Tunneling (fraud)
Encyclopedia
Tunnelling, or tunneling, is a colloquial term for a specific kind of financial fraud. A group of major shareholders or the management
of a publicly traded company orders that company to sell off its assets to a second company at unreasonably low prices. The shareholders or management typically own the second company outright, and thus profit from the otherwise disastrous sale. Tunnelling differs from outright theft because people who engage in tunnelling generally comply with all of the relevant legal procedures; it is thus a subtler scheme than simply writing checks from a company to a private bank account. While people widely agree that tunnelling is unethical, penalties for tunnelling vary widely; some states impose criminal sanctions, whereas other states provide either for civil suits only, or for no sanctions at all.
(tunelování in Czech
, tunelář for the person committing fraud) during the first half of the 1990s, when several large, previously privatised
banks and factories unexpectedly went bankrupt. It was discovered later that the managements of these companies were deliberately transferring company property and real estate
into their own private businesses, sometimes in offshore
locations.
The term became a common label for this kind of criminal activity among Czechs and Slovaks
. The term subsequently appeared in specialized literature in English, and then in a broader literature during the Asian financial crisis in the late 1990s.
The Brno unique slang Hantec
used terms "tunel" and "křivé tunel" (crooked tunnel) and "vařit křivé tunel" (cooking crooked tunnel) for cheat or dirty trick not only financial category before term tunneling, from the 1960s.
in the post-privatization era was transferring funds and property from high cash flow
corporation
s to companies privately owned by the very same management. Transfers were accomplished via huge loans that were issued without any expectation of repayment, via massive overpayment for outsourced
services, or simply by selling a corporation's real estate for a fraction of its market price
. The main conditions enabling such a fraud is weak law against conflict of interests, non-existent legal liability
of managers for leading their employer towards bankruptcy, and incompetence of financial authorities.
A typical example was the huge industrial complex Škoda Works
in Plzeň, Czech Republic
, which was tunneled by its top manager. The fraud, together with failures in management strategy, resulted in bankruptcy (2001) and then restructuring of the company. The manager was later acquitted by a court, which claimed that "such practices were common at the time".
The typical 7-Step 'Tunnelling' Process:
Step 1: Identify and incentivise a trusted company 'insider', usually in the finance dept, that will be willing to trample over company compliance and authorisations – and enter secretly into a loan/loans - with a person 'outside' of the company. ‘Granting’ a partial or a full 'security’ over some of, or over the assets, or over the entire business and all of its assets.
Step 2: Rapidly run down the cash in the company, usually by buying and holding in inventory equipment and stock - that is unnecessary at that time.
Step 3: At short (sometimes only 24-48 hours) notice, announce that the company is ‘insolvent’ - and have the company immediately forced into a bankruptcy process.
Step 4: The ‘only'/'main creditor’ is of course the local 'outsider’ - and so it is THEY that dominates a rapidly assembled ‘creditors committee’ - which similarly rapidly agrees to sell some or all of the company assets.... to a holding company that THEY already control.
Step 5: Knowing that the original owners are eventually likely to seek justice and also the re-establishment of ownership of their assets, the ‘tunnellers’ next typically pay a local Police Dept officer, to file (knowingly false) 'charges’ - against the original owner of the company – usually by claiming that a 'loan' or ‘loans’ (which the original owners were entirely unaware of!) were ‘taken, with no intention of repaying them’.
Step 6: The ‘tunnellers’ typically pay a local Local/Regional Court official, to:
(a) accept the knowingly false ‘charges’
(b) hold ‘Court Hearings’, without serving any formal Notice on the victim - the original owners
(c) gain ‘convictions’ against the original owners.
Step 7: The ‘tunneller’ next offers a ‘Settlement Agreement’ - under which:
(i) they get to keep all of the misappropriated assets, that they have ‘legitimately purchased from the ‘creditor’s committee’.
(ii) they have a clause included, whereby the original owner agrees to waive all rights - to ever sue the 'tunnellers' in the future.
