Speaker 1: [inaudible]
Greg: Hello and welcome to the employee theft hub podcast. My name is Greg Wood. I'm an attorney in San Francisco, California. I've been practicing civil litigation in San Francisco for 20 years, specifically in the areas of trade secrets and embezzlement cases, both plaintiff and defense.
What I would like to do with this employee theft hub podcast, is bring together some other people that I've worked with and people that I haven't, that are in the employee theft area, either trade secrets or embezzlement, and ask them questions, and see if they can tell us some fun stories and see what we could learn from their various experiences. So, we'll get right to it, and like I said, welcome. If you have any questions, feel free to email me; gwood@litigation.com.
All right. We're here with, Joe Rosenbaum of Rosenbaum & Company in Marin County, a forensic consulting firm. Hello Joe.
Joe: Hi, Greg, how are you?
Greg: I'm doing pretty good. Thanks for being on my show here. Show slash experiment.
Joe:
No problem. Happy to do it.
Greg:
Thank you. First question. Let's introduce you. Can you tell everybody a little bit about yourself, maybe just give us your website bio? Pick and choose what you want people to know.
Joe:Oh, sure. Well, I am a forensic accountant, and my background includes investigating financial fraud, both, financial misstatement fraud and also employee misappropriation, and embezzlement, and that sort of thing.
I've done this kind of work for over 35 years. And when I was thinking about that, it was, yikes over 35 years, but that's how long it's been. Mostly with the large, public accounting firms, some of the big four. I had a great opportunity out of college. My background was accounting, undergrad. I have an MBA and a law degree, but right out of college for my first paid gig, I had the opportunity to do an internship with Arthur Anderson in two locations in Europe, and in the Netherlands, and in Switzerland. And so that's sort of steered me on a career path toward public accounting. So, when I got back to San Francisco, I was already employed and decided, however, I wasn't going to be an auditor, but they had a couple of projects that involved forensic accounting. So, I began there and haven't looked back.
I was a partner at both Arthur Anderson and at Ernst & Young, and one of my crowning achievements of Ernst & Young was founding Ernst & Young's data discovery practice where we would do everything from capturing email and sorting through it, to looking through the metadata of various documents. So that's very handy when you're doing particularly large-scale investigations. I've been involved, like I said, in very many large cases and small cases. I testified in the largest case ever brought against the United States; the largest class action suit back in Washington, DC, with anywhere from 250 to 500,000 class members with allegations that exceeded a hundred billion at one point. All the way down to assisting on my smallest case, and that was one where an individual was stealing money out of the till at a charity Christmas street sale. So, that's a bit of my background, Greg. Any questions about that?
Greg: Yeah, that’s pretty good. I don't know whether to ask about the case against the United States or the Christmas tree till - which ones were interesting. I tell you what though, having done this now for a long time, and even in the paper, you see it, there is a lot of nonprofit theft. I see all these stories about the booster club and the coach takes all the money for himself or whatever. Anyway, the Christmas tree story made me think of that. So, tell me about this case against the United States. What was that about?
Joe:Well, it's a very interesting case. It's called the Cobell case. It starts back in the 1800s. I actually had done a couple of cases that are very historical in nature, but this particular one, back in the 1800s, the United States government were trying to resettle native Americans and we're allocating plots of land around the West with the intention that these individuals would homestead. But at the same time, in the thinking of the time was that, the native Americans couldn't manage their own affairs so that the government stepped in and was going to do it for them in trust, and so they created a very, very extensive trust system where in the government was going to account for everyone would lease the land on behalf of all the individuals, keep an account for them, and provided every year the benefits.
Some people had had land that was valuable with timber, grazing, some had oil, which was even more lucrative. Anyway, at some point in time, there was an allegation that maybe the government wasn't doing their trust accounting correctly and that some of the money was being spent and misused and put into the general fund, etc., and so there was a class action brought against the government, asking for an accounting of all of these funds from way back when. Sixty minutes did an episode on it, but it was really quite an interesting thing. But, we were engaged to look at some of the names, class numbers, and trace their funds and their accounting all the way back to the 1800s forward to today.
