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— Judgment Call —
Swindles and scams abound during economic downturns. The Great Depression was a golden age of flimflam. The recessions of 1981-'82 and 1990-'91 generated a bumper crop of bunco. If history is any indication, the recession of 2008-? will see a resurgence of the very same types of fraud that stung investors in the past, along with some new variations. Here are a few that this corporate investigator expects to be seeing in the months ahead:
Commodity schemes. When securities markets tank, the smart money moves into commodities, or so some believe. Whatever the commodity, such schemes all share a common premise. A large amount of the commodity is supposedly available at a significant discount to its market price. A common red flag, aside from the commodity's "fire sale" price, is the amount of the commodity involved, which is often unrealistically large. I was once consulted about a deal involving an amount of platinum that, upon investigation, turned out to be more than half of the platinum known to exist in the entire world. Another deal involved a shipment of sugar sufficient to create a sugar cube nearly the height of the Empire State Building. High-yield investment programs. The high-yield investment program originated in the "prime bank" fraud from the 1980s, multiplied like a cancer during the recession of 1990-'91 and lives on today. This particular fraud is predicated on guarantees or other instruments supposedly issued by the world's money-center or "prime" banks. The bank paper is purportedly traded in a secretive, high-level market, generating rates of return far above those available in mainstream markets. Fraudsters claim they can provide access to the exclusive market through "trading programs" that pool funds from multiple investors. As in commodity schemes, the fraudsters deceive their victims with documents bearing the names of well-known banks and replete with esoteric financial jargon. Most HYIPs are simple advance-fee frauds or Ponzi schemes.
What distinguishes bank guarantee scams from garden-variety Ponzi schemes is the class of victim targeted by the fraudsters, who boldly go after big game like professional asset managers and sophisticated investors. I have investigated situations in which financial professionals were persuaded of the authenticity of fraudulent guarantees by the presence of Cusip numbers on the fake paper and bogus "quotes" the perpetrators managed to disseminate through a reputable financial data provider. Alternative energy scams. Contemporary concerns over global warming and reliance on foreign oil have reignited investor interest in biofuels, wind power and other alternative energy sources. The "green gold rush" has also sparked a surge in stock frauds involving energy companies. During the past year, advisories on energy scams were issued by all the major U.S. securities industry regulators. Given the allure the industry has for fraudsters, it is essential to conduct due diligence on investment opportunities in this area. Close scrutiny of the offering documents and the company's management will almost always expose the fraudulent nature of hard-to-believe opportunities. Carbon finance fraud. We anticipate an increase in deceptions involving speculation in carbon credits, carbon offsets, renewable energy certificates and the like, as the rapidly growing market for these instruments is opaque, fragmented and largely unregulated. A Government Accountability Office report issued in September found that the market in carbon offsets lacks controls such as standardized mechanisms for verifying the authenticity of offsets. Cooking the books. When credit is tight and capital markets bearish, companies may be more likely to embellish their financial statements, and deal-hungry bankers less inclined to heed the red flags of financial reporting fraud. There are myriad ways in which a company might deceive lenders and investors: overstating revenue by stuffing distribution channels (à la Sunbeam Products Inc.) or booking sales in 35-day months (Computer Associates Inc.), understating expenses by booking line costs as capital expenditures (WorldCom Inc.) or hiding losses in off-balance-sheet entities (Enron Corp.), to name just a few. All of the companies just mentioned committed their frauds during a stock market boom, which would appear to undercut the notion that economic downturns create incentives for financial reporting deceit. The plain truth is, there is always a bull market in fraud. Thomas Fedorek is a managing director in the global risk and investigations practice at FTI Consulting Inc. |
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