4.2 Other schemes (bankruptcy, tax, securities, insurance, money laundering)

Beyond the financial statements

The CFE Exam's Financial Transactions and Fraud Schemes section covers several specialized schemes a fraud examiner must recognize even when they fall outside routine corporate accounting. Each has its own actors, motives, and detection points, and they frequently interlock in a single case.

Bankruptcy fraud

Bankruptcy is meant to give honest debtors a fresh start, but it is exploited in two principal ways. In asset concealment, a debtor hides property from the bankruptcy estate, transferring it to relatives, undervaluing it, or simply omitting it from the schedules, so that assets that should satisfy creditors are kept for the debtor. In a bust-out (also called a planned bankruptcy), the fraudster builds a business's credit over months, then orders large quantities of inventory on credit, quickly sells or diverts the goods, pockets the cash, and files for bankruptcy or simply disappears, leaving suppliers unpaid. Red flags include a sudden spike in orders just before default, inventory that vanishes without recorded sales, and newly formed entities with thin trading histories. Bankruptcy fraud is a federal crime, and false statements made under oath in the filings compound the offense.

Tax fraud: evasion versus avoidance

The examiner must sharply distinguish two ideas that sound similar. Tax avoidance is the legal structuring of one's affairs to minimize tax: claiming legitimate deductions, timing income, or using tax-advantaged accounts. It is entirely permissible. Tax evasion is the illegal and willful attempt to defeat tax owed: hiding income, keeping two sets of books, claiming fictitious deductions, or falsifying records. The dividing line is legality and willful intent. Evasion requires proof that the taxpayer knew of the duty and deliberately violated it, which is why intent evidence, such as concealment, lies to auditors, and destroyed records, is central to tax cases. Investigators often prove unreported income indirectly: the net-worth method shows that a subject's assets and spending grew far beyond reported income, while the specific-items method ties particular unrecorded receipts to the return. Both let the examiner establish evasion even when the books are silent.

Securities fraud

Securities fraud manipulates investment markets. Insider trading is buying or selling a security while in possession of material, non-public information in breach of a duty. Pump-and-dump schemes hype a thinly traded stock with false or exaggerated claims to inflate its price (the pump), then sell the promoters' holdings at the peak (the dump), collapsing the price on later buyers. A Ponzi scheme pays purported returns to earlier investors using money contributed by newer investors rather than from any real profit; it collapses when new money slows or too many investors seek redemptions, as in Bernie Madoff's landmark fraud. A related pyramid scheme rewards participants chiefly for recruiting others. Red flags include guaranteed high returns with little risk, suspiciously consistent returns regardless of market conditions, and difficulty withdrawing funds.

Insurance fraud

Insurance fraud spans padded or wholly fabricated claims, staged accidents, arson for profit, faked deaths or injuries, and premium fraud by policyholders or agents. On the industry side, insiders may divert premiums or churn policies to generate commissions. Detection relies on claims analytics, spotting the same 'witnesses,' medical providers, or repair shops recurring across unrelated claims, and on inconsistencies between the loss described and the physical or medical evidence. Additional red flags include claims filed soon after a policy is written or a coverage limit is raised, losses with no independent witnesses, reluctance to provide documentation, and a claimant unusually familiar with insurance procedures and terminology.

Money laundering

Money laundering disguises the criminal origin of funds so they appear legitimate. It classically proceeds through three stages, shown below.

Structuring, also called smurfing, breaks a large cash sum into multiple deposits, each below the $10,000 reporting threshold, to avoid triggering a Currency Transaction Report (CTR). Under the U.S. Bank Secrecy Act (BSA), financial institutions must file CTRs for cash transactions over $10,000 and file a Suspicious Activity Report (SAR) when they detect transactions that appear designed to evade reporting or otherwise lack a lawful purpose. Deliberately structuring transactions to dodge a CTR is itself a crime, independent of whether the underlying money is dirty. Anti-money-laundering (AML) programs, know-your-customer (KYC) rules, and SAR filings are the examiner's primary tools for detecting illicit funds moving through the banking system.

Why these schemes overlap

These categories rarely appear in isolation. A Ponzi operator launders proceeds and evades tax on them; a bust-out artist files a fraudulent bankruptcy to bury the debt; an arsonist commits insurance fraud to raise cash for another scheme. The fraud examiner therefore follows the money across categories, using net-worth analysis to show unexplained wealth and tracing funds through the placement, layering, and integration stages to connect a suspect's lifestyle to hidden illicit income.