The expertise of most advisors usually stops short of forensic accounting or detecting client fraud. What do you do when there is evidence of missing assets or forgeries? To uncover intentional - and increasingly sophisticated - deceits, planners need to know about forensic accounting, financial planning, tax law and criminology.
Fraud can take a variety of forms and financial fraud cases can be brought under federal or state laws. So-called off-book fraud, which is often not covered up, can be as simple as a client working a side job, getting paid in cash and then spending the cash to fund an extramarital affair or gambling. On-book fraud requires falsifying records or lying to mask deception. A husband or wife might transfer money from a joint account, or open an individual account and spend it without the spouse's knowledge.
Often, the perpetrator's identity is known; the fraudster is most usually a spouse or family member, but might also be an outsider brought in for hire, such as a nanny, housekeeper or elder caregiver.
Donald Cressey, a criminology professor at Indiana University in the 1940s, coined the phrase, "the fraud triangle,'' which posits that any trusted person can become a trust violator. Three elements must be present for a violation to occur: perceived opportunity, a motive and a rationalization.
An individual must perceive that they have an opportunity to commit a crime or abuse without the chance of getting caught. The second element that must be present is motive. Trust violators are afraid of losing the approval of those around them and are unable to confide in others about their problems, which often are financial. Other motives may include midlife crisis issues, peer or societal pressure, excessive personal debt, or vindication over a real or perceived slight. A dependence on drugs or alcohol may also explain the reason for fraud.
The final component of the fraud triangle is rationalization. Justifying one's actions is part of the motive, where a perpetrator might think, "the person can afford it'' or "the money will not be missed.''
Many red flags can signal fraud is occurring, such as changes in lifestyle, a move toward secrecy or fluctuations in spending or income. Changes in lifestyle may become apparent before the fraud or bad behavior is discovered.
An advisor might ask: Is the spouse reporting that he's working more hours? Does the husband have a new hobby in which the wife is not included? Some changes are obvious and others can be subtler. Are certain family members being avoided? Has computer usage risen? Are there distractions that might deflect guilty behavior?
An advisor might also ask about changes in confidentiality. Does a working wife no longer talk about her day? Does the nonworking spouse no longer have access to family financial records? Is mail being rerouted to a post office box instead of home? Are there unknown return addresses?
A few years ago, a financial planning client in Chicago took out a $100,000 line of credit against the house he owned with his wife, forged her signature and had the statements mailed to his office so his actions would go undetected. Eventually, the wife discovered her husband had gambled away the entire proceeds and was unable to pay their bills. Perpetrators often create complex financial trails to keep the victim unaware.
There are many signs a client may be lying to you, both physical and verbal. These can include a refusal to make eye contact, changes in facial coloring or evading questions and leaving the room. Perpetrators may get defensive, answer questions with questions or give too many facts or details.
Other clues to fraudulent acts can involve income and assets, either positive or negative. If someone has less spending money than before, it may signal an addiction or reduced hours at work. If someone has a sudden unexplained windfall, it could mean they have gambling winnings or stole someone else's assets or income.
An advisor might get involved after a spouse becomes suspicious and asks for help in uncovering what, exactly, is going on. An outside expert, such as a forensic accountant, may be able to trace sources of money entering or leaving accounts. Clues might come from examining net worth statements from one year to the next, looking for large discrepancies or spending patterns, as well as analyzing deposits, wire transfers and checks.
Consistency and transparency are the keys to sound financial planning. If there are any discrepancies, they must be logically explained. An example of this might be looking at the withdrawal or distribution section of a brokerage account. Every transaction should be accounted for and assigned a legitimate reason for withdrawal. Unknown movement of money is a red flag that other accounts or assets may exist. Money manipulation can occur with our most sterling and respected clients.
TRAIL OF EVIDENCE
Although the suspicion of fraud can rest on circumstantial evidence, proving fraud requires direct evidence. Bank statements, credit cards, loan applications, estate planning documents, brokerage accounts, life insurance policies and tax returns are common sources of information.
When looking for fraud or misallocation of funds, examine the general ledger and financial statements, tax returns, incorporation and partnership paperwork, receipts from suppliers and vendors, as well as employee records. Fraud examiners often search through thousands of pages to put together a case.
Investigations often use electronic data. There has been a surge of subpoenas in the last decade that have allowed authorities to review hard drives and handheld devices in both homes and offices. Cellphones, GPS systems and tollbooth receipts can provide a trail of someone's travels. ATM withdrawal locations are also recorded. Social media websites are the most recent places to search for evidence.
Advisors can also help prevent fraud by following certain sound practices. The more autonomy clients give others over their assets, the more opportunity someone will have to overstep their moral boundaries. If someone believes they will not be caught, they are much more likely to commit the indiscretion. Deterrence is the No. 1 protector of assets being squandered or moved.
One best practice is to avoid situations where one spouse will sign a tax return without reading it. Clients should never be asked to sign papers that are put in front of them without understanding what they are signing. An advisor should review and explain everything. An advisor can also encourage families to have an annual meeting just like a business. Such meetings should include as many family members as possible so that many members understand the financial picture.
As guardians of your clients' financial assets, you're at the front lines of detection. It is never easy to know when to raise an alarm, or how to respond to clients' concerns or when to bring in outside experts to track down potential trouble. But your clients will be grateful for your diligence and preparedness.
Peggy Tracy, owner of Priority Planning in Wheaton, Ill., which focuses on divorcing clients, is a CFP, CPA, certified divorce financial analyst and certified fraud examiner.