Increasingly, we are using the Cloud to create, manage and store documents, such as through Xero, LinkedIn, Dropbox and Google. However, the Cloud is unique in that control of the documents passes outside of your physical possession and onto someone else's computer, which is often overseas.  

Consequentially, there are several issues that a business owner needs to be aware of. 

- How secure is your data and how much control do you have over it once it is in the Cloud?

Often, you will have no idea where the data is stored, you have no idea how the supplier is protecting your data, and occasionally, there is no ability for you to produce a back-up of the data you have stored in the Cloud.

Issues can ultimately arise, for example, when a local or overseas regulatory authority seizes servers containing your data (think Kim Dotcom and Megaupload), an employee emails a client database stored in the Cloud to the wrong party, where your provider goes bust (think Nirvanix), where your provider is hacked (think JP Morgan Chase), and when you are trying to recover that deleted document.

- What happens if your service provider ceases to provide the Cloud service?

The internet has seen large numbers of businesses bomb, such as webvan, eToys, Kiko and Wesale (have you heard of them?!!!!).  The question therefore ultimately becomes, can you easily export your data to another comparable service for ongoing use, and is there another comparable service?

- Do you retain ownership of your data once it is in the Cloud?

This is about you retaining ownership of your documents, and it has been well publicised by the media.  There have been arguments over who owns the data when you use Google or Facebook, for example.  Can someone else use your emailed photograph in an advertisement? Ownership of your Xero account may correspondingly be with your accountant, not you. With the cost of legal action, possession may ultimately be nine tenths of the law. 

- Can you check who has viewed or altered your data in the Cloud?

This is about confirming who did what and when with your documents.  Particularly with financial information, there should be some form of audit trail available to confirm who, for example, created an invoice or payment through internet banking. Does your software allow this, or do you need to purchase tracking software and retain backups of core documents? 

- Are you complying with legal requirements when storing documents in the Cloud?

Generally speaking, you are legally required to store and produce documents in an easily accessible form for seven years under, for example, sections 145, 189 and 190 of the Companies Act 1993.  However, we often find ourselves deleting documents within six months to fit within size restrictions set by our IT administrator.  This may include expense invoices in support of your income tax return, which may come back and bite you if the Inland Revenue Department comes knocking.

Directors and employees also have a legal duty to restrict external access to company information to protect against, for example, insider trading or industrial espionage.  Are you inadvertently or accidentally sharing material company information with suppliers, and the supplier's other customers, thorugh the use of Dropbox?  Are company documents being stored in an account under the name of another legal entity? 

- Can documents stored on the Cloud be used to enforce your legal rights?

This is about making sure that the documents that you have can be used to enforce your rights.  For example, how do you confirm that the scanned contract was created at the mentioned date?  What happens if someone alleges that they never signed it and it is a forgery? 

Inadequate record keeping or data loss will not necessarily lead to the failure of a business.  However, it will ultimately make life more difficult.  At the end of the day, documents such as cashbooks, invoices and contracts, all increasingly stored in the Cloud, form a key basis of a business.  Their loss can also form the basis of a claim against a director by their company, a liquidator or a regulatory authority.

We therefore recommend that all businesses consider information management and security as a key aspect of their business, in the same way that marketing and accounting, for example, is considered at management level.  Many large businesses have a "Company Information Officer" and/or "Compliance Officer" to complete this.  In smaller businesses, the internal or external company accountant can take on the task.

McDonald Vague is commonly employed by businesses, their advisors and their financiers to provide corporate governance and forensic accounting services, and this is an increasing issue for our clients.  We are happy to provide further advice in this area upon request.

Introduction

A Chartered Accountant providing business services arrives at results through double entry bookkeeping. That is, for every debit there must be a credit. That same accountant, although they are excellent at their job, may be confused if they are asked to draw conclusions from inadequate records.

On the other hand, the forensic accountant thrives on inadequate records and is used to coming to conclusions by drawing information from different places and bringing it together to a meaningful conclusion.

One of the duties of a liquidator is to realise the assets of a company. Often those assets take the form of a claim against someone who has defrauded a company. For a liquidator to do their job properly they must recognise that fraud has occurred and that everything may not be what it appears at face value.

