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Investment Fraud.

One detective working white-collar crime encountered an investor who claimed that he did not receive a promised 900 percent annual profit on an investment. To complicate matters, the investor dumped stacks of paperwork on the detective's desk attempting to prove the fraud. Upon further questioning, the detective learned that the investor made the investment 2 or 3 years ago, but it had not paid out during the past year. The investor explained that he thought he had invested in an overseas program guaranteed by banks involving the Federal Reserve that made money by trading some type of bank instruments. He had hesitated to issue a complaint because he believed the investment would pay off soon. The scheme involved volumes of thick contracts, letters of intent, secrecy clauses, and a host of other financial terms that the investor really never understood and could not explain to the detective. The investor only understood that his involvement had no risk and that he would receive an extraordinary return. But, t he investment failed.

This scenario describes a prime bank trading program fraud. These types of investment frauds have existed for many years and, historically, have involved individuals investing huge sums of money--between $500,000 and $1 million. Today, these scams have evolved into targeting larger numbers of people for smaller dollar amounts--usually between $5,000 and $100,000 each. [1]

Unfortunately, these scam artists rarely face prosecution because courts traditionally have regarded the cases as civil in nature, and the complexity of the issues and the difficulty in establishing criminal intent needed for conviction prove challenging. However, the FBI's Sacramento office has implemented investigative techniques to successfully prosecute these schemes. Initially, when investigators receive an investment fraud complaint, they should contact promoters and explain the illegality of marketing such schemes. By doing so, investigators establish the knowledge of the promoter and warn the promoter that continuing the fraud may result in prosecution. If the promoter continues to contact potential investors to take money, the U.S. Attorney's Office may charge the scam artist with mail and wire fraud.

HOW THE FRAUD WORKS

Assuming a department eventually opens a criminal case, most investigators will become discouraged after the initial interview with these con artists. Usually, they admit taking money from the victim, promising an extraordinary return, explaining the guarantee of the investment, and failing to perform as promised. But, investment criminals will advise that they were victims, too, because although they took money from investors, they gave it to their contacts who promised they had access to a trader who could deliver the promises. Then, they will explain how their contacts took the money but failed to perform as expected. At this point, they reach into their file cabinet, pull out a huge stack of paper, throw it on the desk, and advise that they are a victim as well.

A number of promoters claim that they have access to individuals who can purchase bank instruments at a discount and resell them for a higher price for a small profit. These promoters perpetrate prime bank scams throughout the world and claim that they do this continually, making huge profits in a short time period with no risk.

The promoters collect funds from investors and have them sign a series of documents to enter into the investment. Types of documents seen at this stage include "letters of intent" and "proof of funds letters," all designed to make investors believe that they have to qualify for the investment. Additionally, the documents lend credibility to the scheme by making the investment application process appear official.

The promoter will enter into an agreement with another person, often called an intermediary or facilitator. The promoter will sign letters of intent or proof of funds and eventually sign a contract with the intermediary.

Promoters receive payment by keeping a portion of the investment and sending the balance to the intermediary, or by making arrangements to receive a percentage of the profits. At this point, the money starts to flow. The investor gives money to the promoter, who, in turn, passes it along to the intermediary who initially performs as promised. Usually, the investor receives one or two payments as profits. Then, the payments reduce greatly or cease all together. Promoters then will provide a series of excuses, often in writing, explaining in detail exactly why the investment cannot pay this month, but that it will pay soon.

In the final analysis, no legitimate investment ever takes place. In fact, everyone in the chain is an intermediary who takes a portion of the money as fees or commissions and passes the balance to the next person in the chain.

At this point, law enforcement easily recognizes the investment as a classic Ponzi scheme [2] in which money paid to old investors represents, in reality, investment principal from the new investors. By the time the matter comes to the attention of law enforcement, the money has passed through several hands and, often, through several states or countries.

TACKLING THE PROBLEMS

Several problems arise in this type of scam. First, investigators have difficulty proving that anyone involved acted with intent to defraud, especially promoters of the scheme. These con artists use excuses like "I thought it was real" or "I thought it would work" as their most common defense.

