Module 6
Fraud Against Organizations and Consumer Fraud
a. Fraud Statistics
We delve into the intricate world of occupational fraud, drawing extensively from
Joseph Wells's seminal work, "Occupational Fraud and Abuse," with permission. Wells's
comprehensive insights and meticulous research serve as a cornerstone for our
exploration into the various facets of fraud within organizational settings. Additionally,
we leverage his other notable contributions to the field of fraud examination and
prevention, which enrich our understanding and analysis of this complex phenomenon.
Wells's book not only offers a thorough taxonomy of occupational fraud but also
provides invaluable insights into the psychology, methods, and motivations behind
fraudulent behavior. By dissecting the intricacies of fraud schemes and case studies,
Wells illuminates the diverse tactics employed by perpetrators and sheds light on the
vulnerabilities within organizational structures that allow fraud to occur.
Furthermore, our examination is informed by two prominent surveys: the 2010
ACFE (Association of Certified Fraud Examiners) Report to the Nation on Occupational
Fraud & Abuse and KPMG's Integrity Survey for 2008–2009. These surveys offer
empirical data and real-world perspectives on the prevalence, trends, and impact of
occupational fraud across industries and regions. By synthesizing findings from these
surveys, we gain valuable insights into the evolving landscape of occupational fraud and
the challenges faced by organizations in combating fraudulent activities.
The periodic nature of these surveys underscores the dynamic nature of
occupational fraud, highlighting the need for ongoing vigilance and adaptation in fraud
prevention efforts. As fraud schemes evolve and perpetrators devise new tactics,
organizations must stay abreast of emerging trends and implement proactive measures to
mitigate risks and safeguard their assets.
Moreover, our exploration extends beyond mere identification and analysis of
fraud occurrences to encompass a broader examination of organizational culture,
governance structures, and risk management practices. By examining the root causes and
contributing factors of occupational fraud, we aim to provide actionable insights and
recommendations for fostering a culture of integrity, transparency, and accountability
within organizations.
In summary, our examination of occupational fraud draws upon a rich tapestry of
scholarly research, empirical data, and practical insights. By synthesizing insights from
Joseph Wells's seminal work and prominent industry surveys, we aim to offer a
comprehensive understanding of occupational fraud and equip organizations with the
knowledge and tools needed to combat this pervasive threat effectively. Through
collaborative efforts and a steadfast commitment to ethical conduct, we strive to build
resilient organizations that are capable of thwarting fraud and preserving trust and
integrity in the workplace.
In the landscape of occupational fraud and abuse, the 2010 ACFE Report to the Nation
serves as a comprehensive guide, delineating three primary types of fraud perpetrated
against organizations: asset misappropriation, corruption, and fraudulent statements.
While financial statement frauds have been extensively covered in preceding, this delves
into the nuanced realms of misappropriation and corruption, shedding light on their
intricacies, impact, and prevention strategies.
Asset misappropriation, the first category outlined in the report, encompasses a
broad spectrum of schemes aimed at the theft or misuse of an organization's assets. From
embezzlement and theft of cash or inventory to fraudulent disbursements and payroll
manipulation, asset misappropriation schemes pose significant financial and reputational
risks to organizations of all sizes and sectors. By dissecting the modus operandi of
perpetrators and identifying red flags indicative of such schemes, organizations can
implement robust controls and detection mechanisms to mitigate the risk of asset
misappropriation.
Corruption, the second category highlighted in the report, involves the abuse of
power or influence in a business transaction to secure an unauthorized benefit, often at
the expense of the organization's interests. Common forms of corruption include bribery,
kickbacks, and conflicts of interest, which erode trust, compromise ethical standards, and
undermine the integrity of organizational decision-making processes. By fostering a
culture of transparency, accountability, and ethical conduct, organizations can deter and
detect instances of corruption, thereby safeguarding their reputation and fostering trust
among stakeholders.
While financial statement frauds garner significant attention due to their potential
impact on investors and capital markets, misappropriation and corruption remain
pervasive threats that can have equally devastating consequences for organizations. By
addressing the root causes and contributing factors of these fraud schemes, organizations
can implement targeted interventions and preventive measures to mitigate risks and
protect their assets, reputation, and stakeholders' interests.
Moreover, this explores the interplay between misappropriation, corruption, and
organizational culture, governance structures, and risk management practices. By
examining case studies, best practices, and industry insights, organizations can glean
valuable lessons and actionable strategies for fortifying their defenses against fraud and
abuse.
In summary, the 2010 ACFE Report to the Nation serves as a roadmap for
understanding and combatting the multifaceted challenges posed by misappropriation and
corruption in organizational settings. By leveraging insights from the report and
supplementing them with practical guidance and real-world examples, this equips
organizations with the knowledge and tools needed to detect, prevent, and respond
effectively to fraud and abuse. Through collaborative efforts and a steadfast commitment
to integrity and accountability, organizations can build resilient defenses against fraud
and foster a culture of trust, transparency, and ethical conduct.
The insights gleaned from the KPMG 2008–2009 Integrity Survey underscore the
pervasive nature of misconduct within organizational settings and the imperative for
proactive measures to combat fraud and abuse. With responses from over 5000 U.S.
employees, the survey provides valuable empirical data on the prevalence and severity of
misconduct in the workplace, shedding light on the magnitude of the challenge faced by
organizations in upholding integrity and ethical standards.
One of the key findings of the survey is the alarming prevalence of misconduct,
with nearly three out of four employees reporting that they had observed such behavior
within the prior 12-month period. What's more concerning is that nearly half of these
employees reported witnessing serious misconduct that could potentially result in a
significant loss of public trust if discovered. These findings underscore the urgent need
for organizations to address the root causes of misconduct and implement proactive
measures to prevent and detect fraudulent activities.
Furthermore, the survey highlights the effectiveness of proactive antifraud
measures, such as hotlines and ethics training, in mitigating the risk of fraud and abuse.
Organizations that have implemented such measures reported a significant reduction in
instances of fraud against them, underscoring the importance of investing in robust
compliance programs and ethical training initiatives. By fostering a culture of
transparency, accountability, and ethical conduct, organizations can create an
environment where employees are empowered to speak up about misconduct and
unethical behavior without fear of reprisal.
Moreover, the survey findings emphasize the importance of ongoing monitoring
and evaluation of antifraud measures to ensure their effectiveness and relevance in
addressing evolving threats and vulnerabilities. As fraud schemes continue to evolve in
complexity and sophistication, organizations must remain vigilant and adaptable in their
approach to fraud prevention and detection.
