Ethics Within the SEC During the Madoff Years

On 10 December 2008, the largest “Ponzi-scheme” started to unfold when Bernard L. Madoff reportedly admitted to “one or more employees of BMIS” that he was conducting a Ponzi-scheme and his liabilities estimated around $50 billion (SEC vs. Bernard L. Madoff, 2008). The next day the Securities and Exchange Commission (SEC) filed a complaint against Madoff and Bernard L. Madoff Investment Securities LLC (BMIS) to (a) halt ongoing fraudulent offerings of securities and investment advisory fraud by Madoff and BMIS, (b)expedite relief needed to halt the fraud and prevent the Defendants from unfairly distributing the remaining assets in an unfair and inequitable manner to employees, friend and relatives, at the expense of other customers, and (c) seek emergency relief, including temporary restraining orders and preliminary injunctions, and an order to impose asset freezes; appointing a receiver over BMIS; allowing expedited discovery and preventing the destruction of documents, and requiring the defendants to provide verified accountings (SEC vs. Bernard L. Madoff, 2008).

Prior to his Ponzi-scheme, Madoff’s managed funds were ranked highly in NASDAQ stocks, order flow in the New York Stock Exchange, and in other specialized securities (Ocrant, 2001). Erin Arvedlund, a Barron’s reporter, published an article on May 7, 2001, this article attempts to explain how Madoff delivers above average returns, 10% to 15%, using a secretive split-strike strategy (Arvedlund, 2001). Within the Barron’s article, Erin Arvedlund states, “What’s more, these private accounts have produced compound average annual returns of 15% for more than a decade. Remarkably, some of the larger, billion-dollar Madoff-run funds have never had a down year.”

Madoff Investment Securities reportedly had $6-7 billion in assets that were funneled through him by three feeder funds (Ocrant, 2001). These feeder funds brought in new customers and established a steady stream of cash flow to allow the Ponzi-scheme to carry on for years. Madoff’s knowledge of the markets, regulatory gray area in the securities industry, and the lack of internal ethics within the SEC helped Madoff continue his operation for sixteen years.

The Regulatory Gray Zone

As Madoff conducted his Ponzi-scheme, where were the watchdogs that are supposed to protect investors from these types of fraudulent activities, and why didn’t they catch him? The SEC has the authority to investigate entities such as BMIS as well as Bernard Madoff himself. According to the SEC’s website,

“The SEC oversees the key participants in the securities world, including securities exchanges, securities brokers and dealers, investment advisors, and mutual funds. Here the SEC is concerned primarily with promoting the disclosure of important market-related information, maintaining fair dealing, and protecting against fraud (SEC, 2010).”

However, Madoff was not a registered broker-dealer or a registered investment advisor. The Investment Advisers Act of 1940 and its amendment in 1996, under section 203 titled Registration of Investment Advisers, describes exceptions to those who do not have to register with the SEC. For example, subsection (3) states any investment adviser who during the course of the preceding twelve months has had fewer than fifteen clients and who neither holds himself out generally to the public as an investment adviser nor acts as an investment adviser to any investment company registered under title I of this Act (SEC, 2009).

The exceptions within the Investment Advisers Act and other similar exceptions help formulate a “gray area” that allows people like Madoff to fly under the radar. Staying under this “radar” would mean finding the loopholes in each regulatory agency’s rules and it seems Bernard Madoff was just the man for the job.

Madoff was a prominent member in the securities industry throughout his career. The National Association of Securities Dealers (NASD) knew Madoff as their vice chairman for a period of time, a member of NASD board of governors, and as chairman of its New York region. The NASDAQ Stock Market knew Madoff as a member of the board of governors and executive committee while serving as chairman of its trading committee (SEC, 2008).

Because of his affiliation with each agency that works with the securities industry Madoff was in the position to fully comprehend the ins-and-out of the system and if anyone could find a loophole, it was Madoff. Madoff would use his “Industry Stature” to intimidate examiners and investigators during the 16 years that the SEC complaints started coming in. For example, one examiner from the SEC’s Northeast Regional Office (NERO) characterized Madoff as “a wonderful storyteller” and “very captivating speaker” and noted that he had “an incredible background of knowledge in the industry (Kotz, 2009).” Another NERO examiner, from the same report, recalls that Madoff would become angry during examinations and then Madoff’s “veins were popping out of his neck” and he was repeatedly saying, “What are you looking for? . . . . Front running. Aren’t you looking for front running, “and “his voice level got increasingly loud.”

