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THE

FORENSIC

EXAMINER

VOLUME 18 • NUMBER 3 • Fall 2009

The Official Peer-Reviewed Journal of The American College of Forensic Examiners

COVER STORY

A Memorable Day in the Life of Forensic Examiner Dr. John Brick

FEATURES 08

Principles and Approaches to Criminal Investigative Analysis: Part 2 of 4 By Gregory M.Vecchi, PhD, CFC, CHS-V, DABCIP, DABLEE

Derivatives: A Cautionary Tale By Barbara Apostolou, PhD, CPA and Nicholas G. Apostolou, DBA, CPA

and Psychological 24 Challenges Dynamics of Negotiating Risks in Failed States: The Somali Case By Barry Austin Goodfield, PhD, FACFEI, DABFE, DABFM and Andre LeGallo, BA

4 THE FORENSIC EXAMINER® Fall 2009

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ALSO IN THIS ISSUE 70

ACFEI News

Conference Preview

80 Book Review

CASE STUDIES/OTHER FEATURES Vans, and Automobiles: Medical Escort of 58 Planes, the Forensic Patient By Heidi Bale, RN, CFN

New Opportunities in a Growing Field: ACFEI’s Forensic Nursing Field Including an Exclusive Interview with Dianne Ditmer, RN, PhD, CFN, DABFN, CMI-III, CHS-III, SANE, FACFEI

Detective’s Corner: A Jewel of a Case 66 The By Shirley McCann

a Sex Offense: When 46 Masking a Non-Sex Crime Really Is a Sex Crime

Observe Carefully, Deduce Shrewdly: Dr. Joseph Bell By Katherine Ramsland, PhD, CMI-V

Falsely Accused: Wrongly Convicted Teen Set Free

By Scott A. Johnson, MA, LP, DABPS

Police Criminalistics: Learning Modalities and Evaluation By Thomas E. Baker, MS, MEd, CAGS

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PUBLISHER: Robert L. O’Block, MDiv, PhD, PsyD, DMin, DD (Hon) (rloblock@aol.com)

2009 EDITORIAL ADVISORY BOARD Louay Al-Alousi, MB, ChB, PhD, FRCPath, FRCP(Glasg), FACFEI, DMJPath, DABFM, FFFFLM Nicholas G. Apostolou, DBA, DABFA, CPA, Cr.FA Larry Barksdale, BS, MA E. Robert Bertolli, OD, FACFEI, CHS-V, CMI-V Kenneth E. Blackstone, BA, MS, CFC, DABFE David T. Boyd, DBA, CPA, CMA, CFM, Cr.FA Jules Brayman, CPA, CVA, CFD, DABFA, FACFEI John Brick, PhD, MA, DABFE, DABFM, FACFEI Richard C. Brooks, PhD, CGFM, DABFE Steve Cain, MFS, DABFE, DABRE, FACFEI, MF-SQD, DABLEE Dennis L. Caputo, MS, DABFET, REM, CEP, CHMM, QEP, FACFEI Donald Geoffrey Carter, PE, DABFET David F. Ciampi, PhD, FACFEI, DABPS Leanne Courtney, BSN, DABFN, DABFE Larry Crumbley, PhD, CPA, DABFE, Cr.FA Jean L. Curtit, BS, DC Andrew Neal Dentino, MD, FACFEI, DABFE, DABFM Francisco J. Diaz, MD James A. DiGabriele, DPS, CPA, CFSA, DABFA, Cr.FA, CVA, FACFEI John Shelby DuPont Jr., DDS, DABFD Scott Fairgrieve, Hons. BSc, MPhil, PhD, FAAFS Edmund D. Fenton, DBA, CPA, CMA, Cr.FA Per Freitag, PhD, MD, FACFEI, DABFE, DABFM Nicholas Giardino, ScD, FACFEI, DABFE David H. Glusman, CPA, DABFA, CFS, Cr.FA, FACFEI Karen L. Gold, PysD, FACFEI, DABPS Ron Grassi, DC, MS, FACFEI, DABFM, DABFE James Greenstone, EdD, JD, FACFEI, DABFE, DABFM, DABECI, CMI-I, CHS-III Roy C. Grzesiak, PhD, PC Richard C. W. Hall, FACFEI, DABFM, DABFE, MD, FAPA, FAPM, FACPsych Raymond F. Hanbury, PhD, ABPP, FACFEI, DABFE, DABPS, CHS-III James Hanley III, MD, DABFM, FACFEI Nelson Hendler, MD, DABFM David L. Holmes, EdD, FACFEI, DABFE, DABPS Leo L. Holzenthal Jr., PE, DABFET, FACFEI Linda Hopkins, PhD, CFC, DABPS, DABRE Edward J. Hyman, PhD, FACFEI, DABFE, DABFM, DABPS Zafar M. Iqbal, PhD, FACFEI, DABFE, DABFM Nursine S. Jackson, MSN, RN, DABFN Paul Jerry, MA, DAPA, DABFC

Scott A. Johnson, MA, DABPS, DAACCE Philip Kaushall, PhD, DABFE, DABPS, FACFEI Eric Kreuter, PhD, CPA, CMA, CFM, DABFA, FACFEI Ronald G. Lanfranchi, DC, PhD, DABFE, DABFM, DABLEE, CMI-IV, FACFEI Richard Levenson, Jr., PsyD, DABFE, DABPS, FACFEI Monique Levermore, PhD, FACFEI, DABPS Jonathon Lipman, PhD, FACFEI, DABFE, DABPS, DABFM Judith Logue, PhD, FACFEI, DABFSW, DABPS, DABFE, DABFM Jennie Martin-Gall, CMI-I Mike Meacham, PhD, LCSW, DABFSW, FACFEI David Miller, DDS, FACFEI, DABFE, DABFM, DABFD John V. Nyfeler, CHS-III Jacques Ama Okonji, PhD, FACFEI, DABFE, DABPS Norva Elaine Osborne, OD, CMI-III Terrence O’Shaughnessy, DDS, FACFEI, DABFD, DABFE, DABFM George Palermo, MD, FACFEI, DABFE, DABFM Ronald J. Panunto, PE, CFC, CFEI, DABFET Larry H. Pastor, MD, FACFEI, DABFE, DABFM Theodore G. Phelps, CPA, DABFA Marc Rabinoff, EdD, FACFEI, DABFE, CFC Harold F. Risk, PhD, DABPS, FACFEI Susan P. Robbins, PhD, LCSW, DABFSW Jane R. Rosen-Grandon, PhD, DABFC, FACFEI Douglas Ruben, PhD, FACFEI, DABFE, DABFM, DABPS J. Bradley Sargent, CPA, CFS, Cr.FA, DABFA, FACFEI William Sawyer, PhD, FACFEI, DABFE, DABFM Victoria Schiffler, RN, DABFN, FACFEI Howard A. Shaw, MD, DABFM, FACFEI Henry A. Spiller, MS, DABFE, FACFEI Marilyn Stagno, PsyD, DABFE, DABFM, DABPS Richard I. Sternberg, PhD, DABPS James R. Stone, MD, MBA, CHS-III, DABFE, DABFM, FACFEI, CMI-IV Johann F. Szautner, PE, PLS, FACFEI, DABFET William A.Tobin, MA, DABFET, DABLEE, FACFEI Robert Tovar, BS, MA, DABFE, DABPS, CHS-III Brett C.Trowbirdge, PhD, JD, DABPS, FACFEI Jeff Victoroff, MD, DABFE, DABFM Patricia Ann Wallace, PhD, FACFEI, DABFE, DABFM, CFC Raymond Webster, PhD, FACFEI, DABFE, DABFM Dean A. Wideman, MSc, MBA, CFC, CMI-III, DABFE