In summary, the KPMG 2008–2009 Integrity Survey provides valuable insights
into the prevalence of misconduct in the workplace and the effectiveness of proactive
antifraud measures in mitigating the risk of fraud and abuse. By leveraging the findings
of the survey and implementing targeted interventions, organizations can strengthen their
defenses against fraud, uphold integrity and ethical standards, and safeguard their
reputation and stakeholders' trust. Through a concerted effort to foster a culture of
integrity and accountability, organizations can create a workplace where ethical conduct
is valued, encouraged, and rewarded.
b. Asset Misapproriations
Employees, vendors, and customers of organizations have three opportunities to
steal assets: (1) they can steal receipts of cash and other assets as they are coming into an
organization; (2) they can steal cash, inventory, and other assets that are on hand; or (3)
they can commit disbursement fraud by having the organization pay for something it
shouldn’t pay for or pay too much for something it purchases. With each of these three
types of fraud, the perpetrators can act alone or work in collusion with others
He divides asset misappropriations into two major categories: (1) thefts of cash
and (2) thefts of inventory and other assets. He subdivides thefts of cash into three
subgroups: (1) larceny (intentionally taking away an employer’s cash without the consent
and against the will of the employer), (2) skimming (the removal of cash from a victim
entity prior to its entry in an accounting system), and (3) fraudulent disbursements.
Similarly, he divides the misappropriation of assets other than cash, including inventory,
into two groups: (1) misuse and (2) larceny. The ACFE study showed that asset
misappropriations are by far the most common form of occupational fraud. We will now
discuss the misappropriation of assets according to Wells’s classification scheme.
With larceny, cash is stolen by employees or others afterit has already been
recorded in the company’s accounting system. As a result, larceny schemes are easier to
detect than skimming schemes and are far less common. Cash larcenies can take place in
any circumstance in which an employee has access to cash. Common larceny schemes
involve the theft of cash or currency on hand (in a cash register or petty cash box, for
example) or from bank deposits. Cash larcenies are most successful when they involve
relatively small amounts over extended periods of time. With such thefts, businesses
often write the small missing amounts off as “shorts” or “miscounts,” rather than as
thefts. For example, in one bank, the annual cash shortages by tellers exceeded $3 million
per year. Some of this teller shortage could have been caused by miscounting, and
certainly customers are more likely to inform a teller when he or she gives them too little
cash than when the teller gives them too much cash. However, a significant portion of the
shortage is probably caused by larceny. As an example of a cash larceny fraud, consider
the case of Jane Doe (name changed):
Jane Doe was a long-term accounting employee of a consumer electronics firm in
Los Angeles. Although lacking a formal education, she was well-rounded; originally
hired as an accounts receivables clerk, her most recent position required her to oversee
the accounting department’s petty cash funds. Jane was responsible for immediately
depositing all cash in excess of $3,150, the maximum allowable “cash on hand,” into her
employer’s bank account.
Jane’s responsibilities entailed receiving cash, paying for miscellaneous expenses
out of the petty cash fund, and documenting the cash coming in and going out. She also
prepared a cash schedule at the end of each month for her supervisor, who posted cash
entries into the company’s computerized accounting system based on Jane’s handwritten
cash schedule. The primary source of the cash handled by Jane came from the company’s
distribution center (DC). Customers, some of whom were employees, paid for
merchandise, parts, and miscellaneous services inside the distribution center, and
although only a small percentage of the company’s sales were cash transactions, every
week DC employees hand-delivered to Jane an average of $1,000 cash, inside envelopes.
Along with the cash, these DC employees handed Jane copies of a form indicating
the amount being delivered to Jane. These forms were signed by the DC employees, but
Jane was not required to give the DC employee any documentation (receipt) in return, nor
was any other employee required to verify the cash exchange. One day, Jane’s supervisor
reviewed an endof-the-month cash report submitted by Jane. The report consisted of
customers’ names, invoice numbers, and method of payment. This indicated the cash paid
by the customers. The total cash balance was then indicated, and all funds in excess of
$3,150 were supposed to have been deposited to the bank. Jane’s supervisor discovered
that Jane’s reported total did not balance the sum of all the entries on her end-of-
themonth cash report; there was an 8 cent discrepancy. Normally, this would have been
sent back for Jane to correct. However, Jane was absent on that particular day and was,
therefore, unable to correct the simple error.
Jane’s supervisor totaled the cash listed on the report again, but it did not match
the total Jane had shown on the report—it was not even close. Since Jane was absent and
Jane’s supervisor wanted to be sure she posted the correct amount into the company’s
computerized accounting system, using the bank’s online banking system, the supervisor
then turned to the company’s online banking records and looked for whether the deposits
correlated with Jane’s reports. She discovered, much to her surprise, that cash deposits
had not been made in several months. Was this a mistake? Jane’s supervisor subsequently
contacted a bank representative and checked to see whether the deposits were
accidentally posted under any of the company’s other numerous accounts. There were no
such deposits. Sensing something was wrong, Jane’s supervisor notified the controller,
who launched an immediate investigation. After close review of the company’s cash
records, Jane’s files, accounting entries, and Jane’s computer, the company discovered
Jane had embezzled over $150,000 in cash from the petty cash fund over the past four
years.
Check tampering is a type of fraudulent disbursement scheme in which an
employee either (1) prepares a fraudulent check for his or her own benefit or (2)
intercepts a check intended for another person or entity and converts the check to his or
her own benefit. Check tampering is unique among the disbursement frauds because it is
the one group of schemes in which the perpetrator physically prepares the fraudulent
check. In most fraudulent disbursement schemes, the culprit generates a payment to
himself or herself by submitting some false document to the victim company, such as an
invoice or a timecard. The false document represents a claim for payment and causes the
victim company to issue a check, which the perpetrator then converts. These frauds
essentially amount to trickery: the perpetrator fools the company into handing over its
money. Check-tampering schemes are fundamentally different. With check tampering,
the fraud perpetrator takes physical control of a check and makes it payable to himself or
herself by forging the maker (signing the check), forging endorsements, or altering
payees.
