FBI: Corporate, mortgage fraudsters actively threaten your financial future

While the Federal Bureau of Investigation can claim success against all manner of fraud in the US, the number of cases and the shear volume of lost money is obviously a tidal wave that is only barely held back.

The FBI issued its annual Financial Crimes Report today and said that while the number of cases in 2007 involving the falsification of financial information remains relatively stable but that corporate (which has increased 80% since 2003) and mortgage industry fraud (which as grown 176% since 2003) cases are costing citizens millions if not billions of dollars and continue to grow.

Some key findings presented in the report included:

* As of the end of Fiscal Year (FY) 2007, 529 corporate fraud cases were being pursued by the FBI, several of which involve losses to public investors that individually exceed $1 billion. Through FY 2007, cases pursued by the FBI resulted in 183 indictments and 173 convictions of corporate criminals. Numerous cases are pending plea agreements and trials. During Fiscal Year 2007, the FBI secured $12.6 billion in restitution orders and $38.6 million in fines from corporate criminals. The chart below reflects corporate fraud pending cases from Fiscal Year 2003 through Fiscal Year 2007 as follows: Fiscal Year 2003 - 279 cases; Fiscal Year 2004 - 332; Fiscal Year 2005 - 423; Fiscal Year 2006 - 486; and Fiscal Year 2008 - 529 cases.

* The 1,204 pending mortgage fraud cases in FY 2007 resulted in 321 indictments, 206 convictions, $595.9 million in restitution orders, and $21.8 million in recoveries. Through Fiscal Year 2007, 1,204 cases resulted in 321 indictments and 260 convictions of mortgage fraud criminals. The following notable statistical accomplishments are reflective in Fiscal Year 2007 for mortgage fraud: $595.9 million in restitutions, $21.8 million in recoveries, and $1.7 in fines. Mortgage fraud pending cases have grown three-fold since 2003 from 436 cases to 1,204 in 2007.

* FBI securities and commodities fraud cases increased from 937 in FY 2003 to 1,217 in FY 2007, and resulted in $24 million in recoveries, $1.7 billion in restitution orders, and $202.7 million in fines in FY 2007.

* Through FY 2007, the 2,493 health care fraud cases investigated by the FBI resulted in 839 indictments and 635 convictions of health care fraud criminals.

* The FBI investigated 548 money laundering cases in FY 2007, resulting in 141 indictments, 112 convictions, $66.9 million in restitution orders, $2.2 million in recoveries, and $11.4 million in fines.

In the corporate fraud realm, stock options continue to be the main issue. Such options are corporate incentives that allow the holder to purchase stock at a fixed "strike" price sometime in the future, regardless of the prevailing market price, the FBI stated. Generally, the strike price is the cost of the stock on the date the options were granted.

The benefit to the options holder is the difference between the strike price and the later sales price. When stock options are backdated, however, the date of the options is set to a time in the past when the price of the stock was lower than on the date the options were actually issued. Backdating stock options inflates their value to the holder at the expense of regular shareholders. Some corporate executives have also changed their stock options exercise date (the date the option can be converted to stock) to avoid paying income tax. As of the end of Fiscal Year 2007, the FBI was investigating over 70 cases involving the manipulation of executive stock options.

The FBI singled out a number of key cases including:

Brocade Communications Systems: the FBI said Brocade routinely used stock options to compensate its employees. In July 2006, former Chief Executive Officer (CEO) Gregory L. Reyes and former Vice-President of Human Resources Stephanie Jensen were charged in connection with a scheme to backdate stock option grants. The two executives made fraudulent entries into Brocade's financial books and records, made false statements to auditors, and filed false financial statements with the SEC in furtherance of the scheme. After internal auditors restated earnings for the years 1999 through 2004, it was estimated that the cost to Brocade exceeded $400 million. On August 7, 2007, a jury convicted Reyes of ten counts of conspiracy and securities fraud. Reyes was the first person to be tried on charges related to stock options backdating and was sentenced to 21 months in prison. On December 5, 2007, a jury convicted Jensen of conspiracy to commit securities fraud and falsifying corporate records. Jensen is currently awaiting sentencing.

Qwest Communications: In 2000 and 2001, the company reported sales revenues of $16 billion and $19 billion, respectively, in its published financial statements. In 2002, Qwest issued a press release that acknowledged the company had improperly recorded $1.1 billion in revenue since 1999, and the FBI opened a criminal investigation. Five executives were indicted and either pled guilty or were convicted of securities fraud or insider trading. This included the former CEO Joseph Nacchio, who was convicted of insider trading on April 19, 2007. He was sentenced to six years in prison, ordered to forfeit $52 million gained as a result of his illegal stock sales, and fined $19 million.

Meanwhile in the mortgage fraud arena, the FBI said potential impact of mortgage fraud on financial institutions and the stock market is clear. If fraudulent practices become systemic within the mortgage industry and mortgage fraud is allowed to become unrestrained, it will ultimately place financial institutions at risk and have adverse effects on the stock market. Investors may lose faith and require higher returns from mortgage backed securities. This may result in higher interest rates and fees paid by borrowers and limit the amount of investment funds available for mortgage loans.A significant portion of the mortgage industry is void of any mandatory fraud reporting. In addition, as initial mortgage products are repackaged and sold on secondary markets, the sale of the mortgages in many cases conceal or distort the fraud, causing it not to be reported. Therefore, the true level of mortgage fraud is largely unknown, the FBI stated.

However, based on various industry reports and FBI analysis, mortgage fraud is pervasive and growing. The FBI compiles data on mortgage fraud through Suspicious Activity Reports (SARs) filed by federally-insured financial institutions and the Department of Housing and Urban Development-Office of Inspector General. For example, SARs in Fiscal Year 2005 were over 35,000; Fiscal Year 2006 were over 46,000; and the 1st Quarter of Fiscal Year 2007 were 14,916, which extrapolates to 60,000 SARs.

The top 10 mortgage fraud states for 2007 were Florida, Georgia, Michigan, California, Illinois, Ohio, Texas, New York, Colorado, and Minnesota. Other states significantly affected by mortgage fraud included Arizona, Maryland, Utah, Nevada, Missouri, Indiana, Tennessee, Virginia, New Jersey, and Connecticut, the FBI said. Currently, the total value of subprime loans outstanding is estimated at $1.3 trillion, while total mortgage loans outstanding is $4.5 trillion.

The downward trend in the housing market provides an ideal climate for mortgage fraud perpetrators to employ a myriad of schemes suitable to a down market, the FBI stated. Several of these schemes have emerged with the potential to spread as the recent rise in foreclosures, depressed housing prices, and decreased demand place pressure on lenders, builders, and home sellers. As lending practices tighten, in response to the subprime lending crisis, fewer loans will be originated. Perpetrators will seek alternative methods of defrauding mortgage loan products. Identity theft is historically a popular tool for use in mortgage fraud schemes.

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