Madoff may have known the security industry better than the SEC’s teams that investigated him, but did this give the SEC a reason not to catch Madoff’s Ponzi-scheme? Even though Madoff hid his activities behind the gray areas of the security industry, evidence points to other reasons for the SEC’s failure to catch Madoff.

SEC’s failure to catch Madoff

After Bernard Madoff confessed to his multi-billion dollar Ponzi-scheme an investigation conducted by the Office of Inspector General (OIG); the OIG findings are detailed in a report titled, “Investigation of Failure of the SEC to Uncover Bernard Madoff’s Ponzi Scheme.” Lead by Inspector General H. David Kotz, the investigation details that the SEC received eight separate complaints between June 1992 and December 2008. Three of the complaints were from the same source and the first two versions were dismissed entirely (Kotz, 2009). The report also makes known that the SEC was fully aware of the two articles regarding Madoff’s questionable returns. If the SEC had received complaints and knew about the two articles then why didn’t the SEC catch Madoff?

During the sixteen year time span that the SEC received complaints concerning Madoff and BMIS, the SEC conducted three examinations and two investigations into his advisory business based on the complaints that Madoff was possibly misrepresenting his trading and could be operating a Ponzi-scheme. The OIG report states that the most critical step in examining or investigating a potential Ponzi-scheme is to verify the subject’s trading through an independent third party,” and “Yet, at no time did the SEC ever verify Madoff’s trading through an independent third-party, and in fact, never actually conducted a Ponzi scheme examination or investigation of Madoff (Kotz, 2009).”

The first opportunity that the SEC had to catch Madoff’s Ponzi-scheme was in 1992, sixteen years before Madoff confessed. A complaint lead the investigation team to door steps of Avellino & Bienes, an unregistered investment firm providing its customers with 100% safe investments. Although, the focus of this examination was to discover if Avellino & Bienes was operating as an unregistered investment firm, the SEC’s lead examiner states that, “Madoff’s reputation as a broker-dealer may have influenced the inexperienced team not to inquire into Madoff’s operations (Kotz, 2009).” Madoff would rinse and repeat this strategy within all investigations and examinations that were conducted.

The SEC’s blunders into all investigations concerning Madoff and his associates could be considered gross neglect. The interworking of the SEC seems to be missing something that would help them perform their duties better. Maybe that specific piece of the puzzle is ethical values.

Ethics within the SEC

The SEC made many mistakes during the Madoff investigations. Were these mistakes related to internal ethical decisions on the part of the SEC? One way to find out if the SEC’s mistakes were due to internal ethical decisions is to look into the decision history during the Madoff investigations.

Over the years the SEC has established a number of ethics changes in its rulemaking. One ethical change was the SEC’s Final Rule for implementing section 406 and 407 of the Sarbanes-Oxley Act of 2002 (Haynes and Boone, LLP, 2003). Also, a Final Rule, titled Investment Adviser Codes of Ethics, adds new amendments to the Investment Advisers Act of 1940, and requires registered advisers to adopt codes of ethics (SEC, 2004). As we can see the SEC is aware of the need for companies to implement a code of ethics.

The SEC faced many ethical situations during the Madoff investigations; the ethical situations that were prevalent within the SEC, during the time of the investigations, seemed to affect the core decisions that were being made within the SEC. As stated earlier the SEC’s main goal is maintaining fair dealing, and protecting against fraud, with this in mind unethical decisions would entail any decision that fails to align with that mission statement. The OIG report contains a number of decisions, made by the SEC, that failed to align with their mission statement, to name a few: (a) failure on behalf of the SEC to perform due diligence when conducting investigations; (b) the SEC failed to prevent conflict of interests; (c) the lack of internal controls and standardization for conducting investigations; (d) absence of “Tone-at-the-Top;” and (e) the SEC’s lack of formal training for investigators (Kotz, 2009).

The future of the SEC will rest in the ability to perform better investigation and examinations. David Kotz outlines several recommendations, for the SEC, that will improve investigations in the future. Among the recommendations are better training to investigators, better internal controls, and mandating better control over how to handle tips, and arranging more qualified investigation teams (Kotz, Testimony Before the U.S. Senate Committee on Banking,Housing and Urban Affairs, 2009).

