Memorable cases, part 1

"Tell me a story." That command probably was one of your first sentences as a toddler. You wanted word pictures in your head. Colorful characters. Plots of bad guys, suspenseful situations, and good men and women to the rescue. Now, if you're pressed to admit it, you still like a good story. Only this time you need to know how a fraudster committed a crime. And how the fraud examiner discovered evidence, investigated subjects, learned lessons and gave recommendations.

Well, we've got a few bedtime stories for you. (See "It's their nature to defraud" at the end of this article.)

These cases perch on many of the limbs of the ACFE Fraud Tree and some of the branches. But take note: They aren't just war stories; they're case histories you can learn from — whether you're in a classroom or board room; corner office or cramped cubie; at a Fortune 500 company or a one-person business. We'll begin with four cases and conclude with additional practical stories in the March/April issue of Fraud Magazine.

Mortgage fraud: unrealistic incentives

Many countries are emerging from the Great Recession — some slower than others. One of the roots of the nail-biting crisis — at least in the U.S. — were fraudulent mortgages. Jenny Brawley, CFE, CAMS, director – fraud, AML and OFAC governance at Freddie Mac, tells of a Florida case from 2006 through 2008 in which desperate condominium developers offered incentives to buyers in a saturated and downturned market. Cases like this one were common in markets with a concentration of conversions in resort areas, says Brawley, who teaches the ACFE's two-day Mortgage Fraud course.

"The incentives typically consisted of ‘no money down,' guaranteed rental income and cash back at closing," Brawley says. "The developers were able to control the appraisal process to inflate the values to cover the cost of the incentives.

She says the developers also worked closely with loan officers and real estate agents to conceal the incentives from the lenders. When the borrower didn't qualify, the officers and agents misrepresented income, assets and/or employment.

"The developers actually contributed the borrowers' down payments and made it appear to the lenders that it was the borrowers making the down payments." Brawley says. "The developers also pocketed loan proceeds — based on the inflated values — to make the mortgage payments for four years. The real estate agents removed incentive documentation from the purchase contracts so the lenders would not be aware of the seller-paid contributions."

She says the closing attorney also knew that the buyers didn't have any of their own funds and prepared the closing documents to mislead the lenders on the source of funds.

"Cases like this one were very typical in the mid 2000s," Brawley says. Many in the housing and lending industry thought the stabilization or increase in values within this area were indicative of a recovering market, she says. No one involved thought to question if "this is too good to be true." But the red flags were there; sustainable property values and numerous sales in a downward economy didn't make sense, she says.

Greed, pressure and timing

Brawley says the fraudsters committed their crime because of greed, pressure and timing. "One driving factor was the construction loan provided to the developers," she says. "The multimillion-dollar loan contained a provision that the developers must sell a certain number of units by a certain date or they would forfeit a $1 million non-refundable deposit. The market had just begun to turn when this loan was granted," she says.

"The pressure associated with the terms of the loan, along with the inability to sell units, caused the developers to resort to mortgage fraud to entice buyers with lavish incentives," Brawley says. "When the loans finally went into default after four years — the developers quit making the loan payments — the losses to the lending institutions was close to $25 million."

Discovering the fraud

Brawley says they found the fraud through simplistic data mining. "While we do utilize more sophisticated data mining tools, this was a fairly simple Excel-based query of loan data," she says.

"Our data mining for these types of schemes was geo-centric. We queried by ZIP code to identify large volumes of loans in a short period of time within the same developments," Brawley says. "We then looked at other patterns within that population of loans — like the same property seller, loan officer, appraiser and title agent. The loans typically had the same characteristics like loan-to-value, FICO scores, employer and banking institution."

Fraud examination: interviewing and documentation

Brawley says the interview process was complicated because multiple individuals touched the loans from beginning to end. "I attempted to interview everyone who had been part of the process and found their stories were inconsistent with each other."

Brawley says this case was frustrating. "I had the documentation and evidence that confirmed mortgage fraud and implicated many of the players," she says. "But in the early stages of the investigation, federal law enforcement was not interested because there were no losses — the loans were performing. But I persevered and kept knocking. When the loans started going into default and lenders were taking losses, federal law enforcement was able to demonstrate losses needed for prosecution and acted on the case."

She says she worked closely with the FBI and the Federal Housing Financing Agency's Office of Inspector General on this case. Eight years after the fraud, seven defendants were indicted, including the developer, loan officers, real estate agents and the closing attorney. Four pleaded guilty, and three went to trial and were convicted.

"I had interviewed the closing attorney three times, and each time she lied straight to our face. I asked her about missing documentation that allegedly was provided to the lenders to explain the legality of the incentives. She claimed she had all the documents, but they weren't accessible at the moment. My interview notes captured her statement.

