Trial - Garvey Accounting Report

20:22 FAR 410733382? JDHH Second Amended Expert Witness Report of Ro rt A. Garvey. CPA, January 2, 2004 $21 Corporation 1711 a Beckett Brown International. Inc. and John C. Dodd, Pa Rakowski, at of. Civil ion No. OT llr??Tr?E?lE 20:23 Fill-i 0107933002? JDHH 0000 015E030 Second Amended in Report of Robert A. Garvev .Ir. CPA, CTFA Introduction 321 Corporation ?le/a Becket town International, Inc. (321) and John C. Dodd, ?led suit in Talbot County, Meryl against Paul W. Rakowski Sr, Timothy 3. Ward, James Kerr, Eric Pikus and Che eake Strategies Group, Inc. The suit alleges culpable mismanagement, misapprop ion of assets, waste of corporate assets, breaches of contract, constructive fraud, ach of ?duciary duties of care, loyalty and good faith, fraud, accounting malpractic negligent misrepresentation, breach of covenant not to compete and tortious interfer ce with contract and prospective economic advantage. It is my understanding that I, was organized in 1995 and that the four initial stockholders were James C- It dd, Paul W. Rakowski, Richard M. Beckett, Jr. and Joseph A. Masonis. The busi ?ss combined an executive search segment managed by Beckett and a security segine managed by Rakowski and Masonis. Dodd was to serve as a member of the Board of irectors and a ?nancier. James W. Kerr, CPA and his run James W. Kerr, PA. were engaged as the independent accountants for the company i resolution of the Board of Directors on August 23, 1995. As is typical in many engage rents between a CPA and small closely held companies, Kerr provided many services eyond the preparation of compiled and reviewed financial statements. One could argue I at his services mirrored the level of effort provided by a controller or even a chief ?n .. eial of?cer Records I reviewed indicate - at Kerr was Beckett?s personal CPA and a vice president of a company owned by Beeke I I town as ?Cen?dential Background Reports, Inc.? prior to and during his tenure as the i npany independent accountant. Personal banlo'uptcy filings by Beckett and his wi i Melanie N. Beckett, note that Kerr was dieir bookkeeper as early as 1986. Dodd advised me during a 1 ting on May 0, 2003 that Rakowski represented Beckett as ?solid and clean as a whistle '1Dodd noted that he relied on this representation when making his decision to inves the company. Documents reviewed during my investigation are at odds wit akowski's alleged assessment. Dodd loaned 3210120000 0 II 'ng August of 1995. During the years 1996-1999, Dodd loaned 521 and additional $3 . ,000. Rapaymeuts during the period totaled $180,000. In total, Dodd loaned sn appr imately $700,000. Scope of my Assignment I have been retained to iew and analyze ?nancial records relating to the above referenced civil action at, if deemed necessary, subject the records to certain investigative procedures to etermine their completeness and accuracy. In addition, I lla??fr?E?lE 20:23 Fill-t JDHH 010E033 have been asked to identify er rs in Compiled and Reviewed ?nancial statements issued by James W. Kerr, CPA durir the years 1996 thru 2000. IWas also asked to investigate and report indications of rnis proptiation of assets by the defendants and others. I was asked to quantify the ?nancial 3: pact of the alleged misappropriations. Methodology l, or members of my staff at a i- direction and under my supervision, have, among other things, performed the followi - procedures in reaching the conclusions contained in this report: .- Analyaed documents - electronic media obtained by Dodd and others from the offices of $21, includi correspondence, schedules, faxes, ?nancial documents, invoices, memoranda, ports, income tax returns, checks, bank statements and corporate minute boo - Analyzed available ge ral ledgers, subsidiary ledgers, payroll lodgers, journal entries and other acco I. I Analyzed documents d! I Analyzed documents tained by subpoena from Talbot Bank. I Interviewed Mr- John Dodd, and Ms. Lisa Andrew, CPA conceming the business of $21 and time line of events. I Read a time line of cv ts provided by John C. Dodd, I Interviewed the outsi - auditor, Mr. Patrick M. CPA of Mullen, Sondberg, Wimbish tone, PA. (Mullen, Sondberg) concerning the audit and ?Adverse Opinionthe reliability of the 821 financial statements for the ye nded December '31, 1999. i I. As of the date of this report, i i' ositions of the defendants and others have not been completed. Absent testimony .- the contrary, I believe that the documents analyzed support the conclusions reac it in this report. Ass prions and Limiting Conditions 1. My ?rm has not audited - financi a1. infomiation pre a person who prepared the 2. We have relied on repres other documentation pro no responsibility is ass 3. This report was prepared ?nancial statements or income tax returns or other nted. Their accuracy is solely the responsibility of the atements and tax. returns. tations made in the complaint, amended complaints and ed. These representations are believed to be reliable, but id for their accuracy. the use of legal counsel involved. in civil litigation. No reproduction, publicatioi istribution, or other use of this report is authorized without the prior written I nsent of the ?rm and the undersigned. 4, This report and its concla 'ons are subject to revision upon the presentation of data that may have been undis losed or not avail-able for inspection andfor analysis on the date of issuance of this rd I 011. 'l'lr?0?t'r?2013 20:23 410?03002? Misleading Financial Staten During their term as of?cers, responsibility for the recordin were responsible for hiring art were the primary contact with his staff to ensure that the tin compiled financial Kerr?s engagement. These - reasonable acetiracy the ?ner statements presented a disto challenge faced when attemp multiple compilation reports Other than one report issued statements Were based on cas Examined appeared to be pre things, this method requires numerous instances were de revenue. If revenue is not rec I materially distorted. Bad Debt expense was not prepared, even though questi contained notations indicatin year?end. During 1996, unearned reve ?nancial statements. As mo 1996 were erroneously post The ?nancial results were when certain accounts were entry was to overstate Cash $50,000, Retained Earnings this entry and it Was not reed same month. JDHH 0000 Ulir?UEEl Fin dings eckett, Raltowski, Ward, and Pikus had control and of transactions in the books and records of 321. They i accounting and bookkeeping staff, and they i. err and his staff. It was