Web of Lies: Unraveling Defenses of Unverified Affluence

Our previous column discussed the importance of identifying red flags. Now, we take the next logical step: How do we deal with subjects' affirmative defenses about the sources of allegedly ill-gotten gains? Based on case law and investigative practice, finding the truth is a process - more art than science. Dismantling a "web of lies" can strain even the most experienced investigators, but it is an important skill that new and budding fraud examiners should begin to master.

UNVERIFIED AFFLUENCE

As investigators, we frequently encounter unexplained affluence - someone has accumulated wealth with no explainable source of income. We believe an even better phrase to describe this condition is unverified affluence because we want to identify subjects whose sources of wealth have not been independently verified. We will be able to show they are truthful or deceptive by asking the right questions and obtaining documentation to verify sources of wealth.

GERRY'S STORY CONTINUES

In the May/June column we left off with the fictitious story of Sue, the Certified Fraud Examiner, who was conducting a background investigation on Gerry who had applied to be a senior loan officer at Sue's bank. During the course of the investigation, Gerry's financial picture became suspect because he had installed an in-ground pool even though he had not been working for a year after being laid off.
There were other red flags: Gerry's wife was a stay-at-home mom, the family had declared bankruptcy six months prior, and Gerry's creditors noted he was delinquent on three loans. Sue discussed the case with her supervisor, who agreed with Sue's recommendation that they conduct an interview to determine the source of the funds.

A STORY IS TOLD

When the reality of fraud examinations or investigations set in, subjects have two choices: cooperate and admit their involvement or submit affirmative defenses. In many cases, they will submit concocted stories about where their money came from.

Indeed, the U.S. Supreme Court recognized this when it ruled in the landmark case Holland v. U.S. (348 US 121, 127): "[The] favorite defense asserts that the cache [of money] is made up of many years' savings for which various reasons were hidden and not expended until the prosecution period."

Common defenses include:  

• Cash on hand (the "buried in my backyard" excuse).  
• Loans and gifts from friends or family.  
• Inheriting money that did not go through the probate process.  
• Business income that wasn't properly documented.  

The investigator must:  

1. Be thoroughly prepared for potentially having to investigate any and all defenses.  
2. Have a file system for documenting and organizing evidence that supports or refutes the claims made by
   the defendant/subject.  
3. Conduct interviews thoroughly and document them adequately as well as collect and analyze documentary evidence.  
4. Search for all "reasonably possible" leads that could indicate a source of income.  

PREPARATION AND ORGANIZATION

Being forewarned is being forearmed. We must understand from the beginning that subjects will probably raise one or more of these defenses. Compile a complete filing system on each case that will allow you to quickly access information that could counter any of the subject's excuses. It will save you time and resources. If the case goes to trial, it will assist the prosecutor.

THE SUBJECT INTERVIEW

The Internal Revenue Service's Criminal Investigation Division manual (IRM 9.5.9.5.7) states that "when a subject offers leads or information during [an]... investigation that, if true, would establish his/her innocence, such leads must be pursued."

After Sue and her boss sat down with Gerry and established rapport during the interview, Sue began asking questions about Gerry's financial status:

Q: Gerry, tell me about your financial situation since you were let go at Banc Delta-Meridian [Gerry's former
employer].
A: I was let go in February, a year ago, and they gave me a nice severance package of $18,900.
Q: What did you do with the money from the severance package?
A: Not much, mostly tried to pay bills. I think my wife Gina paid off a few bills.
Q: I noticed your new pool. When was that put in?
A: Oh that? Yeah, it's really nice. The kids absolutely love it, especially when their friends come over. What was the question again?
Q: When did you put it in?
A: Hmm. I think May of last year.
Q: How much did it cost?
A: I don't remember.
Q: How did you pay for it?
A: Good question - it was Gina's [Gerry's wife] mom that put it in for us.

Clearly, when Sue asked Gerry about the pool, he became evasive and was not forthcoming about the details. Sue, as the good investigator she is, knows that she needs to ask the right questions and then document them thoroughly so Gerry has no wiggle room. Gerry was cooperative, but did not provide a full confession. Sue did gain his consent to interview Gina and her mother.

