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Forensic Accounting in the Underground Economy

December 02, 2010

Walter C. King II, CPA, PFS, ASA, CFE

Periodically our government calculates the Gross Domestic Product (GDP).  The GDP includes income and output of our economy from legitimatesources – the GDP is expected to pass $1 trillion in the near term.  What about funds generated from illegitimate sources?  This had been estimated at 10% of the GNP.  More recently, U.S. Senator Carl Levin (D-Michigan) estimated that the U.S. Treasury loses $100 billion each year in unpaid taxes alone.  This is commonly called the underground economy.  In this article, I shall discuss the sources that fund the underground economy, how those funds are hidden and, more importantly, how they may be detected by forensic accountants.

How Illegal Funds are Hidden
The underground economy is funded by people who are attempting to avoid detection.  Examples of reasons people are attempting to avoid detection are tax evasion, drug monies, profit from insider trading and fear of seizure by government, creditors and previous spouses.  These funds can be hidden by investing the proceeds in precious metals, stamps, travel checks, insurance policies, foreign bank accounts or simply hoarding currency. 

Foreign bank accounts are by far the most common method of hiding currency.  Many foreign countries have laws protecting "bank secrecy."  Bank secrecy laws protect the identity of those depositing funds.  If one deposits $10,000 in a U.S. account or any trade or business, the organization is required to report that transaction on a FinCEN11 Form 104 or IRS Form 8300, and then send a Form 1099 to the depositor at year end to report the interest income.  If that same deposit is secretly made in a bank account of many foreign countries, there is no reporting.  Switzerland, for example, has a bulwark of bank secrecy laws.

60 Minutes
On August 8, 2010, 60 Minutes on CBS Newsinterviewed Swiss banker Bradley Birkenfeld, an employee of UBS.  Mr. Birkenfeld reported that his job at UBS was to help wealthy Americans hide their money, and a total of 60 UBS private bankers – each with an encrypted laptop computer – had similar responsibilities.  Mr. Birkenfeld would help his clients invest their funds by setting up sham companies or trusts in tax havens like the British Virgin Islands, Hong Kong and Panama – or by sending illegal funds overseas – and he estimated a total of 19,000 clients deposited $19 billion.  Mr. Birkenfeld was prosecuted notwithstanding his voluntary reporting of his illegal activities to the Justice Department.  There are believed to be 52,000 Americans who have foreign bank accounts and have broken U.S. tax laws. 

The Russian from Laguna Beach
The most notorious example of a Birkenfeld client is Igor Olenicoff of Laguna Beach, California and Lighthouse Point, Florida.  Olenicoff moved from the Soviet Union in 1957 and started his fraudulent transactions with deposits in the Cayman Islands and the Bahamas.  In 2000 he made contact with Birkenfeld and secretly moved $200 million to UBS in Geneva.  A U.S. District Court Judge sentenced Olenicoff to two years probation and 120 hours community service.  He paid $52 million in back taxes.

Role of Forensic Accountants   
The detection of investments in the underground economy is demanding and time consuming.  This list provides some procedures that should be conducted in a forensic investigation:

  1. Personal information:  birth date and birthplace, parent names, name of former and current spouses, children, criminal convictions, bankruptcies, education and banking information.
  2. Business information:  names of all organizations, including non-profits, that subject has had investments in over the last 10 years. 
  3. Secure copies of subject's tax returns from the last ten years – include gift, income and business tax returns. Returns may be requisitioned directly from the IRS.
  4. Financial Profile: an analysis of income and balance sheets from the last 10 years.
  5. Secure travel itinerary for the last five years.

The above steps have to be corroborated with independent investigations of the allegations.  The sources of information would include court records, consumer credit reports, DMV records, UCC filings, aircraft ownership, media data basis and property searches. 


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