accountants
and CFE's include many types of specialized investigators as well as forensic
accountants.

According to the January/February 1997 White Paper, the journal of the ACFE,
interest began in the Netherlands in the 1980's as registered accountants were
used more and more to support official agencies fighting crime and fraud. They
participated in complex cases and appeared as expert witnesses. The courts




                                        3
attached great value to the findings and the opinion of the National Criminal
Intelligence Service (CRI) accountants. Eventually it "became clear that
registered accountants, with extra training in criminal law and procedure and a
rapid introduction to practical examples, were able to obtain evidence from
complex or incomplete accounting records enabling public prosecutors to bring
successful charges. According to Arthur de Groot, author of the article and a
specialist in forensic accountancy with Moret Ernst & Young in Utrecht, the
Netherlands, "The `core business' of the forensic accountant or fraud examiner
was gathering and interpreting evidence." The term forensic accounting was not
used in the Netherlands until the late 1980's when it was finally "adopted from
the English-speaking world, especially the U.S. and Canada."

Basically, while forensic accounting/auditing is such a new term that there is no
generally accepted definition of it yet available, almost all authorities who have
published works or spoken on the subject agree that then key to this new branch
of the accountancy profession lies in its specialized attention to the gathering of
evidence according to the rules of jurisprudence for probable use in court
proceedings.

The forensic accountant/auditors must gather more evidence, analyze it more
carefully and weigh it more judiciously that the financial accountant/auditor.
He/she must be an expert in criminal law, especially as regards the acceptability
and admissibility of evidence in judicial proceedings.

"Most business people (in the Netherlands) now know that these professionals
not only conduct financial investigations for the police and the courts, but their
work has become a part of the standard package of services offered by major
accounting firms," de Groot concludes. The situation in the Netherlands is
typical of the growth of forensic accounting/auditing during the past decade.

Canada, which seems always to be on the cutting edge of anything related to
auditing, has provided much leadership in forensic accounting/auditing. The
December, 1996 CGA Magazine Online states that in Canada "Forensic
accountants used to be hired after the fact, once a problem had emerged. Now
they are brought in sooner, usually at the same time as the lawyers. This is
mainly because forensic accountants are able to identify, assess, and quantify
risk rather than follow a prescribed checklist." One early and very prolific
forensic accountancy writer/practitioner, Canadian Chartered Accountant Robert
J Lindquist, has actually relocated to Washington and is now with Price
Waterhouse where he serves as the firm's guru of forensic accounting services.
All other major auditing firms have now set up similar forensic accountancy
specialist units.

According to the many private firms which now hold themselves out to practice
forensic accounting publicly for clients they use a combination of accounting,
auditing and investigative skills when conducting an investigation. They must
be able to respond immediately and communicate financial information clearly
and concisely in a courtroom setting. Forensic accountants/auditors are prepared




                                         4
to look beyond the numbers and deal with the business realities in the situations
they are called upon to review.

Here is the best definition I have found taken from The Accountant's Handbook
of Fraud and Commercial Crime by Bologna, Lindquist and Wells published in
1993:

       "Forensic and investigative accounting is the application of
       financial skills and an investigative mentality to unresolved
       issues, conducted within the contaxt of rules of evidence. As a
       discipline, it encompasses financial expertise, fraud knowledge,
       and a strong knowledge and understanding of business reality and
       the workings of the legal system. Its development has been
       primarily achieved through on-the-job training, as well as
       experience with investigating officers and legal counsel."

This definition could be applied to forensic accounting/auditing in the public
sector by simply changing only one word in the phrase "understanding of
business reality" to "understanding of government reality".

There does not seem as of yet to be any clear differentiation between a forensic
accountant and a forensic auditor. The terms are used interchangeably, but
forensic accountant and forensic accounting seem to be the preferred terms.
This may be because this identifies the accountancy profession more clearly as
the source of the particular financial expertise.