Greg: Well, that is some serious forensic work for sure. How do you spell that, Cobell?
Joe:Cobell. C O B E L L.
Greg: Got it. Interesting. Well, there we go. Start out with a pretty good one right there. My next question to you was, where do you work now? You have your own shop in Marin County, right?
Joe:Yeah. So I took early retirement from Ernst & Young in 2010, and in 2011 formed my firm, Rosenbaum and company.
Greg: So, thank you for telling me, telling us and everybody about your past there and I will just add, I will repeat that I've worked with you, and some of your staff with great success. We worked on a case together recently in which we got a jury verdict for 10 million, which of course, I'm going to repeat in every podcast episode that I can, because I'm proud of it. But anyway, you were a part of that, and you did great. Well Rosenbaum and company did great work there and you yourself give a great expert witness presentation. So, you do, in addition to just doing the forensic work, you've testified in court a number of times, is that right?
Joe:Yeah, I've testified a number of times, but then there's also been numerous times where, for whatever reason, we have decided to not have testimony. And that's always an interesting discussion.
We had one, another historical case, where it was a very complicated case and we were working as potentially an expert would be called for the defense and in a very significant, broad matter, and the more we discussed findings, the more the defense council decided that it would make better sense to use our team as consulting experts, as opposed to testifying experts, and so we were then made aware of a lot of previously privileged information, and that freed us up quite a bit. That was really quite an interesting experience, I will say, to be really on the team of legal counsel and providing insight and suggestions as to how things ought to proceed.
But to answer your question, yes, we are always prepared to testify on just about any case we begin. As you know, most cases settle. But at the same time, we begin every case with the thought and knowledge that we are likely to be called to testify.
Greg: You know, the case that we worked on involved employee theft, but obviously, forensic investigations go beyond that. You know, just for the completely naïve and new to the world of forensic investigation, what's under the umbrella of forensic investigation in addition to finding out if employees stole or if another business partner has taken money. What else can forensic investigations involve?
Joe:Well, a lot of times, I've mentioned this briefly earlier, the use of data discovery. Forensic accounting, I think now, encompasses such a broad scope, so it's not simply looking at sort of the transactions and seeing how things were booked and the underlying records. And I will tell you a story about one of those but, also, getting into the electronic data.
So, we will have teams together side by side with legal teams looking through email. So, we'll do our searches through the various historical email batches. We can sort it out between things that hit on the accounting terms and separate those out from the legal. A lot of times we'll just do it shoulder to shoulder. But that is something we do a great deal of. Now I don't have my own data discovery and practice, but, have relationships with some very good data discovery shops that allow us to do that.
We also do a lot of interviewing, and that's really one part of the job that really does benefit from experience. When you have done all of the background work that you can look through emails, you've looked through the documentation, you've seen how transactions have been accounted for, and you're armed now with what you think might be the situation. You start conducting interviews. Usually start with those that are going to provide you some background all the way up to those that you suspect might be actually involved as a perpetrator. And it is a skill that can be and needs to be developed. It's not something that you can just jump in and be good at straight away.
Greg: Yeah. It takes me back to my first deposition, and I can't imagine what that was like, but I'm sure I was pretty bad at it. But 20 years later, and now I know it's much more of an art, asking questions and picking up on cues from the examinee.
Joe:Exactly. I mean, it's one thing to have your outline and where you think is going to go, but I will tell you numerous times, I have thrown away the outline after the first question, because the response gives you a whole new insight as to what is going on.
Greg: All right. So why don't you tell us about –you've been doing this for obviously a number of years. We won't count them, but a number of years, and you've got a lot of cases and stories behind you. And so, maybe you could tell us about your most interesting, either embezzlement or employee theft, really anything, but our focus is in the employee arena here. So, if you've got a story from there, great, but tell us, looking back on your career, what's a case that jumps out at you from your work?
Joe:
It was very similar to the one we worked on. It was a situation where a small startup company that left the payroll and check processing in the hands of a single individual. And that happens a great deal. Bigger companies - you've got internal controls, you've got your checks and balances, you've got different people that would have to get involved in order to perpetrate certain kinds of frauds. But in smaller companies, a lot of times the owners are focused on growing the business or making the business better or inventing a new product and aren't really as focused on the background.
