In the electronic version of the NYT on May 27, 2016: “Even though Silicon Valley professes to be for free speech — this is where Twitter was invented, after all — the reaction opens a window into the thinking of the digerati, who are becoming more guarded and elusive even as their products make the world more transparent.” A commonly held and disseminated conclusion is that digital technology enhances transparency. This is true in some cases, however those that have practiced in the field of financial investigations can affirm that digital technology can just as easily be used to create a virtual but false set of statements (financial and non-financial) that purports to reflect (economic or other) reality but actually misleads. Financial fraudsters frequently need digital technology to create an intentionally bogus audit trail. Just as firearms can defend or offend, digital technology can inform or misinform; it may be deployed to cause statements and conditions to appear or disappear.

Digital technology enables rapid communication, but the underlying information may be claptrap. Concealment of beneficial owners (i.e., directing wills / minds) and actual business purposes depend on the present infrastructure of legal fictions and digital technology that forms a global bridge across which electronic funds travel under the cover of legitimate commercial activity. See an earlier notice of financial-related crimes with Panama as a hub.

From the same NYT article (accessed May 28, 2016 at 6:45 am ET): “A journalist’s job, at least in theory, is to ask questions and print the truth, which means it is less than loved in citadels of power.” This cynical take on human nature, specifically that of the digerati, presumes that those in power are not fans of truthful reporting. If this is true,….

Available from the NYT website is a Baylor report based on Pepper Hamilton’s investigation and high-level audit of sexual harassment or violence at Baylor. For those eager to become familiar with private investigations and reports, this is a wonderful exemplar of the inputs, process, and output frequently found in such investigations; i.e., private investigations commonly follow the protocol and reporting techniques deployed by Pepper. (See also the Pepper – Penn State inquiry.) Some takeaways include the following:

• Though the report was described as containing findings of fact, there are no individuals identified in the report. Corporate bodies such as Baylor may be legally and financially liable in some cases, but these bodies have yet to get a suntan like many individuals. Some offices and departments within Baylor were listed as having provided witnesses – none of whom were named. Note that the reader has no clear way to assess these factual findings (e.g., are these largely inferences made by experts within Pepper; are these primarily based on personal knowledge of specific individuals; are these facts composites of personal knowledge and professional investigative expertise, etc.) Is the report like an expert report (see FRE R. 702)? Who are the experts (corporate bodies – even LLPs – do not testify in courts of law)? That the report is hearsay (i.e., a set of out-of-court statements) is clear, however would it comprise an exception to the rules disallowing hearsay testimony (see FRE R. 803)?
• Though the report was the result of a high-level audit, there are no standards noted or described from which the reader may obtain an informed understanding of whether the investigation complied with applicable standards (or whether there were no applicable standards). Compare financial and performance audits for which standards are available within the public domain (e.g., the Yellow Book). Just as Baylor did it (or didn’t do it), Pepper investigated it – neither of these corporate bodies have named individuals accountable to independent review in the public domain. That Mr. Starr suffered at least a reputational loss in a public demotion is known, but the reader has an incomplete understanding about the inspection and oversight function at Baylor, except that it failed on some occasions in responding / not responding to allegations against Baylor football players.
• Though the report listed ten pages of (broad and specific) recommendations that were adopted by Baylor’s board, the reader has no way of assessing whether many or most of these recommendations are essential, except to hold the presumption that all of them are essential. The reader is left to contemplate in the dark about the likely effects of these recommendations. No mention is made of Pepper or the board having done or considered a cost-benefit analysis of these proposed and adopted recommendations (cf. the recent brouhaha over the SEC and cost-benefit analysis). Thus, the reader is left to believe that the failures of the inspection and oversight function were as a result of deficiencies in design and implementation of internal controls that are readily achievable. What were the root causes of such failures? What are the standards against which to assess these adopted recommendations? Who will conduct follow-up audits of the agreed upon adoption of the recommendations to provide assurance they have been met; the same committees that failed previously?

These are only some takeaways. Under fair disclosure, I have participated in the preparation and review of such private sector investigative reports, and it may be true that I know one or more of the individuals that prepared the report / participated in the investigation (just speculating…). Some key items that would assist the reader that must rely on disclosures in the public domain for his/her understanding (though Baylor includes important detail on its website) because he/she is not an insider can include the following:

1. A copy of the engagement letter, including proposed and accepted budgets and schedules / deadlines for completing the investigation / high-level audit, between Baylor and Pepper;
2. A copy of the documents requested and reviewed;
3. A copy of the witnesses whose statements were obtained (including whether particular individuals were interviewed more than once);
4. A copy of all of the detailed invoices from Pepper to Baylor, including whether third parties were hired by either party to assist in the investigation / audit;
5. A copy of all preliminary reports prepared by Pepper, including all emails and other correspondences between Baylor and Pepper relating to the investigation / audit….

