Uncovering common control and evidence in fraudulent misappropriation schemes

Banner image depicting city view
Is it possible for the most sophisticated international fraudsters to adequately conceal their grand fraud schemes? Michael Radcliffe and Michael Barber discuss ways to cut through the opacity and substantiate key connections. They draw here, in particular, on their experience in matters involving CIS, Middle Eastern and offshore jurisdictions.

Establishing control of involved entities is almost always a key part of big-ticket civil fraud litigation. With complex multi-jurisdictional structures, nominee owners and a general lack of transparency, it can be challenging to definitively prove who controls an implicated entity.

With careful investigation, however, forensic accountants can gather a compelling raft of evidence consisting of numerous coincidental factors alluding to common control.

We may draw this evidence from a range of sources – although the core documents are often simply bank statements and corporate filings. A meticulously assembled set of facts helps courts and tribunals to see the reality, make logical inferences and ultimately make evidence-based decisions.

Here we look at how forensic accountants uncover common control and circumstantial evidence in large-scale fraudulent misappropriation schemes.

1 A Potemkin Village

A ‘Potemkin Village’ is an idiom to describe a metaphorical or physical construction whose sole purpose is to provide an external façade to disguise the true reality of a situation. The phrase originates from fake transportable villages allegedly built by Grigory Potemkin, the Russian former lover of Empress Catherine the Great, to attempt to impress her during her journey to Crimea in 1787.

However, despite their best efforts, it is virtually impossible for fraudsters to construct a perfect Potemkin Village to disguise their fraudulent scheme. Especially a big one. The ‘best’ fraudsters do though make frankly impressive efforts to disguise what is really happening, especially when there are tens or hundreds of millions of US dollars being shuffled around.

At its most sophisticated, a fraudulent scheme can involve clusters of dozens of dedicated entities passing the fraudulent proceeds through a multi-step chain. These ‘shell’ companies may have already had artificial transactional and corporate histories built-up over a period of years, with nominee directors dutifully signing the annual filings year-on-year in preparation.

Often, they are 'trade agents' for a high-value commodity, providing convenient cover for large money transfers. Then comes the production of a false paper trail of invoices, delivery receipts, perhaps customs documentation, and so on. A lot of work.

Ensuring each shell company is entirely different, and perfectly legitimate in appearance is near-impossible in today’s data-heavy world. However, establishing individual websites and online footprints is often a step too far, and the lack of expected digital trails can be a tell-tale sign of illegitimacy for an alleged trading business.

2 Finding basic links between companies

Establishing control can be as simple as identifying public admissions made by the ultimate beneficial owners (UBOs) in the media, or through evidence previously volunteered in open court. Otherwise, it can be signalled by two or more ostensibly independent companies having coincidental directors, addresses or establishment dates.

A common trick for an oligarch is also the methodical tidying up of ‘teams’ of companies that have served their purpose by liquidating them en masse. Simultaneous bankruptcies and the appointment of common liquidators are further indications of links between these entities.

Another red flag can be the recurrence of the same public officials approving the bankruptcies when a variety of officials might ordinarily be expected. This may happen, in countries with more ‘flexible’ judiciaries. We can also consider the main creditor who has put the company into insolvency. It may well be a ‘friendly’ creditor whose status was established with an artificial debt to guarantee control of the creditor committee upon liquidation.

3 Innocent past may help reveal a guilty present

An implicated company may have initially been used for an entirely innocent purpose. Several years later, when long forgotten by the fraudster, that company may then be used for more malign purposes.

Transactions observable during the initial ‘innocent’ phase can reveal who owns that company. A   forensic accounting investigation may uncover long-forgotten payments with entities known to be linked to the targets, or even with the UBOs themselves or their close associates.

4 Detecting circular cash flows

A powerful point about common control can be made from same-day circular payment flows. Why, and indeed how, would several companies that are unrelated make the same value payment in an apparent circle on the same day?

A logical deduction is that this would not be possible without a single directing mind.

5 Uncommercial trade terms

Showing that payments between two companies lack a logical independent commercial rationale can be persuasive. A go-to transaction description is often simply 'financial assistance' – conveniently short and nebulous but one that draws various questions. Why would company A assist company B financially? That may indicate common control in itself. Why was the financial assistance not repaid? Or if it was, why was no interest charged? A similar situation is where one company guarantees borrowing by another. Why would it do so if there was no link between them? Banks need real assets as collateral and that is when the fraudsters can show their hand.

For transactions purporting to be for the purchase of specified goods and services, we can also compare the pricing to open market rates to determine reasonableness. The nature of the goods can also simply be contrasted with the stated business activities of the seller and purchaser – if it lacks sense, that is another red flag.

Further tell-tale signs of uncommercial behaviours may include:

  • constantly deferred payment or delivery timings
  • lack of apparent deliveries or imports of the goods; or
  • the ‘purchase’ of absurd quantities ( individually or cumulatively) that have been calculated to match the sum being laundered rather than adhere to real-world logic

6 Mixing with the wrong crowd

We have frequently found the same nominee director’s involvement not just with companies related to one alleged fraudulent case, but recurring across multiple separate cases we have been working on.

Such individuals have often been found to have been reported publicly in the mainstream press as potentially linked to large-scale money laundering. When such individuals pop up, it is not in itself proof of fraud or money laundering, but their presence adds further weight and context to the allegations.

7 Busy traders used as a fund mixer

After having travelled through layers of apparent shell companies, payments may then be funnelled into a more legitimate busy trading entity as part of the layering stage of money laundering. This can be to seek to legitimise as well as properly obfuscate the payment flows since busy trading businesses have more ‘noisy’ bank statements.

Trading entities though may have more transparent ownership structures and be subject to greater reporting requirements, which can help unlock the identity of the invisible hand behind the apparent misappropriation scheme.

8 Downstream use of monies

Further downstream, investigators may find themselves in calmer seas where the misappropriated funds are actually being spent for the benefit of the directing individuals, often abroad. Classically this can be the purchase of expensive retail goods in London or Dubai, the payment of expensive private school fees and large transfers to solicitors for property acquisition. All of this can, of course, also assist with establishing jurisdiction for a claim. This is the ‘placement’ stage of money laundering.

Fraudsters typically go to great lengths to ensure that access to such downstream information is exceedingly difficult to obtain. However, it can often be secured by international lawyers tenaciously pursuing the banking and accounting documents through various legal actions, from Norwich Pharmacal orders (NPOs) in the UK, to US CHIPS applications (the largest private sector US dollar clearing system in the world).

Summing it all up – the forensic accountant's role

It is not for the forensic accountant to conclude that the red flags definitively prove common control. Or, if when combined with other factors, the evidence adds up to a certified civil fraud scheme. That is, of course, the prerogative of the court or tribunal.

But, the methodical investigation and clear articulation of key facts and patterns often provide a weighty set of evidence for the decision-maker to place on one side of the scales when making their reasoned judgment.

This article was first published in the Thought Leaders 4 magazine.

To discuss this topic further, contact Michael Radcliffe or Michael Barber.