EY settles with the SEC

This week, the NY Times reported that the SEC reached a settlement with EY for its audits of Bally Total Fitness. The article reports that "Six current and former Ernst partners, including Randy G. Fletchall, the partner in charge of the firm’s national office, were ... sanctioned by the commission in one of its most sweeping actions against auditors involved in a failed audit." The SEC's $8.5 million settlement is reported as "one of the highest ever paid by an accounting firm.”
Here are a few quotes:

“It is deeply disconcerting that partners, even at the highest levels of E. & Y., failed to fulfill their basic obligations to the investing public by not conducting proper audits.”

“This case is a sharp reminder to outside auditors that they must carry out their duties with due diligence."

"Mr. Fletchall, who remains with Ernst, was in charge of resolving technical accounting issues in the United States ... was censured by the commission."
"A veteran S.E.C. official ... said he knew of no previous enforcement cases in which a partner of a major firm was cited for his actions as head of a national office."
"Ernst was reacting in 2002 to a growing number of accounting scandals, including Enron, and decided to get tough with clients who had previously been allowed to take aggressive accounting positions. The firm forced Bally to stop recording revenue in an improper manner that allowed it to claim earnings earlier than was allowed by accounting rule. But in doing that, the firm allowed Bally to not admit to having violated the rules in the past, an action that would have forced it to restate its accounts and admit that losses in previous years had been much larger."
"The case could provide support for reformers who have said companies should be forced to periodically change accounting firms, a change that Congress considered but rejected in passing the Sarbanes-Oxley law in 2002."

Internet Urban Legends and Fraud

I'm always amazed at how many urban legends fly around cyberspace. Today I got one that had a video that purportedly showed President Obama being snubbed by a Russian delegation. The email said:

For those of you who haven’t seen this already – I hope you can all get it. Pretty amazing! Could it be that the bloom is leaving the rose with this Nobel Peace Prize Winner? Watch this 10-second video where a lineup of leading Russians refuse to shake his hand. Did you see this on ABC, CBS, NBC, CNN or MSNBC?

This is "hard ball", Soviet Style. After the third handshake refusal,,, it becomes obvious. The facial expression is priceless. "I guess we're no longer in Chicago ".
And, how in the world did Katie Couric, Charlie Gibson, Diane Sawyer, miss this? If it had been Bush, think the media would cover it? Anyone ever seen a Head of State snubbed like this? Speaks volumes.

Attached to the email was this video. From looking the statistics on the YouTube variations of this video, it appears that this "evidence" of Obama's snubbing has been viewed on YouTube over 1 million times. However, since I received the video as an email attachment -- not a link -- it's very likely that the video has been viewed many times more from email.

I wonder how many people believe Obama was snubbed by the Russians. I've decided he wasn't. Let me explain.

After watching the snubbing video I decided to look for other news about it. I searched Google and found the email was right in that the mainstream media was not making a big deal out of this. However, I found other videos that said the snubbing did not happen. These videos asserted that Obama was holding out his hand to introduce Medvedev to an American congregation.

After watching several videos, I came to the same conclusion--Obama was simply holding out his hand to introduce Medvedev. I reported this to my friend and sent him some videos. However, he still believed Obama was snubbed.

It's interesting how the lens we look through can influence what we see. Psychology research calls this a "confirmation bias." I believe that the many people passing on this email were looking through a distorted lens caused by frustration, fear and maybe a little paranoia. I believe my friend is a great guy with good intentions but because he doesn't like what is happening to the world under President Obama, he has an easy time confirming that there is a scandal happening around Obama. When someone paints a picture that suggests a scandal exists around Obama, he sees that picture--even if the picture is distorted and taken out of context.

I've found my own views are not free from these distortions and that I need to be very honest with myself or I won't recognize the distortions. I've also found that many times others are not open to reason or challenging their views and they refuse to clean their lens when it's pointed out to them that it might have some dirt on it.

I saw another video recently that purportedly showed Obama had admitted to being Muslim. The scandal was that this was kept out of the news and that Obama had lied about it. However, Aaron pointed out to me that all the quotes were very short and no context was given around them.

As I studied the video again I found there was only one quote that really could be evidence that President Obama was a Muslim. I then found a longer version of this interview where it appeared he admitted to being Muslim and it was clear that he had a simple slip of the tongue and corrected himself.

You might be asking, what does this have to do with fraud? Well, the thing that is most amazing to me is that so many of these legends are being fabricated by taking pictures and quotes out of context. It would take real effort to take these quotes and clips out of context and put them all together to paint a fraudulent picture of President Obama. What kind of fraudster is trying to find video and audio that can be used to discredit the President?! Amazing!

Now, just for clarification, I did not vote for President Obama and I disagree with many of his policies. However, I hope that I can be unbiased enough to see clearly when someone sends me some bogus information on him.

With that said, I believe the press does this in a more subtle way all the time. Some say it's in the President's favor, others say the press is distorted against the President. I believe the truth is that each report we watch is going to be biased. The key is for us to be very honest with ourselves and to be open to reason when new information is found.

In the end, I found a link to my favorite place to investigate urban legends: Snopes. I should have gone to Snopes first! Snopes is the best place to start when you receive any email with some amazing new fact that hasn't been in the mainstream media!

Lessons learned: 1) be skeptical of any email with news that never made it to the mainstream media; 2) be doubly skeptical of any audio or video clips that are short and out of context and 3) check out www.snopes.com before wasting too much time!

New Stimulus idea: Promote fraud to create jobs!

This is the idea that a delegate from Russia seemed to espouse as he commented in a meeting yesterday.

I was asked by the Marriott School to speak to a small group of delegates from Russia who were interested in understanding fraud and corruption. As we talked about the effects of fraud and corruption on an economy, one of the delegates (a lawyer) kept smiling and commenting that unethical business conduct leads to job creation!

It's true that when people are unethical in business, you need to increase controls including people and systems to monitor, prevent and detect the conduct. However, this does not lead to economic gain overall. After several explanations of how corruption creates friction in an economy, I was amazed that he persisted in this thought. He continued to smile and espouse this job creation from unethical business conduct over and over again even though we tried to explain how corruption can cripple an economy.

I tried to explain how corruption in an economy has crippled many third world countries such as Haiti. I've been to Haiti and seen people who are willing to work hard for $3 a day but who can't find work because viable businesses can't survive there because the costs of bribes and corruption are so extreme. As a result 90% of the people are out of work.

The argument of this lawyer is about like saying we ought to promote violent crime so we can create more jobs for police officers, builders of jails, jail keepers, emergency room workers and so on!

I've tried to imagine what our economy would be like if people had a high standard of ethics. If people followed the golden rule to treat others how you want to be treated, the economy would be very different. I must agree with the Russian lawyer that many people would find their jobs were not in demand. This includes police officers, auditors, fraud examiners, virus detection software programmers, alarm system companies, lawyers, etc. The list goes on and on. Unfortunately, I think the future is only getting brighter for careers in these areas.

I believe that the drain on the economy from all the economic effort needed to protect us from being exploited and hurt by one another is tremendous. I also believe that the drain is getting bigger with time. I can only imagine that a high standard of living could be accomplished for all with much less work if we didn't need to spend so much energy protecting ourselves from one another.

Yes, it's true that unethical business conduct leads to job creation. In fact, it also leads to a lower standard of living for every economic input. So, if we now have to work 50 or 60 hours a week to have a reasonable standard of living, I believe the same standard of living would probably require about 10 hours a week of working in a society that lives the golden rule. If corruption increases, either we will need to work more or our standard of living will decrease in order to support all the jobs needed to protect ourselves from the corruption.

That's not the stimulus package I want to see!

Madoff victims, SIPC and a zero-sum game...

How would it be to be in charge of deciding which Madoff victims get protection under SIPC and can receive up to $500k in government insurance? That's what Stephen B. Harbeck does as the head of SIPC. A New York Times article today gives some details on how SIPC goes about this process. Here is a quote from Mr. Harbeck:

“Nobody likes to say no to people who are, without question, victims,” Mr. Harbeck said in an interview. “That’s been hard for me. That’s been hard for my staff. But this is a zero-sum game — a dollar we give to someone who is not eligible is a dollar we do not have for someone who is.”

Leadership and fraud

This short article in US News on leadership is worth scanning. It talks about the tendency to put leaders in charge of organizations who are high on rhetoric and charisma but low on ethics and integrity. Here is a quote worth considering:

"We go for these effervescent leaders when what's really needed is a dull, focused, plodding [person] building effective groups and organizations,"

Fraud in science...