New Independent Audit Guidance - Statement on Accounting Standards
      (SAS) 82

The American Institute of CPA's just last month issued SAS 82 for the first time
dealing with the word "Fraud" and replacing SAS 54 "Errors and Irregularities"
issued only in 1988. This highlights the rapidly changing status of the
accountancy profession's recognition of its responsibilities in this area in
performing financial audits. Some of SAS 82's changes include the following:

                     auditors are required to document in their working papers
                      how they considered the risk of material misstatement due
                      to fraud.

                     auditors are provided for the first time official guidance
                      from the AICPA about fraud and how to detect it.

                     auditors are required to inquire of management regarding
                      the risk of material misstatement due to fraud.

                     auditors are clearly charged to exercise more professional
                      skepticism on audits, thereby hopefully detecting more




                                        5
                       frauds.

SAS 82 is a further, but hesitant, step in the right direction for the profession.
Many CPA's/CFE's feel that it will be necessary to go much further soon by
promulgating even stronger measures in this area in order to fully meet the
public's expectations of fraud detection by independent auditors.


Are there Forensic Accountants/Auditors in the Public Sector?

In the United States, according to William P. Thornhill in Forensic Accounting:
How to Investigate Financial Fraud, published in 1995, "...there are few public
accountants, internal auditors, or accountants in the private sector who have been
trained in or are experienced in the discipline of forensic accounting. At the
p[resent time, the largest body of trained and experienced forensic accountants
come from U.S. governmental audit and investigatory agencies, such as the
Internal revenue Service (IRS); Federal Bureau of Investigation (FBI); General
Accounting Office (GAO), the audit arm of the Congress; Securities and
Exchange commission (SEC); and the U. S Department of Defense (DOD)." I
suspect that so far many of those Thornhill describes as forensic accountants
actually consider themselves to be such. The staffs of the U.S. agencies
Inspectors general should also me mentioned among these. Thornhill points out
that state and local level police authorities in the U. S. as yet have few such
resources available to them.

The answer therefore is that in many of the industrialized countries at least, there
are probably many more forensic accountants/auditors in the public sector than
in the private sector. For developing countries, where there is an almost uniform
scarcity of professional accountants across the world, it is less likely that many
forensic accountants/auditors are available.


Should Supreme Audit Institutions Develop Forensic Audit
Capabilities/Staffing?

This is a question which should spark some debate. Some leaders in the SAI
community feel that SAI's should not get involved in forensic
accounting/auditing. They feel that other agencies which specialize in criminal
investigation should develop their own forensic accounting/audit staff leaving
the SAI free to perform financial and performance or comprehensive audits.
Some feel strongly that the SAI should maintain a more positive approach in
seeking to improve government and that forensic auditing might not only distract
limited resources from more useful type audits , but also through increased
media attention might create an image of the SAI as a "policing" institution,
rather than one which helps government managers achieve their goals more
efficiently, economically and effectively.

A very strong argument can be made that the SAI's entry into the forensic




                                          6
auditing jungle will eventually cause it to lose sight of its other more positive
audit functions, including even financial audits. This has been my own point of
view until recent years. I well remember the old GAO Comprehensive Audit
Manual's warning that once the GAO auditor found strong indications of fraud
or other criminal act, the FBI or other investigatory agency was to be brought in.
 Thereafter, GAO auditors were to assist in any way, but to refrain from taking a
lead role in the investigation. Fortunately GAO was further removed from the
forensic auditing field by the Inspector General Act of 1977 and other follow on
legislation while has charged the IG's now in most all U.S. Federal agencies with
regular internal audit functions and criminal investigatory duties. GAO
originally opposed this liaison and lobbied for the IG's to be called Auditors
General but Congress in 1977 was more interested in the investigatory function.
 It still is today.

Most of the IG's in the U.S. Federal government today have a criminal
investigatory background, rather than an auditing background, thus adding
evidence to the theory that "the forensic audit function tends to drive out all
other audit functions in a government audit agency" eventually resulting in the
direction of most, if not all, audit resources into the attractive and fertile areas of
fraud detection/substantiation. It is this theory that sustains those who feel that
the SAI should not perform forensic audits. This is a valid fear based upon what
has happened in several countries and among the U.S. Inspectors General.

