P ^ R e g a n reads The Waltirnal and sees that a majorscandal is brewing at a For-

e 500 company, the San Francisco-based accountant reckons "there'sprobably a 30 to 50 percent chance

Coming^rom somebody else, thatdeclaration might sound a trifle boast-ful. But Regan, who at 61 is presidentof the 100-person forensic accountingfirm. Hemming Morse, is just tellingit like it is. Since graduating from theUniversity of San Francisco in 1968and taking his first job at Peat Mar-wick Mitchell where, early in hiscareer as a certified public accountant,he examined suspicious dealings ofaviation-and-movie mogul HowardHughes Regan has delved intomany of the highest-profile financialfrauds of the past four decades.

In the 1980s, as an independentauditor, he was called in by severalU.S. regulatory agencies, includingthe Resolution Trust Corp., to helpwith investigations into the savings-arid-loan scandals. He and his teampored through the entrails of some25 expired thrift institutions in Cali-

Adelphia Communications, ParmalatSpA and, of course, Enron Corp. Theengine driving these and otherworld-class frauds over the last twodecades or more, Regan says, hasbeen the explosive growth of theglobal stock exchanges and debt mar-kets in which trillions of dollars are atstake every day.

"The most common, recurringissues are the misstatement of a com-pany's financial position," Regansays. "Typically, what I see the mostis a company claiming revenues thatdid not represent a legitimate trans-action and did not result in a selleractually collecting those revenues."

Positive quarterly earnings canhave the immediate effect of sparkingbuzz and excitement on Wall Street,rurming up a company's stock priceand enriching top corporate officialsat public companies, especiallyCEOs, who may be lavisly compen-sated with stock options and grants.For many leading national attorneyswho specialize in seeking recompensefor aggrieved investors as weli asbondholders, employees, suppliers,financiers, creditors and other stake-

Going After the Bad Apples

Q

Oi

Forensic accountant

Paul Regan cut his

teeth in a fraud case

against Howard

Hughes, and he's

become a leader in

a specialized area,

mostly attempting

to recover money for

shareholders.

fornia, Texas, Florida and New Yorkto reconstruct their often byzantinedealings.

In the 1990s came the cases ofmassive accounting irregularities atPhar-Mor and MiniScribe (see"Miniscribe, Maxi-Fraud, page 26), aswell as Xerox Corp. and SunbeamProducts Inc., both of which hehelped uru-avel for the U.S. Securitiesand Exchange Commission andwhich brought SEC sanctions againsttop accounting firms.

The new millennium has broughtcalls from shareholders and theirlawyers for assistance in lawsuitsseeking redress for multibillion-dol-lar rip-offs and insider trading abusesin the highly publicized frauds at

holders Regan is the goto guy."He is one of the top gurus in the

country," says Houston attorneyAllan Diamond. "I've been relying onhim as an accounting expert for 25years, particularly in complex finan-cial litigation that involves auditmalfeasance and malpractice."

As a de facto white-collar crimedetective, Regan, who holds a mas-ter's degree in accounting and is alsoa certified fraud examiner, covers thewaterfront. His areas of investigafiveexpertise include mortgage banking,the steel and automotive industries,securities trading, highway and pow-er plant construcHon, motion pictures,airline acquisitions and Insurance,

Bob Ivey, an attorney at the Los

24 financial executive I december 2007 www.f inancialexecuti ves. org

Angeles office of Holland & Knight,has hired Regan as an investigator,analyst and expert witness in numer-ous cases, including a years-long trialinvolving the collapse of two shoddi-ly built luxury hotels at the RoyalPalm Resort on Guam in an August1993 earthquake. "Paul has a varietyof skills," lvey says. "We have oftenused him for determining the level ofdamages in construction cases."

lvey acknowledges that Regandisplays the "tenacity of a bulldog,"but says: "That's a common cliche inthe legal profession. I think 'imagina-tive' is the term I would use todescribe him. He's able to analyzedocuments and produce findings ir^ways that i just wouldn't havithought of."

Regan keeps a powerful magnify-ing glass handy for iine-by-lineperusal of the fine print in the myri-ad documents bound in fat dossiersoccupying his office bookcases."Accounting records form a historybook of a business or a company innumeric form," he says.