Where there's smoke there's fire...

This from the WSJ: The public has every reason to ask why they felt the need to rig the game if their science is as indisputable as they claim.

And this from Telegraph.uk: Our hopelessly compromised scientific establishment cannot be allowed to get away with a whitewash of what has become the greatest scientific scandal of our age.

Danny Pang Profile

The WSJ has an interesting profile on Danny Pang here.

More Madoff Accomplices Arrested

Today's WSJ reports:

Two former computer programmers for convicted Ponzi scheme operator Bernard Madoff were arrested and charged Friday with creating computer programs that helped Mr. Madoff hide a massive fraud from regulators for more than 15 years.

Jerome O'Hara and George Perez, who began working as computer programmers at Bernard L. Madoff Investment Securities LLC in the early 1990s, were charged with conspiracy, falsifying books and records of a broker-dealer and falsifying the books and records of an investment advisory.

The article reported that there is evidence that the two computer programmers knew what they were doing was fraudulent and received compensation to keep quiet.

Fraud Research in the News

Forbes discusses the recent publication of Using Nonfinancial Measures to Assess Fraud Risk, by Joseph Brazel, Keith Jones, and Mark Zimbelman, in Journal of Accounting Research.

What is this guy thinking?!

The more I read about the former auditor for Bernie Madoff's Ponzi scheme, the more questions I have about this guy. The WSJ reported that Mr. Friehling said that he is a victim of Madoff's scheme too. According to the article, Mr. Friehling revealed that "he entrusted his own retirement and his family's investments to Mr. Madoff, saying he had about $500,000 with the firm." I'm starting to think Mr. Friehling knows about as much about auditing as the typical High School student! Doesn't he know that an auditor is forbidden to invest in a company that he audits?! This is basic auditor independence! Something is missing here...but it may just be that Mr. Friehling is missing something...

Another guilty plea

Madoff's auditor, David Friehling, operated out of a small office in suburban New York and ran a three-person auditing firm that would be hard pressed to effectively audit anything but the smallest businesses let alone a huge hedge fund! As such, the auditor should have been a huge red flag to anyone investing with Madoff, not to mention regulators.

Today, the 50 year old auditor decided to plead guilty to "securities fraud, investment adviser fraud, making false filings with the Securities and Exchange Commission, and obstructing or impeding the administration of the Internal Revenue laws."

While prosecutors argue that Friehling must have known that Madoff was pulling off the largest Ponzi scheme ever, Friehling is claiming: "At no time was I ever aware Bernard Madoff was engaged in a Ponzi scheme."

Personally, I believe Friehling had no idea that Bernie was committing fraud. However, that does not excuse him from what might be considered constructive fraud and was surely gross negligence on his part. I believe Friehling was so over his head in trying to perform that audit that he should have never taken the engagement. .

No doubt Bernie paid a handsome fee to his auditor just as he did to his investors. Too bad Bernie was giving away other people's money!

Madoff victims get some money

It was reported today that victims of Bernard Madoff's Ponzi scheme received $530 million which was guaranteed by the Securities Investors Protection Corp (aka SIPC). The SIPC guarantees brokerage accounts up to $500,000 and is similar to the FDIC which guarantees bank accounts. Apparently, this payout of over one-half billion dollars is a record which exceeded the combined payout of the SIPC from 321 previous payouts since 1970! Sad as it is, Bernie Madoff will definitely be remembered as a fraudster for the record books!

Madoff friend found dead in his pool

The Madoff case seems to get crazier each time a news report comes out on it! Last week's allegations were deemed too speculative for us to do a post. We want to see some confirmation about these allegations before wasting too much energy on them. They are definitely extreme but this is an extreme case so who knows?!

However, the most recent news is not speculative but involves a fact that Madoff's friend, Jeffry Picower was found dead at the bottom of his pool at his Palm Beach mansion. Here are a few claims from an article posted yesterday on CNNMoney.com:

• Picard is listed as one of the wealthiest Americans by Forbes magazine.
• Madoff trustee, Irving Picard, claims Picower was complicit in the fraud.
• Picard claims that "Picower was the biggest beneficiary of Madoff's scheme, having withdrawn either directly or through the entities he controlled more than $7.2 billion of other investors' money."
• Picower was being sued by the Madoff trustee for $7.2 billion.

Today's WSJ and other reports say that Mr. Picower's lawyer said an autopsy shows Picower suffered a massive heart attack that caused his drowning while he was swimming.

Insider Trading Loss

More on Raj Rajaratnam's alleged insider trading scheme: the alleged scheme produced a net loss for defendants (from NYT):

Raj Rajaratnam, the authorities say, masterminded one of the biggest insider-trading schemes in a generation.

But if Mr. Rajaratnam was trading on insider information, apparently he was not very good at it.

A close examination of the trades that led to his arrest last week reveals a startling fact: In all, Mr. Rajaratnam lost millions from what prosecutors characterize as illegal trading.

Marc Dreier on 60 Minutes

This 60 Minutes segment on Marc Dreier is very candid and well worth the 13 minutes it takes to watch:

Catching Up: A Few Links

Another reminder that tax incentives and poor oversight are a great recipe for fraud (via WSJ):

...Des Moines, population 200,000, is dealing with a nasty hangover. A lavish tax-incentive program that brought Hollywood to its doorstep has come to a halt amid allegations of faulty oversight, poor record-keeping and potentially criminal abuse.

Charges were brought against 41 individuals allegedly involved in a widespread mortgage fraud scheme (via NYT):

“The fraud schemes alleged in the cases unsealed today reflect a veritable smorgasbord of scams,” Mr. Bharara said during a news conference in Lower Manhattan. “Whether the economy was going up or the economy was going down, these alleged fraudsters were working feverishly to game the system.” 

Other Madoff Aides Said to Be Tied to Fraud:

The trustee, Irving H. Picard, citing his own findings, asserted that 245 of the almost 5,000 active Madoff accounts were directly managed by other Madoff staff members, not by Mr. DiPascali.

Like Mr. DiPascali, these employees created records of fictional trades that maximized the reported profit in the accounts, the trustee’s filing asserted. Indeed, it claimed those accounts showed bogus profits in excess of the fictional gains recorded in the DiPascali accounts, which ranged from 10 to 17 percent.

According to the filing, the accounts included those set up for Stanley Chais, a Los Angeles investment manager whose clients lost millions in the fraud, and Jeffry Picower, a professional investor who withdrew billions from his Madoff accounts.

The special accounts also included ones set up by members of the Madoff family and employees at the firm, according to the document.

And finally, PCAOB Announces Ambitious Agenda; May Be Time to 'Dial Up' on Fraud, Silvers Says (HT FASRI):

In response to questions, Silvers said, "We should not expect that every audit is a forensic audit... that's absolutely not what I'm saying." However, he added, "I think we need to move the dial a little bit so auditors have some greater obligation than is currently embodied in the current fraud standard, to have an obligation to act when there is reasonable suspicion of fraud."

"This was subject to some extensive discussion in the Treasury committee (Treasury's Advisory Committee on the Auditing Profession or ACAP]," said Silvers, adding, "some people, [e.g.] Lynn [Turner], may feel my approach is not tough enough, some people felt we should move to some absolute liability standard [i.e.] if you don't find fraud, it's the auditors fault; but it's also not my view that looking for fraud is not related to the audit, that doesn't parse with the public's [perception] of the audit profession."

Alleged Insider Trading

You may have seen recent reports in the news of an alleged insider trading ring.  The WSJ points out that the "prominence of the alleged conspirators" is surprising:  

Why a purported billionaire would want to risk all of that for insider trades that prosecutors say yielded some $20 million in total gains is a mystery that we assume further evidence will explain.

I am interested in seeing how this case unfolds.  Based on what we know now, it seems that the potential costs of insider trading far outweighed the potential benefits to this group of individuals.  Since this appears to be a group of highly intelligent individuals, you have to wonder what would motivate them to participate in the alleged insider trading ring.

Enron Update

The WSJ reports that the Supreme Court will consider the appeal of Jeffrey Skilling, former President, CEO, and COO of Enron:

The justices agreed to look at two issues in the Skilling appeal. Both could have broader repercussions in criminal cases, say legal observers. One has to do with the government's contention that Mr. Skilling violated his legal obligation of providing "honest services" to Enron shareholders because he lied to the public about the company's financial condition. Enron collapsed into bankruptcy in December 2001. The second issue involves Mr. Skilling's claim that he wasn't able to get a fair trial in Houston, Enron's headquarters, because of anger in the community over the company's collapse.

