William J. Burns, CPA, Attorney at Law

9 February 2012

On February 9, 2012, the United States Attorney’s Office for the Northern District of California reported the sentencing of two individuals for committing bank fraud.  http://www.justice.gov/usao/can/news/2012/2012_02_09_roscoe.sentenced.press.html.  Based on the second superseding indictment in the matter (U.S. Dist. Ct., San Jose Division Case No. 5:07-cr-00373-RMW), it appears that the fraud these two individuals engaged in involved overstating the value of inventory on a borrowing base certificate submitted to an asset-based lender that the FDIC insured.  To overstate the value of inventory, the fraud had a three pronged attack: 1) value inventory at retail selling price instead of purchase cost; 2) value inventory at a cost that did not take into account the value of significant discounts the supplier allowed; and 3) inflating the quantity of inventory on hand.  The fraud lasted about two years and overstated inventory by about $16 million dollars.  To detect this type of fraud, a typical due-diligence exam employs test counts and cost tests.  The very first time the lender caught the fraud it could have immediately moved to limit its losses.  A due diligence exam conducted before funding and at least once a year would likely have detected this fraud.  The estimated cost of such an exam, about $14,000 each.

3 February 2012

On February 16, 2010, the Montreal Gazette reported that Bertram Earl Jones pleaded guilty to defrauding 158 clients of $50 million in a Ponzi scheme he operated for more than two decades.  A judge handed him an 11-year sentence.  (http://www.montrealgazette.com/news/Earl+Jones+gets+years+Ponzi+scheme/2567329/story.html).  In one instance, according to the Montreal Gazette, it appears that Mr. Jones used a power of attorney to take out a loan in one of his victim’s names, secured with the victim’s home.  The victim sued the creditor and a notary.  What makes the case interesting is an argument the notary’s attorney made.  On February 3, 2012, the Gazette reported that the attorney questioned the victim’s credibility arguing that the victim "put all her eggs in one basket with Earl Jones."  (http://www.montrealgazette.com/news/Victim+Earl+Jones+wants+loan+annulled/6095091/story.html).  In effect, the lawyer argues that you need an expert to investigate your expert or else you had better diversify.  Incredible!  The lawyer blames the victim for not being an expert.  Before giving anyone a significant amount of cash, a power of attorney with authorization to borrow money and take mortgages, or even buy a home, stakeholders should obtain an independent attorney’s opinion.  For about $1,000, this particular victim could likely have avoided the imbroglio in which she now finds herself had she performed her due diligence prior to giving a reprobate access to her assets.

2 February 2012

According to Reuters, on February 1, 2012, two former Credit Suisse (“CS”) traders plead guilty to conspiring to falsify books and records and to commit wire fraud stemming from the collapse of the sub-prime mortgage market (http://ca.news.yahoo.com/ex-credit-suisse-traders-admit-cooking-subprime-books-005027132.html).  On the same day, the SEC filed a 32-page complaint in the US District Court for the Southern District of New York against the traders and others (Docket No. 12CIV0796).  The SEC Complaint alleges that the traders manipulated CS’s mark-to-market mechanism to hide losses in a mortgage-backed securities portfolio.  To hide losses, the traders manually overrode CS’s market-pricing tools.  According to the Complaint, CS had a Price Testing unit “responsible for reviewing the prices assigned by traders, but in practice the unit lacked the expertise to adequately challenge pricing by traders and Price Testing personnel were often deferential to the views of traders.”  In the end, CS had to write-down the value of its portfolio by $2.6 billion with an earnings effect of $650 million. 

What spawned the Defendants to engage in such nefarious activity?  The Complaint contains ample evidence to suggest that CS’s management pressured employees to produce or else.  According to the Complaint: (a) “Defendants . . . were placed under intense pressure to avoid showing negative P&L” ¶ 35; (b) when faced with a significant write-down, one Defendant stated "I want to be up a little bit of money today, because everyone's going to think werre (sic) going to be up and be very surprised if we're not." ¶ 70; and (c) during a telephone call one party said "People are expecting us to make money. (The head of Credit Suisse Group's investment bank) knows what our positions are. Today, we have to be up at least 10 bucks (million)." ¶ 105.  The Complaint also indicates that the Defendants desired multi-million dollar bonuses and one defendant wanted a “coveted promotion.”

The Complaint contains almost all of the elements to suspect fraud: a) personal greed; b) pressure to perform at all costs; and c) weak oversight.  Even bringing in an outside independent party to conduct random tests would not likely help in this pressure cooker.  Based on the Complaint, it appears top management knew of an issue, but turned a blind eye.  Based on the SEC Complaint other lawsuits will likely haunt CS for years to come for putative violations of securities laws.

11 January 2012

On January 11, 2012, the Folsom Telegraph reported that a 29-year old man from Folsom, CA, plead guilty to one count of wire fraud and one count of aggravated identity theft related to a $19 million fraud scheme.  According to a complaint filed in the United States District Court of the Eastern District of California, Docket No. 2:09 MJ00046KJM, one part of the scheme involved offering investors a real estate vehicle in which the investors served as nominees for the purchase of real estate.  The Complaint specifically references Citimortgage and the falsification of mortgage materials Citi relied upon to fund three mortgages.  The investors did not serve as nominees, but actually owned the real estate and Citi thought the mortgagees intended to occupy the home whereas the investors thought they had simply invested in real estate managed by another.  The most interesting part of the Complaint, however, concerns the attachment the government included in which the writer discusses how the writer: (a) became a fraudster; (b) beat the regulatory system; and (c) how to change the system to prevent people like the writer from beating it.  The fraudster proposes combining Freddie, Fannie and other governmental entities as well as creating an information verification center.  The writer also notes that investors like Citi did not verify the data that supported the loans such as credit reports, W-2’s and paystubs.  When an investor did catch a fraudulent loan, the writer claimed the loan an anomaly, fired the person that generated the mortgage and replaced the fraudulent loan with another loan.  Investors, in turn, packaged these loans into mortgage-backed securities.  According to the writer, the writer’s firm generated $810 billion dollars in mortgage-backed securities in which most of the underlying mortgages had some sort of material fraud made in order to fund the loan.  The writer also asserts “[t]hese investors, who were securitizing these assets as AAA rated were not even verifying anything in the files? I am sure that their investors were assured everything from correspondents was being audited.”  As a stakeholder, investors needs to conduct its own due-diligence.  Firms like WJ Burns, Esq., CPA can help in this regard.

 4 Jan 2012

On December 30, 2011, the New York City field office of the Federal Bureau of Investigation reported on the successful prosecution for bank fraud, among other things, of the CEO of GDC Acquisitions, a holding company.  (http://www.fbi.gov/newyork/press-releases/2011/former-chief-executive-officer-of-construction-supply-company-convicted-in-bank-fraud-scheme).  GDC apparently inflated the value of its accounts receivable to the detriment of GDC’s asset based lender.  As in most cases involving fraud, the fraud only came to light after a GDC accountant turned himself in to the FBI.  According to the FBI press release, GDC reported to its asset-based lender a receivable value of $25.2 million when the value actually amounted to $9 million.  GDC achieved this feat through creating fake sales.  This particular issue begs the question as to why the asset-based lender’s field exam missed such a brazen overstatement of assets.  A field exam usually employs the sample testing of invoices comprising a borrower’s accounts receivable in order to verify the existence assertion.  A field exam will not likely catch small over-billings, but field exam should catch a 280% overstatement of accounts receivable.  This case illustrates the need for banks to use competent field examiners for proper due diligence in order to monitor credits.

Financial Fraud - Prevent and Detect Before You Have No Choice

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