Another problem involves the level of complexity these types of schemes present. One judge characterized a prime bank scam as inherently complex, deliberately designed this way by criminals. The judge compared the difficulty of investigation to a large jigsaw puzzle thrown to the ground, leaving the investigator with seemingly unrelated pieces to pick up and reassemble. [3] The sheer volume of the paperwork alone can discourage investigators. Even if investigators manage to understand the case, they probably will have difficulty explaining it to the prosecutor. Although the investigator and the prosecutor eventually may unravel the scheme, explaining it to a jury can feel almost impossible. Nevertheless, law enforcement can investigate and prosecute these cases successfully with a minimum of frustration, assuming that they pay particular attention to contact with promoters, investors, and the prosecutor.

Contact with Promoters

Investigators strive to show intent to defraud. To prove intent, they have to show that the promoter lied intentionally about the investment to get the investor's money. Proof of intent can include evidence that the promoter previously knew that the investments were fraudulent. If the promoters did not know of the fraud before, investigators should tell them now, as well as provide an information sheet, which describes different types of investment programs and proclaims certain ones as fraudulent. [4] This sheet can prove helpful as an investigative tool for law enforcement. Investigators can give the sheet to promoters to advise them of the fraudulent investments--a criminal violation subject to federal securities laws.

Advising promoters of the fraudulence of these programs alerts them that moving any money between bank accounts in this type of program may constitute money laundering. Documenting the fact that investigators have warned promoters about the fraudulent investment may not help in the prosecution of frauds that already have occurred; however, it can help prove fraudulent intent if the individual continues to promote even after receiving the warning. Law enforcement should ensure that all promoters receive this warning during the interview. This process can assist prosecutors during trial when negating a defendant's claim of ignorance as to the illegality of the scheme.

Second, investigators need evidence that promoters have been involved in these types of investments in the past and have lost money belonging to other individuals. Items obtained by search warrants, such as bank records, may prove helpful. Investigators should ask promoters about specific deals in which they have participated in the past. If they claim that they have done this successfully before, investigators should get all the details. On the other hand, some promoters will claim that they have never done this before. If investigators learn that promoters have been involved in failed deals in the past, but still received a large payment, this fact may prove useful.

Contacts with Investors

When dealing with a large number of victims, sometimes the only method of collecting information is mass mailing questionnaires. [5] Any communication with victims should remain open and honest. Often, victims of such schemes do not trust investigators who, they think, might ruin their investment opportunity. When writing to victims, investigators should provide all of the information that they have about the investigation. Promoters deliberately might try to interfere with victims by disseminating erroneous information. Being open and candid with investors may convince them to cooperate early. To avoid any subsequent allegations by the defense, investigators should include language advising that defendants are presumed innocent. If investors still remain in contact with promoters, any evidence of statements made by the promoter to the investor (known as "lulling" statements) will prove useful, particularly if promoters make them after investigators already have contacted the promoters and warned them about the true nature of these schemes.

Contact with Prosecutors

These types of cases can become inherently complex. Investigators should present the case to prosecutors first, then conduct the investigation. Also, investigators always should remember that the goal is to prove intent to defraud, not understanding how the investment should have worked. In fact, understanding the investment can prove impossible because of the amount of fictional information involved. Investigators should not spend too much time trying to understand the meaning of all of the financial jargon and, although investigators might think the investment sounds like it makes sense, no investments pay extraordinary returns without risk.

CONCLUSION

By using innovative investigative techniques and following certain steps in the investigation, law enforcement can prosecute fraudulent investment schemes successfully. First, investigators should interview promoters, obtain a history of their past involvement with these schemes, and warn them that these types of investments are fraudulent. Additionally, investigators should obtain evidence of previous scams through interviews, search warrants, and bank records and search for evidence that promoters knew that the program would not work.

Second, law enforcement should interview the victims. Officers should obtain evidence of lulling statements made to victims, as well as declarations made by promoters about their past success with these programs.

Most important, prior to beginning any steps, investigators should contact the prosecutor, explain the case and strategy, and keep the prosecutor informed throughout the investigation. Chances for a successful prosecution of the case increase if a prosecutor works on the case early in the investigation. If law enforcement waits until the end of the investigation to request the prosecutor's help, continuing with a civil case may be the only response.

Endnotes

(1.) Kim Clark, "Pumping the Prime: 'Prime Bank' Schemes are Back and Targeting the Middle Class," U.S. News and World Report, March 15, 1999.

