FRAUD IN THE NEWS

January - February 2012
CPENet Fraud in the News Newsletter

Disability Scammers Loot Millions - Forensic Accounting Investigations Essential

"You're never going to figure it out, honey," Marie Baran confidently told an FBI special agent.

Following a Sept. 20, 2008, front-page article ("A Disability Epidemic Among A Railroad's Retirees") in The New York Times, federal investigators began asking pointed questions about $250 million in potentially unwarranted benefit payments made to Long Island Railroad (LIRR) retirees for the disabilities they claimed to have. The investigation is ongoing. If the payments continue, they ultimately will exceed $1 billion. Baran had reason to be sure of herself. As a former manager of the Westbury, N.Y., Railroad Retirement Board (RRB) office, she knew the disability system inside and out because she had overseen the processing of LIRR claims until she retired in 2006. After she left the RRB, Baran opened a consultancy that advised LIRR workers on how to apply for disability benefits.

Times reporters had focused on the LIRR disability program after they learned that its claims and benefit awards far outstripped those of other railroads. Between 1998 and 2008, two independent physicians had certified the disability claims of 956 LIRR employees who each had retired with at least 20 years of service.  Those who received benefits had said they no longer were physically able to do their jobs, and their physicians agreed. But Times reporters and others had observed the claimants participating in activities — golf, tennis, bicycling and aerobics — at least as strenuous as their workplace functions.

Then, in 2009, a Government Accountability Office performance audit found that LIRR workers applied for RRB occupational disability benefits at a rate 12 times higher than workers from other commuter railroads.

OVERCONFIDENT?

Baran might have underestimated investigators’ abilities to unravel the complexities of RRB and LIRR benefit systems. Guilty or not, she and others have been under intense scrutiny during the ongoing investigation.  The probe gathered momentum when a new lead investigator — transferred from the FBI — arrived at the RRB Office of the Inspector General in October 2010. RRB-OIG Special Agent Adam M. Suits had been a senior claims adjuster and fraud investigator for a private insurer, so he knew exactly how to "figure it out."

Suits searched claimant medical records for details of suspects’ actions that corroborated their self-incriminating statements recorded during surveillance. In 2008, non-suspects who worked in the medical offices in which the allegedly bogus examinations took place agreed to wear hidden recording devices to capture evidence when they discussed LIRR disability cases with the doctors and others suspected of committing fraud.  New York, where all those participating in the taped conversations were located, is one of 38 states and the District of Columbia in which it is legal to record a conversation when only one of those in the discussion — in person or on the phone — is aware of the recording.

On Sept. 26, 2008, a non-suspect colleague of Peter Ajemian, one of the two suspected doctors, asked him to comment on the issues in the Times article. During their recorded conversation, Ajemian said that “before they come to my office, [his LIRR patients] already had that expectation” that “they’re gonna end up with a [claim] narrative suggesting disability.” Ajemian said he relied on the patients’ descriptions of their conditions.  "I take what they tell me … to be the truth. And I can't question their integrity," Ajemian said, adding that the proportion of occasions in which he recommended disability “could have been one hundred percent."

In 2010, Suits discovered medical records in Ajemian's office that indicated that claimants each had paid Ajemian $800 or more in cash so he would certify that their disability onset dates coincided with their retirement dates. Thus, claimants’ instructions — not their medical conditions — governed Ajemian's disability determinations.  Suits also found LIRR disability certifications in Ajemian's office that Ajemian had prepared and backdated after his partners had fired him from their practice because of the growing evidence of his alleged scheme.  By October 2011, Suits had amassed evidence sufficient to file a criminal complaint in the U.S. Southern District of New York. He charged Baran and 10 others — the two physicians and eight LIRR retirees — with conspiracy to commit health care fraud and mail fraud. They face up to 20 years in prison.

THE RR-WHAT?

To further understand this case, we must understand the evolution of employee benefits in the U.S.
In 1874, a railroad established the first industrial pension plan in North America. By the 1930s, there were more such plans in this industry than any other. But administration and funding of these plans was sometimes inadequate. So in 1934 Congress established the RRB to better meet the social welfare needs of the railroads’ workforce — then the nation's biggest. Since then the RRB has funded and administered retirement, unemployment and disability benefits that predate and resemble those of the Social Security Administration (SSA). Taxes collected from railroads and their employees fund most of the RRB’s programs and benefits.

There are limits to the similarities between SSA and RRB. In fiscal year 2010, SSA outlays exceeded $700 billion — 20 percent of all mandatory federal expenditures, the largest share of any program. RRB benefit payments for the same period were $11 billion.

