What CPAs need to know about organized crime

Sophisticated financial fraud seeks to use, confuse accountants.

BY RANDAL A. WOLVERTON, CPA/CFF
April 1, 2012

The FBI called it “The Case of the Stolen Company.” New Jersey U.S. Attorney Paul J. Fishman said it “gave new meaning” to the term corporate takeover. An indictment filed in a New Jersey federal court said that a group with ties to La Cosa Nostra (LCN), commonly known as the Italian Mafia, “relied on … threats of economic and physical harm and intimidation” to take over a publicly traded Texas company and defraud shareholders of at least $12 million.

The alleged pillaging of FirstPlus Financial Group (FPFG) is just one example of how the government says organized crime has expanded into increasingly sophisticated financial fraud. This article examines examples of these types of illegal activities, explains how criminals can use knowledge of procedures ordinarily performed by financial statement auditors to hide transgressions and explores warning signs in financial statements that could alert CPAs to the possible infiltration of legitimate businesses by criminal organizations.

“A CRIMINAL’S DREAM”
The FirstPlus indictment, filed late last year, accuses 13 people of seizing power at the Irving, Texas-based financial services company, which eventually filed for bankruptcy. Among those indicted are two men with alleged ties to the Italian Mafia: Nicodemo Scarfo, a member of the Lucchese crime family, and Salvatore Pelullo, an associate of the Lucchese and Philadelphia LCN families. The indictment asserts that a group led by Scarfo and Pelullo falsely accused an FPFG board member of committing financial improprieties with company assets and then threatened to sue the board member unless the individual convinced the other board members to surrender control of FPFG. The board member did as told, according to the indictment, giving control of the company to the Scarfo-Pelullo group, which installed a new board and management team.

After that, the new board approved deals that paid about $7 million and more than a million shares of FPFG stock to buy virtually worthless shell companies set up by Scarfo and Pelullo, according to the FBI, which led the investigation and called the FPFG situation “a criminal’s dream.”

The new board also allegedly approved “consulting” agreements that resulted in the accused criminals’ receiving several hundred thousand dollars in payments. In addition, the Scarfo-Pelullo group allegedly used money pilfered from FPFG to make a $215,000 down payment on a $715,000 home for Scarfo’s future wife.

Some of the activities detailed in the indictment speak to the violence traditionally associated with organized crime. Scarfo and Pelullo allegedly amassed a cache of several guns and hundreds of rounds of ammunition “due to the historically violent nature” of LCN activities, the indictment said. The indictment also accuses Pelullo of threatening to sell the children of one of the new board members into prostitution if the board member ever went to the authorities.

The 25-count indictment charges the group with being a racketeering enterprise that committed crimes such as securities fraud; wire, mail and bank fraud; extortion; money laundering; and obstruction of justice (see sidebar "Law Enforcement’s Big Weapon: RICO," below). In addition to Scarfo and Pelullo, the indictment names five attorneys and one CPA. The attorneys include inside and outside counsel for FPFG. The CPA is accused of being hired on retainer by Pelullo to serve as FPFG’s internal accountant. In that role, the CPA allegedly failed to provide truthful financial information to the company’s outside independent auditor.

OTHER CASES
The LCN has shown on multiple occasions that it is unafraid of moving illegal activities into otherwise legitimate business environments, including those that fall under U.S. GAAP accounting rules and regulations. For example, indictments allege that the LCN has infiltrated securities firms to conduct illegal stock manipulation and fraud schemes. Other indictments allege schemes designed to take over businesses to loot pension funds and other assets. Some of the victim companies were publicly held companies registered with the SEC.

