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s ...--- August 1993 Volume 62 NumberS

U.nited States Deparfinentof Justice Federal Bureau. of Investigation Washington, DC 2(1535 Features I William S. Sessions, Director. 1'-fJ.101 e.ontributors' opinions and Lead POisohmg: Exposure to lead on the firing statements should not be a range threatens the health of considered as an A Firearms Safety Hazard shooters and firearms instructors. endorsement for any policy, program, or service by the By Amelia Newberry Martinez FBI. The Att6meyGeneral has d.etermined thai tile . pu':llication of this periodical Ethics in Police Deci~'in'fn~'fng II Lesso.nslearned!rom~orporate . is.necessary inthe'" By Dennis M Payne Amenca can as.slst police manafjers transaction of the public '; . to develop and Implement effectIVe business required by law. \: codes of ethics. Use of funds. for printing this " periodical has been i4'f111 approved by the Director of • The Cash Flow Analysis Method The cash flow analysis method the Office of Management enables law enforcement agencies and Budget. . By Thomas L. Kitchens I to investigate and prosecute Ponzi lID schemes more successfully. The FBI Law Enforcement Bulletin (ISSN-0014-5688) is publisned monthly by the . . Federal Bureau of The Ad Hoc Task Force Involving employees in the . Investigation, 10th and decisionmaking process creates Pennsylvania Avenue, N.W., By Jeffrey S. Brown an atmosphere that is receptive Washlngton,D,C.20535. to change . . Second:Class postage paid at Washington,D.C.fand additional mailing 9ffices.. " i 4-'i1i J- Postmaster: Send address '. Leaders vs. Managers: The future of law enforcement is changes to FBI Law in its leaders, not its managers. Enforcement Bulletin, The Law Enforcement Formula Federal Bureau pf By Carl Dobbs and Mark W. Field Investigation, Washington, . D.C. 20535.

E;ditor i 4a.f7i.3 Deadly Force in Defense of Life Legal rules, circumstances, and Dr. Stephen D. Gladis reasonableness should guide Managing Editor By John C. Hall officer discretion in the use of Kathryn E. Sulewski deadly force. Art Director .John E. Ott Associate Editors Andrew DiRosa Karen F. McCarron Departments Kimberly J. WagQoner Assistant Art Director Amelia J. Brooks 8 Police Practices 21 Book Review ProdUction Manager T.L. Wilson . Project EARS Financial Crimes Staff Assistant DarleneJ. Butler Cover photo by 14 Focus on Technology 26 Bulletin Reports Larry Wallery, FBI Video Teleconferencing

ISSN 0014-5688 USPS 383-310 i44709- U.S. Department of Justice 144713 National Institute of Justice

This document has been reproduced exactly as received from the person or organization originating it. Points of view or opinions stated in this document are those of the authors and do not necessarily represent the official position or policies of the National Institute of Justice. Permission to reproduce this copyrighted material has been granted by • FBI Law Enforcement Bul1etm

to the National Criminal Justice Reference Service (NCJRS). Further reproduction outside of the NCJRS system requires permission of the copyright owner. The Cash Flow Analysis Method Following the Paper Trail in Ponzi Schemes

By THOMAS L. KITCHENS .WIII .$:18

mong criminals, Charles the offender attracts more and more exhibits. In the past, these cases Ponzi-a diminutive investors, using their new money to generally took several years to in­ A swindler who emigrated make interest payments to previous vestigate and prosecute. However, from Italy to the United States in the investors-in other words, "robbing the Ventura County, California, early 1900s-was afforded a rare Peter to pay Paul." In reality, the District Attorney's Office now em­ distinction. A specific category of offender uses the bulk of the im­ ploys an investigative technique financial scam was named in his mense cash reserves to finance an that, when appropriately applied, honor. expensive lifestyle and pay personal significantly reduces the time re­ Today, Ponzi schemes continue bills. quired to investigate Ponzi cases. to flourish throughout the United For a number of reasons, these Accountants and auditors have States. In a typical scam, an offender types of "pyramid schemes" have long used cash flow analysis to trace lures unsuspecting investors with traditionally been among the most the flow of funds into and out of claims of unusually high yields on difficult cases for law enforcement particular bank accounts. The over­ their investments. While the of­ agencies to detect. The investiga­ all objective of the cash flow analy­ fender provides contributors with tions invariably involve multiple sis method with regard to Ponzi vague background information on victims and witnesses-often from scheme investigations is to establish the firm or venture to be backed, no numerous jurisdictions-as well as how offenders illegally received and such entity actually exists. Instead, thousands of documents and court spent their victims' money, the total

