Business owners have been watching the slow rollout of the Patient Protection and Affordable Care Act (PPACA) for a while now. But that doesn’t mean they have a firm grasp on the breadth of the challenges, requirements and decisions that are inherent to its wide-reaching health care and insurance changes.
“If you’re like most business owners, you have already spent significant time gathering and processing information,” says Bill Norwalk, tax partner-in-charge at Sensiba San Filippo LLP. “Very soon, you will make vital decisions that will have significant effects on the future success of your organization.”
Norwalk says it’s critical for business owners not to get too caught up in the political maneuvering and analysis that fills the news coverage.
“Regardless of emotion or political leanings, business owners must understand that the PPACA is a reality and needs to be addressed like any other challenge,” he says. “Taking an unbiased, strategic look at the law and its ramifications for your business will allow you to make decisions that aren’t clouded by emotion or outside factors.”
Smart Business spoke with Norwalk about the PPACA, its ramifications and how businesses can adapt to its effects.
How will businesses be affected by health care reform implementation?
The PPACA will have an impact on benefits planning, tax planning and your ability to compete in a challenging labor market. Making the best decisions will require you to understand all of the decisions and consider their varied consequences.
Taking a decision-and-consequences-based approach to your analysis will help you understand the potential effects of your choices. Many businesses are considering the pros and cons of offering qualifying health insurance versus dropping health coverage and allowing employees to utilize newly established insurance exchanges. While the analysis of direct costs may be straightforward, you need to understand how your employees will view a change in coverage. Changes in health care benefits could have a substantial impact on your ability to attract and retain talent.
What are the potential tax effects and what can businesses and individuals do to plan?
Tax implications of the PPACA are wide reaching for both businesses and their shareholders. New taxes were introduced that could result in significant tax increases — especially for business owners and managers who don’t plan ahead.
Corporation shareholders and shareholders of pass-through entities could both be affected by the 3.8 percent tax on net investment income. An additional 0.9 percent Medicare surtax was also introduced by the PPACA. Shifting from investment income to regular income could be an effective strategy, but the analysis is often far more complex. Depending on your wage level, an additional self-employment tax on regular income could more than offset potential savings from decreasing net investment income. Alternative minimum tax considerations can further muddy the waters. The PPACA simply makes tax planning more convoluted. Fortunately, qualified professionals will have the tools and resources needed to help you consider various scenarios and develop a plan to minimize your liability.
Where should business owners turn for guidance?
Decisions related to PPACA implementation will affect human resources, tax strategy and the broader organization. Business owners must first identify the key decisions and then weigh the consequences of each. If your strategic plan related to the PPACA isn’t complete, it’s time for you to speak with someone who can help.
Work with an insurance or benefits adviser. He or she can help you understand your coverage alternatives and the associated costs. An experienced accountant can offer assistance with compliance, tax and organizational planning. The right information, advisers and analysis will allow for decisions that can minimize negative consequences and maybe even provide a competitive advantage. ●
For more health care reform information and tax tips, visit Sensiba San Filippo's blog.
Insights Accounting is brought to you by Sensiba San Filippo LLP
California State University, East Bay: How more market oversight delivers better investment in private equityWritten by Jayne Gest
Private equity firms use capital, usually committed by large institutions, to invest in different companies. Often their investments are riskier companies at the start-up stage, so the returns can be quite large if these businesses become successful.
Recently, a sub-category of private equity, listed private equities (LPEs), traded on the stock exchange, are gaining popularity in the U.S.
“Until now, the whole section of private equity, from a small investor’s point of view, wasn’t accessible. With this emerging trend of LPEs, every investor, including the smaller players or individual investors, can invest a portion of their wealth into private equity and get that exposure,” says Sinan Goktan, Ph.D., assistant professor of finance in the College of Business and Economics at California State University, East Bay.
Smart Business spoke with Goktan about how LPEs work, and the performances of companies backed by LPEs versus traditional private equity firms.
Why are LPEs growing?
