An external auditor is required to perform an assessment in accordance with generally accepted auditing standards for the purpose of rendering an opinion that the financial statements have been prepared in accordance with general accounting principles applied on a consistent basis. The audit is essentially intended to uncover significant deviations from standards and to verify that acceptable accounting and auditing practices have been used in the preparation of financial statements.
A forensic accountant takes a more proactive, skeptical approach to examining the books of a company. This specialist makes no assumption of management integrity and brings to the evaluation process less concern than an auditor with whether the reports conform to GAAP and more interest in exposing any possibility of fraud. Since a forensic accountant often faces legal issues, an accountant practicing in the forensic area needs to have an understanding of the legal environment in which business operate. For example, the evidence the forensic accountant derives from an investigation may require his/her testimony as an expert witness. Prosecutors, criminal, and civil attorneys often use forensic accountants before trial and as expert witnesses.
The techniques of forensic accounting and the legal environment that expert witnesses face are illustrated in this case using a real-world situation. This case highlights the importance of familiarity with the basic rules of accounting, SEC actions, litigation release, Ponzi schemes, temporary restraining orders, law briefs, receivers, and knowledge of courtroom procedure.
JUST THE FACTS, MA’AM
Wilson Energy Resources was a Nevada corporation. Its principal place of business was located in Woodland Hills, California. Wilson Energy was managing general partner of a number of oil and gas offerings. As the Managing General Partner, Wilson through its owners, Mr. James Andes and Mr. Robert sands, exercised exclusive authority over the operation of wells and properties in which interests were offered.
Mr. Robert Sands was the co-owner of M and M Company. As one of the owners of M&M Company, Mr. Sands operated and controlled the offerings made by M and M Company and controlled the operations, bank accounts, and other day-to-day operations of the companies. For example, Mr. Sands was the signatory on most of the M&M bank accounts into which investor monies were deposited as well as on the accounts from which distributions were made to investors.
TEMPORARY RESTRAINING ORDER
On September 22, 1997, Judge Dick Train, the Judge of the U.S. District Court of the Central District of California in the Eastern Division, issued a temporary restraining order (TRO) whereby the assets of the defendants and principals were frozen. A receiver, Jay lane, was empowered and directed to conduct an investigation to locate and account for all of the assets of the companies-a fourteen-year business. He was to take custody and control of these assets, and take all actions necessary and appropriate to preserve these assets.
The TRO was based upon a declaration of Jeanne Neighbors, a certified public accountant employed by the Securities and Exchange Commission (SEC). she was the senior accountant in the Pacific Regional Office located in Los Angeles, California.
The defendant, Wilson Energy, offered and sold securities to investors in the form of joint ventures and general partnership interests in oil and gas properties. Mountain Petroleum, Inc. served as the operator, on behalf of M&M Company, of most oil wells in North Dakota in which they had an interest. Mountain’s primary duties were to present properties for acquisition to the defendants and to operate the oil and gas properties. Over a period of about two years, however, Mountain did not send Wilson approximately $2,234,824 of oil and gas revenues. Instead, Mountain merely offset this money against expenditures that Mountain incurred in the oil and gas fields. The amount of expenditures that Mountain incurred was in dispute, as well as the amount that the defendants should have received.
These offsets were memorialized mountain with voided checks in the correct amount. The SEC’s accountant knew about the more than two million dollar offsets to cash receipts and revenues before she prepared her initial report which resulted in the TRO. She was at the deposition of Keith Cole (Mountain) on August 14, 1997, and Mr. Cole clearly told the SEC about huge offsets of cash receipts and revenues. Larry Luke, Wilson Energy’s revenue accountant, described these massive offsets in his deposition on March 12, 1997, as did Barbara McLean (Mountain) in her deposition on August 15, 1997. The defendants themselves were even forced later to acquire these voided checks from the SEC.
In her first declaration filed in support of the SEC’s motion for a TRO and appointment of a receiver, Jeanne Neighbors compared cash receipts of $120,004.39 (without about $1,253,286 of offsets) to the cash distributions of $1,313,925. The SEC accountant then made the inflammatory statement “that less than 10% of investor distributions were derived from oil and gas operations based on distribution checks issued during the relevant period.” In other words, the SEC argued that Wilson Energy was operating a Ponzi like scheme.
Where Did The Money Come From
Where Did the Money
Beginning Balance $268,439 Money distributed to investors $2,281,255
Money Raised From Investors 6,704,320 Employees/Principals/Overhead $2,332,066
Oil and Gas Production 394,575 Oil Field operations $1,616,000
Ending Cas Balance
The receiver, Jay Lane, hired a CPA, Jim Finn, from San Diego. The receiver,s November 6, 1997 “cash receipt statement” prepared by Mr. Finn appeared as follows:
CASH RECEIPTS STATEMENT
The Receive stated that the findings of the CPA support the conclusion that during 1996 and 1997, defendants used significant portions of investor money to make distributions on prior unrelated investments rather than for the purposes described in the offering memoranda. For example, in 1996, the defendants made distributions to investors of $819,740 in excess of the profits actually derived from the oil and gas operations. To make matters worse, according to Jay Lane, the defendants apparently failed to pay the up-front expenses related to the wells in excess of $430,000. Thus, even the funds characterized by defendants as “net income” were illusory.
Receiver lane argued that by making distributions to investors, the impression was created that many wells were profitable when, as a result of the expenses for reworking and maintaining the wells, there were no profits. Moreover, according to the offering memoranda, the expenses for reworking the wells and the purchase of mineral rights were to be paid out of the initial investment, not from income from operations. Thus, by implication, the defendants were operating a Ponzi scheme. There were about 33 new investors over the two-year time period.
In a hearing on November 21, 1997, and November 25, 1997, at the request of defendants to have the receiver removed, Judge Train stated that this “was one of the worst set of books that I have ever seen kept by an accountant.” [During this hearing the judge stressed that he had previously worked for Arthur Andersen, and he knew accounting.] however, he seemed obsessed about the fact that the cash flow from investors was commingled into one single bank account.
QUESTIONS AND REQUIREMENTS
1. What are some characteristics of a Ponzi scheme? Why is it called a Ponzi scheme?
2. Was this situation a Ponzi scheme? Use the internet to learn more about other Ponzi schemes. Is this like Bernie Madoff’s scheme?
3. Was there any improper professional conduct involved in this case study? Read SEC Rul.102 (e)(1).
4. If you were the expert witness for the defendant, what would be your arguments?
5. What should happen to the SEC accountant and plaintiff’s expert witness?
Answer the Questions and Requirements 1-5, inclusive. Your submission should be 2 double-spaced pages minimum excluding a cover page and a reference page.
The question first appeared on Write My Essay