Financial Fraud

1. October 3, 2019 How to Identify and address Fraud By Geoff Sheldon EA and Sean Malone CPA, MBA Financial Fraud

2. Geoff Sheldon 42 years with the Internal Revenue Service Special Enforcement Program (Fraud) Manager 12 years Small Business Program Manager 12 years Senior Commissioner’s Representative Southern California Qualified as Expert in Tax for Federal District Court and Tax Court Prosecutions for Title 18 (Money Laundering), Title 31 (Bank Secrecy Act), and Title 26 (Income Tax) Curriculum Vitae-Course of your Life

3. Sean Malone CPA, MBA Internal Revenue Agent- Small Business 7 years Traced money laundering and transferring pricing through foreign bank accounts Developed civil fraud cases for pocket corporation against CPA Unwound fraudulent pension and employee classification case Created audit strategies for creative tax accountant under 6700 investigation Developed civil fraud case on auto body repair business on specific items Curriculum Vitae-Course of your Life

4. Disclaimers We are going to present our take on financial fraud as former Internal Revenue Service Agents We have seen the worst of society so our sense of humor is twisted If you have a viewpoint that fraud does not exist in the world, this presentation is not for you. Please come back in two hours. We suggest visiting the Planes of Fame Museum 14998 Cal Aero Drive, Chino, CA 91710 Or Alternatively The Crossroads Marketplace 13111 Peyton Dr. Chino Hills CA 91709

5. Financial Fraud: What’s Our Objective? Think like a Crook! Do not act like a crook! ADD A FOOTER

6. Prison is not fun There is no club fed. Federal prison sentences are only commuted by 15% for good behavior. You could be cell mates with anyone no matter their rap sheet. Do not do the crime if you cannot do the time. https://www.nolo.com/legal-encyclopedia/how-much-time-off-good-behavior-federal-prison.html https://www.cracked.com/personal-experiences-1256-7-horrifying-things-you-didnt-want-to-know-about-prison.html ADD A FOOTER

7. Prison is not fun Prison food is terrible i.e. nutraloaf (several kinds of food blended together into a flavorless loaf). 6 by 8 feet is a small amount of space to spend your life in. Prisoners get a limited number of visits per month. Large percentage of prisoners are violent offenders. Most prisoners are in their cells for 18 hours a day. Having a record and losing your freedom is never worth it https://www.nolo.com/legal-encyclopedia/how-much-time-off-good-behavior-federal-prison.html https://www.cracked.com/personal-experiences-1256-7-horrifying-things-you-didnt-want-to-know-about-prison.html ADD A FOOTER

8. Prison is not fun-Hostile Takeover • Geoff had a conviction of a tax preparer who served their sentence in chowchilla state prison • Might makes right in prisons • She wanted to upset the current prisoner hierarchy and become the top boss • The existing powers that be crushed the coup d’etat • She spent a month in the ICU and a few months in the hospital recovering https://www.nolo.com/legal-encyclopedia/how-much-time-off-good-behavior-federal-prison.html https://www.cracked.com/personal-experiences-1256-7-horrifying-things-you-didnt-want-to-know-about-prison.html ADD A FOOTER

9. Fraud • Intentional falsehood in order to induce another to part with something of value or surrender a legal right • Loss of funds from fraud is a strain on colleges • Fraud impairs trust in our institutions • Education Fraud Title 20 USC 1097 (a) ADD A FOOTER

10. Detection of fraud? • Please ask questions and comments as we go along so we can make this interactive • Is the detection of fraud part of any one’s job? • Who has discovered some sort of fraud in the course of their employment? • We want to teach you to think like a crook ADD A FOOTER

11. Bad Bob • Former IRS agent and his son charged with 201 felonies • Bob’s son ran the accounting company helping in scheme • Accepting bribes from one the largest farmers in the Imperial Valley and money Laundering • Bob was a 30 year IRS employee • Single Largest bribery case in history IRS of $600,000 in bribes • https://www.latimes.com/archives/la-xpm-1991-05-09-mn-1962-story.html • https://www.upi.com/Archives/1992/04/14/Farmer-charged-in-one-of-the-IRSs-largest-cases/7692703224000/ ADD A FOOTER

12. Bad Bob • Bob helped Mario deduct personal expenses as business expenses • Created ghost employees to deduct moving profits out of his agricultural companies • Mario Saikhon dodged $30 million in taxes • Bribery ran from the late 1970’s to the early 1990’s • Bob was sentenced to 12 years in prison • Mario died in prison of cancer after serving nine months • Bob was released after serving 12 years in Federal prison • https://www.orlandosentinel.com/news/os-xpm-1993-03-25-9303240425-story.html ADD A FOOTER

