An interesting twist

Here's an interesting case: Two lawyers were found guilty of fraud when they tried to obtain fraudulent claims for their clients. The WSJ reports:

The jury found that William Guy and Thomas Brock committed fraud as part of an asbestos lawsuit they filed in 2001 against Illinois Central Railroad Co. The jurors concluded that the lawyers knew their clients had lied about taking part in an earlier asbestos suit. And they ordered the lawyers to pay $210,000 in actual damages and—turnabout is fair play—a further $210,000 in punitive damages to Illinois Central.

Is Bernie enjoying the life of a cushy white-collar prisoner?

Mark Morze was the ZZZZ Best fraud perpetrator who could play the copy machine like Horowitz played the piano. He created about 10,000 fictitious documents to support Barry Minkow's fraudulent carpet cleaning and restoration business. Morze ended up serving five years in federal prison. I once read an article documenting his experience of prison life. Here is a quote:

With a five-year sentence to serve, Morze expected an early parole from a plush, white-collar prison/resort complete with golf course and tennis courts, a la Erlichman and Haldemann of the Watergate scandal. But reality didn't jibe with expectation. He got five long years of sleepless nights, living in fear of routine prison stabbings, rapes, and assaults at Lompoc prison, Lompoc, Calif.

"Gangs control everything," Morze said. "Guards don't run prisons, the inmates run them. The guards just keep you from escaping."

An article in today's WSJ suggests that Bernie Madoff is having a similar prison experience. Here is an excerpt:

Mr. Madoff was treated for a broken nose, fractured ribs and cuts to his head and face, according to a felon currently at Butner serving time on drug charges who was familiar with his condition at the time. ... Another inmate who recently was released from Butner after serving time on drug charges also confirmed the assault, as did a third person familiar with Mr. Madoff's situation. The former inmate said the dispute centered on money the assailant thought he was owed by Mr. Madoff.

It's tragic that fraud perpetrators have to learn critical lessons of life the hard way all the while leaving a wake of suffering victims behind them as they eventually enter a life of misery themselves. Fraud may pay in the short run but it never pays in the long run!

U.S. Connections to Corruption in Haiti

An investigation by Mary Anastasia O'Grady shows U.S. political connections to corruption in Haiti (see a video here and the article here). I've personally been to Haiti twice and found the people to be hard working but destitute. When I saw the work ethic of may Haitians, I wondered why businesses can't come in and put these people to work and help their economy. The unemployment rate at the time was about 80% and the average wage was $2 per day.

I quickly saw that because of corruption in government, businesses would never get their profits from Haiti. As such, the Haitian people are suffering tremendously. In talking with many Haitians, I also found out that many of them believed that our government had wronged them in the past and it led to much of their troubles. This article confirms these beliefs and suggests that at least one of the individuals given responsibility for overseeing aid to Haiti was connected to this corruption: President Bill Clinton.

I don't claim to know all that has happened in Haiti over the years but this investigation suggests that U.S. politicians were behind some of the corruption that has crippled that country for decades. I am very troubled by the suffering that has existed in Haiti for decades and is only now in the spotlight with the January earthquake.

What I really wonder is how people can sleep at night knowing that they are taking money out of one of the poorest nations on earth where millions of orphans, widows and others are starving. How tragic.

Skilling and the Supreme Court

The LA Times has more information on the Skilling appeal to the Supreme Court. Based on this article, it appears that Skilling has a good chance of getting a reduced sentence because of a vague law called the "honest services" law. Whether he has a chance of being set free is unclear in my opinion. Here are a few key quotes:

The justices, both conservatives and liberals, agree on the principle that a criminal law must clearly state what is a crime. And the law that makes it a crime to "scheme . . . to deprive another of the intangible right of honest services" is anything but clear.

During Monday's argument, a lawyer for Skilling said that under the government's approach, it could be a crime for an employer to use an office computer for his personal use.

... It was the third time in recent months the justices have voiced doubt about the "honest services" law. However, even if part of Skilling's conviction were overturned, government lawyers say some of his conviction for securities fraud should stand.

FraudBytes is now on Twitter

For all of you Twitter addicts out there, we have created a FraudBytes Twitter account that will automatically update every time we post to the blog.  Follow us here.