Common types of fraud include the following:-

• Business assets such as cars and equipment somehow being regarded as directors' personal property
• Sale of assets to the director or an entity controlled by them at an undervalue
• Sale by director to company of assets at overvalue
• False invoices from companies controlled by director or perhaps in-house accountant
• Valid invoices to customers, but showing the director's own bank account details
• Non-existent people on the payroll
• Suppression of creditors at the time of preparation of annual accounts
• Showing stock that does not exist in the annual accounts
• Giving personal trading trusts the good profitable contracts and leaving the failing company with unprofitable contracts
• Taking money and showing it as having been invested in an overseas investment

The skills of a forensic accountant

For a forensic accountant to succeed they need more than ordinary accounting skills. They need legal skills, an enquiring mind, and to be a student of human behaviour. A degree of cynicism also would not go astray.

Psychological skills

These become very important. What is the best way to approach someone to get information out of them:-

• Do you flatter them?
• Do you make them believe you already have the answers?
• Do you suggest they might be more lightly treated if they come clean?
• Do you give them the impression that you know more than you actually do?

Following this:-

• What does the person's body language tell you?
• Is the person hiding something?
• Is the person telling the truth?

Accounting skills

The accounting skills required are unlike those of the usual accountant. For a start, in the usual accountant's office the detailed work such as posting individual items to the ledger is done by clerks. On the other hand the forensic accountant must themselves be prepared to trawl through a mass of detail.

The forensic accountant must be aware of creative accounting practices and have an instinct as to where something unusual might have happened. In particular, they must be able to differentiate between the ordinary and extraordinary.

They will notice things which would not be normally noticed in a Chartered Accountant's office; such things as abnormal behaviour and the timing and sequence of events. They will be on the look out at all time for possible manipulation. They will understand information flows and be in a position to compare ratios and results with those of similar businesses.

Legal skills

The duties of directors are set out in the Companies Act 1993. The forensic accountant will have those duties in mind at all times.

For example:-

• Have the directors exercised their powers for a proper purpose?
• Have they acted in the best interests of the company?

An example of the enquiring mind

An actual case which comes to mind came about when the director of a company had a new boat. The forensic accountant, with his enquiring mind, wondered how the director could afford such a luxury while the company was making losses?

An examination of the books and records solved both the problem of the losses and the acquisition of the vessel. The company was in the business of importing machinery to order for its customers. An invoice to one customer simply stated as follows:-

Needless to say, the motor yacht never appeared in the books of the company. The director of the importing company simply treated the vessel as a personal asset.

Computer forensics

Because they understand the flow of information, the forensic accountant will recognise when information is missing from a computer. They will then use forensic software such as 'Encase' to examine the computer. The forensic accountant connects to the target computer and selects the media (disc, hard drive, USB device etc) for investigation. A duplicate of the original media is created. This protects the integrity of the base data. Investigation is performed on the data image using the tools in Encase. These tools include keyword searches, hash analysis, file signature analysis, filters and compound queries and data encryption. Evidence and investigation results are documented using the Encase reporting function. Any hard drive of any size can be compressed and stored on removable media, allowing the forensic accountant to take evidence with them. Even files that have been deleted, hidden or renamed can be located quickly and easily.

Conclusion

For a liquidator to properly do their job they must take control of the assets and realise them. Without good forensic skills it is not possible for liquidators to recognise all those assets which are capable of being realised.

DISCLAIMER
This article is intended to provide general information and should not be construed as advice of any kind. Parties who require clarification on issues raised in this article should take their own advice.

Many of our clients don't deal with insolvency on a daily basis, and therefore have only a fairly generalised idea of what we do. This article seeks to provide a better understanding of how the liquidation process works. It also demonstrates how choosing the right insolvency practitioner can result in funds being recovered for creditors that would otherwise not be available.

The liquidation process 

Most people have a basic intuitive feel for a liquidator's role. This is usually that he or she closes down a business, dismisses staff, sells assets and collects debts. This may well be true, but generally such activities form only part of a much more involved process.

