LEGAL: Now Showing: Accounting Sleuths Detect Fraud

When a California hauling firm told the Central Contra Costa Sanitary District in 1996 it could reduce charges to customers, district officials were pleased. Only a few weeks later, however, the company was singing a different tune. Now, it was asking for approval of higher rates. Why? To ward off bankruptcy, the hauler claimed.

“Both these things can't be true,” Paul Morsen told The New York Times, noting that no competently managed company lowers its rates when it is in financial trouble. At the time, Morsen was the district's deputy general manager.

Skeptical, Morsen turned to Dan W. Ray, a forensic accountant based in San Francisco. Fundamentally, a forensic accountant examines the books and records of a business, searching for accounting irregularities and prowling for lost money. Although many accountants conduct such audits on behalf of businesses, it's only when the atmosphere turns accusatorial — evoking blame, guilt, incrimination or liability — that the forensic accountant steps in.

“[Forensic accounting] is a growth industry,” says a spokesman for the Austin, Texas-based Association of Certified Fraud Examiners. “It has a lot to do with organizations being more aware of the threat of white-collar crime,” he adds. Since 1991, almost 3,300 accountants have joined the group, which expects to add another 1,500 in the current membership year.

Ray and his colleagues began their probe by searching for information on other California companies in which the hauling firm's owner, William D. Lomow, had an interest. Accommodatingly, the hauler's contract with the district specifically allowed this kind of inquiry. As it turned out, a reliable database revealed that Lomow indeed owned other California businesses. Feigning ignorance, the accountant asked Lemow if he owned any other businesses.

“He said no, and that was the wrong answer,” Ray says. “It told me I was dealing with someone who was not truthful. [He failed] my litmus test of management integrity.”

Suspicious that Lomow was withholding other information, the accountants combed through the hauling firm's cancelled checks, eventually discovering a payment to a San Francisco area company. They then traced the check to a corresponding deposit in an Idaho bank where Lomow had a personal account.

Upon further inquiry, Ray and his team discovered that a fictitious person was listed as the owner of the company making the deposit. This person also was named as “owner” of other companies that received payments from the hauling firm. These firms, each with a questionable address — at a Mail Boxes Etc., an unoccupied building and a post office box — just happened to be incorporated on the same day, month and year, according to the accountant.

As Ray surmised, Lomow established these sham companies, which ostensibly provided maintenance and other support services, to drain cash from the hauling firm. Invoices from these companies provided “costs” to substantiate the hauler's requests for rate hikes, while payments from the hauler for these services ended up in bank accounts that Lomow controlled.

Ray handed over his findings to district officials who, in turn, filed suit against Lomow and a colleague, Robert M. Sliepka. The court awarded the district damages in the amount of $9 million. Reportedly, some portion of the amount will be refunded or rebated to customers.

Lomow and Sliepka were convicted on criminal charges.

Why did it take a specially engaged accounting sleuth to discover the fraud?

That's what the district wanted to know, and that's why it filed a malpractice suit against its accounting firm.

Unlike the Contra Costa case where the details were publicized (most likely because it involved a public authority), many entities that lose track of money insist that their forensic accountants keep the circumstances confidential. After all, what officer or manager wants to openly admit that his operations are susceptible to fraud?