CPA was hired to be an expert witness in a civil fraud case. On
cross-examination the opposing attorney asked the expert a seemingly
simple question: “Would you please define ‘fraud’ for the jury?” The CPA
replied, “Do you want to know the legal definition or my definition?” The attorney countered, “You mean there is a difference?”
The expert’s answer provoked a snicker from the judge and jury, and
the CPA’s credibility went downhill from there. Before the
cross-examination was over, the expert was made to look like an idiot.
The truth is, the CPA knew a lot about accounting and he was well-versed
in the facts of the case, but he knew little about the legal aspects of
fraud—a crucial element for an antifraud witness. As a result, the case
was lost. This article will summarize the basic common-law concepts of
fraud, beginning with the requisite: The purpose of this article is to
familiarize you with the law, not to provide legal advice. For that,
check with your attorney.
Definition of Fraud
All multifarious means which human ingenuity can
devise, and which are resorted to by one individual to get an advantage
over another by false suggestions or suppression of the truth. It
includes all surprises, tricks, cunning or dissembling, and any unfair
way which another is cheated.
Source: Black’s Law Dictionary, 5th ed., by Henry Campbell Black, West Publishing Co., St. Paul, Minnesota, 1979.
Appeals courts direct trial judges to closely examine the
qualifications of purported experts before allowing them to testify.
Failure to answer the basic question above could mean the “expert” might
not be allowed to testify. Imagine the implications if the case had
been lost because the time for naming new experts had passed.
To qualify as experts, CPAs have to give proof of knowledge,
education and/or experience to convince the judge they have reliable and
valuable information for the jury. (See “ So You Want to Be an Expert Witness. ”)
Qualification is on a case-by-case basis; despite public misinformation
by some groups, a blanket qualification—even for CPAs—does not exist in
any court system.
Criminal and civil frauds differ in the level of proof required. For
civil cases that burden is a “preponderance of evidence.” In criminal
fraud the standard is “beyond a reasonable doubt.” WHAT CONSTITUTES FRAUD Under
common law, three elements are required to prove fraud: a material
false statement made with an intent to deceive (scienter), a victim’s
reliance on the statement and damages. A material false statement. Let’s assume an
attorney hires you to examine the financial statements of ABC Corp. The
attorney represents shareholders who have filed a lawsuit against ABC
claiming the financial statements are fraudulent. Your job is to help
the attorney determine whether the claim constitutes fraud. You begin by
seeking to find out whether the financial statements contain false
statements, and if so, whether they are “material.”
Books CPA’s Handbook of Fraud and Commercial Crime Prevention (# 56504JA). Financial Reporting Fraud: A Practical Guide to Detection and Internal Control (# 029879JA). Fraud Detection in a GAAS Audit (# 006615JA). CPE Introduction to Fraud Examination and Criminal Behavior (# 730275JA). Identifying Fraudulent Financial Transactions (# 730244JA). Finding the Truth: Effective Techniques for Interview and Communication (# 730164JA).
For more information, to register or to place an order, go to www.cpa2biz.com or call the Institute at 888-777-7077. Antifraud initiative Antifraud and Corporate Responsibility Resource Center, http://antifraud.aicpa.org/ .
SAS no. 99 information. Management Antifraud Programs and Controls (SAS no. 99 exhibit). Fraud Specialist Competency Model. Free corporate fraud prevention training and CPE. Academia outreach and assistance. Other antifraud activities.
For CPAs, materiality is a familiar concept. Generally speaking, a
transaction is material if prior knowledge would have changed the
outcome of the investor’s decision to part with money. The good news for
CPAs is that this element of proof typically involves familiar ground:
determining the real numbers. But CPAs inexperienced in fraud cases
might stop there. In reality, they should just be getting started; the
real work comes when proving intent.
There is no such thing as an accidental fraud. What separates error from fraud is intent ,
the accidental from the intentional. Assume ABC’s financial statements
contain material false statements: Were they caused by error or fraud?
