Cashing Out: Solving Frauds in the Cash Economy

Through surveillance and police work, investigators in Wellington, New Zealand, had strong suspicions that  middle-aged male was selling illegal narcotics. However, a financial analysis of the suspect’s lifestyle failed to show a cash shortage when comparing his expenses against his reported legitimate income. So, what was the suspect doing with the money he made from his drug deals?

The police decided to execute a search warrant on the suspect’s home. During the search, one of the investigators noticed a freshly dug area in the backyard. Thinking the suspect had buried his drugs, the investigators proceeded to dig in the loose soil. Instead of finding illegal narcotics, the investigators uncovered hundreds of thousands of dollars in gold coins. This was the missing key! This explained what the suspect was doing with his ill-gotten gains. When the purchase of gold was factored into the financial analysis, it was revealed that the suspect had a significant deficit in available cash, which proved to be strong circumstantial evidence when it was presented in court with the rest of the investigation’s findings.

Because New Zealand has proceeds of crime legislation, this analysis convinced the judge to levy a substantial fine against the defendant to be paid to the New Zealand government. Consequently, the defendant’s bank accounts were cleared out and all his assets and property were sold.

Like street criminals, white-collar fraudsters often believe that if they deal primarily in cash, their crimes are undetectable. Fortunately for those of us in the fraud examination field, this belief is simply not true. By using income determination methods, such as the cash available technique used in the above example, fraud examiners can build a case of circumstantial evidence that often leads to a successful prosecution in court.

Income determination methods generally require that the fraud examiner have certain statutory powers to access information, and therefore, these techniques are more relevant to investigators working within regulatory agencies such as taxation or customs authorities, police agencies, and social services. However, there are situations in which these techniques are applicable to private practice fraud examiners. For instance, the methods can be used when the issue under investigation is relatively narrow and there’s public information available (i.e., if a suspect purchases a house and there’s no registered mortgage).

Revenue authorities around the world initially developed income determination methods to counter tax evasion. Now other governmental agencies are developing expertise and dedicated staff to utilize these techniques. Police agencies use the methods to determine crime proceeds, and welfare agencies use them to quantify benefit frauds.

There are three basic types of income determination methods: asset accretion, source and disposition of funds, and cash available. The cash available technique, which will be covered here, is the most relevant tool for cash economy frauds.

Cash Available Technique 

The U.S. Internal Revenue Service used a variation of this technique to put the infamous Al Capone behind bars in Alcatraz. The premise of this method is to demonstrate that the offender is maintaining a lifestyle that can’t be supported financially by his reported legitimate income.

There was a case in Wellington, New Zealand, in which two city employees, who were responsible for collecting the money from city parking meters, stole $2 million in coins over a period of time! The men, who legitimately earned modest livings, didn’t want to arouse suspicion by spending their ill-gotten money on flashy houses or designer clothes. They kept the curtains in their average suburban homes drawn, and they never invited co-workers or friends to visit. When investigators finally searched their homes, the reason became apparent. The houses were crammed with expensive antiques, collectibles, and high-tech stereo equipment. In their garages were brand new BMWs that they couldn’t drive without raising the neighbors’ eyebrows. The fraudsters would just go out to their garages occasionally and turn over the motors!

The cash available technique, of course, is based upon the assumption that the proceeds of the fraud are used either to increase discretionary spending (i.e., purchase luxury and entertainment items) or to acquire wealth (i.e., buy assets or retire debt). By analyzing the movement of these items the extent of fraudulent activity can be determined.

A limitation with this technique is that it alone doesn’t prove an offense. Having excess cash expenditures doesn’t prove that a person is a criminal. It merely proves that he is living beyond his means. Therefore, this method should be used to reinforce or supplement a primary investigation of the offense.

Fraud examiners must focus on tracking the cash flow rather than the physical “products” of the case, such as stolen goods, illegal drugs, etc. This doesn’t mean, of course, that the physical elements are irrelevant; they’re just not the primary focus in a cash available analysis.