(2.) An investment swindle in which some early investors are paid off with money put up by later ones in order to encourage more and bigger risks. Merriam-Webster's Collegiate Dictionary. 10th ed, (1996), s.v. "Ponzi scheme."

(3.) U.S. vs. Sid Tweady, et al., Cr. S.-99-293 DFL (E. D. CA 2000) statements by Judge David Levi.

(4.) Investigators can obtain this information sheet, created by the FBI and the Sacramento U.S. Attorney's Office, by contacting either of these offices. A copy of the sheet also is provided with this article.

(5.) The questionnaire consists of a cover letter explaining the nature of the investigation, the status of the prosecution, and any information known about the disposition of the money. It consists of questions such as: "what promises were made? What was the promised return? What was the risk? who made the promises? What is the promoter telling you now?" Also, the questionnaire includes a copy of the Information Sheet.

Information Sheet

The purpose of this notice is to alert the public to persons who reportedly have marketed investment schemes that appear to be fraudulent. Various prime bank trading programs or similar trading programs which purport to offer above-average market returns with below-market risk through the trading of bank instruments are fraudulent. Offering such programs, or claiming to be able to introduce investors to persons who have access to such programs, violates numerous federal laws, including criminal laws.

It is illegal to engage in fraud in the offer or sale of a security. Under most circumstances, it is also illegal to sell securities that have not been registered with the U.S. Securities and Exchange Commission. A security includes the following items: "note," "stock," "bond," and "debenture," as well as more general terms, such as "investment contract" and "any interest or instrument commonly known as a 'security.'" In the leading opinion, the U.S. Supreme Court held that the definition of a security includes an investment contract, which is "a contract, transaction, or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or third party...." Designating such instruments as "loans" does not alter their legal status as securities.

The FBI, as well as other federal and state agencies, have identified several characteristics common to fraudulent schemes. These characteristics include--

* claims that investor funds can be placed in a bank account, and then used, without risk, to trade bank debentures, or other financial instruments;

* claims that invested funds can be used to lease or rent U.S. Department of the Treasury obligations and then use these same leased securities as collateral for further trading programs;

* claims that trading medium term notes (MTNs), prime bank notes, or any other bank instruments, on a riskless basis, will yield above market average returns; and

* claims that letters of credit or standby letters of credit can be traded for profits.

In general, investment programs that offer secret, private investment markets, which offer above-market rates of return with below-market rates of risk for privileged customers in Europe, are fraudulent. There are no "secret" markets in Europe, or in North America, in which banks trade securities. Any representations to the contrary are fraudulent.

In addition, investment programs in which a financial institution is asked to write a letter, commonly referred to as a "blocked funds letter," advising that funds are available in the account, that they are "clean and of noncriminal origin" and are free of "liens or encumbrances" for a certain time frame are used frequently to perpetrate fraud schemes. These letters have no use within legitimate banking circles.

Some phrases are seen commonly in documents presented by fraudsters in the course of marketing fraudulent investment schemes. If one or more of these phrases appear in documentation, they should be treated with suspicion. These include, but are not limited to--

* noncircumvention, nondisclosure;

* good, clean, clear, and of noncriminal origin;

* blocked funds trading program;

* prime bank trading program;

* federal reserve approved;

* roll programs;

* irrevocable pay orders;

* prime bank notes, guarantees, letters of credit; and

* fresh cut paper.

The marketing of fraudulent investment schemes violates federal criminal laws. In order to report instances of suspected fraud, please contact Special Agent John M. Cauthen, FBI, Sacramento, California Division, telephone 916-481-9110 or any of the sources listed below.

Sources that can corroborate the above information include:

* U.S. Treasury Department, Comptroller of the Currency, Enforcement and Compliance Division, 250 E Street, SW, Washington, DC 20219

* Securities and Exchange Commission, San Francisco District Office, 44 Montgomery Street, Suite 1100, San Francisco, CA 94104, 415-705-2500

* Bureau of Public Debt, Chief Counsels Office, 200 3rd Street, Room G-15, Parkersburg, WV 26106

* Federal Reserve, Washington DC, Office of General Counsel, 202-973-5021
COPYRIGHT 2001 Federal Bureau of Investigation
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Author:CAUTHEN, JOHN
Publication:The FBI Law Enforcement Bulletin
Geographic Code:1USA
Date:May 1, 2001
Words:2594
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