Tag Archives: money laundering

The Versatile Microcap

A microcap is a publicly traded company whose stock might be worth only pennies, which causes its price to be volatile and thus easier for fraudsters to manipulate. Although CFEs like our Central Virginia Chapter members might not regularly come across microcap stock manipulation, it’s important for all of us to be aware of the methods and motivations behind this significant criminal activity. In this scheme, promoters and insiders, after cheaply purchasing a stock, typically pump up its value through embellished or entirely false news. However, as reported recently in the trade press, other fraudsters have successfully employed much more creative strategies in exploiting microcaps. Several articles and books have told of the involvement of organized crime, especially throughout the ’00s and ’10s, in this highly profitable illegal business.

Basic pump and dump schemes, also known as hype and dump manipulation, involve the touting of a company’s stock (typically micro-cap companies) through false or misleading statements to the marketplace. After pumping up the stock, scam artists make huge profits by selling or dumping their cheap stock onto the market. Today, pump and dump schemes have been updated and most frequently occur over the Internet, where it is common to see e-mail and other messages posted that urge consumers to buy a stock quickly or to sell their stocks before the price goes down. In some cases, a spam-call telemarketer contacts potential investors using the same sort of pitch. Often the promoters claim to have inside information about an impending development, or to have employed an infallible combination of economic and stock market data to pick stocks. In reality, they may be company insiders or paid promoters who stand to gain by selling their shares after the stock price is pumped up by the buying frenzy they create. Once these fraudulent promoters dump their shares and stop hyping the stock, the price typically falls and investors lose their money.

In another recent but simple form of the micro-cap scheme, a caller leaves a message on a potential victim’s voice mail under the guise of someone who dialed the wrong number. Sounding as if they didn’t realize they had misdialed, the message contains a hot investment tip for a friend. However, the caller is actually a spammer, someone being paid to tout this stock on hundreds of cell phones. Those behind the scheme generally own some of the stock and hope to profit by pumping up the share price and selling off their investments.

Pump-and-dump schemes can be as relatively simple as the one above, or such as an individual or small group releasing false information in a chat room or insiders publishing inflated company information. Sometimes the business owners themselves are complicit, especially with shell corporations that have little actual operations or value. Occasionally, scammers dupe business owners into participating in schemes through promises of investment support and/or related marketing help. Or fraudsters, unbeknownst to the victim company, hijack their target company’s stock and falsely hype it, which often causes irreparable damage to the owners’ and to their business’ reputations. CFEs whose clients include small or new venture businesses should be especially cautious of unsolicited offers made to their clients to receive loans or to raise capital through microcap stock offerings. Criminals commonly target businesses in the pharmaceutical, energy or technology sectors, attempting to use their names and initial offerings to manipulate stock for profit.

More complex microcap stock manipulation schemes involving organized crime typically employ a number of persons who are instructed to buy in at various points that coincide with a series of false press releases and concurrent investor forum-controlled chat and spam emails. This orchestrated activity provides the illusion of stock movement resulting from large investor interest thus drawing in the required funds of outsider victims. The actual manipulation often resembles a series of smaller pumps and dumps instead of one large event. So the fraudsters can use the same stock over and over with less chance of detection by regulatory authorities. More refined players also employ foreign or off-shore brokerage accounts as a further veil over their illegal activities.

When the organized manipulation plan succeeds, the ringleaders will permit the accomplices to sell and obtain their related profit depending on their hierarchy in the organization. However, the end process is often far from perfect. Occasionally, accomplices don’t follow instructions, at their significant personal risk, and sell too early or late. Even if the manipulation isn’t always successful, organized crime members who have invested in the process expect and demand a certain profit, which places additional pressure on participants who might find they have debt on their hands because of their failures.

Occasionally, outsiders also take large positions either profiting from or destroying the momentum of the criminal group. In the 1990s, when trades were completed through actual brokers, criminals could use threats or actual violence to control such unwanted participants. However, technological trading platforms have made this more difficult.

A less common, yet also profitable, technique is to put downward pressure on a stock (or cause the price to decrease) after buying the equity on loan through a contract, or option, with the hopes of buying the stock or settling the contract once the stock has dropped in price. Fraudsters can initiate this manipulation technique, commonly known as ‘short and distort,’ by promoting rumors such as a bad quarter or failed new drug test.

