November 19, 2009

During an economic downturn, which brings with it intensified financial pressures and an uptick in insolvency and bankruptcy filings, we typically see a proportionate growth in the levels of fraudulent activity. These days, we hear about another fraud in the business world nearly every day, ranging in size from several thousand dollars to billions of dollars. In this context, it is important for businesses (and individuals) to be vigilant about fraud schemes, including how and where they can take form.

Common types of fraud include falsifying financial information, employment records and revenue recognition; exaggerating reserves and inventory reporting; financial institution fraud; Internet fraud; telemarketing fraud; redemption fraud; credit card fraud; forgery; access device fraud; identity theft; Ponzi schemes; letter of credit fraud; and pyramid schemes. Each of these categories of fraud has variations and subparts. Moreover, the frauds being perpetrated are not limited to the victimization of vulnerable seniors; instead, fraudulent activity is affecting businesses of every size, including fraud-savvy financial institutions. In fact, "60 Minutes" aired a report on November 8, 2009, in which a special agent for the FBI's Cyber-Crime Division stated that far more money ($100 million so far in 2009) is now stolen from U.S. financial institutions as a result of fraud than traditional bank robberies.

Clearly, fraud has reached a pandemic level. What do we do about it?

Volumes could be written about the fraud schemes in existence today, and how to best protect against these known plots. Unfortunately, the desperate souls behind these acts are constantly varying those schemes in order to avoid getting caught and to increase their take at the expense of innocent people and institutions. Consequently, even with the benefit of a current fraud prevention handbook, it would have to be revised almost weekly to account for the ever-changing variants of fraud being committed.

Many of us assume the Secret Service exists only to protect our President and other elected officials. But in truth, the Secret Service has a Financial Crimes Division (FCD) that works with the Department of Justice to investigate civil and criminal fraud against federally insured financial institutions. In conjunction with the American Banker's Association, the Secret Service has identified the two most prevalent types of fraud today: (1) the fraudulent production of negotiable instruments (e.g., counterfeit currency or corporate checks) through what has become known as "desktop publishing," and (2) access device fraud. In addition, the Secret Service has seen a significant rise in credit card fraud, fictitious document fraud and identity theft. Furthermore, losses attributed to credit card fraud (which includes using stolen PINs to access ATMs and stolen cell phone chips that assign billing) have been in the billions of dollars every year since the Secret Service began tracking these cases after the passage of the Fictitious Instruments Act in 1996.

Ponzi Schemes

Amid this rash of fraudulent activity, the typical Ponzi scheme is one type of business fraud that seems to fly under the media's radar (with the obvious exception of massive frauds like the billion-dollar Bernie Madoff scheme). Often committed by small to midsize businesses, most Ponzi schemes involve efforts to obtain funds from financial institutions fraudulently by conjuring up invoices, accounts receivable, contracts and even serial numbers for equipment that a company never purchased with the money that was loaned to it for the purpose of buying or leasing the equipment.

How can a business protect itself from Ponzi schemes?

  • Have regular field audits completed by a trusted, independent third party.

  • Instruct the third party to scrutinize even the most trustworthy of customers as closely as it would a suspicious person or entity.

  • Do not rely solely on records provided by a company or its so-called captive accounting firm. Have independent accountants verify the information; the added cost may save you millions.

How can individuals avoid investing in a Ponzi scheme?

  • Use great care and due diligence in selecting investments and become familiar with the people with whom you invest.

  • Make sure you fully understand the investment before you move forward with a deal.

Redemption Schemes

Another type of fraud that seems to be gaining popularity is the bizarre redemption scheme. Recently, several banks have presented me with what appeared to be money orders drawn on the U.S. Department of the Treasury and promissory notes drawn on financial institutions, both known and unknown to me. After closely scrutinizing these items, as well as poring over recent fraud cases and Department of Justice websites, I learned that there is an entire cottage industry out there selling the "redemption theory," which was addressed recently in U.S. v. Dilley. In that 2009 decision, the U.S. District Court for the Northern District of Indiana explained the redemption fraud scheme as follows:

[T]he United States government went bankrupt in 1933 when it suspended the gold standard, and no longer had collateral with which to back its debts. Thus, the theory claims, the United States pledges its current and future citizens as collateral and has accounts linked to the birth certificate number of each citizen. The theory states that each citizen has a "straw man" that controls the account linked to the birth certificate. Litigants espousing redemption theory claim that this account is a valuable asset worth millions and that they can gain control over their straw man and this account by making particular UCC filings. Once they have made these UCC filings, litigants relying on this theory claim that they can execute a promissory note, bill of exchange, or "sight draft" drawn on their birth certificate account at the United States Treasury and use the note as cash.

There are even official-looking websites that sell kits with information on how to engage in a redemption scheme and variations of it. Not surprisingly, however, these sites claim to represent a coalition of concerned citizens who are lawfully taking back our country and that it is actually the United States government that has committed fraud.

What should individuals do to avoid being conned by a redemption scheme?

  • Be wary of individuals or groups selling "kits" that they claim will show you how to access secret bank accounts.

  • Be wary of individuals or groups proclaiming that it is not necessary to pay federal and/or state income tax.

  • Do not believe claims that the U.S. Department of the Treasury controls bank accounts for all citizens.

  • Be skeptical of individuals advocating that speeding tickets, summons, bills, tax notifications and similar documents can be resolved by writing "acceptance for value" on them.

What should a business do to protect itself from someone trying to perpetuate a redemption scheme?

  • Carefully review any documents that have been presented, looking for language that is out of the ordinary.

  • Reserve the release and satisfaction of notes, judgments and payments until the negotiable instrument has been honored by the payor institution.

Other Common Types of Fraud

Let me also share a few thoughts on Internet fraud, telemarketing fraud, identity theft and the like. The best way to avoid any of these schemes is to trust only people and institutions you know intimately. Doing business with an unknown individual or company and providing those entities with personal information (such as your social security number) exposes you to a degree of risk. For example, you may have seen the booths that offer a free T-shirt or token gift if an application is made for a credit card. As I sum up for high school students during my CARE (Credit Abuse Resistance Education) presentations, never give someone your social security number and bank account information in exchange for a really cool T-shirt; your personal information is worth more much than that. Likewise, while the Internet is an easy and convenient way to get business done, it pays to always think carefully about the sites you are using and the information you are providing.

Suffice it to say, we are experiencing an economic collapse unlike anything since the Great Depression. As a result, people are desperate and willing to do just about anything to obtain money from those who have it. Even trusted financial institutions are being accused, by certain state attorneys general, of committing fraud in their lending practices. Given these grave economic times, being cautious and adhering to best business and lending practices can go a long way toward fraud prevention. I would suggest, however, that caution itself is not enough. You must be vigilant, inquisitive and even prying to make certain your money will not become an add-on to the billions of dollars lost to fraud schemes every year.

For More Information

Regardless of the state of the economy, fraud is a risk of doing business today. But when you add into the mix the significant increase in financial stress that has accompanied the current downturn, the environment is even more ripe for fraudulent activity. If you would like more information on this important issue and how it can affect businesses and individuals, please contact me and visit the website of the Association of Certified Fraud Examiners, which recently celebrated its annual International Fraud Awareness Week.

This article contains material of general interest and should not be construed as legal advice or a legal opinion on any specific facts or circumstances. Under applicable rules of professional conduct, this content may be regarded as attorney advertising.