Forensic Accounting in Your Divorce Case
In a divorce, asset division can be one of the most contentious issues facing the parties, especially if there is suspicion one spouse is hiding assets or otherwise misappropriating marital property. When sorting out a complicated financial picture in divorce cases, it may be necessary to hire a forensic accountant to investigate and reveal financial information that can affect asset division, child support, and spousal support determinations.
Recently, we spoke with forensic accountant Alex Spaete about the role of forensic accounting in family law; here are some insights we will cover on this topic.
Can you tell us a little bit about what a forensic accountant does and what you do in particular?
The best way I would describe what I do is that I help attorneys and their clients wrestle with family law financial issues and quantify potential legal claims or reimbursement claims that are being made in the context of either mediation or settlement for a case. I’m brought in sometimes really early on in the initial discovery stages of a case, and sometimes right on the heels of a trial to assist with some component that involves financials.
It could be assisting the parties with figuring out how much money they have to divide or tracing money from one place to another throughout the course of the marriage or through different assets and figuring out where different sources or character of funds might have ended up. It could be assisting with a complicated separation where three years later the couple is still living out of a joint account and needs someone to untangle it. That helps in mediation, providing our insight to parties to determine if this is something they even want to fight over or if there’s a way to reach an agreement faster. Alternatively, this work can be preparation for taking issues all the way to trial.
Another area we assist with, which is often lumped in with forensic accounting, is business valuation. (Some forensic accountants do this and others don’t.) Very often in the context of divorce there is a family business or a small business that needs to be valued as part of the divorce action, and it may be the most significant asset for the parties. We assist with that appraisal aspect.
You talked about looking at the financials and trying to figure out everything that is there and where it is. What is it particularly that you don’t do when you’re looking at all of the assets and investments?
That’s a great question; that distinction comes up a lot. A forensic accountant is not a private investigator. What I and others in this role do is provide a representation of financial activity based on the inputs provided by the parties (bank statements, credit card information, etc.) as background information.
There are times when we might ask for additional documentation about particular transactions or movements of funds, but ultimately, what we put together are representations of documents that we are typically able to get from counsel or from the parties. We don’t go independently beyond that; I might see a transfer to a foreign bank account or a moneygram that goes out, but I don’t follow that thread any further because I don’t have the ability to issue a subpoena.
I can provide a quantification of how much money might have gone through that avenue so someone might seek reimbursement, but we’re not necessarily going all the way down that rabbit hole to figure out where that money went. However, this can result in a kind of push and pull where our initial set of findings turns up additional accounts and/or financial institutions that prompt another round of subpoenas by the attorneys to obtain more information to further the investigation.
From a legal perspective, you’re brought most often to help establish a marital standard of living to help figure out spousal support, or to unravel post-separation spending out of a joint account. Even though you become very familiar with the parties’ finances through this process, your role is not to also be a financial advisor, correct?
We do get a very deep dive for a limited period of time into someone’s financials, but we’re not financial advisors. I’m not going to tell someone what stock to pick or how to balance their portfolio. Other professionals do that, and at the tail end of the divorce process parties may go to someone like that to help them move forward with their new financial picture.
I have been asked to comment on breach of fiduciary duty in the course of an investigation, for instance, when someone has invested in a set of stocks and suffered significant losses. However, the role of a forensic accountant is to quantify what the loss might have been, not determining whether that was a prudent investment or the right thing to do.
Some forensic accountants do tax returns—why do you not?
There’s a bit of a conflict issue that comes up; if parties are in the middle of a divorce and we’re one side’s forensic, it’s hard for us to be the joint tax preparer. I have a great referral list of people that have the expertise in the tax preparation side of things, and we’re often working quite closely with those tax preparers to help transfer our information on what happened during the dissolution over to the return.
For purposes of business valuations, what can you do and what can’t you do? And what types of valuations don’t you do (such as property valuations)?
The baseline is to figure out, is there much of a value there? In family law, we’re trying to figure out the value of the enterprise from the perspective of a passive owner. One of the most significant adjustments that is often made in any business valuation for family law is when the owner doesn’t pay themselves a salary out of the business for tax advantage purposes.
The business may look very profitable, but if someone had to pay someone to replace the owner, who is maybe acting as the executive or head of sales, would it still be as profitable? If the enterprise is essentially an individual acting as a consultant, how much extra residual value is there other than this person who’s working 80 hours a week? There can be divergent opinions on market value replacement. The parties can also have different views on how much time the other spends in the business. This can be tough to tease out, because most professions don’t require you to keep a time card, and there’s work you do as an owner that is silent and unrecorded.
The other big key is that for smaller enterprises, the basis we have for financial reporting is their tax returns and internal financials. The goal for most small businesses is not to look appealing to shareholders; it’s to pay the least amount of tax possible. There might be deductions running through the business that have a personal benefit to the owners. For example, I had a pizza operation that was an on-premise location that had $80,000 of travel expenses per year.
Upon looking at more detail, it was family vacations and things like that. We don’t deal with whether someone should be doing things like this—that’s between them and the tax authorities—but when we’re trying to value the business for family law purposes we are trying to determine the benefit stream the business generates, so we need to look at those things. In a family law valuation, you’re almost never taking what’s on the financials at face value; we want to look behind the scenes to see how things are being reported.
The really challenging layer in a business valuation is if the financials are in such disarray that you can’t really make any sense of them. At that point we’re almost having to reconstruct financials, which can make it really difficult to come up with a value.
I don’t do personal property or real estate valuations. I’m happy to rely on someone’s input regarding the value of their fine art or wine collection, but I am not an appraiser who can supply an independent professional evaluation.
Is there anything you wish people would know before they hired you that may make your job easier?
First, having a framework for understanding what we do is very helpful. Second, having some kind of organization of your documents goes a long way. In some cases, the organization can be a significant part of the cost of undertaking forensic accounting, so it is helpful to have a handle on what you have and what you don’t have, especially for things like real property documents.
Finally, having a good expectation of what it is that we’re going to be able to do and not is important. The whole process is tough, and no one thing is going to be a magic bullet that is going to solve all the problems in a case.
Protecting Your Financial Future in Divorce
At Hart Ginney LLP, we’re experienced in navigating the complexities of marital finances and the difficulties of divorce asset division, especially during high-conflict divorces. We can help advise you on your best course of action to secure your fair share of marital assets, including when a forensic accountant should be brought in. To reach us, call us at (510) 628-0250 or fill out the contact form below.
1939 Harrison Street, Suite 210
Oakland, CA 94612