The funny one that I will tell you is one, it's not funny from the company standpoint, because they had an individual in charge who over the course of only a year and a half, a brand-new employee had come in to be responsible for payroll and accounts payable, had set up several different fictitious vendors that she was paying that were actually going directly to her bank account. She set herself up to be paid twice. So, she was listed twice on the payroll reports, but through a quirk that identified to the payroll processing company, very large payroll processing company, she was able to process these double payments to herself, but then enter a correction that would show the double payment had been reversed. In fact, the cash had gone out, but the report was changed so that when, if anyone did look at the monthly report, it would seem as though the payroll was correct, even though, an additional check had been written twice a month.
But this went on and probably would have gone on without the notice of the two founders of the company who were, like I said, busy doing something else. But what happened was a CFO of a different company called the owners of this particular company and said, we don't do any business, but why did I just receive a very large check from your company? And it turned out they did a little bit of research. The perpetrator had a spouse that worked at this other company. And over the course of the year, when one or other of the companies had a cash shortfall, this husband and wife team would simply wire money back and forth to the other company to help them cover their cashflow issues, unbeknownst to ownership of either of the two small companies. And so, it turns out that wasn’t - they didn't take any of the money, they were just helping each other out. But it did uncover the fact that - sort of pointed the fact that nobody was actually minding the store and that they were able to get away with a lot of things. So that was one of the more unusual ways that fraud was uncovered, as opposed to finding it through an audit or an internal control.
Greg: Yeah, it actually brings up a good point. It's interesting how these things get uncovered. How much did the perpetrator take in that case? Do you remember?
Joe:I do. Here we're talking about a company, like I said, it was a startup that had only approximately $10 million dollars in sales and over a year and a half, this employee had walked away with somewhat over a million and a half dollars. So, I mean, it was on the one hand astounding that these founders did not realize that a 10th of their sales had been embezzled, but they were, like I said, they were busy on other things.
Greg: Yeah. I am really reluctant to blame the victim, but in each one of these embezzlement cases, there is some room to do that. I've been on the defense and the prosecution side, and in every case you do have to go to management at some point and say, did you ever look at a financial document for 12 months or beyond? Had you looked at it, you might've seen some of these things, that over time sort of get more and more glaring and ugly.
Joe:
And that is a situation where you've got an individual that is completely in charge of - you know, there's really no oversight as you point out. I mean, no one really ever looks, but there are other situations, and another one that I'll tell you, that involves a little collaboration, and this is one where it's a fraud nonetheless, but it was one that was sort of widely known, but I don't think a lot of the participants actually viewed it as such, and it was one that we kind of stumbled upon in doing some investigation about one aspect of a division of a very large fortune 500 company. But what we noticed were, you know, some odd accounting for reserves, and reserves are - it's an accounting construct where you're essentially putting money away for a rainy day. I shouldn't say it that way, but that's the way sometimes it's done. You've got an unforeseen event or, sorry, an unquantifiable event that you know is going to take place in the future, and so you might reserve some money set aside for it,
Greg: Just as examples. Insurance companies obviously have reserves for each case, but they don't know what the ultimate up comes is going to be, but also manufacturers, right, or warranty plans? They maintain fairly decent reserves.
Joe:And actually that's exactly what was going on here. It was in fact a warranty claim. But the interesting thing is that the warranty expense seemed to vary a little more than you would have expected. And ultimately, we determined that the management team of this division was being compensated in a bonus arrangement by whether or not they met certain profitability measures, which is not uncommon. But the thing is that every quarter they either just barely met the profitability standard or missed it by a great deal, and comparing the bonus calculations to how they were setting the reserves pointed out quite clearly, that they were using - if they had a particularly, horrible quarter where they knew they were not going to make their bonus targets, they would go ahead and set reserves at a very high level. In other words, set aside a lot more money, and then, in a quarter where there was going to be a close call, they would reduce these reserves and therefore increase profitability, and therefore, have the bonus kick in. So it was quite an interesting discovery, which I will say, did not go over well at the board level when we were making the presentation, since the CEO of that division had been thought of as a likely successor in a few years to the CEO of the company.
Greg: Yeah, that sounds like a good one. And give us some insight. So, in a situation like that, who hired you to do what? How did this thing unfold? What kind of work did you guys do? Just sort of, if you could deep dive a little bit into the work on that case, just to give people an insight into what a forensic investigation in that sort of context looks like.
Joe:Well, in that context, when they're in this, like I said, it wasn't necessarily just this bonus, but there were some other things. But if there is any, in this particular case, there was an indication that there might be some financial statement, misrepresentations or manipulation. And so, in that case, which is common, if there is a suspicion that maybe there might be someone in the “management chain” involved, the board of directors would step in. And so, it will be set up as an investigation by the board, and in many cases, they'll set up a small subcommittee of the board of directors to be more hands-on and involved in this investigation.
And so, we, as forensic accountants would, work together and under the purview and privilege umbrella of outside counsel and conduct an investigation to see whether or not any of the allegations were true, or whether they were not true. At the same time, if we uncover anything else that might be a problem, we're obliged to bring that to everyone's attention as well. But in many of the cases that I've worked on, we have been - our clients so to speak is the board of directors or a subcommittee of the board. And so we would conduct our investigation. As I said, one of the examples earlier we would, and did get email from a number of people that we could then sort through and see if there's any discussion about any of the financial statement or misrepresentation. We looked at a lot of the records and then we conducted interviews.
And ultimately what we do is we present our findings to the board of directors. The board of directors then has to make a decision as to what to do, whether it's going to be dismissing management or somehow - you know - dealing with management at that level. But some of the cases, then they have to decide whether or not they're going to report it to either both the DOJ and, or the, the SEC. So that either the, if it's a publicly traded company, the securities and exchange commission wants to know about any issues with financial statements and the department of justice, likewise likes to know about any fraudulent manipulation.
Greg: Right. So, in this case, you were - this manufacturer - the board of directors must have had some suspicion or at least wanted to run something down, hired you guys and then you guys came in, and probably not welcomed at least by the warranty division folks that were being investigated. But, you go in and start asking for records and emails and start conducting interviews. And where did the interviews happen? Did they happen on the company's premises or somewhere else?
Joe:Almost all interviews will happen on company premises. There have been situations where, we can do them remotely, or someone would prefer not to be seen talking to the folks doing investigations - they'd rather not be seen on site, but by in and large, a conference room is set up and we'll come and just invite people to have their interview taken.
Greg: And do they know why you're there? Or do you have to say you're there for a different reason, something, you know, more -
Joe:No, there have been times when we are viewed more as sort of regular auditors, but by in large there’s no real reason to sugar coat it or to try to do anything too sneaky. It’s usually known. We don’t advertise it, but word gets out. It’s amazing how the water-cooler-talk and the grapevine will announce your presence within an hour of arriving on site
Greg: Yeah. In that case that you were talking about with the warranty and the reserves, how many people were involved with the scheme?
Joe: There were - I am going to say not many. Maybe three or four. And like I said, I don't know that they really viewed it as being that bad, unfortunately. And that maybe infects a lot of white-collar crime is that, I think they were simply of the opinion that this is the way things were done. If it had been done that way, the prior quarter or quarters before, let's just continue to do it, that's just the way work is done. And I've seen that in other occasions too, where people are failed to really ask a hard question of themselves. What exactly are we really doing? And is this right? But in that case, we did interview folks and they explained, I mean, when you have the documentation and you have email evidence, and you already know going in, or have a real suspicion as to what was going on. It's very difficult for someone to try to convince you otherwise. Some try, but most will acknowledge what was done and maybe trying to make an excuse, but, in this situation, we never did interview the CFO directly. We got to the point where we knew exactly what was happening. We didn't really need to interview that individual. We just presented it the board and the board, in that case, did go to both DOJ and the SEC. But they also disciplined the CEO. I think he was let go very unceremoniously soon thereafter.
