Forensic Accounting in Connecticut Business Litigation

Forensic accountants are frequently necessary in business litigation.  This is my next installment of the "ask the experts" series.   Stephen Pedneault is an expert in forensic accounting.  He is the principal of Forsenic Accounting Services.  Here is my interview with Stephen.

Disclaimer:  I am not endorsing any experts that I feature on this blog or the opinions expressed.  I am posting these interviews to offer insights from the various professionals that get involved with business litigation cases.

What are the biggest issues you see now with respect to forensic accounting and business litigation?  Probably the biggest issue we face in every case regardless of the venue it’s in is the availability of records. We can pretty much figure out anything if we have records available, computerized records or paper records. The biggest challenge for us is getting access to them and actually getting the opposing side to produce them. That’s our biggest stumbling block in pretty much every engagement we do. 

If a business owner suspects fraud, how soon should they come to you or an attorney to deal with that issue? 

Well as soon as possible. We get a lot of calls from exactly the audience you described and one of the first things we have to ask them is you know do you have counsel, do you have an attorney that’s either representing you as a shareholder or a partner or a member, or does the LLC or the entity have counsel because before I hear too much of the story there’s no privilege between an accountant and a client. So I don’t want to hear too much, what I want to make sure is as early as possible, I want to be involved early, but I got to make sure that before I’m involved early on there’s an attorney involved so we can establish some attorney/client privilege and then we can get retained directly by counsel to be part of that privilege and then we can start talking about what are the issues and concerns. 

What can business owners do to stop or detect or prevent fraud amongst it’s employees?   When we’re talking employee embezzlement, there’s really only three things that are available. You can prevent certain things, you can detect certain things, and then you can insure against the things you didn’t prevent and detect. Certainly setting up the controls to prevent as much as possible, so employees not signing checks, having business owners involved in the signing of checks, not issuing credit cards and bank cards to employees, limiting what they have access and opportunity. That’s on the prevention side but you can’t prevent everything from occurring so on the detection side, starting with the basics, the owners looking at the bank statements every month, looking at the cancelled check images, looking online at the banking activity, looking at accounts receivable, knowing who owes what balances and are we getting paid, managing the cash flows. These are all important basic controls that over time probably start out as the owners are doing but then people get busy and they hire key people and they delegate the responsibilities and once again you know down the road that key employee, and it’s almost always the key employee that we depend on, has taken advantage of the situation and started either stealing the checks or paying themselves extra payroll or stealing the deposits.  

 What kinds of problems have you come across that have been created in terms of your investigations of fraud brought about by smartphones and portable devices?

Well there is two clear trends. One is that our evidence which was already computerized is now becoming wireless. The evidence meaning the transactions and also where the records are maintained. This whole concept of cloud computing, businesses are putting all their business records no longer on their servers, their putting it out on a server somewhere in the world. So they can access it anywhere on the internet. The problem is gaining access to that evidence is going to be a challenge because nobody really knows where it’s hosted. It could be hosted next door, it could be hosted in Nigeria. So getting access to the ultimate records of where the company’s accounting system is maintained is a challenge. Using cellular devices to do the banking there is no history on any laptop servers or computers, it’s all wireless. So the whole nature of gaining evidence is changing and becoming a huge challenge for us just to get access to it. 

What records do you look to get access to from an audit perspective and also what form of the records do you like to receive it in?

That answer depends on what the context is for the forensic accounting. Ultimately we want to see the underlying reliable records: bank statements, cancelled check images, deposit details, credit card statements. We like the general ledgers, we like the computerized records but they can all be manipulated so we like to get, we’d like to get the records but we’d like to be able to corroborate them to underlying source third party records that are ultimately reliable and whether we get them in computerized form, we get them in images, we get them in paper, it doesn’t really matter to us, we’re used to dealing with boxes and boxes of records.

Connecticut Business Lawsuit Roundup

As a new addition in 2011, I am going to regularly feature new business lawsuits along with the usual trial and appellate decisions of interest in Connecticut.  Here’s the first installment:

Appellate Court:

Cianci v. Original Werks, LLC 

Appellate Court finds that $150,000 mechanic’s lien was timely filed despite claim that it was made after statutory limit of 90 days from date "services" were performed. The decision includes a discussion of the legislative history of the mechanic’s lien statute and the definition of "services" under the statute. The court determined that services includes work done in or utilized in the building to be constructed, raised, removed, or reparied or the improvement of any lot or subdivision. In this case, the court construed the mechanic’s lien statute liberally and found that that contractor returning to the property at the request of the homeowner to investigate alleged deficiencies constituted lienable services.