their duty to work with Ken and I. cial reports were reasonably accurate. rtements Were prepared for almost every month during cial statements were relied upon by Dodd to present with al position of 321. Unfortunately, many of these financial picture of the financial position of $21. An additional to ascertain the ?nancial picture was the proliferation of the same month issued by Kerr. Kerr on March 7, 1996, Which indicated that the ?nancial receipts and disbursements, all the financial statements I ed using the ?Accrual? basis of accounting..Among other enue to be recorded in the period earned. I noted 1' i its or advance payments or ?retainers? were recorded as dad in the period canted the net income or loss could he able invoices were being tracked. Some of the reports Beckett had instructed that the invoices be written off at was found in nine of the twelve compiled fully discussed later in this report, bad debts related to to retained earnings in 1997. I rially overstated for the year ended December 31, 1996 creased by use of an adjusting entry. The effect of this l00,000, Custdmer Deposits $50,000, Security Revenue - 0,000 and Net income $100,000. No invoices supported ed in the books until January 1997 and reversed in the llr?0?i'r?20l3 20:24 Fill-i 410133332? Had the 1996 ?nancial results different ?nancial picture. JEIHH 3333 013E033 een prepared correctly Dodd would have seen a vastly 1996 Income Reporte i Financial Statements 9 342,099 Bad Debts not 0 ucted that applied to 1999 (56,040) foicer Compens ion not deducted as an expense (12,527) Retainer booked income during December (100,000) Adjusting entry no support reversed 1/1/97 (100,000) Corrected inco Before income Tax 1996 72.724 During 1997, unearned reveui ?nancial statements. This pro contained significant overstat and April because Dodd madl of credit during the period. Tl be seen in the following table: was found in seven of the twelve compiled em accelerated in 1993 when nine of twelve months ents- Of particular concern were the months of March ash advances and signed as guarantor on a $250,000 line impact of overstated revenue during March and April can Ignoring bad debts and recon ended December 31, 1998 ?t March April 1993 1993 TotaiSal recorded $240,317 $291,735 Total Ex ses 225,996 214,735 Income (1 as) 14,921 79,999 Retainers rid Advances (30,000) (37,100) Adjusted neome (15,079) 39,399 Percenta a change 201% 43% ng revenue incorrectly had a significant impact on the year eial statements, as the following table illustrates: 1993 Net income Re orted on Financial Statements $(170,244) Bad Debts not corded (43,400) Corrected Ne ncome for the Year $(219,644) The misleading statements retainer and advance paymer surfaced. Of the approximatl approximately $120,000 or tinued in 1999, with ten of twelve months containing recorded as reVenue. During 1999, a new problem $260,000 invoices recorded improperly as revenue, ?i/o were ultimately written off as not collectible. The 112?01'2?2013 2022-11 F1111 4107033002? JDHH 0000 01021030 following table illustrates the impact of recording invoices incorrectly during 1999. Other adjustments that ould have been made would also have impacted the reported results. - 1999 3 Jan Feb til .I April May June July Sep Oct Nov Dec ales Total 199.091 195.594 19 505 245,522 197.79 229.9? 295.197 103.235 135.392 129.151 122.199 llncorne(L055) (55.99511 (47.414 31) 39.395 (20.251 45.540. (20.101)! (70.172) 4.955 13.522 23.417 Retainerd I Advances 15.000 5.000 750 82.500' 49.50 23.500 25.530 5.000 15.000 1.250 5.000 Revised I - moon-latices) (70.095) (52.414) {551) (42.505) (59.751 22.145 (45.939) (54.172) (10.034) 12.372 18.41? Percent error 427% I 4% 207% .244 51%. 4.14% 95% 302% 9% 21%. As more fully discussed later 1 this report. in addition to causing misleading financial statements. many of ijl ese invoices Were sold to Talbot Bank. The Talbot Bank agreement required that only lid invoices for services rendered be presented. As noted previously. of the 3260.000 it properly recorded in 1999. 5120.000 or 46% were 1 ultimately written off. Many the invoices were written off because no service was performed. 5 I reviewed a document entitle ?Summary 1998 Adjustments Pending? dated July 1999. which indicates that Beckett ti?ed Kerr to adjust (write off) $34.000 in sales recorded during 1998. A hand written te indicates that Kerr instructed the staff. in what can be interpreted as an attempt to 3111115 bad debt. to post the invoices directly to the retained earnings account. The effect I as to understate the 1999 less by 534.000. An additional $16.42? in 1998 sales identi in the document as not collectable was not written off until December 1999. Had se transactions been recorded properly and timely. the July compiled ?nancial statemen - issued August 5. 1999 would have indicated that the company was losing money ther than the profit of $11,802 reported. After Beckett resigned on A ust '16. 1999. Kerr issued two revised July financial statements. one on Septemb 14. 1999 that indicated a year to date loss of $117,419 and one on November 5. 1999 i I eating a loss of 5157.103. Despite attempts to correctt Sondberg?s audit report indi audited loss was 562.000 hi misleading statements issued earlier in the year. Mullen . tes that the loss was actually 5341.000 for the year. The than the 1999 results reported by the defendants. During the first quarter 012 I ll the pattern of recording retainers and advance payment invoices continued. Dodd 111! - that during the ?rst quarter of 2000 he was led to believe that 521 was rebounding. calculations indicate differently: 1120122013 20224 F211 410103882? 0000 Jan 2000 Feb 2000 Mar 2000 Sales Reported Sales to the Month 98,074 152,258 79,951 Reported Income oss) 5,050 53,509 17,035 Retainer 8 Adv Payment 14,200 12,000 31 ,881 Corrected lncom (Loss) (9,150) 41 ,009 (14,845) Manipulation of Internal Di Attempts to prepare divisions 1998. While I was not able to appropriateness of the method allocation of overhead away 1? salary was allocated to the rec Since Beckett was in charge a commission for those six mot base compensation to be allot: In addition to multiple Versioi intemally prepared divisional generated in some months. Tl manipulating the allocation 0 Accounts Receivable Agi_n_g Mullen, Sondherg noted in th from the 821 books was mate receivables were overstated notes in a letter dated Januan reconciled, the and 1 not accurate.? 1 reviewed ?Firm Billing Wu corporate records for the peri suggests that the aging was 11 The following table is 50111111 sional Financial Statements ro?t and loss statements began in the second half of ad adequate documentation to form an opinion on the logy, I did examine dociunents, which appear to tilt the Beckett?s recruiting division. Only 10% of his base iting division in a calcalation done at June 30, 1998. that division and had-received over $56,000 in s, 1 would have expected a much larger percentage of his ted to his division. of ?nancial statements issued, I noted a similar pattern in naucial statements, with numerous versions being so internally generated statements appeared to be verhead and expense to the various operating segments. ani ulation 1' audit work that the accounts receivable aging prepared ally misstated. Their workpapers indicate that total over 40% at December 31, 1999. Patrick. CPA 2001; ?Since account balances were not being ar end ?nancial information that was being presented was sheet documents found in the November 1998 through January 1999. My analysis ng manipulated in 1998 also. 'ses data taken from the BWE reports: Days Outstanding I (1-30 31-60 61-90 91-120 Over 1.20 Total November 1998 51,102 $229,921 $281,023 December 1998 $121,151 $163,298 $284,449 January 1999 37,616 78,602 $190,378 $306,596 0292030 1120122013 20226 Hill 410163032? JDHH 0000 0212033 In general, an accounts receive :5 I 1e aging system works by adding new receivables each month which are then less the i 0 days old. Items in every other category are then adjusted to re?ect payments eived. The remaining balances are then. moved to the next category unpaid invoices: om November which were in the 31-60 days category move to the 61-90 days categ I es in December if they are still unpaid to re?ect the additional time period they i been outstanding.) Based on the BWE reports fr i ll November 1998 through January 1999, the ?gures provided cannot be accurate. pi there are $0 receivables in the 0-30 day category in November and December, it i iot possible to then have new receivables appear in the 31-60 day category one montri ater. If there are $0 receivables 91 to 120 days old in December 1998 then it is not - I ssible for receivables in excess of 120 clays old to grow by approximately $27,000 fr December 31, 1998 to January 31, 1999. l. For example, in this case, as November 30., 1998, 100% of receivables were older than 90 days and 31.82% ofthe re ivables were over 120 days old. in the December report, only 57.41% ofthe receivabl are over 90 days old, and 42.59% are less than 60 days old. Finally, in the January re 62.09% of the receivables are over 90 days old and 37.91% are less than 90 days d, Ward acknowledged in a lett to Lisa Andrew that be caused payments to be misappli ed. He wrote, The amount ($32 I1 00) when received was applied to past due invoices from 1999. The $32,000 that we unable to collect from 1999 should not be included in Lisa Andrew, in an analysis memo, noted that the net my 2000 commission schedu bad debt that resulted when d?s misapplied payments were reconciled was $25,000. Mullen, Sondberg included umentation in their worltpapers that indicates that Beckett and Raltowslti were covering I, un-collectable invoices. The memo states that staff advised them that Beckett an alcowslo' instructed them to apply payments to oldest invoices first. 5 Business Manager Loan enant Violations On .1 anuary 12, 1999, 521 op I ed the ?Business Manager" account with Talbot Bank in Easton, Maryland. The agre ent called for 321 to sell its then current outstanding receivables as well as future ceivables represented by invoices delivered to the bank, up to a maximum amount of $7 ,000 at any one time. i that ?its receivables are and that they will be at the time of a isting obligations of customers of the business arising out 1 clear of all security interests, liens and claims whatsoever S21 represented and warrant their creation, bona tide and of its sales or services, free a of third parties." Between January 1999 and i 2001, invoices totaling approximately $2,700,000 were sold to Talbot Bank. Of thes invoices totaling approximately $3 l2,000 were charged back to 821. Approximately 167,000 was written off the boolrs as not collectable. llr?0Tr?2013 20:25 Filli 4107033002? 0000 022E030 My analysis of the invoices mitted to Talbot Banlt revealed a pattern of invoice sales to the bank that were not lson 1de and existing obligations at the time of sale. Many of the so?called invoices were a ainer? or advance payment requests. Unsigned engagement letters I reviewe ndicate that the retainers were for contingent executive search efforts. In a memorandum from Pilm Ward, Films admitsthat he knew of the scheme to submit the fake invoices. He tes, ?Approximately $130,000 of the charged backed invoices were in violation of agreement when submitted.? I have examined $21 docume that'indicate members of $21 management and Kerr knew of the scheme to submi Ilalce invoices to Talbot Banlt, including an internal document 9/15/99 that notes, ivoices which we deleted but still show with the bank.? Transaction On April 26, 1999, $21 enter into a contract with Corporation to provide security services. The schedu of compensation called for an initial retainer of $100,000, due prior to the commencem i of the project, and hourly rates for services thereafter. The initial retainer Was recei on May 17, 1999. On .luly 26, 1999 invoice #9 134 was issued to Mr. Tedson J. Myers of Courdert Brothers. It was identi?ed as . ?progress retainer" in amount of $150,000. This invoice was entered in the books as 0,000. $21 documents indicate that this was actually a invoice. A report attributed to Lisa or, 521 staff member, dated October 26, 1999 noted that "invoice 990134 was ectuel' for $1 .5 0,000 and the wire transfer were received 8/2/99. lf- invoice #99?0102 $1 2.8 70 and $37,130 towards invoice We used $50, 000 to i. I #99-01 6 which has remez? .. igr balance of $1 926. 00. Various billing reports as well as entries in the 321 books in nn this treatment. 1 could not locate any indica in in the data examined that would explain this most unusnal transaction. The cas-l hat may have been subsequently received on invoice #99- 0102 and #99-0116 is not ac unted for in the sat books- A second questionable invoi i for $100,000, #99-0104, was addressed to on June 30, 1999. 1 could not lo this invoice in the Company records. However a duplicate invoice 99?0104 as entered in the books addressed to Sodexo Marriott Corporation. Duplicate invo' are frequently used as a method to steal cash. Duplicate Invoices In addition to the i; invoice discussed above, I discovered ?ve other duplicate invoices created in 1999 Ii 000 totaling approximately $36,000. 