Selecting the Right Investigative Resource: When Does an Allegation of Financial Statement Fraud Call for an In-House Investigation, and When Is Hiring outside Experts Prudent? (2009)

EXECUTIVE SUMMARY * A financial fraud allegation demands an appropriate and timely response, The process includes knowing how to assess the allegation and selecting the appropriate investigative resources. Follow this process for determining how and by whom an allegation should be investigated: all Identify implicated parties in the organization who may have been involved or had knowledge of the alleged misconduct. Will investigating these individuals put internal resources in a position to review their peers, their direct reports or their direct/indirect supervisors? If so, the investigation may require the use of external resources. * Consider the quality of preliminary information and deter mine if the alleged misconduct is, in fact, improper under relevant laws, policies and procedures or if the allegation makes sense relative to the company's overall business practices, policies and procedures. * Assess the quantitative and qualitative materiality of a possible fraud to the greatest extent possible. Consider qualitative as well as quantitative considerations, including senior management's involvement. * Determine if specialized knowledge of the company and its processes or procedures is required to conduct the investigation. Internal resources may be considered objective in some circumstances, but they may not possess the specialized investigative skills required. In addition, auditors and regulators might consider external resources more credible. * Mind the logistics: language, resources and timing. Identify resource needs and ensure that your proposed investigation team is able to dedicate sufficient resources to meet reporting deadlines. * Consider the perspectives of other constituents such as external auditors, litigators and regulators. Those relying on the conclusions of the investigation, such as external auditors, will want assurances that the investigators were objective and competent. * Perform a cost-benefit analysis. External investigative resources will almost always be more expensive, but costly delays or rework, follow-up inquiries by auditors, and costs related to renegotiating loans or other financing may be reduced or avoided. ********** It's Friday at 4 p.m., seven days before the filing deadline for an SEC registrant's annual financial statements. The general counsel has just received a detailed but anonymous e-mail alleging improper revenue recognition at the company's Chinese subsidiary and must decide what to do next. [ILLUSTRATION OMITTED] This scenario, enough to panic audit committee members, CEOs, CFOs, general counsels, and internal and external auditors alike, calls for an appropriate response. What should that response be? Should the external auditors be notified and, if so, what should they be told? Will the filing deadline be met? Often, the most pressing question is how to assemble a team to address the allegation appropriately and efficiently. These early decisions are often the responsibility of the audit or other authorized committee of the board. Frequently, the committee will look to management, in-house counsel or internal audit for support in gathering data necessary to inform the committee's decisions. This is acceptable so long as objectivity is preserved. It is important to remember that these initial procedures are designed to determine how an allegation should be investigated and how the investigation team should be structured. This initial assessment phase is not designed to supplant an investigation, and care should be taken to complete the assessment before beginning an investigation. In today's challenging economy, companies are eager to preserve cash wherever possible while still maintaining good corporate governance. As a result, it is increasingly common to look to internal resources to work alongside, or in lieu of, outside investigators. …