Tag Archives: investigative techniques

Reaching Behind the Curtain

Not too long ago a close friend of one of our Chapter members paid a substantial sum of money to a relative, the owner of a closely held corporation, in exchange for a piece of the relative’s real estate to which, it turns out,  the relative/owner did not have clear title.  The relative apparently used a substantial portion of the funds to immediately clear debts of his corporation of which he and his wife are the sole officers and shareholders.  He now claims that, since he used the sale proceeds for corporate purposes, the refund of the purchase price he owes our Chapter member’s friend is a debt of the corporation and not of his personally.   Our Chapter’s friend has engaged an attorney at the suggestion of our certified Chapter member.

Our legal system recognizes that corporations have a separate existence from their shareholders/owners and are treated as ‘individuals’ under the law. There are two ways for a wrong-doer to use the existence of a corporation to avoid efforts to recover a money damage judgment from him or her:

–As in this case, the scammer argues that the corporation and not the shareholder/owner committed the offense, and therefore the shareholder’s personal assets and property should not be used to satisfy any judgment for the offense.

–Argues that the wrongdoer/shareholder’s property is held in the name of the corporation, and therefore s/he has no personal assets that can be used to satisfy a judgment against him  or her.

The first reflects the classic doctrine that shareholder/owners are not liable for the debts or liabilities of the corporation. Of course, if the shareholder/owner also controls the corporation and personally acted wrongfully, s/he may still be liable for her misconduct, and the corporation may simply be jointly and severally liable together with her. Whether the wrongful conduct was that of the corporation or that of an individual shareholder usually is a question of fact to be decided by the jury.

The second reflects the corporation’s ability, as a separate legal entity, to own its own property. If the corporation owns the property, then the individual shareholder does not.  Since both pre-judgement attachment writs and writs of execution can only reach a defendant’s interest in leviable assets, a wrongdoer can appear without assets and judgment proof – and your client can be unable to satisfy a money judgment against her- if the wrongdoer/shareholder has transferred title in her personal assets to the corporation. This does not apply to a non-money judgment to recover specific money or property which can reach proceeds or property in the hands of the wrongdoer or of third persons. Of course, if the wrongdoer’s transfer of assets to the corporation was to defraud creditors, the injured party can seek to have the transfers set aside.

However, even where a corporation apparently shields the defendant or his or her property, the wrongdoer and her leviable property can still be reached if the court can be convinced to disregard the corporation or to regard it merely as her alter ego. The court may do so if it can be proved that the corporation is merely a sham whose sole purpose is to help the wrongdoer fraudulently avoid liability for her conduct. This is sometimes called piercing the corporate veil.

If the corporation is found to be the alter ego of the shareholder, then either or both of the following consequences apply, depending on the goal in piercing the corporate veil:

–The wrongdoer is no longer shielded from liability for the corporation’s misconduct because the wrongdoer and the corporation are viewed by the court as one and the same.

–Corporate property can be reached to satisfy a judgment against the wrongdoer because the property is now regarded, properly, as the wrongdoer/shareholder’s property.

One of the factors to consider in attempting to pierce the corporate veil is whether the corporation is closely held; i.e. owned or directed by one or by a small or limited number of shareholders, officers, and directors (often all the members of the same family). Obviously, the larger the number of shareholders, and the more broadly the corporation’s directing positions are distributed, the less likely it is to be a sham or alter ego for one person. However, given the lawful goals and purposes of incorporation, even a small, closely held corporation may be legitimate. Conversely, the existence of other shareholders or other directors and officers may not mean that the corporation is not a sham.

The ACFE tells us that there is no hard and fast test to determine whether a corporation is a sham. Instead, courts will look at a variety of factors to determine whether to pierce the corporate veil. These factors include:

–As in this case, does the wrongdoer exercise sole or ultimate control over the activities of the corporation?

–Does the corporation’s charter describe the approved activities of the corporation with some specificity, or is it left largely to the discretion of the wrongdoer?

–Does the corporation fail to hold director’s and shareholder’s meetings, record minutes of those meetings, and otherwise observe the formalities of corporate existence?

–Is the corporation so undercapitalized as to raise questions about its viability as a separate entity?

–Are the corporation’s finances so intertwined or identifiable with those of the wrongdoer as to raise questions about its separate existence?

–Does the corporation own property which does not seem to reasonably relate to its activities, particularly as described in its charter?

–Does the wrongdoer use the corporation’s property as if they were her own, personal assets, including but not limited to whether she uses them for purposes not within the corporation’s approved activities?

These and similar or related facts can indicate that the corporation is a sham and has no true, separate existence from the wrongdoer/shareholder. In that case, the court would be justified in ruling that the corporation should be regarded as an alter ego of the wrongdoer and that the corporation and the wrongdoer be considered as one and the same ‘person’ for purposes of determining liability or levying on assets to satisfy a money judgment.

Many thanks to our member for bringing this case to our attention!

Lessons Learnt from the Dread Pirate

OldShip—Rumbi Petrozzello, CPA/CFF, CFE
2016 Central Virginia ACFE Chapter Vice-President

I’m sure that just about every fraud examiner and forensic accountant knows that when Al Capone was finally brought down and sent to prison, it was for simple tax evasion.  Eliot Ness and his Untouchables are famous for doggedly going after Capone and raiding his illegal businesses.  Frank Wilson, the Internal Revenue agent who built the tax evasion case against Capone, is largely unsung.  I thought of Frank Wilson the other day, when a friend shared a New York Times article with me. It was about Gary Alford, the IRS tax investigator who identified Ross Ulbricht as Dread Pirate Roberts, the founder of Silk Road. The piece was particularly interesting because, initially, Alford was brushed aside when he voiced his suspicions about the true identity of Dread Pirate Roberts.  He had to stick to his guns and collect more and more information before the Drug Enforcement Administration (DEA) agents finally took him seriously.

The work of a fraud examiner or forensic accountant is most often not the exciting surveillance, car chases and gun fights that make up action movies. The evidence that’s collected and analyzed can be complex and leave many reviewers cross-eyed, trying to follow the path down which the investigator is trying to lead them.  However, due to the importance of the work we do, it’s important to not give up if, at first, others are not quite finding what you’re proposing to be that compelling. I was struck by how Alford continued to research the leads he’d found, seeking financial and non-financial information to bolster his case and continuing close interaction with his colleagues until he was successful.  I appreciated how the New York Times outlined the various methods that Alford, an IRS tax investigator, employed to collect the evidence that he needed to tie Dread Pirate Roberts to Ross Ulbricht. When I speak to people about the work I do, they’re surprised when I mention the importance and volume of the non-financial information involved, such as chat room posts and the results of Google searches, to corroborate some of the financial information we’re analyzing. When we finally bring together the results of our investigations, if others aren’t quite seeing things as we do, the challenge for us is to figure out how to better communicate our results.

In Alford’s case, to say he was frustrated during his investigation is an understatement. He initially brought forward his theory about the true identity of Dread Pirate Roberts in June 2013. He was excited by his discovery and thought it would be greeted with a degree of enthusiasm equal to his own. He was wrong. But he didn’t give up.  Instead, he went back to work on collecting yet more information and after taking all this to someone else was again rebuffed.  Finally he was advised by a colleague to give it up – essentially that he had done what he could and should do himself a favor and just drop the whole matter.  Fortunately, in September, Alford asked for yet another background check on Ulbricht which, this time, finally led to Ulbricht’s arrest.

In appreciation of Alford’s diligence, his superiors presented him with a plaque with the following Sherlock Holmes quote, “The world is full of obvious things which nobody by chance ever observes.” It’s up to us to be mindful of this and be the nobodies who observe the obvious things, even when others sometimes initially refuse to believe us.