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..."