An Endless Stream of Lies (4 page)

“From 2000 to 2002 Alex and Noel sold ‘irrevocable trust’ tax schemes” (18). “The sole purpose of these ‘trusts’ was to evade the customer’s tax obligations” (19). “In marketing the ‘trusts,’ Noel would target primarily wealthy elderly customers to join Certified Estate Planners, Inc. Advertisement was made through flyers, conferences, and via their website” (20).

“These advertisements falsely claimed that the customers would be able to avoid their income taxes by placing their assets in trust while still continuing to ‘manag[e] everything’ but ‘own nothing’” (21). “Once a customer joined, Alex and Noel would create an individual ‘irrevocable trust’ for that customer. Each trust would obtain an Employer Identification Number (EIN) from the IRS. These ‘trusts’ typically listed Alex as a trustee and Noel as co-trustee” (22).

“After the trust was established, customers would withdraw assets from their retirement accounts, IRAs, annuities and other deferred tax devices and deposit the funds into their ‘irrevocable trust.’ The customers then used these assets for personal expenses such as mortgage payments and home repairs” (23).

“The early withdrawal of these funds and subsequent use for non-tax-exempt purposes should have resulted in the assets being subject to taxation and early withdrawal penalties. As a result, the income should have been reported on the customer’s individual federal income tax return. However, Alex and Noel’s scheme resulted in the customer not reporting this taxable income” (24).

“As part of this scheme, Alex prepared customers’ Form 1040 Individual Federal Tax Return and Form 1041 Federal Tax returns for the customer’s ‘trust.’ Instead of reporting the withdrawn assets as personal income subject to taxation on the customer’s individual Form 1040, Alex improperly reported the customer’s withdrawn funds on the customer’s Form 1041 ‘trust’ tax return. Further, Alex would consistently under-report the total amount of this income on the Form” (25).

“After reporting this taxable income on the wrong form, Alex would make fraudulent deductions on the customer’s Form 1041 return to fully deduct, or ‘zero out,’ the income reported. This would result in customers paying nominal, if any, taxes on this income. Alex improperly listed personal expenses (such as mortgage payments, utility bills, rent, and health insurance) as deductions on the customer’s Form 1041 trust return” (26). “Alex would further reduce the customer’s reported income by reporting large K-1 distribution fees, claiming that the customer’s ‘trust’ distributed the income to the customer. However, these large ‘distributions’ were not then reported on the customer’s Form 1040” (27).

“As part of this scheme Alex and Noel created a new trust, Pinnacle Fiduciary and Trust Group (PFTG), designating Alex as the trustee. As before, the customers transferred all their assets into the PFTG trust. This ‘trust’ was designed to be a meta-trust, meaning it held all of the assets of all of PFTG’s customers in one trust. They commingled the customers’ funds in order to conceal them from the IRS” (31).

“Once deposited into this ‘trust’ they did not track the individual customers’ funds. As a result all of the various customers’ funds became indistinguishable and they were unable to determine the value of each customer’s ‘investment’” (32). “They would then use the funds in the PFTG ‘trust’ to ‘invest’ at their discretion” (33). “These ‘investments’ consisted of Alex and Noel making short-term trades, ‘investing’ money in Noel’s enjoined mineral business, and withdrawing large account management fees” (34).

“Customers were not aware of their ‘investments’ and they only issued reports of the customer’s account activity upon request. However, these reports did not accurately represent the customer’s account ‘activity’ because they were unable to determine which percentage of the PFTG ‘trust’ belonged to an individual customer” (35).

“They used the PFTG ‘trust’ as a shelter to hide their customers’ assets from the IRS and avoid their correct income tax responsibility” (36). “They evaded taxes by falsely reporting trust performance on a Form 1041, utilizing arbitrary amounts that eliminated the tax liabilities. In essence, these returns underreported the customers’ tax liabilities by not accurately reporting the basis for tax calculations, such as income earned on the customer’s assets in the meta-trust, early withdrawal penalties, and capital gains the customer would have incurred” (37). “As a result, the customers evaded taxation of income earned on assets held in the PFTG trust by claiming that the assets were fully distributed” (38).

“Additionally, they did not issue Forms 1099 (forms that report non-wage income) to all of their customers; instead, they only issued the Forms 1099 to those customers who requested the information. However, even on the Forms 1099 that they did issue, they were unable to report the accurate gains and losses for each customer because they had combined all customers’ assets and failed to keep records. As a result they reported arbitrary amounts” (39).