When anyone is able to purchase shares in an LPE firm, gaining exposure to the private equity market, investors can further diversify their financial portfolios. This new asset class is drawing capital into the private equity market from a new investor group and the flow of capital is continuous (since the firm is listed), unlike the traditional private equity capital that has a typical investment horizon of eight to 10 years. Eventually, a traditional private equity fund needs to be exited and new capital needs to be raised, which can be costly. The appeal of access to public markets as a continuous source of capital is leading more private equity firms, especially the larger ones, to list themselves. At the same time, LPE investments are more flexible and liquid than unlisted private equity.
Although LPEs are more established in European financial markets, particularly London, some big U.S. firms are Blackstone, KKR and The Carlyle Group.
How are LPEs different than unlisted private equity firms?
Both private equity types function similarly, except in how they raise capital. However, research with my co-authors Volkan Muslu and Erdem Ucar has shown that there’s a difference in how the companies they invest in perform in the long run.
When LPE-backed companies go public, they are more conservative and reliable in how they report earnings before and after the initial public offering (IPO) year. They also are timelier with recognizing losses. LPEs are subject to greater scrutiny by the SEC due to being listed in an exchange. Our results may be attributed to the higher reporting requirements of LPEs spilling over to the companies they are backing.
More reliable numbers mean more control and less risk for the investor. Traditionally, with unlisted private equity, potential new investors didn’t know much about private equity-backed companies’ progress until the IPO. The relatively timely and accurate financial information revealed by LPE firms has an impact in financial markets.
How else does the type of private equity backing affect an IPO?
Looking at the example of Facebook, if there’s lack of information, analysts will come up with wildly different price estimates. Because of their nature and the greater information content with the LPE-backed companies, the first day’s pricing is more accurate, which creates a lower initial return. Since companies revisit the financial markets repeatedly, they need to earn the trust of investors by providing accurate information in a timely manner to generate price stability.
What does your research suggest about increased disclosure requirements?
With passage of the Dodd-Frank Act, even unlisted private equity firms must file information with the SEC. Recent evidence suggests that investigators also are more likely to approach small private equity firms to ask for more information about their investments. Thus, the more opaque the private equity firm, the more information is required. Ultimately, the general trend is that investors are increasingly seeking more financial information before committing capital. Companies will either choose to reveal better quality information themselves, or the SEC will probably require them to reveal more information as needed. ●
Sinan Goktan, Ph.D., is an assistant professor of finance in the College of Business and Economics at California State University, East Bay. He teaches finance in the MBA Program. Reach him at (510) 885-3797 or firstname.lastname@example.org.
Insights Executive Education is brought to you by California State University, East Bay
Gone are the days when companies could simply post openings on job boards and expect responses from a large pool of qualified candidates.
“It’s no longer appropriate to just reactively post on a job board — to post and pray that a correct candidate will submit a resume. You need to have a recruitment strategy,” says Mary Oslin, manager of Talent Acquisition at TriNet, Inc.
“It used to be that managers went to HR about an opening. Now the entire organization needs to be involved in talent acquisition. Managers should be meeting about talent acquisition on a regular basis to determine what recruiters should be pipelining,” Oslin says.
Smart Business spoke with Oslin about how the hiring process has changed, and simple steps to ensure your company’s job openings reach top quality candidates.
What are some current trends in talent acquisition?
Pipelining — having a network of candidates you keep in contact with — is one. For example, IT is always a hot skill set, so your recruiters should be in constant communication with candidates. You may not have a need now, but you may have a need in six months, so you want to be ready with pipelined candidates who have the skills you need.
Mobile recruiting is another trend. With mobile apps, contact is immediate. You might think your employees are checking news headlines when they’re actually applying for a job or negotiating terms. Applicants no longer have to wait until they get home or have a break to correspond with a recruiter. Mobile needs to be one of the tools in your toolkit for talent acquisition. Top talent is making use of mobile apps, and they want to get their resumes in front of a hiring manager as soon as possible. Employers that are only utilizing job boards are losing out to companies that are using mobile apps to reach those candidates immediately.
