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to the judge that Stanford had a friend get his Antigua passport and bring it to him in Houston and that he had withdrawn $100 million from a Swiss bank account.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

The Board of Directors Club

I have been thinking about corporate governance and the role of the board of directors a great deal lately. My thoughts keep coming back to this post at the Harvard Law School Corporate Governance Blog. The post discusses a recent study on the appointment of CEOs as outside directors. Among other things, the study finds that, "The appointment of a CEO outside director helps certify the appointing company and its management, but it does not lead to measurable improvements in operating performance or corporate policies." Still, even though CEO directors add little (or nothing) to the corporate governance environment of the boards that they sit on, they are still highly sought after by firms.

We have recently posted on the need to get rid of moonlighters, and the shortage of truly independent directors. A host of other issues, such as executive compensation, would be reduced or perhaps solved by stronger governance from directors. So what needs to change in order to strengthen the governance of the board?

Perhaps one way we could improve upon our current situation is to increase the consequences of negligence. Ideally, stricter penalties for a failure in oversight would weed out directors who are not adding value to the corporation on behalf of the shareholders. Although firms may need to look outside of the 'club' for independent directors, the resulting increase in independence and oversight would go a long way toward reducing the occurrence of fraud.

Bride scams in China

While we are recovering from a real estate bubble that was at least partially fueled by government policies, China has a bubble of their own: an oversupply of unwed males leading to exorbitant prices for available brides. This WSJ article describes some of the scams that are resulting from this situation. I guess it shows that government intervention in life or markets can lead to all sorts of problems...

Fraud or tax planning?

The WSJ reported today that seven people have been charged criminally with fraud for selling tax "products" for over a decade starting in 1994. Denis Field, former BDO Seidman, LLP chairman, was among the seven charged with fraud. Mr. Field's lawyer expressed his disappointment in the charges and stated that Mr. Field "always believed that the transactions at issue in the indictment were legitimate tax planning." Now, I don't know if BDO's tax products were fraudulent or not but saying Field always believed they were legitimate is about like an embezzler saying he always planned to pay back the money! I think Mr. Field may want to get a new attorney!

Madoff Victims Want More

A group of Madoff victims have filed suit to change the way losses are being calculated in the fraud. Currently, losses are calculated as the difference between the total amount paid into the scheme and the total amount withdrawn. However, this group of victims believes that the current calculation is unfair. Via the NYT:

The customers say that, by law, they should be given credit for the full value of the securities shown on the last account statements they received before Mr. Madoff’s arrest in mid-December, even though they were bogus and none of the trades were ever made. According to court filings, those account balances add up to more than $64 billion.

The calculation of losses is especially relevant when considering eligibility requirements for SIPC compensation:

Customers who qualify are eligible for up to $500,000 in immediate compensation from SIPC. Those whose eligible losses exceed that amount would divide up the assets recovered by the trustee.

Thousands of long-term investors, including elderly people who lived for decades on withdrawals from their Madoff accounts, do not qualify for SIPC payments because they withdrew considerably more over time than they originally entrusted to Mr. Madoff, Barry Lax, a lawyer for the plaintiffs, said.

Aside from the fact that many of these individuals are undergoing serious hardships because of their losses, I don't see any possible justification for the calculation of losses based on fictitious gains. The bottom line: why should we give taxpayer dollars to individuals who profited from Madoff's Ponzi scheme?

Kozlowski's prophesy is realized...

The Wall Street Journal just reported that the U.S. Supreme Court ruled that a West Virginia judge had a conflict of interest in a case that involved a company that gave the justice over $3 million in campaign contributions. Given that the judge received these contributions, the court ruled that the judge's failure to recuse himself before overturning a lawsuit against the company needed to be rectified.

What is a bit shocking to me is that the ruling on the bench was 5-4. What were the other four justices thinking? My guess is that they never saw the classic movie "A Man for All Seasons" in which Sir Thomas Moore explains to Richard Rich that being a judge can involve incredible pressure in the form of bribes and that Rich should avoid those conflicts because he lacked the integrity that Moore exhibited when he gave his life on principle. In my opinion, Moore's life is an amazing story and "A Man for All Seasons" is one of the GREATEST movies ever filmed!

