Financial Investigation and Forensic Accounting

Third Edition

FINANCIAL

INVESTIGATION

and

FOR ENSIC

ACCOUNTING

George A. Manning, Ph.D, CFE, EA

Third Edition

FINANCIAL

INVESTIGATION

and

FOR ENSIC

ACCOUNTING

CRC Press is an imprint of the

Taylor & Francis Group, an informa business

Boca Raton London New York

CRC Press

Taylor & Francis Group

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© 2011 by Taylor & Francis Group, LLC

CRC Press is an imprint of Taylor & Francis Group, an Informa business

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Version Date: 20110714

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© 2011 by Taylor & Francis Group, LLC

In loving memory of my wife, Lois E. Manning,

who passed away suddenly in 2002.

She was a very loving and devoted wife

and mother to our two children.

© 2011 by Taylor & Francis Group, LLC vii

Table of Contents

Figures xxxix

Tables xli

Exhibits xliii

Acknowledgment xlv

About the Author xlvii

1 Economics of Crime 1

1.1 Introduction 1

1.2 Cost Reality 1

1.3 Microeconomics 2

1.3.1 Arson 3

1.3.2 Bankruptcy Fraud 3

1.3.3 Forgery and Uttering 3

1.3.4 Larceny 3

1.3.5 Identity Theft 3

1.3.6 Loan Sharking 3

1.3.7 Credit Card Fraud 4

1.3.8 Mail Order Operations 4

1.3.9 Medicare/Medicaid Fraud 4

1.3.10 Repair Fraud 4

1.3.11 Skimming/Embezzlement 4

1.3.12 Stock Manipulation 4

1.3.13 Swindling 5

1.3.14 Narcotics 5

1.4 Macroeconomics 5

1.5 Organized Crime 6

1.6 Local Industries 7

1.6.1 Construction 7

1.6.2 Waste Removal 8

1.6.3 Motor Vehicle Sales and Repairs 8

1.6.4 Cash Businesses 8

1.7 Data and Statistics 8

1.7.1 National 9

1.7.2 State 9

1.8 International Statistics 9

1.8.1 International 9

1.9 Cocaine 10

1.9.1 Mexico 10

1.9.2 Costa Rica 10

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1.9.3 Guatemala 10

1.9.4 Honduras 11

1.9.5 Panama 11

1.9.6 Bolivia 11

1.9.7 Brazil 11

1.9.8 Ecuador 11

1.9.9 Peru 12

1.9.10 Colombia 12

1.9.11 Bahamas 12

1.9.12 Cuba 13

1.9.13 Middle East 13

1.9.14 Sicily 13

1.9.15 Far East 13

1.10 Summary 14

2 Financial Crimes 15

2.1 General 15

2.2 Arson 15

2.3 Bankruptcy Fraud 15

2.4 Bribery 16

2.5 Loan Sharking 16

2.6 Credit Card Fraud 17

2.7 Prostitution and Pandering 18

2.8 Fencing 18

2.9 Mail Order Operations 19

2.10 Pornography 19

2.11 Gambling 20

2.12 Skimming/Embezzlement 21

2.13 Labor Racketeering 21

2.14 Stock Fraud and Manipulation 22

2.15 Narcotics 22

2.16 Racketeering 22

2.17 Continuing Criminal Enterprise 23

2.18 Nonprofit Organization Fraud 24

2.19 Corrupt Churches 24

2.20 Burglary 25

2.21 Forgery and Uttering 26

2.22 Larceny 27

2.23 Robbery 28

2.24 Tax Evasion 29

2.25 Bank Frauds 29

2.26 Restraint of Trade 29

2.27 Government Contract Fraud 30

2.28 Corporate Raiding 30

2.29 Extortion 30

2.30 Coupon Fraud 30

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2.31 Money Laundering 31

2.32 Medicare and Medicaid Fraud 31

2.33 Repair and Maintenance Fraud 31

2.34 Computer Thefts 32

2.35 Insider Trading 32

2.36 Corporate Fraud 32

2.37 Swindlers 33

2.38 Conspiracy 33

2.39 Principal 33

2.40 Accessory 34

2.41 Kidnapping 34

2.42 The

ft 34

2.43 Identity Theft 34

2.44 Child Support 35

2.45 Counterfeiting 35

2.46 Bad Checks 35

2.47 False Statements 35

2.48 Misprison of Felony 36

2.49 Summary 36

3 Offshore Activities 37

3.1 General 37

3.2 Characteristics 37

3.2.1 Taxes 37

3.2.2 Exchange Control 38

3.2.3 Banking 38

3.2.4 Bank Secrecy 38

3.2.5 Stability 38

3.2.6 Communication 38

3.2.7 Corruption 38

3.3 Tax Haven Countries 39

3.3.1 Andorra 39

3.3.2 Anguilla 39

3.3.3 Antigua and Barbuda 40

3.3.4 Aruba 41

3.3.5 Bahamas 42

3.3.6 Barbados 43

3.3.7 Belize 43

3.3.8 Bermuda 44

3.3.9 Cayman Islands 44

3.3.10 Costa Rica 45

3.3.11 Cyprus 46

3.3.12 Dominica 47

3.3.13 Gibraltar 47

3.3.14 Guernsey 48

3.3.15 Hong Kong 48

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3.3.16 Isle of Man 49

3.3.17 Jersey 50

3.3.18 Liberia 50

3.3.19 Liechtenstein 50

3.3.20 Luxembourg 52

3.3.21 Malta 53

3.3.22 Mauritius 54

3.3.23 Montserrat 54

3.3.24 Niue 55

3.3.25 Nauru 56

3.3.26 Netherlands Antilles 56

3.3.27 Nevis 57

3.3.28 Panama 58

3.3.29 Switzerland 58

3.3.30 Turks and Caicos Islands 58

3.3.31 Vanuatu 59

3.3.32 British Virgin Islands 59

3.4 Mutual Legal Assistance Treaties 60

3.5 Financial Action Task Force 60

3.6 Organization for Economic Cooperation and Development 61

3.7 Fraud Indicators 62

3.8 Outlook for Tax Havens 63

3.9 Summary 63

4 Evidence 65

4.1 General 65

4.2 Evidence 65

4.2.1 Relevancy 66

4.2.2 Materiality 66

4.2.3 Competency 66

4.3 Limited Admissibility 66

4.4 Hearsay 66

4.5 Admissions and Confessions 67

4.6 Exceptions to Hearsay Rule 67

4.6.1 Business Records, Public Records, and Commercial

Documents 67

4.6.2 Expert and Opinion Testimony 67

4.6.3 Reputation 68

4.6.4 Records of Documents Affecting an Interest in Property 68

4.6.5 Mental and Physical Condition 68

4.6.6 Excited Utterance (also known as “Spontaneous

Declaration”) 68

4.6.7 Recorded Recollection 68

4.6.8 Absence of Entry 69

4.7 Hearsay Exceptions: Declarant Unavailable 69

4.7.1 Former Testimony 69

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4.7.2 Statement against Interest 69

