Wednesday, January 07, 2015

Feds Announce Five Accounting Fraud Arrests

[This story previously appeared in Securities Regulation Daily.]

By Amanda Maine, J.D.

The Manhattan U.S. Attorney and the FBI announced that former executives and employees of an unnamed New Jersey-based company (the Company) were arrested on federal bank fraud, wire fraud, and conspiracy charges for their roles in an accounting fraud scheme. Principals of the Company, which provided in-store displays for retailers, made false and misleading statements about its financial condition and sales to secure millions of dollars in loans. These statements included phony invoices and purchase orders to two unnamed customers, Customer-1 (a New York-based sports apparel and footwear retailer) and Company-2 (an Oregon-based multinational designer and manufacturer of athletic footwear, clothing, and accessories).

Accounting fraud. According to the indictment, the defendants created fictitious and falsely inflated purchase orders purporting to reflect sales in order to create the false impression of sales. Customer-1 was also tricked by the defendants into paying falsely inflated invoices. The defendants provided cash payments, personal vacations, home renovations, and other kickbacks to an employee of Customer-1 for helping perpetuate the scheme. That employee, who was also arrested and charged, verified to the Company’s lenders false information about the Company and caused Customer-1 to pay invoices from the Company she knew were inflated.

Fake emails. One method the defendants used to prevent the Company’s lenders and auditors from discovering the fraud was the use of fake emails belonging to Customer-1 and Customer-2 employees, according to the Government. The fake email accounts, which used domain names that were similar to the Customers’ actual domain names, were used by the defendants to pretend to be actual employees of the Customers. Using the fake emails, the defendants would verify false information about the Company’s financial condition to its lenders and outside auditors.

Shell companies and false documents. The defendants also used shell companies to keep their scheme afloat. Through the shell companies, the defendants engaged in “round-trip” transactions to create the appearance that customers were paying the Company’s outstanding phony receivables. One of the defendants used his graphic design skills to create documents such as fake invoices and purchase orders to support the false representations about the Company’s financial condition.

Misappropriation. The indictment alleged that three management defendants misappropriated nearly $3 million of the loan proceeds which were falsely secured though the accounting fraud. They used this money to pay for homes, luxury cars, private school tuition, and personal credit card bills. Some of the misappropriated funds were also used to pay the kickbacks to the Customer-1 employee for her assistance in the scheme.

Charges. The five defendants were charged with various criminal violations, including bank fraud, wire fraud, and conspiracy to commit fraud or money laundering. According to the U.S. Attorney’s press release, each count carries a potential sentence of between 20 to 30 years in prison.

The case is No. 14 CRIM 845.