Are all of these steps necessary? Are they sufficient? Will the outsider get these documents? Of course, not. However, investigations and audits, especially those for which standards, underlying evidence, specific processes, etc. are not clearly disclosed, may be subject to investigators and auditors reaching conclusions that they are expected to reach (cf. publication bias). Actual and potential biases demand exploration according to transparent standards, disclosures of key evidence, specific identification of individuals’ conduct, etc. such that an impartial review of the report and its supporting exhibits would persuade reasonable individuals unfamiliar with the case of the veracity and usefulness of its findings and recommendations.

Addendum: Note that investigative standards exist for the inspectors general. See the AIG and CIGIE.

Per the NYT of May 23, 2016: “There is an entire industry that exists to provide lines of credit to lawyers working on contingency. There is also a small netherworld of investors who back certain lawsuits.” This may be acceptable in U.S. courts (as it may be in other jurisdictions’ courts like Australia). Financing is not consistently and uniformly transparent within and across jurisdictions (e.g., the Panama Papers scandal). The risk of undisclosed side-agreements, undisclosed principals and beneficiaries, etc. makes informed and intelligent judgment especially difficult for the outsider that needs to rely on searching and researching the public domain for indications of undisclosed and improperly assessed bias.

The definitions of insider and outsider are comparative. There are core insiders (e.g., beneficial owners and board chairpersons), and there are others that are more inside than other groups. For instance, many members of senior management would likely be more inside than lower level managers, who in turn would be more inside than rank-and-file employees (this is a general and not absolute rule, especially where operating divisions control information reported upstream). These concentric circles depicting comparative status and possession of key information are dizzying.

Auditors and other external assessors may be more or less dependent on core insiders (e.g., Marine Corps audit). This raises the question of the usefulness of the attribute of “independence” that is often ascribed to one organization or another (e.g., credit rating agencies) in support of the credibility of its expert opinion. Legal independence (i.e., so-called independent contractors, including management consultants) is dwarfed by real impartiality (i.e., so-called objectivity). Frankly, money talks, as well as the potential for increased (revenue) opportunity from meeting expectations of core insiders, which makes identification of the core insiders so important.

Until transparency gets deeper than identification of corporate bodies and shell companies, information cannot be fully assessed. Contrary to those believing that we live in the age of information, we more frequently live in the fog of data and scarcity of evidence.

Based on a NYT article of May 17, 2016 there soon may be enhanced disclosure in the public domain of an alleged financial fraud storm breaking out over the Covenant House, a nonprofit organization. An NYC department (Youth and Community Development – a public sector agency) is the nominal and immediate victim. However, the ultimate stakeholders are you and me. Three items to consider:

1. The investigation was allegedly triggered by an anonymous complaint to CH’s internal hotline. This is a common catalyst for the detection and reporting of financial crimes, especially fraud. You will likely see both this type of discovery and the not too vigorously reported but highly organized resistance to empowering this type of discovery (beyond lip service) for decades to come. It’s too embarrassing (i.e., both ‘roguish fraud’ and the ‘roguish’ reporting / whistle-blowing of it).
2. The basis for public sector fund reimbursement was allegedly intentionally inflated (i.e., number of individuals served by the nonprofit organization). Incentive structures tend to overwhelm ordinary mortals and their ethics, especially where inspection and oversight is inadequate or sporadic. You will likely see intentional overstatements of bases for reimbursement from independent contractors under public sector contracts for decades to come.
3. The (artificial) person responsible for directing and conducting a follow-on investigation on behalf of the CH boards is a prominent private (proprietary) sector law firm. Whether this investigation will be complete in all material respects is an issue that suspicious and reasonable minds may debate. However, large and prominent proprietary law firms have been fixing and cleaning up after ‘roguish frauds’ for decades, and this pattern should be expected to continue for decades to come. Also, NYC will likely conduct its own investigation. Whether investigations are better done by public sector agencies than private sector persons is also an issue that will survive this particular set of allegations of financial fraud.

