INTRODUCTION

In this paper the role of the expert in dealing with issues of money laundering, corruption and fraud in arbitration is examined. Given the nature of these activities the expert is likely to be a qualified professional accountant, although other relevant professional experience may be equally valid, e.g. banking. The expert's role is considered from three perspectives, namely that as an expert appointed to assist one or (jointly) all of the parties, as expert appointed to the arbitral tribunal and, third, the expert as a member of the arbitral tribunal participating in the determination of the dispute.

In view of recent well-known accounting scandals I will first examine the subjective nature of financial statements, which impacts significantly on issues of financial wrongdoing, and consider how the concept of materiality can weaken the boundaries between acceptable commercial behaviour and fraud. Examples of accounts manipulation with particular reference to recent wellpublicised allegations will be explored. The move to tighten accounting standards and regulation generally in light of recent difficulties will be explained.

Finally, examples of transactions which may indicate that money laundering, corruption or fraud has taken place are given together with a brief note on the relationship between the expert and law enforcement authorities.

1. THE SUBJECTIVE NATURE OF FINANCIAL STATEMENTS

It may be thought that the treatment of accounting transactions in financial statements is fairly straightforward because accounting transactions are seemingly simple matters of fact. Money is earned and spent, profits are taxed, funds are invested or borrowed. But financial statements are not necessarily limited to matters of fact. There is scope for the use of subjective assessment adequately to reflect the nature of the transaction. Most such assessments are entirely legitimate, but where they go beyond what is properly reasonable they may stray into the area of wrongdoing. Expert opinion may then be needed to provide an informed view as to whether the treatment is reasonable and appropriate or is wrong.

The simplest way of demonstrating the subjective nature of financial statements is to draw attention to my brand new Chester Barrie Savile Row suit that I am wearing for the first time today. For the purposes of this illustration it will be assumed that the tax authorities have agreed that the purchase of the suit is permitted for business purposes and may be shown in business accounts. A Chester Barrie suit is made to the highest tailoring standards, even though it is ready made, and compares favourably to an expensive suit handmade in Savile Row. Until recently Chester Barrie suits sold for about £800 in selected menswear shops. A few months ago the Chester Barrie company went into liquidation.

An enterprising retailer purchased bulk quantities of stock from the liquidator and advertised Chester Barrie suits at a sale price of £265. For the discerning male consumer this was an unbelievable bargain. I visited the store immediately and discovered that if you purchased two suits the price was further reduced to £250 per suit. I bought two and could hardly believe my good fortune. On returning to my car with my new possessions, my pleasure was somewhat dampened to discover a parking ticket on the windscreen. In my anticipation of a bargain I had not noticed the parking restriction. I was fined £30.

This leads to a number of important accounting issues. First, if I write off the cost of each suit as an expense in the profit and loss account in the current year, has each suit cost me £250 or has it cost £265, i.e. the basic £250 plus £15, being half of the cost of the £30 parking fine which I would not have incurred had I not gone shopping?

But the bigger issue is that the suits, being of a high quality, will last for many years. As such, they constitute an asset which can be recorded in the balance sheet. Each year a proportion of their value can be expensed in the profit and loss account as depreciation or amortisation, representing the value that I have obtained from the suits by wearing them in each period. The remaining value of the suits, after depreciation, will continue to be carried in the balance sheet as an asset.

What is the appropriate value of the suits that should be recorded in the balance sheet? At one level the initial value of each suit can either be £250 or £265, depending on how I treat the parking fine. But they are really £800 suits; I just happened to get them at bargain prices. The real value of each is £800, so £1,600 can be shown initially in the balance sheet as the value of the asset. However, as the manufacturer is in liquidation the suits are no longer available to be purchased for £800. An equivalent suit would need to be hand-made by a Savile Row tailor. This would cost at least £1,500 per suit which is the replacement cost. The subjective nature of value means that I can record the value of each suit in my balance sheet at any one of four values, £250, £265, £800 or the replacement cost of £1,500.

The value in the balance sheet will help to establish the amount of the annual depreciation charge, the higher the asset value, the more being available to be written off as a depreciation expense each year. But this raises another problem. Over how many years should the suits be depreciated? Is it three years, five years, eight years, or are you one of those who takes such good care of clothes that the suits will last in good condition for fifteen years or more? So there is a further subjective assessment to be made regarding the number of years that the suits will be depreciated.