I find it curious that eight years after Enron's collapse we still see some ambiguity regarding the legal consequences of the Enron scandal.  If nothing else, this highlights the increased opportunity that managers have to get away with fraud, as financial statement fraud appears to be a difficult crime to prove/prosecute.

Medicare fraud

Medicare fraud is a huge problem and has many dimensions. I've heard promises that the health care reform proposals will be partially funded by reducing such fraud. With those promises floating around, it's amazing to me to read in the WSJ that the Senate Finance Committee rejected a proposal to require immigrants to "prove their identity when signing up for federal health care programs." This makes absolutely no sense to me...

The Madoff trustee has been busy lately...

The WSJ has reported two major lawsuits filed recently by the Madoff trustee. The first was reported yesterday and involves a $7.2 billion claim against Palm Beach, Fla., investor Jeffry Picower. Apparently, Mr. Picower was able to specify the returns he wanted and Bernie gave them to him. The trustee claims that Picower took home profits totaling $7.2 billion! That's not a bad arrangement: I want a 50% return, compounded daily please! Of course, Mr. Picower claims he had no idea Bernie was operating a Ponzi scheme.

Then, today, the WSJ reported that the trustee is suing various Madoff family members for nearly $200 million. While it doesn't sound like a lot any more, this really is an incredible sum of money. Apparently, Bernie paid nearly 75% of these funds to family members in the last six months before the scheme unraveled. Peter and Shana Madoff held the titles of Chief Compliance Officer and Compliance Officer at Madoff's firm. As such, the trustee is saying they were essentially complicit in the fraud because if they would have done their job they would have prevented or detected the scheme.

Some other revelations that are coming out of the trustee's investigation include:

• the trustee believes the total losses by Madoff investors is about $18 billion
• approximately half of the investors took out more money than they put in
• total deposits to Madoff were about $36 billion
• total funds sought by the trustee in lawsuits to this point are $15 billion

This saga will continue for a long time. We do know one winner in it all: the attorneys will undoubtedly come away from it with plenty of money to invest with someone. I wonder who is eying their cash and soliciting their investments...maybe the next huge Ponzi scheme will get their funds!

Tell us what you really think Harry...

Here's a juicy quote from Harry Markopolos regarding the SEC's ability to find fraud:

Harry Markopolos, the fraud investigator who brought his allegations to the S.E.C. about improprieties in Mr. Madoff’s business starting in 2000, testified that the agency’s staff “was not capable of finding ice cream in a Dairy Queen.”

I wonder what he thinks about the ability of independent auditors to detect fraud...I'm not trying to defend the SEC or disparage auditors but it might be interesting to evaluate the number of frauds detected as a function of resources devoted to auditing or detecting material fraud between these two institutions who are both charged with responsibilities for fraud detection: the SEC and independent auditors. Anyone have a guess as to which mechanism would have the best track record?

Fraud and motivated reasoning

Have you ever wondered why some victims of fraud end up believing the fraud perpetrator is innocent long after a loud and clear signal that they have been duped has been revealed?

I observed this behavior in a profound way a few years back when Charis Johnson was accused with strong evidence that her "12 Daily Pro" investment was no more than a Ponzi scheme. Charis was paying 12% interest per day and she had many followers who knew she was a saint because she was paying them this outrageous interest rate which compounds to an absurdly enormous rate of return. I calculated at the time that $1.00 invested in 12 Daily Pro would grow to 9,217 trillion dollars in one short year if interest was compounded daily! That amount was 333,000 times the US federal budget for 2007 when 12 Daily Pro was running strong!

I would think that any reasonable person who had these facts explained to him or her would be outraged at Charis and be thrilled to learn what was necessary to avoid future losses. However, when the Dean of BYU's Marriott School of Management explained that 12 Daily Pro was a scam, he received death threats from investors around the globe. In addition, numerous people ridiculed him for suggesting that this scam could not be based on anything short of a pyramid scheme. Why so?

It turns out that the 12 Daily Pro story above is not unusual. In fact, many people become committed to an idea and then justify the idea both emotionally and cognitively. They end up reasoning in a way that allows them to keep their belief, even when facts suggest otherwise.

A recent article in the NY Times explained how this took place decades ago when two explorers claimed to make it to the North Pole. Both are now believed to be frauds. However, at the time they had many believers who refused to see the facts as they were due to what is known as motivated reasoning. Motivated reasoning can be very costly to victims of fraud schemes. It's likely that many of Bernie Madoff's investors had clear signs that the scam was a fraud, including articles in Barrons and other warning signals. However, they were getting their returns so they found a way to dismiss the warning signals.

The tip of the iceberg...

Anyone want to guess what percentage of the stimulus funds will be taken by fraudsters? Nobody knows for sure. However, what we do know are a few axioms of frauds. First, wherever there is money there is fraud. Second, wherever there is government money there is more fraud! In the end, the stimulus spending will stimulate the economy for auditors, fraud investigators and attorneys on both sides of the courtroom. Read this recent NY Times article to learn about the tip of the iceberg in stimulus fraud.

I know we have some political challenges in the U.S. but it could be worse...

I would say that this NY Times OpEd describes level of political corruption in Africa that makes our troubles sound pretty mild...

It sounds like the Lebanese Madoff studied under Bernie or Charles Ponzi himself when he designed his strategy to scam $1 billion from his fellow countrymen.

Consider a few quotes from a recent NY Times article and you can see the common conditions of successful Ponzi schemes:

First: "He was known as a deeply religious and charitable man, with a gift for winning people’s friendship."

Pyramid schemes often involve "con men" who build confidence by "winning people's friendship" and appearing to be religious. Bernie Madoff also built confidence and many fraudsters appear to be deeply religious.

Next: "But the dollar figures have drawn less attention here than Mr. Ezzedine’s close links with Hezbollah, the militant Shiite movement. Many of the investors — mostly Shiites living in Beirut and southern villages like this one — say those party links were the reason they chose to risk their hard-earned savings with a man who offered 40 and 50 percent profits but never showed any paperwork."

In this quote we see a few more common ingredients including affinity with a group and outrageous returns. Affinity is used since it gives the perpetrator a group of people who trust one another's opinion. Once one person in the group gets excited, the rest follow and seem to turn off any due diligence based on the fact that others in their group are doing it. Bernie's scheme started in among his fellow Jewish friends.

As for the outrageous returns, when will the world learn that "if it seems too good to be true, it is probably a scam!"

Sir Allen: Proof that what goes up must come down!

Here are a few quotes from a recent NY Times article reporting the woes of Sir Allen:

(T)he Texas financier accused of a $7 billion fraud, has no money to pay a lawyer so a federal judge on Tuesday ordered a public defender to take over his defense.

...

Mr. Stanford, who once traveled by private jet and owned yachts and luxury homes in Texas, the Caribbean and Florida, has been in jail since June, when criminal charges were filed.

For some reason I don't feel too sorry for him...However, I do have compassion on the people who thought they had $7 billion in legitimate certificates of deposit and found out they had nothing but a share of a Ponzi scheme...

Madoff was taped telling Fairfield how to deal with SEC

As Bernie Madoff's dealings are revealed, it appears clear that he viewed his scheme as a game. Too bad for those who lost billions...

Here is an article describing some of his instructions to others on how to deal with the SEC when they asked questions about him.

Insights on Madoff's interactions with the SEC

The SEC released the 22 page summary of the 450 page report detailing its interactions with Bernie Madoff. The NY Times article on this summary described how Bernie was able to persuade investigators when they were getting close to catching him. We know that all successful fraud perpetrators are great at building confidence and are often referred to as a "con man" as a result. The report noted Bernie's abilities in this area and also showed that he could be very domineering when he needed to be. Here are a few excerpts from the NY Times:

One investigator described Mr. Madoff as “a wonderful storyteller” and “a captivating speaker” after the 2005 encounter in which Mr. Madoff, a former Nasdaq chairman, boasted of his ties to people high up in the S.E.C. and said he was on the short list to be the next agency chairman — the post that went to Mr. Cox.