And so the stream of lies began and continued to flow (as shown by the information presentation of
Complaint For Permanent Injunction And For Other Relief
in the preceding paragraphs) with increasingly disastrous potential. But the question is, “Began at what point?” From having read the complaint above, we can only see the surface of the water. The real dangers lie in wait below the surface. For years, to the investors, and even to Alex’s partner, the waters looked fine. The surface was calm and there were no warning signs posted along the banks.

In Shakespeare’s
King Henry VI
, part II, act III, scene I, we learn, “by wicked means to frame our sovereign’s fall. Smooth runs the water where the brook is deep.” The brook was indeed deep, and sovereigns, whether considered as money or people, did, with a certainty, fall. Alex’s undertakings to frame, and thus control, that fall were there, hidden just below the surface.

As we plunge below the surface to plumb the depths, we are mindful that fraud is a human construct. Humans—in this case Alex—are motivated toward gain and more emphatically away from pain. Alex has, at this point, already undertaken drastic steps for the first dynamic—gain—and will in time take action regarding the latter—the avoidance of pain.

THOUGHTS, COMMENTS AND ANALYSIS

What are your impressions, to this point, with regard to this circumstance?

Exactly what do you know?

What is it that you
know
that you don’t know?

What questions would you ask in order to know?

What steps would you take in order to know?

Points to Ponder

In contrasting the elements in the “Complaint For Permanent Injunction And For Other Relief Case 1:07-cv-00306, filed September 24, 2007” with Alex’s words at his sentencing:

And it was never my intent to lose anyone’s money or divert anyone’s money or scheme anyone out of anything.

1. What are your initial impressions from the comparison?
   
2. Is it conceivable that someone could machinate these complexities while having no intent to lose, divert or scheme?
   
3. What could possibly be Alex’s plan once the injunction was published, yet all the while, he was continuing to deceive the federal authorities?
   
4. Why would he view his continued deception as his best option?
   
5. If actions do speak louder than words, to which of the two is it most advantageous to attend?
   
6. What questions would you pose to Alex at this point?
   

Content – Context Application

Former Controller of Luxury Car Dealership Accused of Embezzling

A former controller of a luxury car dealership was charged in a federal indictment for embezzling approximately $285,000. The charges involved making and possessing forged securities with the intent to deceive. The indictment indicated the former controller had issued over 130 company commercial checks to a variety of entities and individuals. He then would deposit the checks into bank accounts that were controlled by him. He was accused of forging the endorsements on the back of the checks in order to make the deposits.

1. What similar mindsets might there be as demonstrated by the actions of Alex and the controller?
   
2. Is there, in your mind, a difference in defrauding an organization as opposed to defrauding an individual?
   
3. Why or why not?
   
4. What questions would you pose to this individual?
   

CHAPTER THREE

ALEX AND THE FRAUD TRIANGLE

THREE ATOMS TO FORM WATER –
THREE REQUIREMENTS TO FORM FRAUD

Water, water, every where,

And all the boards did shrink;

Water, water, every where,

Nor any drop to drink.

The Rime of the Ancient Mariner

—SAMUEL TAYLOR COLERIDGE

NAVIGATION POINT AND HEADING

The chemical formula for water is H2O. A molecule of water is comprised of two hydrogen atoms and one oxygen atom. The atoms are connected by a type of chemical bonding that involves the sharing of pairs of electrons (Wikipedia.org). Fraud is also comprised of three components. These components must, in like fashion, be bonded or connected. In the case of fraud, the connections involve the circumstances in a person’s life, the latitude in which they have to operate and their adaptive cognitions. How does an individual’s (in this case, Alex) life-changing circumstances come down to a diagram? Paddle on and let’s see.

THE FRAUD TRIANGLE

In the 1950s, criminologist Donald R. Cressey presented what has classically become known as “the fraud triangle.” He theorized that for the commission of fraud to take place, three components must be in place:

• Pressure/motive
  
• Opportunity
  
• Rationalization
  

His proposal has stood the test of time and is very much a part of fraud investigative applications today. Various entities have applied the terminology over time to a multitude of circumstances. One of the most salient, fraud-related issues, at the time of this writing, involves teachers and educational administrators manipulating the end of grade test scores by providing the answers to the students in advance or changing the students’ incorrect answers after the fact. But, the concept is still the same. Once an incentive (economic, moral or societal) is attached to an outcome, two of the three fraud-related elements are subsequently in play. In the teacher–administrator case, the incentive is economic.