"When the FBI seized her computer, they found an email written by her immediately after our interview stating, ‘We need to start creating documentation that Freddie Mac is asking for,' " Brawley says.

Lessons learned for future application

Brawley's advice is to document all interviews thoroughly, completely and immediately after the sessions. "The person who accompanied me on the interview with the developer did not write up his interview notes until two weeks after the interview," she says. "The defense attorney tried to use this to discredit him on the stand."

She says that fraud examiners should protect all evidence and its chain of control because cases can take years to investigate and prosecute and nobody can remember evidence sources.

"Maintain a good, positive and mutually beneficial relation with law enforcement," Brawley says. "Even though their hands were tied until losses started to occur, we stayed in contact."

The best advice she can give is to persevere. "Mortgage fraud cases, like a lot of other white-collar crime cases, are very complex and take a lot of time and resources," she says. "Don't give up! It is frustrating if a complex investigation does not materialize in the expected outcome, such as a criminal indictment or civil litigation. But you never know unless you try. I feel like my efforts in this case did make a difference on many fronts." And finally, "if it looks too good to be true, it probably is too good to be true." Trust your gut, she says.

Invaluable first case

Janet M. McHard, CPA, CFE, MAFF, CFF, hearkens back almost 20 years to her very first case when she worked for a regional accounting firm, Meyners + Company LLC, as a senior litigation support specialist. (She teaches several courses to auditors and internal investigators for the ACFE.)

McHard, founding partner of McHard Accounting Consulting LLC, recalls this skimming case in which a CFO of a nonprofit medical facility (who likely colluded with the CEO) had a need to feed her shopping addiction. (The CFO also committed three additional frauds: expense reimbursements, ghost employees and personal purchases.) McHard says they never determined the total dollar amount of the fraud.

"The board of directors of the medical facility fired the CEO for insubordination," McHard says. "And that same day the CFO abandoned post. The fraud was discovered based on tips from community members and employees that surfaced after the CEO and CFO had left, she says.

Bad karma eventually caught CFO

"We interviewed accounting and billing staff," she says. "We requested information from insurers, looking for payments to the clinic and attempted to trace those payments into the clinic's bank account. We found about $100,000 in payments, which did not trace into any known clinic bank account. Despite working with the Medicaid investigators we were unable to get copies of the canceled checks to determine where these were deposited."

McHard says the Medicaid investigations team was unfunded in mid-investigation so they were never able to prosecute. "Despite this, I later learned that the suspect was indicted and then convicted on charges related to an entirely different scheme at a different employer," she says.

"It was invaluable to work my first case with experienced law enforcement officers and to have access to documents subpoenaed through the grand jury process," McHard says.

"Several employees of the clinic suspected that fraud was occurring but didn't feel like they could come forward with both the CEO and CFO involved," she says. "After the fraud, the facility implemented a hotline so that reports would be made directly to a board member and upper management."

Fearful employees in false claims fraud

Eric R. Feldman, CFE, CIG, recalls a huge U.S False Claims Act fraud when he was Inspector General for the U.S. National Reconnaissance Office. (Feldman is now the senior vice president and managing director of the corporate ethics and compliance programs at Affiliated Monitors Inc. He teaches Bribery and Corruption, Contract and Procurement Fraud and other courses for the ACFE.)

Circa 2002, Northrop Grumman Corporation submitted false claims for reimbursement of defective U.S. satellite parts. (See Military Contractor Agrees to Pay $325 Million to Settle Whistle-Blower Lawsuit, by Christopher Drew, April 2, 2009. This isn't the first time Northrop Grumman has been in trouble for false claims fraud. Also, see Vindication at a high price: An interview with James Holzrichter, recipient of the ACFE's 2015 Sentinel Award, Fraud Magazine, July/August 2015.)

"Northrop Grumman engineers hid past test failures for commercial application and told the U.S. federal government that the failure was a 'new discovery,' " says Feldman.

Northrup Grumman agreed to pay the U.S. government $325 million under the False Claims Act to settle a lawsuit. "But that didn't come anywhere near the true loss to the taxpayer, which probably exceeded $1 billion," says Feldman.

According to The New York Times article, the lawsuit was brought by a scientist, Robert Ferro, and joined by federal authorities. The lawsuit "contended that TRW Inc. tried to stop Mr. Ferro, who worked for a subcontractor, from disclosing his finding about faulty electronic components on military and intelligence-gathering satellites. TRW was later acquired by Northrop Grumman," according to the article.

"My office conducted the joint investigation with the Department of Justice (DOJ), which joined the [Qui Tam whistle-blower case] claim based on the information we developed," Feldman says.