Investigators also must identify what’s missing from the information they’ve obtained. This is the essential difference between the cash available technique and a normal audit, which requires that a fraud examiner look at the presented facts and express an opinion. To use this technique, the following steps should be taken:

• Obtain all bank statements. This is most easily done by enforcement agencies that have statutory powers of search and seizure or the power to request information from other parties. Fraud examiners without such statutory powers would have to hope that the offender has kept all his bank statements and is willing to hand them over for examination. However, sometimes if fraud examiners inquire with the banking institutions concerned, they’ll find that the institutions will supply missing statements with the account holder’s permission or by paying a fee, usually calculated at a set rate per page requested.
• Review the bank statements and ensure that all the start and end dates run consecutively and that no pages are missing. Ensure that you have all bank statements for every account that existed during the period under investigation. This includes the accounts of all associated parties who could have benefited financially from the fraud. In our investigations, we’ve uncovered fraudulent accounts under the names of employees’ children. We used publicly available birth register information and asked the involved banks whether any accounts existed in the children’s names. A simple inquiry that paid dividends!

We also once discovered a defunct volunteer organization’s bank account that the treasurer secretly kept open and used as a depository for his ill-gotten gains – a good hiding place for the fraudster’s name wasn’t on the account. We simply went to the fraudster’s former employer and obtained a copy of his résumé (which is usually kept on permanent file). The résumé proudly stated the offender’s volunteer work, including a stint as treasurer for a local charity group, which had since dissolved. We contacted former leaders of the organization and asked for a list of all the bank accounts used during the fraudster’s office term. An inquiry with the concerned banks revealed one account that was still open in the group’s name. Even more telling was that it contained deposits far in excess of what a small community group would receive, and they were made after the group disbanded. It was clear we had our man.

• Obtain vouchers for suspicious transactions, such as deposits that can’t be traced, or check withdrawals for rounded amounts. The notations on check stubs are unreliable, particularly if you’re dealing with a fraudster. Our experience has shown cases in which check stubs indicated normal business expenses, but the actual check was written for something quite different, usually for personal items or other unauthorized expenses.
• Analyze listed expenses in the account. This is best done by entering all the bank statements into a spreadsheet, using a software program such as Microsoft Excel. Use column headings such as: date, page, reference number (i.e., check number), details, and amount.
• Once you’ve entered all the basic data from the bank statements, transform your information into a makeshift cash book. Use column headings to group similar types of expenses, such as groceries, rent, or utilities. By doing so, you can more easily identify any gaps in which these expenses weren’t incurred. For example, let’s say your analysis covers one year. In the utilities column, there are 12 monthly checks written to the power company. However, in the mortgage column, you discover checks were written to the mortgage company only during the first four months and last three months of the year. The five-month gap could be a red flag that the offender was using either cash or a check from an undisclosed account to pay his mortgage.
• Review the spreadsheet for transactions that could lead to additional assets, loans, or other accounts. There may be checks written for rent-to-own accounts (i.e., for furniture, appliances, TVs, or stereos), wire transfers to other banks, or payments against credit cards.
• Analyze any invoices seized at the target’s residence (if you have the statutory authority to do this) to determine any expenses paid in cash. This also may lead you to other inquiries. For example, if you find a store credit card receipt, you could approach the store for details of payments made against that account.
• Conduct third-party inquiries to determine how payments are made on regular utilities, such as electricity, telephone (home and mobile), gas, and rent/mortgage. Compare the results of the third-party inquiries against the details already entered into the cash book spreadsheet. Can you find a corresponding transaction for every reported expense?
• Compare the total cash available (checks that were cashed, cash withdrawals, money machine withdrawals) to total cash spent (cash receipts, cash payments for bills, and cash deposits to bank accounts). Has the offender spent more than he had available?

By applying the above investigative measures, fraud examiners should be able to determine if the fraudster’s legitimate income supports his known expenses.

Admissibility of the Cash Available Technique 

Because a cash available analysis can be persuasive in a courtroom, defense attorneys often attempt – but fail – to exclude this analysis as inadmissible. Most judges will allow the analysis as circumstantial evidence of a fact from which an inference can be drawn as to the existence of the facts in issue. Furthermore, evidence to prove the motive is usually circumstantial, rather than direct. Surplus cash graphs, such as Exhibits 1 and 2, draw a powerfully cogent visual image as to motive.

Exhibits 1 and 2 demonstrate how we used the cash available technique during one of our cases as investigating accountants for the Ministry of Fisheries in Wellington. We already had found direct evidence that the culprit illegally sold fish in August 1998; however, we suspected there was more to the fraud. We were right. Our analysis revealed circumstantial evidence that the major offenses occurred during November and December 1997. The analysis also showed the suspect had – at a minimum – $35,000 in unexplained cash over a 12-month period. Faced with the quality and accuracy of this information, the perpetrator pleaded guilty.

This graph shows how on a monthly basis the offender’s expenditure (the green area) had consistently exceeded his available cash (the blue area). The large green spike is the period when this offender was most active. This graph is purely “cash,” that is, bills and coins. It doesn’t include checks, credit cards, debit cards, or other methods of payment. [Exhibit 1 is no longer available. — Ed.] 

In this graph, the cash available and cash spent have been incremented on a monthly basis. At the end of the analyzed period the difference between the blue area and the green area is the value of the offense committed. [Exhibit 2 is no longer available. — Ed.] 

The Advantages of the Cash Available Technique 

Quantify the Offense 

Sometimes fraud examiners only are able to prove a single incident of fraud, although they suspect there’s a pattern of offenses. The cash available technique can be used to quantify the extent of the fraud for the period under review. For example, we know of a case in which an employee was caught processing two false invoices, totaling $20,000, for payment to a company she secretly owned. Fraud examiners on the case suspected there were more fraudulent transactions using different company names or techniques. They developed a lifestyle profile on the busted employee from discussions with colleagues and a review of publicly available information (such as land office records, vehicle and securities registers, and share registers). While the profile wasn’t comprehensive – and, therefore, of lesser evidential quality – it revealed the employee had a cash deficit of $300,000. This information was used to negotiate a guilty plea to a higher charge than $20,000, and assisted in the recovery of more than $20,000.

Use of the Suspect’s Information 

The suspect has generated the fundamental data used in a cash available analysis, so a defense counsel will find it difficult to challenge its factual basis. However, when hard data is lacking for a particular expense item, don’t estimate it. Instead, draw the court’s attention to the fact that “normal” items are missing (i.e., payments for rent, groceries, or a car loan). Provide the court with as much circumstantial evidence as possible so the judge can draw his own inference as to the value of the missing data. For example, if a suspect lives a lavish lifestyle, but an analysis hasn’t shown any expenditure for entertainment or luxury items, the following types of evidence could be presented to the judge:

• Interview notes from the bartenders and waiters of the establishments the suspect frequents;
• Photographs of the suspect’s home furnishings, liquor cabinet, or the size and quality of his wardrobe. (This assumes that the fraud examiner has the statutory power to access the house. If not, then external photos of the target’s house, car, boat, etc., will do.);
• Evidence of vacations; and
• National statistics on the normal level of expenditure on entertainment for the suspect’s socio-economic group.
  Be careful to protect the quality of the evidence by never using estimates. If your target doesn’t spend legitimate money on clothing, it isn’t appropriate to estimate or express an opinion on how much the target spent – that is the function of the court. The fraud examiner’s role is to give the court the facts (i.e., the target wears designer suits to work, has a lakefront summer home, and drives a luxury sports utility vehicle). Merely draw the court’s attention to the fact that there’s no allowance for these items and let the court make its own inferences.

Cost Effectiveness 

Some fraud examiners question the cash available technique’s cost-effectiveness. We do agree that this is a time-consuming method that requires good project management skills, but used correctly, it delivers great results. When the investigation’s objective is to quantify the total fraud, this is a good technique. However, the analysis isn’t the most appropriate method if you just have to obtain sufficient evidence to dismiss an employee. In those cases, you simply would need to show that the employee fraudulently altered one company check, and deposited it to his personal account. This would be sufficient to dismiss the employee, but wouldn’t show the total dollar value of the offense. After all, how many fraudsters will stop after just one check?

Our experience has shown that the cash available technique usually saves cases from going to court. Most offenders upon seeing the analysis of their lifestyles choose to cut their losses and plead for reduced sentences – a big cost and time saver!

Fraudsters who feel safe because they’re operating in the cash economy have a false sense of security. Income determination methods, such as the cash available technique, are effective tools in building cases against these criminals, and often can lead to successful prosecutions.

Roland Daysh, CFE, BCA, CA, is the chief investigating accountant and Anita Exley, CFE, BCOM, CA, is an investigating accountant for the Ministry of Fisheries in Wellington, New Zealand.