At this point, we have an overview of the topography of this financial water system. Let’s endeavor to find the source of a specific tributary—Alex’s debilitating stock trading activities and subsequent false financial reports. This undertaking involves a four-year tributary that systematically evaporated resources that belonged to others.

Statement on Auditing Standards No. 99: Consideration of Fraud in a Financial Statement Audit

First, an explanation of the “Statement on Auditing Standards No. 99: Consideration of Fraud in a Financial Statement Audit” will assist in our understanding of the relationship of the fraud triangle, the actions which Alex had undertaken and their downstream consequences:

NOTE
: What is SAS 99?

“Statement on Auditing Standards No. 99: Consideration of Fraud in a Financial Statement Audit
, commonly abbreviated as
SAS 99
, is an
auditing statement
issued by the
Auditing Standards Board
of the
American Institute of Certified Public Accountants
(AICPA) in October 2002. The original exposure draft was distributed in February 2002. SAS 99, which supersedes
SAS 82
, was issued partly in response to recent accounting scandals at Enron, WorldCom, Adelphia, and Tyco. The standard incorporates recommendations from various contributors including the
International Auditing & Assurance Standards Board
. SAS 99 became effective for audits of financial statements for periods beginning on or after December 15, 2002” (Wikipedia.org).

NOTE
: How does SAS 99 describe fraud?

“SAS 99 defines fraud as an intentional act that results in a material misstatement in financial statements. There are two types of fraud considered: misstatements arising from fraudulent financial reporting (eg. falsification of accounting records) and misstatements arising from misappropriation of assets (eg. theft of assets or fraudulent expenditures”).

Note
: How does SAS describe the fraud triangle?

“The standard describes the fraud triangle. Generally, the three ‘
fraud triangle
’ conditions are present when fraud occurs

First, there is an
incentive or pressure
that provides a reason to commit fraud.

Second, there is an
opportunity
for fraud to be perpetrated (eg. absence of controls, ineffective controls, or the ability of management to override controls.)

Third, the individuals committing the fraud possess an attitude that enables them to
rationalize
the fraud” (Wikipedia.org).

In our application of the fraud triangle,
opportunity
is located at the top of the triangle.
Pressure/motive
is placed at the left base of the triangle.
Rationalization
is found at the right base of the triangle. And while the elements of the triangle are not limited to fraud, they certainly find application in this circumstance.

ELEMENT ONE: OPPORTUNITY

We will resume our examination of Alex’s continuing actions, at this point, with the most obvious of the fraud triangle elements—opportunity. Clearly Alex had the opportunity to commit the fraud all along. As the transcript from his testimony at Noel’s trial indicates:

“As Bryan was becoming more involved with Titan Composites, and he actually moved his office out of the CEP offices to become involved with Titan at their offices, I had to take a more day-to-day role in the business in terms of overseeing the staff and making some of the decisions necessary for operating the business.”

“Opportunity” can be defined as,
“
a situation or condition favorable for attainment of a goal
”
(Dictionary.com). Within the business functions of Certified Estate Planners, Alex’s operational responsibilities were replete with opportunities for the commission of fraud. The opportunities did not suddenly make themselves available. They had always been there. Our reading of the “
Complaint For Permanent Injunction And For Other Relief
” serves to underscore the plethora of opportunities. At some point, as we will learn from his own words, Alex took advantage of those opportunities. A most critical component of our examination is not whether or not the opportunities were available to enable him to commit the fraud, but rather, that he ultimately did commit the fraud.

Within any organization, there are opportunities for fraudulent undertakings. Ranging from taking a number two lead pencil to selling national security secrets, if an individual’s goal is to divert assets to himself there will exist “a situation or condition favorable for attainment of a goal.” An individual may work in an organization for ten years and never engage in an illegal act. But on day one of the eleventh year, circumstances can change and the same individual utilizes an opportunity that had been there all along. What happened in Alex’s life that released the fraudster that had, seemingly, lain dormant to that point?

Two of the salient, fraud triangle elements—pressure/motive and rationalization—provide a most intriguing focus of our inquiry to understand his behavior.