In the U.S. the Office of Special Investigations (OSI) at GAO now handles high
level criminal investigations, normally based upon Congressional requests so
important or so sensitive that they cannot be handled by other agencies. GAO
did not seek to establish this function, but in fact resisted it. However, the U.S.
Congress felt that a forensic auditing/investigatory function was needed at the
SAI level and basically ordered GAO to set it up. Its primarily investigatory
staff is composed of ex-FBI agents and persons with similar backgrounds who
are supplemented by forensic accountants from GAO's audit staff as needed.

We at the World Bank have recently had a number of requests from SAI's to
assist them in developing a forensic audit capability. For example, only three
weeks ago we added forensic audit training and technical assistance to the
proposed third phase of our ongoing efforts to strengthen the institutional
capacity of the Bolivian Comptroller General's Office, now one of the strongest
SAI's in South America. We also have had, among others, your own request to
speak at this important Congress of Caribbean Auditors General on the subject.

Why the sudden interest of SAI's in forensic auditing? My first preview of this
coming phenomenon came one January a few years ago when while working for
USAID I was suddenly sent to Panama at the request of that country's
Comptroller General to help develop a means of strengthening its SAI in the
wake of the involuntary departure of General Noriega. The SAI itself, as well as
the entire government has been corrupted. Panama had become example
number one of Kleptocracy in action.




                                           7
The resultant USAID project in Panama, not only created an Integrated Financial
Management System and a System of Comprehensive Audit but also an office of
Ethics within the Panamanian SAI which administers and provides training in
the Code of Ethics in the Public Service promulgated by the President of
Panama. The SAI component provided training in fraud auditing for selected
staff auditors of the SAI, as well as overview training in fraud awareness for all
SAI and internal auditors. This was not referred to as forensic auditing at the
time because the term was not then widely used. So far as I know the Bolivia
project I previously mentioned is the first World Bank project to use this term.
We have other requests in this area and where we can fulfill them we hope to do
so, within the limits of the scarcity of real experts in the forensic auditing field
available for international consulting and training.


Why SAI's May Have No Other Choice

The accountancy profession has not moved on its own volition to place more
emphasis upon fraud detection in financial audit work and to offer forensic
accounting/auditing services. It has been forced to do so by the ever increasing
numbers of scandals in industrialized countries which have rocked capital
markets, depleted government guarantee coffers and nearly bankrupted all the
Big-Six auditing firms through verdicts and judgements holding them
accountable for failing to detect frauds and other irregularities in spite of
professional pronouncements that they were not so responsible.

In like manner, the SAI community across the world is witnessing increases in
government and government/business corruption growing in geometrical
proportions. There is an undeniable plague of corruption cursing the
governments of every country on earth at this moment. There is likewise a
growing cry of "enough" from citizens across Planet Earth who are reacting with
rage to eject corrupt officials from office, even when this involves stretching
Constitutional principles to the breaking point as evidenced by the Fujigolpe in
Peru in 1992 when a corrupt Congress was turned out and the reverse Fujigolpe
of last month in Ecuador when a corrupt President was forced out by the people,
even though he was only in his first year of an elected four year term. From
Pakistan to Italy to Brazil to Japan to Spain to Venezuela to India to Portugal to
Honduras to the U.S. states of Alabama, Oklahoma, Rhode Island and New
Mexico the public is bodily throwing out corrupt public officials and
simultaneously demanding honesty in government.

In many countries only the SAI is in a position to do the necessary investigative
auditing work to prove the cases in court against corrupt public officials. In
those countries where the SAI is impotent (and there are many) and where the
prosecutorial and judicial functions are at best ineffective and at worst totally
corrupt, who is to satisfy the citizens demand for leadership in the fight against
corruption, if not the SAI?

In those countries where democracy actually works and Congresses reflect the




                                         8
growing outrage of the citizenry with corruption, are those Congresses going to
allow the SAI to avoid entering the anti-corruption battle?

I changed my own mind on this issue a few years ago in Panama when the
Comptroller General there told me that the judiciary could not be trusted to
pursue the Kleptocratic money trails of General Noriega, that the public
prosecutor could not do the necessary work to pursue the millions of dollars
taken abroad by the fleeing officials and that only the SAI stood any chance of
recovering the plundered public treasury. A special investigatory unit was set up
in the Panamanian SAI at that time to pursue and recover the Noriega millions
across the world. This was not a normal SAI function, but if the SAI had not
done it and done it then. Panama would now be even poorer than is.