Focusing on employer branding also has become much more prevalent. A subset of that is the practice of using current colleagues not only for referrals, but to act as ambassadors for the brand via social networking and professional networking sites.
Do strategies change with the level of the job?
Strategies need to fit the candidate. C-level and senior management positions are typically more difficult to fill, so more networking is required. Get involved in professional organizations and professional networking social media sites like LinkedIn. For some administrative jobs, it may be OK to use the old method of posting a job and gathering resumes. But for higher-level and more skilled positions, finding passive candidates through networking is the way to go. Occasionally, great candidates are looking for a job and apply to a posting. However, the real talent is the people who are happy with their jobs and not actively looking to leave.
Is branding particularly important when it comes to attracting passive candidates?
You want your company to be one where people want to work, so be careful about what type of reputation it has in the marketplace. Many employers aren’t aware of how they are perceived.
Survey your employees and find out what can be done to make your company a great place to work. Create an atmosphere where people are happy coming to work, proud to say where they work and willing to post positive workplace developments on social media, such as Glassdoor.
What are some tips to follow to ensure talent acquisition is done well?
Every company should seek to improve its branding and reply to applicants — it’s not good to start developing a reputation of being a black hole. Eventually, word will get around and people will be told not to bother sending you their resume. Establish a procedure to contact the candidates who are not selected, whether by email or phone.
Focus on the candidate experience. Those who are not hired may walk away disappointed, but you want them to be impressed that the process was professional and they were treated with respect. ●
Insights Human Resources Outsourcing is brought to you by TriNet, Inc.
Saving money on insurance sounds good to any business, particularly one that may be struggling. But going with a policy that includes a self-insurance retention (SIR) can be risky, especially if you become involved in a lawsuit.
“Companies that are struggling to stay in business and accept a larger SIR than they probably should can be put in a very bad position because they may be without insurance protection if they are not able to satisfy the SIR,” says Michael T. Ohira, a partner at Ropers Majeski Kohn & Bentley PC.
Smart Business spoke with Ohira, whose practice includes advising insurers in construction defect lawsuits, about how SIRs work and when they make sense for businesses.
What are the key differences between SIRs and deductibles?
The differences are pretty profound. SIRs and deductibles are both forms of risk assumption by the policyholder and are traditionally for a set amount, generally referred to as the retained limit. The policyholder basically agrees to be responsible for paying losses or claims within the retained limit, although there are differences regarding when the insurance company’s duties begin.
With an SIR, the insurance company essentially has no duties unless and until the retained limit is paid. Many times SIR endorsements provide that only the insured can satisfy the SIR, and the payment obligation is not excused by the insured’s insolvency or bankruptcy. So an insured is at its peril — if it cannot satisfy the condition of paying the SIR, it is not entitled to the benefits provided under the insurance policy.
SIRs are common in construction. Many insurers have left the market because of the proliferation and cost of defending construction defect lawsuits. Subcontractors can be in a difficult situation because general contractors require their subcontractors to have liability insurance and to add the general contractors as additional insureds under the subcontractor’s liability policy.
Typically, the reasons to have an SIR are about cost and the availability of insurance. A large corporation that is financially strong can reduce its insurance costs by electing to purchase a policy with an SIR, which commands a lower premium.
What are the benefits of deductibles over SIRs?
The biggest benefit of a deductible is that, unlike an SIR, the deductible does not need to be paid upfront and is not a condition to receiving insurance benefits. That’s important when you have a liability policy, get sued and need a lawyer. With a deductible, the insurance company will provide a lawyer and provide a defense immediately, as opposed to requiring the insured to pay its own attorneys’ fees until the amount of the retained limit is satisfied.
Where do companies make mistakes in deciding which route to go?
Some companies will assume an imprudently large SIR. If the business is in decline and gets hit with a liability claim, then paying for a defense lawyer on top of normal operating expenses can push the company into a precarious financial condition. I’ve seen retained limits as high as $250,000. Businesses that assume a large SIR, that they cannot later pay, can find themselves without insurance coverage.
