Category: Fraud

Fraud Awareness Week

The Association of Certified Fraud Examiners is urging organizations worldwide to participate in International Fraud Awareness Week, November 7-13, 2010 to help cast a spotlight on the problems arising from fraud.

This weeklong campaign encourages business leaders and employees to proactively take steps to minimize the impact of fraud by promoting anti-fraud awareness and education.

In its 2010 Report to the Nations on Occupational Fraud & Abuse the ACFE found that:

  • Fraud schemes are extremely costly. The median loss caused by the occupational fraud cases in the ACFE study was $160,000. Nearly one-quarter of the frauds involved losses of at least $1 million.
  • Schemes can continue for months or even years before they are detected. The frauds in the study lasted a median of 18 months before being caught.
  • Occupational fraud is a global problem. Though some findings differ slightly from region to region, most of the trends in fraud schemes, perpetrator characteristics and anti-fraud controls are similar regardless of where the fraud occurred.
  • Small businesses are especially vulnerable to occupational fraud. These organizations are typically lacking in anti-fraud controls compared to their larger counterparts, which makes them particularly vulnerable to fraud.
  • Tips are key in detecting fraud. Occupational frauds are much more likely to be detected by tips than by any other means. This finding reinforces the need for promoting awareness to foster an informed workforce.

The 2010 Report to the Nations is available for download online at the ACFE’s website: ACFE.com/RTTN. The Report is in PDF format

Become an Official Supporter
There’s no charge to become an official supporter of International Fraud Awareness Week. You will receive downloadable anti-fraud resources, as well as a logo to post on your company or organization’s web site. You will also be provided with a customizable press release to send to local media announcing your involvement in this important movement.

Influence Future Professionals
Speak to local university students enrolled in business, management and accounting courses about the importance of being trained in the detection and prevention of fraud.

Reduce Risk
Send an email to clients outlining the risks and cost of fraud. Encourage them to reduce their fraud risk.

Spread the Word
Encourage other colleagues and students to become involved with the ACFE in the fight against fraud.

Host an Anti-Fraud Seminar
Hold a free fraud prevention seminar in your community. Download anti-fraud resources or contact [email protected] for more information.

Rosand Enterprises and Real Estate Fraud

I find looking at fraud cases instructive, seeing common themes, failures and techniques. Since my company is in real estate, real estate fraud catches my eye. Recently the SEC brought a case against Rosand Enterprises and one of its principals, Robert A. Anderson.

The Securities and Exchange Commission came in late. The Illinois Secretary of State had already filed an order against Rosand Enterprises, Rossetti and Anderson.

In the Illinois order, they alleged that the enterprise had solicited investors to loan them $2.735 million, with repayment at 15% per month for a six-month note or 20% for a twelve-month note.

The SEC found a broader network of $12 million solicited from 77 investors. (I wonder why the SEC did not include Mr. Rossetti their complaint.) The US Attorney also got involved and announce criminal charges.

Let’s look at some of the red flags.

Extremely high returns should be a big warning. Rosand was offering returns of 15% or 20% per month on loan payments. If the business is that profitable, why bother getting outside collateral. They are doubling their money every six months.

The money was guaranteed. Risk equates to reward. If money is in a safe investment, you should only get a small return. If there is a high rate of return then the investment is going to be risky. Any promised returns above 10% per year should immediately be suspect.

They were offering the notes to non-accredited investors. If you make less than $200,000 per year or have a net worth of less than $1 million you are non an accredited investor. That means you are not generally able to purchase unregistered securities like the notes offered by Rosand.

One aspect of real estate is that ownership is part of the public record. Anyone can walk into the registry of deeds and see who owns a piece of property and who they bought it from. In most places, you can also see the price paid.  If Rosand was buying and rehabilitating houses, a potential investor could easily look up the information in the land records.

The Cook County Registry of Deeds is online. I ran a quick grantor/grantee search on “rosand.” No surprise, Rosand Enterprises has not bought or sold any real estate in the past 15 years.

Like most Ponzi schemes, eventually you will run out ways to get new money in the door to cover the money going out. Rosand stopped making payment in June 2008. Two years later, the State of Illinois and the SEC stepped in to protect investors.

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The New Face of Evil?

The New Face of Evil?

His crime was simple: collect money from investors, fake the returns, pocket the money, and repeat. His crime was the biggest: $20 billion in cash plus $45 billion of fake returns.

