The Love of Money: Audits and Fraud

The love of money…

A Case of Fraud at LocatePlus Holdings Corporation

 

In business, greed comes most frequently not in the pursuit of profit but in the form of financial fraud. Individuals who lack or loosen their ethical restraints often rationalize their behavior as unavoidable or good-intentioned. But, make no mistake, people who commit fraud normally do so in order to enrich themselves even if that enrichment comes to cover up a failure which would affect the wealth they have come to feel entitled to.

The failure or lack of ethical restraint lies central to the case of LocatePlus Holdings of Beverly, Massachusetts, a company in the business of selling its services to provide access to personal data and investigative background information.

In 2012 and 2013, the Chief Executive Officer of LocatePlus Holdings, James Fields and former CEO John Latorella both pled guilty to various charges of fraud and violations of Federal securities regulations.

The Case

gavelAccording to documents filed in the US District Court of Massachusetts by the Securities and Exchange Commission, Fields and Latorella created a number of fictitious companies including one called Omni Data Services (ODS) which the two executives falsely charged for services from LocatePlus which it did not actually provide but which Omni Data paid for using funds routed from LocatePlus to ODS through the other fake entities which the executives created in order to hide their illegal activities.

This type of fraud is common enough that Federal authorities have labeled it the “roundtrip transfer” because the person committing the fraud is transferring funds from his own company around a loop of fake companies in order to make the real company’s revenue appear larger than it is. Such circular transfers can fool or confuse accountants and auditors not familiar with the business and generate lucrative bonus payments for a fraudulent executive.

Fields and Latorella managed to get away with this tactic for almost two years.

As a result, during 2005 and 2006, Fields and Latorella managed to record approximately $2 million in bogus sales on the LocatePlus books. Fields and Latorella created another company called Paradigm Tactical Products with an accomplice, Daniel O’Riordian who helped the pair illegally sell Paradigm stock to private investors which Fields and Latorella transferred to ODS to reimburse LocatePlus for the fake sales.

Compliance and regulatory issues

supreme courtNaturally, laws exist to protect stockholders from this sort of fraud. Both Fields and Latorella plead guilty to violations of the Securities Act of 1933 and the Securities Exchange Act of 1934, receiving both prison time and orders to pay restitution in an amount exceeding $4.9 million. The third conspirator, O’Riordian plead guilty to separate securities fraud charges.

However, what this case illustrates is the importance of clear and independent auditing and adherence to compliance and regulations in business accounting. Like in most states, companies doing business in Massachusetts must adhere to generally accepted accounting principles; and by law or by practice, most corporations contract financial auditing firms to review and sign-off on the corporate books at least annually.

Furthermore, any business listed with the Securities and Exchange Commission must abide by SEC accounting, reporting and auditing regulations as well. The extent to which Fields and Latorella went to hide their illegal acts however may well have masked their activities from even the most experienced auditors.

Nevertheless, LocatePlus initial outside auditors obviously felt something was wrong at the company and resigned from their contract, forcing LocatePlus to contract another outside firm which ended up having to face the SEC investigation along with LocatePlus.

Analyzing the central issues

Obviously, when people are willing to go to such lengths to satisfy their greed, the company failed to create a culture of strong ethical values. As a case study, however, the LocatePlus fraud presents some interesting questions to consider.

  1. How does a company establish a culture of strong ethical standards?
  2. How do accounting teams recognize fraud when it happens?
  3. What responsibility did the initial firm have in reporting any concerns to the authorities?
  4. What responsibility did the auditors who quit possess in regards to relating any of their concerns to the new auditors?
  5. What responsibility did the new auditors have to the company after the discovered that their client gave them falsified information?
  6. How can someone report suspected criminal acts if and when they are recognized?

At least one of these questions is easily answered. The Sarbanes-Oxley Act of 2002 requires all public companies to create an “anonymous reporting mechanism” for employees to report fraud.

Perhaps the most important questions however are what accounting practices could have prevented this, and what happens to the people and stockholders of LocatePlus who had nothing to do with these crimes?

People who commit crimes rarely consider how their actions will affect others.

Identifying and evaluating sources

analysisBecause criminals fail to consider or don’t care how their actions affect other people, citizens, even though governments have created laws in the hopes of limiting fraud and law enforcement agencies to punish those who do.