Like a historian (or a coroner), hiswork as a forensic accountant usually

commences after the fact. Once onthe scene, he reconstructs events,gathering and collecting data andinformation, making sense of thefacts and, finally, composing a finan-cial narrative. The result is usually aheavily footnoted report, depositionor courtroom testimony.

"Every transaction, every expen-diture, every asset," he says, in whatalmost sounds like a mantra, "everytelephone call, every lunch reim-bursement, every piece of travel,every rental car receipt, every widgetsold is recorded somewhere andorganized in a set of books andrecords. And, if you know how toobtain them, you can analyze andevaluate the information and deter-

mine what's at the heart of a contro-versy."

Consider the case of the collapsedGuam hotels. While contractors were"over budget," Regan says, in buyingmost of the hotels' constructionmaterials, a painstaking review ofcost records indicated that they wereunder-budget for labor costs andsteel rods. That meant, Regan testi-fied, that only about half the reinforc-ing steel necessary to buttress the castconcrete was actually bought.

Regan's testimony, along with thetestimony of civil engineers, photo-graphs and other evidence, helpedthe hotels' owners win a $150 millionjudgment against contractors.

Attorneys also realize that

accountants can play a key role in"data analysis" using the servicesof people like Regan to provide sta-tistical proof where only a suspicionmight have existed before. In Califor-nia, for example, Regan was hired togather evidence when 2,402 insuranceadjusters contended that theiremployer. Farmers Insurance Group,routinely required overtime whiledenying them the extra payments.

By deposing 90 workers, he wasable to calculate that, on average,employees worked nine extra hoursof unpaid overtime a week from1993-2001, resulting in a judgmentof $90 million, plus some $30 mil-lion in interest.

Finding skilled people wilting to u-

www, finandalexecutives.org december 2007 I financial executive 25

MiniScribe, Maxt-fraud

O f all the rip-offs that Paul Regan has investigated innearly four decades as a forensic accountant, the fraudat MiniScribe Corp., he says, stands out as perhaps thecleverest work of financial fiction he ever encountered.

Once a darling of the Nasdaq market, Longmont, Coio.-based MiniScribe was perceived as an up-and-coming sup-plier of hard-disk drives to the computer industry. Mini-Scribe's chief executive a man with the improbably Dick-ensian name of Q.T. Wiles was hailed in the press as aturnaround expert. He boldly asserted to shareholders inthe 1987 annual report: "We achieved the best results inthe company's history and now have 10 consecutive quar-ters of increased revenues and earnings."

But, it turned out that now-defunct MiniScribe, whichclaimed pre-tax profits of $33 million in 1987, a 44 percentincrease over 1986, produced those glowing financialresults almost entirely through creative writing.

MiniScribe's sleight-of-hand included a dubious account-ing gimmick known as "bill and hold." Using this strata-gem, the company booked sales when its product wasshipped to the warehouse, rather than when it was actuallysold. But the company went further still, concocting anelaborately criminal scheme that involved stocking ware-houses with phony inventory.

"The company staged a big picnic, complete with a soft-ball game, on the last Saturday of the fiscal year," Reganrecalls of the scam, which he investigated on behalf ofattorneys for bond underwriters who were suing the exter-nal auditors. "And, afterwards," he adds, "the employees

packed up $20,000 worth of bricks and put them on palletsinside common carrier trucks and sealed the doors. Thenthey hauled the disguised bricks away in the trucks."

As Regan tells it, employees at those receiving compa-nies participated inthecharade by refusing to accept theshipments. "So, they brought the disguised bricks back tothe warehouse and recorded them as part of $15 million inreturned inventory."

Thanks in part to Regan's investigative work, the plain-tiffs won a $550 million judgment from a Texas jury againstthe company's auditor. Coopers & Lybrand (now Pricewa-terhouseCoopers). it was the largest judgment to thatpoint against an accounting firm. (C&L later paid an undis-closed figure, believed to be about $50 million, accordingto The Wall Street Journai.)

Wiles and the company's chief financial officer bothwent to prison for fraud and insider trading.

"I can't fault for them for not detecting the bricks,"Regan says of the auditors, "but if they had done the auditin accordance with generally accepted accounting princi-ples, they would have said, 'Holy Toledo! We can't givethese guys a clean bill of health.'"