The American College of Forensic Examiners International (ACFEI) does not endorse, guarantee, or warrant the credentials, work, or opinions of any individual member. Membership in ACFEI does not constitute the grant of a license or other licensing authority by or on behalf of the organization as to a member’s qualifications, abilities, or expertise. The publications and activities of ACFEI are solely for informative and educational purposes with respect to its members. The opinions and views expressed by the authors, publishers, or presenters are their sole and separate views and opinions and do not necessarily reflect those of ACFEI, nor does ACFEI adopt such opinions or views as its own.The American College of Forensic Examiners International disclaims and does not assume any responsibility or liability with respect to the opinions, views, and factual statements of such authors, publishers, or presenters, nor with respect to any actions, qualifications, or representations of its members or subscriber’s efforts in connection with the application or use of any information, suggestions, or recommendations made by ACFEI or any of its boards, committees, publications, resources, or activities thereof. The Forensic Examiner® (ISSN 1084-5569) is published quarterly by The American College of Forensic Examiners International, Inc. (ACFEI). Annual membership for a year in the American College of Forensic Examiners International is $165. Abstracts of articles published in The Forensic Examiner® appear in National Criminal Justice Reference Service, Cambridge Scientific Abstracts, Criminal Justice Abstracts, Gale Group Publishing’s InfoTrac Database, e-psyche database, and psycINFO database. Periodicals Postage Paid at Springfield, Missouri, and additional mailing offices. © Copyright 2009 by the American College of Forensic Examiners International. All rights reserved. No part of this work can be distributed or otherwise used without the express written permission of the American College of Forensic Examiners International.The views expressed in The Forensic Examiner® are those of the authors and may not reflect the official policies of the American College of Forensic Examiners International. CONTACT US: Publication, editorial, and advertising offices of ACFEI, 2750 East Sunshine Street, Springfield, MO 65804. Phone: (800) 592- 1399, Fax: (417) 881- 4702, E-mail: editor@acfei.com. Subscription changes should be sent to ACFEI, 2750 East Sunshine, Springfield, MO 65804. POSTMASTER: Send address changes to American College of Forensic Examiners International, 2750 East Sunshine Street, Springfield, MO 65804.

EXECUTIVE ART DIRECTOR: Brandon Alms (brandon@acfei.com) EDITOR IN CHIEF: Karissa Scott (karissa@acfei.com) ASSOCIATE EDITOR: Amber Ennis (amber@acfei.com) ASSOCIATE EDITOR: Meggin White (meggin@acfei.com) ADVERTISING: Karissa Scott (karissa@acfei.com) (800) 592-1399, ext. 158

ACFEI EXECUTIVE ADVISORY BOARD CHAIR: David E. Rosengard, RPh, MD, PhD, MPH, FACFEI, CMI-V, CHS-V, DABFE, DABFM, DABECI, FACA, FAPA, MTAPA, FAAIM VICE CHAIR: Michael Fitting Karagiozis, DO, MBA, CMI-V, CFP MEMBERS: John H. Bridges III, DSc (Hon), CHS-V, CHMM, CSHM, DABCHS, FACFEI Cam Cope, MS, DABFET, DABFE; Chair, American Board of Forensic Engineering and Technology Dianne Ditmer, MS, RN, CFN, CMI-III, CHS-III, FACFEI, DABFN, CMI-III; Chair, American Board of Forensic Nursing Douglas E. Fountain, PhD, LCSW, DABFE, DABFSW Raymond F. Hanbury, PhD, FACFEI, DABPS, DABFE, CHSIII, ABPP Lee Heath, DABLEE, CHS-V Brian L. Karasic, DMD, MScFin, FACFEI, DABFD, DABFM, DABFE, MOA, CMI-IV, FAAIM Michael G. Kessler, Cr.FA, CICA, FACFEI, DABFA, DABFE Marilyn J. Nolan, MS, FACFEI, DABFC, DABCIP Thomas J. Owen, BA, FACFEI, DABRE, DABFE, CHS-V Dennis Thibodeaux, CISSP, CISM, CFC, CHS-V; Chair, American Board of Information Security and Computing Forensics Gregory M.Vecchi, PhD, CFC, CHS-V, DABLEE, DABCIP; Chair, American Board of Critical Incident Professionals

CONTINUING EDUCATION ACFEI provides continuing education credits for accountants, nurses, physicians, dentists, psychologists, counselors, social workers, and marriage and family therapists. Approvals for continuing education activities are subject to change. For the most up-to-date status, please check the course catalog on our Web site, www.acfei.com, or by contacting the Continuing Education staff toll-free at (800) 423-9737. ACFEI is an approved provider of Continuing Education by the following: Accreditation Council for Continuing Medical Education National Association of State Boards of Accountancy National Board for Certified Counselors California Board of Registering Nursing American Psychological Association California Board of Behavioral Sciences Association of Social Work Boards American Dental Association (ADA CERP) The Missouri Sheriff’s Association co-sponsors Police Officer Standards Training (POST) accreditation for the American College of Forensic Examiners Institute’s activities. The American College of Forensic Examiners Institute is a member of the National Certification Commission and the Alliance for Continuing Medical Education. Ethics Course, Law Course, Evidence Course, Certified Medical Investigator® , Certified Forensic Accountant, Cr.FA ® , and the Certified in Homeland Security, CHS ® Levels I-V are all approved for the G.I. Bill Benefits.

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ACFEI EXECUTIVE ADVISORY BOARDS American Board of Critical Incident Professionals Chair of the Executive Board of Critical Incident Professionals: Gregory M.Vecchi, PhD, CFC, CHS-V, DABLEE, DABCIP Vice Chair: Kent A. Rensin, PhD, DABCIP Monica J. Beer, PhD Sam D. Bernard, PhD, DABCIP, CHS-III Marie Leeds Geron, PhD, CHS-V, DABCIP Raymond H. Hamden, PhD, FACFEI, DABPS, DABCIP, DABCHS, DAPA, CFC, CMI-V, CHS-V Tina Jaeckle, CFC Marshall A. Jones, MS, DABCIP Marilyn J. Nolan, MS, FACFEI, DABFC, DABCIP Rev. Roger Rickman, ThD, MBA, ACC, CFC, CHS-V, CMI-I, SSI, CRS, DABCHS, DABCIP, DAPA, FABI, PI, SCS, FAAIM Debra Russell, PhD, CMI-V, CHS-III, CRC, CISM, DABCIP Dorriss “Ed” Smith, Col. US Army, CHS-V, DABCIP Vincent B.Van Hasselt, PhD, DABCIP Alan E. Williams, MS, CHS-V, DABCIP American Board of Forensic AccountING Chair of the Executive Board of Accounting Advisors: Michael G. Kessler, Cr.FA, CICA, FACFEI, DABFA, DABFE Chair Emeritus: J. Bradley Sargent, CPA, CFS, Cr.FA, DABFA, FACFEI Stewart L. Appelrouth, CPA, CFLM, CVA, DABFA, Cr.FA, ABV, FACFEI Gary Bloome, CPA, Cr.FA Alexander Lamar Casparis, CPA, CVA, MBA,Cr.FA D. Larry Crumbley, PhD, CPA, DABFA, Cr.FA, CFFA, FCPA June M. Dively, CPA, DABFA, Cr.FA Michael W. Feinberg, CPA, Cr.FA David Firestone, CPA, Cr.FA Mark S. Gottlieb, CPA/ABV/CFF, CVA, CBA, DABFA, MST David H. Glusman, CPA, FACFEI, DABFA, Cr.FA Eric A. Kreuter, PhD, CPA, CMA, CFM, FACFEI, DABFA, SPHR, CFD, CFFA, BCFT Robert K. Minniti, CPA, MBA, Cr.FA Dennis S. Neier, CPA, DABFA Kim J. Onisko, CPA, Cr.FA Joseph F. Wheeler, CPA, Cr.FA, CHS-III, CFF, CAMS American Board of Forensic Counselors Chair of the Executive Board of Forensic Counselors: Marilyn J. Nolan, MS, FACFEI, DABFC, DABCIP Vice Chair: Steven M. Crimando, MA, CHS-III Chair Emeritus: Dow R. Pursley, EdD, DABFC Irene Abrego Nicolet, PhD, DABFC, MA George Bishop, LPC, LAT, LAC, FACFEI, DABFE Laura W. Kelley, PhD, LPC, DABFC, FACFEI Robert E. Longo, FACFEI, DABFC Kathleen Joy Walsh Moore, DABFC, CHS-III DeeAnna Merz Nagel, MEd, LPC, CRC, DCC, CFC Hirsch L. Silverman, PhD, FACFEI, DABFC, DABFE, DABFM, DABPS William M. Sloane, JD, LLM, PhD, FACFEI, DABFC, CHS-III, CMI-I, DACC, DCPC, FAAIM, FACC, MTAPA Gary Smith, MEd, FACFEI, DABFE Ava Gay Taylor, MS, LPC, DABFC, FACFEI American Board of Forensic Dentistry Chair of the Executive Board of Forensic Dentistry: Brian L. Karasic, DMD, MBA, MScFin, FACFEI, DABFD, DABFM, DABFE Members of the Executive Board of Dental Advisors: Ira J. Adler, DDS, DABFD Bill B. Akpinar, DDS, CMI-V, FACFEI, DABFD, DABFE, DABFM Stephanie L. Anton-Bettey, DDS, CMI-V Jeff D. Aronsohn, DDS, FACFEI, DABFD, CMI-V Susan Bollinger, DDS, CMI-IV, CHS-III Michael H. Chema, DDS, FACFEI, DABFD, DABFE James H. Hutson, DDS, CMI-V, DABFD, FACFEI John P. Irey, DDS, CMI-V, LLC Chester B. Kulak, DMD, CMI-V, CHS-III, CFC, DABFE, DABFD Morley M. Lem, DDS, FACFEI, DABFD, DABFM, DABFE, DABPS John P. LeMaster, DMD, DABFD, CMI-V, CHS-III, DABFM, FACFEI Jeannine L. Weiss, DDS American Board of Forensic Examiners Chair of the Executive Board of Forensic Examiners: Michael Fitting Karagiozis, DO, MBA, CMI-V, CFP Members of the Executive Board of Forensic Examiners:

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Jess P. Armine, DC, FACFEI, DABFE, DABFM Phillip F. Asencio-Lane, FACFEI, DABFE John H. Bridges III, CHS-V, CHMM, CSHM, DABCHS, DABCIP, FACFEI Ronna F. Dillon, PhD, DABFE, DABPS, CMI-V, CHS-III Nicholas J. Giardino, ScD, FACFEI, DABFE, RPIH, MAC, CIH Bruce H. Gross, PhD, JD, MBA, FACFEI, DABFE, DABFM, DABPS, DAPA Kenneth M. Gross, DC, FACFEI, DABFE, CMI-I Darrell C. Hawkins, MS, JD, FACFEI, DABFE, DABLEE, CMI-V, CHS-III, F-ABMDII, IAI-SCSA, IAAI-CFI Michael W. Homick, PhD, DABCHS, CHS-V John L. Laseter, PhD, FACFEI, DABFE, DABFM, CMI-IV, CHS-III Jonathan J. Lipman, PhD, FACFEI, DABFE, DABFM, DABPS Leonard K. Lucenko, PhD, FACFEI, DABFE, CPSI Edward M. Perreault, PhD, DABFE, FACFEI Marc A. Rabinoff, EdD, FACFEI, DABFE, CFC David E. Rosengard, RPh, MD, PhD, MPH, FACFEI, CMI-V, CHS-V, DABFE, DABFM, DABECI, FACA, FAPA, MTAPA, FAAIM Janet M. Schwartz, PhD, FACFEI, DABFE, DABFM, DABPS, DABCHS, CHS-V, DAPA, NCC, NCP, CDP-I Larry F. Stewart, MSFS, CFC American Board of Forensic Engineering and Technology Chair of the Executive Board of Engineering and Technology Advisors: Cam Cope, BS, DABFET, DABFE Vice Chair: George C. Frank, CFC, DABFE Second Vice Chair: Ronald G. Schenk, MSc, MInstP, Peng (UK), CHS-III, CMI-I, SSI Chair Emeritus: Ben Venktash, DABFET, DABFE, CHSP, REA, FRSH (UK), FIET (UK) David Albert Hoeltzel, PhD Robert K. Kochan, BS, FACFEI, DABFET, DABFE J.W. “Bill” Petrelli Jr., AIA, NCARB, TAID, FACFEI, DABFET, CFC Max L. Porter, PhD, DABFET, DABFE, PE, HonMASCE, Parl, Dipl ASFE, FTMS, FACI, CFC, FACFEI James A. St.Ville, MD, MS, FACFEI, DABFET, DABFM Kandiah Sivakumaran, MS, PE, DABFET Malcolm H. Skolnick, PhD, JD, FACFEI, DABFET, DABFE American Board of Forensic Medicine Chair of the Executive Board of Medical Advisors: David E. Rosengard, RPh, MD, PhD, MPH, FACFEI, CMI-V, CHS-V, DABFE, DABFM, DABECI, FACA, FAPA, MTAPA, FAAIM Vice Chair: Michael Fitting Karagiozis, DO, MBA, CMI-V, CFP Members of the Executive Board of Medical Advisors: Terrance L. Baker, MD, MS, FACFEI, DABFM, CMI-V, CFP, DABFE Douglas Wayne Beal, MD, MSHA, CMI-V, CFP, DABFE, DABFM John Steve Bohannon, MD, CMI-IV, CFP, FACEP Zhaoming Chen, MD, PhD, MS, FAAIM, CFP John A. Consalvo, MD Edgar L. Cortes, MD, DABFM, DABFE, FAAP, FACFEI, CMI-V, CFP Albert Basil DeFranco, MD, FACFEI, DABFM, DABPS, CMI-V, CFP, CHS-III James B. Falterman Sr., MD, DABFM, DABFE, DABPS, FACFEI, CMI-IV, CFP Malcolm N. Goodwin Jr., MD, MS, FACFEI, DABFM, DABFE, FCAP, Col USAF MCFS (Ret), CFP Vijay P. Gupta, PhD, DABFM Richard C.W. Hall, MD, FACFEI, DABFM, DABFE, CFP Louis W. Irmisch III, MD, FACFEI, DABFM, DABFE, CMI-V, CFP E. Rackley Ivey, MD, FACFEI, DABFM, DABFE, DABMCM, DAAPM, CMI-V, CFP Kenneth A. Levin, MD, FACFEI, DABFM, DABFE, CFP E. Franklin Livingstone, MD, FACFEI, DABFM, DABFE, DAAPM, FAAPM&R, CFP John C. Lyons, MD, FACS, MSME, BSE, FACFEI, DABFM, DABFET, DABFE, CMI-IV, CFP Manijeh K. Nikakhtar, MD, MPH, DABFE, DABPS, CMI-V, CHS-V, CFP John R. Parker, MD, FACFEI, DABFM, FCAP, CFP Jerald H. Ratner, MD Anna Vertkin, MD, CMI-V, DABFM, CFP Maryann M. Walthier, MD, FACFEI, DABFM, DABFE, CFP Cyril Wecht, MD, JD, FACFEI, CMI-V, CFP

