Following the money isn't a cliché

On June 17, 1972, police were called to the Watergate Complex near Washington, D.C. and subsequently arrested five men for burglary. What was characterized as "a third-rate burglary" by President Nixon's press secretary was far from such. When the dust settled almost 70 government officials were charged in the Watergate investigation, including two former U.S. attorneys general, two former CIA operatives and a former FBI agent.

The movie, "All the President's Men," details the Watergate investigative reporting of Washington Post reporters Bob Woodward and Carl Bernstein. One of the notable scenes is when Woodward, portrayed by Robert Redford, meets in a dark parking garage with a high-ranking government source — codenamed Deep Throat. Woodward tells the source that the trail has run cold. Deep Throat says in a quiet, raspy voice, "Follow the money." Thus the phrase entered the American lexicon.

As fraud examiners, how do we follow the money? Here I'll address benefits of following the money during the course of a fraud examination.

True badges of honor: 'paper cuts'

Fraud examiners use many investigative techniques in the course of a fraud examination including, but not limited to, document review and analysis, public records checks, surveillance and interviews.

Seasoned CFEs will tell you they spend a great deal of time and effort in the document review — the investigation and analysis of paper trails, which provide us with many leads as we follow evidence in fraud schemes. For example, it might become important to review accounting/business records (such as general ledgers, invoices, contracts, etc.), emails, business operation policies and procedures, and just about anything that could you give you a paper cut (if it was printed).

Perhaps the single most important set of documents for scrutiny in a fraud examination are legally obtained bank account records. A bank-account analysis serves three primary purposes: proving the fraudulent scheme, determining the disposition of illicit funds and supporting the loss calculation. (According to the ACFE's 2016 Fraud Examiners Manual, the Right to Financial Privacy Act regulates how financial institutions share information with the government. It prohibits financial institutions from disclosing financial information about individual customers to governmental agencies without the customer's consent, a court order, a subpoena, a search warrant, or other formal demand. See 3.613.)

'Good' versus 'bad' money

The overall objective of a fraud examination will determine the depth of money tracing. Thus, it's important early on to assess the purpose for following the money. It's common for fraud schemes to include both legitimate and illegitimate transactions. Legal problems arise when  "bad" money is commingled with "good" money, which is especially true in both civil and criminal forfeiture cases when investigators are tracing money in order to seize the fruits of a crime. The concept of commingled money also poses problems for attorneys and accountants working legal cases involving solvency, trust/surety issues, claims subrogation and fraudulent conveyance, among others.

When it comes to tracing the disposition of illicit funds, fraud examiners might use various methods depending on the circumstances of their fraud examinations. Tracing of money comes in two forms: common-law tracing and equitable tracing. The common law tracing form requires that the party have an actual ownership interest in the money and isn't allowed if money is commingled. Conversely, equitable tracing allows for the commingling of money so long as a party has an equitable interest in the money.

We have no right or wrong methods for tracing commingled money. Fraud examiners must use their best judgments. (Personally, I'm an advocate of making things simple and using a commonsense approach.)

Proving a fraudulent scheme

Following the money can assist in proving the elements of a fraudulent scheme. Here are some general examples that prove this.

A common mortgage fraud scheme that occurred before the 2008 mortgage meltdown crisis: A homebuyer provides down-payment money from another party without telling the lending institution. Often, if the lender had known the actual source of the down-payment then it wouldn't have funded the loan. By simply following the money a fraud examiner could trace the down-payment funds, determine the original source and show the intent to defraud.

A CFE could uncover an investment fraud scheme by determining if the promoter (fraudster) actually invested the customers' (victims') money into a fund or project that they said they would. Investment fraudsters commonly promise high rates of return, low risk and guarantee of principal investments. If you follow the money you can determine if the fraudster is placing investments in an underlying asset that would allow for the investment to appreciate. However, if you can show that that the fraudster was using the money to pay off their new luxury automobile then you potentially have good evidence of a misstatement to the victim. After all, it would be quite exceptional if investors knowingly would allow their financial advisor to use their investment money for the purchase of luxury items.

Of course, the movement of money can't solely prove a fraud has been committed, but it does provide information that might support the narrative of a fraudulent scheme. Dr. Joseph T. Wells, CFE, CPA, founder and Chairman of the ACFE said it best in the September/October 2014 issue of Fraud Magazine: "Books and records don't commit fraud; people do." (See 10 pointers for fighting fraud.)

Thus, the review and analysis of monetary transactions might provide corroborating evidence to statements of witnesses, victims and subjects. Additionally, the tracing of money also might identify witnesses, victims and other accomplices that will help you develop investigative leads for future inquiry.

The tracing of money in the Watergate investigation led to the discovery that $25,000 was paid to one of the burglar's bank accounts via the Committee for the Re-Election of the President's account, thus tying President Nixon to the break-in.

Determine the disposition of illicit funds

Following the money provides context about the disposition of fraud proceeds. This is important because it shows the fruits of the crime and identifies potential assets for forfeiture.

In many instances, attorneys are interested in showing glamorous purchases made by the subject. Tracing the disposition of illicit funds to vacation beach homes, expensive automobiles and exotic vacation locales provides motive for a fraudster's actions.

The criminally convicted former CEO of Tyco International, Dennis Kozlowski, is well known for not only looting the company of $100 million but for extravagant purchases tied to those proceeds. The infamous custom gold shower curtain costing $6,000 became a symbol of corporate greed. Tracing of illicit proceeds to the shower curtain didn't prove a fraud, but it was a strong element that led to diversion of funds.

Illicit money tracing assists in identifying specific assets that might be confiscated through forfeiture. Let's face it — many fraudsters, as nonviolent offenders, don't face long-term incarceration. Even though they might steal tens of thousands of dollars they might only spend a year or two in prison.

Ponder this question: If you could steal half a million dollars and only spend one year in prison would it be worth it? Some fraudsters might consider that deal if they purchased many toys and luxuries they know will be waiting for them after they serve their sentences if they'd hidden those assets.

So following the money to determine available assets for seizure and forfeiture should be part of every fraud examination not only to deprive fraudsters' benefits but because those assets should be available to pay back restitution to victims.

Support the loss calculation

Following the money not only helps prove fraud schemes and determine what fraudsters spent the money on but is necessary for calculating loss amounts for sentencing and restitution to victims. U.S. judges use dollar loss amount as one factor in the federal sentencing guidelines when imposing sentences on convicted fraudsters. Obviously, the higher the loss amount the longer the prison sentence.

In civil proceedings, following the money can help determine a dollar value loss that courts could order in money judgments.

Finally, following money to and from victims might provide insight into how the courts should equitably distribute restitution upon judges' order of the money judgment. For example, Irving Picard, the court-appointed trustee in the Bernie Madoff investigation, was not only responsible for recovering assets to payback investors but also for seeing those assets were equitably distributed. (See Balancing Act: An Interview with Irving H. Picard, Fraud Magazine, July/August 2010.) Understanding investors' deposits and withdrawals through his analysis of bank records undoubtedly assisted him with this process.

Show me the money

Whether you're just starting out or a seasoned fraud examiner, understanding the benefits of following the money will make you better at your job. The importance of following the money shouldn't be underestimated because it will assist in proving the scheme, identifying the fruits of the crime for potential forfeiture and assisting in bringing justice for fraud victims.

L. Christopher Knight, CFE, CPA, is a forensic accountant in Indianapolis, Indiana, and an adjunct faculty member at Indiana University's Kelley School of Business in Bloomington and Indiana University-East in Richmond. His email address is: lchristopherknight@yahoo.com.