In one case investigated by the FBI, LCN associates allegedly bribed brokers who manipulated the price of securities by artificially creating demand for them. These brokers made false claims to customers to induce them to buy a certain stock so the price would rise. The trading activity increased the stock’s price so that the conspirators could sell their shares for a profit. As the “pump and dump” stock manipulation scheme continued, the LCN families involved allegedly took control of two branches of the trading company and tried to expand the scheme to include other small-cap companies. LCN members sought to control the brokers to avoid detection and to control who would receive profits from the scheme. As a result of this investigation, 33 people were indicted on charges of extortion, securities fraud, stock manipulation and commercial bribery. Twenty-eight defendants pleaded guilty, and five were convicted after two separate jury trials.

Other organized crime groups have set up phony entities to steal hundreds of millions of dollars from the U.S. government and investors. In one 2010 case, the alleged leader of an Armenian-American organized crime ring known as the Mirzoyan-Terdjanian Organization pleaded guilty in the Southern District of New York to stealing the identities of patients and doctors, setting up 118 “phantom” medical clinics nationwide and using the stolen IDs to submit more than $100 million in bogus Medicare bills. “The diabolical beauty of the Medicare fraud scheme—from the criminals’ standpoint—was that it was completely notional,” Janice K. Fedarcyk, assistant director in charge of the FBI’s New York office, said in a news release. “There were no real medical clinics behind the fraudulent billings, just stolen doctors’ identities. There were no colluding patients signing in at clinics for unneeded treatments, just stolen patient identities. The whole doctor-patient interaction was a mirage. But the money was real, while it lasted.”

In another example, a 2003 indictment filed in the Eastern District of Pennsylvania charged Semion Mogilevich, an alleged boss in the Russian mafia, and several co-conspirators with numerous financial fraud violations, causing losses in excess of $150 million. The defendants were charged with defrauding investors of several publicly traded companies. The fraud was facilitated through the creation of false accounting records such as phony bank statements, invoices, customer lists, shipping documents and audit confirmations. Mogilevich is among the FBI’s Ten Most Wanted Fugitives.

OUT OF SIGHT, OUT OF MIND
Members of organized crime groups need to stay hidden and separated from business transactions that fall under the scrutiny of internal and external accountants. The criminals, therefore, have become educated on what accountants are looking for and where they are looking. Equally important, the crooks know where accountants are less likely to scrutinize transactions. This knowledge enables organized crime members to hide their control and influence, as well as the transactions where money is removed from company coffers.

Information gained from many organized crime investigations and debriefings of admitted conspirators provides valuable lessons for accountants. While it is difficult to describe all of the fraud schemes used to make or hide money, accountants should know that organized crime often creates a maze of easily formed empty shell LLCs and other corporate organizations to interact with legitimate businesses. Phony revenue and expense transactions are used to hide the theft of assets, extortion and bribe payments, and the laundering of illegitimate money through businesses. For example, criminals have used consulting or other soft-cost, service-related invoices for money laundering or looting money from a business because the delivery of the services is difficult to quantify. Other invoices could be completely phony or inflated but mixed in with a larger universe of legitimate transactions.

WHAT CPAS CAN—AND CAN’T—DO
CPAs who perform accounting services for a company, including preparing company financial reports, can help fight fraud in several ways. The first is to establish accountability for transactions and documents. For example, a CPA who performs accounting services may notice payments to a consulting group and discover that the group has only a post office box for an address, an immediate red flag. The CPA can then try to track down information on the consulting group via the Internet or other public sources of information. If no website or contact information can be found, the CPA may determine to ask the company’s senior management about the transaction.

Professional skepticism also is an important factor for CPAs when preparing or scrutinizing financial reports and transactions. In the case of the suspicious consulting group described above, it would be commonplace for criminals to set up a phone number that connects callers to an answering service staffed by people who give the impression that the consulting group exists. In such a situation, CPAs could be excused for concluding that the evidence indicates that the consulting group is legitimate. An appropriately skeptical CPA, however, may ask questions about the nature of the consulting work and for any documentation that proves the work was done. An exceptionally thorough CPA may diligently record those answers and also keep copies of all relevant documents.