Next, there is the method of depreciation. Should the suits be depreciated by the same amount each year, or do you take into account what happens in practice? Suits looks fresher and sharper in their first year or two of use, however well maintained they are, compared to subsequent years. So depreciation can be accelerated in the first two years to reflect this fact, writing off, say, two-thirds of the value and thereafter depreciating the balance on an equal basis for however many years you want to write it off.

It is thus evident that a simple financial transaction, namely the purchase of a heavily discounted suit at a cost of £250, or is it really £265, can be reflected in the financial statements in many different ways. If this extent of subjectivity and variation can be introduced into this transaction it will be recognised that in the world of complex commercial activities, the range of alternative accounting treatments that can be introduced to reflect business transactions is almost infinite. Expert opinion is needed to assess what is, and what is not, a reasonable and valid treatment in the circumstances of the case.

Subjectivity in accounting treatment can be further complicated by the concept of materiality. Take the £15 parking fine per suit. It is not a vast sum and it may easily be considered to represent part of the cost of the suit. But if the fine was much larger, which it might have been had I not settled payment quickly, the extra amount could be material to the cost of the suits and it could be necessary to ask whether it was appropriate that the fine be added to the capitalised value of the suits in the balance sheet instead of being expensed in the year in which it was incurred.

2. OPPORTUNITIES FOR MANIPULATING ACCOUNTS

With this understanding of how subjective assessments can affect the treatment of accounting transactions, we can examine some typical areas where financial transactions may be wrongfully manipulated. A few examples are:

Revenue

-Advancing or delaying the recognition of sales
-Manipulating rebates and discounts
-Under or over providing for bad debts

Expenses

-Under or over accruals
-Delaying or advancing expenses
-Manipulating rebates and discounts
-Misrecording capital or revenue items

Inventory

-False quality
-False quantity
-False valuation

Cash

-Hidden pledges relating to cash deposits

Other

-Manipulating transfer prices
-Misuse of inter
-company and suspense accounts

3. CURRENT ACCOUNTING SCANDALS

With this understanding of how financial statements can be manipulated we can examine some of the recent accounting scandals that have rocked corporate America. In one case it is suggested that a corporation has concealed rising expenditure that would otherwise have depleted profits and threatened the share price of the company. Expenditure was apparently capitalised and carried forward in the balance sheet as an asset, rather than being written off as an expense in the year in which it was incurred. It has been reported, for example, that the cost of plane flights to inspect possible new sites for the company's expanding telecommunications network was treated as capital expenditure. For the financial year 2001 and the first quarter of 2002 some US $3.8 billion of operating costs were said to have been treated as capital expenditure. Without these transfers the corporation would have made losses during these periods instead of profit of US $1.4 billion in 2001 and US $130 million in the first quarter of 2002.

Treating some employee costs as capital expenditure is deemed legitimate by many telecommunications operators, as the expenditure is considered to represent capital investment for future profit depending on the nature of the work of the employees. The key difference with one corporation under scrutiny was said to be the scale of the capitalisation, i.e. it was an issue of materiality. Newspaper reports suggest that the US $3.8 billion which was capitalised represented 39% of the corporation's total capital expenditure for the periods indicated, which compare to about 15% for some of its major competitors. Since the investigation commenced it has been suggested that in the years 1999 and 2000 certain reserves were reversed into income, hence the total overstatement of earnings is alleged to be at least US $7.2 billion. Furthermore, it has been reported that the corporation may write off US $50.6 billion of intangible assets when it restates its accounts for the years 2000 to 2002.

In a second case the essence of the problem was, apparently, to remove trading activities from the core of the business by putting them into separate partnerships, thereby enabling the debt and, where appropriate, profits, to be withheld from the company's financial statements. It has been reported that the US Senate Investigation Committee believes that if the company under investigation had properly accounted for certain transactions as debt, the debt load of the company would have increased by 40% and the cashflow operations would have been halved.

Organisations where fraud is uncovered often display a number of similar characteristics. These include a dominant leadership, the sidelining of the internal audit department, an intense pressure to meet the predictions of financial analysts and others, orders to forbid employees talking to the external auditors and queries as to the nature and depth of the work undertaken by the auditors. These are matters that an expert will evaluate in forming a view as to whether wrongdoing has taken place.