Visibility being proportionate to size, government watchdogs might scrutinize RRB less than the SSA. If the RRB — and, consequently, the LIRR — had been more attentive to detecting and preventing fraud in the railroad benefit programs perhaps it would have more closely examined disability trends and launched a full investigation years earlier than it did.  But, in the absence of such oversight, leaders of both organizations professed ignorance of what had become obvious to outside observers. The Times, before publishing its findings in 2008, presented them to RRB Chairman Michael S. Schwartz, who said, "I've not seen that until you just showed it to me." LIRR President Helena E. Williams, who had been in her post only a year, told The Times that the data were "alarming" and asked the RRB-OIG to investigate.

Since 2008, both organizations have worked to improve their fraud detection and prevention training and resources. [Beginning in 2008, the LIRR increased ethics training for its employees, established a compliance unit to review the propriety of all RRB correspondence related to disability applications by LIRR employees, encouraged employees to use its hotline to report suspected disability fraud and asked Congress to pass legislation that would re-assess the statutory and regulatory framework underlying the RRB disability program. See "LIRR President Outlines Actions to Curb Abuse of U.S. Railroad Disability System." Also since 2008, the RRB has been following a five-point plan it set up then to enhance oversight of LIRR claims. Under the plan, the RRB’s own doctors examine claimants, claimants undergo disability re-evaluations, the RRB closely oversees its Westbury office with biweekly phone calls and quarterly visits, the RRB analyzes LIRR claims separately for red flags and the RRB collects data on how many LIRR managers (non-laborers) apply for disability. See "Implementation Plan for Long Island Employees."]

But employees who have seen their managers either ignore or fail to actively detect and prevent fraud may not perceive and emulate a strong anti-fraud tone at the top for a long time.

CFEs can lead their clients and employers toward proactive mitigation of such risks with the ACFE’s Fraud Prevention Check-Up, which outlines effective anti-fraud controls and explains how to implement them.

PRIVATE INSURERS ALSO AFFECTED

According to the criminal complaint, the scheme also involved large-scale fraud outside of the public sector. The two independent doctors discussed above received more than $2 million from private insurers for unnecessary medical treatments and fees for preparing fraudulent medical documentation of the LIRR employees' claimed disabilities.

Each day more than 7,000 working-age Americans experience disabling injuries or illnesses, according to the Council for Disability Awareness, a nonprofit organization. Many of those harmed are not employees. In response, private insurers offer groups and individuals a variety of health-related policies. Some cover the cost of medical care, while others replace income when a claimant becomes disabled. To control the cost of serving numerous lines of business, insurers often engage outside specialists for help in assessing, for example, the information claimants supply as documentation of their pre-disability income.

Suzanne Tarchala, CPA, is a partner of international forensic accounting firm Matson, Driscoll & Damico, and heads its Detroit, Mich., office. Her clients include numerous insurers who offer disability income replacement policies. Tarchala specializes in evaluating the financial and operating records of individual claimants to quantify their income losses due to disability. Her findings provide the insurers with reliable data they can use to accurately calculate the amount of benefits due to an income replacement policyholder.

Most of the claims she investigates are from small business owners or professionals, although some are from employees who choose to buy policies independent of whatever coverage — if any — their employer offers. Virtually all of them buy "own occupation" coverage, which, like that provided by the RRB, covers you if disability prevents you from doing your own job but not other types of work.

DO IT YOURSELF

"To evaluate such claims, you really have to understand exactly what the claimant does each day at work," Tarchala said. "A claimant typically pays higher premiums for ‘own occupation’ coverage than he would for 'any occupation,' which would not pay benefits unless the claimant is so disabled he can’t perform any job. So, after years of paying premiums, one might feel entitled to benefits when he or she gets injured in any way. But that might not be what the income replacement disability policy covers."

For example, if the disability is due to a physical injury, a claimant might say that most of what he does each day is physical. But the investigator has to find out whether that is true. In some cases, Tarchala said, the claimant manages the business but does little, if any, manual labor. So if the disability does not interfere with the claimant’s ability to work in his normal occupation, he is not considered disabled under the policy terms.

"Interviews can be adversarial," Tarchala said. "For the claimant, the disability and loss of income are very personal. For some CPAs or anyone who hasn't participated in such interviews in the past, transitioning to it requires you to develop new skills and sensibilities. I let the claimant know I'm trying to understand his situation. When I pose a question, I make sure the claimant’s response provides the information I've requested. And I ask myself how it compares with everything else I know about the case. If it doesn't make sense, I ask more questions. Sometimes my client will say, 'Just give me a list of things to ask the claimant.' The problem is that they don't know the follow-up questions. So whenever possible I interview the claimant myself."

