20 Aug 2015

Out of scope: excluded material in investigative forensic accounting reports

by Dugan Cunningham, Will LeMass

Forensic accountants take careful instructions and make very clear, in the report, any limitations on the material which was available to them.

A recent focus of a Senate Inquiry is allegations of "front running" by an employee of IOOF (IOOF commissioned a report into the matter by PwC).

The report concluded that "we did not identify any information to indicate [redacted] engaged in front running from 22 December 2009 to March 2015 through research reports released by IOOF/Bridges … We identified the potential for [redacted] to front run using an asset management role that he held in late 2008/early 2009 …".

The report also states that IOOF advised PwC that review of the relevant person's computer or email files was not required in order to identify any other potential inside information. Certain other "scope exclusions" are noted in the report.

The Inquiry has considered whether or not the report was adequate for IOOF to rely upon in relation to this issue and the nature of the information which PwC did not have access to in preparing it.

What is front running?

"Front running" can be a form of insider trading. It occurs where an individual, who knows through access to confidential information that a large investment is about to be made in a particular company, acquires shares in that company just before the substantial investment is made. When the substantial investment occurs, the individual profits from an increase in share value.

This conduct has the potential to occur within investment institutions, who advise large investors on stock market investments, where employees have early access to advices regarding recommended investments.

ASIC representatives were examined by the Inquiry on 7 July 2015. Broadly, they commented that:

  • front running is not specifically identified in the relevant legislation, but can fall within the definition of insider trading;
  • in any event, front running is regarded as poor behaviour. Financial advisers taking advantage of their position will undermine the trust that exists between an investor and their financial adviser;
  • market participants are required to report to ASIC when they suspect that someone is guilty of insider trading.

Role of forensic investigators

The relevant ASIC representatives also commented to the Inquiry that quite frequently ASIC is provided with reports prepared by external forensic accountants that have been commissioned by the relevant company in connection with breach reporting.

The role of a forensic accountant is, typically, to investigate a matter and reach certain factual conclusions where it is contemplated that those issues may be the subject of legal proceedings. Inevitably, forensic accounting reports are based on certain limitations and assumptions which impact on the findings in the report.

The Inquiry has paid close attention to the types of material which PwC did not have access to in preparing its report. The following comments were reported to have been made by Senator Dastyari on 3 August 2015:

"PwC state they did not have access to interview the employee who had made the allegations. They did not have access to interview or directly request information from staff within the research department. They did not have the capacity to interview the person the allegations were made against. They did not have data information from client order books for details of other bridges, trades, and securities. They did not have access to computer hard drives, and electronic devices and they did not consider trading history prior to 2008. They did not consider other allegations made by the employee and they did not have access to other trading facilities through another broker ... Is this an extensive account of the matter?".

Similarly, the Inquiry Chair stated on 7 July 2015:

"I cannot comprehend how you can have a thorough detailed examination without speaking to the person who is making the allegations, the person who has the information as to the front running that has occurred"

On the other hand, Senator Edwards on 7 July 2015 commented:

"Can I tell you: the evidence we have received is lucid. It appears quite credible. A lot of the contentions which are made in rebuttal to the whistleblower seems somewhat hollow this morning ... we are going to run a credible inquiry, and we will give you an opportunity to do this rather than try to provide a forum for which there are trapdoors for people."

An ASIC investigation is on foot in relation to the above matters. ASIC's findings as a result of that investigation are not complete and have not been published.

Focus areas for forensic accountants

The matter brings into focus the following key areas for forensic accountants to keep in mind when undertaking an investigation:

  • there is a need to take careful instructions and make very clear, in the report, any limitations on the material which was available to the investigators;
  • it is important to carefully consider who the intended audience of the report is and the purpose of the report. If the report is to be relied upon in relation to whether or not any breach notifications need to be given, limitations on the type of information supplied to the investigators may be significant. If the report is obviously incomplete or potentially inaccurate because of the information which is 'out of scope' that should be noted in the report. The extent to which an investigating accountant, retained by the relevant company, should note in the report any requests for information which were declined by the company may be the subject of further consideration in the Inquiry;
  • comments made in the Inquiry appear to be directed to maintaining trust and confidence in the financial industry generally. Many of the comments made during the examination of ASIC representatives considered the extent to which an organisation's culture can influence compliance and breach reporting. It is difficult for these types of concepts to be incorporated into legislation in relation to the financial industry. However, given the Inquiry's comments, it would be reasonable for investigating accountants to have regard to these concepts when preparing reports about conduct such as insider trading.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.