That can be an issue for general contractors. If a subcontractor has an SIR that allows only the subcontractor to pay the SIR, then the general contractor would be without coverage as an additional insured under that subcontractor’s policy, if the subcontractor fails or is unable to pay the SIR. This is because the insurance company’s obligations are not triggered until the subcontractor pays. So, general contractors and developers need to carefully review the insurance policies of the subcontractors they hire to ensure that the subcontractor either doesn’t have an SIR or that the policy allows the developer or general contractor to pay the retention if the subcontractor is unable.
When deciding whether to have an SIR, take a hard look at your financial situation. Do you have the financial wherewithal to comfortably absorb that initial share of risk? It’s a business decision — weigh the cost savings against the benefit of being able to get insurance benefits more immediately, and from dollar one. ●
Insights Legal Affairs is brought to you by Ropers Majeski Kohn & Bentley PC
The Jumpstart Our Business Startups Act (JOBS), passed in early 2012, mandates that the Securities and Exchange Commission (SEC) adopt rules to help start-ups and small businesses raise capital. Because of this, companies can advertise, market and publicly disclose that they are fundraising. The change also allows companies to raise up to $1 million from a large number of “nonaccredited,” or non-high net worth investors.
Smart Business spoke with Mark L. Skaist, shareholder and co-chair, Corporate and Securities Practice, at Stradling Yocca Carlson & Rauth about what this could mean for businesses.
Why does it matter that companies can advertise that they’re fundraising?
Companies need to either register their securities offering with the SEC or find an exemption from registration. Registration is often prohibitively expensive for start-ups, so most emerging companies rely on an exemption from registration, the most common of which is Rule 506 under Regulation D. This permits sales of an unlimited dollar amount of securities to an unlimited number of accredited investors and up to 35 nonaccredited investors. However, in order to rely on this exemption, companies had been prohibited from offering or selling securities through any form of general solicitation or general advertisements.
By allowing companies to advertise their securities offerings to the general public, companies should have a bigger pool from which to solicit investments.
There are, however, two conditions companies must meet in order to use general solicitation and advertisement and sell securities under Rule 506. Namely, all purchasers in the offering must be accredited, which for natural persons generally means net worth in excess of $1 million, or annual income of at least $200,000. Also, the company must take ‘reasonable steps’ to verify that the purchasers are accredited.
How are companies supposed to verify that a purchaser is accredited?
The SEC has said that companies need to make an objective determination in the context of the given facts and circumstances. It has come out with a nonexclusive list of verification methods that can be considered ‘reasonable steps.’ The specific methods and types of information the SEC considers sufficient include written representations of investors combined with two years of federal tax returns; bank statements combined with credit reports; and written confirmation from a broker, attorney, investment adviser or accountant.
How are the proposed rules regarding crowdfunding supposed to work?
These proposed rules provide that companies may sell up to $1 million of securities during any 12-month period to accredited and unaccredited investors. They also limit annual crowdfunding investments by investors with annual income or net worth below $100,000 to the greater of $2,000 or 5 percent of the investor’s annual income or net worth. For investors with annual income or net worth in excess of $100,000, annual crowdfunding investments cannot exceed 10 percent of their annual income or net worth.
There are also proposed initial and annual filing requirements by the company doing crowdfunding financing, which may include financial statements, a business plan and tax returns. Companies can use intermediaries, such as brokers and funding portals, and may not advertise the offering other than to provide a notice directing potential investors to the intermediary.
Based on the proposed rules, which require that companies raising between $100,000 and $500,000 through crowdfunding provide reviewed financials, and companies raising more than $500,000 provide audited financials, it’s likely that the accounting fees alone are going to be a significant roadblock to many small companies relying on this exemption.
While it seems steps have been taken toward making it easier for start-ups and emerging companies to raise money, time will tell whether they have any real impact. In the meantime, businesses are popping up that are looking to get involved with these types of offerings, either by verifying that investors are accredited or by setting up funding portals for crowdfunding. ●
Insights Legal Affairs is brought to you by Stradling Yocca Carlson & Rauth
Merchant services affect the majority of companies — more than 90 percent of online purchases use credit cards.