Smoking guns in emails

"We subpoenaed thousands of company documents and interviewed hundreds of company personnel and technical experts," he says. "Ultimately, email trails among engineers constituted smoking guns with such statements such as: ‘What a coordinated pack of lies this is' and ‘God help us if the Government finds out what we've done.' "

The government ultimately deemed Northrop Grumman too important to national security to press for the full amount of damages, Feldman says. "It was a case of ‘too big to fail' outside the financial community.

"The problem stemmed from weak corporate ethical culture at the working level of the organization," he says. "Employees were fearful of communicating bad news and were afraid of retaliation."

Recommendations

"In my view, the DOJ should apply similar standards for settling False Claims Act cases as it does for criminal cases," Feldman says. "That is, require reasonable assurance of remediation to prevent reoccurrence. Often this involves the use of an independent monitor to report on the company's ongoing efforts to enhance controls and corporate ethical culture. In this case, as in many False Claims Act cases, the settlement involves only the writing of a check, which for large defense contractors represents a ‘slap on the wrist' and a cost of doing business." 

More cases upcoming in the March/April issue of Fraud Magazine.

Dick Carozza, CFE, is the editor-in-chief of Fraud Magazine. His email address is: dcarozza@gmail.com.

It's their nature to defraud

I find it difficult to identify "my most memorable case." Since I became a member of the anti-fraud community in the early 1990s, I’ve worked on hundreds of interesting cases and learned things from all of them. Cases come to mind from my early days — when I was learning a lot — to the present, when novel features still demonstrate the depths of human creativity.

But as I reflected on the most interesting cases, a theme emerged: It’s the nature of fraudsters to defraud. I recall an old fable about a cat and bird. The cat gets into trouble and the bird helps him. Instead of being grateful, the cat eats the bird. The lesson? It’s a cat’s nature to eat birds.

This simple aspect of human nature runs through my most interesting cases: some people are naturally fraudsters, and others just aren’t. Those that are or could be fraudsters see the potential for abuse and personal gain around every corner, and a great many act on the opportunities. Those who aren’t often are blind to fraud — even when it’s happening right in front of them.

The unreformed drug dealer

In the 1990s, I periodically volunteered to work for the criminal defenses for pro bono defendants to help out and to experience different kinds of cases. In one case a man was accused of selling drugs at a high school parking lot, but he insisted he was framed.

One aspect of the fraud examination involved retracing the witness accounts, which revealed that the key witnesses couldn’t have seen the acts because the time of night, actual lighting and hilly terrain prevented clear lines of sight from their locations.

The public defender, armed with this information, made plans to visit the accused. But the day before their meeting the police served a search warrant on the man’s home, where they discovered him packaging kilos of illicit drugs for distribution. A rational person who was claiming to be falsely accused would’ve keep his nose clean, but it was just his nature to be a drug dealer.

Mrs. Claus’ recurring habit

A few years later, I worked an embezzlement case involving a woman I nicknamed “Mrs. Claus.” She was an older grandmotherly woman with a cheerful personality who always remembered her coworkers’ birthdays with homemade cakes.

Mrs. Claus was in charge of the accounting function and was suspected of having mishandled some credit card accounts. The fraud examination revealed that she’d embezzled millions from the company. And further investigation into her background revealed that she’d stolen money from every company she’d worked for, and each had fired her without prosecuting. However, this company was different; they fired her and called the police who arrested and indicted her.

While under indictment Mrs. Claus applied for and obtained another job as a controller of a local company. We were preparing for her criminal trial when we discovered that she’d embezzled hundreds of thousands of dollars at the new job and used the money to pay her attorneys for our case!

As our case neared its trial date, Mrs. Claus was arrested again for her second fraud. She made bail and, yes, applied for and obtained yet another accounting job. She was only in this job a week when the police came by to question her. The company owner then checked the bank records and discovered that she’d already written herself a check for nearly $10,000. Despite her grandmotherly look and cheerful disposition, it was Mrs. Claus’ nature to steal.

Change the good employees

These cases demonstrate just how hard it is for the vast majority who don’t have fraud in their DNA to see fraud. ACFE surveys have consistently revealed that many fraud schemes continue for years.

Despite the growth and development of the anti-fraud profession, the explosion of new tools and technologies, and the vast increase in awareness, fraudsters are still succeeding.

So, here’s my key takeaway: Reducing fraud requires us to stop focusing not just on the fraudsters but on changing the way good employees think about fraud. The best outcomes in the cases in which I’ve been involved weren’t necessarily those with the smallest losses and largest recoveries. The most beneficial results were from the cases in which organizations learned from the experiences and were able to stop future events before they occurred.

Regent Emeritus Jonathan E. Turner, CFE, CII, is the senior director of global compliance investigations for Wright Medical Technology. He teaches ACFE courses on investigation, money laundering and several other topics. His email address is: jonathan.turner@wmt.com.