American Board of Forensic Nursing Chair of the Executive Board of Nursing Advisors: Dianne T. Ditmer, MS, RN, CFN, CMI-III, CHS-III, FACFEI, DABFN, CMI-III; Chair,American Board of Forensic Nursing Heidi H. Bale, RN, CFN, CCHP Marilyn A. Bello, RNC, MS, CMI-IV, CFC, CFN, SAFE, DABFN, DABFE Wanda S. Broner, MSN, RN, FNE, CEN Cynthia J. Curtsinger, RN, CFN Linda J. Doyle, RN, CLNC, CFN, CMI-III L. Sue Gabriel, EdD, MSN, MFS, RN, Diane L. Reboy, MS, RN, CFN, LNCC, FACFEI, DABFN, CNLCP Elizabeth N. Russell, RN, BSN, CCM, BC, DABFN, FACFEI LeAnn Schlamb, MSN, RN-BC, CFN, DABFN Sharon L. Walker, MPH, PhD, RN, CFN Carol A. Wood, RN, CFN, BS, NHA American Board of Forensic Social Workers Chair of the Executive Board of Social Work Advisors: Douglas E. Fountain, PhD, LCSW, FACFEI, DABFE, DABFSW Chair Emeritus: Karen M. Zimmerman, MSW, DABFSW, DABFE Susan L. Burton, MA, MSW, LMSW, DABFSW, DABLEE Judith V. Caprez, MSW, ACS, LCSW, DABFSW Peter W. Choate, BA, MSW, DABFSW, DABFE Judith Felton Logue, PhD, FACFEI, DABFE, DABFSW, DABPS, DABFM Michael G. Meacham, PhD, LCSW, DCSW, FACFEI, DABFSW Kathleen Monahan, DSW, MSW, CFC, DABFE Susan P. Robbins, PhD, LCSW, DCSW, BCD, LDC, DABFSW Steven J. Sprengelmeyer, MSW, MA, FACFEI, DABFSW, DABFE, LISW American Board of Psychological Specialties Chair of the Executive Board of Psychological Advisors: Raymond F. Hanbury, PhD, FACFEI, DABPS, DABFE, CHS-III, ABPP Vice Chair: Raymond H. Hamden, PhD, FACFEI, DABPS, DABCIP, DABCHS, DAPA, CFC, CMI-V, CHS-V Chair Emeritus: Carl N. Edwards, PhD, JD, FAAFS, FICPP, FACFEI, DABPS, DABFE Carol J. Armstrong, PhD, LPC, DABPS Robert J. Barth, PhD, DABPS Monica J. Beer, PhD John Brick III, PhD, MA, FAPA, FACFEI, DABFE, DABPS Alan E. Brooker, PhD, FACFEI, DABPS, DABFM, DABFE, CMI-III, ABPP-Cn Brian R. Costello, PhD, FACFEI, DABPS, DABFE Ronna F. Dillon, PhD, DABPS, DABFE, CMI-V, CHS-III Brent Van Dorsten, PhD, FACFEI, DABFE, DABFM, DABPS Douglas P. Gibson, PsyD, MPH, DABPS, CMI-V, CHS-III Mark Goldstein, PhD, DABFE, DABPS, FACFEI Thomas L. Hustak, PhD, FACFEI, DABPS, DABFE Richard Lewis Levenson Jr., PsyD, FACFEI, DABPS, DABFE, CTS, FAAETS Stephen P. McCary, PhD, JD, FACFEI, DABFE, DABFM, DABPS, FAACP, DAPA Helen D. Pratt, PhD, FACFEI, DABPS Douglas H. Ruben, PhD, FACFEI, DABPS, DABFE, DABFM Richard M. Skaff, PsyD, DABPS Charles R. Stern, PhD, DABPS, DABFE, DABFM, FACFEI, CMI-V Joseph C.Yeager, PhD, DABFE, DABLEE, DABPS, FACFEI Donna M. Zook, PhD, DABPS, CFC American Board of Recorded Evidence Chair of the Executive Board of Recorded Evidence Advisors: Thomas J. Owen, BA, FACFEI, DABRE, DABFE, CHS-V Ernst F.W. (Rick) Alexanderson, BA, MBA, FACFEI, DABRE, DABFE Eddy B. Brixen, DABFET Charles K. Deak, BS, CPC, DABFE, FACFEI Ryan O. Johnson, BA, DABFE, DABRE Michael C. McDermott, JD, DABRE, DABFE, FACFEI Jennifer E. Owen, BA, DABRE, DABFE Lonnie L. Smrkovski, BS, DABRE, DABFE, FACFEI

Fall 2009 THE FORENSIC EXAMINER® 7

CASE STUDY

For the purpose of this series of articles, the term “investigative processes” will be used to describe both criminal investigation and crime scene processing. Any distinctions between criminal investigation and crime scene processing will be designated as such. Although crime scene processing is part of criminal investigation, it is distinct; crime scene processing requires rigorous scientific methodologies (i.e., collection procedures, testing protocols, etc.), whereas criminal investigation has less of a “hard science” character and relies more on the experience and skills of the investigator rather than rigid scientific protocols and procedures. In this light, crime scene processing can be viewed as the “science” of investigative processes, whereas criminal investigation can be viewed as the “art.” The purpose of this article series is to provide information on the entire spectrum of investigative processes that is useful for all individuals involved in the investigations: the responding officer, detectives/investigators, police supervisors, lawyers, judges, and other criminal justice professionals.

By Gregory M. Vecchi, PhD, CFC, CHS-V, DABCIP, DABLEE

Principles and Approaches to Criminal Investigation,

Part 2

The views expressed in this article do not necessarily represent the views of the FBI. 8 THE FORENSIC EXAMINER® Fall 2009

Introduction This article examines testimonial evidence and the documentation of investigations and crime scenes. At the heart of testimonial evidence lies the interview and interrogation, which can be described as “conversations with a purpose.” In both interviews and interrogations, the investigator obtains information from or about persons connected with a particular incident. Documentation (i.e., writing reports, drawing sketches and diagrams, photographing, etc.) is oftentimes the most tedious part of investigative work; however, it is probably the single most important activity the investigator will accomplish. Documentation memorializes every activity accomplished during the investigation and preserves it for subsequent investigation and court. It is because of documentation that the entirety of the crime scene can be brought into court—photographs, sketches, video and audio tapes, notes, observations, and reports, which allow the prosecutor to reconstruct the scene and argue theories before a jury. Interviews Interviews are conducted with people the investigator believes are willing to give information about a case. Interviews can be conducted with victims, witnesses, and complainants/accusers www.acfei.com

and are accomplished to develop the facts of the case. Investigators should show concern for the victim. Witnesses should be separated as soon as possible and questioned one at a time. Complainant and accuser information should be carefully scrutinized by the investigator in order to discern false or misleading information. With all interviews, it is possible that the victim, witness, or complainant/accuser may lie on purpose to “get at” someone else or to hide their own criminal involvement. They may also be too eager to please and unintentionally distort the facts or tell the investigator what he or she “wants to hear.” In these situations, it might be necessary to interrogate a victim, witness, or complainant/ accuser (Gordon & Fleisher, 2002; Hess, 1997; Holmes, 2002; Milne & Bull, 1999). Interrogations Interrogations are conducted with people whom the investigator believes are not willing to give information about a case, as well as people whom the investigator believes have committed or helped commit a particular criminal offense. Interrogations should be avoided on anyone who can be successfully interviewed. Suspects are interrogated to learn whether or not they have committed an offense or to obtain admissions of guilt or a confession. An admission of guilt does not amount to a complete acknowledgement of guilt, whereas a confession is a complete acknowledgement of guilt of all elements of the offense. Since interrogations oftentimes produce incriminating statements that may be used in court, it is important for the investigator to understand when it is necessary to inform the suspect of his rights against self-incrimination and his right to have counsel present. Generally speaking, a waiver of rights is only necessary when the suspect is in custody (or about to be taken into custody) AND the questioning pertains to the culpability of the suspect with regard to the offense(s) under investigation. If either of these two elements is missing, then a waiver of rights is not required by law. For example, if an investigator speaks with a suspect at a restaurant and obtains criminal admissions from that suspect, the admissions are usually admissible in court without a signed rights waiver. In this example, the investigator would make an effort to ensure that the suspect verbally acknowledges his or her understanding that he or she is not under arrest (or going to be arrested fol(800) 592-1399

lowing the interview) and that the interview or any portion of it is voluntary (meaning that the suspect could decline the interview altogether or stop the interview at any time without penalty). It is very important for the investigator to document that the suspect fully understood his or her rights (Gordon & Fleisher, 2002; Hess, 1997; Holmes, 2002; Milne & Bull, 1999). The following are some strategies for interrogations (Department of the Army, 1985):

• Always identify yourself as a law enforcement officer. • Have at least one law enforcement officer as a witness. • In a custodial situation, obtain a waiver of rights from the suspect. In a non-custodial situation, ensure it is clearly documented that the suspect fully acknowledged the situation and fully understood his or her rights. • If the investigator believes that legal counsel has been appointed for or retained by the suspect for the specific offense under investigation, the counsel should be notified immediately before beginning any interrogations. • For extended interrogations, offer the suspect food and liberal restroom breaks and document these efforts. • If possible, avoid conducting the interrogation on the suspect’s “turf ” (e.g., home or business). It is preferable to conduct interrogations on the investigator’s “turf ” (e.g., office or station) or at least on public or neutral ground. Polygraph Examinations In some instances, the polygraph can aid the investigator in obtaining the truth, whether it be obtaining admissions of guilt or clearing a person of a crime. It is important to note that a polygraph cannot detect truth or deception, as

Gregory M.Vecchi, PhD, CFC, CHS-V, DABCIP, DABLEE is the Unit Chief of the Behavioral Science Unit (BSU), Federal Bureau of Investigation (FBI). Dr.Vecchi was assigned to the BSU in January 2006, where he conducts research, training, and consultation activities in behavioral-based conflict analysis and resolution, crisis management, conflict and crisis communication, and global hostage-taking.

Fall 2009 THE FORENSIC EXAMINER® 9

“The investigator cannot rely on a chance that a suspect will make incriminating statements against themselves during a polygraph. . . . The investigation must already be thorough and as complete as possible before employing a polygraph.”