As is often the case, Regan says, it took a tip from a dis-gruntled employee to uncover the scheme of the disguisedbricks. Although he does not find dishonesty especiaiiycharming, Regan nonetheless marvels at the deviousness of itall. "I thought it was quite ingenious, and very imaginative,"

Paul Sweeriey

work in forensic accounting is nosimple undertaking, asserts BillUeitzen, who heads a 30-personforensic accounting firm in Sacra-mento and has v^'orked both withand against Regan in legal disputes.He looks for "intuitiveness, presenta-tion skills and integrity" all quali-ties that Regan has, in Ueltzen's view.He adds: "A forensic accountant hasto be thick-skinned, and mostaccountants don't like sitting in frontof a jury and being cross-examined."

Regan, who is soft-spoken andsturdily built he plays golf to an11-handicap and works out severaldays a week on a stationary bicycleand Bowflex machine adds thatgood health and the willingness towork long hours are probably thechief qualities required In a forensicaccountant.

Regan also asserts that "a sense ofoutrage" is important. "It pushes youto keep digging and to push your-self," he says. "I don't like to seesomeone use power to mistreat peo-

ple. I don't like bullies." He's takenthat philosophy to public service, as aformer mayor and now city councilmember of suburban Hillsborough,and a past president of the CaiifomiaSociety of CPAs.

Regan exhibited such inclinationsearly on. At PeatMarwick, whilereviewing documents of HowardHughes's takeover of Air West,renamed Hughes Airwest (later tobecome part of General Motors), hediscovered a stunning number ofwrite-downs in property values,

Says Regan; "[Hughes] had identi-fied a number of assets that he didn'twant to pay for and instructed hisaccountants to write them off. Theyalso calculated in things like contribu-tions to a retirement plan, but theywere not in accordance of GAAP" (gen-erally accepted accounting principles).

By the time he helped attorneysfor Airwest's shareholders win a $72million judgment against Hughes in1976, Regan and another like-mind-ed accountant had left Peat Marwick

(a forerunner of KPMG), venturedon their own for a couple of yearsand merged with Hemming Morsein 1975. The Hughes case remainedwith them. "The people at Peat Mar-wick weren't happy with forensicaccounting," Regan says. "Theythought it was risky stuff that itmight lead to the firm being sued."

In addition, he says, the nationalfirm was worried that ferreting outfraud would lead to controversiesinvolving fellow accountants in theBig Eight (now shrunk to the "BigFour.") Indeed, Regan has spentmuch of his career crossing legalswords with the fraternity of giantaccounting firms.

Many of his investigations haveresulted in outsized judgmentsagainst them. For example, Regan aid-ed the British government in trackingdown the disappearance of tens ofmillions of dollars in economic devel-opment funds invested with Jolin Z.DeLorean, the late maverick automak-er. In 1998, 16 years after DeLorean's

26 financial executive december 2007 wwvi'.f inancialexecutives.org

Northern Ireland car plant went bank-rupt, a Manhattan jury found in favorof the U.K. plaintiffs, assessing a $110million judgment against accountingfirm Arthur Andersen.

In the cases of lawsuits allegingfraud at both disk-drive supplierMiniScribe and discoLuit drug concernPhar-Mor, juries relied on Regan's tes-timony to find Coopers & Lybrand(now PricewaterhouseCoopers) liablefor failing to uncover massive fraud.For the SEC, he testified againstaccounting firm KPMG and several ofits partners over their role as externalauditors that resulted in Xerox Corp.'srevenue restatement of roughly $6 bil-lion for the years 1997-2001.

A number of patterns continuallyrecur in the cases of corporatewrongdoing, making good corporategovernance a key antidote. Behindthe scams involving massiveaccounting improprieties, for exam-ple, there frequently lies an autocrat-ic, over-compensated CEO, an inef-fective board, a weak audit commit-tee and external auditors angling forlucrative consulting contracts.

"Fear and greed are huge motivat-ing factors," Regan says. "I mean,how would you like to work for a guynicknamed 'Chainsaw Al?'", referringto former Sunbeam CEO Albert Dun-lap, a notorious corporate hatchetman. During his tenure at Sunbeam,the company claimed revenuesearned on contingent sales, accelerat-ed sales from later periods into thepresent quarter and used improper"bill and hold" transactions.