4. STRENGTHENING ACCOUNTING STANDARDS AND REGULATION

The concern caused by the recent accounting scandals has led to calls for the strengthening of accounting standards and their uniform application on a worldwide basis and for improved regulation generally.

From 2005 there will be a requirement that all listed companies within the European Union must publish consolidated financial statements that conform with international accounting standards. This will affect some 9,000 EU listed companies, of which about 500 already comply with international accounting standards1. Major differences exist between EU and US standards, and these are presently the subject of considerable discussion amongst the accounting regulators.

In October 2002 it was reported in the Financial Times that international and US accounting standards look set to achieve significant harmonisation as a result of an agreement reached between the International Accounting Standards Board and the US Financial Accounting Standards Board. The two Boards issued a memorandum of understanding that locks the two bodies into a long-term collaboration project on convergence.

The project is expected to remedy deficiencies in US accounting standards exposed by recent corporate scandals, and it is likely that there will be a change in the United States from a rules based to a principles based approach. The memorandum states that the two Boards are committed to the development of high-quality, compatible accounting standards that can be used for both domestic and cross-border financial reporting. They agreed to select the better standards from their two rule books in a number of areas.

The adoption of international accounting and auditing standards does not necessarily enhance the quality of financial reporting unless it is accompanied by measures to ensure the enforcement of their application. In an attempt to crack down on fraud, for example, the Finance Minister of Germany recently established a new financial taskforce to combat balance-sheet manipulation by corrupt managers and auditors. His measures include an accounting taskforce empowered to conduct snap audits at companies suspected of manipulating financial information. The US Sarbanes-Oxley Act, which was enacted in July 2002, grants considerable discretion to the SEC to execute tighter corporate supervision and includes a measure that executives may face prison sentences if they mislead their company auditors. The UK arm of one of the major big four accounting firms has stated that it intends to improve fraud detection measures in its routine audit work, and this will include the use of greater forensic skills in its testing work and checking the past track records of members of management. John Plender2 has noted that the big four international accounting networks do not themselves guarantee common standards of quality. He pointed out that the networks located throughout the world do not operate under common ownership and are not consistently regulated or licensed. In many parts of the world the right to carry out a statutory audit is given only to local firms in which locally qualified professionals have a majority stake and management control. A World Bank/OECD report3 stated that in practice the standards of audit performance across the networks are a voluntary matter and that lack of transparency about internal arrangements and performance standards means that buyers of the service cannot make an informed judgement. The report stated that some networks use different standards for local work and trans-national work. Mr Plender noted that the networks themselves can be highly fluid in management terms in that the membership of a particular network can change relatively frequently. Hence the expert should not necessarily accept without examination the adequacy of a clean audit report signed off by a regional office of a major accounting firm.

5. MONEY LAUNDERING

Where the possibility of money laundering arises the expert will look for some of the following typical indications, which do not attempt to be exhaustive: -Unusually large cash deposits given the nature of the business -Large numbers of accounts in relation to the type of business -Transfers to financial centres known for financial secrecy laws -Frequent overrides of internal controls or policies -Transactions incompatible with client/customer size or normal operation -Payments by third parties -Payments from unusual or suspicious sources

6. CORRUPTION

Matthias Scherer4 has noted that there is no universal definition of corruption. He has stated that from the point of view of international arbitration, it is generally accepted that giving a public official money or other advantages to favour the offering party or his or her principal is incompatible with public policy, whatever the applicable law. Mr Scherer examined the type of circum-stantial evidence often found to surround the possibility of corruption. These include vague contractual terms which may hide the illegal intentions of the parties. The conduct of the parties is, however, usually a more trust-worthy guide than the terms of the contract. While parties will be aware that documents may be created to hide their true intentions, documentary evidence from the time before the dispute arose between the parties often bears out their common understanding of the contract. Such documents may provide invaluable evidence. A party's refusal to allow the arbitral tribunal access to such documents may lead the tribunal to draw an adverse inference5.

An unusually high commission may suggest corrupt practices, but the amount of the commission must be examined in perspective; whether a fee is unusually high can only be established in the light of all the circumstances. The fact that levels of corruption are high in certain countries does not necessarily constitute evidence of corruption in a particular case.

