Fraud fingerprints: The warning signs of fraud and money laundering

Kevin Shergold explores the trends and warning signs of fraud and money laundering in law firms and client organisations

Fraud is on the increase and international estimates suggest losses due to fraudulent action by employees alone could account for five per cent of organisations' annual revenues.¹ Across the UK, one in two firms may have been impacted by economic crime, which underscores the ubiquitous nature of fraud. From asset misappropriation, bribery and corruption to cybercrime and accounting fraud, such threats continue to impact organisations and infiltrate the consciousness of business leaders.

The legal sector is not immune and the imperative to address this challenge is building on two fronts: on behalf of clients, which require investigations into financial irregularities; and on firms' own doorsteps, with fraud and money laundering posing a perennial danger. The Solicitors Regulation Authority's Risk Outlook has further reinforced the scale of the threat, highlighting a rise in reports relating to money laundering, as well as ongoing serious money laundering cases involving law firms. Detecting the warning signs of money laundering in-house and managing investigations of fraud may well be a pressing feature in the year ahead.

'Black box' analysis

Faced with financial crime, either emanating from inside the firm or as part of a client case, the first priority is to ensure that the multitude of issues that emerge are swiftly and actively managed.

This would include:

• maintaining privilege;

• managing reporting responsibilities;

• fulfilling obligations to witnesses, whistleblowers and suspects; and

• gathering data and preserving evidence.

Most important of all, however, is unearthing the truth behind an alleged
or suspected financial irregularity -
rarely an easy task.

Seeking the truth behind a financial irregularity can be challenging and the investigation of fact requires an analysis of widely-sourced information juxtaposed to highlight consistencies and, often more interestingly, inconsistencies. While emails and electronic files, paper documents and interviews are all potentially vital information sources, transactional records within the accounting system are likely to hold invaluable clues.

The accounting system is the repository for identifying what went
wrong, with details of an individual transaction and the aggregation of all transactions captured by an entity's accounting records. Quite simply, mined correctly, the accounting system is to a company what the 'black box' is to a plane.

The principle of double-entry bookkeeping means that any transfer of assets in or out of a business must be recorded to ensure the books balance.
The evidence trail that is left from an
illicit or uncommercial transaction
expands as culprits attempt to
traverse the prevailing processes
and controls to cover their tracks. Often, the key to an investigation
is identifying:

• the circumvention of controls;

• unusual behaviour in recording third-party relationships, decisions and transactions; and/or

• the trail left behind on a significant transaction.

The fraud landscape

Fuelled by advancements in technology, growing internationalisation and wider macroeconomic and social factors, the shape of fraud is changing. Investigations commonly require a tailored approach to unearthing the facts, which are held deep within the accounting system.

Nevertheless, there are often recurring themes identified during the interrogation of an accounting system which may subsequently support the investigative process. Below are some examples.

Accounting fraud and money laundering

Consider the laundering of money through tax havens. Companies have long sought friendly countries in which to establish 'trading arms' purely to allow the transfer of true profits away from their domestic tax regimes. The premise here is for the friendly jurisdiction's authorities to tacitly agree a heavily-reduced profit figure with the launderer, which will generate tax revenues in-country.

Lawmakers and enforcers, tax authorities and independent auditors collectively turn a blind eye to the fact the cost of sales for that entity required to create this artificial profit include fund transfers to a third jurisdiction, this time an offshore tax-free jurisdiction: they
are reported as business expenses,
as opposed to the dissipation of profits.
In the recipient's offshore bank, those funds are supported by bona fide
sales documents. The launderer has avoided paying tax on the majority of
its true profits.

An examination of the payments and supporting accounting documents would readily reveal the true purpose and the accounting fraud that facilitated them.

Procurement fraud and asset misappropriation

When investigating procurement fraud or potential bid-rigging over competitive tenders, it is important to ensure any communication and document review is underpinned by an understanding of the protocols and practices that are meant to be followed, rather than merely relying on keyword searches and interviews.

Take the case that was raised following concerns when the counterparty to a multi-million-dollar commodity purchase failed to deliver materials to
an Eastern Bloc government ministry. Backed by an understanding of the ministry's budget and decision-making process, this knowledge was overlaid with transactional records, which revealed that officials had circumvented key controls, pushed an agenda to select a specific supplier and made a decision which was not based on commercial grounds.

Bribery and corruption

The use of commission payments to agents or consultants as a cover for making bribery payments are commonplace in corruption cases. Understanding where illicit transactions can be hidden in the accounts can be critical to identifying tainted payments
and agent relationships.

