Tag Archives: affinity fraud

Empty Shells

I attended an out of town presentation not too long ago on investment and tax avoidance scams targeting well-to-do retirees. An especially interesting portion of the CFE presenter’s presentation (a recent retiree himself), focused on the use of paper or shell corporations and companies as tools by the perpetrators of such schemes.

Our presenter emphasized that regulators and other law enforcement personnel attempt to identify instances of fraud against retirees and others in order to prosecute the perpetrator and return the fraudulently obtained goods to the victims. However, such frauds tend to be an under-reported crime as victims may be embarrassed that they easily fell prey to the fraudster or may remain connected to the offender because of the engendered trust cultivated. Reluctance to report the crime can stem from a belief that the fraudster will ultimately do the right thing and return any fees or funds. In order to stop such fraud, regulators and law enforcement must be able to detect and identify crime, caution potential investors, and prevent future frauds by taking appropriate legal actions against the perpetrators.

He went on to say that one of the foremost reasons for the existence of the underground economy is to escape taxation, which in some countries can be as high as 51 percent of a person’s nominal income. Swiss bankers have a saying, “There would be no tax havens without tax hells.” As the rate of taxation increases, so does the cost of honesty. The higher the tax burden, the more incentive people have to attempt evading those taxations. Because it is illegal, tax evasion always involves financial secrecy.

Every few years the Internal Revenue Service (IRS) releases its top 12 most blatant tax scams affecting American taxpayers. Over the years the Service has repeatedly warned retirees not to fall for schemes peddled by scammers for the avoidance of taxes featuring the use of dummy corporations (or shells) associated with off-shore accounts in tax havens and emphasizing that there is no secret trick that can eliminate any senior’s tax obligations. Every tax payer should be wary of anyone peddling any of these scams.

The IRS aggressively pursues taxpayers and promoters involved in promoting abusive offshore transactions to wealthy seniors. Such promoters pitch seniors in the use of methods to avoid or evade U.S. income tax by hiding income through shells with accounts in offshore banks, brokerage accounts, or through other entities. Such actively promoted scams feature the use of offshore debit cards, credit cards, wire transfers, foreign trusts, employee-leasing schemes, and private annuities or life insurance plans. The IRS has also identified the use of shells in abusive offshore schemes including those that involve use of electronic funds transfer and payment systems, offshore business merchant accounts and private banking relationships.

But, as our speaker pointed out, shell companies aren’t just for big and medium-sized tax evaders anymore. They have become the financial and deception vehicle of choice for some of the most corrupt, dangerous and ruthless individuals and entities on the planet. Arms dealers, drug cartels, corrupt politicians, scammers, terrorists and cybercriminals are just a few of the most creative and frequent users of shells.

It’s also important to emphasize that not all shell companies are used for nefarious purposes; assurance professionals and investigators need to be aware that there are legitimate uses for these entities, such as using one as a holding company or creating a shell company (in name) to preserve future business rights or opportunities. Not every shell is involved in a criminal conspiracy, so it’s important to understand why someone might use a shell for criminal purposes.

The primary purpose of the use of a shell in a fraud scheme is like that of the fraud itself: to conceal fraudulent activity. This may include the nature, origin, or destination of misappropriated funds and/or concealment of the true owners and decision-makers of a criminal act or conspiracy.

In many instances, one shell company isn’t enough; fraudsters create networks. Dozens of shells, nominee directors, addresses and fake shareholders might be required to fully conceal a scheme or criminal plot. Big-time criminal conspirators will utilize shell incorporators to do the heavy lifting and help create a corporate web of disguise that can perplex and confuse even the best of investigators.

Shells can come in all different shapes and sizes, and the jurisdiction in which they reside can help further the concealment. Some fraudsters create shell companies for single uses and then discard them. Or they may use them repeatedly and have them change hands multiple times. They also may form what our speaker dubbed shelf companies and not use them for a period of time. A shelf company has a better chance of appearing legitimate and fooling a novice investigator or basic due diligence mechanisms because it appears to have existed longer than it really has. An older shelf could have a creation date predating any specific areas of investigative concern, which would allow it to engage in business activities when it otherwise couldn’t without arousing suspicion.