10 / FBI Law Enforcement Bulletin amount of money stolen, and the number of victims involved. Each of these considerations becomes an "[The cash flow important issue when courts render analysiS method] punishment to convicted offenders. significantly reduces A TYPICAL thetimefequiredto Using the cash flow analysis investigatePonzJ method, the Ventura County Dis­ cases. trict Attorney's Office has success­ ". , fully prosecuted a number of com­ plex pyramid scams. The following ", case demonstrates many of the characteristics of a typical Ponzi .. M~; Kit?h~nsisa sen~qrin~estigator with ,hr:>VeoturaCounty, . Califorma, District Attorney s Offlce whe((~ he supervises the Major scheme. l '. Fraud and the Consu"!liJrarid cl1VironrTlt;Jntal ProteqtionUnits. Charles Stephen Hodson pre­ sented himself as an investment banker. In reality, he stole nearly $~O million from victims-many of whom were family members ments, as Hodson had promised. for investigators is to obtain all and acquaintances-over a 6-year However, these payments did not relevant records-such as checks, period. come from dividends on invest­ deposit slips, and monthly bank Hodson told his victims that ments; they came from funds statements-from the financial through connections with several drawn against Hodson's own institution(s) in which the suspect "Fortune 500" companies, he could business checking account. placed ~he victims' money. The sec­ offer investment opportunities guar­ Hodson's scheme began to ond step involves turning over these anteeing 18- to 25-percent interest crumble when he stopped making financial records to a forensic ac­ returns on privately borrowed monthly interest payments to his countant for the cash flow analysis. victims. Several filed reports with funds. He went on to inform some Step One the local police agency, prompting investors that he also had connec­ Since most victims make their tions in Switzerland, where he could an investigation into Hodson's busi­ ness dealings. A cash flow analysis investments by personal or cashier's deposit their money in major banks check, the Ponzi artist usually de­ that paid high interest rates. Hodson of relevant bank account records clearly revealed that Hodson did not po~its t?ese funds (if only tempo­ further informed investors that the ranly) lllto a bank account. This terms of their investments would invest any of his victims' money into major corporations or Swiss makes each investment a traceable generally be from 60 to 90 days. transaction. After investigators be­ While these types of arrange­ banks. Hodson was convicted of sev­ come confident that they have ments-known as commercial pa­ amassed sufficient probable cause, per transactions-can be legitimate, eral counts of grand theft and in­ come tax evasion and is currently they can obtain a search wan'ant and Hodson possessed none of the "con­ secure the relevant records. nections" he claimed. In fact, he serving a 7-year sentence in a Cali­ fornia State prison. Many of his vic­ Generally, in an investment never intended to invest his victims' fraud case, courts base the probable tims suffered financial devastation. I money. Hodson simply used the cause necessary to obtain a search funds to support his own lavish CASH FLOW ANALYSIS warrant on multiple factors. Several lifestyle. METHOD individuals must have given money Still, once the victims invested, The cash flow analysis method to ~ suspect for purposes of making most received timely interest pay- is a two-step process. The first step an lllvestment; these investors relied

August 1993 / 11 Charles' ponz;

, , , . '- , , B",,0111 inParma, Italy, hl.tM late 1800s, in initiated' ana~dit of the Securities-and , " Charles Ponziimmigrated to the United E., XCh,an~,e cO"m,,paliy'~" 'n~,' cial, ',l'eCO,rd, s'"W, hile Statesin1903. Destitute,he eventually settled 'the audit procee et("Ponzlagreed to cease' in Boston, Mass-acp~ls'etts, where, in 1919, he accepting ne , lllVestors, but he continued to pay, founded the Securit~ , and Exchange Company. interest ymentson the existhlg investments; From his location in the eart of the financial eanwhile, the audit revealed that Ponzi district, Ponzi sold 45- and' -day promis~ory , umerelytaken pewinvestQr fupdsto payoff note irfvestments to the' unsuspe i:Qg public, to previous investors. His "tnagic" had been to whom he guaranteed 50.,. to 100-pe£ce tinter t . amass largenu1,nberso'f "Petei:s" to pay ofOhe rates; He informed investors that he was "Pauls." Ip. reality. the audit showe(iPonzi to be chasing International Postal Reply Co , ons insolvent from the first day of the swindle. In from Spain and could sell,thelJl intbe United the end, heowedinvestQrsnearIy $14,375,000: States at a substantial profit due tff'iheexcessive t the condusion or the audit, he admitted that