4.7.3 Dying Declarations 70

4.8 Documentary Evidence 70

4.8.1 Best Evidence Rule 70

4.8.2 Application of Best Evidence Rule 70

4.8.3 Secondary Evidence 71

4.8.4 Admissibility of Specific Forms of Documentary Evidence 71

4.8.4.1 Regular Course of Business 72

4.8.4.2 Photographs, Photostats, and Microfilmed Copies 72

4.8.4.3 Transcripts 72

4.8.4.4 Charts, Schedules, and Summaries 73

4.8.4.5 Notes, Diaries, Workpapers, and Memorandums 73

4.9 Proving Specific Transactions 73

4.10 Official Records 73

4.10.1 Authentication of Official Records 73

4.10.2 Admissibility of Official Records 74

4.11 State and Territorial Statutes and Proceedings 74

4.12 Chain of Custody 74

4.13 Identification of Seized Documentary Evidence 75

4.14 Constitutional Provisions 75

4.14.1 The Fourth Amendment 75

4.14.2 The Fifth Amendment 75

4.14.3 The Sixth Amendment 76

4.15 Statutory Provisions 76

4.15.1 Court Decisions 76

4.15.2 Access to Books and Records 76

4.16 Privileged Relationships 76

4.17 Foreign Evidence 77

4.17.1 Foreign Public Documents 77

4.17.2 Foreign Documents 77

4.17.3 Consular Officers Commission 78

4.17.4 Deposition on Foreign Documents 78

4.17.5 Foreign Records 78

4.17.6 Foreign Witnesses 78

4.18 Awareness 78

4.19 Summary 79

5 Net Worth Theory 81

5.1 General 81

5.2 Tax Use 81

5.3 RICO Use 81

5.4 History 82

5.4.1 Burden of Proof 84

5.4.2 Cash on Hand 84

5.4.3 Family Group 84

5.4.4 Cost of Living 84

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5.4.5 Corroboration 84

5.5 RICO Use 85

5.6 Continuing Criminal Enterprises 85

5.7 Connection 86

5.8 When Use Is Required 86

5.9 Theory 87

5.9.1 Cash on Hand 87

5.9.2 Cash in Banks 88

5.9.3 Inventory 88

5.9.4 Accounts/Loans Receivable 88

5.9.5 Intercompany Transfers 89

5.9.6 Sole Proprietorship 89

5.9.7 Exchanges 89

5.9.8 Securities 89

5.9.9 Personal Property 90

5.9.10 Real Property 90

5.9.11 Cash Value Insurance 90

5.9.12 Subchapter S Corporation 90

5.9.13 Partnership 90

5.9.14 Prepaid Insurance 91

5.9.15 Controlled Foreign Corporations (CFC) 91

5.9.16 Accounts Payable 91

5.9.17 Credit Cards 91

5.9.18 Deferred Gains 92

5.9.19 Prepaid Interest 92

5.9.20 Contributions 92

5.9.21 Capital Gains and Losses 92

5.9.22 IRA and Keogh Accounts 92

5.9.23 Personal Living Expenses 93

5.9.24 Various Income Items 93

5.9.25 Civil versus Criminal 93

5.10 Defenses 94

5.11 Summary 95

6 Expenditure Theory 97

6.1 General 97

6.2 Tax Use 97

6.3 RICO Use 97

6.4 History 97

6.4.1 RICO Use 98

6.4.2 When Use Is Required 99

6.5 Theory 99

6.5.1 Cash on Hand 100

6.5.2 Cash in Bank 100

6.5.3 Inventory 100