“If you’re not sure if merchant services is the right fit for your company, think about what your competitors are doing. If you don’t accept cards today, then prospective customers may be going to other businesses,” says Jan Mitrovich, manager for Treasury Management and Merchant Services at California Bank & Trust.
Smart Business spoke with Mitrovich about how to understand merchant processing services and costs, and when to talk to your banker about new solutions.
How do you know if your company is using merchant services correctly?
Every company should consider where it’s doing business and how it’s transacting with customers. Examine whether you are effectively leveraging all your channels for sales opportunities. You may have a storefront that does terminal credit card processing. However, other payment options, including Web-based and e-commerce, may be worth considering.
How much of you sales efforts need to be in the field, such as industry shows? A mobile solution can extend your customer outreach while providing convenience to your customers.
The merchant services environment is continually changing. There are varying degrees of complexity, from processing basic transactions through a card reader, to merchants that need multiple payment channels, gift and loyalty card programs, check verification services and more. Your merchant partner can help you better understand your options and select the right solutions for your business.
What’s important to know when getting a merchant account?
The processing transaction fee can turn off businesses, but they must consider the value proposition of expanding their customer base by accepting more transactions.
Depending upon the transaction type and how it is processed, fees will vary, which gets confusing. Merchant processors also don’t always present the statement information and pricing in the same fashion. It’s common for business owners to think a quoted rate is the all-in cost.
Be aware of hidden fees. For example, only some organizations do pass through pricing for the interchange fees. A discount rate doesn’t necessarily compare apples-to-apples, so a more important question is, ‘What is the cost of the service?’
You also need to understand and educate your employees on the associated responsibilities and risks as a merchant processor, such as protecting customers’ sensitive data. Validation of payment card industry compliance is an important step to ensure credit card data is being protected. Data breach coverage can protect merchants from the cost associated with a data breach, which can easily run $35,000 or more.
What additional factors help determine which provider is the best fit?
One differentiator is customer service. Banks typically have a higher level of customer service, like 24/7 call support, than independent sales organizations.
You also need to consider whether to lease or buy equipment. The industry is moving toward chip-enabled cards that will require companies to change equipment during the next few years. Take the time to understand your options and pricing structure, as well as if any equipment is proprietary.
Finally, cut-off times for transactions and settlements can be a game changer. Settlement time frames differ, anywhere from next day to 30 days, depending upon the vendor. If you want to improve cash flow, in some cases, you can process transactions up to midnight with next-day availability of those funds.
How should you review current services?
Take the time to review your merchant statements and pricing. If your business model or activity levels have changed, talk with your merchant representative. New services or tools may be available that can create processing efficiencies for your business. For example, card-present transactions are generally lower risk and thus cost less to process, while manually keyed transactions cost more. You could make internal changes to reduce the volume of keyed entry transactions or possibly process transactions through a lower-cost channel. ●
Jan Mitrovich is manager of Treasury Management and Merchant Services at California Bank & Trust.
Insights Banking & Finance is brought to you by California Bank & Trust
For-profit organizations use the theory of profit to strategize and lead. However, not-for-profits, like Woodbury University, operate under the theories of constraints and strength.
“With the theory of constraints, the idea is to review past performances, coupled with ongoing and future goals or expectations, to identify areas that may delay or stop you from reaching goals,” says Kenneth Jones, vice president for finance and administration and CFO at Woodbury University.
That goes along with the theory of strength, which relies on engaging your total community, including your customers, to help develop your strategic plan, he says. Stakeholders help you achieve your vision.
Smart Business spoke with Jones about putting customers first to build strong loyalty and enhance your value.
What can for-profit businesses learn from the theory of strength when strategizing?
All organizations, for-profit or not-for-profit, need a strategy map that defines their mission, values and where they are headed. However, it’s important to include all stakeholders in the process of inception, implementation and assessment.
