Embezzlement Between Partners Is Not a Crime
By Leah Wietholter, MBA, CFE, PI
Many clients have come to us with suspicions of embezzlement in their company. Through our client intake and information gathering process, it sometimes comes to light that the suspected embezzler is not an employee, but a partner in the company. Unfortunately, we have to discuss that this particular theft cannot be prosecuted criminally, and that what they are dealing with is actually a civil partnership dispute. One memorable such case was that of ABC Co.
Background
ABC Co. was made up of three partners. Two of the three partners made cash investments in the founding and origination of ABC. The third partner, Scott, was hired as CFO at a reasonable salary and would be given an equity stake in the business over several years. He would earn his portion of the ownership with his time and “sweat equity,” receiving additional equity in the business with each completed year of work.
The business seemed to be successful without any red flags until one of the partners, Bill, received a phone call from the bank that their line of credit was due for renewal. In this conversation, Bill discovered that the line of credit presumed to have never been used was actually maxed out. Bill was caught off guard because Scott had told him that the line of credit was just a back-up plan. Bill’s next call, after hanging up with the bank, was to Scott. Scott had plenty of explanations, but instead of feeling better, Bill got off the call even more confused.
ABC called their attorney, who called us immediately for help with forensic accounting procedures in this partnership dispute. Our primary objective, at the client’s request, was to determine why and how the line of credit had been used.
Data Sleuthing and Forensic Accounting Findings
In an attempt to maximize efficiency for the client, I always like to start with verifying whether or not QuickBooks is reliable instead of immediately digitizing bank statements. I do this by identifying if the QuickBooks records are reconciled. If they are, the next step is to then analyze the audit trail (using a handy macro we have) looking for deleted payments, changes in payees, and other fraud scheme cover-up methods. In the case of ABC, this strategy was halted immediately because in the entire five-year life of the company, QuickBooks had never been reconciled!
As a result, we moved on to digitizing the bank statements. In doing so, I discovered the following types of transactions that benefited Scott in addition to his salary:
Numerous ACH transactions with the description “ABC Co.”: This was odd as I usually expect ACH payments for utilities or credit card bills, but the number of transactions with ACH descriptions listing the name of the company itself was unusual.
Wire transfers: Wire transfers always make my list of suspect, high risk transactions, especially in a small to mid-sized business like ABC Co.
Usage of closed bank accounts and line of credit: ABC Co. bank accounts and a line of credit that were believed to have been closed previously were still being used.
Bank Statement Details
ACH transactions are electronic payments typically listed on bank statements with the payee somewhere in the transaction description. Financial institutions have supporting documentation for every line item on a bank statement, including ACH transactions and wire transfers. The supporting documentation available for such transactions discloses details regarding the beneficiaries and routing and account numbers for the transactions.
Finding the Money
By requesting this supporting documentation from the multiple financial institutions involved, we identified that ABC Co. funds were paid via ACH payments to XYZ Investments totaling $275,000. A simple public records search revealed that XYZ Investments belonged to Scott. When Scott would enter the ACH payment request via online banking, he was able to input the payee description as “ABC Co.” This then appeared on the bank statement, even though the actual beneficiary was his LLC. (As a side note, actions like these that conceal the true destination of a transaction are vital to track to help attorneys and prosecutors with evidence for intent—but we’ll cover that in another blog post.)
Wire transfers for the benefit of XYZ Investments to a bank in the Caribbean totaled another $200,000. Even though QuickBooks was not reliable in calculating any kind of loss, as so many transactions were missing, memos and notes for the deleted payments helped identify the intentions behind the transactions. For example, it was using this information that we obtained the address of a vacation home Scott had purchased in the Caribbean.
By reviewing the bank statement transactions, we also found credit card payments to Scott’s girlfriend’s personal credit card totaling $209,000.
Why Embezzlement Between Partners is Impossible
As one can imagine, when the ABC Co. partners discovered the reason the line of credit was maxed out was due to the funds taken by Scott, they were outraged! “Put him in jail!” and “Call the District Attorney!” and “Call the FBI!” were some of the top comments I heard in meetings with the client. Sadly, I had to be the bearer of the bad news that technically, Scott did not commit embezzlement.
Embezzlement is a state crime in which someone entrusted with property for another takes the property through fraudulent means. When a partnership exists, if one of the partners takes more than his/her fair share of the assets, that partner is not charged with embezzlement; he/she does not fit this definition since he/she owns the business assets rather than being entrusted with the business on behalf of the owner.
In my experience, no prosecutor has ever charged a partner with embezzlement. When I have asked, knowing the ultimate answer, at the repeated request of my client, the response has been, “That is a civil matter.” Although Scott was being paid a salary, he was granted ownership and equity each year. As such, my clients could pursue legal action against Scott through the civil courts as fraud but not through criminal charges such as embezzlement, wire fraud, interstate commerce and the like.
How to Detect Fraud in a Partnership
The simplest way to detect fraud in a partnership is for the owners who do not manage the financial areas of the business to examine bank statements and credit card statements on a regular basis. If there are questions about the expenditures on those statements, ask and obtain supporting documentation from the partner and the financial institution. If the explanation from your business partner doesn’t make sense, keep asking questions, investigating, and digging until it does.