The ability to manipulate microcap stocks with relative ease also makes the activity an ideal tool to hide payments between parties and launder money. Instead of paying cash or wiring funds to settle a drug debt, one can simply provide a tip relating to a microcap stock that’s about to be manipulated. The party who’s owed the debt then only has to buy the stock cheaply and await for the pump to make the sale and generate the profit.

Perpetrators also have used the same process to offer bribes to public servants. Troublesome envelopes or bags of cash aren’t required. The profit appears as a simple lucky or astute stock pick, and culprits can even report them as capital gains thus removing the risk of highly feared and powerful tax investigators becoming involved in a possible money-laundering investigation. Police and securities regulatory authorities have observed and reported such suspicious activity. However, it’s often difficult to link those who profit from the manipulation with the culpable manipulators. Also, considering that organized crime elements employ microcap manipulation for debt payments and as profitable crimes, it’s again challenging for authorities to identify the exact goals of their participation without some inside knowledge. Proving all the elements of the crime is nearly impossible without wire taps or a co-conspirator witness.

With all this said, it’s ironic, yet not surprising, that more than one organized-crime figure has said they don’t invest their own criminal earnings in microcap stocks because they deem such markets to be too risky and plagued by manipulators.

So, in summary, if you, as a CFE, come across information relating to a microcap investment involving a case you’re working, you might want to take a closer look.

With regard to preventing investment fraud schemes in general … caution your clients:

• to not invest in anything based upon appearances. Just because an individual or company has a flashy website doesn’t mean it is legitimate. Websites can be created in a matter of hours and taken down even faster. After a short period of taking money, a site can vanish without a trace.
• to not invest in anything about which they are not absolutely sure. Do homework on an investment to ensure it is legitimate.
• to thoroughly investigate the offering individual or company to ensure legitimacy.
• to check out other websites regarding this person or company.
• to be cautious when responding to special investment offers (especially through unsolicited e-mail) by fast talking telemarketers. Know with whom you are dealing!
• to inquire about all the terms and conditions involved with the investors and the investment.
• Rule of thumb: If it sounds too good to be true, it probably is.

Financing in the Dark

money-laundering_1A reader of our last blog post on risk assessment, a CFE employed as an internal auditor by a large overseas financial services firm, has been asked, (in light of the Panama Papers), and as a member of an evaluation team, to perform a review of the controls comprising his company’s anti-money laundering program.  I thought his various questions about ACFE guidance on money laundering might furnish interesting matter for a blog post.  The ACFE has long identified money laundering, including terrorist financing, as a global problem.

Due to government concerns globally, laws have been enacted in countries such as the United States (the Bank Secrecy Act (BSA), Canada (Proceeds of Crime, Money Laundering and Terrorist Financing Act), and Australia (Anti-Money Laundering and Counter-Terrorism Financing Act, 2006) to combat money laundering and financing of terrorist activities. Such legislation embodies recommendations from the Financial Action Task Force (FATF), a Paris-based intergovernmental body formed in 1989 by the Group of Seven industrialized nations. As a result, financial institutions in many countries have taken initiatives to implement appropriate policies and infrastructure for ensuring compliance with applicable money laundering requirements and practices. One such step has been to implement anti -money laundering/ counter-terrorist financing programs based on FATF recommendations.  Our reader’s company is to be commended for undertaking the review since independent testing by knowledgeable assurance professionals (including CFE’s) is a critical component in ensuring existing anti-money laundering programs remain robust and fully aligned with regulatory requirements. The testing of these programs should be cohesive and integrated and include a well-defined strategy that takes a risk-based, enterprise wide perspective.

According to the ACFE, an effective anti-money laundering program includes:

–Appointment of a senior officer responsible for ensuring risks are understood, addressed, and mitigated enterprise-wide;
–Development of formal policies, procedures, and controls that are aligned with Federal and local regulations;
–Implementation of a risk-based approach for identifying risks by client, geography, product, and delivery channels;
–Implementation of a program of dynamic rules-based transaction monitoring for purposes of identifying and reporting suspicious activities;
–Implementation of training programs customized to specific functions and activities;
–Independent, periodic testing of the program.

The ACFE stresses that to be successful it’s necessary that the review team understand the organization’s products and delivery channels as well as its types of clients and their geographic location(s). It’s also necessary to understand the company’s organizational structure, infrastructure, policies, procedures, and controls for mitigating money laundering and terrorist financing risks. Also as part of the audit strategy, auditors should list all anti-money laundering regulatory requirements in the countries in which the organization does business. Once these components are clearly defined and understood, a risk profile can be developed (using the interviewing strategy featured in our last post) to ascertain risk levels and enable the creation of appropriate audit programs, staffing, and overall management of the review assignment. Needless to say, the audit strategy should always be formally approved by the organization’s chief audit executive.

The temptation to use boilerplate or template audit programs should be minimized by the development of tailored audit programs fitted to the specific nature of the business process being audited. One of the biggest challenges in developing such audit programs for money laundering is determining appropriate sampling methodologies for performing the required testing and validation. Inappropriate sampling will lead to incorrect and unsupportable conclusions. Sampling criteria and attributes must be defined clearly and be consistent with audit objectives. Once again, the audit manager should approve the sampling methodology before execution.

Our reader’s audit team will need to verify compliance with local regulations, which is not an easy task due to the high transaction volumes characteristic of industries like his. However, in most financial organizations, transaction-based processes must be automated to work and queries can be developed to create exception reports where deviations from expected outcomes exist. Out reader asked for examples of such automated exception reports and some common ones recommended by the ACFE are:

–Cash deposits of US $10,000 or greater where the required regulatory reporting has not been completed. (This threshold applies to Canada and the United States and may vary in other countries);
–Transactions with countries where trade sanctions exist;
–Industry codes listing clients in high risk industries to assess the level of enhanced due diligence performed;
–List of employees who have not completed required anti-money laundering training;
–List of clients with Post Office box addresses;
–List of clients with missing Taxpayer Identification Numbers;
–List of wire transfers from accounts owned by governments into accounts of private investment companies and politically exposed persons;
–Validating that “know your client” and customer identification requirements are compliant with local regulatory requirements;
–Validating that enhanced due diligence is performed on high-risk businesses.

Business culture has traditionally revolved around management of risks relative to sales, markets, economic trends, and reputation. Only relatively recently has regulatory risk as it relates to money laundering requirements received more intense scrutiny. Regulators have adopted a zero tolerance position, as evidenced by penalties against financial institutions for noncompliance with the ever growing body of legislation.  Financial institutions like our reader’s are considered an integral defense in the fight against money laundering and terrorist financing. It’s thus imperative that these organizations implement effective independent testing programs to assess the quality of controls relative to their anti-money laundering programs.  Sound independent testing by assurance professionals who have in-depth knowledge of fraud and regulation, as well as of risks, controls, and business processes in general is considered a key control within any organization. Fraud risk assessment review work of the anti-money launder business process provides management with the necessary intelligence for proactively managing deficiencies and ensuring that a well-aligned top-to-bottom control environment with appropriate resources and infrastructure is in place for mitigating money laundering risk.

Because fraudsters and criminals are creative and money laundering methods and techniques change constantly in response to evolving countermeasures, a useful reference for CFE’s and for auditors of all kinds is always the ACFE which provides live seminars and on-line training insights into emerging money laundering related threats as well as on-going suggestions for new areas for investigation and testing.

It’s Not Just About Tax Avoidance

off-shoringRegister Today for Investigating on the InternetMay 18-19 2016 RVACFES Seminar!

The ACFE tells us that countries in virtually all parts of the world, but especially those located in the Caribbean and South Pacific, are commonly regarded as tax havens.  A tax haven is a country whose laws, regulations, traditions, and treaty arrangements make it possible for a person to reduce his or her overall tax burden. Secrecy is basically supplied by such countries in two ways.

1) Domestic bank secrecy laws: Laws which bar insight by outsiders;2) Blocking statutes: Statutes which effectively prevent the disclosure, copying, inspection, or removal of documents located in the host country in compliance with orders issued by foreign authorities.

Moreover, in many countries, legal depositions may not be taken on national territory in connection with judicial proceedings being undertaken abroad. Many countries, such as the United Kingdom, France, South Africa, Germany, Australia, Norway, and Canada have comprehensive statutes to guard their sovereignty from the extraterritorial reach of foreign authorities. Although these countries are not generally thought of as tax havens they have laws which can be used by the asset hider. In addition to asset hiding, some foreign countries have a legal, banking, or economic climate that provides an excellent site for laundering money. Historically, places such as Panama, the Cayman Islands, the Bahamas, Switzerland, and the Netherlands Antilles have been associated with hidden bank accounts, fictitious corporations, and money laundering.

The most popular off-shore jurisdictions in the news recently are:

–Switzerland
–Panama
–Cayman Islands
–Netherlands Antilles

Countries like Panama with relatively small, open economies have often embraced the financial secrecy business as a way of promoting economic development. With some notable exceptions, these countries are geographically isolated with a narrow production concentrated on a few major commodities, usually for export. This tends to make them vulnerable to adverse climatic conditions and international market development. It also limits their ability to produce an adequate domestic market, invest in an infrastructure, attract foreign direct investment, and gain access to a diversified mix of importers and exporters.

It’s important for CFE’s to understand the general concept of a financial center with regard to financial havens.  Financial centers are of two types:

–A functional center is defined as country where transactions are actually undertaken and the value added is created in the design and delivery of financial services. Examples of functional centers include New York, London, Singapore, Bahrain, and Hong Kong.
–A booking center is defined as a country where transactions are recorded but the value added involved is actually created elsewhere. Examples in this category include Panama, the Bahamas, Cayman Islands, Seychelles, and Vanuatu.

Accordingly, the ACFE classifies the tax havens of the world into four broad categories:

No Tax Havens – these countries have no income, capital gains or wealth taxes. It’s legal to incorporate and/or form a trust. The governments of these countries do earn revenue from corporate registration fees, annual fees and a charge on the value of corporate shares. Examples of “no tax” havens are the Bahamas, Bermuda, the Cayman Islands, Nauru, the Turks, Caicos and Vanuatu.

No Tax on Foreign Income Havens – These countries impose income taxes, but only on locally derived income. Any income earned from foreign sources that involves no local business activity (apart from simple housekeeping and bookkeeping matters) is exempt from taxation. There are two types of “no tax on foreign income” havens. Those that:

–allow corporations to conduct both internal and external business, taxing only the income from internal sources;
–require a decision at the time of incorporation as to whether the company will conduct local business or will act only as a foreign corporation. If the company elects the latter option, it will be exempt from taxation. If it chooses to conduct local business, it incurs the appropriate tax liabilities. Examples are Panama, Liberia, Jersey, Guernsey, the Isle of Man, Gibraltar, Costa Rica and Hong Kong.

Low Tax Havens – These are countries that impose some income tax on company income, wherever it is earned. However, most have double taxation agreements with “high tax” countries. This agreement can reduce the withholding tax on the income derived from a high tax country by local corporations. Examples of “low tax” havens are Cypress, the British Virgin Islands and the Netherlands Antilles.

Special Tax Havens – Special tax havens are countries that impose all or most of the usual taxes, but either allow concessions to certain types of companies, or allow specialized types of corporate organizations such as the flexible corporate arrangements offered by Liechtenstein. Tax havens offering special privileges for holding companies are Liechtenstein, Luxembourg, the Netherlands and Austria.

Understanding the role of tax havens, involves distinguishing between two basic sources of income:

–Return on labor
–Return on capital

The return on labor refers to earnings from salary, wages, and professional services – your work. Return on capital describes the return from investments such as dividends from shares of stocks; interest on bank deposits, loans or bonds; rental income; and royalties on patents. Placing “return on capital” income in certain tax havens can benefit the secrecy seeker. By forming a corporation or trust in a tax haven this income may become tax-free or be taxed at such a low rate that the taxation is hardly noticeable.

In the case of Panama, for example, off-shore banking and incorporation are a major source of revenue. It’s also a good country for laundering drug money through its banks. It was reported by the financial trade press some years ago that at one time $200-$300 million a month was laundered through Panamanian banks. Panama is one of the most effective off-shore havens for money-launderers, offering tremendous secrecy. As the Panama papers seem to bear out, its banking haven business has always been regarded as supplemental to its status as a tax haven.

Before asset hiders and money launderers can utilize off-shore secrecy havens, they must first establish secret off-shore bank accounts. The off-shore account provides asset protection because the existence of such an account will not readily be known by someone seeking to collect against assets. Foreign banks, regulated by their own authorities, are under no obligation to inform the fraudster’s home country bank examiners of the ownership of the accounts they hold. Even if the existence of an off-shore account does come to light, judgments from home country courts are generally invalid in foreign countries, so creditors normally have to get a judgment in the country where the account is located. This allows time for the individual to fight the action or, unless the court immediately issues an order prohibiting the transfer of assets, simply move the assets out of the account.

So why do fraudsters and others secretly move money off-shore?  Not just tax avoidance. There are many additional benefits of doing so, extending well beyond simple tax avoidance:

–Off-shore bank accounts allow an individual to invest in foreign stocks and mutual funds that are not registered with home country government agencies;
–In some instances, off-shore bank accounts offer more flexible customer options than home country accounts;
–The account can be used to profit from currency fluctuations, buy stocks from mutual funds, purchase foreign real estate, and earn the high interest rates available in many foreign countries;
–Foreign accounts are used to trade precious metals and other assets through the banking system;
–For U.S. citizens, off-shore banking income is not presently considered “subpart F income” on U.S. tax returns. The profits accumulate in the off-shore bank and are compounded free of U.S. taxes;
–Most off-shore banks allow transactions to be conducted by mail, fax, or telex.

Keeping money in off-shore bank accounts is generally considered to be a safe move. On the rare occasion when a bank fails, in most developed countries the major banks in the country will take over its business to ensure that depositors do not lose any money. Some countries even have stronger capital requirements for banks than the United States.

The off-shore financial safe haven sector constantly evolves and adds more attractive customer services over time, just like every other dynamic market place that wants to retain and grow its customer base.  To effectively investigate the role off-shoring plays in many high profile frauds, CFE’s need to realize that tax avoidance is often just the tip of the concealment iceberg.

Forensic Accounting in a Time of Terror

CitySceneIt seemed that, hardly had we bid the last family member goodbye and cleared away the Thanksgiving dishes, that we heard about yet another terror attack, this one domestic, in Colorado Springs.  It increasingly feels that the terrorists freely swim in the sea of the vulnerable rest of us.  As fraud examiners and forensic accountants confronted with the problem of assisting our clients and law enforcement in combating the illicit financing of this scourge, it seems to me we should have two basic objectives, follow the money and dry up the money.  I know I’m preaching to the choir but law enforcement and government agencies in collaboration with forensic accountants and fraud examiners can play a key role in tracing the source of terrorist financing directly to those financial activities used to support terror attacks on both our national and on global citizens. Using this information, law enforcement agencies can utilize existing investigative and predictive analytics tools to gather, dissect, and convey data in an effort to distinguish the types of distinctive patterns (just as we daily do with fraud scenarios) leading to future terrorist perpetrated events. Government agencies can employ database inquiries of the terrorist-related financial information that fraud examiners have helped to build to evaluate the future probability of terrorist financing and attacks. Forensic accountants can also review the data to identify the specific patterns related to previous transactions by utilizing those same data analysis tools, which can also be used to assist in tracking the sources of the funds.

Our pivotal role is being increasingly recognized on all sides by those actively engaged in this struggle. According to the ACFE, forensic accountants use a combination of “accounting knowledge with investigative skills in … litigation support and investigative accounting settings” (ACFE, 2015). Hence, it’s no news to readers of this blog that numerous organizations, agencies, and companies employ us forensic accountants to provide investigative services and fraud risk assessments. Among them are public accounting firms, law firms, law enforcement agencies, The Internal Revenue Service (IRS), the Central Intelligence Agency (CIA), and the Federal Bureau of Investigation (FBI).  The FBI is a case in point.  All the way back in 2009, the FBI officially created a forensic accounting position within the Bureau to complement its standard criminal investigations. Now the agency is actively utilizing forensic accountants to investigate domestic and foreign terrorists involved in financial wrongdoing. FBI forensic accountants use various investigative tools to track terrorist financing, i.e. government-wide databases and Financial Crimes Enforcement Network (FinCEN) data inquiries to trace the illicit funds and related transactions of suspected terrorists. The search for illicit funding sources commences after Government agencies share information regarding red flags of possible terrorist activities such as money laundering.

