Wednesday, March 12, 2008

Data Mining Brings Down Governor Spitzer

When New York Governor Elliott Spitzer resigned earlier today the proximate cause was the revelation that he had spent thousands of dollars (maybe tens of thousands) on prostitutes. This hypocrisy on the part of the former NY Attorney General who is married with three teenage daughters, and a long record of prosecuting the wrongdoings of others made his continuation in office untenable.

But how was he caught? The answer is that the complicated financial transactions he made in an attempt to disguise his spending on prostitutes were flagged by fraud detection software that banks now use routinely to detect money laundering and other financial crimes. In a news report on NPR this morning, reporter Adam Davidson interviewed a representative from Actimize, an Israeli company that specializes in fraud detection and compliance software. The software scores every bank transaction with a number from 0 to 100 indicating the probability of fraud. The software takes into account attributes of the particular transaction, but also its relationship to other transaction (as when several small transactions with the same source and destination are used to disguise a large transaction), the relationship of account owners involved in the transaction, and attributes of the account owner such as credit score and, unfortunately for Governor Spitzer, whether or not the account owner is a "PEP" (politically exposed person). PEPs attract more scrutiny since they are often in a position to be bribed or engage in other corrupt practices.

Banks are required to report SARs (Suspicious Activity Reports) to FinCEN, the Treasury Department's financial crimes enforcement network. The reports--about a million of them in 2006--go into a database hosted at the IRS and teams of investigators around the country look into them. One such team, based in Long Island, looked into Sptizer's suspicious transactions and eventually discovered the connection to the prostitution ring.

Ironically, one of the reasons there are so many more SARs filed each year now than there were before 2001 is that in 2001, then New York Attorney General, Elliott Spitzer aggressively pursued wrong-doing at financial institutions and said they had to be aware of criminal activity conducted through their accounts. Apparently, the software banks installed to find transactions that criminal organizations are trying to hide from the IRS is also capable of finding transactions that Johns are trying to hide from their wives.

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