(iii) the 'tunnellers' agree to retract all of the knowing false claims and allegations - that they made against the original owner – thereby quashing all any ‘convictions’ or ongoing legal proceedings.
Academic sources for learning more about tunneling include "The Law and Economics of Self-Dealing," by Djankov et al. at the National Bureau of Economic Research.
Martin Frankel
's scam is an example of tunneling, although so far the press has not described it in this way.
Management
Management in all business and organizational activities is the act of getting people together to accomplish desired goals and objectives using available resources efficiently and effectively...
of a publicly traded company orders that company to sell off its assets to a second company at unreasonably low prices. The shareholders or management typically own the second company outright, and thus profit from the otherwise disastrous sale. Tunnelling differs from outright theft because people who engage in tunnelling generally comply with all of the relevant legal procedures; it is thus a subtler scheme than simply writing checks from a company to a private bank account. While people widely agree that tunnelling is unethical, penalties for tunnelling vary widely; some states impose criminal sanctions, whereas other states provide either for civil suits only, or for no sanctions at all.
Origin
The word 'tunnelling' was probably first used in this way in the Czech RepublicCzech Republic
The Czech Republic is a landlocked country in Central Europe. The country is bordered by Poland to the northeast, Slovakia to the east, Austria to the south, and Germany to the west and northwest....
(tunelování in Czech
Czech language
Czech is a West Slavic language with about 12 million native speakers; it is the majority language in the Czech Republic and spoken by Czechs worldwide. The language was known as Bohemian in English until the late 19th century...
, tunelář for the person committing fraud) during the first half of the 1990s, when several large, previously privatised
Privatization
Privatization is the incidence or process of transferring ownership of a business, enterprise, agency or public service from the public sector to the private sector or to private non-profit organizations...
banks and factories unexpectedly went bankrupt. It was discovered later that the managements of these companies were deliberately transferring company property and real estate
Real estate
In general use, esp. North American, 'real estate' is taken to mean "Property consisting of land and the buildings on it, along with its natural resources such as crops, minerals, or water; immovable property of this nature; an interest vested in this; an item of real property; buildings or...
into their own private businesses, sometimes in offshore
Offshoring
Offshoring describes the relocation by a company of a business process from one country to another—typically an operational process, such as manufacturing, or supporting processes, such as accounting. Even state governments employ offshoring...
locations.
The term became a common label for this kind of criminal activity among Czechs and Slovaks
Slovaks
The Slovaks, Slovak people, or Slovakians are a West Slavic people that primarily inhabit Slovakia and speak the Slovak language, which is closely related to the Czech language.Most Slovaks today live within the borders of the independent Slovakia...
. The term subsequently appeared in specialized literature in English, and then in a broader literature during the Asian financial crisis in the late 1990s.
The Brno unique slang Hantec
Hantec
Hantec is a unique slang previously spoken among lower classes in Brno, Czech Republic during the 19th and early 20th centuries. It developed from the mixing of the Czech language as spoken in Moravia with the languages of other residents of Brno, including Germans and Jews...
used terms "tunel" and "křivé tunel" (crooked tunnel) and "vařit křivé tunel" (cooking crooked tunnel) for cheat or dirty trick not only financial category before term tunneling, from the 1960s.
Examples
The most common scheme in Central EuropeCentral Europe
Central Europe or alternatively Middle Europe is a region of the European continent lying between the variously defined areas of Eastern and Western Europe...
in the post-privatization era was transferring funds and property from high cash flow
Cash flow
Cash flow is the movement of money into or out of a business, project, or financial product. It is usually measured during a specified, finite period of time. Measurement of cash flow can be used for calculating other parameters that give information on a company's value and situation.Cash flow...
corporation
Corporation
A corporation is created under the laws of a state as a separate legal entity that has privileges and liabilities that are distinct from those of its members. There are many different forms of corporations, most of which are used to conduct business. Early corporations were established by charter...
s to companies privately owned by the very same management. Transfers were accomplished via huge loans that were issued without any expectation of repayment, via massive overpayment for outsourced
Outsourcing
Outsourcing is the process of contracting a business function to someone else.-Overview:The term outsourcing is used inconsistently but usually involves the contracting out of a business function - commonly one previously performed in-house - to an external provider...
services, or simply by selling a corporation's real estate for a fraction of its market price
Market price
In economics, market price is the economic price for which a good or service is offered in the marketplace. It is of interest mainly in the study of microeconomics...