But Mr. Madoff turned angry — “veins were popping out of his neck,” an investigator said — when asked to produce certain documents, and he tried to dictate what paperwork he would yield. When the investigators reported back to their superior in the S.E.C.’s Northeast regional office, “they received no support and were actively discouraged from forcing the issue.”

More on how Madoff kept his scheme going so long...

Information coming out about Madoff has been slow but here is the latest potential tip as reported by Bloomberg:

Family members of a U.S. Securities and Exchange Commission enforcement official, whose unit got an anonymous tip in 2005 suggesting Bernard Madoff may be running a Ponzi scheme, entrusted $2 million to the scam, the agency’s internal watchdog said.

Right now the details are pretty sketchy but it sounds like something fishy may have been going on at the SEC.

"Fudge This"

The Big Picture reports that NZ Farming (NXZ) got into trouble with regulators for including a certain comment in their financial statements (HT FASRI):


In a response letter, the company clarifies that (emphasis added):

The comment was a personal file note included in an earlier working draft of the notes to the Financial Statements. The file note was made as a prompt to reconcile a minor rounding difference between the cash-flow reconciliation note 3 and the fixed assets note 11 in respect of depreciation expense for the period. Importantly the comment was not in the Financial Statements reviewed and approved by the Board of Directors of NZS or its auditors.

Whoops. I am sure that the auditors and board of directors love it when the company files a set of financial statements that is slightly different than the ones that were reviewed and approved by the board and the auditors... I guess the tie out can be more exciting than associates/interns might have guessed.

In any case, I think we should give them a blue ribbon for being transparent!

Huron and Arthur Andersen

Some of you probably have heard about Huron Consulting Group Inc's restatement recently. You should read this article about Huron's connection to Arthur Andersen. Here are a few tidbits:

You can take the accountant out of Arthur Andersen. You can’t take the Arthur Andersen out of the accountant....Huron was founded by about two dozen Arthur Andersen LLP partners in March 2002...Today, Huron is better known as the forensic-accounting shop that couldn’t keep its own books straight, and blew up its business model in the process...There hasn’t been an accounting fiasco this rich with irony since the tax-return preparer H&R Block Inc. had to redo its financial reports in 2006 to correct errors in its accounting for corporate taxes.

Stanford CFO Pleads Guilty

As expected, Stanford Financial Group's CFO, James Davis, pleaded guilty today to fraud and conspiracy, admitting that "he and others had knowingly bilked Stanford investors for nearly two decades." (via WSJ) Mr. Davis's plea agreement included something curious:

In Mr. Davis's signed plea agreement, federal prosecutors allege that Mr. Stanford performed a "'blood oath' brotherhood ceremony" with a Caribbean banking regulator. The oath sealed an agreement that the regulator, Leroy King, would accept cash bribes and in return ensure that the Antigua Financial Services Regulatory Commission wouldn't "kill the business.

Although we already knew that Leroy King has been accused of accepting bribes to keep Stanford's alleged fraud alive, a "'blood oath' brotherhood ceremony" seems like a pretty extreme way to formalize an agreement to defraud others. It seems like most schemes to conceal a fraud have "good" intentions--something like, "If we don't fudge these numbers, we may have to lay off workers; besides, next quarter will be better and nobody will know," as opposed to an overt, "Let's work together to defraud these people." Framing the scheme with "good" intentions makes it easier for participants to rationalize the fraud. However, assuming this story is true, Stanford, King, Davis, and whoever else knew about his ceremony didn't seem to have any problems rationalizing their overt decision to defraud others...

PwC now being sued in Madoff case...

Victims in the Madoff case have now expanded their efforts to recover some of their losses by suing PricewaterhouseCoopers. A UK news report states:

The Canadian arm of PwC has been named in seven separate lawsuits claiming as much as $2bn in damages for investors who lost almost everything in the largest fraud in history. PwC Canada was auditor to Fairfield Sentry, the feeder fund that placed $7.2bn of investors' money with Madoff, and which became the biggest single casualty.

At the heart of the suit is the claim that:

As auditors, PwC would have been required to check that the treasury notes existed. However, Madoff was able to conceal any shortfall because he was not just the "execution agent" for Fairfield Sentry's investment strategy but also the custodian of the money. As such, PwC would have received assurances from Madoff that the treasury notes existed.

Investors argue that his dual role should have been a "red flag" that raised suspicions and persuaded the auditors to verify the claim with the US Treasury. Investors also say that Madoff's unusual habit of liquidating the entire Fairfield Sentry investment and converting it into US treasuries for a few days over every financial year-end should have been another "red flag". Since Madoff pleaded guilty to fraud, it has become clear the funds never existed.

This effort to get into PwC's deep pockets followed a similar case where KPMG is being sued for $3.3 billion in the Madoff case for its work on another feeder fund: Tremont Group. I believe BDO Siedman was the first to get sued for its work on a Madoff feeder fund.

My guess is that now that we have two auditors of the feeder funds being sued by Madoff victims that it's only a matter of time before we see more auditor lawsuits related to Madoff.

Overlap

Usually overlap would be considered an effective deterrent to fraud, at least from the corporate perspective. Internal controls that include some measure of redundancy would make it harder to commit a fraud, should one of those controls fail or be overridden. However, an interesting editorial in Forbes argues that for regulators, overlap may not be the best fraud prevention policy. From the article:

The thousands of regulators spread out among the seven positions are simply too many fielders converging for the same ball on the same field at the same time--and at the critical moment, they all assume that someone else will catch the falling ball.

Is it that simple an answer? No ... but, to some extent, it's a good starting explanation for the current regulatory mess: too many overlapping cops, too many organizations competing for starting time and the spotlight, too few stars willing to step up and take control--a team of players lacking a leader.

On an individual level, psychologists call this behavior of passing the buck "diffusion of responsibility." However, I am not familiar with an organizational equivalent. I am not convinced that organizational diffusion of responsibility was the primary reason that regulators overlooked recent frauds, however, it may have contributed to managerial myopia by regulators in allocating their scarce resources. The article discusses FINRA's short-sighted policy of only following up on complaints from customers but not complaints from industry employees. This policy caused the agency to overlook a tip on the (alleged) Stanford fraud given in 2003. Perhaps the agency originally decided to adopt the policy because it felt that another agency (such as the SEC) would be better suited to follow up on complaints from industry employees, which would allow FINRA to specialize in investigating investor complaints.

From an external audit standpoint, I wonder if increasing specialization (crucial to many of today's incredibly complex audits) is causing individual auditors to overlook fraud cues that are outside of their area of expertise...

"Putting America to Work"

Shifting gears for a moment, I have to ask: Who thought it would be a good idea to put up signs like this at road construction sites all across the U.S.? While moving out to Illinois, I lost count of the number of these signs we passed. In fact, it seemed like we spent a third of our 21 hour drive in constructions zones brought to us by the American Recovery and Reinvestment Act (ARRA).

Without expressing any opinion on this act or its creators, I have to wonder why no one seems to have put much thought into the decision to dot the country with these signs. Are these signs supposed to create a positive perception of ARRA and its authors? Am I supposed to be thinking, "Gee, I am so glad that I get to add hours to my travel time so that we can stimulate the economy"? Don't get me wrong, I think that updating our infrastructure is important, I just think that it may have been better to wait to put the signs up until after the roads were done. That way, people would think, "These smooth, fast roads were brought to you by President Obama and his buddies in congress," instead of, "This horrible traffic and added commute time were lovingly brought to you by your President."

Foregone Opportunities...

From GoComics.com:

What do Bernie and Barry have in common?

Those of you who have studied famous fraudsters, you will know the name of Barry Minkow. Barry was the apparent whiz kid entrepreneur who started ZZZZ Best Carpet Cleaning in the 1980's. ZZZZ Best was a too-good-to-be-true business that ended up being one massive lie. A fraud that cost investors, banks and others millions of dollars when it came to light.

Enter Bernie Madoff on the scene in 2008 when the largest Ponzi scheme of all time comes to light due to the fact that the economic downturn led Madoff's investors to try to redeem too much of the $65 billion that Madoff said they had with him. Bernie could no longer find enough cash to provide the redemptions that were being requested so he confessed his crime and is now serving a 150 year sentence. Bernie's business was also one massive lie.

So what do these two fraudsters have in common? For one, they both have the initials of "BM." Interesting as it is and coincidental that this is a less than flattering acronym, that's not what I had in mind. It turns out that one key connection that they have is that the key to both these massive lies was there skill at being paperwork manufacturing machines.

