Chapter 4

Complex Frauds and

Financial Crimes

Critical Thinking Exercise

• A woman came home with a bag of groceries, got the mail, and walked into the house. On the way to the kitchen, she walked through the living room. In the living room, she glanced in her husband’s direction. Sadly, her husband had blown his brains out. She then continued to the kitchen, put away the groceries and made dinner. What might explain this behavior?

“Accidental Fraudster” versus the “Predator”

• Accidental Fraudster– Characteristics: first-time offender, middle aged,

male, married with children, trusted employee, in a position of responsibility, good citizen in community

– Typically has non-sharable problem that can be solved with money, which creates perceived pressure

– When discovered, others are often surprised by the alleged behavior of the perpetrator

– Edwin H Sutherland describes them as “white collar criminals”

“Accidental Fraudster” versus the “Predator”

• “Predator”– Often start as accidental fraudster– Seeks out organizations where he or she can start

a scheme almost immediately upon being hired– Deliberately defraud organizations with little

remorse– Usually better organized – have better concealment schemes– better prepared to deal with auditors and other

oversight mechanisms

Collusion: Multiple Individuals, Organizations and Jurisdictions

• Central element to complex frauds and financial crimes

• May be among individuals within an organization, individuals across organizations, multiple organizations and often span multiple jurisdictions

• When individuals work in concert with others, the damage can be devastating and more pervasive

• Internal controls are often ineffective in preventing fraud when collusion is present

Legitimate Activities Mixed with Illegal Activities and the Need to Isolate

Illegal Activities• Most complex fraud and financial schemes

include a mixture of legitimate and illicit activities

• Challenging for investigators to isolate the illicit from the legitimate activities

• Fraud and forensic accounting professionals must know the greater “organization,” even if the organization is not recognized as a legal entity

Legitimate Activities Mixed with Illegal Activities and the Need to Isolate

Illegal Activities• M.I.C.E acronym

– Money

– Ideology

– Coercion

– Ego

Dismantling Organizations

• Asset forfeiture or seizure is an important part of dismantling an organization

• What is the purpose of seizing assets?• Investigation needs to show that the

perpetrator(s) or the organization(s) involved received assets and what happened to those assets

Schemes and Illegal Acts Associated with Complex Frauds and Financial Crimes

• Align more with predators than the accidental fraudster

• Motivation and intent is nefarious and deliberate• Mode of operation is more sophisticated• Perpetrators often collude with others• Tend to be sophisticated and very disciplined• Make full use of technology

Schemes and Illegal Acts Associated with Complex Frauds and Financial Crimes

• Financial statement fraud – Usually a complex fraud– Almost always involves the CFO, controller or

some other sophisticated participant within financial reporting structure

– Executive level individuals work in concert to override the system of internal controls

Schemes and Illegal Acts Associated with Complex

Frauds and Financial Crimes

• Corruption schemes– Include bribery, illegal gratuities, economic

extortion, and conflicts of interest– At least one party and possibly all parties, set out

to achieve certain goals as a result of their activities

Organized Crime• Organized Crime Control Act of 1970

– Unlawful activities of… a highly organized, disciplined association

• Many organizations involved in organized crime are professionally run– Opportunistic– Diversified– Require political support– Capital Investment

• Annual impact of organized crime profits to be approximately $1 trillion

Organized Crime

• Manipulate and monopolize financial markets

• Infiltrate labor unions• Align itself with traditional

businesses• Purchase political support• Understanding the storyline

(who, what, when, where, how, and why) and the flow of money provide a solid investigative approach for case development

Drug Trafficking• The trafficking of narcotics for illegal sale in countries

all over the world• Countries form partnerships to tackle illegal drug

problems• Illegal drug trafficking costs the US $70 billion

annually• Probability of detecting drugs drop considerably one

they enter the US• Bilateral and multilateral counter-narcotics efforts

are the key effective response to fighting drug trafficking

Terrorism Financing

• Terror organizations need funds to operate• Deny terrorist groups access to the international

banking system– Impair ability to raise funds

• Primary sources of terrorist financing– State sponsorship – Revenue generation from legitimate and illegitimate

activities• Terrorists utilize less restrictive overseas banks• Charities can be used to fund terrorism• Kidnapping in Columbia

“Terrorism Triangle”

• Opportunity– Most important to investigators because without

opportunity to generate, move and control cash flows, the financing of terror cannot occur

• Ideological motivation (versus pressure)– Terrorists have inherent motivation to inflict terror

• Ideological rationalization– Terrorists rationalize their activities based on their

ideological beliefs

Money Laundering• The process to make dirty money appear

clean• Money laundering takes place in 3 stages

– Placement• Placing money into financial system

– Layering• Hide or disguise source of money

– Integration• Use money without risk of being associated with dirty

money• Must deprive criminal of the use of their ill-

gotten gains

Money Laundering• To prove money laundering, the government

must demonstrate:– Financial transaction was attempted or conducted– Defendant knew the proceeds derived from

unlawful act– Property derived from a specified unlawful act– Defendant attempted to accomplish one of the

following objectives• Promote a specified unlawful act (SUA)• Conceal the nature, source, location, ownership or

control the proceeds of an SUA• Attempted to avoid federal reporting requirements• Attempted to evade taxes

Racketeering Influence and Corrupt Organizations Act (R.I.C.O.)