13. Bad Bob • l ADD A FOOTER

14. Restaurant Owner Story • l • IRS agent(in training) went out to do audit of a restaurant owner in a nice part of San Diego • During the initial interview the owner states I am in trouble, you caught me • Restaurant owner had three restaurants • He reported the least successful restaurant on his income tax return • The other two (more profitable) restaurants he deposited the income and did not report it • Is this fraud? ADD A FOOTER

15. Restaurant Owner Story • l • IRS agent (in training) thought this was a misstatement of income but not fraud • The auditor has to suspect there is fraud to invest the proper amount of time, energy and resources to properly document the suspicious activity • No one wants to be the one to cry wolf • Review, document and investigate then make a determination • Take the appropriate action of referring fraud or fixing negligence ADD A FOOTER

16. What is Fraud? • How do we determine what is fraud? • You will know fraud when you see it. • Which one of the following examples is fraud? • Which one of the following examples is negligence? • Why? ADD A FOOTER

17. What is Fraud Example #1 • Example #1 Bookkeeper for a business adding checks to deposit into the business checking account. • The bookkeeper gets a total of $148,235. • The correct total of checks to deposit is $184,235 • Was this fraud? • Was it negligence? ADD A FOOTER

18. What is Fraud Example #2 • Example #2 A Bookkeeper for a business adding checks to deposit into the business checking account. Bookkeeper pulls a few checks to cash at their friendly local check cashing place to keep. • The new deposit total is $123,235. • The correct total of checks to deposit is $184,235. • Was this fraud? • Was it negligence? ADD A FOOTER

19. What is Fraud? • Example #2 is fraud because of the taking of $61,000. The bookkeeper was defrauding the business owner. It was not an accident. • Example #1 is negligence in understating sales $36,000 from an accidental miskey • The difference is intent • As auditors we have to document to show intent ADD A FOOTER

20. Proving Fraud • How to prove fraud and intent? • Ask the six questions about the situation (Who, what, when, where, why, how)? • Answer the questions by interviewing the relevant people • Ask, look and follow the money • Document relevant transaction and details with supporting documentation ADD A FOOTER

21. What makes a Crook? • Stress- Something has to drive the individual to take actions outside of their normal course of life • Financial (Debts, gambling issues, medical bills, • divorce/child support) • Revenge ( Overlooked for promotions, wronged by • organization) • Romance (Support for higher lifestyle or keeping partner) ADD A FOOTER

22. What makes a Crook? • Opening- There has to be a option for the individual to take advantage of • Power- Their status in the organization allows them • access or paths others do not have • Weak Controls- They notice a weakness the organization • does not know about or fails to monitor • Indoctrination- Can you keep quiet and make some extra • money? ADD A FOOTER

23. What makes a Crook? • Justifying- How does the fraudster square their actions with their internal code? • They need to act to satisfy higher loyalties (Family, • romantic partners, friends) • Their actions are not the same as well known crimes • Displace responsibility-everyone does, it was outside my control • Denial of the victim- they owe me, it’s me or them • Denial of the crime- no one will notice, I will pay it back ADD A FOOTER

24. Soccer Player • Tax compliance officer (TCO) was auditing an international soccer player who played in England • Asked tax preparer if they had any foreign bank accounts. • “No just bank accounts in the US” • Does anyone see a problem? • Do not accept the answer you are given at face value • Make sure you get all perspectives and angles on suspicious activity ADD A FOOTER

25. Think like a Crook? • What has a high value that no one will notice (for a while) when its gone? • What has a high value that can easily disappear? • What numbers/transactions can be changed without approval that will benefit my bank account? • Does anyone approve or review these transactions? • Can the tracks be covered up? • Will they notice? ADD A FOOTER

26. Think like a Crook? • Is there opportunity to influence the winning bidder on this contract? • Can this insurance claim be increased and redirected? • Make straw student’s and get financial aid for them? • Falsely lower my income to increase my financial aid? • Submit false tax returns to get more financial aid? • Substitute material B for material A and save $5 per unit? • Push this $35K change order through that isn’t needed? • The moral is the ability to think like a crook doesn’t mean you should become one ADD A FOOTER