Working with an organisation's IT and accounting teams in a Foreign Corrupt Practices Act (FCPA) investigation, it was possible to identify a significant number of hidden consultancy payments by searching for a variety of abbreviations and terms in the accounting ledgers - including, for example, 'COMM' in description fields of the purchase ledger. The full extent of tainted transactions was revealed, as many payments had been deliberately miscoded to avoid detection.

Systemic fraud

In certain situations, the evidence provided by accounting and IT teams may not withstand scrutiny, which would require further investigation of the accounting records.

Exposing the true details of what happened behind the collapse of a retail bank in Southeast Asia can be traced to the moment the team identified a secret field in the back-end data tables of the accounting records. This US$1 billion systemic fraud continued to be obscured by the bank's shareholders, management and staff, until this inescapable truth was discovered following a detailed review of the bank's accounting system. In a world of obfuscation and half-truths by witnesses and the accused alike, the traces left in the accounting records are often the only reliable evidence available.

In matters involving financial irregularities, overlooking the information contained in the accounting system is akin to investigating a murder and ignoring the fingerprints at the scene. Evidence obtained from a forensic accounting examination tends to be objective, ever present and uniquely informative, both on its own and alongside other information sources, such as witness assertions and employee emails.

Risks to law firms

The Financial Action Task Force (FATF) has identified the methods of money laundering commonly used and which require the involvement of a legal professional. Based on more than 100 cases involving money laundering, its
June 2013 report, Money Laundering and Terrorist Financing Vulnerabilities of Legal Professionals, sets out the following methods for money laundering involving legal professionals:

• misuse of client accounts;

• purchase of real property;

• creation of trusts and companies;

• management of trusts and companies;

• managing client affairs and making introductions;

• undertaking certain litigation; and

• setting up and managing charities.

The difficulty for lawyers in spotting warning signs stems from the fact that the methods and techniques used by criminals to launder money may also be used by clients with legitimate means for legitimate purposes. Making the distinction inevitably boils down to truly knowing the client and the beneficial owners, the business relationship and the source of funds being used in a retainer.

The box 'Red flags that a client is using your law firm for money laundering', which draws on FATF's recommendations is, therefore, a sensible starting point.

 

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Red flags that a client is using your law firm for money laundering

• The client is evasive about the fundamentals of the transaction, including: the beneficial owner; where the money is coming from or the reason for the transaction; or there is a lack of sensible commercial, legal, tax or financial rationale

• The client avoids personal contact, including the use of an agent when it does not seem necessary, does not provide all necessary documents or there is a concern that documents are falsified

• The business entity has a limited online footprint and/or the client is linked to public office, is the subject of investigations or has been convicted, or is known to be associated with illicit financing

• The parties or representatives are based in high-risk countries, or are connected without an apparent business reason

• The transaction involves a disproportionate amount of private funding which is inconsistent with the socioeconomic profile of the individual or financial stature of the business entity

• Funds received from or sent to a foreign country with no apparent connection or payment instructions are changed without logical explanation

• An asset is purchased with cash and then rapidly used as collateral for a loan or back-to-back property transactions, with rapidly-increasing value or purchase prices

• Instruction of a legal professional at a distance from the client or transaction without legitimate or economic reason

• The client requires an introduction to financial institutions to help secure banking facilities

• Creation of complicated ownership structures when there is no legitimate or economic reason, or there is increased complexity in the transaction or structures which result in higher taxes and fees than apparently necessary

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Picking up the trail

Law firms have a duty to combat fraud and money laundering. Such risks must be actively managed by senior partners to ensure internal systems and processes are fit for purpose. However, faced with increasingly sophisticated perpetrators, the role of the evidence-gathering strategy in securing a successful outcome is becoming increasingly important.

Just as the black-box flight recorder has proved invaluable in determining the facts surrounding aviation incidents, the use of transactional records in investigating financial wrongdoing is
of paramount importance.

Fraudsters and launderers will leave traces behind at the scene and analysing records in the accounting system can strengthen the investigative process. Whether investigating fraud on behalf of clients, within the firm or identifying money launderers, challenging the commercial nature of decisions and arrangements is often key to picking
up the trail.

Kevin Shergold is a vice president in the forensic accounting department of Stroz Friedberg (www.strozfriedberg.com)

Endnote

1. See Report to the Nations on Occupational Fraud & Abuse,Association of Certified Fraud Examiners, 2014