6.5.4 Intercompany Transfers 100

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6.5.5 Sole Proprietorships 100

6.5.6 Exchanges 101

6.5.7 Accounts/Loans Receivable 101

6.5.8 Subchapter S Corporation 101

6.5.9 Partnership 101

6.5.10 Credit Cards 101

6.5.11 Other Assets 102

6.5.12 Loans and Mortgages Payable 102

6.5.13 Income and Expenses 102

6.5.14 Deferred Gains 102

6.5.15 Depreciation, Amortization, and Depletion 102

6.5.16 Controlled Foreign Corporations (CFC) 103

6.5.17 IRA and Keogh Accounts 103

6.5.18 Capital Gains and Losses 103

6.6 Civil versus Criminal 103

6.7 Defenses 103

6.8 Summary 104

7 Scenario Case 105

7.1 Case 105

7.2 Financial Data 105

7.2.1 Search Warrant Data 105

7.2.2 Public Records 106

7.2.3 Life Insurance 106

7.2.4 Home Improvements 107

7.2.5 Corporations 107

7.2.6 Individual Tax Returns 107

7.2.6.1 Lounge Doe, Inc. 109

7.2.6.2 Doe’s Kwik Stop, Inc. 110

7.2.6.3 Real Property, Ltd. 111

7.2.7 Bank Accounts 112

7.2.8 Credit Card 112

7.2.9 Living Expenses 112

7.2.10 Automobiles 112

7.2.11 Rental Property 113

7.2.12 Individual Retirement Accounts 113

7.2.13 Trusts 113

7.2.14 Earnings 114

7.2.15 Securities 114

7.2.16 Property Taxes 114

7.3 Intelligence 114

7.3.1 Background 114

7.3.2 Commodities 114

7.3.3 Offshore Mortgage 115

7.3.4 Offshore Bank 115

7.3.5 Surveillance 115

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7.3.6 Corporate Check 115

7.3.7 Girl Friend 115

7.3.8 Currency Transaction Reports 116

7.3.9 Wiretap 116

7.3.10 Telephone Records 116

7.3.11 Bahama Banks 116

7.3.12 Barbados Banks 117

7.3.13 Spanish Banks 117

7.3.14 Cayman Island Banks 118

7.3.15 Swiss Banks 118

7.3.16 Aruba Banks 118

7.3.17 Jamaican Banks 119

7.3.18 Accountant 119

8 RICO Net Worth Solution 121

8.1 General 121

8.2 Principals 121

8.3 Problem 121

8.4 RICO Net Worth Schedule 121

8.4.1 Cash on Hand 122

8.4.2 Cocaine, 2 Kilos 122

8.4.3 Bank Accounts 122

8.4.4 Accounts Receivable 122

8.4.5 Inventory 125

8.4.6 Business Assets 125

8.4.7 Security System 125

8.4.8 Electronic Equipment 125

8.4.9 Appliances 125

8.4.10 Fixtures 125

8.4.11 Furniture 125

8.4.12 Cabinets 125

8.4.13 Paintings 125

8.4.14 Pool and Tennis Court 125

8.4.15 100 Alpha Street 126

8.4.16 100 Bravo Street 126

8.4.17 Gold Bullion, 10 Bars 126

8.4.18 Lounge Doe, Inc. 126

8.4.19 Doe’s Kwik Stop, Inc. 126

8.4.20 Real Property, Ltd. 127

8.4.21 Mercedes Benz 127

8.4.22 Toyota Sedan 127

8.4.23 IRA—John Doe and Suzy Que 127

8.4.24 Bahamas Residence 127

8.4.25 First National Bank—Car Loans 127

8.4.26 Credit Card 128

8.4.27 Accounts Payable 128