We specialize in advising and coaching clients through high net worth divorces. The goal is to identify common traps that dissipate wealth during their divorce so we can help clients employ proven strategies to grow and preserve their wealth as they navigate through this tumultuous time.
In many high net worth divorces, the prospect of hiring a forensic accountant is raised. That said there’s no fixed definition of forensic accounting. There’s no certification from the AICPA for friends and accounting, and there’s not even a licensing requirement.
So, what is this ephemeral individual that we call a forensic accountant?
When I ask Chat GPT, an artificial intelligence system, “what is a forensic accountant,” the reply is:
“A forensic accountant is a professional who uses their accounting knowledge and skills to assist in legal matters. This can include investigating financial crimes such as embezzlement and money laundering, as well as analyzing financial records in civil lawsuits and disputes. Forensic accountants often work closely with law enforcement agencies, attorneys, and other legal professionals to gather and analyze financial evidence and present their findings in a clear and concise manner.”
This is correct in a broad sense, but how does this apply to a divorce?
In my experience, a divorce forensic accountant does two different things: tracing and detecting hidden assets.
By far the easiest and most effective method is tracing. This process looks at the source and use of each dollar during the marriage. It does not matter if the dollar exists at the end of the marriage—only that it appeared at some point during the marriage.
When we trace, we follow every single dollar through all accounts to find out who owns it at the end of the marriage. Along the way, there are numerous events that can change the character of a dollar. For example, let’s say that spouse A inherited $1000; that would normally be classified as spouse A’s sole and separate property. This means that if spouse A kept the thousand dollars in an account under their name, then at the end of the marriage it is still their $1000; no matter how much money the couple made or lost during the marriage. However, certain acts can happen to that $1000 during the marriage. For instance, if the couple purchased a house and that $1000 was used for the down payment and the house was titled in both their names, that act transmutes (a fancy word for transformed) the funds from spouse A’s separate property to joint property now owned by spouse A and spouse B; effectively dividing it.
It often helps to think of divorce as having three or more participating parties. Obviously, there are the two individuals that were married, but there is often a third-party that we call the community. This is a shadow individual whose possessions get divided in half at the end, in turn each of the parties take their own halves. What’s more complex is that sometimes we create a fourth party who looks after the interests of children or other dependents. Forensic accounting is the process of creating buckets for each of these parties and placing each dollar into the applicable buckets. The end is easy: we simply take the number of dollars in each bucket and assign it to the proper person.
Tracing can be very complicated because it is paper-intensive and requires a close reading of every transaction in every account throughout the term of the marriage. For this reason, it can often be very expensive in terms of time billed with expenses ranging from a few thousand to almost $100,000. That said, skilled tracing can often reduce the amount of acrimony and legal wrangling in a divorce; depending on the net worth involved, it could even be more valuable than the case’s legal work.
The second type of forensic accounting looks for hidden assets. This type of accounting was invented by the IRS, and it was used to convict Al Capone. In short, they looked at his lifestyle versus his reported income and simply showed that these items were grossly unequal therefore, there must be hidden money paying his bills. Based on this type of accounting, he served 7.5 years in prison.
We often get asked to do the same thing when there is a belief that funds have been hidden or alternatively, the marital standard of living seems to be much higher than the separated standard of living. This type of analysis is much harder to assert correctly because courts like evidence, and by definition, this evidence comes via inference. Consequently, the credibility and experience of the expert witness is very important to allow the court to reach a finding. Obviously, it works much better in a tax context because here you are guilty until proven innocent, opposite of the civil court system. For this reason, forensic accounting that looks for hidden assets can often be extremely speculative and money spent on the service is less likely to result in a recovery of assets or income for the party pursuing it.
There can also be legitimacy issues when using the tracing method too. We often see the “out” spouse assert that there is hidden money and they have evidence of it because they logged into the other spouse’s bank accounts and downloaded the records. It would seem obvious that if we can see the assets, then little tracing required to show that those funds have been omitted. However, court systems rely on rules of evidence. We’ve all heard the story of a police officer who collected evidence in a questionable manner having their cases thrown out even when the defendant “looks” guilty. This happens because the courts want a very clear evidentiary custody trail, ideally in which the person possessing the evidence is also the one producing it. Therefore, in many cases, when a spouse steals or otherwise obtains evidence without the consent of the owner, it is not allowed to be used for supporting a conclusion. For this reason, clients should rely on a well written subpoena or document request which we work closely with attorneys to create.
Forensic accounting is one of the most important disciplines in a high net worth divorce. When done correctly, it can reduce expenses and fighting in the divorce. It can also lead to an outcome that is perceived as equitable to both parties. That said it is important to choose the right person to perform the forensic accounting. This may or may not be a CPA. For complex financial transactions including options, real estate, or complex business ownership situations there are experienced experts in those fields who might serve as better forensic accountants.
At Camelotta Advisors, we have endeavored for 20 years to provide clients with quality forensic accounting and divorce financial advice. If you know someone who might find our services useful in their divorce, they can request a free divorce review below.