The corporate world often develops a strategy map through modeling and the experience of employees, but they don’t look at the No. 1 objective, the customer. A customer’s perspective and feedback is essential. If you don’t involve them, you’re not going to see what they see and you’re not going to react to the environment as readily.
In the education world, we have to understand our customers, the students, to do an effective job and provide a better service. As educators get older, our students stay the same age, so educators must change teaching methods as needed. Educators need to scan the environment of each new class, keeping the same core while adapting the delivery.
In the corporate world, you can create efficiencies with your basic business practice, distribution center, administrative center, etc., but you absolutely need to have a focus on your customers and get them involved.
Beyond understanding customers, how can you help clients become part of your community?
If you have value in your company, people want to share what they have to help enhance that value. By including key vendors, clients or customers in your mission and strategic plan, you show them the value of their input. When you deliver the outcome, they see that their opinions matter. They are not an offset of the community, but part of it.
As part of the community, you want to take care of all your stakeholders. For example, when the Cal Grants were cut in 2012 and scholarships for low-income students were reduced, we knew how hard it would be for our students to succeed, so Woodbury issued vouchers to make up the difference.
As another example, Woodbury has a lot of first-generation college students on financial aid. We can reach out and ask for input on how to make everything more affordable, making students part of the process. This in turns leads to former students wanting to give back. They could start a scholarship, set up a writing center or help with counseling services. You can’t build loyalty when you create an environment where you absorb the profit and customers take the loss. Stick to your word and show customers the quality they subscribed to.
Under the theory of constraints, how do not-for-profits do more with fewer resources?
One high-level constraint may be affordability. From an administrative perspective, we can accomplish that by investing in technology to shorten our operating processes, increase automated processes and eliminate processing constraints, thereby reducing the processing cost of material and labor.
The purpose isn’t just to create revenue or improve the bottom line. You want to create efficiencies, and then redirect resources elsewhere by investing in areas of strength.
Also, you don’t want to acquire something that is a constraint on your operations right away, just because you want to diversify your product line. For example, we wouldn’t bring in a dentistry school at Woodbury just because we can acquire it. It has to fit within the strategic map of the institution. Bring in something that you’re strong at, which will be a prototype for the next development. ●
Insights Executive Education is brought to you by Woodbury University
Most employers are distant from their workers’ compensation claims and thus leave money on the table when it comes to premium savings.
Good claims management starts at the beginning. As a claim progresses, there will be fewer opportunities to positively affect the outcome. It has to be an ongoing process, says Kimaili “Ken” Davis, ARM, assistant vice president at Momentous Insurance Brokerage, Inc. Employers need to be sure that the adjuster is aware of the mechanics of the injury and affected body parts. There are milestones that can change the path of a claim. Be sure that a claim goes in the right direction.
“Employers may think someone else will take care of it, whether it be the adjuster and/or insurance broker,” he says. “Yes, a good broker is going to have a knowledgeable claim professional monitoring the claims, but it’s best to take a team approach, where the adjuster, employer and broker are working together.”
Smart Business spoke with Davis about creating a culture of safety and attention to claims to give you a competitive advantage.
How does California’s workers’ compensation compare to nearby states?
California laws tend to (unfairly) favor employees when it comes to claims, so it’s important for employers to stay involved. In California, an employee can fail to follow the rules and still receive a positive outcome. In other states, the rules are enforced equally, meaning that both the employee and employer must play by the rules. I’ve seen cases before the appeals board where an employee has missed more than one hearing without good reason and has not been penalized. In other states, this conduct would negatively impact their claim.
What’s the best way to manage individual claims to decrease costs?
Employers need to manage their employees. If you create an environment where people want to come to work, claims will be resolved quicker and for less money.
After an accident or incident, don’t just investigate what happened, look at what caused the injury and ways to prevent future injuries. Also, have human resources and/or the supervisor keep in contact with the injured employee on a regular basis. Ideally, you want an injured employee to feel like part of the team, and have a desire to get back to work and resolve the claim promptly.
