Investigation and Prevention of Financial Crime

Knowledge Management, Intelligence Strategy and Executive Leadership

Petter Gottschalk

• Publisher: Routledge
• Year: 2016
• Print ISBN:
  9781409403319
• eBook ISBN:
  9781317113072
• Topic: Social Sciences
• Subtopic: Business General
• Index: Social Sciences

So long as there are weaknesses that can be exploited for gain, companies, other organizations and private individuals will be taken advantage of. This theoretically-based but hugely practical book focuses on what is generally seen as financial or economic crime: theft, fraud, manipulation, and corruption. Petter Gottschalk considers how, in some competitive environments, goals can 'legitimise' all kinds of means, and how culture can exert a role in relation to what is seen as acceptable or unacceptable behaviour by individuals. In Investigation and Prevention of Financial Crime he addresses important topics including organized crime, money laundering, cyber crime, corruption in law enforcement agencies, and whistleblowing, and provides expert advice about strategies for the use of intelligence to combat financial crime. The uniqueness of his approach to the subject lies in the way he is able to explain intelligence and intelligence processes in the wider context of knowledge and knowledge management. The numerous case studies throughout the book illustrate the 'policing' of financial crime from an intelligence, knowledge management and systems perspective. Law enforcers, lawyers, security personnel, consultants and investigators, as well as those in auditing and accountancy and with responsibilities for containing risk in banks, other financial institutions and in businesses generally, will find this an invaluable source of practical guidance. The book will also be of interest to advanced students and researchers in criminology and police science.

1
Financial Crime Categories

A number of illegal activities can occur in both the commercial and public sectors. So long as there are weaknesses that can be exploited for gain, companies and other organizations as well as private individuals will be taken advantage of (Pickett and Pickett, 2002).

Therefore, we find a great variety of criminal activities that are classified as financial crime. This chapter attempts to develop main categories as well as subcategories of financial crime. The four main categories are labelled fraud, theft, manipulation and corruption respectively. Within each main category there are a number of subcategories. This chapter is based on exploratory research to stimulate future research in refining and improving the categories suggested here and illustrated in Figure 1.1.

Fraud Crime

Fraud can be defined as an intentional perversion of truth for the purpose of inducing another in reliance upon it to part with some valuable thing belonging to him or to surrender a legal right. Fraud is unlawful and intentional making of a misrepresentation, which causes actual prejudice or which is potentially prejudicial to another (Henning, 2009).

ADVANCE FEE FRAUD

Victims are approached by letter, faxes or e-mail without prior contact. Victims’ addresses are obtained from telephone and e-mail directories, business journals, magazines and newspapers. A typical advance fraud letter describes the need to move funds out of Nigeria or some other sub-Saharan African country, usually the recovery of contractual funds, crude oil shipments or inheritance from late kings or governors (Ampratwum, 2009). This is an external kind of fraud, where advance fee fraudsters attempt to secure a prepaid commission for an arrangement that is never actually fulfilled or work that is never done.

Victims are often naïve and greedy, or at worst prepared to abet serious criminal offences such as looting public money from a poor African state. The advance fee fraud has been around for centuries, most famously in the form of the Spanish prisoner scam (Ampratwum, 2009: 68):

In this, a wealthy merchant would be contacted by a stranger who was seeking help in smuggling a fictitious family member out of a Spanish jail. In exchange for funding the ‘rescue’ the merchant was promised a reward, which of course, never materialized.

Advance fee fraud is expanding quickly on the Internet. Chang (2008) finds that this kind of fraud is a current epidemic that rakes in hundreds of millions of dollars per year. The advent of the Internet and proliferation of its use in the last decades makes it an attractive medium for communicating the fraud, enabling a worldwide reach. Advance fee fraudsters tend to employ specific methods that exploit the bounded rationality and automatic behaviour of victims. Methods include assertion of authority and expert power, referencing respected persons and organizations, providing partial proof of legitimacy, creating urgency, and implying scarcity and privilege.

BANK FRAUD

Fisher (2008) describes a US banking fraud case. It involved Jeffrey Brett Goodin, of Azusa, California who was sentenced to 70 months imprisonment as a result of his fraudulent activities. Goodin had sent thousands of e-mails to America Online (AOL’s) users that appeared to be from AOL’s billing department and prompted customers to send personal and credit card information, which he then used to make unauthorized purchases. The e-mails referred the AOL customers to one of several web pages where the victims could in-put their personal and credit information. Goodin controlled these web pages, allowing him to collect the information that enabled him and others to make unauthorized charges on the AOL users’ credit or debit cards.

Bank fraud is a criminal offence of knowingly executing a scheme to defraud a financial institution. For example in China, bank fraud is expected to increase both in complexity and in quantity as criminals keep upgrading their fraud methods and techniques. Owing to the strong penal emphasis of Chinese criminal law, harsh punishment including death penalty and life imprisonment has been used frequently for serious bank fraud and corruption. Cheng and Ma (2009) found, however, that the harshness of the law has not resulted in making the struggle against criminals more effective. The uncertain law and inconsistent enforcement practices have made offenders more fatalistic about the matter, simply hoping they will not be the unlucky ones to get caught.

Figure 1.1 Main categories and subcategories of financial crime

Financial fraud in the banking sector is criminal acts often linked to financial instruments, in that investors are deceived into investing money in a financial instrument that is said to yield a high profit. Investors lose their money because no investment actually takes place, the instrument does not exist, the investment cannot produce the promised profit or it is a very high-risk investment unknown to the investor. The money is usually divided between the person who talked the investor into the deal and the various middlemen, who all played a part in the scheme (Økokrim, 2008).

CHEQUE FRAUD

When a company cheque is stolen, altered or forged, it may be diverted to an unauthorized person who accesses the funds and then closes the account or simply disappears (Pickett and Pickett, 2002).

CLICK FRAUD

This occurs when an individual or computer program fraudulently clicks on an online advertisement without any intention of learning more about the advertiser or making a purchase. When you click on an advertisement displayed by a search engine, the advertiser typically pays a fee for each click, which is supposed to direct potential buyers to its product. Click fraud has become a serious problem at Google and other websites that feature pay-per-click online advertising. Some companies hire third parties (typically from low-wage countries) to fraudulently click on a competitor’s advertisements to weaken them by driving up their marketing costs. Click fraud can also be perpetrated with software programs doing the clicking.

CONSUMER FRAUD

These are attempts to coerce consumers into paying for goods not received or goods that are substandard, not as specified, or at inflated prices or fees. The growing use of Internet websites, as an alternative to unsolicited phone calls or visits to potential customers, compounds this problem (Pickett and Pickett, 2002).

Consumer fraud is a term also used in the opposite meaning, where the consumer is fraudulent. An example is consumer insurance fraud, which is defined as a deliberate deception perpetrated against an insurance company for the purpose of financial gain. Common frauds include misrepresentation of facts on an insurance application, submission of claims for injuries or damages that never occurred, arrangement of accidents and inflation of actual claims (Lesch and Byars, 2008). Insurance fraud is a global economic problem that threatens the financial strength of insurers and threatens the survival of the insurance institutions (Yusuf and Babalola, 2009).

CREDIT CARD FRAUD

This is use of stolen credit card details to secure goods or services in the name of the cardholder. Sometimes a brand new credit card is forged using known details. Cards can be stolen or details obtained from files that are not properly secured; credit card details may also be purchased from people who are able to access this information (Pickett and Pickett, 2002). Credit card fraud can be considered a subcategory of identity theft (Gilsinan et al., 2008).