Given the intent, with a small sum of money, time and patience, fraudsters can set up a very elaborate web of shell companies in little time. But establishing the company name is only the first step in creating a shell network of deception. The company needs nominee directors and shareholders, often illegitimate, to further the concealment.

Scammers use nominee directors, and in some instances, other shell companies, to disguise true owners of entities while giving the appearance of legitimacy. Some nominees simply sell their names to fraudsters who use them on company documents. Others actually provide limited services for the shell companies such as processing corporate records, signing for company documents and forwarding mail. These nominee directors are the linchpins to linking and disguising international criminal organizations and operatives. Their use is so widespread that IRS conducted searches among entities frequently disclose nominee directors crossing paths. Some are even listed as directors for the same shell entities.

So what does our speaker recommend that individual CFEs do if we think that one of our clients may be unwittingly doing business with a nefarious shell?

— A shell company can be set up practically anywhere, but successful incorporators have learned to use particular countries and regions. Advantages can include lack of government enforcement or specific laws protecting corporate secrecy. A good source of a high-risk country list is the U.S. State Department’s annual list of major money-laundering countries.
— Use SWIFT codes – a SWIFT code is a unique identifier that’s associated with particular financial and non-financial institutions around the world. If you can identify the SWIFT code for the financial entities the suspected shell is dealing with, you might consider monitoring for any funds originating from or being disbursed to these banks or check to see if any of your client’s customers/vendors have bank accounts associated with these specific institutions.
–Review all available internal data that contains contact, banking, address and ownership information, such as vendor/customer data, wire transfer data, ship to/ship from locations for sales and purchases, purchase orders and invoice support documentation.

Look for :

• Information that doesn’t make sense given the nature of the business relationship with the entity.
• Entity information mismatch: address, phone, fax, ship to, bank, cell contact, etc. in different geographic locations.
• No discernible online presence when compared to the goods/services and the amount of money changing hands.
• The entity “representative” is associated with numerous other companies.
• Payment is made to or received from an unrelated third party. Review incoming/outgoing wire transfer documents.

Our speaker summarized that involvement with shell companies and those associated with them can be very bad news for any of our client companies. Fraudsters within your client organization might make use of them as vehicles of corruption or asset diversion. External perpetrators can passively use them as money-laundering vehicles against your client organization.

All assurance professionals should attempt to stay current with the latest types of abuse associated with the shell company model, trends in international corruption, fraud and asset diversion, and money laundering. ACFE training is, as usual, an excellent resource to do this. To the extent possible, try to screen information on your client’s customers, vendors and employees on an on-going basis. Cross-reference known bad actors and shell companies in the news against the entities with which your clients are doing business. Contact authorities if you and/or your client determine that it has become the victim of a shell company related scheme.

#We Too

The #Me Too phenomenon is just one of the latest instances of a type of fraud featuring a betrayal of trust by a fellow community member which is as old as humanity itself. The ACFE calls it affinity fraud, and it is one of the most common instances of fraud with which any CFE or forensic account is ever called upon to deal. The poster boy for affinity frauds in our time is, of course, Bernard L. Madoff, whose affinity fraud and Ponzi scheme ended with his arrest in 2008. The Madoff scandal is considered an affinity fraud because the vast majority of his clientele shared Madoff’s religion, Judaism. Over the years, Madoff’s clientele grew to include prominent persons in the entertainment industry, including Steven Spielberg and Larry King. This particular affinity fraud was unprecedented because it was perpetrated by Madoff over several decades, and his investment customers were defrauded of approximately twenty billion dollars.

But not all targets of affinity fraud are wealthy investors; such scams touch all genders, religions, age groups, races, statuses, and educational levels. One of the saddest are affinity frauds targeting children and the elderly.

Con artists prey on vulnerable underage targets by luring them to especially designed websites and phone Aps and then collecting their personal information. TRUSTe, an Internet privacy seal program, is a safe harbor program under the terms of the Children’s Online Privacy Protection Act (COPPA) administered by the U.S. Federal Trade Commission. This was the third safe harbor application approved by the Commission. Safe harbor Aps and programs are submitted by the Children’s Advertising Review Unit (CARL) of the Council of Better Business Bureaus, an arm of the advertising industry’s self-regulatory program, and the Entertainment Software Rating Board (ESRB), which were both previously approved as COPPA safe harbors. Sadly, in spite of all this effort, data collection abuses by websites and Aps targeting children continue to increase apace to this day.