To do this, agencies such as the SEC and FBI employ specially trained individuals known as forensic accountants, but anyone studying or working in accounting needs to know what sources need to be gathered or analyzed when matters seem suspicious or fraud is suspected.

The Financial Statements

The Financial Statement is invariably the most crucial source in proving or disproving any allegation of fraud. Many if not all decisions regarding executive pay depend on elements contained with the financial statement. Manipulating the financial statement by falsifying revenue, liabilities, inventory or assets prove the be the most common schemes; and often, experienced accountants possess the knowledge and instincts to root out most account discrepancies. Discovering discrepancies or proving the statement true then becomes the task of the forensic accountants.

Government Documents

Paperwork required by local, state and federal agencies are another source of evidence which can prove or disprove fraudulent activity especially if information contained in those documents can be proven false. In the LocatePlus case, the SEC cited false reporting in the company’s filings to the SEC as part the charges. The FBI also uncovered evidence regarding the fake companies the conspirators set up that allowed them to temporarily avoid detection from internal and external accounting.

Computer Systems and Software

Never believe that computers cannot or do not lie. The old adage Garbage In-Garbage Out hold just as true in computer-assisted accounting. Information contained in computer systems and software is only as reliable as the person entering the numbers. Nevertheless, software exists which can track keystrokes, changes and deletions in any system, while other software can scan for suspicious entries such as vendors with different names but the same address. Computerized information, fraudulent or not, and regardless of how it is obtained, makes for compelling evidence either guilt or innocence.

Knowledgeable Witnesses

Here, some judgement is required in evaluating who may make a reliable witness and who might not. Even so, almost a third of all fraud cases are discovered thanks to someone with enough ethics and courage to report it. Perhaps the most influential witness in any fraud investigation is the person who discovered the fraud, whether that is an employee or a professional forensic accountant. That said, anyone who possessed access to or authority over suspected account needs to be interviewed by at least two separate and competent investigators. This way, the investigators can compare notes and recall individuals of interest to clarify or expand upon any issues of discrepancies.

Examining the case from a law-enforcement point of view

Once the information in any case becomes clear, the next step is to identify any violations of laws or regulations.

In some instances, determining what law may have been broken requires an experienced prosecutor or knowledgeable judge. For the most part though, this is a clear-cut process of comparing the actions of individuals involved to the statutes and agency regulations governing the activity in question.

In the LocatePlus case, numerous violations of numerous sections of federal and state business law occurred. Creating a company which provides no service or products is not a crime in itself, but doing so for the purpose of making fraudulent transfers of funds is. Transferring funds from company to company happens constantly. Transferring funds for services which were not rendered or products which do not exist is a felony. Filing forms with the SEC that contain errors might result in a fine, but purposefully filing fraudulent information with the SEC will put the person doing so in the federal penitentiary, as all three defendants in the LocatePlus case eventually discovered.

Gathering and organizing evidence to support the allegation

Even when the evidence is clear and the crime is identified, the work necessary in prosecuting fraud is not over. Next is gathering and organizing the information is such a way that each piece of information builds upon the last in such a way that they support the allegations being made.

For example, if the three accused executives in the LocatePlus fraud case plead not guilty, the SEC and the FBI would have needed to present evidence that the Fields, Latorella and O’Riordian did in fact sell securities in Paradigm then transfer the money to one or more of the other allegedly fake corporations for services not rendered which, in turn, transferred funds to LocatePlus, and that the defendants did so with the intent of defrauding the company.

Intent, unfortunately, is difficult to prove without a confession or documents, emails or eye-witness testimony from someone who is a party to the fraud or someone who overheard the people involved discussing their plans. Most of the time, intent to commit a crime is proven through circumstantial evidence such as the creation of a shell corporation, hiding activity from others or making statements that can be proven false. More than likely, FBI possessed such proof, and more, judging by the fact that all three defendants plead guilty reasonably quickly.

Fraud comes in many forms, it exists based on the simple fact that businesses are run by people. Most businesses govern employees through a statement of ethics, but people choose to abandon ethical concerns, or have no concern as to how our actions affect others, they can fall victim to a love of money strong enough that they are willing to commit fraud in order to satisfy their greed.