Summary

Bernard Madoff may have been a great manipulator and master of the security industry, the fact still remains, the SEC should have caught on to the Ponzi-scheme years before he confessed. The SEC had more than enough complaints, from reputable sources that pointed out many red flags. A total of three examinations and two investigations failed to catch Madoff’s Ponzi-scheme. The SEC displayed unethical decisions throughout all inquiries conducted within Madoff’s businesses. Now that the SEC has the hindsight into what when wrong, it’s up to the SEC to fix their internal issue.

In the end, the lives of the people that invested with Madoff and his feeder funds were forever changed. Pointing the finger at this point in time may give some relief to those who seek justice but does nothing to change the outcome to what has already taken place. We, as society, must push to become a more proactive nation that seeks due diligence and higher ethical values for everyone. Forcing companies to setup ethics policies and perform due diligence will not stop people from unethical behavior or making poor decisions. I believe we must find away to instill not just the letter of the law into society but the spirit in which the law was created. My moving beyond compliance, I believe, society will suffer far less instances of fraud by eliminating gray areas that laws fail to address.

References

Arvedlund, E. (2001, May 7). Don't Ask, Don't Tell: Bernie Madoff is so secretive, he even asks his investors to keep mum'. Barron .

Haynes and Boone, LLP. (2003, January 24). SEC Adopts Code of Ethics Disclosure Rules. Retrieved April 18, 2010, from HG.org: http://www.hg.org/articles/article_182.html

Kotz, H. D. (2009). Investigation of Failure of the SEC to Uncover Bernard Madoff's Ponzi Scheme. Office of Inspector General (SEC).

Kotz, H. D. (2009, September 10). Testimony Before the U.S. Senate Committee on Banking,Housing and Urban Affairs. Retrieved April 20, 2010, from SEC.gov: http://www.sec.gov/news/testimony/2009/ts091009hdk.htm

Ocrant, M. (2001, May). Madoff tops charts; skeptics ask how. MAR/Hedge No. 89 , pp. 1-5.

SEC. (2004, July 4). Investment Adviser Codes of Ethics. Retrieved April 18, 2010, from SEC.gov: http://www.sec.gov/rules/final/ia-2256.htm

SEC. (2009, October 13). INVESTMENT ADVISERS ACT OF 1940 [AS AMENDED THROUGH P.L. 111-72].

SEC. (2008, December 11). SEC Charges Bernard L. Madoff for Multi-Billion Dollar Ponzi Scheme. Retrieved April 19, 2010, from SEC.gov: http://www.sec.gov/news/press/2008/2008-293.htm

SEC vs. Bernard L. Madoff, 08 CIV 10791 (U. S District Court Southern District of New York December 11, 2008).

SEC. (2010, January 20). What We Do. Retrieved April 19, 2010, from SEC.gov: http://www.sec.gov/about/whatwedo.shtml

By: Joseph Dustin

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Non-Cash Asset Fraud Schemes

Occupational fraud and abuse comes in many forms. One form of occupational fraud is called asset misappropriations. Asset misappropriation, as defined by The Complete Idiot’s Guide to Frauds, Scams, and Cons, is, “when your employees take your stream of revenue and divert some of it into their own pockets.” (Swierczynski, 2003)

Asset misappropriations can be broken down into two different silos, cash and non-cash assets. According to the 2006 National Fraud survey, conducted by the Association of Certified Fraud Examiners (ACFE), states that cash assets have a higher frequency of misappropriations with 87.7% of all asset misappropriations. Although cash misappropriations are more frequent then non-cash assets, non-cash asset schemes are more costly to the company.

The ACFE also states that the cash asset median loss is $150,000 dollars compare that to non-cash assets at $200,000 dollars. (ACFE, 2006) Non-cash misappropriations schemes can be broken down into five categories. The five categories are misuse, unconcealed larceny, asset requisitions and transfers, purchasing and receiving schemes, and fraudulent shipments. Of the five categories of non-cash misappropriations schemes, I will be taking a closer look into unconcealed larceny schemes and how they can be prevented.