In considering whether corrupt practices have taken place, the expert will want to examine all relevant records, and a refusal to provide such records may be considered decisive circumstantial evidence for the irregularity of the payments. In an ICC arbitration, where the agent refused to disclose information about its group structure, the arbitral tribunal concluded that this was a case of corruption6.

It will often be the expert who undertakes the investigation into allegations of corrupt practices, and he should be able to assist in identifying and classifying the transactions which are the subject of the allegations.

7. PERJURY

Perjury is an issue that often arises in arbitration, as it does in litigation. Michael Watson7 has noted the prevalence of this practice and quoted an eminent American legal commentator who once estimated that perjury was committed in 50% of all contested civil cases, in 75% of all criminal cases, and in 90% of all divorce cases. Watson explained that there are two elements to perjury, a "wilful" statement by a witness which "he knows to be false or does not know to be true". The motive is irrelevant. It has been held that a witness who gives evidence which is literally true but is intended to give a false impression commits perjury. In one case a witness put a mouse in the mouth of a dead testator, then swore that "there was life in" his body. He was duly convicted of perjury8.

It will be for the expert to expose perjury by the deployment of better evidence and the demonstration of inconsistency on the part of the perjurer.

8. THE ROLE OF THE EXPERT: GENERAL MATTERS

Some party-appointed experts have been criticised for the degree of partisanship that they have shown in presenting their opinions. This smacks more of advocacy than the expression of independent and objective expert opinion. As part of the Woolf reforms of court procedures introduced in England a few years ago, the new Civil Procedure Rules ("the CPR") now contain, as Part 35, a section dealing with experts and assessors. It is the duty of an expert to help the court on the matters within his expertise, and this duty overrides any obligation to the person from whom he has received instructions or by whom he is paid. The Rules specify the form and content of experts' reports which are addressed to the court. Expert reports presented to English arbitral tribunals adopt the same approach, and the Rules state as follows:

An expert's report should be addressed to the court and not to the party from whom the expert has received his instructions.

An expert's report must:

1. Give details of the expert's qualifications.

2. Give details of any literature or other material which the expert has relied on in making the report.

3. Say who carried out any test or experiment which the expert has used for the report and whether or not the test or experiment has been carried out under the expert's supervision.

4. Give the qualifications of the person who carried out any such test or experiment, and

5. where there is a range of opinion on the matters dealt with in the report:

i. summarise the range of opinion, and

ii. give reasons for his own opinion.

6. Contain a summary of the conclusions reached.

7. Contain a statement that the expert understands his duty to the court and has complied with that duty, and

8. contain a statement setting out the substance of all material instructions (whether written or oral). The statement should summarise the facts and instructions given to the expert which are material to the opinions expressed in the report or upon which those opinions are based.

An expert's report must be verified by a statement of truth as well as containing the statements required in paragraphs 7 and 8 above.

The form of the statement of truth is as follows: "I believe that the facts I have stated in this report are true and that the opinions I have expressed are correct."

Following the introduction of the CPR Rules, the Commercial Court in London issued guidance notes in respect of expert evidence given in cases before it. These are as follows:

1. It is the duty of an expert to help the court on the matters within his expertise. This duty is paramount and overrides any obligation to the person from whom the expert has received instructions or by whom he is paid.

2. Expert evidence presented to the court should be, and should be seen to be, the independent product of the expert uninfluenced by the exigencies of litigation.

3. An expert witness should provide independent assistance to the court by way of objective unbiased opinion in relation to matters within his expertise. An expert witness should never assume the role of an advocate.

4. An expert witness should not omit to consider material facts which could detract from his concluded opinion.

5. An expert witness should make it clear when a particular question or issue falls outside his expertise.

6. If an expert's opinion is not properly researched because he considers that insufficient data is available, then this must be stated with an indication that the opinion is no more than a provisional one.

7. In a case where an expert witness who has prepared a report could not assert that the report contained the truth, the whole truth and nothing but the truth without some qualification, that qualification should be stated in the report.

8. If, after exchange of reports, an expert witness changes his view on a material matter having read another expert's report or for any other reason, such change of view should be communicated in writing (through legal representatives) to the other side without delay, and when appropriate to the court.