Then there’s the elderly. It’s an unfortunate fact that elderly individuals are the most frequent targets of con artists implementing all types of affinity frauds. Con artists target the elderly, since they may be lonely, are usually willing to listen, and are thought to be more trusting that younger individuals. Many of these schemes are performed over the telephone, door-to-door, or through advertisements. The elderly are especially vulnerable targets for schemes related to credit cards, sweepstakes or contests, charities, health products, magazines, home improvements, equity skimming, investments, banking or wire transfers, and insurance.

Fraudsters will use different tactics to get the elderly to cooperate in their schemes. They can be friendly, sympathetic, and willing to help in some cases, and use fear tactics in others. The precise tactics used are generally tailored to the type of individual situation the con artist finds herself in in relation to the mark.

Ethically challenged fraud practitioners frequently focus on home ownership related schemes to take advantage of the vulnerable elderly. The scammer will recommend a “friend” that can perform necessary home repairs at a reasonable price. This friend may require the mark to sign a document upon completion confirming that the repairs have been completed. In some cases, the elderly victim later learns that s/he signed the title of his house over to the repairman. In other cases, not only is the person overcharged for the work, but the work is not performed properly or at all.

Another frequent scheme targeting the elderly involves sweepstakes or prizes. The fraudster continues to influence the elderly victim over a period of time with the hope that the victim will eventually win the “grand prize” if they will just send in another fee or buy a few more magazines.

Fraudsters also frequently solicit the elderly with “great” investment opportunities in precious metals, artwork, securities, prime bank guarantees, futures, exotics, micro-cap stocks, penny stocks, promissory notes, pyramid and Ponzi schemes, insurance, and real estate. Other common scams involve equity skimming programs, debt consolidation offers, or other debt relief services which only result in the loss of the home used as collateral if the victimized debtor misses a payment.

The societal effects of affinity fraud are not limited solely to the amount of funds lost by investors, churches, the elderly or by other types of victims. Once these frauds are uncovered, investor confidence can diminish the financial and other legitimate markets, and a general level of distrust can decrease the government’s ability to provide protection. Loss of confidence manifested itself after the Madoff fiasco with such negative effects evident throughout the economy. Unfortunately, affinity fraud erodes the trust needed for legitimate investments to occur and grow our economy. Essentially, affinity fraud victims of all types become less likely to trust any future monetary request and honest charitable organizations suffer from a loss of endowments. Subsequent to a large affinity fraud being discovered, time is spent by regulators and law enforcement not only prosecuting these cases but also in the expenditure of endless taxpayer dollars assessing what went wrong. Time consuming, expensive investigations generally also include implementation of regulatory changes in an attempt to assist in detection of these frauds in the future, another costly burden on taxpayers.

Once affinity fraud offenders have targeted a community or group, they seek out respected community leaders to vouch for them to potential victims. By having an esteemed figurehead who appears to be knowledgeable about the investment or other opportunity and endorses it, the offender creates legitimacy for the con. Additionally, others in the community are less likely to ask questions about a venture or investment if a community leader recommends or endorses the fraudster. In the Madoff case, Madoff himself was a highly esteemed member of the community he victimized.

Experts tells us that projection bias is one reason why affinity fraudsters are able to continually perpetrate these types of crimes. Psychological projection is a concept introduced by Freud to explain the unconscious transference of a person’s own characteristics onto another person. The victims in affinity fraud cases project their own morals onto the fraudsters, presuming that the criminals are honest and trustworthy. However, the similarities are almost certainly the reason why the fraudster targeted the victims in the first place. In some cases when victims are interviewed after the fact, they indicate to law enforcement that they trusted the fraudster as if they were a family member because they believed that they both shared the same value system.

Because victims in affinity frauds are less likely to question or go outside of their group for assistance, information or tips regarding the fraud may not ever reach regulators or law enforcement. In religion related cases, there is often an unwritten rule that what happens in church stays there, with disputes handled by the church elders or the minister. Once the victims place their trust in the fraudster, they are less likely to even believe they have been defrauded and also unlikely to investigate the con.

The ACFE tells us that in order to stop affinity frauds from occurring in the first place, one of the best fraud prevention tools is the implementation of increased educational efforts. Education is especially important in geographical areas where tight-knit cultural communities reside who are particularly vulnerable to these frauds. By reaching out to the same cultural or religious leaders that fraudsters often target in their schemes, law enforcement could launch collaborative relationships with these groups in their educational efforts.

In summary, frauds like Madoff’s occur daily on a much smaller scale in communities across the United States. The effects of these affinity frauds are widespread, and the emotional consequences experienced by the victims of these scams cannot be overstated. CFEs, assurance professionals, regulators and law enforcement and investigative personnel need to assess the harm caused by affinity fraud and continue to determine what steps need to be taken to effectively confront these types of scams. State and Federal laws should be reviewed and amended where necessary to ensure appropriate enhanced sentencing is enforced for all egregious crimes involving affinity fraud. Regulators and law enforcement should approach fraud cases from different angles in an attempt to determine if new methods may be more effective in their prosecution.

Additionally, anti-fraud education as provided by the ACFE is needed for both the general and investing publics and for regulators and law enforcement personnel to ensure that they all have the proper knowledge and tools to be able to understand, detect, stop, and prevent these types of scenarios. Affinity frauds are not easily anticipated by the victims because people are not naturally inclined to think that one of their own is going to cheat them. Affinity frauds can, therefore, only be most effectively curtailed by the very communities who are their victims.

Summer’s End

TropicalSunset2As a kid I spent my summers with my mother and sister at our family’s house in Rehoboth Beach, Delaware.  My father, a federal judge, would drive up from Washington to join us on weekends, though, given the pressure of his work, not often.  When my father died, my mother closed the Georgetown house and made Rehoboth her permanent residence, dividing her year between a long summer in Delaware and a short winter in Fort Lucie, Florida (she drove herself back and forth until the end!).  Fiercely independent in everything, she personally managed all her assets including a substantial investment portfolio right up to her sudden death (over a week-end) at the age of 88.  She never manifested any sign of psychological impairment or diminished capacity and was quite active physically until the week before her passing.

Given all this, you can imagine my sister’s and my surprise to find that our mother had been the victim of an elder fraud.  As sharp and capable as she was, she had been talked into a patently fraudulent real estate investment by an ethically challenged relative of one of her best friends.  Although the matter was settled out of court (after several years) and some of the funds were eventually returned, I’ve often reflected that if such a thing could happen to my financially knowledgeable and canny mother, how easily it could happen to any elder.

What happened to my mother was elder financial abuse. Financial abuse, or exploitation is limited to, the illegal or improper utilization of an elder’s funds, property, or assets. Undue influence or the ability of someone to misuse their power to exploit the trust of a weaker person’s decision-making is an important factor when defining this type of abuse.  The ACFE says that a senior can become a victim under four different scenarios:

(1) the senior is a “financial prisoner,” physically and perhaps psychologically dependent on a caregiver;

(2) the senior is losing the ability to handle financial affairs because of physical or cognitive impairment, a “new best friend” gradually assumes the responsibility for handling the senior’s affairs and then abuses that trust;

(3) a widow or widower does not know how to handle financial affairs that their deceased spouse used to take care of and is taken advantage of by someone offering assistance; and

(4) a senior, perhaps out of fear or paranoia, refuses help or financial advice from reliable, responsible relatives or other individuals and instead turns to strangers.

The fraudulent depletion of seniors’ resources places the burden of paying for elder care on the rest of us. This may include the imposition of higher taxes to fund the gap of the social welfare agencies. With the recently enacted Affordable Care Act, new taxes have already been enacted, i.e., the 3.8% investment tax that applies to those citizens that hold investments and generate income of $200,000 or more. Over $5 million dollars within the Affordable Care Act has been set aside to establish a federal elder justice coordination team in an effort to further protect seniors.

Extended family members, like my sister and I, are also affected by the fraudulent depletion of a senior’s financial resources. These family members could very well experience the reduction of their own resources if forced to support the senior. As a result of abuse, the senior’s life might also be cut short due to fear, depression, suicide, or hopelessness. The cost of elder financial abuse may extend even beyond the death of a victim, as it affects beneficiaries who would otherwise inherit his or her assets. The impact to the profitability and reputation of financial institutions that create products to help seniors sustain a better quality of life could also be adversely affected if elder financial abuse is not eliminated.

Fraud examiners need to know that the Affordable Care Act authorized funds to create a federal elder justice coordination team. The team is charged with combining previously fragmented elder abuse initiatives across the federal government and determines what actions are needed to enhance protection efforts. The Elder Justice Act directs the Department of Health and Human Services to develop this coordination team among other efforts to focus on education, research, leadership and guidance in establishing programs to prevent elder abuse. Although Congress has authorized $125 million dollars for the directives of the Elder Justice Act, only $8 million was actually appropriated in the 2013 federal budget.

The good news (that it’s important for fraud examiners investigating such scams to know) is that most states have a reporting requirement for the following professionals: police, social workers, public assistance and mental health workers, nursing home employees, and licensed health care providers. They’re required to report possible incidences of abuse to agencies and, as a result, an investigation commences within a prescribed period of time – normally 48 hours. If the agency processing the initial report is not a law enforcement entity, the agency will turn the case over to a law enforcement agency if it’s believed a crime had been committed. There are reporting agencies within each state; however, in most cases, there is no one cohesive centralized agency with the ability to immediately assess the senior’s situation and put processes in place to protect the senior’s assets.

The ACFE recommends expanding the scope of professionals who must report elder abuse to include: financial planners, accountants, attorneys, bankers, funeral home directors, and church officials. Each would be in the position to assess how the individual is affected by life events. For example, a banker dealing with a grieving spouse might notice that the spouse is not sure of her financial situation or appears to have diminished mental capacity. If the employee of the bank were required to report an at-risk senior, the opportunity for fraudsters to take advantage of that senior may be significantly diminished.

Elder financial abuse can only begin to be eradicated if a preemptive approach is implemented. We fraud examiners and other assurance professionals have a duty to understand the history and growth of elder financial abuse, the government’s attempt to enact new laws, the current reactive process, and the cost to society, before brainstorming can commence to develop a better elder fraud prevention model. Only through a partnership between agencies, state and local authorities, the private sector, law enforcement, and nonprofits can approaches be developed to protect our aging population from this form of shameful and tragic abuse.

Trust Me

GavelDuring a joint training seminar between our Chapter and the Virginia State Police held earlier this year, I took the opportunity to ask the attendees (many of whom are practicing CFE’s) to name the most common fraud type they’d individually investigated in the past year. Turned out that one form or another of affinity fraud won hands down, at least here in Central Virginia.

This most common type of fraud targets specific sectors of society such as religious affiliates, the fraudster’s own relatives or acquaintances, retirees, racial groups, or professional organizations of which the fraudster is a member. Our Chapter members indicate that when a scammer ingratiates himself within a group and gains trust, an affinity fraud of some kind can almost always be expected to be the result.

Regulators and other law enforcement personnel typically attempt to identify instances of affinity fraud in order to prosecute the perpetrator and return the fraudulently obtained goods to the victims. However, affinity fraud tends to be an under reported crime since victims may be embarrassed that they so easily fell prey to the fraudster in the first place or they may remain connected to the offender because of emotional bonding and/or cultivated trust. Reluctance to report the crime also frequently stems from a misplaced belief that the fraudster is fundamentally a good guy or gal and will ultimately do the right thing and return any funds taken. In order to stop affinity fraud, regulators and law enforcement must obviously first be able to detect and identify the crime, caution potential investors, and prevent future frauds by taking appropriate legal actions against the perpetrators.

The poster boy for affinity fraud is, of course, Bernard Madoff.   The Madoff tragedy is considered an affinity fraud because the vast majority of his clientele shared Madoff’s religion, Judaism. Over the years, Madoff’s list of victims grew to include prominent persons in the finance, retail and entertainment industries. This particular affinity fraud was unprecedented because it was perpetrated by Madoff over several decades, and customers were defrauded of approximately twenty billion dollars. It can be debated whether the poor economy, lack of investor education, or ready access to diverse persons over the internet has led to an increase in affinity fraud but there can be no doubt that the internet makes it increasingly easy for fraudsters to pose as members of any community they target. And, it’s clear that affinity frauds have dramatically increased in recent years. In fact, affinity fraud has been identified by the ACFE as one of the top five investment schemes since 1998.