Greg: Right, right. And you did another thing that, you touched upon is - there is this sort of amazing, I'm going to call it an entitlement - a sense of entitlement, even in the most egregious employee theft where they're just taking money. They will find so many ways to rationalize and justify what they were doing. And you very rarely if ever see any remorse from them or any recognition that, Oh, yeah, you're right, this was - even the ones that get the FBI gets involved and they go to prison. I've taken their deposition, and none of them have said, yeah, I screwed up, that was a bad thing. You never hear that.
Joe:I'll tell you one more story, Greg. I hope you have time.
Greg:
I do. Yeah, yeah.
Joe:
There was one case where, and it was kind of interesting. I don't remember exactly what prompted the investigation, but we were working for the board in a company. It was a private company, but they had had hopes of going public. And so, it was built up by the CEO. He was a very hands-on CEO. He had a fairly compliant CFO, chief financial officer. They had hoped to take the company public, but it kind of run into some problems. The sales were a bit lagging and they didn't think they were going to be able to go public, but they then pinned their hopes on trying to sell it to a bigger company. And this would benefit everybody in the company, obviously. An IPO would allow everyone to cash in some of the stock that they had, or the options that they had. Obviously more benefit to the officers.
But they started down this slippery slope and started doing some things that were really bad. They started falsifying sales, saying that the shipments were made and putting them over in the corner of the warehouse. This is some of the things that maybe you or your listeners have heard about, but that does happen. This was a company here in the U.S. but were making a lot of sales in Asia. But one of the other things they tried to do to get it ready for sale - on a sale was being negotiated, was to show that their gross margins were really good, but that they were just spending a lot of time with sales and that was why the company wasn't very profitable. So they had a real incentive to show that the gross margins were okay.
And I'll briefly explain that in a financial statement, a gross margin is essentially a calculation of how much every sale is going to benefit you. So, every sale is worth a lot of money, that's great, and then you can still lose money by trying to increase the number of sales through some of your marketing efforts and things like that. But the gross margin, how much money you make on every sale, is a widely looked at metric. So one of the things that they did, they started cutting their prices, but they didn't want to show this because the gross margin would suffer. So instead, they created some documentation that made some of these discounts for the discounted revenues appear as if they were marketing costs. And so even though the bottom line is the same, it looks a little better to someone thinking of buying the company.
The board is - we were doing this and we didn't really have a lot of hard documentation. We had heard a number of these things we had not yet visited Asia. We were pretty sure that we understood what the code words were in the email that we were listening to, but the board was still a little in disbelief that this would happen and could happen. And during one of the presentations that I made, which changed their mind completely was one, in which, I said, okay, here are a number of documents, and I'm going to walk you through and explain why we think it is the way we are, but I want you to take these next two. And I want you to hold them up to the light, put them together and hold them up to the light. And what you can see is that there, these two documents were exactly the same, except that the middle part of it had been whited out and change from one document to the other. And I had received these two documents during an interview in someone's office, where I was simply talking about how they did document these various discounts. And the individual did not think they were doing anything wrong, just doing what they were told and had kept copies of both the original and the one that had been whited out and changed. So that definitely changed the entire tenant investigation
Greg: Yeah
Joe:At that point, we never got to interview the CEO because he fled the country to his home in a foreign country that did not have an extradition treaty with the United States.
Greg: Now, that is a good story. Yeah. I definitely think if you're getting the whiteout out, that right there should trigger something in your mind, something's wrong. Nobody uses whiteout, but still - that's a fun one. Go ahead.
Joe:
You know, Greg, nobody uses white out anymore, but documents now are just as easy to manipulate. You can manipulate PDFs. And that I think is a big challenge now because it is easy to change electronic documents. And the only way to really understand and combat that is to have someone look at what the metadata of documents should do. It's not sufficient any longer to simply look at a hard copy document. You really need to look at the underlying electronic document.
Greg: And so that kind of ties into what you were saying when you were just describing some of the experience that you have. So you were talking a lot about that discovery practice and forensic investigations being more than just following the money, which is at least one pillar of what forensic investigation is, and I'm sure you'd agree, but it sounds like another pillar, especially in this day and age, like you say, with electronic documents so easily manipulated, that any good forensic investigator is going to need to know what to look for when it comes to just looking at invoices and records and just being able to tell by looking at them saying, Hey, you know what, this one's a little bit off. This one is where we need to dig into this a little bit more.
