The truth always comes out. 13 is a very interesting number.
The truth always comes out. 13 is a very interesting number.
“It ought to be remembered that there is nothing more difficult to take in hand, more perilous to conduct, or more uncertain in its success, than to take the lead in the introduction of a new order of things” – Niccoló Machiavelli, The Prince
Fraud Friday is coming to you from the long & winding road this week. Accompanying the lovely & talented spouse to a corporate awards event & enjoying a brief respite from the deep freeze of the Central Plains has been a much-needed change of pace.
However, there is no escaping the increasingly-chaotic situation brought about by the recent sweeping changes to the federal tax code. We’ll focus on the implications for increased tax fraud & the deterioration of enforcement capabilities on the part of the regulatory agencies (aka the IRS).
As most of you are surely aware, Congress passed H.R. 1, the Tax Cuts & Jobs Act in late December of last year. While this blog assiduously attempts to avoid discussing the overt political aspects of the legal & regulatory environment, a couple of key developments pertain specifically to those of us in the compliance and investigative universes:
1) Loopholes in loopholes inside loopholes that also contain loopholes
Look, I am FAR from being an expert on tax structuring/avoidance, but minds far greater than mine have pointed out how the new legislation contains enough vague, opaque language to provide decades of billable hours to the tax nerds:
Of particular concern is the potential for clever manipulation of individual earned income into lower tax rates by creating what are essentially one-person corporations. As explained by Vox:
‘Under the new law, the top ordinary rate on labor income will be much higher than the top rate on corporate income. As a result, many taxpayers will be able to shield a portion of their labor income from tax by setting up a corporation. So Joe Smith, previously an assistant account director for a PR firm, can become Joe Smith, Inc., a new startup company! The firm makes payments to the new corporation instead of to Smith. Thus, Smith shields his labor income from the higher individual tax rate.
The IRS might investigate whether the new corporation pays Smith a reasonable fee for his services, which some tax-law precedents suggest it is obliged to. That’s one check against this tax dodge, and there could be others. But how many new corporations can the IRS investigate? And if Smith can find a few friends to join his new corporation, it will be even harder for the IRS to challenge.” Which brings us to our second point:
2) The IRS is Hosed
It’s no secret that there has been an exodus of the IRS workforce over the past several years. And who can blame them? Years of significant budget cuts, failure to recruit new talent, and a seemingly infinite supply of political contempt for the entity that administers the collection of the vast majority of federal funds.
Predictably, the enforcement rate has plummeted, and academics and tax experts generally agree that the “rate of non-compliance” (i.e. tax cheating) is under-estimated, because it’s common sense that many people who cheat won’t volunteer that information on a survey, and enforcement actions against non-compliers by definition clearly don’t capture the full picture of tax cheating. As for that dreaded staple of American life, the audit, rates have never been lower. From CNBC:
‘The number of people audited by the IRS in 2016 dropped for the sixth straight year, to just over 1 million. The last time so few people were audited was 2004. Since then, the U.S. has added about 30 million people.
The IRS blames budget cuts as money for the agency shrunk from $12.2 billion in 2010 to $11.2 billion last year. Over that period, the agency has lost more than 17,000 employees, including nearly 7,000 enforcement agents. A little more than 80,000 people work at the IRS.
IRS Commissioner John Koskinen said budget cuts are costing the federal government between $4 billion and $8 billion a year in uncollected taxes.
‘We are the only agency if you give us more people and money, we give you more money back,’ Koskinen said in an interview.”
3) Which leads to Some Unsettling Possible Societal Outcomes
Besides the obvious fact that in order to function, the US gov’t requires revenue, there are additional sociological implications to a steady erosion in the willingness of the populace to pay what they owe. Income taxes are unlike many other forms of taxation in that they rely to a large degree on the voluntary compliance of taxpayers. As that obligation becomes less ingrained in the American psyche, questions arise about long-term societal stability and the underlying fundamental assumptions of our Republic: https://www.vice.com/en_us/article/d33daz/dont-look-now-but-americas-tax-system-may-collapse-soon
It will be certainly be interesting and scary to see how this plays out over the next several years.
Gotta go with a couple of classics on this one. Topically appropriate: “You know where you are? you’re in the jungle, baby! And you gonna die!”
Norman Love Confections. While in Southwest Florida this week, we visited this shop on the urgent recommendation of our Über driver, and we are quite glad we did. All manner of indescribably delicious confections that are also miniature works of art. The chocolate alligator looked absolutely real! A must-visit if you’re in the Ft. Myers/Na-les area, and they ship worldwide.
Until next time, keep up the good fight!