10 THE FORENSIC EXAMINER® Fall 2009

it only measures bodily reactions to questions. It does this through measuring blood pressure, galvanic skin response (electric skin impulses), and upper and lower chest respiration (Kleiner, 2002; Milne & Bull, 1999; National Research Council, 2002). It is important to remember that the polygraph is only an aid to the investigation. The investigator cannot rely on a chance that a suspect will make incriminating statements against themselves during a polygraph. The suspect should have already been interviewed, and there must be more information needed to complete the investigation. In addition, there must be reasonable cause to believe the suspect has knowledge of, or was involved in, the matter under investigation. In other words, the investigation must already be thorough and as complete as possible before employing a polygraph (Kleiner, 2002; Milne & Bull, 1999; National Research Council, 2002). Prior to administering the polygraph, the investigator has the responsibility to provide the examiner with all the facts of the investigation to include connections between the suspect and other persons and things, peculiarities of the crime scene, what is known about the suspect’s actions and behavior, the results of laboratory examinations and crimes scene processing, and anything not publicly known about the offense (especially things only the victim or offender would know). It is the examiner’s responsibility to take into account all the facts of the investigation and develop a battery of questions in collaboration with the investigator. The examiner also must ensure that the suspect is not mentally or physically fatigued, overly emotional, mentally disordered, physically disabled, or under the influence of alcohol or drugs, as these issues will preclude the polygraph examination (Kleiner, 2002; Milne & Bull, 1999; National Research Council, 2002). For a polygraph examination to be accurate, the examiner must determine a “base line” of bodily measurements through question construction and delivery. Certain questions are asked of the subject that are non-threatening, such as “Are you sitting down” or “Is your name Monica?” These questions allow the examiner to adjust the machine for nervousness. There are also questions that are meant to be failed (although the subject is not informed of this) such as “Have you ever lied to anyone?” or “Have you ever sto-

len anything no matter how small?” The final set of questions deals with the pertinent issues of the case such as “Did you steal money from the bank vault on September 7, 2008?” or “Did you know about the death of John Smith before today?” If, for example, the subject shows the most reaction to the question regarding the bank vault, then he or she would most likely be scored as “deceptive.” Contrarily, if the subject showed the most reaction to having ever stolen anything, then the test would be most likely scored as “no deception indicated.” Sometimes, the subject is “inconclusive,” indicating that the examiner was unable to determine whether or not the subject was deceptive. Inconclusive results usually require that the examiner redefine some of the questions or determine other causes, such as the subject fidgeting during the test (Kleiner, 2002; Milne & Bull, 1999; National Research Council, 2002). Notes Notes are the most readily available record of any investigation. Although there are no official rules pertaining to note taking, they should be detailed sufficiently enough to remain meaningful even months or years after the event. Poor note taking is often the root of poor testimony during cross-examination, and it forces the investigator to rely on his or her memory or gross approximations. For example, forgetting to note the date or time of day of an event and then guessing it wrong becomes not only embarrassing for the investigator and prosecution, but a point of contention for the defense attorney. Notes are the basis for both reports of investigation and testimony. Reports of investigation are detailed summaries of the notes, whereas testimony requires the recall of more detail. Therefore, it is important for the investigator to anticipate the requirements of both written reports and questions that may be asked during testimony when writing notes. For consistency purposes, it is best to have as few investigators as possible taking notes on the same event or portion thereof (Department of the Army, 1985; Fisher, 2004; Lyman, 2008; Ogle, 2007; Osterburg, 2007). Notes should be taken on a loose-leaf notebook, as they can be better organized than bound notebooks. This reduces the likelihood that other notes not relating to the instant case will end up being inadvertently disclosed to others or in www.acfei.com

court. Also, missing pages from a bound notebook that were used for purposes other than the instant investigation tend to raise integrity questions by the defense in court (Department of the Army, 1985; Fisher, 2004; Lyman, 2008; Ogle, 2007; Osterburg, 2007). Notes should be numbered and include the date, agency, case number, name of investigator, and the initials of the investigator to ensure clarity as to what case they belong, who wrote them, and who to return to if the notes are lost or misplaced. Notes should be written in black or blue ink that doesn’t smudge. Any mistakes should not be erased or torn out, but should be lined out and initialed by the investigator. Finally, notes should be archived and locked in a secure place even after a successful prosecution, as future appeals or inquiries may require their retrieval (Department of the Army, 1985; Fisher, 2004; Lyman, 2008; Ogle, 2007, Osterburg, 2007). Photographs Photographs supplement notes and sketches or clarify points relative to a case. Photographs are also used to identify individuals, and they form a permanent record of fragile or perishable evidence such as fingerprints or blood splatter. Photographs are admissible in court only if they accurately depict the area observed. It is important that entry photographs be taken before any evidence is touched or before the crime scene search commences. These are area shots of the entire crime scene that overlap. Individual close-up photographs should be taken of each item of evidence from several angles in order to preserve its condition at the time it was discovered. It is usually a good idea to include a ruler or other standard item such as a coin to provide scale. Exit photographs should be taken after the crime scene has been processed to demonstrate that the scene was properly processed and that no unnecessary damage occurred. Like entry photographs, exit photographs should document the entire crime scene, and these photographs should show overlapping areas (Department of the Army, 1985; Fisher, 2004; Lyman, 2008; Ogle, 2007; Osterburg, 2007). The most important aspect of photography is maintaining perspective. Perspective is the ability of the investigator to reproduce the scene as it would appear to someone standing in the photographer’s shoes. Any significant distor(800) 592-1399

tion will reduce or destroy the evidentiary value of the photograph. As such, it is important that the investigator use lenses, lighting, and angles that reproduce the same colors, hues, textures, and positioning as observed with the naked eye (Department of the Army, 1985; Fisher, 2004; Lyman, 2008; Ogle, 2007; Osterburg, 2007). The photo log is the equivalent of notes for photographs. The photo log should include the name of the photographer, date, time, agency, case number, type of camera and serial number, type of film, number of exposures, lens focal length and serial number, filtration, f/stop, shutter speed, and flash attachment. For digital cameras, include the number of megapixels, format (jpeg, bitmap, etc.), and storage media. Every photograph taken should include time, photograph number, type of photo (outside entrance, evidence, inside entrance), depiction (door, pistol), distance from object, and remarks (shutter speed, f/stop) (Department of the Army, 1985; Fisher, 2004; Lyman, 2008; Ogle, 2007; Osterburg, 2007). Sketches Sketches can be used when questioning people, preparing reports of investigation, and in presenting evidence in court. They assist in acquainting the court with crime scenes, and they assist witnesses in orientating themselves before they testify. Sketches complement notes and photographs; however, they concentrate attention on the most essential elements of a crime scene and their relationships. Sketches are classified as either rough or smooth. Rough sketches are drawn at the crime scene and their purpose is to accurately portray information. These sketches are usually not drawn to scale but they do show accurate distances, dimensions, and relative proportions. For clarity purposes, it is sometimes necessary to draw several sketches, such as one sketch per room or a sketch dedicated to a murder victim. A smooth sketch can be made from a rough sketch and is usually to scale and prepared by an experienced draftsman (Department of the Army, 1985; Fisher, 2004; Lyman, 2008; Ogle, 2007; Osterburg, 2007). Each sketch should include the critical features of the scene and the major, discernable items of physical evidence. Sketches must show accurate measurements of the crime scene and the location of each piece of evidence, via the Fall 2009 THE FORENSIC EXAMINER® 11

triangulation method. Format requirements include a caption, title block, direction of magnetic north, scale designation (if none, indicate “not to scale”), and a legend. The title block should include the agency and case number, offense, scene portrayed, location, victim (if applicable), time and date began/ended, sketched by, and verified by. The legend explains symbols, numbers, and letters used to identify objects in the sketch (Department of the Army, 1985; Fisher, 2004; Lyman, 2008; Ogle, 2007; Osterburg, 2007). Accurate measurement is a critical requirement of sketches, as errors can introduce doubt as to the validity of the entire sketch. Measurements should be uniformly made and recorded using the same scale (feet, inches, centimeters, millimeters, etc.). The triangulation method is used for indoor and outdoor sketches that have fixed reference points. Objects are located by creating a triangle of measurements from a single, specific, identifiable point on an object to two fixed points at the scene (all on the same plane). It is important not to triangulate evidence to evidence or triangulate under or through evidence (Department of the Army, 1985; Fisher, 2004; Lyman, 2008; Ogle, 2007; Osterburg, 2007). Observations and Descriptions Observations assist in building descriptions of persons, objects, places, and events so that whom or what was seen can later be identified and described. The accuracy of observations can be affected by lack of sleep, illness, or other outside influences. Weather, distractions, psychological, physiological, experiential factors, perception, bias, culture, and emotion all have the potential to diminish the accuracy of observation. Trained observers are aware of these factors and make allowances for these outside influences when they interpret what they observe by using a systematic approach to observations and descriptions. Accuracy in observation is most assured if the investigator follows a set pattern. It is similar to checklists used by pilots, which systemize preflight safety requirements. Patterns used for observation begin with general features and move to 12 THE FORENSIC EXAMINER® Fall 2009