Joe:Absolutely. A healthy sense of skepticism, or maybe even an unhealthy sense of skepticism is sometimes required when doing some of these investigations
Greg: You mentioned startups a couple of times and doing some work in that space. There's so much money to be had when these companies convert, whether it's going public or being bought or whatever. There's so much pressure, you know, to make sure the deal goes through or even get the company to be inviting, and then, step two, to make sure the deal goes through. Really a lot of pressure on people, and they stand to make so much money. It seems to me, that's just an area that's ripe for fraud, or just very inviting for fraud.
Joe: Well, I will tell you, that's absolutely correct. And you've got different motivations. And so there's, I'll explain one, one other recent investigation that we did.
It was a startup company that several of the investors were well-known individuals and well-known companies that had put money into this. Ultimately, the company was not viable. And so they commissioned an investigation as to what went wrong in an attempt to point blame. And there were instances of, expense account abuse. There were large parties and first-class travel to go to different conferences and things like that that you could classify as a problem. But the truth of the matter was that, the investors were hoping just like everybody else, that this was going to be a home run company. And whether they knew of some of these abuses or whether they chose to ignore them, they were fairly obvious. If they had taken any opportunity to look at all, and these were sophisticated investors. But it's only after the music stops that suddenly they want to assign blame. So there are a lot of situations that are a little different when it comes to startup companies in today's environment, because so many of these startup companies can get very big very quickly and make a lot of money for the founders and early investors.
Greg:
Yeah and you know -
Joe:
A lot of them go belly up.
Greg: You know what always surprises me too is, I think it's almost a myth that if you have an audited financial statement that somehow the company is clean. And I mean, I do work with accountants. So I know and, anybody who's got an audit the engagement letter says, the audit is not going to detect fraud, it's not designed to detect fraud. And yet that's really the main tool that investors use when determining money. You have an audited financial statement. Okay. And they sort of stopped there. I mean, correct me if I'm wrong, but an audited financial statement is not designed to detect fraud. It doesn't tell you whether fraud is going on.
Joe:No, you are 100% correct. And there's actually a term for that in the world of accountants. And it's called the expectation gap. And that expectation gap is exactly what you described. An audit opinion states very clearly what it is and what it isn't. But you're right. Some tend to view it as a little bit more broad than it's intended. So over the years, different of the regulatory bodies have added requirements that auditors consider fraud in their audit, in order to kind of help narrow that expectation gap. But it's not completely narrowed there, but you're absolutely right.
Audited financial statement is not a guarantee that the company is sound or well-managed or going to be around for longer than - well, there's one provision if it's a growing concern that you have questions as to whether it's going to last a year -
Greg:
Right, right
Joe:
But there's no question that it's going to be able to make it through a year. There's no guarantee that it's going to be ultimately successful. So there is that big expectation gap. And that is why a lot of times accounting firms get sued, but generally are able to be dismissed from suits pretty quickly based upon the audit opinion, what it says and says it's doing and what it's not doing.
Greg: Yes, yes. Like I’ve said, I defended accounting firms and we're usually able to get out based on, stated in the engagement letter and in the opinion itself, unless there was something done wrong with the audit. But if the audit was done correctly, the fact that there was fraud was not detected doesn't keep the accounting for a minute.
Well, thank you, Joe. I really appreciate you taking the time. You've obviously got some awesome war stories there. Very interesting cases if CEOs are fleeing the country. I don't know how you can beat that. That is a job well done. I would say if you've caused management to hop on a plane and fly away.
So anyway, thank you very much for taking time out. I really appreciate it. I would encourage anybody in the San Francisco community - any startup who is under pressure and suspects something to call you and anybody else too, that is in this forensic work. But thank you very much.
Joe: Okay, not a problem, Greg. I'll talk to you soon.
Greg: Okay. Have a good one, Joe.
Joe:
Okay. Thanks.
Speaker 1: [inaudible].