Affinity frauds assume different forms, e.g. information phishing expeditions, investment scams, or charity cons. However, most affinity frauds have a common element and entail a pyramid-type of Ponzi scheme. In these types of frauds, the offender uses new funds from fresh victims as payment to initial investors. This creates the illusion that the scam is profitable and additional victims would be wise to invest. These types of scams inevitably collapse when it either becomes clear to investors or to law enforcement that the fraudster is not legitimate or there are no more financial backers for the fraud. Although most fraud examiners may be familiar with the Madoff scandal, there are other large scale affinity frauds perpetrated across the United States almost on a daily basis that continue to shape how regulators and other law enforcement approach these frauds.

Perpetrators of affinity frauds work hard, sometime over whole years, to make their scams appealing to their targeted victims. Once the offenders have targeted a community or group, they seek out respected community leaders to vouch for them to potential investors. By having an esteemed figurehead who appears to be knowledgeable about the investment and endorses it, the offender creates legitimacy for the con. Additionally, others in the community are less likely to ask questions about a venture or investment if a community leader recommends or endorses the fraudster. In the Madoff case, Madoff himself was an esteemed member of the community. As a former chair of the National Association of Securities Dealers (NASD) and owner of a company ranked sixth largest market maker on the National Association of Securities Dealers Automated Quotations (NASDAQ), Madoff’s reputation in the financial services industry was impeccable and people were eager to invest with him.

The ACFE indicates that projection bias is yet another reason why affinity fraudsters are able to continually perpetrate these types of crimes. Psychological projection is a concept introduced by Sigmund Freud to explain the unconscious transference of a person’s own characteristics onto another person. The victims in affinity fraud cases project their own morals onto the fraudsters, presuming that the criminals are honest and trustworthy. However, the similarities are almost certainly the reason why the fraudster targeted the victims in the first place. In some cases when victims are interviewed after the fact, they indicate to law enforcement that they trusted the fraudster as if they were a family member because they believed that they shared the same value system.

Success of affinity fraud stems from the higher degree of trust and reliance associated with many of the groups targeted for such conduct. Because of the victim’s trust in the offender, the targeted persons are less likely to fully investigate the investment scheme presented to them. The underlying rationale of affinity fraud is that victims tend to be more trusting, and, thus, more likely to invest with individuals they have a connection with – family, religious, ethnic, social, or professional. Affinity frauds are often difficult to detect because of the tight-knit nature common to some groups targeted for these schemes. Victims of these frauds are less likely to inform appropriate law enforcement of the problems and the frauds tend to continue until an investor or outsider to the target group finally starts to ask questions.

Because victims in affinity frauds are less likely to question or go outside of the group for assistance, information or tips regarding the fraud may not ever reach regulators or law enforcement. In religious cases, there is often an unwritten rule that what happens in church stays there, with disputes handled by the church elders or the minister. Once the victims place their trust in the fraudster, they are less likely to believe they have been defrauded and also unlikely to investigate the con. Regulators and other law enforcement personnel can also learn from prior failures in identifying or stopping affinity frauds. Because the Madoff fraud is one of the largest frauds in history, many studies have been conducted to determine how this fraud could have been stopped sooner. In hindsight, there were numerous red flags that indicated Madoff’s activity was fraudulent; however, appropriate actions were not taken to halt the scheme. The United States Securities and Exchange Commission (SEC) received several complaints against Madoff as early as 1992, including several official complaints filed by Harry Markopolos, a former securities industry professional and fraud investigator. Every step of the way, Madoff appeared to use his charm and manipulative ways to explain away his dealings to the SEC inspection teams. The complaints were not properly investigated and subsequent to Madoff’s arrest, the SEC was the target of a great deal of criticism. The regulators obviously did not apply appropriate professional skepticism while doing their jobs and relied on Madoff’s reputation and representations rather than evidence to the contrary. In the wake of this scandal, regulatory reforms were deemed a priority at the SEC and other similar agencies.

Education is needed for the investing public and the regulators and law enforcement personnel alike to ensure that they all have the proper knowledge and tools to be able to understand, detect, stop, and prevent these types of frauds. This is where Fraud Examiners are uniquely qualified to offer their communities much needed assistance. Affinity frauds are not easily anticipated by the victims. Madoff whistleblower Markopolos asserted that “nobody thinks one of their own is going to cheat them”.

Affinity frauds will not be curtailed unless the public, the auditing and fraud examination communities, and regulators and other law enforcement personnel are all involved.