Obstructing terrorist financing requires that fraud examiners have an understanding of both the original and the supply source of the illicit funds. As such financing is typically derived from a poisonous mix of both legal and illegal funding sources, terrorists may attempt to evade detection by funneling money through legitimate businesses thus making the money difficult to trace. Charitable organizations and reputable companies provide a legitimate source through which terrorists may pass money for illicit activities without drawing the unwanted attention of law enforcement agencies. Patrons of legitimate charities and non-profit organizations are often unaware that their personal contributions may support terrorist activities. However, terrorists also obtain funds from obvious illegal sources, such as kidnapping, fraud, and drug trafficking.

Terrorists often change daily routines to evade law enforcement agencies as predictable patterns create trails that are easy for skilled investigators to follow. Audit trails can be traced from the donor source to the terrorist by forensic accountants and law enforcement agencies using specific indicators to assist the tracking. Audit trails reveal where the funds originate and whether the funds came from legal or illegal sources.

Take their use of money laundering and virtual currencies as an example.  Money laundering is a specific type of illegal funding, which can provide the forensic accountant a clear audit trail.  Money laundering is the process of obtaining and funneling illicit funds in order to disguise the connection with the original unlawful activity. Terrorists launder money in order to spend the unlawfully obtained money without drawing attention to themselves and their activities. In order to remain undetected by regulatory authorities, the illicit funds being deposited or spent need to be “washed” to give the impression that the money came from a seemingly reputable source. There are particular types of unusual transactions that raise red flags associated with money laundering in financial institutions. The more times an unusual transaction occurs, the greater the probability it’s the product of an illicit activity.  Money laundering may be quite sophisticated depending on the strategies employed to avoid detection. Some identifiers indicating a possible money-laundering scheme are: lack of identification, money wired to new locations, customer closes account after wiring or transferring large amounts of money, executed out -of-the-ordinary business transactions, executed transactions involving the customer’s own business or occupation, and executed transactions falling just below the threshold trigger requiring the financial institution to file a report.

Virtual currency, unlike traditional forms of money, does not leave a clear audit trail for forensic accountants to trace and investigate. The Government Accounting Office (GAO) has discussed the emerging trend of financial anonymity of Bitcoins and other virtual currency and the need for regulators of traditional banking institutions to become more aware of suspicious activities with respect to virtual currency. According to the GAO, because they operate over the Internet, virtual currencies can be used globally to make payments and funds transfers across borders. The obscurity of Bitcoin currency transactions allows international funding sources to conduct exchanges without a trace of evidence. This co-mingling effect is similar to money laundering but without the regulatory oversight. Government and law enforcement agencies must be able to share information with public regulators when they become suspicious of terrorist financing.

The traditional types of data analysis tools, so familiar to the readers of this blog, which can be effectively used by forensic accountants to investigate these types of terrorist financing include: Benford’s Law, Accounting Command Language (ACL) software, Interactive Data Extraction and Analysis (IDEA) software, data mining software, and financial statement analysis ratios.

Forensic accounting technology is most beneficial in terror related investigations when used in conjunction with the analysis tools of law enforcement agencies to predict and analyze future terrorist activity, before it happens. Even though some of the tools in a forensic accountant’s arsenal are useful in tracking terrorist funds, the ability to identify conceivable terrorist threats is limited. To identify the future activities of terrorist groups, forensic accountants, and law enforcement agencies need to cooperate with one another by standardizing and incorporating the principal analytical tools utilized by all their sister agencies. Agencies and government officials should become familiar with virtual currency like Bitcoins. Because of the anonymity and lack of regulatory oversight, virtual currency offers terrorist groups a useful means to finance illicit activities on an international level. It might be helpful to even conceive of a new government agency to tie together all of the financial forensics efforts of the different organizations so that information sharing is not so compartmentalized as to compromise future investigative cooperation.