Happy Friday! We’re currently working on a post about the practical, legal, and financial considerations surrounding employee theft cases, how to avoid them, and how to deal with them if you are unfortunate enough to have one crash-land in your universe. As noted philosopher Jeffrey Lebowski once said, “Lotta ins. Lotta outs. Lotta what-have-yous.” It’s a complicated subject, and there’s much to discuss.
So, while we work on that post (and do our day job(s)), we have news of a KPMG executive arrested for quite literally “stealing the exam”, which (allegedly) facilitated numerous subsequent malfeasances. Via the Atlanta Journal-Constitution:
A former leader at one of the world’s largest accounting firms was arrested on Monday as part of a sweeping fraud investigation, according to the Department of Justice.
David Middendorf, of Marietta, was one of six people charged and was the head of KPMG’s Department of Professional Practice, which oversees the training and internal/external quality control of auditing.
Others charged in the indictment reported to Middendorf, including those he allegedly helped hire away from an organization that inspects KPMG. And, as prosecutors allege, a couple of those hires upon their departure downloaded confidential information about what parts of the Big 4 firm would be inspected by that oversight group.
Having that information on which areas would be targeted by inspectors allowed KPMG to clean them up in advance, essentially making inspections useless.
Brian Sweet was an associate director at the Public Company Accounting Oversight Board, or PCAOB, before he was hired away by KPMG.
The PCAOB is a nonprofit with oversight from the Securities and Exchange Commission created after Congress passed the Sarbanes-Oxley Act of 2002, which increased scrutiny on corporations and their financial disclosures, the indictment explains.
Sweet pleaded guilty of giving PCAOB documents to KPMG and acting as a conduit to alert the accounting firm of where they’d be inspected. According to the Justice Department, Sweet has decided to cooperate with prosecutors.
“As alleged, these accountants engaged in shocking misconduct — literally stealing the exam — in an effort to interfere with the PCAOB’s ability to detect audit deficiencies at KPMG,” said Steven Peikin, co-director of the SEC’s Enforcement Division. “The PCAOB inspections program is meant to assess whether firms are cutting corners, compromising their independence, or otherwise falling short in their responsibilities.”
Middendorf allegdly used the information to make business decisions and moved resources around to be most efficent knowing what parts of of the company would and wouldn’t be inspected.
“He’s a career professional in the public accounting business. He’s dedicated his life to KPMG and intends to defend himself,” Middendorf’s attorney Gregory Bruch told The Atlanta Journal-Constitution on Wednesday. Middendorf, 53, faces a maximum sentence of 85 years, the Justice Department said.
The years of allegedly gaming the system was pre-empted by one bad year. KPMG got dinged about 2014 with twice as many negative comments by the PCAOB compared to its competitors. To improve their image after that year, KPMG promised bonsuses to teams that performed well when it came time for inspection by the PCAOB. So, “in an effort spearheaded by David Middendorf and Thomas Whittle,” they started in July 2014 to hire Brian Sweet away from the PCAOB to KPMG. Sweet interviewed with Middendorf and others and was offered a job in April 2015. Shortly before his last day at the PCAOB, “Sweet copied various confidential documents from the PCAOB internal newtork” onto a hard drive and took physical papers, the indictment said. Included in what he took was a list of specific divisions PCAOB was planning to inspect at KPMG, which he was asked about during a lunch with Middendorf in his first week at the firm.
Later that week, Middendorf “told Sweet to remember where Sweet’s paycheck came from and to be loyal to KPMG,” according to the indictment.
Days after, Whittle pulled the new employee aside and told him that “he was most valuable to KPMG at that moment and would soon be less valuable,” the indictment said.
Later that day, Whittle emailed Middendorf the list of inspection targets. “The complete list. Obviously, very sensitive. We will not broadcast this,” Whittle wrote, according to the indictment. At the request of his new bosses, Sweet also reached back out to folks at the PCAOB to see what at KPMG was slated for inspection and relayed that back to his bosses. According to the indictment, Sweet recruited Cynthia Holder, a PCAOB employee tasked with inspecting KPMG. Prosecutors allege that while she was being recruited, she would get documents that Sweet requested. Holder was eventually hired and allegedly copied PCAOB documents onto a flash drive.
And like Sweet did with Holder, she kept in touch with a PCAOB employee who funneled her information for 2016 and 2017 inspsections, which was forwarded to Middendorf, the indictment said. Middendorf then ordered “stealth” re-reviews of departments that were set to be inspected, according to the indictment.