Should Bernie Madoff be the new name for evil? Christine Hurt of University of Illinois College of Law contrasts Madoff with the original Ponzi schemer, Charles Ponzi himself.

Judge Chin at the Madoff sentencing cast him with the label of evil:

Here, the message must be sent that Mr. Madoff’s crimes were extraordinarily evil, and that this kind of irresponsible manipulation of the system is not merely a bloodless financial crime that takes place just on paper, but that it is instead, as we have heard, one that takes a staggering human toll

His 150 year sentence is a staggering sentence for a non-violent crime. Financial fraud sentences are rapidly increasing in length and severity.

Perhaps, as Hurt point out, this increase in penalty is a reflection of the American society. We are now more afraid of outliving our retirement savings than of home invasion. (But not of people taking pictures of planes.)

Unlike the complexity of the WorldCom and Enron financial misdeeds, Madoff’s were much more straight-forward. It’s an easier story to tell the judge. It’s easier to lay the blame. Bernie kept his mouth shut and did not implicate anyone else.

We are already seeing the “Madoff” label being applied to other fraud schemes. Kenneth Starr’s fraud is being labeled “Madoff-Like.” other frauds are being called “Mini-Madoff.”

Maybe the Madoff label will stick.

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Telling the Truth During Earnings Calls

Is the CEO or CFO lying during the quarterly earnings call? How can you tell?

David F. Larcker and Anastasia A. Zakolyukina of the Stanford Graduate School of Business turned to the rich data set of quarterly calls and subsequent financial restatements. After studying Q&A sections of transcripts of hundreds of calls with CEOs and CFOs, the researchers then looked to see whether financial statements being discussed were substantially restated at some point after the call. If they were restated, Professor Larcker and Zakolyukina (a PhD student at the school)  reasoned that the executive had been “less than candid.”

They found that answers from deceptive executives:

  • have more references to general knowledge
  • fewer non-extreme positive emotions
  • fewer references to shareholders value and value creation
  • use signi significantly fewer self-references, more third person plural and impersonal pronouns
  • more extreme positive emotions
  • fewer extreme negative emotions
  • fewer certainty and hesitation words

Their performance is only 4% to 6% better than a random guess. So it’s statistically significant, but not determinative.

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Power Corrupts – So Does Powerlessness

Rosabeth Moss Kanter points out another reason that the “tone at the top” is only one factor for corporate compliance in Powerlessness Corrupts.

“Power corrupts, as Lord Acton famously said, but so does powerlessness. Though powerlessness might not result in the egregious violations associated with arrogant officials who feel they are above the law, it is corrosive.”

  • Managers spread powerlessness by limiting information.
  • They compound the insult by sneaking unpopular decisions through when they think no one’s looking.
  • Powerlessness burgeons in blame cultures.
  • The powerless retaliate through subtle sabotage. They slow things down by failing to take action
  • Negativity and low aspirations show up in behaviors psychologists call defensive pessimism, learned helplessness, and passive aggression.

Those are a lot of points for targeting the tone at the middle and the tone at the bottom.

Dilbert, being the epitome of powerlessness, captures some of this in today’s strip.
Dilbert.com

Ernst & Young’s 11th Global Fraud Survey

Driving ethical growth – new markets, new challenges, the title of  Ernst & Young’s 11th Global Fraud Survey, shows fraud is up; audit and legal are stretched to deal with these challenges; compliance is patchy; and Boards need more and better information to manage the risks.

They interviewed more than 1,400 chief financial officers, and heads of legal, compliance and internal audit in 36 countries to get their views on how companies are managing the risks associated with fraud, bribery and corruption.

The survey was conducted in 2009 and 2010 on behalf of Ernst & Young’s Fraud Investigation & Dispute Services practice.

Consistent with the experience of past recessions, companies have been struggling with an upsurge in fraud and corruption. Almost one in six of our respondents have experienced a significant fraud in the past two years.

Compliance is New

Compliance is still a developing area outside of the highly regulated industries, such as life sciences and financial services.

About half of the compliance professionals surveyed have been in a compliance role for less than five years.

As a relative newcomer, the compliance function faces the extra hurdle of demonstrating its value. Of course, you need to demonstrate value if you want to get more resources. This was the greatest challenge identified by compliance professionals in their survey.

The competition for resources also reduces compliance’s ability to gather the current management information required to do its job, making it harder still to demonstrate value to the rest of the business.

Board Concerns

Seventy-six percent of respondents feel their boards are increasingly concerned about their personal liability from fraud, bribery and corruption. The survey indicates that the Board’s level of concern with fraud has risen with the overall rise in fraud and corruption risks in the current economic climate. All the survey participants think that board members are taking their own personal exposure seriously.

What About the Rating Agencies?

There has been lots of criticism aimed at Goldman Sachs over the Abacus 2007-AC1 deal. They help set up a CDO so their client, Paulson & Company, could make a bet on a downturn in the residential real estate market. To make that bet, they allowed Paulson to influence the securities that went into the CDO. Most of them turned out to be dreck and the CDO ended up tanking. Paulson made money from his short position and the investors in the CDO lost more than $1 billion.

Who Was the Client?

Paulson & Company hired Goldman Sachs and paid them $15 million for the structuring of the Ababcus 2001-AC1 CDO. So they were clearly a client.

The purchasers of the CDO were clients of Goldman Sachs. Since they were purchasing securities from Goldman Sachs as a broker-dealer, they were not owed a fiduciary duty by Goldman Sachs. That is one of the current differences between the law governing investment advisers and broker-dealers. Goldman made a statement in the materials that they do not have a fiduciary obligation to the investors.

Goldman Sachs had a split loyalty that is common with Wall Street transactions.

Disclosure

In selling securities you are required to disclose all material information and risks in a prospectus for the security and deliver that prospectus to purchasers.

Goldman claims that its Abacus investors had all the information needed to evaluate risks for themselves in the prospectus.

The SEC is claiming that Goldman should have disclosed that Paulson influenced the selection of securities placed in the CDO and that they were engaged by Paulson to build the CDO so Paulson could take a short position against it.

Illegal or Unethical?

Obviously, the SEC is taking the position that Goldman acted illegally. Personally, I’m not sure it was illegal. If it turns out that they said Paulson was long on the CDO, when he was actually short, then they are in trouble.

Lots of people are arguing that they acted unethically. That is a stronger argument. Goldman may not have been required to disclose Paulson’s role in the transaction, but they probable should have disclosed it.

I prefer to use the very technical term “yechy.” Goldman looks very bad. As a company, they seek to have a better reputation than this.

They should not have structured the transaction this way. They should settle this case, chalk it up as a mistake and act better. (I own some stock in Goldman Sachs that I bought when the price dropped because of these accusations.)

What about the Rating Agencies?

Even with all the dreck in this CDO, the rating agencies still gave a AAA rating to the $480 million Class A, AA to the $60 million Class B, AA- to the $100 million Class C, and A to the $60 million Class D.

Clearly one of the factors in the sub-prime market was the failure of the rating agencies. They were giving AAA ratings to collections of dreck.

S&P defines the AAA rating for structured finance as “judged to be of the highest quality, with minimal credit risk.”

Maybe this chart is better explanation of the ratings:

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The Similarites Between WaMu and GM

Never stop the production line!

Yesterday, evidence came out that Washington Mutual knew about fraud in its residential mortgage originations. No surprise. There was lots of fraud in the heyday of the residential mortgage boom.

What was surprising was that WaMu allowed these loans to be sold to investors and packaged into residential mortgage backed securities.

“Washington Mutual built a conveyor belt that dumped toxic mortgage assets into the financial system like a polluter dumping poison into a river.” – Senator Carl Levin (D-Mich)

Since Senator Levin is from Michigan it reminded me of a similar story from a GM plant. They never stopped line in the GM plant. Even if someone had put a Regal front end on the a Monte Carlo, nobody would push the button to stop the production line and fix the problem.

The GM plant managers were paid to get cars off the end of the production line, regardless of what condition they were in or even if they were driveable.

The Washington Mutual loan officers were paid to get loans to the end of the production line, regardless of whether there was fraud or if the loan could be repaid by the borrower.

Both WaMu and GM ended up insolvent. The workers and the managers were paid on quantity, not quality.

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Consumer Complaints and Fraud

Visit the Better Business Bureau

I occasionally like to look at consumer fraud complaints to see if I can learn any lessons for corporate compliance.On the consumer side there is tremendous volume of complaints and many parties trying to help.