An important concern is getting employees back to work as soon as possible. If employees cannot work full duties, see if they can return to modified or alternate work. It will be up to the treating doctor to release them to light duties. Communicate with employees and the treating doctor on a regular basis. The sooner employees are back to work, the less claims dollars will be paid. The result can be a lower premium over time. Further, studies have shown when injured employees return to work within 30 days of the date of injury, there’s a better chance for a full recovery.
Are there certain claims employers should monitor more closely?
Litigated cases are important to monitor, as well as those claims where medical conditions complicate recovery, such as diabetes or obesity. The California Workers’ Compensation Institute found that in claims where obesity exists, a claim averages 81.3 percent more paid losses and experienced 80 percent more lost time. The American Medical Association recently reclassified obesity as a treatable disease, which may increase claim costs.
In addition, closely watch cases where doctors prescribe prescription drugs such as opioids. If an employee becomes addicted, you will likely incur the costs of a detox program.
What’s important to know about your experience modification (ex mod) factor?
An employer’s ex mod factor is determined by a formula that compares claims dollars to audited payroll on a rolling three-year policy basis. When actual losses are less than expected losses, the employer has a lower ex mod and thus lower premiums. Ex mods are calculated based on data valued as of six months following policy expiration. The best thing you can do for your ex mod is to not have claims. Create a culture of safety.
Ultimately, workers’ compensation claims are about people. You can best manage costs by going beyond monitoring the claims process to understanding employee concerns. ●
Insights Business Insurance is brought to you by Momentous Insurance Brokerage, Inc.
The vast amount of public funds and programs in federal, state and local governments can make it difficult to keep track of expenditures. Far too many people seize this opportunity to commit fraud, which in turn halts intended improvements or services.
For example, the Houston-based Dubuis Health System and Southern Crescent Hospital for Specialty Care Inc., in Riverdale, Ga., were accused of overcharging Medicare. The hospitals allegedly hospitalized patients longer than necessary to obtain larger reimbursements from the government. They agreed to repay the U.S. government $8 million to resolve various False Claims Act (FCA) allegations dating back to 2003.
“When fraud involving public funds occurs, the amount of goods or services those funds can purchase diminishes, and taxpayer dollars are wasted. Constituents see declining value. Public officials and stakeholders face questions regarding the use of tax dollars or other people’s money,” says Trish Fritsche, a senior manager in Forensics and Litigation Services at Weaver.
Smart Business spoke with Fritsche about how public sector officials and other stakeholders can respond to fraud schemes with the help of forensic accountants.
What are the most prevalent fraud methods used in the public sector?
Common ways to divert public funds from intended use are asset misappropriation, corruption and financial statement fraud. Although internal controls can be put in place to prevent fraud, in reality, fraud is potentially as unlimited as the human ingenuity to circumvent those controls.
How should organizations respond?
Once an incident of suspected fraud is identified via a hotline or other source, questions to ask include:
- Should the investigation be handled internally or externally?
- Who are the stakeholders?
- What are the resources needed?
- Should the entity self-report fraud?
At this time, attorneys and forensic accountants may need to become involved. Forensic accountants possess the skills necessary to appropriately respond in a crisis. They understand how to discover and develop information that can be used by governmental entities, boards and others with fiduciary responsibility. Forensic accountants also provide consulting services or expert testimony. They work closely with law enforcement and others to properly address the fraudulent conduct.
What laws can assist with addressing fraudulent conduct?
The Fraud Enforcement and Recovery Act of 2009 (FERA), enacted just after the American Recovery and Reinvestment Act, seeks to reduce fraud involving federal money and property. The act expanded various civil and criminal fraud statutes to include mortgage businesses, as well as entities associated with recovery act funding.
Liability under the FCA was originally limited to individuals or entities that directly or indirectly induced payment by the federal government. FERA, however, expanded that. Now, the FCA not only applies to direct recipients of government funds, but also to any contractor or other entity receiving funds. It explicitly prohibits the retention of government overpayments to individuals or entities.