Register disbursement schemes are among the least costly of all disbursement
schemes. Two basic fraudulent schemes take place at the register: false refunds and false
voids. With false refunds, a fraud perpetrator processes a transaction as if a customer
were returning merchandise, even though there is no actual return. The fraud perpetrator
then takes money from the cash register in the amount of the false return. Since the
register tape shows that a merchandise return has been made, it appears that the
disbursement is legitimate. The concealment problem for perpetrators is that, with false
refunds, a debit is made to the inventory system showing that merchandise has been
returned. Since no inventory was returned, the recorded inventory amount is overstated
and an inventory count may reveal the “missing” inventory. A similar but more difficult
fraud to detect is the overstating of refunds. In these cases, merchandise is actually
returned, but the value of the return is overstated. For example, assume that a customer
returned merchandise costing $10. The dishonest employee may record the return as $15,
give the customer $10, and pocket $5.
Fictitious voids are similar to refund schemes in that they generate a disbursement
from the cash register. When a sale is voided on a register, a copy of the customer’s
receipt is usually attached to a void slip, along with the signature or initials of a manager
that indicates the transaction has been approved. To process a false void, the cashier
usually keeps the customer’s receipt at the time of sale and then rings in a voided sale
after the customer has left. Whatever money the customer paid for the item is removed
from the register as though it was being returned to the customer. The copy of the
customer’s receipt is attached to the voided slip to verify the authenticity of the
transaction. Unfortunately for the perpetrator, voided sales create the same kind of
concealment problem that false returns do—that is, someone might discover that
inventory that was supposed to have been returned is missing.
Both check-tampering and register disbursement schemes require perpetrators to
physically take cash or checks from their employers. With billing schemes, the
perpetrator does not have to undergo the risk of taking company cash or merchandise. In
a billing scheme, the perpetrator submits or alters an invoice that causes his or her
employer to willingly issue a check or make other types of payments. Though the support
for the payment is fraudulent, the disbursement itself is facially valid. Billing schemes are
extremely common and quite expensive. The median cost of billing schemes in the ACFE
study was $130,000, second only to wire transfers. Since the majority of most businesses’
disbursements are made in the purchasing cycle, larger thefts can be hidden through false
billing schemes than through other kinds of fraudulent disbursements. Employees who
utilize billing schemes are just going where the money is.
The three most common types of billing schemes are (1) setting up dummy
companies (shell companies) to submit invoices to the victim organization, (2) altering or
double-paying a nonaccomplice vendor’s statements, and (3) making personal purchases
with company funds. Dummy orshell companies are fictitious entities created for the sole
purpose of committing fraud. Many times, they are nothing more than a fabricated name
and a post office box that an employee uses to collect disbursements from false billings.
However, since the checks received will be made out in the name of the shell company,
the perpetrator will normally also set up a bank account in the new company’s name,
listing himself or herself as an authorized signer on the account.
Rather than using shell companies as vessels for overbilling schemes, some
employees generate fraudulent disbursements by using the invoice of nonaccomplice
vendors. For example, perpetrators using this scheme may double-pay an invoice. By
intentionally paying some bills twice and then requesting the recipients to return one of
the checks, the perpetrator keeps the returned check. Another related scheme is to
intentionally pay the wrong vendor and then ask for the payment to be returned. Or, a
dishonest employee might intentionally overpay a legitimate vendor and ask for a return
of the overpayment portion.
Expense and payroll schemes are similar to billing schemes. The perpetrators of
these frauds produce false documentation that causes the victim company to unknowingly
make a fraudulent disbursement. With expense and payroll schemes, the false
documentation includes items like timecards, sales orders, and expense reports. Expense
schemes involve overbilling the company for travel and other related business expenses,
such as business lunches, hotel bills, and air travel.
Four common types of expense disbursement schemes are (1) mischaracterizing
expenses, (2) overstating expenses, (3) submitting fictitious expenses, and (4) submitting
the same expenses multiple times. The first type of fraud involves mischaracterizing a
personal expense to make it look like a business expense. For example, personal travel
might be claimed as a business trip, a personal lunch as a business lunch, or a personal
magazine subscription as a company subscription. Overstating expenses usually involves
doctoring a receipt or other supporting documentation to reflect a higher cost than what
was actually paid. The employee may use eradicating fluid, a ballpoint pen, or some other
method to change the price reflected on the receipt. If the company does not require
original documents as support, the perpetrator generally attaches a copy of the receipt to
his or her expense report. In some cases, such as taxi receipts, the perpetrator actually
completes the receipt, writing in an amount higher than what was actually spent.
Fictitious expense schemes usually involve creating bogus support documents,
such as false receipts. The emergence of personal computers and graphics programs has
made it possible to easily create realisticlooking counterfeit receipts. Alternatively,
perpetrators committing this type of fraud sometimes obtain blank receipts from vendors
or printers, fill them out, and submit them. The least common of the expense schemes is
the submission of multiple reimbursements for the same expense.
Payroll fraud schemes fall into four major categories: (1) ghost employees, (2)
falsified hours and salary, (3) commission schemes, and (4) false worker compensation
claims. Of all payroll fraud schemes, ghost employee schemes tend to generate the largest
losses. According to the ACFE, the average loss per occurrence is very high and can be
quite costly to organizations. Ghost employee frauds involve putting someone on the
payroll (or keeping a former employee on the payroll) who does not actually work for the
victim company. Through the falsification of personnel or payroll records, fraud
perpetrators cause paychecks to be generated to a ghost. These paychecks are then cashed
by the fraud perpetrators or their accomplices.
For ghost-employee fraud schemes to work, four things must happen: (1) the
ghost must be added to the payroll, (2) timekeeping and wage rate information must be
collected, (3) a paycheck must be issued to the ghost (unless direct deposits are used),
and (4) the check must be delivered to the perpetrator or an accomplice. By far, the most
common method of misappropriating funds from payroll is the overpayment of wages,
accounting for 55.4 percent of all payroll frauds. For hourly employees, the size of a
paycheck is based on two essential factors: the number of hours worked and the rate of
pay. Therefore, for an hourly employee to fraudulently increase the size of a paycheck, he
or she must either falsify the number of hours worked or change the wage rate. Since
salaried employees do not receive compensation based on their time at work, in most
cases these employees generate fraudulent wages by increasing their rates of pay.
Commissions are a form of compensation calculated as a percentage of the
amount of transactions a salesperson or another employee generates. This unique form of
compensation is not based on hours worked or a set yearly salary, but rather on an
employee’s revenue output. A commissioned employee’s wages are based on the amount
of sales he or she generates and the percentage of those sales he or she is paid. Thus, an
employee on commission can fraudulently increase his or her pay by (1) falsifying the
amount of sales made or (2) increasing the rate of commission. The most common
method of committing commission-based payroll fraud is to falsify the amount of sales
made in one of three ways: (1) creating fictitious sales, (2) falsifying the value of sales
made by altering prices listed on sales documents, or (3) overstating sales by claiming
sales made by another employee or in another period.
Some commission payment plans are structured in ways that almost encourage
fraud. Take, for example, a graduated commission scheme, such as one that pays 5
percent if a salesperson generates revenue of less than $100,000, 7 percent if the
salesperson generates revenues of between $100,000 and $200,000, and 10 percent if
sales exceed $200,000. Working under this system, sales agents have a very strong
incentive to generate revenues exceeding $200,000 so they can earn a 10 percent
commission on all sales. Thus, if their total sales fall just short of $200,000, they have a
strong incentive to create “additional revenues” that will help them qualify for the higher
commission rate.
Workers’ compensation is not a payroll account, but rather an insurance expense.
Nevertheless, it is essentially an employee benefit, entitling persons injured on the job to
compensation while they recuperate. By far, the most common way to commit workers’
compensation fraud is to fake an injury and collect payments from the victim company’s
insurance carrier. In some cases, the employee colludes with a doctor, who processes
bogus claims for unnecessary medical treatments and then splits the payments for those
fictitious treatments with the “injured” employee.
Before we move on to theft of assets other than cash, it is important to know that
in the past few years, executives of some corporations have allegedly looted their
companies of huge amounts of cash, usually through disbursement frauds. The two most
famous of these types of frauds, sometimes referred to as corporate looting, were Chief
Executive Officer Dennis Kozlowski, Chief Corporate Counsel Mark Belnick, and Chief
Financial Officer Mark H. Swartz of Tyco International Ltd. (Tyco) and John Rigas and
his sons of Adelphia Corporation (Adelphia).
The case of Tyco is one of looting. It involved egregious, self-serving, and
clandestine misconduct by the three most senior executives at Tyco. From at least 1996
until June 2002, Dennis Kozlowski and Mark Swartz took hundreds of millions of dollars
in secret, unauthorized, and improper low-interest or interestfree loans and compensation
from Tyco. Kozlowski and Swartz concealed these transactions from Tyco’s
shareholders. They later pocketed tens of millions of dollars by causing Tyco to forgive
repayment of many of their improper loans. These actions were also hidden from Tyco’s
shareholders. In addition, Kozlowski and Swartz engaged in numerous highly profitable
relatedparty transactions with Tyco and awarded themselves lavish perquisites—without
disclosing either the transactions or perquisites to Tyco shareholders. At the same time
that Kozlowski and Swartz engaged in their massive covert defalcation of corporate
funds, Kozlowski regularly assured investors that at Tyco “nothing was hidden behind
the scenes,” that Tyco’s disclosures were “exceptional,” and that Tyco’s management
“prided itself on having sharp focus with creating shareholder value.” Similarly, Swartz
told investors that “Tyco’s disclosure practice remains second to none.” From 1998 into
early 2002, Belnick received approximately $14 million in interest-free loans from Tyco
to buy and renovate a $4 million apartment on Central Park West and to buy and renovate
a $10 million ski chalet in Park City, Utah. The original loans and the forgiveness of
these loans were hidden from the compensation committee of the board of directors.
A person can misappropriate company assets other than cash in one of two ways.
The asset can be misused (or “borrowed”), or it can be stolen. Simple misuse is obviously
the less egregious of the two types of fraud. Assets that are misused but not stolen
typically include company vehicles, company supplies, computers, securities,
information, and office equipment. These assets are also used by some employees to
conduct personal work on company time. In many instances, these side businesses are of
the same nature as the employer’s business, so the employee is essentially competing
with the employer and using the employer’s equipment to do it.
While the misuse of company property might be a problem, the theft of company
property is a much greater concern. Losses from inventory theft, for example, can run
into millions of dollars. The means employed to steal company property range from
simple larceny—walking off with company property—to more complicated schemes
involving the falsification of company documents and records. Larceny usually involves
taking inventory or other assets from the company premises, without attempting to
conceal it in the books and records or “justify” its absence. Most noncash larceny
schemes are not very complicated. They are typically committed by employees (such as
warehouse personnel, inventory clerks, and shipping clerks) who have access to
inventory and other assets.
Another common type of noncash asset theft is the use of asset requisitions and
other forms that allow assets to be moved from one location in a company to another
location. Often, fraud perpetrators use internal documents to gain access to merchandise
that they otherwise might not be able to handle without raising suspicion. Transfer
documents allow fraud perpetrators to move assets from one location to another and then
take the merchandise for themselves. The most basic scheme occurs when an employee
requisitions materials to complete a work-related project and then steals the materials. In
more extreme cases, a fraud perpetrator might completely fabricate a project that
necessitates the use of certain assets that he or she intends to steal.
A third type of noncash asset theft involves the use of the purchasing and
receiving functions of a company. If assets are purchased by employees for personal use,
it is considered to be a purchasing scheme fraud. On the other hand, if assets were
intentionally purchased by the company but simply misappropriated by a fraud
perpetrator, a noncash asset fraud has been committed. In this case, the perpetrator’s
company is deprived not only of the cash it paid for the merchandise, but also of the
merchandise itself. In addition, because the organization doesn’t have as much inventory
on hand as it thinks it has, stockouts and unhappy customers often result.
c. Corruption
All the schemes we have discussed thus far in this fall into the broad category
called asset misappropriation. A second major type of occupational abuse or fraud
committed against organizations is corruption. Corruption is one of the oldest white-
collar crimes known to mankind. The tradition of “paying off” public officials or
company insiders for preferential treatment is rooted in the crudest business systems
developed. Corruption can be broken down into the following four scheme types: (1)
bribery schemes, (2) conflict of interest schemes, (3) economic extortion schemes, and
(4) illegal gratuity schemes.
Bribery involves the offering, giving, receiving, or soliciting of anything of value
to influence an official act. The term “official act” means that traditional bribery statutes
only proscribe payments made to influence the decisions of government agents or
employees. Certainly, one of the most infamous cases of bribery in early history was that
of Judas Iscariot, the disciple who betrayed Jesus Christ. Judas was paid 30 pieces of
silver by the chief priests and elders of Jerusalem to disclose the location of Christ so that
he could be captured and executed. Another example of bribery was the scandal that
rocked Washington, D.C., in the early 1920s. The paper trail of corruption led back to the
White House cabinet and nearly implicated thenPresident Warren G. Harding. Known as
the Teapot Dome scandal, the incident surrounded several key members of Harding’s
staff who mishandled the leasing of naval oil reserve lands.
Many occupational fraud schemes involve commercial bribery, which is similar to
the traditional definition of bribery, except that something of value is offered to influence
a business decision rather than an official act of government. In a commercial bribery
scheme, payment is received by an employee without the employer’s consent. In other
words, commercial bribery cases deal with the acceptance of underthe-table payments in
return for the exercise of influence over a business transaction.
Bribery schemes generally fall into two broad categories: kickbacks and bid-
rigging schemes. Kickbacks are undisclosed payments made by vendors to employees of
purchasing companies. The purpose of a kickback is usually to enlist the corrupt
employee in an overbilling scheme. Sometimes vendors pay kickbacks simply to get
extra business from the purchasing company. Unfortunately, once kickbacks are paid by
vendors, the control of purchasing transactions usually transfers from the buyer to the
vendor. When the vendor is in control of the purchasing transactions, more goods are
usually sold at higher prices, and the quality of goods purchased can deteriorate
substantially.
Earlier in this book, we described the kickback scheme that resulted in a security
firm buying approximately $11 million of unneeded guard uniforms at increased prices
and lower quality. In a common type of kickback scheme, a vendor submits a fraudulent
or inflated invoice to the victim company, and the employee of that company helps make
sure that payment is made on the false invoice. For his or her assistance, the employee
receives some form of payment from the vendor. That payment, or kickback, can take the
form of cash, reduced prices for goods purchased, the hiring of a relative, the promise of
subsequent employment, or some other form. Kickback schemes almost always attack the
purchasing function of the victim company.
Bid-rigging schemes occur when an employee fraudulently assists a vendor in
winning a contract through the competitive bidding process. This process, in which
several suppliers or contractors are vying for contracts in what can be a very cutthroat
environment, can be tailor-made for bribery. Any advantage one vendor can gain over his
or her competitors in this arena is extremely valuable. The benefits of “inside influence”
can ensure that a vendor will win a sought-after contract. Many vendors are willing to
pay for this influence. The way competitive bidding is rigged depends largely upon the
level of influence of the corrupt employee. The more power a person has over the bidding
process, the more likely the person can influence the selection of a supplier. Therefore,
employees involved in bid-rigging schemes, like those in kickback schemes, tend to have
a good measure of influence over or access to the bidding process. Potential targets for
accepting bribes include buyers, contracting officials, engineers and technical
representatives, quality or product assurance representatives, subcontractor liaison
employees, or anyone else with authority over the awarding of contracts.
A conflict of interest occurs when an employee, a manager, or an executive has an
undisclosed economic or personal interest in a transaction that adversely affects the
company. As with other corruption schemes, conflicts of interest involve the exertion of
an employee’s influence to the detriment of his or her company. Conflicts usually involve
self-dealing by an employee. In some cases, the employee’s act benefits a friend or
relative, even though the employee receives no financial benefit from the transaction.
To be classified as a conflict of interest scheme, the employee’s interest in a
transaction must be undisclosed. The essential element in a conflict case is that the fraud
perpetrator takes advantage of his or her employer: the victim company is unaware that
its employee has divided loyalties. If an employer knows of the employee’s interest in a
business deal or negotiation, there can be no conflict of interest, no matter how favorable
the arrangement is for the employee.
Most conflict schemes fall into one of two categories: (1) purchase schemes or (2)
sales schemes. The most common type of purchasing scheme involves the employee (or a
friend or relative of the employee) having some kind of ownership or employment
interest in the vendor that submits the invoice. The bill must originate from a real
company in which the fraud perpetrator has an economic or personal interest, and the
perpetrator’s interest in the company must be undisclosed to the victim company.
The most common sales scheme involves an employee with a hidden interest
having the victim company sell its goods or services below fair market value. This type
of fraud results in a lower profit margin or even a loss on the sale. As an example, a few
years ago, one of the largest U.S. paper and pulp companies discovered a major fraud
being perpetrated by some of its employees. To get wood for making paper, the company
both owned its own forests and purchased lumber from others. One of the vendors
providing lumber to the company turned out to be a group of its own employees who
were cutting timber on the company’s own forest reserves and then selling the timber
back to the company. In this case, the company was losing twice—once by paying for
lumber it already owned, and then by having less of its own lumber to process.
Some of the most egregious cases of conflictof-interest frauds that have ever
occurred were the mutual fund frauds that took place recently in the United States. Since
the beginning of the mutual fund industry in the 1920s, mutual funds have been thought
of as a relatively safe investment vehicle. Mutual funds were sold as a limited risk
investment which were, in the words of the great poet Bob Dylan, “always safe” and,
thus, represented as a “shelter from the storm.” 7 However, recent revelations have
shown that America’s $7 trillion mutual fund industry was rife with selfdealing, conflicts
of interest, illegality, and impropriety. Not only were funds preferentially allowing select
investors to unlawfully trade in exchange for higher fees and other forms of profit, but
fund insiders, including the most senior executives and founders of certain funds, also
engaged in the same unlawful trading conduct for their own personal gain. Most of the
mutual fund frauds involved basic schemes in which mutual fund companies allowed
certain preferred clients to make illegal trades, including rapid in-and-out trades as well
as trades based upon information not yet reflected in the price of the mutual fund’s assets.
The unlawful trading schemes engaged in by mutual funds involved two practices known
as “market timing” and “late trading.” These manipulative practices were possible
because of the way in which mutual funds are valued. Specifically, mutual funds in the
United States are valued once a day, at 4:00 p.m. Eastern Time (ET) following the close
of the financial markets in New York. The price, known as the net asset value (NAV),
reflects the closing prices of the securities that comprise a particular fund’s portfolio plus
the value of any uninvested cash that the fund manager maintains for the fund. Thus,
although the shares of a mutual fund are bought and sold all day long, the price at which
the shares trade does not change during the course of the day. Orders placed any time up
to 4:00 p.m. are priced at that day’s NAV, and orders placed after 4:01 p.m. are priced at
the next day’s NAV. This practice, known as “forward pricing,” has been required by law
since 1968.
Illegal market timing is an investment technique that involves short-term “in-and-
out” trading of mutual fund shares. According to a Stanford University study,8 market
timing may have caused losses to long-term mutual fund investors of approximately $5
billion each year. Rapid trading is antithetical to the premise that mutual funds are long-
term investments meant for buy-and-hold investors. In-and-out trading capitalizes on the
fact that a mutual fund’s price does not reflect the fair value of the assets held by the
fund. A typical example of market timing involves a U.S. mutual fund that holds
Japanese shares. Because of the time zone difference, the Japanese market may close at
2:00 a.m. ET in the United States. If the U.S. mutual fund manager uses the closing
prices of the Japanese shares in his or her fund to arrive at an NAV at 4:00 p.m. in New
York, the manager is relying on market information that is 14 hours old. If there have
been positive market moves during the New York trading day, which is a reliable
indicator that the Japanese market will rise when it later opens, the fund’s stale NAV will
not reflect the expected price change and, thus, will be artificially low. The NAV does
not reflect the time-current market value of the stocks held by the mutual fund. Thus, a
trader who buys the Japanese fund at the “stale” price is virtually assured of a profit that
can be realized the next day by selling at the higher NAV. Because the artificial
difference between the NAV and fair value has long been recognized, mutual funds
imposed policies to prevent investors from profiting from the stale pricing by rapidly
trading in and out of the funds. Most mutual fund prospectuses represent to investors that
the funds monitor, prohibit, and prevent rapid trading because it is detrimental to long-
term investors. Despite their representations to the contrary, mutual funds as well as their
investment advisers, permitted such trading for their own profit. The resulting harm
caused by the transfer of wealth from long-term investors to market timers, known as
“dilution,” came dollar-for-dollar from longterm investor’s profits.
d. Consumer Fraud and Its Seriousness
With advances in technology, consumer fraud is on the increase. Consumer fraud
is any fraud that targets individuals as victims. For example, consumer frauds can involve
telephone fraud, magazine fraud, sweepstakes fraud, foreign money offers (such as
Nigerian money scams), counterfeit drugs, Internet auctions, identity theft, and bogus
multilevel marketing schemes.
Thus far in this book, we have discussed employee fraud, management fraud,
vendor fraud, and customer fraud. We have also briefly discussed investment fraud, a
form of consumer fraud. However, there are many other types of consumer frauds that we
will discuss in this. Our focus on consumer fraud will be how to protect you and your
families from becoming victims. While the topics discussed earlier in this text are of use
daily by those who pursue employment in government, accounting, corporations, law,
universities, hospitals, or technology corporations, the contents of this should affect and
help every individual, regardless of future occupation or even whether they are employed
or not. Because of its practical application, this may be the most important material you
study throughout your college career. The best defense against becoming a victim of
consumer fraud is education.
Consumer fraud is a very serious problem in the United States and elsewhere in
the world. In October 2007, the United States Federal Trade Commission (FTC)2
released its second survey of consumer fraud in the United States. The survey estimates
that over 30 million adults—13.5 percent of the adult population— were victims of fraud
during 2005. African Americans were the most likely to be victims with 20 percent
experiencing one or more frauds in the preceding year. In addition, 18 percent of
Hispanics were victims and 12 percent of non-Hispanic whites were victims.
The most frequently reported type of consumer fraud involved fraudulent weight-
loss products that promised to allow one to lose weight without diet or exercise but didn’t
deliver on the promises; this fraud is estimated to have affected nearly 5 million
Americans in 2005. Foreign lottery scams, where a consumer was told that he or she had
won a foreign lottery and made payment to receive promised winnings, were the second
most commonly reported category of consumer fraud. Third on the list were buyers’ club
memberships with an estimated 3.2 million estimated victims who were billed for
memberships they did not authorize. A similar scam listed seventh on the report involved
consumers who were billed for Internet services that were unauthorized.
Three of the top 10 most common scams involved services related to consumer
loans or credit including credit card insurance (sixth), advance fee loans (eighth) and
credit repair scams (ninth). While federal law limits consumers’ credit card fraud liability
to $50, fraudsters sell credit card insurance by falsely claiming that cardholders face
significant financial risk if their credit cards are misused. Advance fee loans involved
consumers who paid a fee to obtain a promised loan or credit card that was not received.
In addition, some fraudsters falsely promise consumers that they can help them remove
truthful, negative information from their credit report, or establish a new credit record;
these credit repair schemes are illegal. An estimated 5 million Americans were affected
by these three types of scams.
The remaining three scams on the list involved prize promotions, work-at-home
programs, and business opportunities. Prize promotions involved consumers who paid
something or attended a presentation to receive a promised prized that was not as
promised. Workat-home programs and business opportunities involved programs and
opportunities that generally failed to deliver at least one-half of the promised level of
earnings. The survey revealed that 27 percent of fraud victims first learned about a
fraudulent offer or product from print advertising (e.g., newspapers, magazines, direct
mail, catalogs, posters, or flyers). Twenty-two percent of fraudulent offers were promoted
using the Internet and e-mail. Television or radio advertising accounted for 21 percent of
fraudulent offers and telemarketing was used for 9 percent.
In the last few years, law enforcement agencies across the world have started
working together to target consumer fraud. Consumer Sentinel is a complaint database
that was developed by the U.S. Federal Trade Commission. It tracks information about
consumer fraud and identity theft from the FTC and over 150 other organizations and
makes it available to law enforcement partners across the United States and Canada.
Launched in 1997, the Sentinel database now includes over 5.4 million complaints. You
can access Consumer Sentinel at www. sentinel.gov. You can use this site to lodge a
complaint, examine fraud trends, and obtain other valuable information about consumer
fraud.
e. Identity Theft
According to the Federal Trade Commission, identity theft is the most common
type of consumer fraud, affecting thousands of people every day. Approximately one-
fourth of the complaints reported to the FTC over the last few years have involved some
type of identity theft.3 Identity theft is used to describe those circumstances when
someone uses another person’s name, address, Social Security number (SSN), bank or
credit card account number, or other identifying information to commit fraud or other
crimes. In one case that we are aware of, an individual (we’ll call him Tom) returned
from a vacation to find out that his sister (let’s call her Jane) had stolen his credit card
and stolen his identity. Jane ran up a large bill that Tom refused to pay and he reported
her to the police. Jane was sent to jail as Tom decided to prosecute her. Then, to add
insult to injury, Tom discovered that he was denied housing because Jane’s actions had
ruined his credit.
Unfortunately, personal data such as bank account and credit card numbers, SSNs,
telephone calling card numbers, and other valuable information can be used by others to
profit at your expense. The most detrimental consequence of identity theft isn’t the actual
loss of money, but rather the loss of credit, reputation, and erroneous information that is
extremely difficult to restore or fix. If a fraudster ensures that bills for the falsely
obtained credit cards or bank statements showing the unauthorized withdrawals are sent
to an address other than the victim’s, the victim may not become aware of what is
happening until the criminal has already inflicted substantial damage on the victim’s
assets, credit, and reputation. Indeed, as with most fraud, the most important way to fight
identity theft is to prevent it from happening in the first place. Once identity theft has
occurred, it is very difficult, expensive, and timeconsuming to investigate and resolve.
Identity fraud, like all fraud, can be explained by the fraud triangle of pressure,
rationalization, and opportunity. Many times, those we trust are in the best position to
defraud us. Some consumer fraud victims trusted their neighbors to get their mail while
they were away. Other victims innocently trusted their dinner servers while they were out
to eat to process their credit card payment. Other victims simply trusted a babysitter
while they were out or left personal information where it could be accessed by a friend, a
family member, or even a stranger.
Some identity thefts have completely ruined individuals’ lives. For example, one
criminal incurred more than $100,000 of credit card debt; bought homes, handguns, and
motorcycles; and obtained a federal loan—all in the victim’s name. What’s more, the
perpetrator then called the victim and taunted him stating that he had stolen the
individual’s identity—and that there was nothing he could do about it. After the
perpetrator was finally caught, the victim and his wife spent nearly four years and
$15,000 of their own time and money to try to restore their ruined credit and reputation.
The perpetrator served a brief sentence for making a false claim while buying a firearm,
but never had to make restitution to the victim for the harm he had caused.
The discovery stage involves two phases: information gathering and information
verification. This is the first step in the identity theft cycle because all other actions the
perpetrator takes depend upon the accuracy and effectiveness of the discovery stage. A
powerful discovery stage constitutes a solid foundation for the perpetrator to commit
identity theft. The smarter the perpetrator, the better the discovery foundation will be. If a
perpetrator has a weak foundation, the evidence gathered will be less likely to support a
high-quality identity theft, which minimizes the victim’s overall financial losses.
During the gaining information phase, fraudsters do all they can to gather a
victim’s information. Examples of discovery techniques include such
informationgathering techniques as searching trash, searching someone’s home or
computer, stealing mail, phishing, breaking into cars or homes, scanning credit card
information, or using other means whereby a perpetrator gathers information about a
victim.
During the information verification phase, a fraudster uses various means to
verify the information already gathered. Examples include telephone scams, where
perpetrators call the victim and act as a representative of a business to verify the
information gathered (this is known as pretexting), and trash searches (when another
means was used to gather the original information). Although some fraudsters may not
initially go through the information verification process, they will eventually use some
information verification procedures at some point during the scam. The scams of
perpetrators who don’t verify stolen information are usually shorter and easier to catch
than scams of perpetrators who verify stolen information.
The action stage is the second phase of the identity theft cycle. It involves two
activities: accumulating documentation and devising cover-up or concealment actions.
Accumulating documentation refers to the process perpetrators use to obtain needed tools
to defraud the victim. For example, using the information already obtained, perpetrators
may apply for a bogus credit card, fake check, or driver’s license in the victim’s name.
Although the perpetrator has not actually stolen any funds from the perpetrator, he or she
has now accumulated the necessary tools to do so. Any action taken by the perpetrator to
acquire information or tools that will later be used to provide financial benefit using the
victim’s identity fall into this category.
Cover-up or concealment actions involve any steps that are taken to hide or cover
the financial footprints that are left through the identity theft process. For example, in this
stage, a fraudster might change the physical address or e-mail of the victim so that credit
card statements are sent by the financial institution to the perpetrator rather than the
victim. These concealment actions allow the perpetrator to continue the identity theft for
a longer period of time without being noticed.
f. Other Types of Consumer and Invesment Scams
We have spent almost the entire discussing identity theft. In the next section, we
will briefly cover various other types of scams that target consumers as their victims.
Foreign advance-fee scams have been around for years; however, with the advent of the
Internet, they have recently become much more widespread and common. Unfortunately,
many individuals have become victim to this form of consumer fraud. In the following
paragraphs, we will discuss some of the more common types of foreign advance-fee
scams.
Nigerian money offers are a form of foreign advancefee scams where individuals
from Nigeria or another (usually underdeveloped) country contact victims through e-
mail, fax, or telephone and offer the victim millions of dollars. The catch is that in order
to transfer the victim these monies, it is necessary to provide name and bank account
numbers, including routing numbers, and so on, so the money can be transferred. The
fraudster then uses this information to drain the victim’s account and commit other types
of frauds. Notice that this letter contains several characteristics that are common to
almost all fraudulent money offers. The first characteristic of this e-mail is the promise of
money. The e-mail states that for your minimal help, you will receive “25 percent of
$35,750,000” or about $8,937,500, plus “5 percent of $35,750,000” or about $1,787,500,
for any expenses incurred. Receiving just over $11 million for helping someone sounds
like a pretty good deal to most people. However, remember if something sounds too good
to be true—it usually is.
The second characteristic of this fraudulent e-mail is that the letter asks for help.
In order to obtain victims’ personal information, the perpetrator will deceive (con) the
victim into believing that he or she really is needed for one reason or another. Usually,
the perpetrator will state that this is a “once-in-a-lifetime” opportunity. Third, the
perpetrator will try to build a relationship of confidence with the victim. The perpetrator
will use different means to make the victim feel sorry for him or her. In the example
below, the perpetrator relates the death of her husband so that the victim will further
sympathize with the perpetrator. Fourth, as with most of these requests, this letter states
the need for “urgent assistance.” Nearly all fraudulent money offers ask that the victim
respond immediately and confidentially. Fifth, this e-mail makes the victim feel like he or
she is the only person to receive this “special” opportunity. However, literally thousands
of people are getting this exact same e-mail daily. Sixth, this e-mail states that it is
necessary to meet “for a face-to-face meeting outside Nigeria.” This request is again to
instill confidence.
Meetings such as these never take place, or, if they do, victims never know the
true identity of the perpetrator or the reason for the meeting. Victims who have tried to
attend such meetings have been kidnapped, robbed, and even killed. It is almost always
dangerous to meet anybody that someone has met online. Seventh, the perpetrator of this
letter claims to be the “Widow of the Late Gen. Sani Abacha former Nigerian Military
Head of State who died as a result of cardiac arrest.” Nearly all fraudulent money offers
will claim to have strong ties to high-ranking foreign officials.
Many fraudulent money offers will also send officiallooking documents. These
documents are always forgeries; yet, to many victims they add credibility to the
perpetrators’ claims. Often, fraudulent money offers will also ask victims to send their
bank account number to show that the victim is willing to accept the offer. Other offers
will ask victims to pay large “fees” to process the transaction. Once a victim responds to
the e-mail, or has been deceived one time, the perpetrator will continue to have the victim
pay transaction fees— each time telling the victim that this is the last fee required.
Although Nigerian money offers are the most common type of foreign advance-
fee scams, several other foreign-advance fee scams are becoming more and more popular.
The following are examples of some of these schemes. One of these scams is a
clearinghouse scam. A clearinghouse scam involves a victim receiving a letter that falsely
claims the writer represents a foreign bank. This foreign bank is supposedly acting as a
clearinghouse for venture capital in a certain country. The fraudulent company will try to
get victims to invest in foreign venture capital companies for high returns. To give the
impression that they are legitimate, the perpetrators will set up bank accounts in the
United States. When the victims transfer money into the domestic account, the
perpetrators quickly transfer the money overseas where it will never be seen again. Some
clearinghouse scams will actually give back a portion of the original investments in the
form of dividends. However, such transfers are made only to give the victim more
confidence in the scam so that the victim will invest additional money. Eventually, the
money is transferred and lost.
Another type of foreign advance-fee scam is the purchase of real estate scam. This
scam usually takes the form of someone trying to sell a piece of real estate or other
property to the victim. Perpetrators will see advertisements for land (or other assets)
being sold and send possible victims letters offering to purchase the property on behalf of
a foreign concern. The victims are defrauded when they agree to pay “up-front fees” to a
“special broker.” Once paid, the victim will never hear from the perpetrator again. Sale of
crude oil at below market price is another type of foreign advance-fee scam. In this scam,
the victim receives an offer to purchase crude oil at a price well below market price.
However, in order to receive these “below market prices,” it is necessary to pay special
registration and licensing fees. Once the victim pays these fees, the seller disappears.
Finally, disbursement of money from wills is a foreign advance-fee scam that is
becoming ever more popular. In this scam, perpetrators con charities, universities,
nonprofit organizations, and religious groups. These organizations will receive a letter
from a mysterious “benefactor” interested in contributing a large sum of money.
However, to get the money, the charity is required to pay inheritance taxes or government
fees. Once these taxes and fees are paid, the victims are unable to contact the benefactor.
All of these schemes have common elements. They all come from an unknown
party who claims to have access to large sums of money or assets. The perpetrators are
always willing to transfer that money or other assets to the victims, but only after money
or information is extracted from the victims. The perpetrators are not well-known
businesses (even though they sometimes represent that they are), and there is usually
some urgency to participate. The best advice we can give to avoid being a victim to these
types of schemes is that given above: if it sounds too good to be true, it probably is. Or,
stated another way, “if it looks like a snake, crawls like a snake, and acts like a snake, it
probably is a snake.”
Just a final point about these types of scams. An investigator friend of ours sent us
a mailing that was sent to various perpetrators of foreign-advance fee scams. The letter
was an advertisement for a conference, which was to be held at a five-star hotel in Africa.
The topic of the conference—“Ways to Improve the Collectibility and Success of Foreign
Advance-Fee Scams.” Isn’t it interesting that those who would deceive others would have
a conference at an expensive hotel to trade secrets on how to be more successful at
deception?
Nearly everyone has seen advertisements that read, “I work at home and love it—
work part time and earn $1,000–$5,000 a week.” While not all work-at-home schemes
are illegal or fraudulent, many of them are. You can find people marketing fraudulent
workat-home schemes on the telephone, in chat rooms, on the Internet, through telephone
polls, as banners or advertisements on automobiles, through the use of fliers, on message
boards, in classified ads, and through all other types of communications media.
According to one report,17 con artists pitching work-at-home schemes rake in
approximately $427 billion a year. Here are some of the more common work-at-home
schemes.
Just about everyone has been approached at some time or another to join a
multilevel (or network) marketing (MLM) company. When structured correctly, with
honest people, multilevel marketing is a legitimate form of business. In fact, it is really
another marketing approach from which organizations may choose. In most multilevel
marketing programs, company representatives act as sellers of real products such as facial
creams, health aids, detergents, and foot supplements. These individuals are independent
distributors of a legitimate business. In order to increase the distribution process,
representatives of these organizations recruit friends, family members, and others to join
them in selling the products. Generally, distributors make money both on what they sell
personally and what those they have recruited sell.
However, one of the most common work-at-home schemes is the fraudulent
manipulation of legitimate multilevel marketing organizations. While there are many
variations of fraudulent MLMs, one kind of fraudulent multilevel marketing organization
is also called a pyramid or Ponzi scheme. Instead of selling real, legitimate products, they
have only illusionary products and profits. As stated previously in this book, one of the
most famous frauds of all time was a pyramid scheme perpetrated by Carlo “Charles
Ponzi.” Because Charles Ponzi’s scam was one of the first largescale frauds of the
twenty-first century, pyramid schemes and many fraudulent MLMs have been dubbed
“Ponzi schemes.” Ponzi MLMs can look just like nonfraudulent MLMs. However, Ponzi
MLMs tend to focus their efforts on the recruiting of new members instead of the selling
of legitimate products. In the beginning of a pyramid scheme, the investments of
subsequent investors are used to pay promised returns to earlier investors. These
seemingly real returns excite early investors who then spread the “good news” about the
“investment” to their friends and relations. Sooner or later, however, the scheme either
becomes too big and too exposed and, as a result, subsequent investors dry up or the
perpetrator disappears with the assets. With no new money to make the scheme look like
it is working, the entire organization usually collapses, leaving only a few people at the
top of the pyramid who have actually made money—those at the bottom always lose their
investment.
So how do consumers tell the difference between a legitimate MLM and a
fraudulent MLM, including Ponzi schemes? Usually, investors can tell the difference by
the focus of the marketing and by the company’s compensation plan. If the focus is on
recruitment, instead of products, the MLM may be fraudulent. As stated, fraudulent
pyramid schemes make their money by getting new people to invest in the company,
which in turns pays dividends to those who have already invested. Headhunter fees,
which are fees paid for signing additional recruiters, signal one type of problem. It is
illegal for MLM distributors to receive a commission simply for signing up new
distributors—a product must be part of the distribution process. When investing in an
MLM, investors should avoid MLMs that include headhunter fees. Some MLMs are
organized much like a matrix, meaning representatives only get paid when the
organization becomes “X number of distributors deep” or “Y number of distributors
wide.” This, too, can be a red flag that the organization’s focus is on recruitment instead
of marketing products.
