Financial crime: The lords of frauds

The case of Martin Frankel, the star-gazing fraudster who disappeared from his Greenwich, Connecticut, mansion leaving behind a short to-do list - "launder the money" - various astrological charts seeking to answer whether he would be turned in or go to prison and a $335 million hole in the portfolios of several obscure American insurance companies, highlights the bizarre side of financial crime. The final numbers haven't been counted on Frankel: he may have pulled off the biggest theft ever. Its peculiar features shouldn't obscure a key lesson of the Frankel case: fraud just keeps on getting bigger. Fraud and money-laundering are now said to be among the world's fastest-growing financial markets.

William Cleghorn, head of fraud investigations at PricewaterhouseCoopers reckons that the real costs of fraud could easily exceed $30 billion globally: "internet fraud alone, a rapidly growing source of international fraud, is currently estimated at over £10 billion [$15.9 billion]. IMF and World Bank fraud may also be a real issue. If only 5% of total World Bank/IMF lending is fraudulently diverted, this would place the loss last year at £1.6 billion. Fraud is not just becoming more widespread, it is becoming harder to detect."

Mike Stannard, director of fraud operations at security consultancy Armor Group, estimates that companies may lose 3% to 5% of turnover through fraud each year. At a recent conference in London, fraud and money-laundering experts from all over the world - the heroes, not the villains - got together to compare notes and work out ways of cooperating to fight crime.

Security at the conference was tight, the organizers were wise to fraudsters trying to sneak their way in. One Dutch lawyer confided: "I remember being at a similar conference last year, I was giving a speech on fighting fraud. I looked down into the audience and could see four fraudsters sitting in the front row - their lawyer had got them the tickets."

The problem, says an Interpol fraud expert, is that banks often don't report fraud since their reputations will suffer if clients know the wool has been pulled over their eyes. Fraud has evolved in leaps and bounds over the past few years. The image of basement operations churning out counterfeit banknotes has been replaced by a new wave of fraudsters doing everything from "cyber-crime" and advance-fee fraud through to laundering money through derivatives trading.

Among the oddest fraud organizations to trouble law enforcement agencies in recent years is the Dominion of Melchizedek, a fake nation existing only in cyberspace. Although the place does not exist, it has still managed to declare war on both Serbia and France, and proposed exchanging ambassadors with Saddam Hussein. Almost as astonishingly, the country's leading corporation, the International Monetary Reserve, announced a $20 billion multi-currency euro-medium term note programme arranged by the Bank of Salem and Euro Caribbean Bank, despite revealing in its offering circular an odd absence from its list of principal officers - "chief executive officer: vacant". On its website fraudsters can buy passports and driving licences, can become members of the bar association and, most important, obtain banking licences and buy themselves diplomatic and governmental posts.

Melchizedek is such a successful operation that its currency once appeared on Bloomberg screens trading at seven "equa" to the dollar. The EU once wrote to its minister of internal affairs, and the Bank of England has referred to the Dominion of Melchizedek as a group of islands.

A few years ago, in Hong Kong, a young Austrian banker calling himself Crown Prince Gerald-Dennis Sayn-Wittgenstein-Hohenstein and holding a diplomatic passport as DoM's ambassador at large tried to cash cheques drawn on the Asia Pacific Bank of Melchizedek totalling $500,000. He was jailed for six months.

One lawyer tells of how a bank he represented was nearly duped into putting up millions of dollars for a syndicated loan. The prospective borrowers had a glossy brochure on the proposed deal but only patchy information on the supposedly large Asian parent company. The "borrowers" discouraged trying to find out about the parent company as it would "take too long" and "be too expensive". The lawyer says: "Half an hour later we'd spent £15 on finding out about this company, only to discover it didn't exist."

Advance-fee fraud is growing in the banking community. The fraudster takes an up-front fee or deposit, promising to deliver certain goods - like a loan at a very low rate of interest - but pockets the fee and disappears. The fees involved can be anything from hundred of thousands to millions of dollars.

A variant of advance-fee fraud is the self-liquidating loan. The fraudster suggests the "client" borrows twice the sum it originally wanted. The excess would be invested in (non-existent) "prime bank instruments" which would be traded to pay for the loan. Instead the fraudster pockets the loan.

Gus MacKenzie, a former detective who now works for KPMG, says: "Advance-fee fraud is especially popular in the US. You've got to be really careful in signing a non-disclosure agreement. It is not just ordinary people who get caught with this but lawyers and big companies.

"Some victims have seen how easy it is to be defrauded and have turned the tables and started doing it themselves, others have been so taken in by the fraudster that they are reluctant to give evidence in court lest they breach the confidentiality clause in their contract and forfeit the (non-existent) loan."

Billions of dollars a year - the profits of illegal businesses of every type - are laundered. One of the most effective ways of doing this involves so-called mirror-trading - taking equal and opposite positions in a derivatives contract. Whichever way the price of the contract moves, a loss and a profit is generated that also creates a break in the audit trail. By ensuring that the "dirty" money is on the losing side of the trade, it is sucked into the market in the form of trading losses, only to reappear on the other side of the contract in the form of legitimate trading profits.