Element Two: Pressure/Motive

First, let us define some terms:

“Pressure” is defined as “a moral force that compels” (Dictionary.com).

“Moral force” is defined as “an efficient incentive” (thefreedictionary.com).

“Motive” is defined as “something that causes a person to act in a certain way, do a certain thing” (Dictionary.com).

If we combine the three definitions, to conceptualize pressure/motive, as it relates to fraud, we can develop an operational definition along the line of “an effective incentive that compels a person to behave in a manner consistent with the intention of committing fraud.”

The pressure/motive element, as it related to Alex, came forth as he gave testimony during Noel’s trial. At this ford in the stream, we will focus on the fraudulent activities related to his stock trading. Alex’s stock trading endeavors did not meet with a positive outcome—he was losing significant amounts of money. As the transcript of Alex’s testimony reveals:

Q. Now, when this stock trading program began to be offered in mid 2002 to CEP clients, how was the trading going?

A. The trading went well until about May or June, and then the trading was not so good after that.

Q. May and June of when?

A. May or June of 2002.

Q. And when you say after June of 2002 it wasn’t going so well, what’s that mean?

A. It means that losses were being generated. There were some gains that were being generated, but there were more losses that were generated than gains.

Q. So overall, after the summer of 2002, in a given quarter, were the trades net positive or net negative?

A. In most instances they were net negative.

Q. Did you tell the clients about that?

A. No, I did not.

Q. What do you mean by that?

A. The clients did not know that their funds were losing money.

Q. After the midsummer of 2002.

A. Correct.

Q. Well, weren’t you keeping clients updated on how their accounts were doing?

A. Yes.

Q. Well, how were clients being kept up to date?

A. They were being kept up to date via quarterly statements that would be sent out.

Q. Sent out how?

A. Sent out via the Postal Service.

Q. And who was preparing those client reports?

A. I was preparing figures for them, and then they were put into a presentable format by Heather Noel.

Q. And let’s take the third quarter of 2002. Was the trading in the third quarter of 2002 a net gain or a net loss?

A. The trading would have been a net loss during that point.

Q. Did you send out client reports showing a loss?

A. No, I did not.

Q. Why not?

A. At that point I hoped that the trading system would turn around and right itself at some point.

Q. Well, why couldn’t you tell clients that there had been a loss and just tell them to hang on?

A. I was also not telling Bryan Noel during that time. I was scared to death of the consequences of that getting out to any clients or to him.

Q. Well, what were you concerned would happen if you told Mr. Noel?

A. He’s not a man that takes bad news very well, so I was concerned that he might be extremely irritated with such news and that ultimately clients might want to pull their funds out.

Q. Were you concerned about losing your job?

A. I was concerned about that as well.

Q. So just to be clear, at least beginning the third Quarter of 2002, your Pinnacle trading program is losing money.

A. Yes, it is.

Q. And you’re lying to clients about that.

A. Yes, I am.

Q. And you’re lying to Mr. Noel about that.

A. Yes, I am.

Q. And you’re sending false account statements out in the mail.

A. Yes.

Q. At that point, this fraud that you’re perpetrating, are you doing that by yourself or with someone else?

A. At that point that was by myself.

Keep in mind that pressure/motive is idiosyncratic. A circumstance (stock results flowing into the negative column at an increasing volume) that may, for one individual, be no more than a “bump in the road of life,” may be, for another, perceived as a catastrophic event. According to Alex, the following were the increasingly emerging dynamics:

• Reduction of funds due to his stock trading activities
  
• Fear of telling clients lest they withdraw their money
  
• Fear of telling his partner
  
• The possibility of the loss of his position served as the catalyst (pressure/motive) to set in motion his willingness to falsify the quarterly reports
  

Changing circumstances can serve to reveal a different nature (side) of an individual—a nature of the individual having lain dormant to that point.

Sir Francis Bacon
(1561–1626) was a prolific and insightful writer. He was a man ahead of his time. One of Bacon’s treatises, “Of Nature in Men,” is worth our review and application to Alex:

“Like as it was with AEsop’s damsel, turned from a cat to a woman, who sat very demutely at the board’s end, till a mouse ran before her. Therefore, let a man either avoid the occasion altogether; or put himself often to it, that he may be little moved with it. A man’s nature is best perceived in privateness, for there is no affectation; in passion, for that putteth a man out of his precepts; and in a new case or experiment, for there custom leaveth him.”