di,fference, s in ex, c.hange rat,eess,?£, nOW,in g the Fir,s, t it asqU as-cam. Ponzi was prosecuted and World War., " /." . cori'vJ...Cted in both Federal aJjd State courts for The investm,ent'oppoytunity became pOPlllar the fr:fu,d. ;. . instantly. Crowdslined4lp daily outside, ponzi's, Whrl~n appellate bond, POnZl fled to " office. ,The l110ney c"arrie in so fast that Ponzi' s FIQrida,wlie~ he orchestrated a real estate office clerks beg'!P/biding itin desk drawers, ' swindle: After':sf<.rving a I-year sentencein wastebaskets, and file cabinets. In just 7 county jail for this scheme--:-which ipvolved months of operation, it was estimated thatPonzi selling uuderwater plots lounsuspecting cus~, accumulated over $9 million from more than tomers-,-,-·be was returned t() to 30,000 investors. His reputation for paying' serve lengthy Federal and State ,sentences. Upon exorbitant interest rates made this an even more his release, ,Charles Ponzi was deported from the attractive investment. At tM,same time, Ponzi United States; He died in 1949, a patieptin the enjoyed a lavish lifestyle at the expense oillis charity ward of aSouth American hospital. investors. Tn July 1920, ~lIocalnewspaper reporter This il')formatioo was drawn from Francis began investigating Ponzi's claims. The newspa­ Russell, "Bubble, Bubble-No Toil;, No Troubl€:!;" The Bb$ton Post,August 12, 74~80, Nash, per published an article exposing the inv~st~ 1920, 86; J. ments as' a scam. Soon after; the district attorney Blood/etters and Badmen, (1973), 44e-451.,

on the suspect's promise that their investigation, financial records may are obtained through a grand jury funds would be invested for a spe­ also be obtained through a grand subpoena duces tecum, auditors cific purpose and for a limited pe­ jury subpoena duces tecum.2 How­ must complete the cash flow analy­ riod of time; and the time period has ever, for a cash flow analysis, secur­ sis while the grand jury hears the since expired without repayment to ing a search warrant is generally case. This may prolong the time the investors or a reasonable expla­ preferable. required for an indictment. nation from the suspect. By securing a search wan-ant, Step Two Investigators should be aware investigators receive the relevant that because grand juries possess the bank records directly, which can The second step for investiga­ authority to subpoena aU informa­ then be given to the forensic ac­ tors in this process is to turn over all tion relevant to matters under their countant. If the financial records of the financial records obtained

"-,,- through the search warrant or sub­ legal matters and to testify in court simply be embarrassed because they poena to a forensic accountant for as expert witnesses. made a foolish investment. the cash flow analysis. The forensic While victim reluctance to co­ accountant then analyzes the bank OBSTACLES TO operate hampers many white-collar account records and prepares cash INVESTIGATION crime investigative techniques, it flow compilations of these records In a Ponzi scheme, investigators has little effect on the cash flow in financial statement form. This face the arduous task of determining analysis method. Because. this ap­ statement shows all of the known the validity of suspects' claims to proach traces suspected illegal ac­ receipts of a particular bank account victims regarding their investments. tivity through financial records, it during a specified period of time. In addition, prosecutors must then relieves investigators and prosecu­ Accordingly, this report demon­ demonstrate how offenders spent tors from basing cases predomi­ strates the flow of funds into and out the victims' money. These two ele­ nately on the testimony of victims. of a Ponzi artist's account. ments make Ponzi schemes espe­ When completed, the compila­ cially difficult to investigate and CONCLUSION tion also assists investigators to de­ prosecute, since Ponzi artists gener­ Ponzi artists operate in nearly termine whether the suspect accu­ ally "cover their bases" well. every jurisdiction throughout the rately represented the investments United States. They often rob un­ to contributors. If investigators de­ suspecting victims of their life sav­ termine that a crime may have been ings and lead them to tInancial ruin. committed, the compilation can The cash flow analysis method then be introduced pI; subsequent allows investigators in Ventura court proceedings as demonstrative ... by using this County to address this crime by re­ evidence of theft. The cash flow approach, ducing the number of workhours analysis compilation allows prose­ investigators can required to investigate Ponzi cutors to provide juries with a tangi­ schemes. It does so by providing an ble record of how the suspect com­ aggressively combat a easy-to-follow approach to what is mitted the crime and spent the type of crime that traditionally a time-consuming and victims' money. prosecutors once had research-intensive process. difficulty proving The cash flow analysis method USE OF FORENSIC beyond reasonable also uses forensic accountants to ACCOUNTANTS a doubt. audit suspects' financial records so Investigators traditionally that prosecutors can call upon these underuse forensic accountants in expert witnesses to trace the trail of white-collar crime ca&es. This is an the stolen funds. Perhaps most im­ unfortunate and potentially damag­ portant, by using this approach, in­ ing oversight. vestigators can aggressively combat In other types of major crime Often, in order to limit victims'" a type of crime that prosecutors once cases, investigators employ such inquiries, offenders represent in­ had difficulty proving beyond a rea­ specialists as pathologists, serolo­ vestment opportunities as being sonable doubt. .. gists, psychiatrists, fingerprint highly technical and sophisticated and document examiners, and in nature. Further, many white-col­ Endnotes criminalists to aid in analyzing evi­ lar crime victims hesitate to cooper­ I People v. Hodsoll (Superior Court, Ventura dence. Similarly, in many major ate with investigators, fearing that County, 1987, No. CR-22899). white-collar fraud cases, forensic when the offender becomes aware 2 This is a writ that requires a party summoned to appear in court to bring along a accountants should be called on to of an investigation, investors will document or other piece of evidence for apply their training and expertise to never be repaid. Or, victims may examination by the court.

August 1993 / 13

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