Unconcealed larceny is one of the most basic types of thefts as employees simply walk out with the company’s assets without trying to cover up the accounting books or records. As you can assume, larceny of the company’s inventory can be very costly for employers. If an ongoing larceny scheme goes unnoticed over a period of time, the damage can easily be estimated in the millions. One such story of unconcealed larceny that went unnoticed for five years cost one New York based jewelry store an estimated $3 - $12 million dollars of lost inventory. (Huff, 2009)

Teresa Tambunting worked for the jewelry store for over twenty-eight years and was thought to be a trusted employee. However, somewhere along the way Teresa got sticky fingers. During the last five years that Teresa was employed with the jewelry company she began to stuff some of the jewelry into her purse as she walked out. Over a five year span, Teresa amassed a mountain of gold by patiently carrying out her scheme one gold nugget at a time.

From the fraudster’s point of view, the main problem with unconcealed larceny is the absence of cooking the books or manipulating the records to account for the missing inventory. Eventually, the store realized that between $3 and $12 million dollars worth of inventory was missing and conducted an investigation. Teresa returned one suitcase full of jewelry while authorities found another 447 pounds of gold in her house. As you can see, unconcealed larceny can be very costly to unsuspected employers.

Companies put in a lot of hard work to produce and stock inventory for their company and customers. It should also be important to not let someone walk-off with that hard worked inventory. Joseph T. Wells, CFE is a well known author on fraud and Mr. Wells has a few ideas on how you can prevent and detect larceny of non-cash assets. (Wells, 2008)

First, separation of duties between requisitioning, purchasing, and receiving should be maintained. Further separation of duty would include accounts payable with accounts receivable and purchasing. These separations of duty are set in place to make it harder for one employee to commit fraud without having to include an accomplice.

Physical security is another way to stop larceny of your company’s inventory. Keeping the company inventory behind locked doors will keep most employees from being able gain access to the inventory while maintaining a log on all personnel that do have access will provide you with a list of employees encase inventory does go missing. If the employee believes that there is a high chance for them to be caught, the employee will most likely not commit the fraud according to Richard C. Hollinger and the Hollinger-Clark study. (Wells, 2008)

To exploit this technique of perception, the installation of surveillance cameras can aide in the deterrence of larceny of inventory. The security cameras should not be hidden but placed in a dominant spot for all to see. To prevent the loss of inventory over an extended period of time, you should conduct physical inventory counts on a frequent basis to determine if your inventory control system is the same as your physical count of the inventory.

Your company’s life line lies within the health of your inventory. When your employees start to steal from your inventory, the company will slowly become sick as profits are being lost. To keep the company healthy proper internal controls that allow you to deter and detect non-cash asset schemes from occurring will help keep the company doctor away.


By: Joseph Dustin

Reference

Wells, J. T. (2008). Principles of Fraud Examination 2nd edition. Hoboken, New Jersey: John Wiley & Sons, Inc.

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The Sound of Corruption

John Yeh is a businessman. Like most businessmen, John has the drive and determination that inspire people to succeed. John went to college at the University of Maryland where he earned his bachelor’s degree in mathematics and then pursued his master’s in computer science.

After graduation John started his own company. The company was known as Integrated Microcomputer Systems and after a few successful government contracts, John’s company quickly grew with a revenue of $21 million in 1987.

What makes John Yeh any different from others that have succeeded?

John has a disability that made him have to work a little bit harder than most. Born without the ability to hear, John needed to find an alternate way to communicate. Growing up in China, Taiwan, and Brazil he learned to read lips and knew Chinese sign language.

At the age of 15, John arrived in the United States were he had to translate Chinese to English and then English to sign language. In school he was put in a class with eight and nine year olds, leaving John feeling embarrassed; yet determined.

After graduation he struggled to land a job. When John was ready to start his own company he found it difficult to obtain a loan. Every bank that he went to, turned John away. Then, as luck would have it, John discovered a loan that was available to the handicapped through the U.S. Small Business Administration in the amount of $100,000 dollars. (Knocke, 1989) As you can see, John’s life was not that of anything I would call normal.

John went on to become the 2008 Deaf Person of the Year by Deaf Life magazine and Gallaudet University once honored him as Entrepreneur of the Year. (Washington Post) All of which makes John Yeh’s arrest seem to come as a shock.

What would drive John, who seems to have everything finally going right for him, to commit an occupational fraud? Although that question may never be answered, the Department of Justice unsealed twenty-six indictments on November 19, 2009. (Department of Justice Press Release, 2009) The twenty-six, including John Yeh, was charged with engaging in a scheme to steal millions of dollars from the Federal Communications Commission’s (FCC) Video Relay Service program.

