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1.2. Characteristics and Types of Fraud

Fraud is not only a theft of assets but also an attempt to conceal it. Misappropriation of assets without an attempt to conceal is merely a theft, which is usually uncovered quickly through normal checks and balances procedures. Concealment distinguishes fraud from theft. As perpetrators attempt to conceal fraud, they might continue to engage in similar misappropriations over an extended period of time. A theft often occurs only once because the victim becomes armed with the knowledge of that theft and takes necessary precautions to deter future occurrences; the victim of a fraud, on the other hand, is usually unaware of the loss, and hence the perpetrator can repeatedly commit the crime. In that sense, fraud is nothing but recurring theft on the similar type of victim by the same perpetrator. In the instance of corporate fraud, there is a sole victim, the organization, and usually there are multiple occurrences of theft that impact that organization.

The FBI characterizes fraud as comprising of deceit, concealment, and or violation of trust. Fraud is not usually dependent on the application or threat of physical force or violence. The FBI has recently investigated and prosecuted many financial crimes, including corporate fraud, securities and commodities fraud, health care fraud, financial institution fraud, mortgage fraud, and others. This section provides an overview of these schemes, and subsequent sections discuss in more detail corporate fraud committed by insiders (employees and management) of an organization.

Figure 1.1 plots the number of cases in each category investigated by the FBI over the seven-year period from 2005 to 2011. The “other” category is comprised of money laundering, insurance fraud, and mass marketing schemes. The plot represents the total number of ongoing investigations at the end of each reporting period. It is important to note that this does not reflect the number of new cases for each year. An upward sloping line indicates that the number of new cases in that category exceeded the number of cases that were settled or resolved. Similarly, a downward sloping line indicates that the number of cases settled for that category was greater than the number of new cases. Thus, a decline in the number of open cases does not necessarily indicate a decrease in that category of crime but could be due to speedier resolution of the pending cases from previous years.

Figure 1.1

Figure 1.1 Number of fraud cases by category investigated by the FBI between 2005 and 2011

Data for the graphs obtained from the FBI’s Financial Crimes Report to the Public from the years 2009 and 2011. The 2009 report covers the years 2005–2009, and the 2011 report covers the years 2010–2011.

Over the seven-year period, health care fraud cases have been steadily high at about 2,500 cases annually. In contrast, investigations related to mortgage fraud spiked in 2008 and 2009, exceeding the 2,500 mark. This spike was primarily related to investigations following the collapse of the sub-prime lending market in the United States. Investigations related to securities fraud also increased in the 2008–2009 timeframe, but the increase was not as drastic as the increase in mortgage investigations. Open investigations on corporate fraud were relatively steady over the seven-year period. In contrast, investigations of financial institution fraud and others have been declining in recent years. The percentage of growth or decline in the number of cases over the previous year for each category is plotted in Figure 1.2.

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Figure 1.2 Percentage change in cases by category investigated by the FBI 2005–2011

Investigations related to corporate fraud are usually conducted by the FBI in collaboration with the Securities and Exchange Commission (SEC). Often the investigation is initiated at the SEC following a tip from a whistleblower. Upon follow up if the SEC suspects criminal wrongdoing, the FBI is alerted, and a criminal investigation ensues. Corporate fraud cases usually involve accounting schemes designed to deceive investors, auditors, analysts, and others regarding the true financial condition of the corporation. The usual objective for such crimes is to artificially lower the cost of borrowing by inflating the share price based on fictitious corporate performance indicators. As can be seen in Figure 1.2, the number of such cases has been relatively stable over the seven-year period. In 2011, the pursuit of these cases led to 241 convictions, and the FBI secured $2.4 billion in restitution orders.

Corporate fraud investigations focus not only on the misrepresentation of a firm’s financial conditions, but also on the investigation of allegations involving insider trading. A multitude of parties can potentially engage in trading based on insider and nonpublic information. These parties include corporate insiders, corporate attorneys, traders, and other financial intermediaries such as accountants and investment bankers who are privy to confidential and nonpublic information.

The volatility of the financial market in recent years has caused investors to seek alternative investment opportunities. This investor need has created a demand for new and innovative investment products and opportunities. Concurrent with investors’ growing need for alternate investment vehicles and their eagerness to invest in new and untested products, the FBI saw a steady rise in securities and commodities fraud in 2009 and 2010. These new schemes and trends included

  • Securities market manipulation through cyber-intrusion
  • Increased commodities fraud
  • A continuing rise in Ponzi schemes
  • Onslaught of foreign-based reverse merger schemes

Figure 1.2 showed the plot corresponding to securities fraud spikes in 2009, signifying that such fraud schemes are increasing at a faster rate following the recent financial crisis. The victims of securities fraud include individual investors, pension and retirement funds, government entities, financial institutions, and private and public companies. The creation of complex investment vehicles makes prevention and early detection of such schemes difficult, resulting in higher losses for the victims of such schemes.

As seen from Figure 1.1, health care fraud, an important area of investigation for the FBI, has traditionally been their most prolific type of case; however, the number of cases has been relatively stable over the seven-year period if you compare the data to that shown in Figure 1.2: the graph is close to the x-axis, or zero, denoting little change. Data mining techniques, which are covered in a later chapter, are used to detect health care-related fraud schemes. In 2011, the FBI recovered $1.2 billion in restitution, $1 billion in civil settlements, and an additional $1 billion in fines. The prevalent schemes for health care fraud identified by he FBI include

  • Billing for services not rendered, either wholly or partially.
  • Duplicate billing.
  • Upcoding of services to generate higher payments.
  • Upcoding of items.
  • Kickback schemes.
  • Unbundling, which involves billing separately for individual items to maximize reimbursement when they are required to be billed together at a reduced cost. For example, a laboratory test can be ordered individually or as a panel. A panel test usually costs less than the sum of the individual tests.

Another area of fraud that is rapidly increasing is mortgage fraud, the victims of which include financial institutions and investors. Mortgage frauds primarily occur at entry or exit points. In other words, they occur at the time of loan origination or at the time of foreclosure or delinquency. After underwriting rules were tightened in response to the financial crisis that began in 2007, the year 2011 was the first time that distressed homeowner frauds outnumbered loan origination fraud. As seen in Figures 1.1 and 1.2, the investigations of mortgage fraud spiked considerably in 2009 following the financial crisis and the near-abolition of the sub-prime market.

Following the global financial crisis, many incidents of financial institution fraud came to light. Having started at the highest level in 2007, the cases corresponding to this category have been declining over the years. This includes investigation of financial institution failures. The number of bank failures during 2009 and 2010 had significantly increased to about 150 per year but then in 2011 decreased to under 100 per year. Over the five years following the global financial crisis, there have been about 400 bank failures. Although still a large number, this cumulative total compares favorably to more than 1,000 banks closing over the five-year period from 1987 to 1992 and more than 9,000 bank failures during the Great Depression (1930 to 1933).

Other types of financial fraud investigated by the FBI include insurance scams, money laundering, and mass marketing frauds. One of the most prevalent mass marketing frauds in recent times is the Nigerian email/letter that you might have personally encountered. In this scheme victims are asked to act as U.S. agents to facilitate transfers of huge sums of money held in foreign accounts into the U.S. The victims are promised a generous portion of the total proceeds for their efforts. The victims are then required to open accounts at fraudulent websites and transfer their holdings from legitimate banks to fictitious ones; once completed, the funds are stolen by the perpetrator.

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