RUNNING THE NUMBERS

Tarchala's expertise is in forensic accounting, which enables her to accurately assess a claimant's income before and after the onset of a disability that entitles him to coverage. The risk she helps protect her clients against is that a claimant will report pre-disability income higher than he actually was making and report post-disability income lower than he actually receives. Such fraud increases the insurable gap between pre- and post-disability income.

"There are many ways to provide false data," Tarchala said, "and the best way to expose them is to obtain reliable documentation for all the claimant’s income and expenses. I rely heavily on income tax records. On occasion, a claimant will say he made more than the amount on his income tax return. But he can't have his cake and eat it. I won't disregard the income reported to the government and allow the claimant to benefit from a higher pre-disability income interrupted by his disability."

Tarchala examines the following documents and ratios to obtain a full and accurate picture of a claimant’s income and any expenses that could influence it.

DOCUMENTS TO CONSIDER

Records
Income statements
Monthly charges, collections, adjustments or other production records
Billing records
Bank statements
Detailed general ledger
Pay stubs
Payroll earnings registers
Business and personal income tax returns, including all schedules and attachments
W-2 Wage and Tax Statements
Schedule K-1 for Ownership Interests

Agreements
Pension and/or profit sharing plan annual participant statements
Employment contracts
Shareholder/partnership agreements
Business/operating agreements
Buy/sell documents
Lease agreements
 

Data Mining at the SEC

A new government system for spotting securities fraud is bearing fruit. Over the past month the Securities and Exchange Commission filed four fraud cases against three hedge funds and six people for misconduct, including improper use of assets, fraudulent valuations, and misrepresenting returns. “Hedge fund managers depend on valuation and performance for both their compensation and marketing,” says Bruce Karpati, co-chief of the SEC’s asset-management enforcement unit. “These managers have either manipulated performance or engaged in other falsehoods in order to line their own pockets at the expense of investors.”

The actions are a product of the agency’s initiative to build cases on data analysis instead of relying on tips. “We take a look at performance by comparing funds against their peers and then apply qualitative factors, including looking at experience, assets under management, their regulatory history, and whether they’ve been in trouble before,” Karpati says.

In the most recent enforcement action stemming from the program, the SEC on Dec. 1 filed a lawsuit against Michael R. Balboa, former portfolio manager for the now defunct $844 million Millennium Global Emerging Credit Fund. The lawsuit alleges that he and Gilles De Charsonville, a broker at Greenwich (Conn.)-based BCP Securities, along with an unidentified third person used overvalued securities positions to “generate millions of dollars in illegitimate management and performance fees.” Balboa was also arrested and charged with securities fraud, according to a criminal complaint unsealed in federal court in New York on Dec. 1. Balboa, 42, of Surrey, England, will plead not guilty and “intends to defend the charges,” his lawyer, Joseph Tacopina, says. An attorney for De Charsonville, 49, of Madrid, didn’t immediately respond to a request for comment.

Adam J. Wasserman, a New York attorney at Dechert who works with hedge funds, says fund managers could have concerns if achieving unusually good returns—“doing their job well”—sprouts a red flag at the SEC. “People invest in hedge funds because they expect better returns over time,” Wasserman says. “You don’t want traders and their funds to fear being successful.”

In a speech to the Consumer Federation of America on Dec. 1, Robert S. Khuzami, the SEC’s enforcement director, likened the program to former New York City Mayor Rudy Giuliani’s so-called broken windows approach to crime fighting, which operated on the theory that targeting routine violations would curtail major crime. “If you stop people when they commit small infractions,” Khuzami said, “they are less likely to graduate to bigger ones.”

Canada Cracks Down on Immigration Fraud
 

The Canadian federal government is set to crack down on 4,700 more people believed to have obtained citizenship or permanent resident status illegally in what’s being dubbed the biggest citizenship fraud sweep in Canadian history.  Immigration Minister Jason Kenney is expected to make the announcement that “Canadian citizenship is not for sale” on Friday.

He will unveil the details in Montreal where Nizar Zakka — an immigration consultant suspected of fraud — was arrested in 2009. Zakka is suspected of providing would-be Lebanese immigrants with false evidence — indicating that they were living in Quebec when they were not — to support their cases for permanent residency.  He’s also accused of filing or contributing to the filing of 861 false tax returns for at least 380 clients between 2004 and 2007. The returns allegedly were then used to claim refunds for child care and property taxes as well as the provincial sales-tax credit.