27. False Supplier • Wilfred Sebastian Jobin Reyes was a Seaworld manager in charge of decorating the park for seasons or holidays • Wilfred created a fake supplier company called “SJ Merchandise” • Wilfred would create invoices for disposable decorations • Items included “Wildlife bookmarks”, “Sea Creature rings”, “Purple Shiny Ornaments” • Wilfred created an alias John Caldwell and a dummy email account to correspond with Seaworld • Wilfred used his management position with • Seaworldto approve the invoices • https://www.cbs8.com/article/news/former-seaworld-manager-gets-prison-time-for-fraud/509-e3a47ebf-f503-40cb-aab7-6e8e97328aa2 ADD A FOOTER

28. False Supplier • Wilfred used his work computer to generate the false invoices • He submitted invoices under 10K limit which would require further review and approval • He used his fake company to claim fake expenses on his schedule C tax return • He underpaid his taxes by 200K for 2010-2014 • Willfred stole his friends identity to open business bank accounts and credit cards • He used those accounts to receive the payments from • Sea World ADD A FOOTER

29. False Supplier • The false supplier company went on for eight years • Wilfred was sentenced to 30 months in jail • Damages to Seaworld were $818,000 • He charged $177,000 on the business credit cards from the identity theft accounts • https://www.justice.gov/usao-sdca/pr/seaworld-manager-sentenced-30-months-prison-stealing-more-1-million ADD A FOOTER

30. Signs you have a Fraudster • l • Their lifestyle does not match up to their salary • They claim files and data reports are destroyed • They do not want anyone reviewing their work or backing them up • They never want to go on vacation • They have close personal relationships to suppliers that always win • Their story and backstory do not add up https://www.itbusinessedge.com/slideshows/show.aspx?c=93089&slide=12 ADD A FOOTER

31. What can we do to prevent fraud? • l • Monitor the tone at the top of the organization • Establish a code of conduct for the organization-train employees to do the right thing • Enforce and monitor compliance with the code of conduct limiting bad behavior prevents it from spreading and growing • Make sure the code is promoted and followed by the top of the organization to the bottom • Shred sensitive information • Use two factor authentication to prevent unauthorized access ADD A FOOTER

32. What can we do to prevent fraud? • l • Create a positive environment where issues are welcomed and addressed • When higher ups ignore or belittle small issues they grow and compound • Create an anonymous ethics hotline and message account so tips can be brought forward • Protect whistleblowers to ensure tips and alerts come to Internal Audit • Positive work environments with fair compensation create less incentive for fraud ADD A FOOTER

33. What can we do to prevent fraud? • l • Review separation of duties annually and implement changes • Review unexplained accounting entries, large cash payments, transactions with inadequate records • Review reconciliations of inventory and funds • Review control weaknesses and make improvements to address them • Train staff about phishing and social engineering attempts to protect personally identifiable information (PII) ADD A FOOTER

34. Auditing Sponge Bob • l • You will not be able to predict where audits are leading to • One of Geoff’s taxpayer’s address was 32.71, -117.95 • They claimed to live in the country of Oceania • Taxpayer went to US tax court claiming they never received notice • The US government asked to setup a time to meet the taxpayer at 32.71, -117.95 • The taxpayer conceded it was the Pacific Ocean • and not a country ADD A FOOTER

35. Inconspicuous Fraudster • l • One of Sean’s cases involved taxpayers living in mobile homes in a less desirable San Diego County neighborhood • The taxpayers had an eighth grade education • Found they had a ridiculous number of custom declarations coming into the US with knock off Tupperware • Summonsed bank accounts, check cashing places, currency exchanges and made an international attaché request to SAT in Mexico ADD A FOOTER

36. Inconspicuous Fraudster • l • They had unreported net income of $300K per year from swap meet sales • They owned a company in Mexico manufacturing knock off Tupperware • They did not report income in Mexico or the USA • Applied civil fraud penalties, FBAR penalties and shared information with SAT in Mexico • They had a modest lifestyle which disguised their income • Do not just scratch the surface ADD A FOOTER

37. Expect the unexpected • l • Humans are unpredictable and make our job interesting • You have to be flexible and ready to adapt to circumstances • Keeping good interview notes will help you frame the situation • Confusion and disinformation is a fraudster’s friend • Explore all the angles and keep to the facts • It’s not what you know it’s what you can prove ADD A FOOTER

38. Construction Fraud • l • Construction is vulnerable to fraud because of the dollar volume, variety of suppliers, and different subcontractors • Project fraud can be committed by a variety of people (suppliers, contractors, employees) • Construction fraud increases the cost of building facilities and costs to the educational institution ADD A FOOTER