John’s company, Viable Communications, makes Communication devices that allow deaf people to communicate over the telephone through a video type interface. The video shows a translator that translates the voice or data type message and then uses sign language to communicate back. John Yeh was then able to bill the FCC for a portion of the time being used. The program started off in 1993 with about $30 million and quickly grew to over $400 million in 2007. (Potter, 2010)

John is accused of coaching employees and other on how to make false calls that would not be suspicious. Some of the other twenty-five indictments include those involved with the scheme from various other call centers. Six other call centers are independently owned and did contract work for Viable Communications. Altogether, officials still have not said precisely how much they think was stolen, but the estimate was approximately in the “tens of millions.” (Glod & Johnson, 2010)

The question still remains; did John Yeh use his fiduciary powers to make people commit occupational fraud when they normally would not have?

Occupational fraud is a term that is used to describe a wide variety of corporate fraud cases and can be broken down into more distinct segments to help identify the different types of frauds being committed. Each type of fraud can be easily identified in some schemes, while other schemes are more difficult to identify. One reason for the difficulty in identifying a fraud type is during some cases where fraudsters are committing several fraudulent acts to commit their crimes, thus making it harder to categorize each scheme. For example, one investigation may start with a billing fraud scheme and turn into a conflict of interest/corruption scheme with multiple parties involved.

Corruption, according to Joseph T. Wells, can be defined as an act in which a person uses his or her position to gain some personal advantage at the expense of the organization he or she represents. (Wells, 2008) In this light, John Yeh had the equipment that was needed to deploy the services. John also worked with other independent contractor that needed what John had to offer to turn a profit. This would leave me to believe that he defiantly had the ability to misuse his fiduciary powers to conspire with other and corrupt their business relationships.

In the case of John Yeh, the details may not be clear as to the extent of the corruption. Details such as who was the initiator are still not clear. Knowing who the initiator would better determine the type of corruption, such as economic extortion or bribery.

In either case, to help deter corruption, you should keep an eye out for gifts and create an ethical policy that states employee are not allowed to receive gifts over a certain amount. Maintain a set of reports that actively looks for financial changes and policy deviations as red flags may indicate corruption.

When corruption is at its worst the amount of damage caused is hard to place a price tag on. Although millions of dollars are alleged to be stolen using this scheme, the money itself may not be the only thing lost. If John Yeh is convicted of his crimes, how will it affect all the deaf people that used the service legitimately? Will the service be discontinued or will the price go up if the government chooses to stop giving money for the program?

By: Joseph Dustin

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Billing Fraud - Is Anyone Immune?

When it comes to billing fraud schemes, not even the United States Government is immune from playing the victim. A fraud survey conducted by the Association of Certified Fraud Examiners (ACFE), in 2006, states,

“Among the fraudulent disbursement categories, billing schemes were most commonly reported... Of 675 reported fraudulent disbursement cases, 44 percent involved billing fraud.” (Wells, 2008)

The ACFE Report also stated a median loss of $130,000 per incident. In a recent case that involved the U.S. Government, the United States Government was over charged on a multi-billion dollar contract to supply food for soldiers in Iraq, Kuwait, and Jordan. The Department of Justice submitted a press release on 16 November 2009 stating,

“PUBLIC WAREHOUSING COMPANY, K.S.C., (“PWC”) a logistics company organized under the laws of the Nation of Kuwait has been indicted by a federal grand jury on multiple charges of conspiracy to defraud the United States, committing major fraud against the United States, making false statements, submitting false claims and wire fraud.” (UNITED STATES ATTORNEY’S OFFICE, 2009)

The indictment charges PWC with six counts. Count two in particular alleged a conspiracy based on PWC’s fraudulent over-billing the United States through multiple means. In brief the alleged means are as followed:

1. Intentionally failed to purchase less expensive food items based upon a vendor’s failure to provide PWC with a discount.

2. Fraudulent over billing of the United States by having vendors use a consolidation facility and placing the consolidation costs plus a PWC profit into the Delivered Price paid by the United States contrary to the prime vendor contracts.