. The main conditions enabling such a fraud is weak law against conflict of interests, non-existent legal liability
Criminal law
Criminal law, is the body of law that relates to crime. It might be defined as the body of rules that defines conduct that is not allowed because it is held to threaten, harm or endanger the safety and welfare of people, and that sets out the punishment to be imposed on people who do not obey...
of managers for leading their employer towards bankruptcy, and incompetence of financial authorities.
A typical example was the huge industrial complex Škoda Works
Škoda Works
Škoda Works was the largest industrial enterprise in Austro-Hungary and later in Czechoslovakia, one of its successor states. It was also one of the largest industrial conglomerates in Europe in the 20th century...
in Plzeň, Czech Republic
Czech Republic
The Czech Republic is a landlocked country in Central Europe. The country is bordered by Poland to the northeast, Slovakia to the east, Austria to the south, and Germany to the west and northwest....
, which was tunneled by its top manager. The fraud, together with failures in management strategy, resulted in bankruptcy (2001) and then restructuring of the company. The manager was later acquitted by a court, which claimed that "such practices were common at the time".
The typical 7-Step 'Tunnelling' Process:
Step 1: Identify and incentivise a trusted company 'insider', usually in the finance dept, that will be willing to trample over company compliance and authorisations – and enter secretly into a loan/loans - with a person 'outside' of the company. ‘Granting’ a partial or a full 'security’ over some of, or over the assets, or over the entire business and all of its assets.
Step 2: Rapidly run down the cash in the company, usually by buying and holding in inventory equipment and stock - that is unnecessary at that time.
Step 3: At short (sometimes only 24-48 hours) notice, announce that the company is ‘insolvent’ - and have the company immediately forced into a bankruptcy process.
Step 4: The ‘only'/'main creditor’ is of course the local 'outsider’ - and so it is THEY that dominates a rapidly assembled ‘creditors committee’ - which similarly rapidly agrees to sell some or all of the company assets.... to a holding company that THEY already control.
Step 5: Knowing that the original owners are eventually likely to seek justice and also the re-establishment of ownership of their assets, the ‘tunnellers’ next typically pay a local Police Dept officer, to file (knowingly false) 'charges’ - against the original owner of the company – usually by claiming that a 'loan' or ‘loans’ (which the original owners were entirely unaware of!) were ‘taken, with no intention of repaying them’.
Step 6: The ‘tunnellers’ typically pay a local Local/Regional Court official, to:
(a) accept the knowingly false ‘charges’
(b) hold ‘Court Hearings’, without serving any formal Notice on the victim - the original owners
(c) gain ‘convictions’ against the original owners.
Step 7: The ‘tunneller’ next offers a ‘Settlement Agreement’ - under which:
(i) they get to keep all of the misappropriated assets, that they have ‘legitimately purchased from the ‘creditor’s committee’.
(ii) they have a clause included, whereby the original owner agrees to waive all rights - to ever sue the 'tunnellers' in the future.
(iii) the 'tunnellers' agree to retract all of the knowing false claims and allegations - that they made against the original owner – thereby quashing all any ‘convictions’ or ongoing legal proceedings.
Academic sources for learning more about tunneling include "The Law and Economics of Self-Dealing," by Djankov et al. at the National Bureau of Economic Research.
Martin Frankel
Martin Frankel
Martin R. "Marty" Frankel is an American financial criminal who conducted a series of investment frauds in the late 20th century, causing hundreds of millions of dollars in losses...
's scam is an example of tunneling, although so far the press has not described it in this way.