ROLE OF SITUATIONAL ETHICS
CPA encounters with organized crime can be much more personal and perilous than running across a few fishy transactions in a company’s books. When looking at professionals such as business executives, political figures, attorneys and accountants, organized crime associates are experts at identifying those people who have personal vices, such as a gambling problem or an alcohol or drug addiction. The criminals move to compromise the professional by threats of exposure or even violence.

In addition, the criminals will locate and assess those professionals who exhibit signs of “situational ethics” to determine if they also can be compromised. Situational ethics refers to the willingness of some people to compromise their ethics in certain situations. Again, once a professional is compromised, the threat of exposure or violence is used to control the new victim. Unfortunately, organized crime investigations have shown that many professionals have knowingly participated in illegal schemes that benefited the criminal groups. Professionals have been known to prepare phony tax returns, real estate documents, financial statements and loan applications while also facilitating the improper use of escrow accounts, in exchange for bribes and kickbacks.

CONCLUSION
The hard lessons from organized crime investigations and prosecutions underscore the importance of unyielding ethical principles for all professionals, including CPAs. Investigators and prosecutors know that the vast majority of legal and accounting professionals consistently exhibit the highest ethical standards, and that organized crime’s understanding of how to hide illegal activities in financial statements makes it exceptionally difficult for CPAs to spot problems. Many schemes are discovered and proven long after the events have taken place. Therefore, those who maintained a high degree of professionalism make for excellent witnesses.

The best course of action for accounting professionals is unwavering honesty in their practices, combined with the fortitude to constantly push obscure business transactions into the harsh sunlight of full disclosure. Healthy skepticism combined with the determination to tell the story behind the transactions is critically important to the CPA profession and the battle to keep the criminal world from further infiltrating the business world.

Click here to watch retired FBI agent Randal A. Wolverton, CPA/CFF, describe how Mafia families and other organized crime groups infiltrate and loot legitimate businesses. Such schemes are sophisticated and well hidden, but Wolverton points out warning signs CPAs might spot in company financials.

The Role of CPAs in FBI Fraud Investigations

The FBI has served for decades as the primary, but not the only, investigative agency to address organized crime threats and activities. During that period, the bureau has recruited and employed attorneys and accountants to serve as special agents. Some of these special agents, many of whom are CPAs, add the forensic accounting skills needed to untangle the complex business arrangements and financial transactions organized crime groups use to conceal fraud. The FBI also hires nonagent forensic accountants to assist in a wide variety of investigations. In addition, the IRS supplies considerable and valuable forensic accounting skills to the complex investigations.

Forensic accountants play an essential role in the investigative process—identifying the person or people controlling and benefitting from illegal activity. Collusion between criminals and company insiders often renders internal control procedures ineffective in preventing fraud. Properly trained forensic accountants are tasked not only with tracing fraud through the accounts, but also with assisting in identifying who should have knowledge of the transactions, and how the transactions were “papered up” to create the appearance of legitimacy.

When business organizations are used to hide money or are the victims of looting schemes, forensic accountants are tasked with sorting out the webs of deceit, bribes, kickbacks and extortion payments often hidden through false accounting entries designed to deceive even the best internal and external auditors. Forensic accountants can provide expertise in complex financial investigations by mapping out transactions and then carefully scrutinizing supporting documentation to ferret out phony invoices, stock purchases and exchanges, reported and unreported related-party transactions, improper off-balance-sheet transactions, and other accounting fraud schemes.

Investigators then seek to uncover the back story of the fraudulent documents by interviewing the person(s) responsible for preparing the document and accounting entries, the person(s) directing the activity, and the person(s) benefiting from the activity. The fraudulent accounting transactions provide important evidence to juries about the extent of the crimes and the proactive work by co-conspirators to cover their tracks. Forensic accountants often serve as fact witnesses and expert witnesses to testify and educate juries about how the transactions unfolded. Remember, little pieces of paper can put criminals in jail.