3. PWC’s knowingly manipulation and inflation of Delivered Prices.

The indictment goes into further detail about how some of the alleged billing fraud occurred. PWC would call vendors insisting they provide a discount and label the discount to something that would not facilitate PWC from passing the discount on to the U.S.

PWC on other occasions would ask vendors for a “prompt payment discount” in exchange for providing the vendor with “preferred customer” status, thus issuing that vendor with an increase in business.

When a vendor refused to label discounts as “prompt payment discount” PWC would ask the vendor to label the discount “damage allowance.” PWC at times would ask vendors to increase its “prompt payment discount” upon the vendor’s acceptance to do so; more business would then be shuffled to the vendor.

PWC fraudulently inflated the distribution fees that it billed to the United States by soliciting vendors to manipulate the way products were packed, thus allowing PWC to bill the U.S. twice as much as it should have.

The United States Government was made aware of the fraud by a lawsuit filed under the Qui Tam provisions. According to Jim Higgins,

“Potential purposeful government misbillings came to light in 2005 thanks to a qui tam relator, one Kamal Mustafa Al-Sultan whose company partnered with the company that would become Agility. Justice Department officials have decided to join the civil whistleblower action, providing credence to Al-Sultan’s claims. Al-Sultan stands to share in 15% and 25% of the government’s recovery if it is decided that misbilling fraud has occurred against the military.” (Higgins, 2009)

The U.S. Government's move to pay whistleblowers is paying off in this case and may be something to think about implementing within cooperations.

As this case unfolds the extent at which the United States Government was defrauded is extremely high. My initial thought was that the only victim in this case is the U.S. Government. However upon further thought, I find myself thinking that PWC is also the victim.

PWC stands to lose a multi-billion dollar contract. A loss of revenue this big could quite easily spell disaster for PWC and all of their employees.

How can a company protect itself from the few rogue employees that can plague the cooperation?

The ACFE’s 2008 report to the Nation on Occupational Fraud and Abuse had a question that asked, “How important are the following controls for preventing fraud?” A list was given that included Internal Audit Department, Surprise Audits, Management Review of Internal Controls, Fraud Hotlines, Mandatory Job Rotation/Vacations, and Rewards for Whistleblowers. (Slater, 2008)

An Internal Audit Department rang in at number one and having a CFE can go a long way to prevent ongoing fraud from happening. Another way to prevent billing fraud is through Internal Controls. Internal Controls is simply policies and procedures created to insure business is conducted properly. One of the policies that should be address within your Internal Controls is separation of duties. Creating a separation of duties policy makes it much harder for employees to conduct fraud without collusion. (Rogers)

As you can see anyone can become a victim to billing fraud, even the U.S. Government. Companies stand to lose everything when fraud runs rampant from within. There are some procedures that can be conducted to help deter or detect ongoing fraud.

With procedures in place like whistle blowing rewards, internal controls, and CFE certified Internal Audit Departments fraud will become more difficult to conduct. Only by continually re-analyzing our company’s policies and procedures can we continue to grow our knowledge in helping to fight all types of fraud.


By: Joseph Dustin

References

Wells, J. T. (2008). Principles of Fraud Examination 2nd edition. In J. T. Wells, Principles of Fraud Examination 2nd edition (p. 96). Hoboken, New Jersey: John Wiley & Sons, Inc.

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ATM Skimming - On the Rise!

As economic hardship falls upon our great nation and the unemployment rate rises. Many families are left to endure these trying times while having to make do with less. When pressured to feed one’s family, some people may turn to criminal activities to supplement their ever dwindling income.

The Association of Certified Fraud Examiners (ACFE) has stated that during economic hardships the rate of committed fraud also rises. (ACFE, 2009) The ACFE also believes that the rate of fraud will continue to rise until the turmoil of our economy returns to favorable conditions. No one can foresee when the economy will bounce back; companies must be prepared for the increase of fraud and incorporate the proper risk management steps into their risk appetite.

One such criminal activity that’s stealing headlines around the nation is ATM skimming schemes. ADT.com, a leader in security systems, defines ATM skimming as,

“ATM skimming is when criminals electronically steal or “skim” a cardholder’s personal financial information during ATM transactions. By fitting an unseen portable electronic card reader and mini camera onto an ATM, they can potentially “cash out” debit card accounts, clone new debit/credit cards or sell cardholder personal information to crime syndicates.” (ADT, 2009)

Why do ATM skimming schemes attract so much publicity these days and how can companies deter fraudsters from defrauding company is a hot subject matter.