This week, Madoff's top lieutenant, Frank DiPascali, admitted to creating the paperwork needed to fool about everyone but Harry Markopoulos. DiPascali provided some details to his job of "CPA" (Chief Paperwork Automator) when he admitted to his crimes this week by telling the judge: "I knew it was criminal, and I did it anyway."

Mark Morse was Minkow's chief lieutenant and once said that he could use a copy machine to create any document that anyone wanted. The key is, that's about all anyone wanted: documents.

It seems that for a truly outlandish fraud to survive, the fraudsters simply need to create paperwork. Many professions in our society put a lot of trust in seeing a document. Auditing is one profession that builds its foundation almost exclusively on paperwork.

The scary truth is that with computers and printers today, anyone with a high school education from Queens New York such as Frank DiPascali can be a paperwork manufacturing machine and create the illusion necessary to dupe so called sophisticated investors out of billions!

HealthSouth fraud: The rest of the story

The former CFO, Aaron Beam, of HealthSouth spoke at the recent conference of the Association of Certified Fraud Examiners. He tells a pretty good story. You can watch seven short (2-5 minute) video clips of his speech at this link. I've heard the links won't be there for long so check them out before they get removed. Here are a few highlights:

• Clip 1--Watch out for that charismatic personality: After first meeting Richard Scrushy, "I had never met anyone like Richard Scrushy...I told my wife, I said today I've met the most brilliant businessman I'm ever going to meet or possibly the biggest con artist I'll ever meet."
• Clip 2--Pressure on the CFO to fudge the numbers: "You're holding this company back with your conservative accounting!"
• Clip 3--Fraud is Fun and the Slope is Slippery: "I was a rock star...people knew me...I was worth several million dollars." "I didn't think of it as fraud...lowering the bad debts was okay." "I did not have the moral fiber to stand up to Richard...he was really a scary guy."
• Clip 4--More slippery slope and the moral fiber of a fraudster: "You've done it once, you got blood on your hands so you do it again." Richard (Scrushy) had told (us) "If we ever get caught, I'm going to deny everything." Six years after Beam retires, the fraud comes to light.
  
• Clip 5--The Challenge of Teaching Accounting to a Jury: "They literally were going to sleep."
• Clip 6--Maybe fraud isn't so much fun: Hear about the grilling the CFO had when he was on trial and Scrushy's attorney called him a liar and asked him about an extramarital affair he had.
• Clip 7--Don't do it!: Beam emotionally states: "I embarrassed my family." "There's only one answer: don't do it....you have to say no!"

A word to Ponzi schemers: Stay away from China!

The WSJ and AP reported that two Chinese individuals were executed for defrauding others in a Ponzi scheme in which they promised 10% returns every month. Now that is some serious punishment!

A break in the Madoff case

The WSJ just reported that former Madoff aide, Frank DiPascali Jr., plead guilty to knowingly helping Bernie Madoff perpetuate his $50 billion Ponzi scheme for several decades. We all knew Bernie was lying when he said nobody else knew anything or helped him with the scheme but this is a break in that someone else has admitted to helping Bernie. Hopefully, Mr. DiPascali can shed some light on others who helped Bernie. Here are a few quotes from the WSJ:

Mr. DiPascali ... said Mr. Madoff had amassed a stable of clients as an investment adviser by the early 1990s, but no purchases or sales of securities were taking place in their client accounts. Mr. DiPascali said he learned in the late 1980s or early 1990s that no trading was occurring in those client accounts.

"It was all fake; it was all fictitious," Mr. DiPascali said. "It was wrong, and I knew it at the time."

He admitted to helping perpetuate the illusion that trading was taking place by lying to clients on the phone and through the mail. He admitted to creating fake client documents to reflect the "specific rate of return" Mr. Madoff directed the client receive.

He said he also lied under oath to the SEC in 2006 at Mr. Madoff's direction.

100 years for $126 million fraud

Continuing the recent trend of harsh prison sentences for convicted fraudsters, Edward Okun was recently sentenced to 100 years in prison for running a $126 million fraud scheme. While $126 million may seem like a pittance in comparison to the billion dollar frauds that have dominated recent headlines, Okur's deception was reportedly worse than the deception of other recently convicted fraudsters (via Bloomberg):

Assistant U.S. Attorney Michael Dry argued Okun’s fraud was worse than others, because his victims thought they were using a risk-free service, as opposed to investing. The tax-deferral industry temporarily holds real-estate sale proceeds for a fee under section 1031 of the U.S. tax code, allowing customers to defer taxes when similar properties are bought within 180 days.

Instead of holding the money in banks, Okun used it as a “personal piggy bank” for expenses that included financing a divorce and buying jewelry for his new wife, prosecutors said.

We can only hope that increasingly harsh prison sentences will deter future frauds.

Apparently not all Madoff victims were victimized equally...

According to a recent article, the trustee in the Madoff case is suing Jeffry M. Picower so as to obtain $5.1 billion that was apparently withdrawn from several accounts from the mid-1990s to 2008. Here is an excerpt:

The trustee says that Mr. Picower made numerous withdrawals from his various Madoff accounts from the mid-1990s to 2008, each time realizing enormous profits that, in several instances, exceeded the returns of other Madoff investors who invested during the same period. Mr. Madoff marketed his investment services as offering consistent annual returns of 10 to 12 percent, but the trustee has identified several people who seemed to have a special deal with Mr. Madoff that ensured them extravagant profits.

Over a dozen times between 1996 and 2007, Mr. Picower’s accounts posted gains of more than 100 percent, the trustee said. One account in 1999 chalked up an annual profit of more than 950 percent. But, Mr. Picower claims the same account records show the account earned a 37.6 percent return in 1999 and none of his accounts ever earned a return of more than 100 percent in any one year.

I'm glad that the trustee seems to be tracking some of the money but I doubt we will ever know where a lot of it ended up..."I'll pay you a 950% return this year but send me 1/2 of it through this Swiss bank account..."

Mortgage fraud and bailing out the banks

As the government has been bailing out banks that are the "victims" of a crazy boom in housing, an investigative report shows that banks in Florida were looking the other way when property flippers were getting fraudulent loans from them. Here are a few quotes:

A yearlong Herald-Tribune investigation into thousands of suspicious Florida flip deals found that lenders of all kinds approved risky deals and ignored obvious red flags for mortgage fraud.

...

When a Sarasota home builder was unable to sell his newly built houses, mortgage companies lent him and his family nearly $2 million so they could purchase four themselves. Three of those properties are now bank-owned.

Washington Mutual loaned a Sarasota resident $2 million three months after it had foreclosed on a previous $2 million loan. The new loan went into default less than a year later, about the same time WaMu's crush of bad loans put it out of business.

...

Banks and mortgage companies dug an even deeper hole for themselves by continuing to lend money for suspicious deals long after the real estate boom ended. In 2007, more than a year after the market started falling in mid-2005, flippers arranged more than $1 billion in sales involving suspicious price increases.

...

What makes the flipping fraud so egregious is not just that it happened, but that it would have been so easy to stop.

It makes you wonder what happened to the huge commissions that the loan officers took home as they signed away good money for bad loans.

Yachtzi Scheme

As further evidence supporting the claim that you can sell anything to 3% of the population, the WSJ reports that an outrageous Ponzi scheme may be unraveling in southern California (thanks, Kevin Butler, for the pointer). The focus of the Ponzi scheme? Yachts:

Investors say they were lured by “boat deals.” The plan was for Mr. Fitzgerald to buy boats on the cheap, sell them to buyers he had prearranged and record a hefty profit.

One investor said he earned $4,000 on a $20,000 investment in four weeks. Profits were rolled into the next deal. The investor says he is now out $120,000–$100,000 of which was financed with a home-equity loan.

Client money held in escrow accounts by Mr. Fitzgerald for the purchase of high-end yachts has been cleaned out. Authorities say total losses could be in the millions of dollars.

The case goes to show that even during a global financial crisis, investors are again so hungry for returns they were blind to clear risks. Some investors put money with the broker just two months ago.

Buying boats and re-selling them for quick profit at a time when boat-sales have crashed? It almost make postage stamps sound sophisticated.

I guess this serves as a stark reminder of the need for common sense and skepticism when attempting to avoid fraud...

Bernie's lifestyle change...