In February 2017, Sweet told a high-ranking employee that their group would be inspected by PCAOB. That employee reported the conversation to the KPMG general counsel on Feb. 13, 2017. Middendorf “was separated” from KPMG in April 2017, the indictment said. “These defendants were each meant to be the watchmen of our financial system,” said Manhattan U.S. Attorney Geoffrey S. Berman. He continued: “The defendants who formerly worked for KPMG were vested with the responsibility to audit publicly filed financial statements and issue audit opinions relied upon by the investing public. The defendants who formerly worked for the PCAOB were supposed to help ensure the quality of the work behind those audits. But, as alleged, these defendants chose to cheat the system and to undermine the safeguards put in place to protect investors.”
The revolving door is nothing new, nor in any way exclusive to the PCAOB and the large public accounting firms. In fact, the European Finance Association published (academic access or purchase required) a 2016 study that found a nearly 25% increase in direct hires from financial regulatory agencies and, more importantly, a SIGNIFICANT change in regulated firm managerial strategy immediately following the hire. From the abstract:
The number of top executives with regulatory experience per firm has increased 24% over 2001–15, and hiring is associated with positive average announcement returns and a salary premium. In the quarter after hire, market and balance sheet measures of firm risk decrease significantly and measures of risk management activity increase, especially for hires from prudential regulators, who directly monitor financial firm risk. The absence of this result for unregulated firms and for exogenous shocks to regulatory experience suggests that firms hire ex-employees of their regulators when they perceive a need to reduce risk, consistent with a schooling hypothesis. (Emphasis added)
The KPMG/Sweet/Middendorf case might appear to be an extreme example of revolving-door malfeasance between the regulator and the regulated, but anecdotal evidence points to a higher incidence of such behavior than even pessimistic industry observers estimate. It will be very interesting to see how this plays out for KPMG and the public accounting industry as a whole.
Music Recommendation: Nigel Stanford, Automatica. cool song and a *spectacular* video from late last year. I, for one, welcome our new robot overlords. Worth watching in 4K HD: https://www.youtube.com/watch?v=bAdqazixuRY
Food Recommendation: Caramel apple fried empanada at Taco Bell. DON’T JUDGE ME! Besides, how do you know I’m not one of the Belluminati? Hint: I’m not.
The views of the author are his alone. Any similarity to real tacos, living or dead, is purely coincidental.
Welcome back, fellow believers in Objective Facts, Truth, Justice, and the
Norweigan American Way.* We’re less than three weeks into the new year, and 2018 is already showing signs of being another banner year for financial fraud schemes, collusion, and general white-collar malfeasance. But first, let’s recap on some of 2017’s greatest hits:
“According to the SEC complaint, Woodbridge Group offered investors, many of them seniors, interests in commercial real estate loans made to third parties. The company said these loans were short-term financing with interest rates of 11 to 15 percent, the SEC said. This is generally known as ‘hard money’ lending.
The SEC alleged that these loans were not actually made to third parties, but to Shapiro-owned companies that had no income and never made payments on the loans. The complaint alleged that Shapiro and Woodbridge used investors’ money to pay other investors; paid $64.5 million in commission to sales agents; and diverted $21 million for Shapiro’s personal use, including for charter planes, country club fees, luxury vehicles and jewelry.
Our complaint alleges that Woodbridge’s business model was a sham,” said Steven Peikin, co-director of the SEC’s Enforcement Division. ‘The only way Woodbridge was able to pay investors their dividends and interest payments was through the constant infusion of new investor money.’”
The Paradise Papers, released by the ICIJ in November, were a jaw-dropping and startlingly comprehensive expose of the vastly complex world of offshore banking and how it serves as a global shadow-banking system for the finances of the global elite. We’re talking TRILLIONS of dollars of tax fraud, money-laundering, etc. It’s well worth exploring the high-quality investigative journalism demonstrated by the ICIJ.
“The Department of Health and Human Services Office of Inspector General, state and federal law enforcement executed a massive fraud takedown this month that charged more than 400 defendants in connection with healthcare fraud schemes that involved roughly $1.3 billion in fraudulent billings to government payers including Medicare and Medicaid, the OIG announced.
The takedown is being called the largest in history, both for the number of defendants charged and the amount of money lost, OIG said.
Additionally, OIG issued exclusion notices to 295 doctors, nurses, and other providers related to opioid diversion and abuse. The notices ban participation in or claim submissions to, all Federal healthcare programs.Those who got the notices include 57 doctors, 162 nurses, and 36 pharmacists.”