112?01'2?2013 20:25 Fillt Of?cer and Stockholder C01 The Stockholders Agreement Rsltowski and Masonis were . was to receive a commission revealed that they received co agreement. 1996 Rakowslti received payroll cl bonus he awarded himself in i- allowance" and borrowed deferred compensation accou His W-2 Wage and tax. statem of $99,710. The $11,000 in 4101'03002? JEIHH 0000 0232030 . ensation ovided that three of the four stockholders, Beckett, receive $90,000 per year in salary. In addition, Beckett profits of the recruiting division. My investigation pensation and other cash payments far in excess of the 4 k3 totaling approximately 599,719, including a $25,000 ll, oen'iber. In addition, he received $11,000 for ?car ?'orn the company. The loan was charged against a in August 1996 in for 1990 indicates wages, tips and other compensation i allowance was not included, thus under reporting his income to the IRS by $11,000 Personal expenses paid on his behalf by the company were also incorrectly exclude Beckett received payroll ehee bonus he awarded himself in totaling $23,450 and ?car allo dining November for $20,00t His wage and tax statem of$128,769. The $11,250 in income to the by $11,251 were also incorrectly exclude Dodd has advised me that he issued. 1997 Rakowslci received payroll compensation were extra ch December 31, 1997 appear 1 and Masonis. These extra eh $40,750 that Beckett recein - ?nish his W-2 statement. totaling approximately $100,319, including a $25,000 ecemben Beckett also received commission checks ances? totaling $11,250. A check. was issued to Beckett which was recorded as a note receivable in the books. for 1996 indicates wages, tips and other compensation allowance was not included, thus under reporting his Personal expenses paid on his behalf by the company -- from his W-2 statement. r, as not aware of the bonus checks until after they were 1996 1 Beckett Rahowslti Pilots Ward Regular Salary chec '5 75,000 5 75,000 511.000 5215200 Deferred 9,500 9,500 Bonus 25,000 25,000 Commission 28,400 3,000 Auto reimburse 11,000 11,000 2,250 Total Compensatior - $143,900 $120,500 36,000 48,000 eclcs totaling $130,500 during 1997. Included in this its totaling $40,750. Identical checks of $5,000 issued on 1? be another round of bonus checlts to Rakowslci, Beckett cits were identical in time of issuance and amount to If during the year. Also, he received $10,000 for auto llf0l'i?2013 20:20 Fill-l 4107030027 allowance. No discussion or Board of Director?s minutes expenses were excluded fo Beckett received payroll che compensation were extra chec time of issuance and amount it received $10,000 for auto all: compensation is mentioned ir auto allowance and personal I Beckett took $20,000 and Bio not repaid; it was eliminated #75200 (subcontractor-other) understate officer? compens: amount he reported to the IR Pilcus took commissions in e1 of the recruiting division. I JDHH 0000 024E030 roval for this level of compensation is mentioned in the 1997. Once again,-tlie auto allowance and personal is Statement incorrectly. totaling $134,259 during 1997. Included in this totaling $40,750. These extra checks were identical in $40,750 that Rakowslci received during the year. Also, he auce. No discussion or approval for this level of he Board of Director?s minutes for 1997. Once again, the penses Were excluded form his W-2 Statement incorrectly. charged it to a loan account during 1996. This loan was an adjusting entry that charged the $20,000 to account October 1997. The effect of this adjustment was to overstate subcontractor expenses, and understate the it amounts during the year, not linlced to the performance Rakows ki Ward 1997 Beckett Films Regular Salaly once 3 89,800 39,800 20,000 48,000 Extra payroll choclcs 35,750 35,750 Bonus 5,000 5,000 250 Commission 3,700 15,7 50 Auto reimburse 10,000 10,000 _7,250 Loan 20,000 1 Total Compensation $164,250 $140,550 5 36,000 55,250 L93. During 1998, Rakowslci and $120,000. In addition, Beck: approximately $79,400. He are contained in the board In For the months of January to commission. Beginning in 11 attempt was made to disguis ecl-cett received payroll checks totaling approximately received checks classified as commissions totaling provals for the raise in base pay ?rom $90,000 to $120,000 utes or other documentation we reviewed. une, Pilcus received $1,500 per month classi?ed as y, the $1,500 began to appear as salary. It appears that an commission checks paid to him as salary. . 1998 Beckett Rakowski Pilots Ward Regular Salary Ch: ks $118,800 $118,800 47,700 59,000 Extra Payroll Chec 1,913 1,620 6,331 Commissions 79,400 56,500 Total Compensatio $200,113 $120,420 $104,200 65,331 10 111?01'1?2013 20:20 410103002? 1999 Raltowslo' and Beckett resign extra check for $5,000 with was also disbursed to 111m in also received an unexplained 0000 026E030 during 1999. During January, Rakowski received an documentation or approval; An extra paycheck for $3,333 ugust. Following the patteni established in 1997, Beckett 5,000 check in January, and one in August for $2,917. Item Beckett Rakowslti Piltus Ward Regular Salary on 1:5 3 33,130 $100,333 a 33,730 a 30,000 Extra Payroll Chec 5 7,917 8,333 Commissions 52,800 Total Compensatio 91,667 $109,166 $106,550 5 80,000 Manipulation of Deferred Under the guise of reducing that they were deferring a po Scheme was to avoid payroll auto allowance. The records during the months of April to out?ow. Between April and August, 1 be paid on his behalf, which borrowed $8,900 and caused Masonis caused approximate which were charged to vario understate officer?s compens amount they reported to the i. As part of the proffered plan $1,000 a month. Although th extra $700 per month, per of late 1997. Kerr and his staff were well documentation in the docunt scheme unfolded. The auto not reported to the IRS and Intol'nal Control Wealtne Mullen, identifie circumvention of existing 1999, which were so seriou reviewed for years prior to weal: or nonexistent. Weak mpensatioa Arrangement out?ow, Beckett, Rakowslci and-Masonis advised Dodd 'on of their compensation during 1996. Part of their xes by shifting a portion of their compensation to a fixed veal that while $23,564 was posted to deferred salary ugust 1996, there was no meaningful reduction in cash ckett caused approximately $6,000 in personal expense to ere charged to various expense accounts. Ralcowslci 1,690 in personal expenses to be paid on his behalf. $6,900 in personal expense to be paid on his behalf, expense accounts. The effect of these transactions was to ion, overstate other operating expenses, and understate the. on the 1996 129-2 forrn. heir car allowance Was increase from $300 a month to deferred compensation plan ceased in August of 1996, the cer did not. This amount continued to be paid to them until are of these matters. I found workpapers and other ts produced by him which clearly explains how this owance and the personal expenses, although taxable, were ate as income. umerous exertiples of lack of internal control as well as trols during their audit of the year ended December 31, hey quali?ed as ?Material weakness." Documentation 1 99 supports a conclusioo that the 321 internal controls were non-existent intemal control provides the opportunity for 11 llr??TfE?lE 20:2? 