Law Enforcement’s Big Weapon: RICO

One of the most effective weapons in the fight against organized crime is the Racketeer Influenced and Corrupt Organizations (RICO) Act. The RICO Act was enacted by Section 901(a) of the Organized Crime Control Act of 1970, P.L. 91-452. Under RICO, a person who is a member of an enterprise that has committed at least two of certain enumerated state and federal crimes, known as RICO predicates, within a 10-year period can be charged. RICO predicate offenses include murder, extortion, bribery, kickbacks and a wide variety of financial crimes. An enterprise is defined to include any individual, partnership, corporation, association, or other legal entity, and union or group of individuals associated in fact although not a legal entity.

The RICO statute allows prosecutors to charge a wide variety of crimes in one indictment where the crimes are used to support and protect an enterprise. An organized crime group, due to its structure, is considered an enterprise, and the actions of its members and associates can be charged as racketeering acts. Prior to the RICO law’s enactment, it was difficult to attach accountability to the leaders of the organized crime families because they were removed and insulated from the actual criminal acts. The RICO statute allows prosecutors to reveal the full nature of the enterprise, which may cover many states and long periods of time, and charge the people giving the orders for the criminal activity, as well as the actual perpetrators.

 

EXECUTIVE SUMMARY

 

  Several indictments in recent years outline how organized crime has infiltrated publicly traded U.S. businesses. Various criminal groups have executed a variety of schemes to defraud investors and government agencies out of hundreds of millions of dollars.

 

  Among the criminal organizations named in these indictments are the Italian Mafia, the Russian mob and an Armenian-American organized crime ring.

 

  A federal indictment in New Jersey accuses a group with Mafia ties of taking over a publicly traded Texas company and pillaging it into bankruptcy. The alleged conspiracy involved threatening board members to seize control of the company and then using various methods to defraud investors of $12 million.

 

  Individuals linked to organized crime have to stay behind the scenes from business transactions likely to be scrutinized by internal and external accountants. The criminals often hide their involvement by setting up a maze of easily formed shell companies.

 

  Organized criminals often have a thorough understanding of audit procedures and know how to disguise their fraudulent activities in company financials. One of the most popular tactics is to set up a shell company that is paid through a consulting deal with the company being looted. It’s difficult to quantify whether consulting or other services have been rendered.

 

  CPAs performing accounting services for a company, including preparing a company’s financial statement, may identify signs of possible fraud, such as vendors or other entities that the company has paid but that list post office boxes as their addresses.

 

  CPAs who encounter suspicious transactions in the financials may determine to ask questions of management and others to find out the crucial details of the deal. Who approved the transaction? What services were rendered or products purchased? What documentation is there to show that the transaction was legitimate?

 

  Organized crime specializes in spotting CPAs and other professionals who have a personal vice, such as a gambling problem, or who are willing to compromise their ethics in certain situations. The criminals then use the threat of exposure or even physical harm to push the professional to act as an inside agent who helps execute and hide illegal activities within the victimized business.

 

Randal A. Wolverton (randal.wolverton@gmail.com) is a retired FBI special agent who owns Randal A. Wolverton CPA LLC in Kansas City, Mo.

 

To comment on this article or to suggest an idea for another article, contact Jeff Drew, senior editor, at jdrew@aicpa.org or 919-402-4056.

 

 

AICPA RESOURCES

 

JofA articles

   

Conferences

 

For more information or to register, go to cpa2biz.com or call the Institute at 888-777-7077.

 

Website

CFF Credential Holder Directory

 

FVS Section and CFF credential

Membership in the Forensic and Valuation Services (FVS) Section provides access to numerous specialized resources in the forensic and valuation services discipline areas, including practice guides, and exclusive member discounts for products and events. Visit the FVS Center at aicpa.org/FVS. Members with a specialization in financial forensics may be interested in applying for the Certified in Financial Forensics (CFF) credential. Information about the CFF credential is available at aicpa.org/CFF.

 

OTHER RESOURCES

 

Federal documents

 

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