10 Kasım 2012 Cumartesi

Some Fraud Examples from Real Cases

There are of course many fraud examples and stories all around the world. We have tried to put some of them in this study to show how financial frauds can happen. This will be a starting point for the later sections from which we can understand the fraudulent transactions and their scope. Our first example comes from an equity funding.[1]
Equity Funding was originally based upon a new concept in insurance programs. Traditional life insurance policies are a combination of insurance and a systematic saving program. Pure insurance, called "term insurance," provides protection during a certain period of time and has no residual value. The premiums on term insurance should vary with age and health condition. Standard life insurance provides for constant premiums by charging more during the insured's younger years to cover the additional cost of providing protection during the insured's older years. The excess premiums paid during the younger years are accumulated and invested by the insurance company. The rate of return paid to the insured by the companies is very low compared to the rate the companies earn on the accumulated funds. For example, the insurance companies may make nine percent on the invested funds but pay the insured only two percent. Thus the systematic saving program part of a life insurance policy is profitable for the insurance company. The insurance companies are willing to pay agents a substantial amount to sign people up for life insurance programs.

When life insurance companies invest the accumulated excess premiums in common stock they make a substantially higher average rate of return, but it is not guaranteed. Some insurance programs, called "participating," share the gains from investment in the stock market with policy holders. But participation in the gains of stock market investment means the policy holders share in the risks. However, generally the policy holders' share is low compared with the share going to the owners of the insurance company.

Equity Funding's concept was to sell customers a program which involved:
·         Customers investing in a mutual fund so they would get the gains from stock market appreciation
·         Customers mutual fund holdings serving for collateral for a loan which would be used to pay the cost of the insurance policy

The concept was sound, and more importantly for the financial world, it sounded reasonable. Five individuals with backgrounds in insurance and insurance administration founded the company around 1960. There is uncertainty about the time because various members of the group had formed ventures together before Equity Funding came together and members left the group. Finally in 1970 Stanley Goldblum emerged as the head of the company. Goldblum prior to going into the insurance business had worked in the meat packing plant of his father-in-law. He, through hard work and native talent, had worked himself up to being plant manager, but he wanted more than was possible in that position.

Equity Funding became a major success on Wall Street. Its reported revenues and profits were growing steadily at a high rate. The stock traded at a high price/earnings ratio and so Equity Funding was able to acquire other companies through stock trades. Although the concept behind Equity Funding seemed sound the company, in actually, they never made a profit. When it was reporting earnings of over USD 10 million per year in the early 1970's it had losses of over USD 6 million per year. The losses were disguised and turned into profits by creative and fraudulent practices. Much of the difference between actual losses and reported profit came from creating false insurance policies and selling them through the reinsurance market. But by buying up other profitable companies and combining their real profits with Equity Funding's losses Equity Funding's management was able to bring the losses down to about a half million dollars per year.

It is not known for certain when Equity Funding began creating fake insurance policies but in 1969 they carried out a program of giving their employees "free insurance;" i.e., insurance that the employees did not have to pay premiums for during the first year. Of course, after the free first year the employees could cancel the insurance policy or let the premiums lapse. What made this ploy unsavory was that Equity Funding sold these policies in the reinsurance market knowing full well that they would likely be cancelled. It was later found however that Equity Funding kept paying the premiums for a period of time.

While a number of people within Equity Funding objected to the creation of fake policies none notified the authorities. Some wanted to secure a new job before blowing the whistle that would likely put them out of work. Finally in 1973 the auditors uncovered the scam of fake policies and Equity Funding collapsed. Twenty one people were indicted and 18 of them, including Stanley Goldblum, pled guilty. The other three were convicted in court.

Afterwards people looked back and laughed at a statement made by Stanley Goldblum in a press release made before the fraud was uncovered. Goldblum, commenting on the apparently extraordinary record of insurance policy sales by Equity Funding, said "Quite obviously, this kind of production can only be generated by a professional, thoroughly dedicated group of people."

Another example is called as Nigerian Letter which is very famous. Some employees receive a "Nigerian letter" either at home or at work by mail or fax from someone claiming to be an “official” of the Nigerian Government. The process goes on through the following steps:[2]
·         In this letter/fax this “official” claims he has a large amount (up to USD60 million) of money that the Nigerian government overpaid on procurement contracts.
·         Rather than return the money to the Nigerian government, he is seeking a trustworthy individual into whose foreign bank account he can deposit the money.
·         Once the money is out of Nigeria, the employee will receive a percentage (i.e. 30%) of the money for allowing him to use his/her bank account and the “official” will take the rest.
·         If this employee provides the “official” with his bank account number they usually do not raid his account and take his funds. However, he will eventually be asked to provide up-front or advance fees for various taxes, attorney fees, transaction fees or bribes to receive his percentage of the riches. If he provides any up-front money to the fraudsters he will be also asked to send more until he realizes (hopefully) that he has been tricked.

The fraudsters then disappear with his money and he cannot get it back. This is the Nigerian Letter Fraud. There are several variations of this scam but all involve sending money to someone to receive more money for doing absolutely nothing. This scam has been going on for years and grosses hundreds of millions of dollars annually for the fraudsters.

[1] Thayer Watkins, “Equity Funding”, http://www.sjsu.edu/faculty/watkins/mon.htm
[2] Department of Transportation Tenessee Government, “Nigerian Letter”, http://www.tdot.state.tn.us/internalaudit/tools/NigerianLetter.pdf

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