Wednesday, September 23, 2009

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?

Tuesday, September 22, 2009

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.

Monday, September 21, 2009

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...

Sunday, September 20, 2009

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!"

Saturday, September 19, 2009

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...

Monday, September 7, 2009

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.”

Saturday, September 5, 2009

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.

Tuesday, September 1, 2009

"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!