The Racketeer Influenced and Corrupt Organizations Act (RICO) was enacted in 1970 to combat organized-crime activities. It has since been used to prosecute other offenses, including fraud cases involving government funds. Under RICO, anyone who has committed any two crimes from a list of 27 federal and eight state crimes —such as bribery, embezzlement and money laundering — within a 10-year period can be charged with racketeering. RICO allows a U.S. Attorney to temporarily seize a defendant’s assets and prevent the transfer of potentially forfeitable property. In addition, private parties are allowed to file civil lawsuits under certain circumstances.
Each fraudulent act involving public sector funds not only decreases the funds available, it also causes constituents to lose faith in officials. Effectively combatting fraud enables entities to do the greatest good for the greatest number, while establishing trust among all stakeholders. ●
Insights Accounting is brought to you by Weaver
Related-party transactions have played a significant role in accounting failures and frauds. In a study of Securities and Exchange Commission fraud allegations by the Committee of Sponsoring Organizations of the Treadway Commission, 18 percent of companies alleged to have committed fraud were accused of using related-party transactions to hide misstatements in financial reports.
“Yet the rules on accounting for these transactions have remained stagnant, and very little accounting guidance exists to assist preparers of financial statements,” says Wayne Williams, a partner at Crowe Horwath LLP.
Smart Business spoke with Williams about how related-party transactions can pose reporting problems.
What transactions are prone to errors?
Three that create the most confusion are:
1. Owner’s debt converted to equity. In these cases, there is little accounting guidance. When a business owes debt to an owner and the owner converts it into equity, the fair value of the equity often doesn’t equal the remaining balance of the debt. That means a gain or loss, or some other type of transaction, needs to be recognized for the difference. For example, if a company exchanges $50 million in debt outstanding to its owner for $80 million in equity, the business could make a credit to equity for $50 million or recognize a loss representing the fact that $80 million of equity was exchanged for only $50 million of debt.
The concept of recognizing expenses from certain transactions with related parties is widespread within U.S. generally accepted accounting principles (GAAP). However, what if the entity exchanged $50 million in debt for $40 million of equity? Unlike expenses, gains from capital-type transactions have little support within GAAP. In this scenario, the business should derecognize the carrying value of its debt, which would include elements such as a discount or premium on debt, with the offsetting credit to equity.
2. Related-party forgiveness of debt. An entity shouldn’t recognize a gain when forgiving related-party debt because assumption of debt ordinarily doesn’t result in a loss. When a business borrows from a related party, the business gets cash or other assets. To later recognize a gain from these assets provided by a related party would create an unusual result where invested funds could be treated as income, which appears to contradict existing GAAP on capital contributions when the transaction is considered as a whole. The holder of related-party debt is in effect changing the nature of its investment in the entity from debt to equity, so no gain should be recognized in net income.
3. Related-party forgiveness of other liabilities. An owner or other related party might provide goods or services to an entity and subsequently forgive the entity’s obligation to pay. For example, an owner/manager could have deferred compensation that has been accrued as an expense. If forgiven, should the business recognize a gain, or is forgiveness of the liability a capital transaction? GAAP does not prohibit either.
When deciding the appropriate accounting approach, consider how the original transaction was recognized, the nature of the relationship and the underlying economics of the transaction. In the example of deferred compensation, the arrangement had been recognized as an expense, so a gain might be appropriate. In other cases, the nature of the relationship dictates the answer — owners are more likely to engage in capital transactions because they generally benefit from the risks and rewards of ownership. Related parties are more likely to engage in transactions that would result in gain recognition when the underlying liability is forgiven.
What best practices remove risks involved with related-party transactions?
Know the related parties. Otherwise, you run the risk of failing to identify a transaction, allowing it to bypass internal controls established to evaluate and capture information about related-party transactions.
It’s also important to document related-party transactions as if they involve unrelated parties. Often, rights and responsibilities in related-party transactions are ‘understood,’ but not clearly expressed in documents.
Proceed with caution, maintain a vigilant watch for related-party transactions and you can reduce the chance of errors. ●
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