2018 promises to continue to be at least as surreal as 2017, and until we either get spit out of whatever weird quantum wormhole we’re currently inhabiting, or my doctor gets my medications properly adjusted, we’re bound to have no shortage of material for this year and beyond. Just a few potential sources of financial fraud, in no particular order, are:
P.T. Barnum famously noted that a new sucker is born every minute, and Edward Balleisen’s book Fraud: An American History From Barnum to Madoff is a thoroughly readable and informative primer on the long tradition of ripping off one’s fellow Americans. – Princeton University Press Blog
Fans of the venerable TV series American Greed (that would be all of us, right?), can look forward to a new Netflix documentary, Dirty Money, that promises to be both entertaining and educational. Of particular interest to us here in the Kansas City area is an upcoming episode on convicted payday-loan fraudster Scott Tucker. Tucker, if you don’t know, stole over a billion dollars by running an absolutely deplorable set of online payday lending operations. He tried to hide his operations with a classic straw-man defense in which he claimed the payday lenders were owned by Native American tribes and were thus exempt from most federal lending and usury laws and regulations. It didn’t work, and now he’s staring down 16.5 years in a federal penitentiary. The “money quote’ (sorry, couldn’t resist) from the trailer:
“In the trailer for ‘Dirty Money,’ Tucker is asked whether he is a moral person. ‘I’m a businessperson,’ he responds.
It’s gonna be good!
Music Recommendation: The somewhat-awkwardly-titled live album from The 1975, DH00278 (Live from the O2, London. 16.12.16) is just really, really good. Pop? Punk? Alternative? Rock? White-Boy Funk? – all of the above. Get your groove on…
Food Recommendation: Costco’s Kirkland Signature butter cinnamon loaves. Good God, that stuff is addictive. And we ain’t fancy – Costco is just fine for us humble public servants. It’s worth getting a Costco membership just for this stuff.
See you soon, fellow fraud fans! Hey, if you feel so inclined, give me a follow on Twitter @JustinMcDaid, or connect with me on LinkedIn or Facebook – Justin McDaid
Sorry to have been away so long, but now we’re back just in time for a veritable cornucopia of fraud-related news. Much more to come shortly, and I’m working on some ideas to provide additional in-depth analysis of fraud and internal-control failures both in the public and private sectors. So on to today’s debacle…
The FIFA arrests are top-of-mind for the collective consciousness of much of the world, and boy, they do not disappoint. Rather than rehash them, I’ll just link to this excellent analysis from Screamer, the soccer sub-blog for the sports-related site Deadspin, as well as provide a link to the 176-page indictment document in all its unvarnished glory:
This will be interesting to watch from a legal perspective, to see how the Justice Dept. applies the Foreign Corrupt Practices Act and the Foreign Tort Claims Act to prosecute. Perhaps we’ll try and solicit a guest post from an attorney who can shed additional light on this aspect of the case.
Finally, as we were writing this post, it appears that FIFA President Seth Blatter (awesome supervillain name, btw), has been re-elected to a fifth term, and has essentially become FIFA President-For-Life:
Favorite quote from the Yahoo story, and it is oh-so-true:
“If you grease the skids and take care of the corners then no amount of cries of scandal from the wealthy elite, howls from the media and complaints – or even convictions – of illegal behavior can unseat you.”
More as the case develops. Thanks for reading, and please feel free to suggest topics for future postings!
Now Here’s Some Rock Music:
Today we once again turn our attention to the fascinating world of international money laundering. As I mentioned in a previous post, it’s no secret that in recent years the US government has made a concerted effort to close the Swiss-cheese-like loopholes in both the federal tax and criminal codes that have allowed so many to essentially completely dodge their tax obligations.
However, yesterday a landmark piece of legislation called the Foreign Account Tax Compliance Act (FACTA) took effect that may essentially put an end to the time-honored tradition of stashing your ill-gotten gains/Nazi blood money/FIFA World Cup bribes/despotic-dictator-corruption-skim, etc. in a handy-dandy numbered Swiss account.
This is great news if you’re a law-abiding citizen of the world, or a sovereign government trying to collect taxes that it’s owed, but it may significantly complicate matters for the criminal underworld and big-time tax dodgers. After all, once you steal a billion dollars, you gotta launder a billion dollars. Ask any old-school mafioso or Russian oligarch: Cleaning the money is often more difficult than stealing the money.
Fear Not, Thou Amoral Criminal, New York Real Estate Brokers Have a Solution For This Conundrum:
As detailed by New York Magazine, and referenced by Alison Griswold in today’s Slate, money is flowing into high-end Manhattan real estate transactions faster than you can say “Jamie Dimon”:
The original piece by Andrew Rice, perfectly titled “Stash Pad,” is fascinating and well worth a read: