Cybercrime and Financial Fraud

Financial fraud has long existed. The Internet and social media provide fraudsters with new tools to do the same old nasty things they have been doing for centuries. Now it is faster, easier, and safer for fraudsters to victimize people all over the world and do so from all over the world. Several common Internet fraud methods are listed in Table 12.1.

The Internet Crime Complaint Center (IC3) provides the public with a reliable and convenient reporting mechanism to submit information to the FBI concerning

Table 12.1 Common Cyber Fraud Methods

suspected Internet-facilitated criminal activity. Since 2000, the IC3 has received complaints across the spectrum of cybercrime, including the many forms of online fraud related to intellectual property rights (IPRs) matters, computer intrusions (hacking), economic espionage (theft of trade secrets), online extortion, international money laundering, identity theft, and a growing list of Internet-facilitated crimes.

It is increasingly evident that, regardless of the label placed on a cybercrime matter, the potential for it to overlap with another referred matter is substantial. The IC3, formerly known as the Internet Fraud Complaint Center, was renamed in October 2003 to better reflect the broad character of Internet- or cyber-based matters that are referred to the IC3, and to minimize the need for one to distinguish Internet fraud from other potentially overlapping cybercrimes. There have been 3,463,620 complaints reported to the IC3 since its inception. Over the last five years, the IC3 received an average of nearly 300,000 complaints per year. The complaints address a wide array of Internet scams affecting victims across the globe.

For 2015, the ICS recorded over one billion dollars in losses from reported Internet fraud, with over 125,000 complainants reporting financial losses. The median dollar loss reported by complainants was $560.00 while the average loss was $8421.00. Losses by type of incident reported to IC3 are shown in Table 12.2 [20].

Many types of fraud can be found in social media, e-mail messages, and on websites:

• ? A Ponzi scheme is investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors. Ponzi schemes often share common characteristics, such as offering overly consistent returns, unregistered investments, high returns with little or no risk, or secretive or complex strategies. This arrangement gives investors the impression there is a legitimate, money-making enterprise behind the subject’s story, but in reality unwitting investors are the only source of funding.
• ? Affinity fraud: Perpetrators of affinity fraud take advantage of the tendency of people to trust others with whom they share similarities—such as religion or ethnic identity—to gain their trust and money.
• ? Pyramid schemes: In pyramid schemes, as in Ponzi schemes, money collected from new participants is paid to earlier participants. In pyramid schemes, however, participants receive commissions for recruiting new participants into the scheme.
• ? Prime bank investment fraud: In these schemes, perpetrators claim to have access to a secret trading program endorsed by large financial institutions such as the Federal Reserve Bank, Treasury Department, World Bank, International Monetary Fund, and so on. Perpetrators often claim the unusually high rates of return and low risk are the result of a worldwide secret exchange open only to the world’s largest financial institutions. Victims are

Table 12.2 2015 Internet Crimes by Victim Loss

often drawn into prime bank investment fraud because the criminals use sophisticated terms, legal-looking documents, and claim the investments are insured against loss.

• ? Advance fee fraud: Advance fee schemes require victims to advance relatively small sums of money in the hope of realizing much larger gains. Not all advance fee schemes are investment frauds. In those that are, however, victims are told that to have the opportunity to be an investor (in an initial offering of a promising security, investment, commodity, etc.), the victim must first send funds to cover taxes or processing fees and other expenses.
• ? Promissory notes: These are generally short-term debt instruments issued by little-known or nonexistent companies. The notes typically promise high returns with little or no risk and are typically not registered as securities with the appropriate regulatory agency.
• ? Commodities fraud: Commodities fraud is the sale or purported sale of a commodity through illegal means. Commodities are raw materials or semifinished goods that are relatively uniform in nature and are sold on an exchange (e.g., gold, pork bellies, orange juice, and coffee). Commodities fraud usually involves illicit marketing or trading in commodities futures or options. Perpetrators often offer investment opportunities in commodities markets that falsely promise high rates of return with little or no risk.
• ? Foreign currency exchange (Forex) fraud: Perpetrators of Forex fraud entice individuals into investing in the spot foreign currency market through false claims and high-pressure sales tactics. Foreign currency firms that engage in this type of fraud invest client funds into the Forex market not with the intent to conduct a profitable trade for the client, but merely to churn the client’s account. Churning creates large commission charges benefiting the trading firm. In other forms of Forex fraud, the perpetrator creates artificial account statements that reflect purported investments when, in reality, no such investments have been made. Instead, the money has been diverted for the perpetrator’s personal use.
• ? Precious metals fraud: These fraud schemes offer investment opportunities in metals commodities such as rare earth, gold, and silver. Perpetrators of precious metals fraud entice individuals into investing in a commodity through false claims and high-pressure sales tactics. Often in these types of fraud, perpetrators create artificial account statements that reflect purported investments when, in reality, no such investments have been made. Instead, the money has been diverted for the perpetrators’ personal use [21].

Mortgage fraud schemes employ some type of material misstatement, misrepresentation, or omission relating to a real estate transaction that one or more parties to the transaction relies on. These schemes include foreclosure rescue schemes; loan modification schemes; illegal property flipping; builder bailout/condo conversion; equity skimming; silent second; home equity conversion mortgage; commercial real estate loans; and air loans. The following is a more detailed explanation of these schemes:

• ? Foreclosure rescue schemes: Perpetrators identify homeowners who are in foreclosure or at risk of defaulting on their mortgage loan. Perpetrators then mislead homeowners into believing they can save their homes by transferring the deed or putting the property in the name of an investor. Perpetrators profit by selling the property to an investor or straw borrower, creating equity using a fraudulent appraisal, and stealing the seller proceeds or fees paid by the homeowners. The homeowners are sometimes told they can pay rent for at least a year and repurchase the property once their credit has been re-established. However, the perpetrators fail to make the mortgage payments and usually the property goes into foreclosure.
• ? Loan modification schemes: Scammers purport to assist homeowners who are delinquent in their mortgage payments and are on the verge of losing their home by offering to renegotiate the terms of the homeowners’ loan with the lender. The scammers, however, demand large fees up front and often negotiate unfavorable terms for the clients, or do not negotiate at all. Usually, homeowners ultimately lose their homes. This scheme is similar to a foreclosure rescue scam.
• ? Illegal property flipping: Property is purchased, falsely appraised at a higher value, and then quickly sold. What makes property flipping illegal is that the appraisal information is fraudulent. Schemes typically involve one or more of the following: fraudulent appraisals; falsified loan documentation; inflated buyer income; or kickbacks to buyers, investors, property/loan brokers, appraisers, and title company employees.
• ? Builder bailout/condo conversion: Builders facing rising inventory and declining demand for newly constructed homes employ bailout schemes to offset losses. Builders find buyers who obtain loans for the properties. The buyers then allow the properties to go into foreclosure. In a condo-conversion scheme, apartment complexes purchased by developers during a housing boom are converted into condos. When the market declines, developers have excess inventory of units. Developers recruit straw buyers with cashback incentives and inflate the value of the condos to obtain a larger sales price at closing. In addition to failing to disclose the cash-back incentives to the lender, the straw buyers’ income and asset information are often inflated for them to qualify for properties that they otherwise would be ineligible or unqualified to purchase.
• ? Equity skimming: An investor may use a straw buyer, false income documents, and false credit reports to obtain a mortgage loan in the straw buyer’s name. After closing, the straw buyer signs the property over to the investor in a quit claim deed, which relinquishes all rights to the property and provides no guaranty to title. The investor does not make any mortgage payments and rents the property until foreclosure takes place several months later.
• ? Silent second: The buyer of a property borrows the down payment from the seller through the issuance of a non-disclosed second mortgage. The primary lender believes the borrower has invested his own money in the down payment, when in fact, it is borrowed. The second mortgage may not be recorded to further conceal its status from the primary lender.

• ? Home equity conversion mortgage (HECM): A HECM is a reverse mortgage loan product insured by the Federal Housing Administration to borrowers who are 62 years or older, own their own property (or have a small mortgage balance), occupy the property as their primary residence, and participate in HECM counseling. It provides homeowners access to equity in their homes, usually in a lump sum payment. Perpetrators recruit seniors through local churches, investment seminars, and television, radio, billboard, and mailer advertisements. The scammers then obtain a HECM in the name of the recruited homeowner to convert equity in the homes into cash. The scammers keep the cash and pay a fee to the senior citizen or take the full amount unbeknownst to the senior citizen. No loan payment or repayment is required until the borrower no longer uses the house as a primary residence. In the scheme, the appraisals on the home are vastly inflated and the lender does not detect the fraud until the homeowner dies and the true value of the property is discovered.
• ? Commercial real estate loans: Owners of distressed commercial real estate obtain financing by creating bogus leases and using these fake leases to exaggerate the building’s profitability, thus inflating their appraisal values using the income method approach. These false leases and appraisals trick lenders into extending loans to the owner. As cash flows are restricted to the borrower, property repairs are neglected. By the time the commercial loans are in default, the lender is often left with dilapidated and unusable or difficult-to-rent commercial property. Many of the methods of committing mortgage fraud that are found in residential real estate are also present in commercial loan fraud.
• ? Air loans: This is a nonexistent property loan where there is usually no collateral. Air loans involve brokers who invent borrowers and properties, establish accounts for payments, and maintain custodial accounts for escrows. They may establish an office with a bank of telephones, each one used as the fake employer, appraiser, or credit agency to fraudulently deceive creditors who attempt to verify information on loan applications [21].