In light of the unsurprising nature of these items and their propensity to recur, I could describe the repeating fact-pattern as an inevitable product of human nature, except that it clearly isn’t. Few individuals commit major frauds, and the overwhelming majority of these are preventable and/or timely detectable through robust inspection and oversight. (Fraud may be intentional, but allowing the conditions for its development such as incentive structures not adequately controlled through inspection and oversight might be merely an ‘oversight.’) However, this remedy has a financial cost – a burden and detriment that too many policy- and decision-makers elect not to bear. Austere budgets for inspection and oversight exchange medium- and long-term financial integrity for short-term savings, a swap from which stakeholders such as you and me do not benefit.

From the NYT in May 16, 2016: The China Electronics Standardization Institute reportedly advised that “…as the world connects to the Internet, various forms of attacks and new defensive technologies are ever multiplying, bringing challenges to China’s development of a new digital industry.” Whether considering China’s national interest, Apple’s proprietary interest, or my personal and financial interest, data (and program) protection is two-faced. For example, my security and confidentiality interests can conflict with U.S. national / Apple proprietary interests. As an individual familiar with notices of potential and actual compromises of identity from sources such as financial institutions, payment processors, and the federal government, I am occasionally overwhelmed with the risk of abuse resulting from data (and programs) getting into the wrong hands, especially where they were originally housed with trusted persons (e.g., employers, insurers, etc.) With sensitive personal data (e.g., alleged offenses / crimes) available to anyone with the right key (e.g., PIN), restricting the definition of the right key is essential.

Of course, making my digital defense impregnable entails walling off others’ interests and digital capacities, including the U.S. and Apple. Where governance and policy are shared among the governors, managers, and other interested persons, there should be trade-offs and reasoned and fair compromises (e.g., allegations of threats to national security must be more than routine and unsubstantiated cover). How are these conflicts mediated (cf. FISA court)? Issues disclosed under scandals such as the Panama Papers exemplify that inspection and oversight on a global basis is less than satisfactory (cf. EU data protection).

The hacking criminals are conspiracies among digital guerillas of international and domestic sources. They may be winning.

A helpful introduction to civil asset forfeiture can be surveyed in the NYT of Oct. 25, 2014. Potential and actual abuse of this legal tool were well highlighted and documented in the Institute for Justice’s Policing for Profit report from Nov. 10, 2015, and attempted federal remedies can be discovered, including H.R. 5212 (113th). Where financial shenanigans are suspected, even where financial crimes cannot be proven beyond a reasonable doubt, civil asset forfeiture remains a powerful mechanism to challenge unexplained accumulations of assets, including cash deposited at financial institutions, under preponderance of evidence standards, a threshold qualitatively and quantitatively lower than reasonable doubt. Allegations of misconduct alluded to by, among other sources, the Panama Papers become subject to wide-ranging federal and state powers, especially where the asset implicated is the deposit of U.S. dollars.

The search for suspicious cash accumulations becomes significantly more convenient where digital money is required (e.g., where possession of currency such as U.S. dollar bills is prohibited): There is no need for law enforcement to stop and seize physically – instead, submit an order to seize the account at the depository institution virtually. However, digital money can flow nearly instantaneously, so the regulatory surveillance needs to be timely, anticipating transfers. One can readily infer that the existence of undisclosed principals (e.g., shell companies concealing real beneficial owners such as individuals) will only proliferate as the movement to replace paper currency with digital money gains acceptance among key public policy-makers, especially those with fiscal and monetary oversight of major global currencies such as the U.S. (petro) dollar. Creating a legal but fictitious identity remote from legal process is not just for those seeking to avoid bankruptcy.

Recognizing that emerging trends and potent tools create opportunities in the affected disciplines (e.g., law, accounting, fraud examination, etc.), individuals with a long-term perspective (i.e., extending beyond the horizon of graduation from college) should consider that an important set of knowledge, understanding, and skills in support of these opportunities will continue to be focused on the individual’s ability to search through data, make connections, exercise imagination, and prepare tables, graphs, and narratives that summarize not only quantitative elements such as monetary figures traversing the globe but qualitative relationships such as associations among the illegitimate and legitimate fictive legal persons, their facilitators (e.g., intermediaries such as law and accounting firms, financial institutions, brokers, etc.), and the directing mind / will (i.e., the controlling individual).

The formal and published description of JJCCJ’s Forensic Accounting Certificate Program reads as follows: “Forensic accounting is the application of general theories and methodologies of accounting for purpose of resolving financial issues in a legal setting. The Forensic Accounting Certificate provides in-depth learning opportunities to advance students’ knowledge of fraud examination and to develop skills in the use of investigative and analytical techniques to resolve allegations of fraud and other potential white-collar and financial crimes. The certificate provides comprehensive coverage of all types of financial crimes, but concentrates on fraud prevention, fraud detection, fraud investigation and remediation. The types of fraud schemes studied include corruption schemes, asset misappropriation, and fraudulent financial statements.”