One of the worst data thefts for credit card fraud ever was carried out by 11 men in five countries (Laudon and Laudon, 2010: 326):

In early August 2008, US federal prosecutors charged 11 men in five countries, including the US, Ukraine and China, with stealing more than 41 million credit and debit card numbers. This is now the biggest known theft of credit card numbers in history. The thieves focused on major retail chains such as OfficeMax, Barnes & Noble, BJ’s Wholesale Club, the Sports Authority and T.J. Maxx.

The thieves drove around and scanned the wireless networks of these retailers to identify network vulnerabilities and then installed sniffer programs obtained from overseas collaborators. The sniffer programs tapped into the retailers’ networks for processing credit cards, intercepting customers’ debit and credit card numbers and personal identification numbers (PINs). The thieves then sent that information to computers in the Ukraine, Latvia and the US. They sold the credit card numbers online and imprinted other stolen numbers on the magnetic stripes of blank cards so they could withdraw thousands of dollars from ATM machines. Albert Gonzales of Miami was identified as a principal organizer of the ring.

The conspirators began their largest theft in July 2005, when they identified a vulnerable network at a Marshall’s department store in Miami and used it to install a sniffer program on the computers of the chain’s parent company, TJX. They were able to access the central TJX database, which stored customer transactions for T.J. Maxx, Marshalls, HomeGoods and A.J. Wright stores in the US and Puerto Rico, and for Winners and HomeSense stores in Canada. Fifteen months later, TJX reported that the intruders had stolen records with up to 45 million credit and debit card numbers.

TJX was still using the old Wired Equivalent Privacy (WEP) encryption system, which is relatively easy for hackers to crack. Other companies had switched to the more secure Wi-Fi Protected Access (WPA) standard with more complex encryption, but TJX did not make the change. An auditor later found that TJX had also neglected to install firewalls and data encryption on many of the computers using the wireless network, and did not properly install another layer of security software it had purchased. TJX acknowledged in a Securities and Exchange Commission filing that it transmitted credit card data to banks without encryption, violating credit card company guidelines.

There are many different forms of credit card fraud. One of the more simple methods involves the unauthorized use of a lost or stolen card. Another form of credit card fraud is commonly known as non-receipt fraud. This occurs when the credit card is stolen while in transit between credit issuer and the authorized account holder. A third form involves counterfeit credit cards, which is a scheme utilizing credit card-sized plastic with account numbers and names embossed on the cards. In many instances, a counterfeit crime ring will recruit waiters and waitresses from restaurants to get the necessary information from customers through the use of skimming and apply the information from the magnetic strip or chip to the counterfeit card (Barker et al., 2008).

EMBEZZLEMENT

Embezzlement is the fraudulent appropriation to personal use or benefit of property or money entrusted by another. The actor first comes into possession of the property with the permission of the owner (Williams, 2006).

HEDGE FUND FRAUD

Hedge fund fraud may cause substantial losses for hedge fund investors. Hedge fund is defined by Muhtaseb and Yang (2008) as a pooled investment that is privately organized and administered by a professional management firm and not widely available to the public. The fund managers often invest a considerable amount of their own wealth in the funds they manage. They tend to refuse to discuss their trading strategies because they do not want competitors to imitate their moves.

Muhtaseb and Yang (2008) presented the following hedge fund fraud case. Samuel Israel, James Marquez and Daniel Marino set up and managed Bayou Funds in 1996. Marquez had a good reputation and was well connected in the industry, as he had been a former trader for the billionaire hedge fund manager George Soros. Customers invested more than $450 million in Bayou from 1996 to 2005. The leftover funds were approximately $100 million. To hide and perpetuate their fraudulent scheme, the managers knowingly misrepresented the value and performance of Bayou Funds, and issued false and misleading financial documents to investors. In 2005, Israel sent a letter to the investors that Bayou Funds would shut down at the end of the month. He said that he wanted to spend more time with his children after his divorce. Investors started asking for their money back. Israel sent another letter to explain that the process had been slowed down by auditing work because they had to make sure that the funds closed with accurate book records. The letter also stated that investors would get 90 per cent of their money back in the following week and the rest of capital a little later. However, none of the investors ever received a single penny back. The truth was revealed by Marino’s suicide note typed on six pages in late 2005.