• Addresses the organizations involved in making dirty money clean

• Original goal was to allow investigators to go after businesses and other entities involved in organized crime

• Essentially, RICO makes it illegal for any person who has received funds that derived directly or indirectly from a pattern of racketeering to invest or acquire any other business that is involved in interstate or foreign commerce

• RICO also provides for the forfeiture of assets used in racketeering crimes and permits treble damages in civil cases

Conspiracy• Conspiracy targets the individuals involved in

the illegal activity• Prohibited under RICO• A conspiracy involves 3 elements

– The co-conspirators must have an agreement between them

– The co-conspirators must act or demonstrate an inclination to commit a crime

– The participants must mentally commit to the act through their state of mind

USA Patriot Act• Formally known as, Uniting and Strengthening

America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act

• Identified new types of money laundering crimes and increased the penalties associated with them

• Set out procedure for the forfeiture of bulk cash that had been smuggled

• Permits the confiscation of all property of an individual or entity who participates in the planning of a terrorist attack

Bank Secrecy Act• The BSA was passed to assist in the investigation of

illegal acts associated with drug trafficking and tax evasion– Attacks the placement stage of money laundering process

• Requires that financial institutions maintain adequate records and that financial institutions report certain types of transactions to the federal government

• Transactions involving suspicious persons must be reported on the Suspicious Activity Report (SAR)

• Movement of more than $10,000 into or out of the U.S. must be filed on FinCen Form 105

Mail Fraud• A scheme to defraud someone by fraudulent

pretenses and such fraud takes place in any U.S. Post Office, U.S. Mail depository or through transport by the U.S. Postal Service– Person needs only to cause the mail service to be

used to facilitate the fraud act and the item sent or delivered may be transported by private or commercial carrier in furtherance of the fraud act

Wire Fraud• The use of wire, radio or television to

communicate false or fraudulent pretenses, representations or promises

• Must be associated with interstate or foreign commerce for wire fraud statutes to apply

The U.S. Banking System• Benefit of the U.S. banking system

– everything is written down – most transactions and their back-up

documentation are captured on microfiche or some form of electronic imaging

• Bank account activity can be used to profile account holder

• Checks are very detailed

Jimmy-Jo Venture Capital A West Virginia Corporation November 26 2008 1 (800) Got-CASH Pay to the order of Innovative Learning Place $ 53.21 FIFTY THREE AND 21/100 Dollars

Memo Booklets _signed / John Q Public_____________

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First Huntington Commerce Bank

Moving Money Internationally

• Advance cash payment– Advantageous to provider

• Documentary letter of credit– Both buyer and seller are protected

• Documentary collection• Open account• Electronic funds transfer (EFT)

Other Complex Frauds and Financial Crimes

• Tax Evasion and Fraud• Bankruptcy Fraud• Securities Fraud

Tax Evasion and Tax Fraud

• The Internal Revenue Service (IRS) is responsible for determining, assessing and collecting taxes imposed by Congress

• The IRS is divided into 4 major divisions– Wages and Investment– Small Business / Self-Employed, including Excise

Taxes– Large and Mid-size Business Division– Tax-exempt and Governmental Entities

Bankruptcy Fraud• Bankruptcy fraud includes schemes to file a

false bankruptcy petition, file documents during a proceeding or make false or fraudulent statements, representations, claims or promises before or after the filing of a bankruptcy petition

• Bankruptcy crimes are investigated by the FBI and prosecuted by the U.S. Attorneys Office

• What is the role of the trustee?

Title 18 of U.S. Code• Title 18 identifies 9 offenses

– Concealing property– False oath or account– False declarations– False proof of claims against bankruptcy estate– Receiving any material amount of property from

estate– Bribery– Transferring or concealing property in

contemplation of a bankruptcy– Destroying or altering documents– Withholding documents relating to estate

Bankruptcy Code Chapters

• Chapter 1 – general provisions• Chapter 3 - guidelines• Chapter 5 – rights and obligations• Chapter 7 – liquidation of assets• Chapter 9 - municipalities• Chapter 11 - reorganization• Chapter 12 – farmers and fisherman• Chapter 13 – high net worth individuals

Securities Fraud• Securities Act of 1933

– The “truth in securities act” primarily deals with the initial issuance of securities

• Securities Exchange Act of 1934– Focuses on the regulation of investment securities

after their initial public offering– Contains a full range of anti-fraud measures

• Investment Advisor Act of 1940• Investment Company Act of 1940• Sarbanes-Oxley Act of 2002

Common Securities Fraud Schemes• Pyramid Schemes• “Prime Bank” Fraud• Churning• Unsuitable Recommendations• Parking• Front Running• Bucket Shops• Misuse or Misappropriation of a Customer’s

Securities• Market Manipulations• Insider Trading

From the Fraudster’s PerspectiveA Warning to Wall Street Analysts from a Convicted Felon

• Securities analysts need to ask intelligent questions

• Consider what many companies don’t say as they spin the story their way

• Beware of companies that exclude critics and provide “selective” access to management

• Beware of corporate managements that– Accentuate positive information– Blame others for their company’s problems– Attempt to intimidate you