410183832? JDHH 0000 02Ef033 employee fraud and abuse to - cur. My investigation disclosed transactions and documents, which typically i .1 care possible fraudulent activity- - i As offices and senior membe of management, Beckett, Rakowski, Ward, and Films had a duty and a responsibility to -- sure that the system of internal control was adequate to protect the assets of Compan ill odd advised me that Beckett and Rakowski advised him on numerous occasions that internal controls were tight. Dodd infonned me that be relied on their representations I Questioned Disbursements Following is a partial listing I disbursements made to or on behalf of the defendants listed that appear to be inappr riate, excessive, not business related or no explanation could be found. The alleged - rpayments in compensation and personal expenses paid to Beckett, Rakowski, Ward, kus and others exacerbated the cash ?ow problems. Beckett Dyer $230,000in $21 disburs i ents are questioned, including but not limited to: - Beckett received a $2 00 bonus in late December 1996 that was not supported by approvals or menti. in Board of Director minutes. up During 1997, he recei paychecks totaling $40,750 in excess of his regular paychecks, including $5,000 bonus on December 31. During the years 199 1999, an automatic payment was deducted from the 821 Talbot Bank (31(ng account #0215285101 and transferred automatically by the uk to the account of Beckett Brown international Talbot Bank account 115957900. Beckett Sr Brown International was owned andfor controlled by it ckett. These disbursements were charged to ?of?ce expense? by usting journal entries prepared by Kerr?s staff. The charge to of?ce expense app rs to be an attempt to hide the disbursements. I note that no liability existed be balance sheet for this debt during the years in question. A total of approxima $24,000 Was disbursed. . During November of 996, a check for $20,000 was issued to Beckett. This check was recorded in the in ks as a loanreceivable from him. No loan documents were found in the co rate records and no mention is made in the Board of Director minutes. Th loan is not paid, rather, it is eliminated by adjusting entry in October of 1997 and ritten off as an expense to account #75200 (subcontractor cost). - During 1996, Beckc 'eceived six checks totaling $5,908, which were charged to various expense acc nts. These amounts were later used to reduce the deferred compensation due hi . - Beckett received it in excess car allowances during 1996 and 1997. - During July 1998, kett received check it 1835 for $4,838.91. This check, which was signed I: was identi?ed as ?expenses?. No support for this disbursement could I located. I Do October 1. 1998 eckett withdrew $3,100 from the checking account in cash. No support for this it bursement could be located. 12 llr??'r'f2013 2022? Fax 4101838321" 0000 0212033 . During February of 19 Beckett received check #5865 for $11,000 that was coded to of?ce expens No backup documentation was found in the corporate records to support the eatment of this disbursement. During April of 1999, eekett received check #6233 for $1,000. No backup documentation was fo i in the corporate records to support the treatment of this disbursement. 1 On June 17, 1999, Be ett received chech #0514 for $1,849 supposedly for auto expenses. No backup cumentation was found in the corporate records to support the treatment - this disbursement. Between the months a March and September of 1999, Beckett charged over $33,000 in undocume ed expenditures. Over $15,000 of these items were recorded as ?Office 1 sense? in the company books. During the period Ap to August 1999, approximately $1,500, was paid to Beckett?s personal so not at the ?Crab Claw" restaurant in St Michaels Md, with no receipt indica of business purpose. i Rakowski I Over $180,000 in S21 disbur cuts are questioned including but not limited to: Rakowski received a 5,000 bonus in late December 1996 that was not supported by approv i or mention in Board of Director minutes. During 1997, Rakow I: received paychecks totaling $40,750 in excess of his regular paychecks, in i iding a $5,000 b0nus in late December. During 1996, Rakow i took $3,900 from the company, which was classi?ed as a loan. This amount .4 later used to reduce the deferred compensation due hirn. Rakowski received ,200 in excess car allowances during l996 and 1997. Check #4549 for .47 was issued to Rakowski on June 24, 1998. No support was located. i Check #5865 for $12 54.26 was issued to Rakovvski on October 15, 1998. No support was located. 1 Check #6234 was iss to Ralrowski for $1,000 and posted to of?ce supplies. This check is identic to one issued to Beckett on the same day. Check #6515 for was issued to Rakowski and posted to auto expenses. No backup was found. During November 1 Rakowski signed checks #7272 and #7274 payable to Dan Boone and Boot utterfield totaling $2,122. These checks were coded to of?ce expense. 11; is usual that of?ce expense were purchased from individuals. No support for these i . ecks was located. During the months 0 anuary thru October 1999, Rakowski received nineteen $200 checks totaling 3,800, which was charged to insurance expense. I find this unusual since 321 ha a medical plan available for employees. During the months ll 5 arch to October 1999, Rakowslri?s VISA bills totaling approximately $7,0 were paid, with no receipts found indicating the business purpose. I Check it 5715 for $5 I113 was issued to Rakowski on January 15, 1999. No support was located. 13 llf?i'fEdlS 20:2? 