The problem with proving intent is that it requires determining a
person’s state of mind. As a result, intent usually is proven
circumstantially. Some of the ways we can help prove intent by
circumstantial evidence include Motive. The motive for fraud is a strong circumstantial
element. In the case of ABC Corp., for example, the CPA could attempt to
prove the company was in financial trouble or that earnings per share,
if correctly stated, would have fallen below analysts’ expectations. Or,
if managements’ compensation is tied largely to earnings performance,
documenting that would help establish motive. Opportunity. Management typically has the opportunity to
circumvent or override controls over financial reporting. To prove this
element the lawyers would call witnesses from ABC to testify and
introduce documents relating to job descriptions. The CPA usually would
help identify the specific control weaknesses or overrides that allowed
the fraud to occur. Repetitive acts. Should the financial statements contain a
single false journal entry, a fraudster might be able to claim it was an
error. Or if an employee steals once, he or she may be able to explain
that away. Frauds, whether involving asset misappropriations or
fraudulent financial statements, usually are not single acts. For
example, assume that someone at ABC Corp. decided to inflate last year’s
earnings by falsely debiting accounts receivable and crediting sales.
Since one single large entry might draw attention, it is more likely
there would be numerous false entries of smaller amounts. This fact
makes it more difficult for the ABC fraudster to claim it was an error. Witness statements. Circumstantial evidence rarely can be
sufficient without the statements of witnesses. In a typical financial
statement fraud case, management directs underlings to make the
fraudulent entries. The CPA typically would identify the potential
witnesses, such as bookkeepers or other accounting personnel, who may
have made the fraudulent entries. Concealment. Honest people rarely have the motive to conceal
their acts. Therefore, if, for example, the CEO ordered the destruction
of key ABC documents prior to an audit, this could be powerful
circumstantial evidence of intent. Victim reliance. Even when there is a
material false statement and the intention to deceive can be proved, it
does not meet the legal test for fraud unless there is a victim who
relied on the false statement. That usually is proven by having the ABC
shareholders testify they would not have invested had they known the
true financial condition of the company. It may be even more challenging
to prove reliance by banks extending loans, especially in cases
involving self-employed borrowers who default on an obligation. In many
such cases, the bank would have secured the loan with lots of hard
collateral, or it may have done its own due diligence, thus making it
difficult to prove it actually had been relying on the financial
statements when credit was approved. Damages. The final legal element of fraud
concerns damages—usually in terms of money. In some federal criminal
cases—for example, bank frauds—an actual loss is not required. But
normally, even when there is a material false statement, intent and
victim reliance, there is no fraud if the victim is not damaged. For
example, the shareholders of ABC hardly would be filing suit if the
price of the stock went up as a result of the other elements’ being
There are two major types of damages: actual and punitive. The CPA
will assist the attorney in determining actual damages; the judge and
jury will assess other damages, subject to statutory limitations. In
ABC’s alleged fraud, the CPA might be required to restate the
shareholders’ equity in light of the fraudulent financial statements.
Alternatively, if the stock price has suffered as a result of publicity
about the fraud, the CPA typically would determine the amounts involved.
The attorney would argue that whichever method produced the largest
amount should be allowed as financial damages. The applicable measure of
damages—for example, benefit of the bargain, out of pocket—can vary
from state to state and case to case. The attorney will determine which
measure applies. The CPA can be an invaluable resource in performing the
calculation and proving the amounts.
securities laws address financial statement fraud, prosecutors often
also will charge criminal violations under one or more of the below
categories, depending on the exact circumstances of the case.
Misrepresentation of material facts. Concealment of material facts. Bribery. Illegal gratuities. Conflicts of interest. Embezzlement. Theft of trade secrets. Mail fraud. Wire fraud. Interstate transportation of stolen property. Racketeer Influenced and Corrupt Organizations (RICO).
False claims and statements. Conspiracy. Foreign Corrupt Practices Act. Bankruptcy fraud. Financial institution fraud. Health care fraud. Identity theft. Telemarketing fraud. Computer fraud. Economic espionage. Money laundering.
The criminal prosecution of fraud (see exhibit ,
above), as well as civil frauds, share a common thread: They both
contain the legal elements of fraud. So if you get into fraud work of
any kind, know these elements. And know them well. That way, your definition of fraud and the legal definition are one and the same.