Until publication of the CPR the duties of the expert had been summarised in a 1993 case The Ikarian Reefer9. The principles set out in this case need to be extended in accordance with the CPR and an updated restatement of The Ikarian Reefer principles have been included in Anglo Group Plc v Winther Brown & Co Ltd10, which is a recent 2000 case. The judgement included the following:

1. An expert witness should at all stages in the procedure, on the basis of the evidence as he understands it, provide independent assistance to the court and the parties by way of objective unbiased opinion in relation to matters within his expertise. This applies as much to the initial meetings of experts as to evidence at trial. An expert witness should never assume the role of an advocate.

2. The expert's evidence should normally be confined to technical matters on which the court will be assisted by receiving an explanation, or to evidence of common professional practice. The expert witness should not give evidence or opinions as to what the expert himself would have done in similar circumstances or otherwise seek to usurp the role of the judge.

3. He should co-operate with the expert of the other party or parties in attempting to narrow the technical issues in dispute at the earliest possible stage of the procedure and to eliminate or place in context any peripheral issues. He should co-operate with the other expert(s) in attending without prejudice meetings as necessary and in seeking to find areas of agreement and to define precisely areas of disagreement to be set out in the joint statement of experts ordered by the court.

4. The expert evidence presented to the court should be, and be seen to be, the independent product of the expert uninfluenced as to form or content by the exigencies of the litigation.

5. An expert witness should state the facts or assumptions upon which his opinion is based. He should not omit to consider material facts which could detract from his concluded opinion.

6. An expert witness should make it clear when a particular question or issue falls outside his expertise.

7. Where an expert is of the opinion that his conclusions are based on inadequate factual information he should say so explicitly.

The above Rules and principles clarify the role and duties of experts in court in England and Wales and, by implication, in arbitral proceedings. In Edwin John Stevens v R J Gullis and David Pile11 the Court of Appeal held that an expert witness was barred from giving evidence because he had failed to comply with the CPR requirements for experts; in particular, his report did not contain a statement that he understood his duty to the court and that he had complied with that duty, and his report did not contain a statement setting out the substance of all material instructions (whether written or oral).

The new Rules and guidelines will undoubtedly improve the objectivity of expert reports and help to ensure that experts examine and report on all of the issues in the round rather than focussing narrowly on their clients' position. In the accounting field they should reduce, for example, the type of conflicting expert reports produced in loss of profit claims where one expert produces an unreasonably high figure and the other expert produces an equally unrealistic low figure. This type of report is a clear example of advocacy on the part of the expert.

9. THE ROLE OF THE EXPERT APPOINTED BY A PARTY

The new requirements for experts do not entirely eliminate the problem of advocacy, for it seems to me that one form of what might be termed advocacy is permissible when giving accounting evidence. This arises when a particular accounting transaction may be treated in a subjective manner. While the duty of the expert is to examine all possible treatments of the particular transaction, the expert may be able legitimately to advance the treatment that is most convenient for his instructing party's case if he can demonstrate that the treat-ment is permissible in the circumstances of the case, even if the treatment may be unusual. It would then be for the arbitral tribunal to determine whether the treatment was appropriate in the particular case or whether it provided evidence of wrongdoing by the party.

The new CPR do not deal fully with one problem which especially affects accountant experts. Because of its detailed nature, much of an accountant's work is traditionally delegated to junior staff. Thus, for example, junior audit staff undertake work on an audit assignment and bring technical problems to the attention of more senior staff as they arise. These difficulties will be cleared at increasingly senior levels, leaving only the most complex issues for the partner to resolve. When acting as an expert witness before a court or an arbitral tribunal, routine delegation of this nature is far from satisfactory, as the expert accountant will not have a sufficient grasp of the detail to withstand close cross-examination at the trial. There is no difficulty in delegating tranches of work in a forensic exercise, and the CPR allow for this, as noted above, but the expert accountant will need to be very precise as to the nature of the work that is delegated and what he expects to achieve as a result of that delegation. In order to delegate work effectively, the expert must have full command of his brief.

There is no substitute for the expert doing much of the detailed work himself, partly because in doing so he may identify matters that may be of critical importance in the dispute that may otherwise be missed by less-experienced junior staff. Identifying new issues in a case is an important part of the expert accountant's duties. This can lead to him suggesting amendments to his terms of reference which can play a crucial role in the outcome of the proceedings.

