False Financial Statements

The most common form of financial statement fraud involves the premature or fictitious recognition of revenue. This is often done to meet quarterly earnings targets or loan covenants. Schemes include channel stuffing(shipping excess inventory to distributors that they did not order) or booking sales before the contract is finalized.

We scrutinize the specific transactions flagged by the government. We often find that the dispute centers on the timing of the revenue recognition rather than the existence of the revenue itself. If we can demonstrate that the executive believed in good faith that the criteria for recognition were met (based on a reasonable interpretation of accounting rules), the element of criminal intent is negated.

To make a balance sheet look stronger, companies may overvalue assets or hide debts. This can involve keeping off-balance-sheet liabilities in special purpose entities or failing to write down obsolete inventory.

In real estate or investment cases, this often turns on valuation methodologies. We employ independent valuation experts to testify that the asset values reported were within a reasonable range of fair market value at the time. We argue that valuation is an art rather than a science and that an optimistic valuation is not synonymous with fraud.

Not every error in a financial statement is a crime. The error must be material. This means there is a substantial likelihood that a reasonable investor or lender would consider the information important in making a decision.

If a multi-billion dollar company misstates earnings by a trivial amount, it may be a regulatory violation but it is unlikely to be criminal fraud. We aggressively challenge the government’s theory of materiality. We analyze the stock price reaction to the restatement. If the market did not react significantly when the truth was revealed, we argue that the misstatement was immaterial and therefore not a valid basis for a securities fraud conviction.

Under 18 U.S.C. § 1350 (enacted by SOX), corporate officers must certify that financial reports fairly present the financial condition of the company. Certifying a false report is a specific crime punishable by up to 20 years in prison if done willfully.

This statute eliminates the defense of "I didn't look at the details." However, it still requires knowledge. We defend clients by showing that they relied on a robust system of internal controls and sub-certifications from lower-level management. If a CFO was lied to by a division manager, the CFO’s certification (while factually incorrect) was not criminally willful.

When false financial statements are submitted to a federally insured financial institution to obtain a loan or line of credit, it triggers bank fraud charges under 18 U.S.C. § 1344 and false statement charges under § 1014.

These statutes are incredibly broad. The government does not need to prove the bank lost money. They only need to prove the defendant knowingly submitted false information to influence the bank’s action. 

Common allegations include:

• Inflating accounts receivable to increase a borrowing base
• Removing payables from an aging report
• Fabricating tax returns to support income claims
• Failing to disclose existing liens on collateral

We attack the "influence" element. If the bank manager knew the true state of affairs and approved the loan anyway (or if the false statement was about a minor asset that was irrelevant to the credit decision), we argue that the statement was not capable of influencing the bank.

The government relies heavily on FBI forensic accountants and SEC enforcement accountants to build their case. These experts sift through terabytes of general ledger data, email communications and journal entries to find the smoking gun.

They look for manual journal entries made late at night or on weekends (often used to override automated systems). They look for round-number entries which are statistically rare in genuine accounting. We counter this by deploying our own forensic team to provide context. We show that the "suspicious" entries were legitimate adjustments made during the closing process to correct errors, not to commit fraud.

Many cases originate from a tip under the Dodd-Frank whistleblower program which offers financial rewards to employees who report fraud. This creates an incentive for disgruntled employees to characterize incompetence as fraud.

When a company receives a tip, it launches an internal investigation. This is a critical juncture. Corporate counsel represents the company (not the individual executives). We advise clients during these internal interviews to ensure they do not inadvertently waive their Fifth Amendment rights or provide confused answers that can be framed as obstruction.

The most powerful defense in financial statement cases is reliance on professionals. Executives rely on external auditors to review their books and on internal accountants to prepare the data.

If an external auditor reviewed a transaction and signed off on it (or if the company’s outside counsel approved a disclosure), the defendant cannot be convicted of fraud for that transaction. We gather the "work papers" of the auditors to prove that they were aware of the accounting treatment and raised no objections. This shifts the blame from the client to the gatekeepers who were paid to ensure accuracy.

GAAP is not a set of black-and-white rules; it is a collection of principles that often allows for multiple correct treatments of the same transaction. We exploit this ambiguity.

We argue that the defendant followed one permissible method while the government prefers another. A difference of opinion is not a crime. We use expert witnesses to testify that the accounting treatment chosen by the defendant was defensible. If reasonable accountants can disagree, there is reasonable doubt as to criminal intent.

We fight aggressively over the loss calculation. The government often attributes the entire decline in stock price to the fraud. We argue that market forces, industry trends or other bad news caused the drop.

By hiring economic experts to perform an event study, we can isolate the portion of the stock drop specifically attributable to the revealed accounting error. Reducing the loss amount from $100 million to $5 million can reduce the potential sentence by decades. We also argue for variances based on the fact that the defendant often did not personally profit from the scheme in the same way a thief would.

In addition to criminal penalties, defendants face civil enforcement from the SEC. This typically includes an officer and director bar which prohibits the individual from ever serving as an executive of a public company again.

For CPAs and attorneys, a conviction results in the permanent revocation of their professional licenses. We negotiate concurrent settlements with the SEC and the DOJ to manage these collateral consequences. In some cases, we can negotiate for a time-limited bar rather than a permanent one (allowing a younger client the possibility of a future career rehabilitation).