39. Construction Fraud • Change orders have the potential for abuse because they have less review and documentation than the original project • When change orders are made they need to be tracked, documented and reviewed by construction, facilities and business offices. • A construction project’s schedule of values needs to be updated for each change order. This allows the projects total costs to be accounted for. • Change orders need to be specific calling out the additional work and signed by the college’s representative and contractor. • l ADD A FOOTER

40. Construction Fraud • Bid rigging is when contractors collude to stifle free market completion • The contractors meet in advance of the bid and decide who will be the “low” bidder for this project. The companies take turns being the “low” bidder for developments. The non-winning companies may not submit bids or provide uncompetitive bids. • Bid suppression has competitors withdraw their bid for a payoff or a subcontract • Complementary bidding is when competitors submit obviously high bids or missing critical components of the project • Bid rigging is a felony in the United States • l ADD A FOOTER

41. Preventing Bid Rigging • Expand the list of bidders to as many suppliers as possible. The more suppliers the harder it is to control the market • Require contractors to sign and submit a non-collusion affidavit stating the bidder has not colluded and inform them of the penalties • Ensure purchasing departments are familiar with indicators of bid rigging • Maintain an extensive procurement record history to show a pattern of bid allocation • Ask questions and learn about the industries in which are major impacts to your projects • l ADD A FOOTER

42. Financial Aid Fraud • Misrepresentation of income on FAFSA • By lowering their income increase the applicant’s aid • Request three years of tax returns from the IRS • Compare the income and deduction lines year to year • What changes? What are the patterns? • Is there underreporting of income occurring? • l ADD A FOOTER

43. Financial Aid Fraud • Ensure the tax returns you are reviewing are from the IRS • Does self employment income dry up ? • Does dividend, interest and investment income disappear ? • Look for round numbers • Does the overall income picture match their bank statements ? • Does their reported income support their lifestyle? • l ADD A FOOTER

44. Financial Aid Fraud • Does the applicant’s situation fit the documents? • Are multiple applications coming from the same address, same phone number, same email address, same bank account? • Is the applicant well versed in the school’s financial aid procedures? • Is one phone number on multiple student accounts? • Are they constantly inquiring on their aid? • l ADD A FOOTER

45. Financial Aid Fraud • Ensure financial aid staff receive training • Audit financial aid staff to make sure documents are being thoroughly reviewed • If documents are suspicious request additional information and refer to supervisor or internal audit for further review • Require them to show up in person with a government issued ID (photocopy it) and execute a statement of educational purpose with a notary • Run checks on identities if similarities of addresses, phone number or emails are found • Once something is found document and refer it • l ADD A FOOTER

46. Pell Grant Rings • Maximum Pell Grant 2019-2020 is $6,195 • Tuition 2019-2020 is $1,580 • Opportunity per Pell grant is $4,615 • Pocket that money, flunk out and • keep going twelve semesters • l https://www.chronicle.com/article/Education-Department-Chases/128821 ADD A FOOTER

47. Pell Grant Rings • One of our member institutions was recently hit • 3 individuals charged with conspiracy, wire fraud and mail fraud • Used SSN and identifying information to file applications for federal student aid • 235 fake straw students never went to class usually stolen identities • Total loss was around 1 million • Was found from reported stolen identities • l https://ktla.com/2019/06/27/3-san-bernardino-county-women-stole-more-than-1-million-in-student-aid-for-students-who-didnt-go-to-school-doj/ ADD A FOOTER

48. Pell Grant Rings • Watch out for straw students • Review students academic progress each term • Disburse grants in multiple parts • Report the individual to the OIG for Dept. of Education • Put a hold on student records • Alert other colleges of the individual • Put them in COTOP (Chancellor's Office Tax Offset Program) • l https://www.chronicle.com/article/Education-Department-Chases/128821 ADD A FOOTER

49. What to do when you find something? • Document, document, document • Office of Inspector General US Dept. of Education • Long Beach 562-980-4141 • Sacramento 916-930-2388 • Local district attorney/Local US attorney • Local police/sheriff’s authority financial crimes unit • Form 3949 IRS (Failure to pay tax/Unreported Income) • l ADD A FOOTER https://www.irs.gov/pub/irs-pdf/f3949a.pdf

50. THANK YOU! Geoff Sheldon, E.A. & Sean Malone, CPA MBA