Liquidators have very wide powers to investigate a company's affairs and seek recoveries from various parties. Many claims a liquidator brings (eg to set aside insolvent transactions or insolvent set-offs) are not available to directors, and only arise out of the liquidation process. Liquidators can also require those connected to a company to provide documents and information, and can examine those parties under oath.

Trading on 

It does not follow that a business must be closed down when liquidators are appointed. We frequently trade on businesses and sell them as going concerns. Often the fundamental problem is not the business itself, which may be highly cash-generative, but the unrealistic debt burden the purchaser took on when it bought the business. Trading on invariably results in a better outcome for creditors than an immediate shutdown.

Investigative work 

One of a liquidator's most important roles is to investigate a company's affairs. This involves taking possession of its accounting and other records and identifying those assets or claims which may be available. We recover records from a variety of sources, including the company's accountants and lawyers, and review electronic records including emails. This often produces recoveries which the directors had either overlooked or did not have powers to pursue.

Debtor reviews 

Our investigative work includes carefully examining the company's debtors ledger. In one case we recovered a three year old debt of $10,000, where the directors advised us that the customer had 'disappeared'. We did a company search on the business name and wrote to that party. They had bought the business from the previous owner but happily gave us that party's details. We then wrote to them and received full payment. The entire process involved only an hour or so's work, but enabled a dividend to be paid to creditors who would otherwise have received nothing. We never assume that simply because a debt is old, it must be uncollectable.

Overlooked assets 

There are often sums due to a company which the directors have either overlooked, or were not even aware of. An example is a liquidation where the company had subdivided land. On our appointment all the sections had been sold and there were no remaining assets. However, on reviewing the records we noted that the company had paid a council bond for required landscaping works. The council stated that the work had not been performed, so no refund was due. On closer questioning it emerged that the bond included a 50% uplift to cover possible contractor price increases. We asked for the costs to be requoted at current prices. Due to the property slump, prices had fallen and the amount held was well in excess of that required. This resulted in $28,000 being refunded.

On the same case, we were aware from other liquidations that the North Shore Council was paying refunds of development levies to property developers, following a High Court case. We contacted the Council, and kept the liquidation open pending a possible refund. As a result we received approximately $100,000. This, together with the recovery above, enabled the main creditor to receive a substantial repayment.

Insolvent transactions 

Previously known as voidable preferences, these are payments from a company to a creditor whilst it is insolvent, and where the creditor has reasonable grounds to suspect this. A liquidator can have such payments set aside, going back up to two years before liquidation. Part of our investigative role involves forensically examining accounting records and reviewing creditor payments. We pursue those cases where it is clear that the creditor had reason to suspect the company's insolvency, and has obtained an unfair advantage over other creditors.

Insolvent set-offs 

These are similar to insolvent transactions. They arise where a creditor recovers its debt by setting it off against some other amount it owes the company, at a time when it has reason to believe the company is insolvent. In one case a supplier had not been paid for ten months and was owed in excess of $250,000. Two months before liquidation it suddenly became a customer, but set off the $65,000 due against its unpaid debt, thereby effectively recovering this amount in full. We recovered 95% of the amount set off, in an out-of-court settlement. As a result, the bank was repaid in full and there will be a dividend to unsecured creditors.

GST recoveries 

There are often potential GST recoveries in a liquidation. Where a company is on the Invoice basis, there can be unclaimed refunds relating to bad debts. There can also be refunds due in respect of final supplier invoices which are only issued after liquidation, or where returns have simply not been filed. The amounts involved are often significant.

Overdrawn shareholder current accounts 

It is common for directors to owe their company money in respect of drawings over and above any advances they have made to the company. Sometimes there are no accounting records, but we reconstruct the current account from bank statements. In one case we reconstructed the current account entirely from bank statements and recovered $27,500 from the director.

Conclusion 

These are just a few examples of how liquidators can add value by a thorough investigation of a company's affairs. Whilst liquidation inevitably has a cost, the skill of an experienced liquidator is to ensure that these costs are more than compensated for by additional, and often substantial, recoveries which would otherwise not have arisen.

Note: This article was written by Jonathan Barrett who has subsequently left the firm.

DISCLAIMER
This article is intended to provide general information and should not be construed as advice of any kind. Parties who require clarification on issues raised in this article should take their own advice.