After the interview with Gerry, Sue asked Gina's mother if she could provide documents that showed she had bought the pool, made the pool payments and transaction dates, the source of her money that paid for the pool and the form of her payments. Gina and her mother were unaware of any pool payments for the pool. Sue was now ready to present her evidence that Gerry had stolen money to pay for the pool. A federal grand jury indicted Gerry on one count of wire fraud, for which he was convicted in a brief trial six months later.

Effective questioning techniques include posing the correct questions to sources and subjects and paying attention to how we ask them. If you ask for essentially the same information in multiple ways or times during a lengthy interview, you might identify inconsistent statements. You should be professional and polite (yet firm) even if the subject becomes belligerent, so you can show you're no pushover. Finally, do not just take their word. Get the documents!

THE PAPER TRAIL

You can use financial statements, loan applications, bank records and payroll data, among other documents, to show that the subject was financially destitute and would have had to tap "reserves." Copy and include these documents in your financial defenses' file for the case. Other examples of financial documents include: overdue debt notices, collections, court filings, divorce settlements, tax returns and maxed-out credit card statements. One of the most effective ways to disprove the "stash of cash" alibi is to show the subject has borrowed money, filed for bankruptcy, has a poor credit rating, etc. Many fraud perpetrators have histories of credit problems that led to the pressure to commit fraud. Once you have obtained the evidence, it should be obvious that the suspect did not really have a large amount of available cash.

ADDITIONAL QUESTIONS

Here are some questions you can ask subjects that might help determine the sources and amounts of cash:  

• Who else knew about the cash?  
• If someone else did know about the cash, did they ever see or count it?  
• Was the cash ever shown on any financial statements?  
• What did the subject do with the money?  
• Does the cash still exist? If so, where and how much?  
• What type and size of container is/was it stored in?  
• What were the denominations of the cash?  
• Why didn't the subject put the money in a bank?  
• What was the source of the cash?  
• Did the subject enter the cash disbursements in a log or journal?  
• Did anyone else have access to, or contribute to, the cash?  

THE CAPONE LEGACY

In the early 1930s, the U.S. federal government put Chicago gang lord Al Capone in jail, not for racketeering or murder, but for tax evasion. Capone had told the Internal Revenue Service (then called the Bureau of Internal Revenue Service) that his money had accumulated from a business partnership, not illegal alcohol sales. IRS agents interviewed Capone and his lawyer, Lawrence P. Mattingly. During the interview, which was transcribed in Capone's recently released IRS file, he denied having any records of income, checking accounts or property ownership.

Following the interview, Mattingly, who probably was thinking his client now looked quite suspicious, wrote a letter to the IRS, also contained in Capone's IRS file, to further clarify his client's income: "[Capone] became active as a principal with three associates at about the end . . . of 1925. Because . . . he had no capital to invest . . . his participation during the entire year 1926 and the greater part of 1927 was limited."

Mattingly then claimed that Capone's income was split "one third to a group of regular employees and one-sixth each to the taxpayer [Capone] and three associates." He opined that Capone never made more than $50,000 in any one year, hoping that would placate any criminal charges. But, of course, it backfired. IRS criminal investigators obtained documents and testimony, which showed that Capone actually had spent more than $300,000 over four or five years in furs, cars, gambling and other expenses, according to the prosecution's closing statement. The documents got Capone.

NO FLIMSY EXCUSES

The Capone case is a great example of the importance of overcoming financial defenses. New fraud examiners must investigate and refute (or validate) any excuse to explain sudden, suspicious increases in wealth. You have no excuse for not learning the skills of conducting thorough interviews, obtaining documents, analyzing data and following any possible leads.

Colin May, M.S., CFE, is a forensic financial investigator with a government agency (the views in Starting Out are his own) in Baltimore, Md. 

Mark F. Zimbelman, Ph.D., CPA, Educator Associate Member, is the Selvoy J. Boyer Fellow and professor of accounting at Brigham Young University in Provo, Utah. 

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