Duniap, whose handiwork Reganinvestigated for the SEC, also intimi-dated his external auditors by threat-ening to switch to a rival firm forauditing and consulting services.

ln the post-Enron environmentand in the wake of the Sarbanes-Oxley Act, Regan is increasinglysought after by companies lookingfor help in fraud-prevention andimproved corporate governance.Regan recommends that companiesinstitute an ethics policy while adopt-ing a corporate culture in whichemployees are treated fairly.

The CEO and top corporate offi-

cers should not just adhere to it, butset a good example, he argues. "Ibelieve in the 'tone at the top.' If aCEO is bent on committing fraud, it'shard to stop it."

An independent board of directorsis also key to imposing checks andbalances on questionable or possiblyillicit practices. Since frauds can arisefrom any area in a company eventhe mailroom Regan urges back-ground checks to keep "fraudsters"from gaining a foothold. Becausefraud and the attendant cover-up areoften elaborate, it's also important forthe audit committee to have memberswho are financially sophisticated.

And, since a complex financialfraud usually requires the con-nivance of skilled participants, Reganis a big believer in external hotlinesfor whistleblowers. Data compiled bythe Austin, Texas-based Associationof Certified Fraud Examiners (ACFE)bears out his admonition.

Tips Are Top Fraud AntidoteAccording to the group's latest sur-vey, tips are the No. 1 reason whyfraud is uncovered at public compa-nies 40.2 percent, compared to 26.9percent from internal audits and 22percent from internal controls.

Losses at all organizations sur-veyed (governmental, private andpublic companies) that had hotlinessuffered less in fraud losses amedian of $120,000 comparedwith $218,000 at those without such amechanism. However, only 45.2 per-cent of the 1,050 organizations sur-veyed by ACFE reported having ahotline for tips, "It should operatel'^/7," Regan says of a telephone hot-line, "and it should be both anony-mous and multi-lingual,"

As frauds have gotten more intri-cate and more costly in the computerage, forensic accounting is gaininggreater appreciation. Regan, who ison a committee at the American Insti-tute of Certified Public Accountantsthat is on the verge of creating a certi-fication procedure for forensicaccountants, expects at least 3,500practitioners, and perhaps 5,000, toqualify if that credential is adopted.

But as good as business is thesedays his firm's billings are at $20million today, up from $6.5 millionless than a decade ago Regan fearsthat a looming U.S. Supreme Courtdecision could provide a safe harborfor those who aid and abet white-col-lar fraud. Because the high court con-sented to hear the Stoneridge case, hewarns, it's possible that banks, con-sultants and accounting firms thatparticipated in or were negligent in afraud could escape punishment.

Specifically, the high court willdecide in Stoneridge Investment Part-ners V. Scientific Atlanta whetherfinancial advisers may be liable foraiding and abetting fraud orwhether liability arises only if theyactively participate in it.

In many cases, including at Enron,banks and consultants had conceivedfraudulent schemes and sold theideas to companies. In someinstances, they were culpable indeploying their professional expertiseto help companies carry out the fraud.If the Stoneridge case is decided in thedefendants' favor, "all you wouldhave to do is outsource your fraud,"Regan says. "We'd be letting the guysdriving the getaway car go free."

PAUL SWEENEY (easysioeen@aol.com) is afreelance writer based in Austin, Texas, anda frequent contributor to Financial Execu-tive.

TAKEAWAYS Former public accountant Paul Reganhas been involved in cases involving manyof the most prominent financial frauds ofthe past four decades, Regan says that what he sees themost is a company claiming revenues thatdid not represent a legitimate transaaionand did not result in a seller actually col-lecting those revenues.

Globalization and the vast expansionof stock markets and company valua-tions, and their related stock options, arelargely responsible for the surge in finan-cial fraud, he says, A foremost way of detecting fraud isto have whistleblower hotlines, mannedaround the clock and in different lan-guages. Tips have been shown to be themost effeaive means of alerting compa-nies to fraudulent activities.

www.financialexecutives.org december 2007 financial executive 27