specific features. For example, when developing a description of a person, start with sex, height, weight, race, and then move on to hair and eye color, scars, and mannerisms. For objects, the investigator should note the type, size, and color and then move on to more specific features that set the item apart from other items (Department of the Army, 1985; Fisher, 2004; Lyman, 2008; Ogle, 2007; Osterburg, 2007). Observing and describing events require a systematic and quick observation of time, place, persons, objects, and actions involved, as well as the immediate results of the event. The observation of connected actions after the event may provide major clues to what took place (Department of the Army, 1985; Fisher, 2004; Lyman, 2008; Ogle, 2007; Osterburg, 2007). When observing and describing places, the investigator should cite the elements observed in a way that provides an easily understood “word picture.” For outdoor scenes, the investigator should look for natural or man-made landmarks and note the general scene in relation to roadways, railways, or shorelines. Efforts should be made to identify fixed or semi-fixed structures such as buildings, bridges, or power line poles and any high interest items. For indoor scenes, the investigator should identify obvious and definite boundaries such as walls, hallways, and basements and any objects of interest (Department of the Army, 1985; Fisher, 2004; Lyman, 2008; Ogle, 2007; Osterburg, 2007). Conclusion Interviews and interrogations require extensive preparation by the investigator. Some of the steps include 1) fixing in the mind what is known of the who, what, when, where, how, and why details of the case, 2) obtaining background knowledge of the subject of the interview or interrogation to include biographical information, criminal history, level of education, status in the community, associations, and personal activities, 3) planning a systematic questioning protocol that involves mostly open-ended questions that require elaboration, and 4) determining the effectiveness of a direct versus an indirect approach to questioning.

Documentation is a critical skill that all investigators need to master. Accurate and thorough documentation of crime scenes and other investigative activities preserves and packages the facts of the investigation into a usable format for court and in furthering the investigation. Notes, photographs, sketches, and observations are made of the crime scene, the crime scene search, and other processes throughout the investigation. These activities are essential, as they assist in accurately recalling events and identifying evidence in court. Moreover, these activities form a detailed record attesting to the thoroughness and detail of the process. References Department of the Army. (1985). Law enforcement investigations. Washington, DC: Author. Fisher, B.A.J. (2004). Techniques of crime scene investigation (7th ed.). Boca Raton, FL: CRC Press. Gordon, N.J., & Fleisher, W.L. (2002). Effective interviewing and interrogation techniques. San Diego, CA: Academic Press. Hess, J.E. (1997). Interviewing and interrogation for law enforcement. Cincinnati, OH: Anderson Publishing. Holmes, W.D. (2002). Criminal interrogation: A modern format for interrogating criminal suspects based on the intellectual approach. Springfield, IL: Charles C. Thomas Publishers. Kleiner, M. (Ed.). (2002). Handbook of polygraph testing. San Diego, CA: Academic Press. Lyman, M. D. (2008). Criminal investigation: The art and science (5th ed.). Upper Saddle River, NJ: Prentice Hall. Milne, R., & Bull, R. (1999). Investigative interviewing: Psychology and practice. West Sussex, England: John Wiley & Sons. National Research Council. (2002). The polygraph and lie detection. Washington, DC: The National Academic Press. Ogle, R. R. (2007). Crime scene investigation and reconstruction (2nd ed.). Upper Saddle River, NJ: Pearson Prentice Hall. Osterburg, J. W., & Ward, R. H. (2007). Criminal investigation: A method for reconstructing the past (5th ed.). Newark, NJ: Lexis-Nexis. n n

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The American Psychotherapy Association® is a membership society for psychotherapists of many different disciplines. The association’s purpose is to establish a cohesive national organization that advances the mental-health profession by elevating standards through education, basic and advanced training, and by offering credentials to ethical, highly educated, and well-trained psychotherapists. The American Psychotherapy Association currently offers the following certifications and designations: • Board Certified Professional Counselor, BCPCSM • Certified Relationship Specialist, CRS® • Academy Certified ChaplainSM • Certified in Hospital PsychologySM • Diplomate • Fellow • Master Therapist®

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CE ARTICLE: 1 CE CREDIT By Barbara Apostolou, PhD, CPA and Nicholas G. Apostolou, DBA, CPA, Cr.FA, DABFA

DERIVATIVE$:

A Cautionary Tale

Derivatives are financial instruments that were designed to mitigate financial risk. A fairly simple idea evolved over the past two decades into an enormous unregulated global market activity that has been at the center of financial statement frauds and mismanagement. Thus, the very instrument that was intended to reduce risk has yielded its own peril. The complexity of the transactions can mislead financial statement users, thus creating a much greater risk than that conceived to be managed by the derivatives themselves. This article describes derivatives, discusses some of the fraudulent activities that relied on their use, and presents new guidance from the Financial Accounting Standards Board intended to make derivatives transactions more transparent to the public. A forensic examiner specializing in financial statements must

14 THE FORENSIC EXAMINER速 Fall 2009

be cognizant of the evolving developments with derivatives. Introduction Derivatives were originally created to reduce risk. However, as they evolved and became more prevalent and complex, rather than protecting investments, their use produced peril. The traditional cautionary tale consists of three elements: (1) warning of danger, (2) the warning is disregarded, and (3) the violator meets an unpleasant fate. What is missing from the formula is the presence of a guardian to ensure that the warnings are not disregarded. In the case of the flow of financial information in the marketplace regarding the complexity of derivatives transactions, the forensic expert has a special role to (1) issue warnings, (2) identify violations, and (3) provide assistance when violations occur.

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Derivatives have played a significant role in the recent meltdown of the worldâ&#x20AC;&#x2122;s financial system. As of June 2008, the derivatives market was a staggering $684 trillion (notional amount)â&#x20AC;&#x201D;up from $106 trillion in 2002, and less than $1 trillion 20 years previously (see Table 1). Derivatives can no longer be ignored or regarded as a transaction reserved for analysis by a sophisticated few. The use of derivatives by the great majority of our largest companies will require forensic experts involved in preventing and detecting financial statement fraud to fully comprehend these instruments and the risks associated with their use. Evidence of how insidious these instruments could be has been apparent since the 1990s. But the financial industry lobbied against federal oversight to protect the financial system and was supported by important government figures, including Alan Greenspan, chairman of the Federal Reserve from 1987 to 2006. While the regulators battle over missteps regarding how to manage the fallout of the unregulated derivatives market, forensic experts should waste no time at becoming fully informed about issues involving how derivatives expose companies to the risk of financial loss due to intentional acts or poor management. The purpose of this paper is to describe (a) the nature of derivatives, (b) the benefits and risks of these instruments, (c) the extant accounting rules and regulations that govern derivatives, and (d) recent regulatory changes requiring enhanced disclosures.

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TABLE 1. Amounts Outstanding of Over-the-Counter (OTC) Derivatives By Risk Category and Instrument in Billions of U.S. Dollars Notional Amounts Outstanding Risk Category/Instrument

Jun 2006

Dec 2006

Jun 2007

Dec 2007

Jun 2008

370,178

414,845

516,407

595,341

683,725

38,127 19,407 9,696 9,024

40,271 19,882 10,792 9,597

48,645 24,530 12,312 11,804

56,238 29,144 14,347 12,748

62,983 31,966 16,307 14,710

262,526 18,117 207,588 36,821

291,582 18,668 229,693 43,221

347,312 22,809 272,216 52,288

393,138 26,599 309,588 56,951

458,304 39,370 356,772 62,162

Equity-linked contracts Forwards and swaps Options

6,782 1,430 5,351

7,488 1,767 5,720

8,590 2,470 6,119

8,469 2,233 6,276

10,177 2,657 7,520

Commodity contracts Gold Other commodities Forwards and swaps Options

6,394 456 5,938 2,188 3,750

7,115 640 6,475 2,813 3,663

7,567 426 7,141 3,447 3,694

9,000 595 7,861 5,085 2,776

13,229 649 12,580 7,561 5,019

Credit default swaps Single-name instruments Multi-name instruments

20,352 13,873 6,479

28,650 17,879 10,771

42,580 24,239 18,341

57,894 32,246 25,648

57,325 33,334 23,991

Unallocated

35,997

39,740

61,713

71,146

81,708

Total contracts Foreign exchange contracts Forwards and forex swaps Currency swaps Options Interest-rate contracts Forward rate agreements Interest-rate swaps Options

Source: BIS Quarterly Review, December 2008, Bank for International Settlements, p. A103.