News reports describe some fairly drastic lifestyle changes for Bernie Madoff now that he's in prison. Here are a few excerpts describing Bernie's new life:

"Some of the guys were talking about smacking him around a little, just to get the notoriety of it," said a source who has a relative locked up with the 71-year-old Madoff.

Every day's a bad hair day for Bernie, who was shocked at seeing how much his hair had grown and how unkempt it has looked since he was incarcerated in March.

"When I finally looked in the mirror, I scared myself, because I haven't seen myself in four months, and my hair was everywhere," Madoff told fellow inmates last week.

As for his diet, he's eating macaroni and cheese instead of caviar, filet mignon and $500 bottles of wine.

What's happening in New Jersey?!

A NY Times Op Ed offers these encouraging words to those who don't live in New Jersey:

No matter what dreadful embarrassment your state is facing, you can always console yourself by remembering that you do not live in New Jersey. On Thursday, a vast corruption sweep there netted three mayors, two state assemblymen, five rabbis and a guy who had allegedly been running an organ-trafficking business that has left swathes of the population of Moldova walking around with only one kidney.

Read this for more details...

A minor $700 million Ponzi scheme

Last week, Mark S. Dreier was sentenced to 20 years in prison for running a $700 million Ponzi scheme. Since Bernie Madoff and Sir Allen Stanford have stolen the fraud spotlight in the news, we hardly take notice of these frauds amounting to less than several billions of dollars. It seems that our sense of awe has been permanently warped.

As for Mr. Dreier, he explained his pressure to commit the fraud came because those that he associated with were doing “better financially and seemingly enjoying more status,” and that he felt “crushed by a sense of underachievement.”

He continued: “I was desperate for some measure of the success that I felt had eluded me,” he wrote, adding: “I lost my perspective and my moral grounding, and really, in a sense, I just lost my mind.”

I guess this is a lesson to be careful about how those you associate with may be warping your sense of reality and your priorities. Maybe Mr. Dreier is a reflection of many Americans who got caught up in the real estate boom that has come crashing down of late.

Satyam Fraud

A report by the Comptroller and Auditor General of India indicates that the Satyam fraud could have been uncovered in 2007 (source). However, a government agency appears to have looked the other way, allowing the fraud to continue undiscovered until January 2009. Many of the fraudsters who have been exposed over the past year or so seem to have had an uncanny ability to get government agencies to look the other way.

Schwab Faces Fraud Suit

Via the WSJ:

In an official notice sent to Charles Schwab & Co. Friday, Attorney General Andrew Cuomo warned that his office plans to sue the largest online brokerage firm for civil fraud over its marketing and sales of auction-rate securities to clients. Emails and testimony cited in the letter show Schwab's brokers had little idea of what they were selling and later failed to tell clients that the market was collapsing.

Seems like another example of obscurity on Wall Street. In this case, the brokers allegedly didn't even understand what they were selling...

Catching Up

I know what everyone must have been thinking over the past few days: the Zimbelmans must have been busted for running a ponzi scheme and it hasn't been in the news because it has been overshadowed by the Madoff and Stanford frauds...

Actually, although some have suggested that either my dad or I commit fraud to give our blog more credibility (see Sam Antar or Barry Minkow), neither of us are quite ready to take that step.

During our 10 day hiatus, the fraud world has kept busy. A few interesting stories:

1. An elaborate scheme to defraud state auditors and other vendors is unraveling (source):

North Carolina records show that "Christina Ann Clay" set up three corporations on Jan. 6: Deloite Consulting, Unisyss Corp. and Acenture Corp. The Clay identity was employed again March 16 to register a fourth name, Electronic Data System Corp.

Each name is similar to that of legitimate companies that West Virginia has done business with, to the tune of $202 million since the 1990s, the auditor's records show.

West Virginia isn't the only state to be hit by this scheme--the scammers are also being investigated in Utah and may have defrauded numerous other states. Looks like an epidemic of poor internal controls.

2. Madoff's auditor pleads not guilty

3. Stanford is still complaining about having to account for his assets before the judge will release funds to pay for his defense. Stanford claims that such an accounting would violate his Fifth Amendment privilege against self-incrimination. Sounds pretty sketchy to me...

Dodging the Regulators

Not only did Allen Stanford get help from Antiguan regulators, he also found ways to escape oversight in the US. The Miami Herald reports:

Years before his banking empire was shut down in a massive fraud case, Allen Stanford swept into Florida with a bold plan: entice Latin Americans to pour millions into his ventures -- in secrecy.

From a bayfront office in Miami in 1998, he planned to sell investments to customers and send their money to Antigua.

But to pull it off, he needed unprecedented help from an unlikely ally: The state of Florida would have to grant him the right to move vast amounts of money offshore -- without reporting a penny to regulators.

He got it.

Over objections by the state's chief banking lawyer -- including concerns that Stanford was laundering money -- regulators granted sweeping powers never given to a private company.

The new company was also allowed to sell hundreds of millions in bank notes without allowing regulators to check for fraud.

What good are regulations if companies can be granted exemption from regulatory oversight?

Ethics and Ponzi schemes...

The NY Times published an interesting article that describes how many Madoff victims are upset because the trustee, Irving Picard, is not counting funds that were paper gains in Madoff's Ponzi scheme. This article does a good job illustrating how we often focus on how a decision affects us, personally, and ignore how it impacts others. When we fail to concern ourselves with how a decision affects others, we often behave in ways that are immoral or unethical. I try to help my students see how unethical behavior is selfish and takes from someone else. Here is a classic example from the NY Times article:

Put yourself, for a moment, in the shoes of a certain class of Madoff victim — what the trustee is calling “net winners.” These are the people who took out more money from their accounts than they put in. ... I’m talking about the Madoff investor who put in, say, $1 million and over a 15-year period withdrew $1.2 million.

On that person’s November 2008 statement — the last one before the fraud was exposed — she probably still had a very healthy balance, maybe $500,000 or more. It’s only natural that she views that balance as money that was hers — but that she has now sadly lost. To her, that money is real.

Now look at that same net winner from Mr. Picard’s point of view. In truth, that $500,000 doesn’t exist. After all, Mr. Madoff wasn’t really running an investment fund; he was running a Ponzi scheme. The steady returns, from which that $500,000 was supposedly generated, were fictitious.

“What they were getting was other people’s money,” said David J. Sheehan, a lawyer at Mr. Picard’s firm, Baker Hostetler. In other words, any money our hypothetical Madoff investor received came from the pockets of other Madoff investors, who were putting money into their accounts. That’s how Ponzi schemes work. And because that $500,000 never really existed, Mr. Picard has said he will not count it. He is going to count only how much actual money went into an account versus how much came out.

Perhaps if people would ask whether the latest "get rich quick" scheme that they are considering might be hurting another person, Ponzi schemes wouldn't be so prevalent in our society...

Behind Stanford's Back?

Stanford's number two man, former CFO James Davis, will plead guilty to the charges leveled against him. Stanford's lawyers respond by claiming that Mr. Davis acted without Mr. Stanford's knowledge (via Houston Chronicle):

“If Mr. Davis committed crimes, it was without the knowledge or approval of Allen Stanford, and Mr. Davis will have to answer for those crimes,” DeGuerin said. “It is human nature for a criminal to try to shift the blame for his own conduct in order to make a deal with the prosecution for a lesser sentence and to escape full responsibility for his crimes.”

Let’s assume for a second that Stanford had no knowledge of any wrongdoing by Mr. Davis (which, in my opinion, is highly doubtful). In such a situation, wouldn't it be grossly negligent of Stanford to have no knowledge of activities related to the core business of Stanford Financial Group?

Multimillion Dollar Legal Defense?

Before Allan Stanford can spend millions of dollars on his legal defense, he must prove that those funds are clean (via the Houston Chronicle):

A Dallas federal judge won’t release millions of dollars for R. Allen Stanford to pay his legal team unless Stanford can account for his assets and show that money he wants unfrozen isn’t tainted by the $7 billion fraud he is accused of running.

While Stanford deserves fair legal representation, I think this is a great move by the judge--Stanford shouldn't be able to spend a fortune on his defense with funds that may have been obtained through a Ponzi scheme.

Madoff's feeders reached all the way to Austria

The WSJ reported that prosecutors in the Madoff case are alleging that a fund manager in Austria, Sonja Kohn, received $40 million in kickbacks to feed Madoff's Ponzi scheme. As we've heard many times now, Mrs. Kohn claims that she is "actually the greatest Madoff victim."

