Lish Forensics

Outside Counsel

 

BY DENNIS A. LISH

The Problem With Neutrals in Contentious Divorces

 

 

Divorces often evoke concerns on the part of non-propertied spouses that the decks are stacked against them when it comes to valuations of their spouses’ business interests.  Today, many courts look towards a single neutral forensic accountant to value the business assets, as a way of saving money, time and aggravation from angry or complex matrimonial litigation.  Private mediation is a more drastic way of removing the judicial structure but it also removes some of the safeguards.    We must recognize that there can be devastating disadvantages in bypassing the courts, the advocates and the non-neutral experts, all of whom, when doing what they do best, give each side an appropriate ear, justice and Equitable Distribution.

 

In Early Neutral Evaluation Programs, divorcing couples and their lawyers can volunteer to bring their cases before a panel of voluntary pro-bono matrimonial attorneys, who will review tax returns, financial statements, valuation reports, and hear from the parties and then give them non-binding and non-admissible advice, on the issues and possible outcomes.  Attorney Lawrence M. Schaffer, the administrator of the program in Nassau County, says that in cases where there are short marriages, or where the issues are easily quantified or equilibrated — i.e. two W2 employees, two teachers with similar years of experience, or even in cases where there is a business and both sides are satisfied with an exchange of experts’ reports — lots of time, aggravation and money could be saved.  However, this program would not be appropriate in cases that might make new law or where direct and cross-examination is needed, as in the appointment of a neutral forensic accountant.

 

Power of Subpoenas

 

Experienced matrimonial attorneys know the kinds of jewels that can be discovered by using subpoenas, something very rarely used by mediators or neutrals.  Subpoenas sent to vendors can bring back all the purchases listed by date, even those paid for in cash and even those from businesses that propertied spouses fail to disclose.  Subpoenaed banks respond with loan and credit line applications that sometimes differ from tax returns and correspondence, such as interdepartmental memos that give us gems like, “the propertied spouse’s accountant told the loan officer that the tax returns were understated because inventories are actually three million dollars higher than the reported amount.”  That will speed up the chances for a quick settlement.

 

Propertied spouses, who are not happy with the values prepared by a mediator or a neutral, have the funds and the brain trusts to hire their own experts.  Unhappy non-propertied spouses, after being forced to contribute to paying a neutral or a mediator, are often out of funds and do not have the ability to continue, even if it is overwhelmingly in their best interests.  Remember that the propertied spouse team can get a good idea where the valuation is going, just from what the neutral asks for.  However, the non-propertied spouse generally has no idea where the neutral is going until the report is finished.

 

Some questions regarding procedure should be asked of a neutral, even if the attorney isn’t well versed in accounting, because the neutral will attempt to answer the questions truthfully, without committing perjury.  At the same time, the answers will be placed on the record for the court and for a later appeal.  Following, are questions that should be asked because counsel has no ongoing dialogue with the neutral and often has no idea if these tasks were done.

 

• Did the neutral interview the non-propertied spouse, follow-up on the issues raised and mention these issues in the valuation report?

• Where unreported income is alleged, did the neutral do an extensive reconciliation between the couple’s reported sources of cash and the actual outlays of cash or did he or she rely on the information found in the statutory Statements of Net Worth, usually prepared by paralegals? 

• What were the analytical weak points derived from the documents reviewed?  Were they noted in the report?

• If a business received substantial cash, did the neutral review and comment on the “internal controls”, if any?

• Did the neutral do markup tests to prove that the gross profits are accurate?  Here is where subpoenas of vendors come in handy to verify that all purchases were recorded.

• Did the neutral check the year-end cutoffs to match revenues and expenses?

• Why did other similar businesses do better or worse?  Was that ever reconciled?

• Did the neutral verify payments of materially large items to make sure that the payees entered in the accounting records agreed with the indorsers of the checks?  Imagine finding a check appearing in the accounting records as a $60,000 payment to a wholesaler, while a review of the physical check shows that it was actually indorsed by the owner’s paramour.  A few of those just might affect equitable distribution.

• Were there any assets, entities, documents, information, including computer and accounting systems, from which the neutral was blocked?

• Were any assets that were once owned by the propertied spouse, given to or sold to someone close, like a partner, family member or romantic interest?

• Was a national computer search of assets done?

• Did the neutral present annual income statements for at least 5 years, showing sales, cost of goods sold, inventory and expenses?  These are not supposed to be secrets and they must be in the report, especially where a neutral was the only person looking at the financial records. 

• Did the neutral review real estate appraisals for calculation errors, incorrect assumptions and irrelevant comparables?

 

By the time a neutral’s valuation report is complete, there is a great deal of resistance and a much higher threshold against looking back to see what a neutral overlooked, deemed not material enough or, even intentionally avoided.  The neutral must be monitored and each major issue vetted when discovered.  In one case, a propertied spouse husband kept assets from his wife by setting up another corporation, with almost the exact same name, the exact same address, telephone number, products and employees, including himself.  However, in this second company, which camouflaged substantial assets and income production, his children were the only stockholders.  Discovering this other company, by comparing rent checks to the lease, substantially changed the direction of the valuation.  How far would a neutral have gone to find undisclosed assets and businesses?

Most experienced forensic accountants have their war stories.  We’ve counted hanger purchases to determine the actual sales of dry cleaning stores, melted ice cream to determine how many cups, cones, cakes, etc., you can get out of a three-gallon drum of ice cream to extrapolate the real sales of an entire Baskin Robbins ice cream store and analyzed and counted checks to a building’s painting contractor, only to find that each apartment was being painted three times a year, every year, in a building with not much turnover.  Sometimes we have to be prepared to “go deep.”  If chosen, the neutral must be the dog in each side’s fight, and act as if retained by both sides separately.

 

A new “casus belli” for propertied spouses is to make the divorce process contentious and angry and make the discovery process slow and litigious to increase the pressure on overburdened court systems to appoint neutrals.  The level of anger and litigiousness should never be the determining factor for the appointment of a neutral.  It would give the propertied spouse who has something to hide, no matter how benign or fraudulent, every reason to ratchet up the intensity, knowing he’ll stand a much better chance in maintaining his deception if a neutral is appointed.  He has the money and he can always retain his own expert later on, if the neutral begins to stray passed the tax returns and financial statements.

 

Following the appointment of a neutral, a propertied spouse can feel emboldened and he may want to go a step further.  Meanwhile, the non-propertied spouse does not trust her soon to be ex and she wants her forensic expert observing everything that the neutral is doing, especially at the discovery stages. 

 

The court may allow her expert to be present at all on-site visits, as long as he or she does not try to erode the process.  However, the propertied spouse too often has other things in mind and when the neutral and the non-neutral arrive, he may ask the non-neutral to leave and even threaten to call the police if he does not leave. 

 

This can start a firestorm of mail and accusations and even attacks on the neutral, for not leaving when the non-neutral was thrown out.  Then the neutral may decide to pull back and may tell the court that the engagement will be finished via requests for information and interrogatories, in an effort to bypass the anger and accusations. 

 

If something like this actually happens, and itdoes happen too often, the propertied spouse would have pulled off an amazing feat.  He may have been instrumental in having the court appoint a neutral in the first place and following that he may have found a way to push both the neutral and the retained expert out of his business premises, where observations, impromptu unmonitored interviews and spontaneity in fulfilling information requests are lost. 

 

The propertied spouse accomplished what he wanted to accomplish and the engagement would have changed to a little more than a shallow review of tax returns and T & E receipts, as the neutral has lost that “direct connect” to the business.  That opens up the neutral, especially if he or she goes off-premises, for the questions listed above.  However, those questions can only mitigate, not replace, the access and information lost.

 

Larger Accounting Firms

 

If a larger accounting firm is appointed as a neutral, then complaining about that neutral can become very costly.  The junior accountant tells the senior accountant and the senior tells the account manager and the manager tells the partner. 

Then, if the partner has questions he asks the manager, who asks the senior and finally it goes back to the junior and then back up again, before correspondence goes out.  This process then gets billed, at each level.  Perhaps it would be much more productive and less costly alternative to have two non-neutrals holding each other’s feet to the fire, where neither would want to be embarrassed by a mistake.  The other alternative would be to not monitor and not question the neutral at all. 

 

Many horrendous things happen when mediators and neutrals are allowed the first shot. Sometimes their mistakes or shortcomings go completely unnoticed.  Bringing in a retained non-neutral, after the neutral completes the report is usually too late to get discovery restarted without going to the appellate stage.  Further, you cannot get to the appellate stage if the important financial issues were never properly identified and put on the record because the neutral ignored them.

 

Conclusion

 

Be cautious when neutrals are appointed because it almost always puts the non-propertied spouse at a disadvantage.  It should never be automatic.  It should never serve as a remedy for parties who at war because that will only encourage propertied spouses to play hardball and withhold discovery just to get a neutral appointed. 

 

Most propertied spouses want a single neutral appointed.  But a better time for such an appointment is when there is no money available, in any form, and when the issues are clear.  But even then, remember that they make mistakes, sometimes they get lazy and sometimes they just don’t listen. 

 

Dennis A. Lish is a certified public accountant and a certified fraud examiner in Delray Beac, FL 516 819-9003 - email dlcpa@live.com

 

This article is reprinted with permission from the March 12, 2004 issue of The New York Law Journal © 2004 ALM Properties, Inc.  Further duplication without permission is prohibited.  All rights reserved.