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
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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 illgotten 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
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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
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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
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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
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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 Perspective
A 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