Did Madoff have inside help?

Hot off the press from The Washington Post:

Genevievette Walker-Lightfoot, a lawyer in the SEC's Office of Compliance Inspections and Examinations, sent e-mails to a supervisor, saying information provided by Madoff during her review didn't add up and suggesting a set of questions to ask his firm, documents show. Several of these questions directly challenged Madoff activities that much later turned out to be elements of his massive fraud.

But with the agency under pressure to look for wrongdoing in the mutual fund industry, she wasn't able to continue pursuing Madoff, according to documents and two people familiar with the investigation, and her team soon concluded its work on the probe.

Walker-Lightfoot's supervisors on the case were Mark Donohue, then a branch chief in her department, and his boss, Eric Swanson, an assistant director of the department, said two people familiar with the investigation. Swanson later married Madoff's niece, and their relationship is now under review by the agency's inspector general, who is examining the SEC's handling of the Madoff case.

Getting to the bottom of the first ever "Madoff scheme" (the new phase for an outrageously large Ponzi scheme) may not happen in this life...

Beware of the scammers if you're looking for work.

The FTC announced a new push to crack down on the apparent increase in scammers who are preying on those who are looking for work. It seems that whenever troubles hit a group of people, scam artists see it as an opportunity to take advantage of someone. They offer some product or service that is bogus but is marketed to quickly and easily solve the victim's problems. This includes the unemployed, the elderly who have lost their retirement portfolios, even hurricane victims. Watch out for these shameless fraud perpetrators--they seem to be everywhere!

Sir Allen Stanford to stay jailed

The WSJ reported that the courts have decided that Allen Stanford needs to remain in jail until his court case is completed. The judge said:

"Stanford is a serious flight risk and there is no condition or combination of conditions of pretrial release that will reasonably assure his appearance as required for trial."

Apparently, evidence was presented to the judge that Stanford had a friend get his Antigua passport and bring it to him in Houston and that he had withdrawn $100 million from a Swiss bank account.

More on Satyam's Auditors

Following up on Satyam's auditors, the Times of India reports that Satyam was not audited by PwC (emphasis added):

The questioning of Ramesh Rajan, chairman and CEO of PricewaterhouseCoopers, India (PwC) by CBI last week, has revealed that the Satyam balance sheets were in fact audited by Lovelock & Lewes and not Price Waterhouse (PW). It is also learnt that the auditing fees, though deposited in the name of Price Waterhouse, Bangalore, was later transferred into the account of Lovelock & Lewes. "It is from here that the partners S Gopalakrishnan and Srinivas Talluri withdrew the money," sources involved in the investigation of the case told TOI.

Apart from Rajan, other senior partners of PW, from Delhi and Kolkata, were also summoned by the CBI last week. The partners denied any association with PW, Bangalore and said that Gopalakrishnan and Talluri were not entitled to sign any balance sheet on behalf of PW. "So as it turns out, the auditors who are partners with PW, Bangalore, wrongly signed under the name of PW, and also outsourced the work to Lovelock & Lewes," said sources adding that investigations confirm that the entire auditing team at Satyam is from Lovelock & Lewes.

I am left wondering how all of this could happen without the knowledge of PwC India...

Ruth Madoff breaks her silence.

Ruth Madoff issued a statement (see this link or the full statement below). Among other things, she implies that she is leaving him and has been devastated by the revelation of the fraud. Assuming she is sincere, it appears Bernie even deceived his wife for decades. What a guy! Here is her statement:

I am breaking my silence now, because my reluctance to speak has been interpreted as indifference or lack of sympathy for the victims of my husband Bernie's crime, which is exactly the opposite of the truth.

From the moment I learned from my husband that he had committed an enormous fraud, I have had two thoughts -- first, that so many people who trusted him would be ruined financially and emotionally, and second, that my life with the man I have known for over 50 years was over. Many of my husband's investors were my close friends and family. And in the days since December, I have read, with immense pain, the wrenching stories of people whose life savings have evaporated because of his crime.

My husband was the one we (and I include myself) respected and trusted with our lives and our livelihoods, often for many, many years, and who was respected in the securities industry as well. Then there is the other man who stunned us all with his confession and is responsible for this terrible situation in which so many now find themselves.

Lives have been upended and futures have been taken away. All those touched by this fraud feel betrayed; disbelieving the nightmare they woke to. I am embarrassed and ashamed. Like everyone else, I feel betrayed and confused. The man who committed this horrible fraud is not the man whom I have known for all these years.

In the end, to say that I feel devastated for the many whom my husband has destroyed is truly inadequate. Nothing I can say seems sufficient regarding the daily suffering that all those innocent people are enduring because of my husband. But if it matters to them at all, please know that not a day goes by when I don't ache over the stories that I have heard and read.

Mrs. Madoff's sacrifices and Bernie's prison sentence.

The WSJ reports that Mrs. Madoff has agreed to relinquish her fur coats (valued at $49k), linens and bedding ($18k) and silverware ($9k). Stripped of the means to stay warm, sleep, or eat, life will be burdensome for her now...

Meanwhile, another report says that Bernie was given the maximum sentence of 150 years. That sounds like a new precedent for white collar criminals.

Judge to decide if $500 k bail bond is enough to stop Stanford from fleeing

If he really is the mastermind behind a $7 billion Ponzi scheme, do you think he would be worried about losing $500k?

More on the $134.5 billion bond smuggers

Read this for a follow up to the counterfeit bond story posted on June 18th. In short, the bonds were obvious fakes, the Treasury Department is stumped by it all, the counterfeiters are free and nobody knows where they are!

A dozen years for a $50 billion Ponzi scheme

Get this, Madoff's attorneys are asking that Bernie be sentenced to a mere 12 years in prison for running the World's largest Ponzi Scheme (other than Social Security that is)! They are arguing that because Bernie turned himself in to his sons and is cooperating with officials, 12 years is sufficient. One of his attorneys, Ira Sorkin, also argued that because the norm is 15 years for white collar crimes, Bernie's sentence shouldn't deviate from that time frame by much.

Meanwhile, Bernie's prosecutors are asking for the maximum sentence for the crimes he has admitted to -- 150 years. They are arguing that since this fraud went on for a generation and was so enormous in scope that Bernie should get the maximum sentence. Apparently, Bernie's victims wrote numerous letters that appear to agree with the prosecutors.

Skepticism and Common Sense

While changes in financial regulation (both changes in enforcement and structure) may provide additional comfort to investors in this post-Madoff era, regulation will never eliminate the need for skepticism and common sense. Via BusinessWeek:

Right now, fraud is at the forefront of everyone's mind, and many investors are taking due diligence seriously. But even so, some advisers notice their clients slipping back into the sort of habits that got Madoff investors in trouble in the first place. Peter Turecek, a senior managing director at risk-consulting firm Kroll, says people are desperate to make back the money they lost in the past 18 months. That makes them susceptible to Madoff-like scams. "It's almost a catch-22," Turecek says.

Jason Thomas, chief investment officer at wealth manager Aspiriant, says he already has clients coming to him with investments that appear too good to be true. When he asks them why they want in, the answer is inevitably the same: A smart friend is making a bundle in it. It's human nature, Thomas says. "We're greedy," he says. "We don't want to be riding the bus. We want to be in the town car."

Investors would do well to remember not to let greed outweigh common sense and a healthy dose of skepticism when considering possible investment options.

The latest Madoff news...

Speaking of penalties for fraud perpetrators and their families, the Wall Street Journal just reported that Ruth Madoff, Bernie's wife, has agreed to give up about $80 million in assets while she will be able to keep $2.5 million in cash. I wonder if some of the many less fortunate victims of Madoff's $50 billion Ponzi scheme who are now broke would like to have $2.5 million in cash right now...

Penalties of Fraud

Fraud perpetrators can be especially difficult to prosecute. As a result, many fraudsters lose their jobs, but face little or no other repercussions. The fraudsters then get a job at a new company that usually has no idea that their new employee has been involved in suspicious behavior. The individual defrauds this new employer, gets fired and the cycle continues. Eventually the fraudster gets caught doing something that produces enough evidence to prosecute the individual. Many times, fraud prosecutions dig up a history of fraudulent behavior at several previous employers. By keeping the penalties for fraudulent acts fairly low, we encourage future frauds.