IDENTITY FRAUD

There are many reported cases where people have had to defend themselves against claims because others have stolen their identity, using personal data such as social security number, address and date of birth (Pickett and Pickett, 2002).

Identity fraud is based on identity theft that is a crime in which an imposer obtains key pieces of personal information, such as social security identification numbers, driver’s licence numbers or credit card numbers, to impersonate someone else. The information may be used to obtain credit, merchandise or services in the name of the victim or to provide the thief with false credentials (Laudon and Laudon, 2010).

Miri-Lavassani et al. (2009) found that identity fraud is the fastest growing white-collar crime in many countries, especially in developed countries. In 2008, the number of identity fraud victims increased by 22 per cent to 9.9 million victims.

MORTGAGE FRAUD

To obtain a mortgage for real estate acquisition by a private person, the person has to state his or her income. Before the financial crisis in 2008 in the US, it was determined that 60 per cent of the applicants for the loans examined overstated their income by 50 per cent or more (Linn, 2009). Often, borrowers and real estate professionals combined to engage in fraud for profit schemes. Such schemes exploited the defining characteristics of subprime lending such as 100 per cent financing and weak underwriting standards. In an industry driven by commissions, lending officers were encouraged to participate in fraud schemes. The more loans the lenders’ sales representatives could originate, the more money they made. Mortgage brokers and individuals inside lending institutions thus had powerful incentives to join mortgage fraud schemes by adding dirt to the loan files. They were staging loan files to include false documents as well as ignoring obvious misrepresentations on loan documents.

OCCUPATIONAL FRAUD

Most developed countries have experienced a number of occupational fraud cases in the last decade, including the Enron, WorldCom, Societe Generale and the Parmalat frauds. Peltier-Rivest (2009) defines occupational fraud as the use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization’s resources or assets. Any fraud committed by an employee, a manager or executive, or by the owner of an organization where the victim is the organization itself may be considered occupational fraud, which is sometimes called internal fraud. Sometimes labelled financial statement fraud, inaccurate earnings figures may be used as a basis for performance bonuses (Pickett and Pickett, 2002).

Included in occupational fraud is basic company fraud. For example, when an employee fakes sickness to obtain paid sick leave, submits inflated overtime claims or uses company equipment for an unauthorized purpose, which may be to operate a private business (Pickett and Pickett, 2002).

Peltier-Rivest (2009) studied characteristics of organizations that are victims of occupational fraud. The most frequent category of fraud in their study in Canada was asset misappropriations (81 per cent of cases), followed by corruption (35 per cent) and fraudulent statements (10 per cent). Asset misappropriations may be cash or non-cash. Cash schemes include cash larceny, skimming or fraudulent disbursements such as billing schemes, payroll fraud, cheque tampering and expense reimbursement frauds. Non-cash schemes include theft of inventory, equipment, proprietary information and securities.

The most frequent victims of occupational fraud in the Peltier-Rivest (2009) study were private companies, followed by government entities and public companies. The mean loss suffered by private companies was one million US dollars. The study was based on a sample of 90 complete cases of occupational fraud investigated in Canada.

The same definition of occupational fraud is used by the Association of Certified Fraud Examiners in the USA (ACFE, 2008): Occupational fraud is the use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization’s resources or assets. The Association argues that the typi...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Contents
• List of Figures
• List of Tables
• Introduction
• 1 Financial Crime Categories
• 2 Knowledge Management
• 3 Intelligence Sources
• 4 Information Systems
• 5 Intelligence Strategy
• 6 Regulation and Response
• 7 Investigating Financial Crime
• 8 Executive Leadership
• 9 Prevention Strategy
• 10 Corporate Social Responsibility
• 11 Information Technology Strategy
• 12 Applying Investigative Knowledge
• 13 Conclusion
• References
• Index