The announcement comes six months after the government moved to strip 1,800 people of their Canadian citizenship or permanent resident status for the same reasons. Up until this year, Canada had revoked just 67 citizenships since the Citizenship Act came into force in 1947. The bulk of the citizenship fraud cases are said to be linked to Zakka as well as Halifax immigration consultant Hassan Al-Awaid, who was charged in March with more than 50 citizenship fraud-related offences.  The cases are also tied to a third consultant from Mississauga, Ont., west of Toronto, who remains under investigation, according to a government source who noted the others were brought to light thanks to the new citizenship fraud tip line.

Up until this year, Canada had revoked just 67 citizenships since the Citizenship Act came into force in 1947.  Unveiled in September, the tip line already has fielded 5,366 calls.  Letters are currently being sent to the 6,500 people from 100 countries indicating that Canada is revoking their citizenship or permanent resident status due to fraud. This comes following a lengthy investigation by the RCMP and the Department of Citizenship and Immigration.

Alleged fraudsters, the majority of whom are not currently living in Canada, have up to 60 days to appeal the decision in Federal Court before cabinet moves to void their passports and strip them of all rights and privileges.  According to Citizenship and Immigration, to maintain permanent resident status a person must reside in Canada for at least two years within a five-year period. Permanent residents seeking citizenship must show proof that they’ve lived in Canada for at least three of the last four years before applying.

At the time of Al-Awaid’s arrest, Kenney said he was suspected of helping people “create the appearance they were residing in Canada in order to keep their permanent resident status, and ultimately attempt to acquire citizenship.”  He said investigators had linked Al-Awaid to 1,100 applicants and their dependents, 76 of whom had obtained Canadian citizenship.  He noted that many people were prevented from “fraudulently obtaining citizenship” as a result of the investigation.

The government has been taking action against citizenship fraud for some time. The Cracking Down on Crooked Consultants Act, which imposes tough new penalties for immigration consultants convicted of fraud, including fines and/or prison, is now law in Canada.
 

Financial Statement Fraud by Trusted Employees
 

Small organizations: Beware of those longtime employees who have their hands in every department. They could be like alpha executive Francine Gordon, whose fraud gave her company headaches and grief. Learn lessons from this tale of misplaced trust, faulty internal controls and lack of segregation of duties. 

All financial statement frauds are not in the billions of dollars. They only need to be big enough to be material to the financial statements. Francine Gordon was a highly intelligent, model employee of Small Town Federal Credit Union (STFCU). She had been STFCU’s controller for more than 15 years, but she also managed the data-processing systems. When the data-processing clerk was sick or on vacation, Gordon would step into the position to make sure that the processes ran efficiently. Many employees at the credit union — including Gordon — believed she knew more about the IT systems than the data-processing clerk.

She was not the typical “that’s not my job” employee. For years, she helped out in many other departments and led several projects. Susan Wren, STFCU’s CEO, and many employees tolerated her somewhat dictatorial manner and moody temper because she was so valuable to the credit union. Few employees ever challenged Gordon about credit union issues.  As with many small financial institutions, the credit union had not separated duties because of finite resources and extremely tight budgets. Gordon had some unthinkable duties and responsibilities. Her primary responsibilities as controller were creating financial statements, preparing budgets and forecasts and reconciling STFCU’s lengthy and often complicated bank statement.

In addition to supervising the data-processing department, she was responsible for the accounting — and the management — of STFCU’s investment portfolio. This allowed her to make purchase and sales decisions about investments, although intelligent investment analysis was not one of her strengths. So, Gordon relied on the advice of the credit union’s three approved brokers. Her control of so many of STFCU’s areas created a “witch’s brew” for bad decisions and lax internal controls.

Her compensation was good but not comparable for those working in the upper tier in credit unions of similar size. Regardless, Wren granted Gordon more authority and autonomy throughout the years.
Gordon frequently worked long hours and weekends. She was not married, did not have a significant other or children, seldom visited her faraway family and was not close to other employees and had few friends. Gordon did gravitate toward Steven Edwards, one of the credit union’s investment brokers. Edwards, an older distinguished gentleman with a silver tongue, always was impeccably dressed and manicured. He would send flowers to Francine on her birthday and visit her regularly.

Though the credit union had three approved brokers, it consistently awarded Edwards about 90 percent of its investment business. Because it was a small financial institution, STFCU relied on its brokers to analyze investments and to detail how individual investments and the total portfolio fit into the credit union’s balance sheet and future goals. However, Edwards did not provide these analytics and did not appear to have a solid understanding of how to manage an investment portfolio. In fact, he did not seem to understand financial institutions very well. Apparently, his skills were more social than financial.

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