41070333027" JDHH 0000 023E033 Ward Over $50,000 in disbursemen are questioned including but not limited to: - During 1997, Ward re ived $4,000, which was treated as a note receivable by the company. No approva or loan documentation was located. I Between the months ll anuary and June 2000, Ward charged over $1,100 in gasoline using the cm I lit any credit card. - During 1998, Ward i itted reimbursement requests for over $7,000 that contained no receipts other documentation of the business purpose. I Pikus Over $50,000 in disbursemen are questioned including but not limited to: - During 1993,Pi1tus re ved approximately $56,000 in commissions, with no support or calculation iv. i ated. I find these commissions questionable because Beckett received over '5 9,000 for recruiting commissions in the same year. Inappropriate Outside Busi 58 more Ward was serving as a officer of 321, he was actively involved in another company, Sterling Silver LL II A document located in the company computer system authored by Ward is a marks I'il type letter. A letter written to the sales coordinator of Pin Tail Point on December i 2000 discusses invoices for silver pins and is signed by Ward as an of?cial of Sterlin Silver, LLC. This letter was also retrieved from data contained on 321 computers. Violation of Code of Profes -. in ma] Conduct by James W. Kerr CPA and James W. Kerr PA {Kerr} I The Code of Professional Co :1 not applies to professional services the CPA provides. It?s organized into four sections: I5 'nciples of professional conduct, rules of conduct, . interpretations, and rulings. I principles of professional conduct provide the framework for the code's Sp a i tic rules. The rules of conduct govern the performance of professional standards and a set by the AICPA. Various AICPA committees explain and interpret the rules. late as tattoos are codified in the ET section of the professional standards. During the years 19950000 l: err provided a variety of professional services to 321. As a Certi?ed Public Accountant a member of the AICPA, Kerr was bound by the professional standards of the ICPA as Well as regulations governing the practice of Certified Public Accountant i the State of Maryland and before the Internal Revenue Service. in my opinion, lie id not comply-with certain of those standards and regulations. - Rule 102 - Integrity a Obiectivity Rule 102 of the it Code of Professional Conduct requires that ?In the performance often? a ofessiomtl service. a member shall maintain objectivity and 1 1 4 lli??iiEGlS 20:28 JDHH integrity, shall hefre it conflicts of interest, and shall not lorowingly misrepresent facts or - inordinate his or herjudgment to others. 02.01) Con?ict of Interest Interpretation 102-2 es con?ict of interest may occur a member performs a professional servic a client or employer and the member or his or her firm has a relationship wit another person, entity, product, or service that could, in the member's professi aljutlgment, be viewed by the client, employer, or other appropriate parties mpairing the member?s objectivity. If the member believes that the professional a tee can he performed with objectivity. and the relationship is clisclo to and consent is ohtainedfrom sash client, emplOyer, or other appropriate pa .- es. the rule shall not operate to prohibit the performance of the professional se ice. I . I am aware of a number of i essional services that Kerr provided for Beckett, prior to and during his engagement ii 82L Daily time sheets produced by Kerr indicate that he prepared Richard Beckett?s sonal income tax returns, represented hint before the 13.3 and state income tax authorit and also performed professional services for other entities that Beckett owned 0 ontrolled. As noted previously, he was a vice president of a company owned by Eecke {?own as ?Confidential Background Reports, Inc." prior to and during his tenure as the - npany independent accountant. He was also listed as Beckett?s bookkeeper in a . truptcy filing by Beckett and his wife. I Kerr also provided income services for Masonis and Rakowski. Time records indicate that in addition to income ta jetulrns, he also was involved in tax planning, for Masonis. Dodd has informed me that i: was unaware of the professional relationship between Kerr and Beckett. He has also inf 1: ed me that he did not know that Kerr was providing professional services for a and Rakowski. In my opinion, Kerr had a cl con?ict of interest that was reportable to Dodd. He had a responsibility to notify Dod IE: his complete professional relationship with Beckett prior to agreeing to serve as the i1 pendent accountant. Further he had a responsibility to advise Dodd of the services provided to Masonis and Rakowski when he accepted the . engagement. Misrepresentation Interpretation 102?1 . ?nancial statements he owingly misrepre - he Or she ltnowingl I . I a. Makes. -- ermits or directs another to ntalce, materially false and misleadi r. :3 entries in an entity ?s?nancial statements or records; or b. Fails to rrect an entity ?sftnancial statements or records that are material:_ alse and misleading when he or she has the outlierin to record a: dresses knowing misrepresentations in the preparation of records, It states member shall he considered to have .ted facts in violation ofmle 102 section 102.01] when 15 lif?Tr?EWE 20:28 Fill-t 4107133832? JDHH c. Signs, carp mits or directs another- to Sign, a document containing nacrtericlly i [so and misleading information. As is typical in many engage i'nts betWeen a CPA and small closely held companies, Kerr provided many services yond the preparation of compiled and reviewed ?nancial statements. One. could argue Ii it his services mirrored the level of effort provided by a controller or even a chief ?n ial of?cer. The advice and assistance provided by Kerr included, but was not limited til I Preparing or reviewi trial balances I Recommending adjt - ing entries Consulting on acco 'ng treatment of transactions by providing journal entries supported by explan ory workpapers I Censulting on incon is tax strategy and treatments I Consulting on ?nan 1g transactions I Keeping the books a original entry and subsidiary ledger-s I Preparing checks fo' ignarure by Becket and others Assisting in the ere and allocation of expenses for divisional statements. These services provided Kc ith extraordinary exposure to the day-to-day operations of 321 and its ?nancial situatio {err and his staff were aware of the cash collection issues and the method used to recor invoices. Kerr was also aware that payroll tax reporting forms and W-2 forms tiled liS ?rm on hehal of 821, its officers and employees were incorrect. - Kerr was aware of many mis i! presentations, and either made or allowed his employees to make false and misleading Ir ice in the 521 books and records. Following is a summary of my ?ndings: . Io He or his staf. isguised disbursements made to Beckett as of?ce expense He knew that |;Ivance-payments or retainers were recorded as revenue incorrectly I He allowed i ?nancial ?nancial statements to he issued without an estimate revision for bad debts He or his sta Ii ?ecorded bad debts as reductions of revenue, which disguised los ii He was awar i but Beckett, Rakowski and others were using company credit cards I not documenting the business purpose of the expenditure. He was awar hat W2 fom?ts ?led by his staff on behalf ofthe Company understated able payments made to Beckett, Rakowski and Masonis I Rule 101 Independe independence generally im 5: es one?s ability to be impartial, intellectually honest and free of con?icts of interest. The ICPA has developed rules that establish and interpret independence requirements 1' its members. 16 lla??Ti?E?lS 20:28 Frill JDHH Rule 101.01 of the it of Conduct requires, member in public practice shall be independent in the I . ofprofessionei services as required by standards. promulgate: l. bodies designated by Council, Independence is required for? ttest? services as defined in the Statements on Standards for Attestation Engagements SAB). AT 101 defines an attest engagement as one which a CPA is engaged to issue or oes issue in writing an examination, a review, or an agreed-upon procedures rope I on subject matter, or an assertion about the subject matter, that is the responsibil' t. of another party. The Standards note certain a Vities that would be considered an impairment of a member?s independence. Kc independence may have been impaired when he: - Authorized and inst - ed his staff to post transactions to Sill books, which were kept on his computer i. stern - Authorized, prepared ll approved payroll tax returns - Served as Beckett's istrar or agent or of?cer of any of Beckett?s Companies On March 12, 1998 Kerr issu a ?Review Report? to the Board of Directors of SEI for the year ended December 31. 997. Kerr?s professional and business relationship with Beckett would, at a minimu lead a reasonable person having knowledge of the facts to conclude that the relationshi I need an Unacceptable threat to his independence. i . . Violation of Internal Revert Servrce Regulations Kerr prepared the federal an tate income tax returns for 521. In addition, he or his staff prepared the various payroll reporting forms. He also prepared the personal income tax returns for Beckett, Mas 's and Rakowslci. I . Kerr was aware that Beckett, altowsld and Masonis were ?ling incorrect income tax returns. lcnew that they d' not report auto allowances, personal expenses paid by the Company and forgiven loan =i taxable-income. Kerr?s actions in preparing these returns put 521 at risk for ?ling inco income tax reports. In addition, Kerr may have Violated IRS regulations concerning a I paration and signing returns. Treasury Circular 230 notes in section 10.34 that . . .a pr I: titioner may not ignore the implications of information ftu'nished to or actually kno i by the practitioner." His actions. if brought before the IRS, could be ruled as disre able conduct causing him to be suspended from practice before the IRS. Conclusions Based upon the documentat' i reviewed to date, interviews conducted, procedures performed and my own expr ence, education and background, it is my opinion that: 17 llr??lr?E?lS 20:23 Fill-i 10. JDHH DSEIUSS Misleading and erron I. ?nancial statements were prepared during the years 1996?2000. Documen and. other evidence I examined are similar in nature to the kind usually associate ith fraudulent activity. 821's this financial potion was altered by reporting revenues before the work was started, by misre .- senting of?cer compensation and other expenditures in the books and records by hiding expenses as adjustments to balance sheet accounts. Invoices were created "1d entered in the books and records by the defendants when little or no assu . ce existed that the service would be performed. These invoices were at best, 5 i: oposals or offer to perform services. Beckett, Rakowslci, rd, Pikus and Kerr were aware of errors contained in the financial records. Reasonable and credi different times: le evidence exists that one or more of the defendants at I Took substant bonuses and approved bonuses for employees without Board of Dire or stockholder approval Took compen tion as salary, commissions and auto allowance in excess compensation lled for in the stockholder agreement Caused persoi expenses, unsubstantiated expenditures and personal debts Used S21 ass I Caused 321 submitting in agreement. Excessive cash disbu ements to the defendants or on their behalf impaired the ability of S21 to surv the inevitable in business and had a negative impact on its ability I: recover and grow. . Kerr knew that the i controls at 821 were weak or non-existent and did not bring this fact to the ention of Dodd, who was the Chairmen of the Board. Kerr did not provide w: duty and care of a reasonably competent accountant in serving as the outsid iaccountant for S21, including but not limited to: I Integrity and bjectivity I General Stan l: 'ds of the Profession I - Tax Practice . Kerr?s actions and 'ssions violated the professional standards of the AICPA including but not hi i 1 ed to: I The Accoun t?s Reporting Obligation I Compilation I, Financial Statements I Departures I: Generally Accepted Accounting Principles Withdraw a Compilation or Review engagements I lndependen Kerr's actions and r: issions violated lntemal Revenue Service Regulations including but not ill ted to: I Standards 0 ax Practice Circular 230 Hi to run a personal business iolate its lending agreement with Talbot Bank by iccs that were not in compliance with the terms of the 18 llr??Tr?E?lE 20:23 FAH 410733832? JEIHH 033M333 It is my opinion that the examined to date and the interviews conducted provided reasonable credible complaint that: 1. Beckett, Rakowslei, 2. 3. new: 1/4 I64- McLean, nghler, Sparks Certified Public Accountants from Dodd. Beckett, Ralcowslci, Pi idence to support the allegations contained in the (1, Films and Kerr concealed the true ?nancial results and Ward used corporate funds for personal use. Beckett, Rakowslri am Ward made false and misleading statements to Talbot Bank. Of?cers of the Comps l: took compensation without documented approval Kerr breached his slut) 32L Kerr negligently mier professional care to the stockholders and creditors of resented the ?nancial position of 321. obert A. Garveyr In, CPA Report Preparer 19 HEINHEWE 20:23 FAH 4107?83382? JDHH [3343033 I I DATA . ND DOCUMENTS . NSIDERED 20:23 FAH JDHH 521 Corporation We kett Brown International Inc. an John C. Dodd, Ill Case No; 20-5-02-00461501? ta and Documents Considered Do ment Reference AICPA Code of Professions onduct ET Section AJCPA Statements on Stand ds for Accounting and Review Service All Section AICPA Statements on Stand ds for Tan Practice TS Section Regulations Governing the ra cc of Attorneys, Certi?ed Public Accountants, Enrolled Agents, En lied Actuaries and Appraisers before the IRS. Treasury Dept Circular 230 S21 Corporation We. Be Brown International Inc. and Complaint John C. Dodd, 1.11 Paul P. owslci, Sr. et al. S21 Corporation f/lda Becke Brown International Inc. and Amended Complaint John C. Dodd, 111 Paul P. 1 cwski, Sr. et al. S21 Corporation file/a Becke Brown International Inc. and . Amended Complaint #2 John C. Dodd, Paul P. i cwski, Sr. et al. Stockholst Agreement August 23, 1995 Bylaws Of Beckett Brown ternaticnal Augost 23, 1995 Promissory Note Signed by 'chard Beckett August 24, 12995 Promissory Note ?om Becl C. Dodd, for $120,000 11 Brown International to John August 23, 1995 ?Time Line of Sonic Events History of S21 Corporation Audited F11 cial Statement December 31, 1999 . Mullen, Sondherg, Wimbish d: Workpapers in support of at 'ted ?nancial statement Stone, P.A. Beckett Brown International Brochure describing quali?c tions of defendants and others 1999 Wage and Tax Statcmt ts 1996-2000 General Ledgers and other oks of original entry 199(5'2000 and annual Compi Financial Statements signed by James W. Kerr CPA 1996-2000 Rcviewed Financial Statem CPA Signed by James W. Kerr, December 31, 1997 321 Federal and Sate Inconi Tart Rettuns 1996- Talbot Bank Business Man er loan Agreement January 12, 1999 Memos, Emails and other recovered from S21 computers Invoices, paid hills, cancell notes and other documents S21 checks, letter, memorandum, lieved to be from the of?ces of Bank: records produced by hot Bank ?Expert Report of Andrew I ge, CPA August 15, 2003 HEIIJTHEWE 20:30 FAH JDHH QUALIFICA TIONS, DEPOSITIONS, PRIO AND LICATIONS llf?i'r?ECIlS 29:39 FAR PosrrIoN RANGE oE EXPERIENCE EDUCATIDN I PROFESSIONAL DESIGNATION PROFESSIONAL HISTORY JEIHH Professional Resume Robe A. Garvey,Jr., CPA, McLeai Koehler, Sparks 3; Hammond 1 It Kenilworth Drive, Suite 500 altimore. Maryland 21204 Phone: 410.296.6200 Fax: 410.296.6448 I E?mail: [email protected] Principal nd Practice Leader, Financial Investigation Services McLean, oelIler, Sparks BC Hammond Chief Fi? ncial Officer and Member of Management Committee McLean, oehler, Sparks Hammond Twenty-i i en years of experience in auditing, financial management and business ("insulting Fraud auditing and investigation experience in conunerc- gr business, family law and non pro?t sectors Eachelor Ii. Science in Accounting, University of Maryland, 1972. Continua professional education, 1974 to present. Accredited courses in: audit I: g; fraud examination; criminology; inVestigation; internal controls; - ancial and operational management. Certified ulsic Accountant Certi?ed I orensic Accountant Diploma American Board of Forensic Accounting McLean, i oehler, Sparks 5: Hammond, Principal and Practice Leader, Financia ll vestigation and Financial Advisory Services, July 1, 1999 to present. McLean, oehler, Sparks Eat Hammond, Practice Leader, Financial Investi .- ion and Financial Advisory Services, 1996-June 30, 1999. Aushe 9 Construction Company, Chief Financial Of?cer, 1992-1996. Baier perties, Inca, Chief Financial Q??cer and Director of Admi - ii ration, 1986-19. Realty l" vestment Company, Vice President and Controller, 1932-1986. 20:30 Professional Resume Robert A. Garvey, Jr., CPA JEIHH USEIUSEI McLean, Koebler, Sparks at In uond EITHER PROFESSIONAL EXPERIENCE PRC) FES SI DNAL AF FILIATIDNS DEPOSITION Arthur - and Company, professional staff, 1979-1982. Touche iss and Company, professional staff, 1972?1979. Member i i the of the American College of Forensic Examine Develop -I and taught course on Fraud InVestig-ation which is required for cert 3 non as a forensic account-ant. Develop and taught the course, ?Techniques in Forensic Accounting Deliver" Results.? Develop I: a multi-phase fraud prevention program for use by account to assist clients in detecting and evaluating fraud exposures in small - mid-size organizations. Author li numerous articles on fraud prevention and detection. Board .Ill irectors, American Board of Forensic Accountants Member li? merican College of Forensic Examiners Member ssociation of Certified Fraud Examiners Member merican Institute of Certi?ed Public Accountants Member aryland Association of Certified Public Accountants Member . asyland Association of Certified Public Accountants, Business aluation and'Litigation Services Committee Metnbe I ecutive Committee of Management Consulting Services, - Provi Elli Life and Accident Inaurance Company vs. Richard Bernstein, Case a? 93-3242, Baltimore City, MD, February 1999 Victor i- :i-wn et al vs. Edmund Li Fry et a1, Case 21842531, Circuit Court, ontgornery County, MD, October 2001 rost VS. Frank Bossing, Case 97-1941 CV, Circuit Court Sherry County,l\rlD Frederi I Dortben art, at al v. Prince Geroges County Police Department at 3.1., Case a? 02 CV 346, United States District Court December 2002 - HIGTIEWE Professional R?sum? Robert A. Garrey', In, CPA McLean, Koebler, Sparks TESTIMONY PUBLICATIDHS 410733832? CIT Len 12-0004 E. Circuit Sherry I Frederic] EduCatio Results" Marylan Account Marylan Fraud i Internati 1999, McLean, 1996, McLean, I "Reduce McLean, "Stop JEIHH USEIUSEI ond ?i Services Corporation v. 3129-OC, March 2003 Joseph J. Laputlta, In, et :11, Case billips vs. Willemiua Karsten Appelo Case Number or: for Cecil County, Maryland ?12:12:15. Bossing, Case 97-1941 CV, Circuit Court i I Program - ?Techniques in Forensic Accounting .- Delivering Trial Reporter Magazine (Future Publication), ?The Forensic A Valuable Addition to the Family Law Team? Trial Reporter Magazine (Future Publication), "Employee ot 111 My Family Business? ul - a1 Cemetery and Funeral Management Magazine, September :3 ectu1g and Preventing Ii' oehler, Sparks Hammond Law Firm Advisory, Winter at Your Finn's Banker Wants From You? .I oehler, Sparks Hammond Business Advisory, Spring 1997, 'il Hour Material Costs? I i oeiiler, Sparlu s: Hammond Business Advisory, Winter 1997', Ride - I Want to Get Off?