Walpole Woodworkers, Inc.  v. Manning

Appellate Court finds that homeowner who raised the Home Improvement Act’s technical requirements of start and finish date in bad faith.  The Home Improvement Act in Connecticut requires registered contractors to include the following in written agreements:

  •  signatures of owner and contractor
  • name and address of contractor
  • cancellation rights
  • start date and completion date

Failure to include these requirements can result in technical defenses to enforcement of a  home improvement contract.  However, a homeowner cannot successfully raise these defenses in bad faith.  In this case, the homeowner had no real dispute with the work but refused to pay.  The Appellate Court upheld a finding of bad faith when the homeowner tried to raise the lack of start date and completion date in the contract.

Read here for one of my old posts on Connecticut’s Home Improvement Act requirements and defenses.

New Lawsuits:

Environmental Energy Services, Inc v. Cylenchar Limited, et al.  United States District Court.

Plaintiff Environmental is a Connecticut corporation and claims that Defendants (both from England) made misrepresentations which induced plaintiff to perform services. Plaintiff claims breach of a partnership agreement, unjust enrichment, fraud, and violation of Connecticut’s Unfair Trade Practices Act. Plaintiff alleges that it was in a joint venture business with Defendants to market a technology that removes mercury from exhaust gasses in coal fired utilities. Pursuant to the joint venture, Defendants were to provide a significant cash investment, provide technical assistance, and a license. Plaintiff was to market the technology. Plaintiff alleges that it spent significant sums marketing the technology and gaining a trial customer for the new technology at which time the Defendants issued a cease and desist to Plaintiffs and refused to continue with the joint venture.

 

Tellar v. Webber, et al.  State Judicial District of Hartford.

Plaintiff and Defendant were equal owners of a limited liability company (LLC) engaged in the relish making business.  Plaintiff alleges that Defendant, his co-owner, dissolved the LLC without consent and started another relish business.  Plaintiff alleges the Defendant did so without sharing profits or including Plaintiff.  Plaintiff brought suit as an individual and derivatively on behalf of the the LLC against his co-owner in the LLC and the co-owner’s new business.  The Plaintiff claimed breach of contract to share profits, breach of good faith and fair dealing, breach of fiduciary duty, conversion, civil theft, unfair trade practices, and usurping a corporate opportunity.

Constructive Trusts In Connecticut For Fraud and Unjust Enrichment

In business litigation in Connecticut, attorneys many times seek to impose a constructive trust over assets or income connected to wrong doing, breach of fiduciary duty, or fraud by business partners or agents.  In a decision to be officially released on November 23, 2010, the Appellate Court upheld a trial court’s  imposition of a constructive trust over certain assets of a business.  The case is Trevorrow v. Marcuccio, and you can download it here.

A constructive trust is not a real trust.  Rather, it is a judicially created trust and thus the term "constructive."  It arises when one party unjustly holds title or rights to property, such as assets or profits of a business partnership or corporation.  The wrongdoing may involve simply retaining property, misappropriating property, or converting the property into another form.  The trust is imposed against the wrongdoer who will be deemed to hold title of the property for the benefit of the innocent party.  In Trevorrow, the Appellate Court stated:

the issue raised by a claim for a constructive trust is, in essence, whether a party has committed actual or constructive fraud or whether he or she has been unjustly enriched

Typically, you see attorneys seeking constructive trusts in cases involving fraud, duress, breach of fiduciary duty, or some type of commission of a wrong.  However, the Trevorrow court clarified that the equitable remedy of a constructive trust is not only available in cases of actual or constructive fraud, but it is also available in cases where one party has been unjustly enriched at the expense of another even without a finding of wrong doing. 

In short, in Trevorrow, there was no finding of fraud or unethical conduct.  Rather, the court simply found that one person in the business relationship would have been unjustly enriched if permitted to keep the property. The Trevorrow case also serves as reminder that the trial court’s enjoy discretionary equitable powers to impose constructive trusts if proper facts are present.

Fraud Lawsuits In Connecticut – Is A Promise of Happiness Fraud or Puffery?

Debra Cassens Weiss yesterday posted on article on the ABA’s website about the psychic Sean Morton who is being sued for fraud for taking 6 million dollars from investors on the promise of piles of money and spiritual happiness.  The Securities and Exchange Commission is bringing the suit and the main theory is that Morton is a fraud.  No kidding. 