To get a better look at why ATM fraud is growing we need to take a closer look at how skimming schemes in general are committed. According to Joseph T. Wells CFE, “when it comes to skimming used in fraud schemes, it’s important to remember the “Three R’s”: revenues, receivables, and refunds." (Wells, Skimming: The Achilles’ Heel of the Audit?, 2007)

Both skimming of receivables and refunds require the fraudster to alter the accounting books in order to cover up their theft, thus making the skimming of receivables and refunds more difficult to cover up. However, skimming of revenues takes place prior to entering the books, thus making the skimming of revenues the most difficult to detect in an audit. Recent news reports of ATM skimming schemes are not in short order.

ATM skimming schemes have cropped up in Tennessee, Maryland, Illinois and Georgia and that’s just the tip of the iceberg. The ATM skimming scheme that hit Nashville has been reported by police to have over 600 individuals being victimized; a total of 60 people had fraudulent withdrawals from their accounts for anywhere between $100 to $5,000 dollars. (McGlasson, 2009)

The recent ATM skimming operations in Maryland, Illinois and Georgia has amassed over $120,000 dollars according to law enforcement agencies investigating the crimes. (McGlasson, ATM Fraud: New Skimming Scheme Spreads, 2009)

Once an ATM skimming fraud occurs, what can fraud examiners do to investigate an incident?

In Joseph T. Wells’ book, Principles of Fraud Examination, Wells go on to say that, “essentially three tools are available regardless of the nature of the fraud examination.” (Wells, 2008)

These three tools are: skills in the examination of financial statements, conducting interviews, and observation. Using these three techniques can help us determine if fraud has occurred and maybe to the perpetrators involved.

A fraud case generally begins with predication. Predication is the totality of circumstances that would lead a reasonable, professionally trained, and prudent individual to believe a fraud has occurred, is occurring, and/or will occur. (Wells, Principles of Fraud Examination, 2008)

Using the Fraud Theory Approach as a guideline in our fraud examination we can get a better understanding of the fraud. At the onset of a fraud examination the fraud examiner might be called by a concerned customer that may have discovered a device used for ATM skimming or receive a customer complaint involving missing funds from their bank account. In either case both would give the fraud examiner predication to launch the investigation.

First, I would analyze all current data from the contact, such as the what, when, where, and how the alleged fraud occurred using the conducting interviews tool to investigate. If an ATM device was discovered, I would go to the site, using the observation tool, to determine if the device was operational or a hoax.

Next, if the device was operational I would look at the surveillance tapes if they were available to determine the time the fraud device became active. Once the time became available, a record check of all card activity should be reviewed to determine whose card might have been compromised, thus using the third tool of skills in the examination of financial statements. At this time a decision will need to be made on how to stop the removal of the cash and a call to the FBI might be in order to help find the fraudster before they move forward with the scheme.

To help deter this type of fraud from happening there are a few things a company can do to protect themselves. First, a general understanding of how and why fraud occurs can be helpful. Donald R. Cressey’s fraud triangle can give us a better understanding of what is needed to stop fraud. Cressey’s fraud triangle has three elements to it, they are: Opportunity, Pressure, and Rationalization. According to Cressey all three elements need to be present for fraud to occur. (Kardell, 2007)

Of the three elements opportunity, in ATM skimming, Opportunity would be the element to eliminate to stop the fraud from happening again, as the other two elements are out of your control since to fraudster do not work at your company. Banks will need to protect the ATM using Anti-Skimming devices to help stop the use of the fraud devices and protect their customers. As a customer there is a few ways to protect ourselves from becoming a victim of ATM fraud, like be alert to jammed ATMs, protect your PIN number by covering up the number pad when you enter your number, try to use ATMs during daylight hours, and periodically check your bank account for unauthorized transactions. (LGCU.ORG)


ATM skimming fraud costs banks an ample amount of money each year. As a fraud examiner precaution must be taken to prevent ongoing frauds. ATM skimming schemes may be on the rise, we don’t have to be a victim. The banks need to secure the ATMs from skimming fraud but the banks are not the only ones that have a part in making sure ATM cards are not skimmed. As card holders we have an obligation to insure we do our part and secure our cards from fraudsters.

By: Joseph Dustin

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