The Program provides educational preparation, which is different from experiential learning and on-the-job training, to address the problems attendant to financial crimes, especially fraud. These problems include unjust enrichment; i.e., individuals (and artificial persons) economically and financially benefit from illicit and unethical schemes that deceive victims and obtain their assets without informed consent (cf. extortion). Broadly, accounting is a methodology (quantitative and qualitative) used both to accomplish the wrongful scheme and to prevent / detect / remedy it. Importantly, accounting is a collaborative activity; i.e., there are many individuals involved in doing it (e.g., review and approvals within organizations, inspection and oversight from outside organizations), as well as collective action in setting up the ground rules (e.g., development of generally accepted accounting principles “GAAP”).

There are at least three layers subject to the forensic accounting methodology of inquiry and discovery:

1. The negotiations, agreements, understandings, intentions, caveats, etc. between the party and counterparty (there may be many counterparties): This is economic reality – a construct evidenced by records, recollections, and other data reflective of the preservation of transaction history. In brief, economic reality may be lost, misplaced, or otherwise uncreated (e.g., there are limits to budgets and schedules dedicated to such preparations). A current (alleged) illustration of the divergence between economic reality and represented reality under layer no. 2 below is that suggested under the Panama Papers, where the economic substance of a given set of transactions may be to evade taxation and public exposure of corruption under the false cover of actually conducting meaningful business activities in offshore venues and under offshore jurisdictions. This layer may be buried to protect individuals’ privacy, but it is far from dead (even where the individuals are).
2. The accepted interpretations reported by the party and counterparty: These tend to be mirrored reflections of each other; e.g., one party’s expense is another party’s revenue. However, there are important exceptions (e.g., fair value accounting that allows the reporting of unrealized gains / losses without accompaniment by an actual transaction with a counterparty). Public filings to the SEC are common examples of these interpretations, which are submitted under the overarching guideline of avoiding stating anything materially misleading or omitting something that renders the submission materially misleading. This layer is official reality, which may or may not reflect economic reality under layer no. 1 above. For example, ‘accounting facts’ such as Enron’s earnings per share in a given period may not be factual; these may be later restated as information about improper financial engineering overwhelms the outdated ‘official reality’ of ‘accounting facts.’
3. The reinterpretation performed by the forensic accounting team (there may be many reinterpretations, especially in litigation, which often features battles of experts): A common misperception about forensic accounting is that it depends entirely or even primarily on the actions of accountants. In practice, specialists from other disciplines are helpful, even necessary. For example, consider submission of a medical expense claim by an insured patient. Under layer no. 1 there may be voluminous records and discussions among the individuals responsible for developing the welfare / health care plan. Specialists’ language would be used to distinguish coverable procedures from those not covered. Lawyers, doctors, hospital, pharmaceutical, and insurance administrators, pharmacy benefit managers, actuaries, etc. would contribute to the development of the plan. The result as exchanged among interested parties under layer no. 2 is the plan with its terms and conditions. To many parties, especially patients / claimants without sophisticated legal, medical, and insurance knowledge (read: an overwhelming majority of us), the outcome of whether a procedure is covered and for how much (e.g., reasonable, necessary, customary, etc.) is usually accepted, perhaps grudgingly, notwithstanding the inherent biases in the system (e.g., insurers have a financial interest in limiting losses, medical providers have a financial interest in maximizing revenues, plan sponsors have a financial interest in preserving the assets of the plan, designated claims review team constituents have their own divergent personal and professional financial interests, etc.) that may distort and prejudice the financial interest of the patient / claimant. In brief, inspection and oversight (i.e., checks and balances) within the system may be inadequate in any given case / claim.

Effective inspection and oversight depends on the funding of impartial and competent forensic accounting teams. Independence is neither sufficient nor necessary. Where impartiality is lacking, independence may function as a misleading amplifier of voices that should be countered – not raised. Where competency is lacking, well – don’t need to go there.