10. ROLE OF THE TRIBUNAL-APPOINTED EXPERT

A tribunal-appointed expert, or one appointed jointly by the parties, is independent of the parties. He will be able to present his opinions objectively without any advocacy. As a tribunal-appointed expert he may, of course, be questioned by the parties as to the appropriateness of his opinions and he will need to demonstrate that he has carefully thought through all of the implications of the views that he has expressed.

A tribunal-appointed expert can fulfil one other important function. He can undertake confidential investigative work where so instructed into accounting and other records that are not otherwise subject to disclosure in order to identify disclosable information that may be buried in material to which one of the parties has no entitlement to access. The tribunal-appointed expert will be able to examine this material, having signed a confidentiality agreement, and report to the tribunal and the parties on the information which he has extracted from the records and which are relevant to the dispute. He will be available for examination by the parties on the information that he presents and the opinions that he expresses thereon.

11. THE EXPERT AS A MEMBER OF THE TRIBUNAL

In some jurisdictions and in many international arbitrations, experts in particular fields are regularly appointed as sole arbitrator or as a member of a three- person arbitral tribunal. They are able to bring to bear their considerable experience of technical fields such as engineering, accountancy, shipping and construction to an evaluation of the technical issues that are in dispute. As arbitrator, the expert is likely to seek a high standard of presentation of the issues by the party-appointed experts and may, after the advocates have completed their oral examination of the experts, ask more penetrating questions than can be put by the non-technical expert advocates. The answers to these additional questions may yield the responses that are decisive to the resolution of the technical issues that are in dispute.

12. RELATIONSHIP OF THE EXPERT WITH LAW ENFORCEMENT AUTHORITIES

The expert will need to comply with his professional body in respect of the disclosure or reporting of fraudulent activities. For example, the Institute of Chartered Accountants in England and Wales has issued guidance notes for chartered accountants in respect of money laundering. It is a requirement to report any knowledge or suspicion of money laundering which relates to drug trafficking or terrorist activity.

I know of one instance where arbitrators were required to disclose confidential information to a regulatory or prosecuting authority or to the police where, during the conduct of the arbitral proceedings, the arbitrator had reason to believe that a serious crime may have been involved or that a serious breach of the regulatory rules had been committed or that he was under a legal duty to disclose the information and the disclosure was made in good faith to the appropriate authority. This requirement appeared in the 1992 edition of The Chartered Institute of Arbitrators Consumer Arbitration Scheme for the Finance Intermediaries, Managers and Brokers Regulatory Association (FIMBRA). This scheme was terminated following the demise of FIMBRA as a result of a merger with the UK Personal Investment Authority in the mid-1990's. .

1
D. Cairns, "International standards and the switch to IAS in 2005." Paper presented at a conference on fraud organised in London by The Institute of Chartered Accountants in England and Wales, September 2002.

2
J. Plender, Financial Times, London, 26 June 2002.

3
"Regulatory reform and trade liberalisation in services: the benefits and limitations of strengthening GATS rules". Accountancy Services, OECD-World Bank, March 2002.

4
M. Scherer, "Circumstantial evidence in corruption cases before international arbitral tribunals", International Arbitration Law Review, London, Sweet & Maxwell Ltd, Vol 5, Issue 2, May 2002.

5
IBA Rules on the Taking of Evidence in International Commercial Arbitration, Arts 9.4 and 9.

6
ICC Case No. 3916 (1982), Collection of ICC Arbitral Awards 1974-85, S507, 510.

7
Dr Michael Watson, Bath Spa University College, UK. "The Prevalence of Perjury", a paper awaiting publication in a journal for magistrates.

8
Disney's Criminal Law, (second edition, 1923), 128.

9
National Justice Compania Naviera SA v Prudential Assurance Co. The Ikerian Reefer. [1993] 2 Lloyd's Rep. 68.

10
Anglo Group Plc v Winther Brown & Co Ltd and Others, [2000]; LTL 21/3/2000; (2000) 1T + CLR 559 (2000) 72 Con LR 118.

11
Edwin John Stevens v R J Gullis and David Pile [1999]; LTL 27/9/99, Extempore, TLR 6/10/99; ILR 14/10/99; (1999) CILL 1546; (1999) BLR 394; (2000) 1 All ER 527; (2001) 73, Con LR 42.