Because of this, I get concerned when I read the following (via LAT):

Los Angeles County’s top prosecutor has warned that a budget proposal by Gov. Arnold Schwarzenegger would so weaken court sentencing guidelines that if a swindler such as Bernard Madoff were to be brought to justice in California he would not face state prison time.

The soap opera fraudster: Danny Pang

Danny Pang is in the news again having reportedly taken $83 million from his firm before it was seized earlier this year. Watch out for this guy as he appears to leave dead bodies wherever he goes (literally)...

Election fraud in Iran -- check the digits...

A former student of mine, Dan Leslie, pointed out an article in The Washington Post that analyzes the frequency of the last two digits in the votes reported for the recent Iranian election to see if the vote counts appear random. The authors conclude that:

Each of these two tests provides strong evidence that the numbers released by Iran's Ministry of the Interior were manipulated. But taken together, they leave very little room for reasonable doubt. The probability that a fair election would produce both too few non-adjacent digits and the suspicious deviations in last-digit frequencies described earlier is less than .005. In other words, a bet that the numbers are clean is a one in two-hundred long shot.

As many fraud investigators know, digital analysis has been used to look for financial chicanery too. However, traditional digital analysis generally looks at the first two digits and compares them with Benford's Law to see if they are distributed randomly. The approach used to investigate election fraud is an interesting twist on digital analysis.

Ever heard of click fraud?

Check out this article to read about the latest evidence that whenever there is money involved there will be some fraud perpetrators trying to get it through unscrupulous means...

International Audit Quality

Among those charged in the Stanford fraud is a former chief of Antigua's financial regulatory commission. From USA Today:

Leroy King allegedly was paid more than $100,000 in bribes in exchange for his positive reports on Stanford's Antigua banking operation before it collapsed earlier this year, according to a federal indictment unsealed in Houston Friday.

Even though the U.S. Justice Department is stepping up FCPA enforcement, bribery seems to be becoming even more prevalent overseas. With businesses embracing a more global focus, audit firms must have the network and resources to service global clients. However, I imagine that audit firms face major challenges in ensuring audit quality overseas, especially in less-developed nations.

In many less-developed nations, audit firms face the prospect of hiring employees who have been raised in a culture that views bribery as acceptable. Also, accounting education may be of lower quality and audit standards may be less stringent in such countries. Further, because salaries are lower in less-developed nations, firm employees are more likely to be enticed by a bribe from a client.

Leroy King's alleged price, $100,000 in bribes, seems like a very small price to pay to keep a $7 billion fraud running. With huge incentives and a high likelihood of rationalization for international employees to accept bribes from clients, I hope that audit firms have been able to establish effective controls to ensure audit quality overseas. Perhaps the scarcity of cases where auditors have been accused of accepting bribes is indirect evidence that audit firms are able to prevent such behavior.

Madoff in the news again...

While Bernie Madoff awaits sentencing next week, the SEC has filed new charges against individuals who allegedly marketed Madoff's scheme to investors. The SEC's complaint released today states:

“Madoff cultivated an air of exclusivity by pretending that he was too successful to trouble himself with marketing to new investors,” said Robert Khuzami, Director of the SEC’s Division of Enforcement. “In fact, he needed a constant in-flow of funds to sustain his fraud, and used his secret control of Cohmad to obtain them.”

James Clarkson, Acting Director of the SEC’s New York Regional Office, added, “These Madoff solicitors collectively received several hundred million dollars in fees over the past few decades while Madoff ruined the finances of countless investors.”

You can read more about the charges here.

Richard Scrushy: crime doesn't always pay...

The largest financial penalty ever to be levied against a single executive has been given to 56 year-old Richard Scrushy for his role in the HealthSouth financial statement fraud--$2.88 billion! Scrushy managed to avoid criminal prosecution for the fraud when jurors bought into his claims that subordinates orchestrated the massive fraud without his knowledge.

The WSJ reports that the judge in the civil suit, Judge Horn, rejected those arguments and "said Mr. Scrushy either knew or should have known about the fraud, giving no credence to Mr. Scrushy's repeated insistence that subordinates perpetrated the scheme without his knowledge."

Scrushy is essentially broke now and has five years remaining in jail on a bribery conviction.

Sir Allen Stanford indicted

The latest news is reporting that Sir R. Allen Stanford was finally arrested by the FBI. Stanford is being indicted for running a massive Ponzi scheme involving the high yield certificates of deposit sold by his firm. A Houston grand jury will list the charges against Sir Allen later today.

The mystery remains...

Although it's been 10 days since the Italian government seized a briefcase containing $134.5 billion in U.S. Treasury bonds, we still don't know what the story behind these bonds is. AsiaNews.it is the only source I can find on the topic with two articles (June 12th and June 18th) that claim the two individuals carrying the bonds were set free! The most recent article also says the U.S. Treasury officials are now saying the bonds were counterfeit. Setting free two men who are carrying $134.5 billion in counterfeit bonds seems odd to say the least...

Something smells fishy...

The WSJ reports:

President Obama swept to office on the promise of a new kind of politics, but then how do you explain last week's dismissal of federal Inspector General Gerald Walpin for the crime of trying to protect taxpayer dollars? This is a case that smells of political favoritism and Chicago rules.

From the little I know about this situation, it sounds like Mr. Walpin was trying to protect taxpayer dollars in a time when taxpayer dollars are flowing out the door so fast that nobody knows where they are ending up! That sounds like sufficient cause for dismissal to me...

The largest counterfeit ever?

Two Japanese men were caught smuggling $134.5 billion in U.S. bonds at the border of Italy. The bonds look very authentic and date back several decades. Authorities are still trying to figure out whether they are counterfeit or real bonds. Treasury officials still have no comment. If counterfeit, these smugglers had access to some amazing technology to create the bonds. If real, no individuals held $134.5 billion in bonds and only four countries have that many bonds so it is likely China or Japan that was trying to dump some of their bonds and sold them. Also, Italian smuggling laws make is so Italy gets to keep 40% of the cash if the bonds are real! Fake or real, this is an amazing event. Any ideas why you aren't reading about it in every newspaper? Check out these links for more info: Asia News on June 8th and Glenn Beck on June 15th.

Fair-value accounting and fraud

The WSJ reported that:

Wells (Fargo)'s Boston-based mutual fund Evergreen Investment Management Co. agreed along with its brokerage unit to pay $40 million to end civil state and federal securities-fraud allegations that it overvalued the holdings of its Evergreen Ultra Short Opportunities Fund and then, when it was going to lower the value of the securities, informed only select investors -- many of them customers of an Evergeen affiliate -- allowing them to cash out of the fund and lessen their losses....

The Wells case highlights the valuing of securities as a key issue during the financial crisis as banks, hedge funds and now mutual funds have failed to take losses on their holdings even though there was evidence in the market these securities were trading at lower prices.

I wonder if Wells Fargo's settlement in this case involved the same people who were lobbying Congress to get the FASB to loosen the fair-value accounting rules for banks...

Great follow-up on yesterday's post...

A Colorado con man is revealed

This week's NY Times reports:

The thick-muscled man with close-cropped hair who called himself Rick Duncan seemed right out of central casting as a prop for a Democratic candidate running against Bush administration policies last fall.

Richard G. Strandlof, in his guise as Rick Duncan, an Iraq war veteran, appeared in campaign commercials for Hal Bidlack.

A former Marine Corps captain who suffered brain trauma from a roadside bomb in Iraq and was at the Pentagon during the Sept. 11 attacks. An advocate for veterans rights who opposed the war. An Annapolis graduate who was proudly gay. With his gold-plated credentials, he commanded the respect and attention of not just politicians, but also police chiefs, reporters and veterans advocates for the better part of two years.

Yet, except for his first name, virtually none of his story was true. In reality, he was Richard G. Strandlof, a charismatic drifter with a history of mental illness and petty crimes who had moved from Montana to Nevada to Colorado, assuming different names and identities along the way.

It's fascinating to me how some individuals seem to gain the confidence of everyone they meet. Ocassionally, individuals who have this charisma seem to thrive on telling tales that are bigger than life. When this happens in a hedge fund we see investors losing millions and even billions. In this case, it happened with an individual who claimed he was trying to do good. Others are not so sure now and wonder if he just liked the attention and power he was getting. Regardless of the reality in this case, it's a sad fact that we need to be skeptical of any individual who gains the confidence of all those around him or her. Watch out for the 'con' man who seems to effortlessly gain nearly everyone's confidence. They seem to be attracted to politics and business.