For this post, I review what constitutes fraud in Connecticut under the common law and grounds for Connecticut attorneys to bring a lawsuit for fraud.   In Connecticut, fraud is committed when:

  • a person makes a false representation as a statement of true fact
  • the person knows the statement is not true
  • the person makes the statement to induce another person to act upon the statement
  • the person who acts upon the statement sustains damages

When an attorney brings a lawsuit for fraud in Connecticut, an attorney must allege more than simple facts stating these elements.  Attorneys bringing a fraud case must make specific allegations describing the actual fraud.  In general the false statements must relate to an existing fact, past fact, or a promise to do something in the future with no intent to do so.  Although generally affirmative statements must be made to support fraud, there are circumstances where a failure to speak can be fraud if there is a duty to speak.

When you bring a lawsuit for fraud in Connecticut, there is also a higher standard of proof.  Ordinarily, in civil cases, an attorney must prove the fraud elements of the case by a preponderance of the evidence.  Many people describe this standard as greater than 50% or more likely than not likely.  In fraud cases, the plaintiff must prove the elements of fraud by clear and convincing evidence.  This standard is greater than a preponderance of the evidence.

If a plaintiff is successful in proving fraud, there are two categories of damages that generally apply.  First, a plaintiff may rescind or get out of the induced transaction (i.e. cancel the contract) and sue for restitution type damages.  This type of remedy seeks to put the plaintiff in the same position as if the fraud never occurred.  Alternatively, a plaintiff may affirm the transaction and seek compensatory damages.   This type of remedy may apply when a plaintiff wants to keep some consideration from a transaction but sue for fraud damages.

In addition to these two categories of damages, a successful lawsuit for fraud could also result in an award of punitive damages, which is generally the cost of suit less expenses or the attorneys fees incurred in the case. 

Here is a short list of some of the types of fraud lawsuits attorneys bring in Connecticut:

  • Contract fraud – you enter contract based on false statements
  • Consumer fraud – think about the recent Toyota lawsuits
  • Advertising fraud – you buy a product based on a false claim, bait and switch 
  • Investment fraud – think Bernie Madoff, Sean Morton, Ponzi schemes
  • Real estate or mortgage fraud – false appraisals, straw buyers

When you consider the allegations against the psychic Sean Morton, it is evident he would be subject to a fraud lawsuit in Connecticut.  There might be a legitimate defense, however, to the some of the claim.  In general, puffery, opinions, exaggerations, and comments made in jest are not fraud. 

So what do you think, is a promise of happiness and piles of money by a self proclaimed prophet fraud? 

Connecticut Business Litigation Roundup

Here is a round up of a few interesting business lawsuits making news in Connecticut this past week: 

Smoking Gun "Crap" Email In Case Watched by Wall Street

In Pursuit Partners, LLC v. UBS AG, et al., a 35 million dollar prejudgment remedy was awarded in favor of a Connecticut hedge fund against UBS.  Judge Blawie issued the order in Stamford Superior Court after finding the bank was in possession of material non-public information regarding downgrades to financial products that UBS continued to sell.  This case is getting a lot of attention on Wall Street and reported on by Matthew Goldstein  at seekingalpha.com and Serena NG and Carrick Mollenkamp on WSJ.com. 

The UBS case will be interesting to watch and is another example of the increasing importance of discovering smoking gun emails.  Preliminary discovery in the case turned up internal emails calling some of the financial products "crap."   Here is a docket report on the case. (download).

Fairfield Company Uncovers Fraud and Ejects Board Member

Competitive Technologies (CTT), won a contested default judgment for more than $4 million dollars after discovering a former board member took company money and invested it in a fictitious South American company that did not exist.  Read the report on the case by Michael Juliano of the Connecticut Post.  You can also download here a copy of the judgment from Judge Dorsey who found that the defendants willfully disregarded court orders.  

The fraud was uncovered in part by the work of Breen & Associates.  I have worked with Bill Breen before on several cases.  He is an exceptional fraud investigator and expert.  Looks like he successfully uncovered another financial fraud for a business client.   

Civil Rights Violations Alleged Against Litchfield In Refusing Jewish Temple

Rabbi Joseph Eisenbach has filed a lawsuit in federal court against the Town of Litchfield over the Town’s refusal to permit modification of his property for religious purposes.  The complaint (download here) states that the Rabbi is seeking declaratory relief, permanent injunction, and damages for violations of civil rights and the Religious Land Use and Institutionalized Persons Act of 2000.  This case was reported on by Christine Stuart, editor of  CTNews Junkie where a reader left some disturbing comments about anti-semitic statements at the commission hearings on the matter. 

An attorney for the Town has not yet appeared in the case and no answer has been filed. Given the allegations in this Complaint, this is a case that is likely to stay in the news.