Background Although derivative terminology can be daunting (see Table 2 for an explanation of some basic terms), a broad definition is relatively simple. Derivatives are financial instruments with a value derived from fluctuations in an asset or index (known as the underlying) such as share price, interest rate, or currency exchange rate. The face value of a derivative is referred to as the notional amount. The notional amount can be the number of currency units, shares, bushels, pounds, or other units specified in a derivative contract. The Financial Accounting Standards Board (FASB), the primary rule-making body in accounting, has described a derivative as having three key characteristics: 1. It has (a) one or more underlyings and (b) one or more notional amounts or payment provisions or both. Those terms determine the amount of the settlement or settlements and, in some cases, whether or not a settlement is reached. 2. It requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to market factors. 3. Its terms require or permit net settlement, it can readily be settled net by a means outside Fall 2009 THE FORENSIC EXAMINERÂŽ 15

TABLE 2. Common Derivatives Trading Language Call

An option that gives the buyer the right to purchase a specified quantity of an asset at a fixed price at any time during the life of the option.

Cap

A contract that protects the holder from a rise in interest rates beyond a certain period.

Counterparty

The other party or participant in a financial transaction.

Credit Default Swap

A credit derivative contract where the buyer makes periodic payments to the seller and in return receives protection if an underlying financial instrument defaults.

Floor

A contract that protects the holder against a decline in prices below a certain point.

Forwards

A contract obligating one party to buy, and the other party to sell, a specific asset for a fixed price at a future date.

Futures

A contract between a buyer and seller specifying a commodity or financial instrument to be delivered and paid for at a future date. Unlike forward contracts, futures contracts are managed through an organized futures exchange.

Notional value

The full value of the obligations owed by all parties involved in a derivatives contract.

Put

An option that gives the buyer the right to sell a specified quantity of the underlying interest at a fixed price at any time during the life of the option.

Swap

An agreement by two parties to exchange a series of cash flows in the future.

Swaption

An option giving the holder the right to enter into or cancel a swap at a future date.

Underlying

The asset, index, or benchmark that determines the value of the derivative by its price movement.

the contract, or it provides for delivery of an asset that puts the recipient in a position not substantially different from net settlement (1998, p. 8, para. 6). Derivatives can be based upon currencies, commodities, government or corporate debt, home mortgages, stocks, interest rates, or any combination of these. Although there are hundreds of different types of derivatives, they can be classified into three main classes: 1. Futures/forwards: contracts to buy or sell an asset at a specified future date at a price specified today. 2. Options: contracts giving the holder the right, but not the obligation, to buy or sell an asset at a specified price on or before a given date. 3. Swaps: contracts where two parties agree to exchange cash flows on or before a specified future date based upon the underlying value of currency exchange rates, bond interest rates, commodities, or stocks. Derivatives are one of the cheapest and most effective tools a company has to protect itself against shocks in currency values, commodity prices, and interest rates. For example, compa16 THE FORENSIC EXAMINERÂŽ Fall 2009

nies often use forward and exchange-listed futures to protect against fluctuations in currency or commodity prices. A survey conducted by the International Swaps and Derivatives Association (ISDA) of the worldâ&#x20AC;&#x2122;s five hundred largest companies found that 92 percent of these companies used derivative instruments to manage and hedge their risks more effectively (ISDA, 2003). The companies using derivatives were located in 26 countries around the world and represented a broad variety of industries ranging from aerospace to wholesalers of office equipment. Of the companies using derivatives, 85 percent used them to manage currency risk, 25 percent to reduce commodity price risk, and 12 percent to curtail equity price risk. Of the 500 companies surveyed, 196 were US companies, and 94 percent of these US companies used derivatives. Forwards represent the largest component of the derivatives market due to the need by businesses to reduce the uncertainty of variable costs, such as fluctuation in foreign currency rates. For example, a US importer might promise to buy machinery at a future date for a price quoted in euros. This importer can use a forward contract (or a futures contract, if one is available that meets the firmâ&#x20AC;&#x2122;s needs) to fix the dollar cost of converting the euros at that future date. Thus, the importer avoids a loss if the dollar cost of euros increases between the purchase and delivery dates. When derivatives are used to protect against the risk of economic loss arising from changes in the value of the underlying, the activity is known as hedging. Derivatives also can be used to assume risk, rather than to insure or hedge against risk. Thus, some companies will enter into a derivatives contract to speculate on the value of the underlying asset or index, gambling that the party seeking insurance will be wrong about the underlying value of the asset or index. When derivatives serve as investments rather than as hedges, they can be extremely speculative. The riskiness of speculating in derivatives is inherent in the high leverage assumed. The investment outlay (also called initial margin) is typically a small proportion of the face or notional value that magnifies the potential gain or loss on the investment. For example, a deposit of only $2,000 might enable a company to buy a futures contract representing $35,000 worth of cotton. The initial margin in trading futures is typically 5 to 15 percent of the value of the underlying contract, although in some cases it is even less. The smaller the margin compared to the value of the derivatives contract, the greater the leverage and risk. High leverage can produce large profits when compared to the initial margin if www.acfei.com

the speculator correctly anticipates the future price change. Alternatively, if the price moves in the opposite direction from what was anticipated, a large loss can result. Thus leverage is a double-edged sword. Derivatives can be traded over-the-counter (OTC) or on an exchange. OTC derivatives are traded directly between two parties without using an exchange to facilitate the trade. The OTC derivatives market is huge and continues to grow. Interest rate swaps are the largest segment of the derivatives market with over half the total; credit default swaps until recently were the fastest growing OTC derivative with their total jumping over 400 percent in the period from 2005-2007. A credit default swap (CDS) is a contract between two counterparties where one party agrees to make a specific payment to the other party if a particular event, such as a bond default, occurs. In a CDS, the buyer pays the seller periodic premiums to receive credit protection while the seller guarantees the creditworthiness of the swap. Because these contracts can be sold and resold, the original buyer likely does not know who the guarantor is or the financial condition of that guarantor. CDS contracts can be used to hedge risk if the buyer actually owns the debt; however, investors also can buy CDS contracts for speculative purposes. Because CDS spreads will increase as creditworthiness declines (and decrease as creditworthiness increases), an investor might actually purchase a CDS speculating on the increased probability that a company will default on its debt. The Perils of Derivatives The risk of trading in derivatives became a worldwide concern in the summer and fall of 1998 because of huge losses sustained by hedge funds. U.S. hedge funds are unregulated private investment partnerships available only to qualified investors. A minimum investment of $1 million is often required of hedge fund investors. Because managers generally receive about 20 percent of the profits but do not suffer losses, there is a tendency to assume increasing risks. Consequently, many hedge funds leverage their assets by buying derivatives that give them an exposure far greater than their capital. The most publicized hedge fund failure in the decade of the 1990s was that of LongTerm Capital Management (LTCM). (800) 592-1399

