The surprising persistence of fraud within the financial services industry - most recently underscored by the $100 million authorities said is missing from the Connecticut hedge fund manager Bayou Management - is causing a new operational demand among many firms. And it's not just for forensic accountants, but also for full-fledged private investigators.
When it comes to combating fraud, corporate detective Ernest Brod touts more than 20 years of experience in tracking down assets and ferreting out cyber-vandals. So it's hardly surprising that industry giant Deloitte Financial Advisory Services recently named Brod director of its forensic and dispute service practice.
After 17 years with Marsh & McClennan's private investigation unit, Kroll, where he rose to the position of managing director, Brod and a number of his colleagues broke away and co-founded Citigate Global Intelligence in 2001. A provider of international business intelligence, corporate investigation and business controls and securities, Citigate was recently acquired by Incepta for $3.5 million.
Money Management Executive Reporter Giselle Abramovich recently spoke with Brod, who came to Deloitte on Aug. 1 from the corporate security and investigative service provider SafirRosetti, about the general role of corporate investigation and how Deloitte Financial Advisory Services works with mutual fund companies that are either rebounding from the recent scandal or trying to short-circuit malfeasance before it occurs.
Money Management Executive: What can be done to maintain security at an investment management firm, and how effective can internal controls be in preventing fraud?
Brod: The two elements of crime and fraud, at a mutual fund company or elsewhere, are motive and opportunity. An effective way to eliminate motive is to hire people who are not motivated to commit fraud. In many instances where Deloitte Financial Advisory Services is called in to respond to workplace fraud, our investigators discover that the perpetrator has either had a prior history of wrongdoing or has falsified his resume.
Conducting careful background investigations before hiring is one of the most effective methods of curtailing workplace fraud. The opportunity for fraud can be curtailed by effective controls. My experience is that companies that grow faster than their controls, or are reluctant to incur the expense of controls, often pay the price in the form of vulnerability.
MME: What types of fraud do fund companies run the risk of today?
Brod: Because we believe investment management firms face a wide range of issues, Deloitte provides a number of preventive and reactive services. We can perform intensive background investigations of fund managers and other employees in sensitive positions. We offer anti-fraud and controls evaluations and programs.
To help firms prevent reputation risk, we can investigate the source of investment funds from unknown or controversial investors and provide anti-money laundering services. When firms are faced with litigation or arbitration, we conduct "suitability" investigations, looking into the level of business and investment experience and sophistication of complainants.
When fraud or defalcation is suspected or occurs, our financial investigators and forensic accountants can assist in reconstructing the improper activities, help determine responsibility, and assist in recovery of the diverted funds.
Our business intelligence specialists can help firms reduce the risk of unwise investments by providing market intelligence about companies into which investments are being considered.
MME: Internal controls are often a good way to pinpoint fraud without getting the SEC involved. If a firm has solid internal controls, what right of action might it have against someone proved to be responsible for intentional financial irregularities, or just outward obstruction of justice and does that help protect the firm against government action?
Brod: When fraud is suspected, the company's senior executives are on the horns of a dilemma. They clearly have a responsibility to inquire further, but they do not want to overreact in a way that may unnecessarily disrupt the company and prematurely put employees under suspicion, which may itself produce liability.
Calling upon an outside investigator such as Deloitte to conduct a quiet investigation can be a less-disruptive solution. We can unobtrusively interview former employees or other observers. We can help determine whether suspected employees are living beyond their means and check into their backgrounds. Our outside investigation will be the basis of the company's decision as to whether to conduct a more formal investigation.
Companies in this position should think carefully before turning to law enforcement. U.S. attorney or district attorney offices may only respond to high-profile frauds, and once they are called in, the company typically gives up all control over the investigation.
When the Securities and Exchange Commission gets involved, companies will get "credit" for having reacted appropriately and being cooperative. Any indication of covering up the fraud, or, much worse, obstructing the investigation, can be disastrous for a company. Although companies are sometimes inclined to sweep the problem under the rug as quickly and quietly as possible, they are often better off taking visible action to deal with the perpetrator and plug the holes in their controls as a deterrent to others who are similarly motivated.
MME: Why do you think regulators are beginning to scrutinize hedge funds? Do you think that hedge funds should be more closely regulated?
Brod: The increasing number of news articles about defalcations by investment managers explains the growing call for scrutiny of hedge funds. In my view, regulation is not the answer to hedge fund fraud. The steps I have mentioned - more careful hiring practices and more effective controls - constitute a better response to the problem.
MME: Can you talk a little bit about psycholinguistics, a technique you have successfully used in the past?
Brod: Psycholinguistics is the study of individuals' use of language. In expressing a thought, describing a feeling, or making a request, each of us will choose words which reflect our gender, age, level of education, type of upbringing and geographic region where we live, etcetera...
These selections of words and word order patterns are as individualized as fingerprints. A trained psycholinguist can create a profile of the writer of an anonymous letter or message, and can determine whether the same person did two different writings. In two recent "cyber-smear" investigations, where damaging allegations about a company were being posted on the Internet, possibly by a short-seller trying to drive down the stock price, or by a competitor or employee trying to injure the company, psycholinguistic analysis matched the Internet postings to the e-mails of disgruntled employees of the company.
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