Now Ecuador faces exactly the same situation having suffered double scandals
in the past two administrations. First the Vice President fled to exile to escape
criminal charges for misuse of reserved funds, then the Comptroller General was
impeached and removed from office for allegedly covering up these transactions.
 In the new government which took office last August the President, also now in
exile, stands accused of diverting many more millions into foreign and family
accounts, the former Comptroller General is to appear before the new anti-
corruption commission this week and the Deputy Comptroller General of the
ousted regime is now sought for arrest because he burned all the records of the
reserved accounts.

In a world which is being devastated by collapsing morals of every kind it
appears likely to me that there will be no other alternative to SAI's than to man
the front lines in the battle against corruption by rapidly developing a special
group of forensic auditors capable of performing independent investigatory
audits wherever corruption is alleged.

Each country and each SAI must make its own decision in this crucial and
controversial area. Organizations such as CAROSAI and INTOSAI can but
serve as fora for discussion and sharing of experiences.

Whether or not the SAI is to enter the jungle of forensic auditing is a national
decision, but one which all countries will face before the turn of the Century.

I am not happy about it, but I predict that most, if not all SAI's will be dedicating
the majority of their audit efforts to forensic auditing during the early years of
Century 21.




Accountability

I am enormously pleased to be able to for the first time participate with you in a
CAROSAI Congress. Only God knows whether I will be able to attend another




                                          9
one in the new Century. So I want to impose a bit more on your patience to
leave you with two personal thoughts which I have gleaned over the years and
then conclude with two inspirational points.

First, with regard to performance measurement and auditing, I have observed
that it is highly unlikely that persons who are unable to be accountable for
money, the most easily measurable of all assets, will be able to be accountable
for performance measurement. Therefore financial accountability is a
prerequisite to performance accountability and that order should be followed.

Secondly, I have observed that those persons who do not recognize their own
accountability to a higher being or power, are highly unlikely to have the
capability of being accountable for money or other resources.
To achieve accountability in government or in business we must first get our
own personal accountability relationships straightened out. We can only do that
through finding and continually strengthening our own faith and trust in the
Supreme Being.

Because of this Congress' emphasis in its theme upon accountability I must share
with you the best definition of accountability I have ever heard or read. It was
written by the black Chief of Police of the City of Charleston, South Carolina
with the unlikely name of Rueben M. Greenberg who practices the Jewish
religion and has become a legend in law enforcement:


       "Accountability isn't hard to define. It's the concept that every
       individual is responsible for his or her actions, is liable for their
       consequences, and must answer to someone if these actions harm
       others...Of the many shining values that hold together the fabric
       of civilization - honesty, kindness, truthfulness, generosity,
       decency - I truly think that accountability may be the greatest of
       them all. Without it there can be no respect, no trust, no law ---
       ultimately, no society.


       "My job as a police officer is to impose accountability on people
       who refuse, or have never learned to impose it on
       themselves...We try to enforce external controls by enforcing the
       law...But as every cop knows, external controls on people's
       behavior are less effective than internal controls, such as guilt,
       shame, embarrassment, fear of punishment, and reluctance to face
       public condemnation or ostracism.

       "The sense of guilt or remorse once associated with the
       commission of a felony has vanished...If we exempt...(the
       criminal)..., even partly, from accountability, we become a society
       of endless excuses, where no one is prepared to accept
       responsibility for anything."




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My farewell which I hope you will try to remember and share with others is a
code of ethics which has endured for over 3,000 years:


              Walk with integrity
              Do what is right
              Speak the truth from your heart
              Do not slander others
              Do your neighbor no wrong
              Do not spread rumors
              Keep your word...even when it hurts
              Lend money without usury
              Do not accept a bribe
              Despise a vile man
              Honor those who revere God

                                    by David
                                    King of Israel and Judah
                                    (from Psalm 15, author's
                                    translation)




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