According to the NYT of May 12, 2016: “Security experts who have studied the attacks said the thieves probably were lurking inside the bank systems for months before they were detected.” This compilation of expert opinion was directed at fraudulent financial transactions originating inside an unidentified commercial bank that allegedly lost millions of dollars (U.S. dollars?) of its own digital money (not its customers’ digital money!) Thus, it knows the accounts charged (not its customers). It has the audit trail for these electronic thefts by deception (i.e., it has evidence of who did what). However, its internal control systems were not sufficiently robust and redundant to prevent these financial transactions as they occurred under apparently authorized protocols (though the issue as to whether these controls provided “reasonable assurance” will survive this post). The transactions seemed OK at initiation and authorization stages, and they might not have been detected under its review processes until too late (i.e., the digital money was moved from the initial fraudulent transferee to downstream fraudulent transferees – though the soundness of this argument remains to be seen). Let’s hope the bank’s a better custodian of its customers’ digital money than its own.

Compare these instances of corrupt insiders whose credentials were apparently vetted and approved by the principal (i.e., whether the bank as employer of these corrupt employees or the bank as prime contractor of these corrupt independent subcontractors/agents) with the instances of allegedly shady dealings touching the hub of the Panama law firm in the so-called Panama Papers scandal: many of these principals and the actions generating such prodigious amounts of digital funds (U.S. dollars?) were cloaked under the labyrinth of multiple layers of legal fictions spread across the playing field of electronic global finance.

Next Halloween I will be trick-or-treating as the ABC LLC incorporated in Delaware or Nauru – not sure yet. Or I could go as myself, grab handfuls of candies, and run. However, I suppose the strategy offering the greatest return on investment would be to work with a bank – a safe distance from the candy distributors – and absorb whatever digital funds reside in these distributors’ bank accounts and park these under the ownership of some yet-to-named legal fiction in some yet-to-be identified venue while sipping margaritas on a yet-to-be identified beach where it’s way warmer at the end of October than here in the NYC metropolitan area? Or maybe in the woods of Vermont?

From the NYT Jan. 28, 2016: “Wall Street is a big favor bank,” said John C. Coffee Jr., a professor and expert in securities law at Columbia Law School. “There’s a culture of reciprocity.” Exchange transactions characterize markets. Creative minds with adequate social intelligence comb and expand their networks, perceiving an informational advantage – whether illusory or real (and likely not caring either way) – to manipulate outcomes (i.e., gain and profit) through well-timed sell then buy / buy then sell means and methods. The winners are often celebrated in popular media; the losers deduct their losses. Who would have thought that ‘you scratch my back, I’ll scratch yours’ would lead to financial shenanigans?

From the same article Professor Hazen reportedly said “I’d hope the court would go even further and say, if someone is giving you a tip or valuable information, then the presumption is they’re getting something in return,” he said. “It may just by a psychic benefit, but that should be enough. You shouldn’t have to prove an immediate tangible benefit.” I wonder when this reasoning will apply to political campaign contributions? (Dis)honest services fraud?

The ways that friends know things about one another, the ways that teenagers know the unspoken aspirations and concealed intentions of others, the ways that young children know languages, the ways that skilled psychoanalysts know of patients’ ills, etc. – these are different from the proofs offered by prosecutors and developed by investigators in fraud cases. There is an important set of unwritten rules at play here. Demonstrating that the person of interest knew of the wrongfulness of his/her actions, that he/she knew of the key data and evidence weighing against the asserted honesty of his/her intentions, that he/she knew of the laws and regulations governing the transaction(s) at issue, etc. – these circumstances of the person of interest may be known by those in his/her immediate peer group and those that have frequent contact with the person of interest in the same way that students know their teachers, teenagers know their parents, faculty members know their colleagues, etc. This explains in part why the quanta of fraud developed and proven by investigators and prosecutors are dwarfed by the quanta of fraud occurring under their jurisdictions. Often, the experts’ means of knowing for forensic purposes is deficient to capture many frauds, especially those insulated under numerous layers of review and approval.

Training and education in fraud examination are necessary, but they are not sufficient. The highly educated and refined individual may fit in well with marketing and business development; he/she may be expert in the preparation of spreadsheets and use of reports from databases; he/she may be savvy in executing earnings calls and fielding the usual questions from the media, but these individuals may have buried over and lost use of the ways of knowing honed in the informal brainstorming that occurs routinely in growing up, choosing whom to be friends with, etc. More importantly, the gatekeepers may also have misplaced these means and methods.

As in money laundering – there are the deposit, layering, and integration processes in fraud development and execution. Often, the fraudulently inspired effects commingle with the legitimate effects such that the investigator and prosecutor cannot separate out these components any longer. This is why sometimes individuals imaginatively steeped in the meaning of Andersen’s ‘New Clothes’ may know more about fraud than individuals overly trained in Andersen’s ‘Financial Auditing.’ Sometimes, you have to be pretty smart in the old ways just to see what’s in front of you, hidden by the fog and smog.