It caught my eye when four different organizations got together to identify the top consumer complaints for 2009. Here are their lists:

Massachusetts Office of Consumer Affairs

1. Home Improvement Contractors
2. Auto Insurance
3. Health Insurance
4. Lemon Law
5. Foreclosure assistance

Massachusetts Attorney General’s Office

1. Time Share Resellers
2. Loan Modification Fee Schemes
3. Deceptive Advertising and Solicitations
4. Deceptive Lending Schemes
5. Fake Check Scams

Better Business Bureau of Eastern Massachusetts

1. New Car Dealers
2. Retail Furniture Dealers
3. Collection Agencies
4. Used Car Dealers
5. Movers

Federal Trade Commission

1. Identity Theft
2. Third Party/Creditor Debt Collection
3. Foreign Money Orders/Check Scams
4. Internet Services
5. Shop-at-Home and Catalogue Sales

Differences in the Lists of Complaints

I’m sure each agency has a different taxonomy for categorizing complaints so it’s not fair to compare across agencies. I will anyhow.

It seems really strange that the lists are so different. You would think that there would be some common themes.

I see “Lemon Law” on the Office of Consumer Affairs, with “New Car Dealers” and “Used Car Dealers” on the Better Business Bureau list. So they both have cars, but no sense of the consumer complaint from the BBB list.

The Office of Consumer Affairs has “foreclosure assistance” and the Attorney General has “Loan Modification Fee Schemes” on its list. I sense those entries are a sign of the times and each agency is trying to focus on those related issues.

How you intake complaints will affect how you classify complaints and how you report on complaints. So I thought it would be a useful exercise to see how these agencies intake complaints to see if you can see a relationship to their top complaints.

Federal Trade Commission

Why does the FTC have a category for “Internet Services”? That seems way too broad. I guess it is just the “internet is scary” category. So I tried out the FTC Complaint Assistant.

Its no surprise that “Identify theft” is the top category. That the first question asked. So with the FTC complaint everything is either an identify theft complaint or something else.

The something else is then divided into “Debt collectors or debt collection practices”, “Credit Reports” or something else. So its no surprise what the second item is on the FTC list. It does leave me surprised that “Credit Reports” did not make their top five. The “internet” is one of the categories in other, but the other two on the top five are no obvious from the input taxonomy.

Better Business Bureau

Next I went to the Better Business Bureau’s online complaint form.  Their form’s taxonomy is

  • my vehicle
  • My cell phone or wireless carrier
  • a product or service (other than a vehicle or a cell phone)
  • a charity
  • children’s advertising

So its no surprise that New Car Dealers and Used Car Dealers are in their top five list.

Massachusetts Office of Consumer Affairs

I thought it was strange to see this agency in the mix because it has a limited mandate when it comes to consumer complaints. If you go to their How to Resolve a Consumer Problem webpage they make it hard to even find how to file a complaint with this agency.

They really just have jursdiction on Lemon Law disputes and home improvement arbitration. So what’s odd is that lemon law was only in the number four position in their top five.

(In the interest of disclosure, I worked as a intern at this agency working on consumer complaints.)

Massachusetts Attorney General

This consumer complaint form has the broadest taxonomy, with two dozen categories to choose among.  I would put the most faith its listing of the top consumer complaints because you are not forcing them into a box.

But that leaves me wondering how “time share resellers” are above “loan modification fee schemes”? Maybe there are just lots of people trying to unload their time shares in this bad economy so they can avoid having to modify their loan.

Sources:

  • Press Release: Top 5 Consumer Issues and Complaints Outlined by Patrick-Murray Administration’s Office of Consumer Affairs and Business Regulation, Attorney General’s Office, Better Business Bureau, and Federal Trade Commission

National Consumer Protection Week

National Consumer Protection Week

National Consumer Protection Week 2010 is March 7-13.

Take advantage of the FTC’s free resources, which can help you protect your privacy, manage money and debt, avoid identity theft, understand credit and mortgages, and steer clear of frauds and scams.

This year’s theme is Dollars & Sense: Rated “A” for All Ages. The idea is to highlight the importance of using good consumer sense at every age, from grade school to retirement.

In the meantime, Congress still seems to be thinking about whether there should be a federal consumer protection agency and who should be in charge of it. Senator Dodd appears to want it under the umbrella of the Federal Reserve. US Representative Barney Frank wants a Consumer Financial Protection Agency to be an independent watchdog on financial issues.

For a more light-hearted view:

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