LTCM’s principals included several prominent mathematicians and two Nobel prizewinning economists. Its strategy was to exploit small valuation anomalies between various classes of bonds, dealing in bond derivatives called “total return swaps.” In September 1998, LTCM revealed that it had lost about $2 billion in the previous month owing to the financial crisis in Russia (i.e., default on government bonds), which had led to unexpected changes in bond prices. It also disclosed that its capital base had shrunk to less than $1 billion while its liabilities had ballooned to about $200 billion. Concerned about its possible collapse and the impact on other financial organizations, the Federal Reserve Bank of New York arranged for a consortium of leading investment banks to inject $3.4 billion into LTCM in exchange for a 90-percent stake in the fund. The 1998 LTCM debacle had little effect, if any, on the use and regulation of derivatives in the succeeding years. Several prominent individuals had expressed concern about the stunning growth, complexity, and lack of transparency in this market. In 1997, the Commodity Futures Trading Commission (CFTC), a federal agency that regulates options and futures trading, invited comments about how best to regulate certain derivatives. The chairperson of the commission was Brooksley Born, a graduate of Stanford Law School where she received the “Outstanding Senior” award. Ms. Born was a partner in the international law firm of Arnold & Porter and head of the firm’s derivatives practice. Ms. Born stated in Congressional testimony that the unregulated, opaque nature of the derivatives market could “threaten our regulated markets or, indeed, our economy without any federal agency knowing about it” (Goodman, 2008). She recommended bringing derivatives under the oversight of the CFTC. Furthermore, she recommended increased disclosure of the trading in derivatives and a formal procedure for establishing reserves in case of losses. Her modest proposals were disregarded because of the combined fierce opposition of the Federal Reserve chairman, Alan Greenspan, and the Treasury Secretary, Robert Rubin. Both asserted that imposing new rules would damage Wall Street and encourage derivatives trading to take place overseas; they convinced Congress to freeze the CFTC’s regulatory authority for six months. Ms. Born resigned as of June 1, 1999.

Warren Buffett, the legendary investor and CEO of Berkshire Hathaway, warned about the systemic risk of abusing derivatives contracts. In the 2002 Berkshire Hathaway annual report, Buffett sounded an alarm: . . . derivatives as time bombs, both for the parties that deal in them and the economic system. . . . In my view, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal. . . . that the macro picture is dangerous and getting more so. Large amounts of risk, particularly credit risk, have become concentrated in the hands of relatively few derivatives dealers. The derivatives genie is now well out of the bottle, and these instruments will almost certainly multiply in variety and number until some event makes their toxicity clear. (pp. 13-15) Unfortunately, Buffett’s warnings proved prescient and the consequences became apparent with the global crisis in worldwide financial markets in 2008. The damage a single individual could do to an organization by trading derivatives was highlighted by the example of Société Générale reported in January 2008. Société Générale is a major French bank, operating in 77 countries with 120,000 employees. On January 25, 2008, Société Générale disclosed that a rogue employee executed a series of “elaborate, fictitious” transactions that cost the bank $7.2 billion (€4.9 billion at that time), the largest loss ever perpetrated by a single trader (Clark & Jolly, 2008). Kerviel started work at the bank as a back-office employee where he gained an intimate knowledge of the bank’s processing and control procedures. Eventually, Kerviel was promoted to the trading desk where he engaged in arbitrage transactions intending to profit from small differences between a futures index and the equity futures upon which the index is based. Kerviel began creating fictitious trades in late 2006 but, initially, the transactions were relatively small. Within a year, the unauthorized trading had dramatically increased in size and frequency. Kerviel masked his trades by placing fake orders along with genuine orders. Thousands of hedged trades were hidden behind offsetting fake trades. Instead of taking hedged positions as authorized, he took massive unhedged positions in European stock index futures. A suspicious e-mail from a large bank confirming unauthorized Fall 2009 THE FORENSIC EXAMINER® 17

trades precipitated the investigation into Kerviel’s trading activities. On January 19, 2008, Société Générale uncovered the unauthorized trading and began closing out the positions on January 21. The closing of the unauthorized positions (more than $70 billion notional amount) in a three-day period of declining equity prices resulted in the $7.2 billion loss. Kerviel has been charged with “breach of trust, fabricating documents and illegally accessing computers” and is currently awaiting trial. Derivatives played a key role in the 2008 meltdown of American International Group (AIG), the largest American insurance company in terms of insured assets. AIG had written credit default swaps that covered bonds of more than $440 billion. Firms with high credit ratings could initiate swaps with limited margin. On September 16, 2008, AIG faced a liquidity crisis following the downgrade of its credit rating below “AA” levels. The buyers of the CDS issued by AIG were concerned if AIG had enough money to meet the commitments it made in issuing the CDS contracts. The downgrading of its credit rating forced the company to post collateral with its trading counterparties. AIG did not have the liquid resources to meet its collateral and other cash obligations and faced bankruptcy without an infusion of new capital. Deeming the consequences of the demise of AIG unacceptable, the Fed created an $85 billion credit facility to enable the company to meet its collateral obligations. The government exacted a stiff price. AIG issued a

18 THE FORENSIC EXAMINER® Fall 2009

stock warrant for 79.9 percent of AIG shares to the Board of Governors of the Federal Reserve. Shortly thereafter, the federal government increased the aid package to about $150 billion that includes about $50 billion to buy assets either insured or held by AIG in an attempt to reduce losses at firms conducting business with AIG. AIG has committed to paying back the loans within five years by selling assets. On December 31, 2008, AIG’s stock price was $1.55; its previous 52-week high was $60.04. Accounting for Derivatives: Avoiding the Unpleasant Fate The previous section documented actual instances of cases in which warnings were made and not heeded, and the resultant unpleasant fate to the marketplace. The rules governing derivatives not used in hedging activities are straightforward and can be easily summarized: • All derivatives must be carried on the balance sheet at fair value. The FASB defines fair value as the amount at which an asset (liability) could be bought (incurred) or sold (settled) in a current transaction between willing parties. Typically, the best evidence of fair value would be quoted market prices. • The amount shown for the derivative must be adjusted to fair value on each balance sheet date. • The change in the fair value of the derivative from the previous balance sheet date is reflected as a holding gain or loss in the income statement.

• The only exception to the recognition of a holding gain or loss is for derivatives that qualify as hedges under the rules established by the FASB. The FASB has specified exacting criteria for classifying a derivative as a hedge. Management must provide sufficient documentation at the beginning of the hedge term to identify (1) the objective and strategy of the hedge, (2) the hedged instrument and the hedged item, and (3) how effective the hedge is in eliminating specific market risk for a specific hedged item. Effectiveness is the ability of the hedged instrument to offset any change in the fair value or cash flows of the hedged item. Effectiveness is tested when the hedge is initiated, every three months thereafter, and each time financial statements are prepared. If a hedge is completely effective, the change in the derivative’s fair value will equal the change in the hedged item’s fair value. As a result, earnings are not affected. However, if the hedge is not completely effective, the difference between the changes in the fair value of the derivative and the hedged item will increase or decrease earnings. The change in earnings is the ineffective portion of the hedge. Derivatives that qualify as hedges can be classified in one of three ways: (1) fairvalue hedges, (2) cash-flow hedges, and (3) foreign-currency hedges. Fair-value hedges are designated to hedge the exposure to changes in the fair market value of an existing asset or liability, or a firm commitment (e.g., buying or selling inventory). The gains or losses on the hedged asset or liability and the hedging instrument are currently in the income statement. Cash-flow hedges are designated to hedge the exposure to changes in cash flows of an existing asset or liability (e.g., future interest payments on variable-interest debt) or an anticipated transaction (a futures contract that a processor will pay in two months for corn). The distinction between highly effective and ineffective hedges determines how gains and losses on cash flow hedges are recognized in income. The gain or loss on the ineffective portion of the hedge is reported in current income. The gain or loss on the effective portion of the hedge flows should be reported in other comprehensive income (not included in determining net income). Foreign-currency hedges are designated to hedge the exposure to changes in currency exchange rates of an existing aswww.acfei.com

TABLE 3. Tabular Disclosure of (a) Fair Values of Derivative Instruments in a Statement of Financial Position and (b) the Effect of Derivative Instruments on the Statement of Financial Performance Fair Values of Derivative Instruments In millions of dollars As of December 31

Derivatives designated as hedging instruments under Statement 133 Interest rate contracts Foreign exchange contracts Equity contracts Commodity contracts Credit contracts Other contracts

Asset Derivatives 2010 Balance Sheet Location

Other assets Other assets Other assets Other assets Other assets Other assets

Total derivatives designated as hedging instruments under Statement 133 Derivatives not designated as hedging instruments under Statement 133 Interest rate contracts Foreign exchange contracts Equity contracts Commodity contracts Credit contracts Other contracts Total derivatives not designated as hedging instruments under Statement 133 Total derivatives

Liability Derivatives 2009

2009

Fair Value

Balance Sheet Location

Fair Value

Balance Sheet Location

Fair Value

Balance Sheet Location

Fair Value