Clients who turn a blind eye: No fight in this dog?

Small and medium sized businesses, often family owned and operated, are havens for fraud and financial wrongdoing in difficult times.

Salutations to my friends in the north! We are finally digging out from the worst winter in Chicago’s recorded history: the second coldest and the second most snow. That combination makes 2013-2014 one for the record books, but the inclement weather has not slowed “evil-doers” one bit. Over the past few months, I’ve been hired to investigate a variety of alleged acts involving small family-owned businesses. Typically, these allegations have centred on a trusted friend or family member breaching that faith to divert business assets, primarily cash or credit cards, for their personal benefit. After hearing the initial allegations, I perform a preliminary investigation revealing that not only are the known bad acts real, but the damage may be far worse than originally expected. Again, this is typical of a large portion of the investigations I conduct, so nothing is unusual about this story – yet. Here’s the kicker, after I communicate preliminary findings to the clients, the combination of family/friend relationships and economic uncertainty have led every single client to promptly call a halt to my efforts. This has happened several times and leads me to conclude that there must be some trend emerging in the world of forensics. In the past few months, I have heard such quotes as “yes, it is well over a million bucks, but we think that’s about the extent of it” and “we think he’s only taken $200,000 to $400,000, so we’re not that concerned.” These used to be the types of dollars that would lead a client to exclaim “I want to know EVERYTHING!”

So, what’s really behind this unsettling trend? Since the economic meltdown of 2008 in the United States, I know of many, many potential investigations and lawsuits that have gone untouched due to the current economic condition and fear of the unknown. But to start an investigation and stop it after finding out that things are truly bad? This makes no sense to me. Based on these recent developments, I have concluded that individuals and business entities are so loathe to commence litigation that they have become willing to make horrific settlements with crooks just to get them out of the picture. In truth, these “deals” which are intended to avoid bad litigation usually end up creating worse litigation because the victimized party wants to minimize their perceived damage. In a paradigm right out of Hans Christian Andersen’s The Emperor’s New Clothes, the aggrieved will settle with the bad guys based on a small damage amount, as if agreeing to it changes the reality and severity of the situation. Imagine a business owner who finds out after a preliminary investigation that his cousin, the CFO, has stolen $500,000 from his business. Instead of investigating further to determine the full extent of the damage, the CEO calls the forensic work to a halt. Then, just to get the cousin out of the business, the CEO agrees that the CFO will pay $100,000 in restitution and leave in six months. What if the actual damage is more than $1,000,000? Even if the full extent of the loss is $500,000, why settle for a mere fraction? I wish I had the answers. I would love to hear from you about this “phenomena,” especially if you are a part of a family owner/operated entity.

I completely understand that it is emotionally wrenching to acknowledge that someone you know and trust (and possible love) has betrayed you. These business situations are not unlike a divorce and emotions run high, but rarely in divorce do I see a party agree to a horrific settlement without fully contemplating the ramifications and having a clear sense of the big picture.

The answer I keep coming back to is that my clients must have some dirt on their own hands.   Cynical, I know, but highly likely. In one recent case, I confronted an outgoing CFO with data indicating fraud and he quickly provided spreadsheets detailing how my client had ghost employees on the family business payroll and had been submitting credit card expenses that were entirely personal (over $50,000 per year) for years. Ouch! Talk about a compelling way to kill an investigation!

So, my revised theory is this, small and medium sized businesses, often family owned and operated, are havens for fraud and financial wrongdoing in these difficult times. Second and third generation members often feel entitled to lifestyles and cash flow and will dig as deep as they want to into cash and cash reserves to facilitate this. Stakeholders in these entities who are not a part of the family need to be keenly aware of this growing trend and ask the tough questions. Accountants not only have a moral code, but an actual code of ethics to follow. Idly sitting by which, in effect, tacitly endorses unethical behaviour, is a complete failure. You may protest, “It’s my biggest client, it’s my boss, I need this job!” All true, but if you are quietly participating in theft, what are you truly losing?

Heavy stuff, I know…

I can’t wait to return after the NHL playoffs and my Hawks have defended the Cup!

Are you a part of a family owner/operated entity? Have you seen member of the family get away with despicable acts while non-family members are treated harshly? Let me know what you think or share your story online.

About the Author

Brad Sargent, CPA, CFF