You may be asking: what does this have to do with fraud? Well it may only be indirectly applicable. More on point, however, is the news that the Supreme Court refused to hear appeals from Tyco's former executives, Dennis Kozlowski and Mark Swartz. It looks like Kozlowski's statement that "We have no perks, not even parking spaces" is now going to come true for several years as he lives out his life in jail. Maybe Kozlowski was prophesying...

The buck stops here: The Board of Directors

Corporate governance has long been a concern when massive corporate frauds come to light. Today, Boards of Directors are being criticized for their role in the subprime crisis. Ultimately, the Board is the highest level of control that can prevent or detect corporate malfeasance--whether it be fraud or other illegal business practices. An article in The New Yorker discusses the current state of corporate governance and suggests that Boards need to be much more than moonlighting opportunities for the CEO's friends. The article concludes by saying:

Right now, boards are made up of moonlighters. And, if the last few years have shown anything, it’s that protecting shareholder interests is a full-time job.

A private equity fund gets caught with its hand in the cookie jar...

The NY Times reports on a fraud at Archway and Mothers Cookie Company and, according to the article, private-equity firm, Catterton Partners, was taking out millions in management fees while doing very little to manage the company. Ultimately, the article suggests that the company was booking fraudulent sales and stuffing the distribution channels after its products deteriorated under Catterton's (mis)management.

The article describes one distributor's experience of receiving excess and damaged inventory during the period when the company was channel stuffing in order to boost its sales numbers to keep financing coming. This distributor summed up his view of Catterton's role in the failure of the Cookie Company by saying:

“What soured me on this experience is that these private equity firms that come in and buy companies don’t look at a company to grow it. Whether it sinks or swims doesn’t really matter to them ... They don’t think about the people whose livelihoods depend on that company. I hope I never have to go through that again.”

"Like bees to honey"

While much of the debate over our government's stimulus efforts has focused on the economic rationale for such programs and the resulting moral hazard, the discussion of the fraud opportunities created by the stimulus programs has been seemingly non-existent.

From the Boston Globe:

FBI director Robert Mueller says the government's stimulus package, including the Troubled Asset Relief Program, has "the potential to be the next wave" of cases the agency investigates.

"These funds are inherently vulnerable to bribery, fraud, conflicts of interest, and collusion," he said yesterday at the Economic Club of New York. "There is an old adage: Where there is money to be made, fraud is not far behind, like bees to honey." With trillions of dollars at stake, "even a small percentage of fraud would result in substantial, substantial taxpayer losses," he said.

Neil Barofsky, Special Inspector General for TARP has already launched over a dozen investigations into possible misuses of bailout funds. In addition, he said the following regarding the oversight of TARP (source):

Inadequate oversight and insufficient information about what companies are doing with the money leaves the program open to fraud, including "conflicts of interest facing fund managers, collusion between participants and vulnerabilities to money laundering,"

I almost wonder if some lawmaker, discussing oversight of the federal stimulus programs, said, "You know, I hear that Bernie Madoff has a great auditor," followed by, "I wonder if they are accepting new clients?"

As a footnote, anyone interested in getting a piece of the action should check out this EZ-CASH bailout application.

Making examples of Satyam's auditors

It looks like India's judicial system is a bit different than what we're used to here in the U.S. Two PricewaterhouseCoopers partners who worked on the Satyam audit have been in prison for four months while awaiting trial. The partners claim they had no idea of the fraud and that it was carefully concealed with fictitious documents. Apparently, the prison conditions are not exactly country club conditions either.

A New York Times article explains the partners' situation as follows:

The prison, opened in the 1800s, is surrounded by high watchtowers and a concrete wall. Behind its hulking, metal-studded front door live more than 900 men, held for crimes like pick-pocketing and murder. Then there are the two accountants....

The auditors, who are technically in “judicial custody,” are luckier than most prisoners here. Their wives can bring them food from outside during their twice-weekly visits. But they receive few other privileges. They sleep on the floor in a cell with other inmates, in temperatures that often exceed 100 degrees...

Accounting experts say that while authorities may be treating the PricewaterhouseCoopers partners particularly harshly, making an example of them may prevent more serious repercussions for the country’s economy and even the audit firm itself.

I wonder what they do when they catch terrorists in India...