First Case of Alleged Bailout Fraud

USA Today reports that ex-bank president Charles Antonucci has become the first person charged of attempting to defraud the federal bailout program (note: this should not surprise any regular FraudBytes readers).  According to the article:

Among other allegations, Antonucci was accused of using false information to request $11.3 million from the federal government's TARP bank bailout program.

...Antonucci lied to banking authorities in late 2008 and early 2009 to make them believe he had invested $6.5 million of his own money in the bank when the money actually belonged to the bank and had merely been moved around to make it seem as if it came from Antonucci.

The prosecutor said it was the "functional equivalent of Monopoly money" and was meant to convince federal authorities he should qualify for TARP money, a program to aid struggling banks that was announced on Oct. 14, 2008.

Fortunately, this story didn’t end in a huge loss for the federal government--Antonucci's TARP application was denied:

After the application for TARP money was rejected on Feb. 24, 2009, Antonucci did a media interview in March 2009 in which he said the bank withdrew its application because of "issues" with the TARP program and a desire to avoid "market perception" that bad banks take TARP money, the complaint said.

Federal authorities say Antonucci actually wanted to obtain millions of dollars for his own use, in part so he could obtain a controlling interest in the bank.

Score one for federal oversight!  Still, I wouldn't be surprised if we start seeing many other similar headlines, with less fortunate endings, in the days to come.

More on Repo 105

This article in the Economist has a very interesting note about the questionable Repo 105 transactions that Lehman used to improve its balance sheet (thanks, Brian White, for the link):

Mr Valukas marshals plenty of evidence to back up his claim that “Lehman painted a misleading picture of its financial condition”. The effect of Repo 105 was material: the firm temporarily removed around $50 billion-worth of assets at the end of the first and second quarters of 2008, a time when market jitters about its leverage were pervasive (see table below). Mr Valukas can see no legitimate business reason to undertake the transaction, which was more expensive than a normal repo financing and had to be done through its London-based arm because Lehman was unable to get an American lawyer to agree that Repo 105 involved a true sale of assets. [emphasis added]

This doesn't necessarily mean the transactions were in violation of U.S. GAAP, but it definitely makes the Repo 105 transactions look even more shady (I am not an expert on SFAS 140, the accounting rule Lehman used to justify the reclassification of Repo 105 transactions as a "true sale of assets", but it is very possible that the transactions only needed to qualify as a sale of assets in the country where they were being conducted).

Buyer's Denial

The Times has a great article about buyers denial: "[The] belief that somehow a fraud was not what it seemed to be, and that there was still a way to avoid losing the money the victim had foolishly invested."  The article centers on victims of a fraud involving a company called CMKM Diamonds:

Several shareholders in CMKM — some of whom kept buying shares after the government exposed the fraud — want 10 current and former commissioners of the Securities and Exchange Commission to pay them $3.87 trillion, an amount equal to about half the United States government debt in public hands. You might think that would be enough, but the suit claims those are merely compensatory damages. They also want punitive damages, but do not cite a figure.

That is an impressive amount for a company whose last published balance sheet showed total assets of $344. That is dollars, not millions.

The tale the shareholders tell, in a lawsuit filed in January in federal district court in Santa Ana, Calif., is of a conspiracy involving not just the S.E.C., but also the Justice Department and the Department of Homeland Security. 

The article as a whole is worth reading.  Indeed, many fraud victims seem to go through an incredible amount of motivated reasoning in order to avoid facing the reality of having been duped.  Perhaps motivated reasoning is what got them in the fraud in the first place, making them more likely to engage in further motivated reasoning when confronted with evidence that they have invested in a fraud? 

Most crooked CEOs

Time Magazine online lists their top ten most crooked CEOs (Criminal Executive Officers). At the top of the list is Bernie Madoff. Also on the list are the CEOs of the major financial statement frauds of the past decade including Enron's Lay and Skilling (2nd), Tyco's Kozlowski (3rd), Adelphia's Rigas (4th) and WorldCom's Ebbers (10th).

Will Harry be the next SEC Chairman?

I doubt it. Here is a link that explains Harry Markopols' (famed Madoff investigator) challenges in getting that, apparently, coveted post. According to the WSJ, Professor John Coffee from Columbia University said that Harry "...is what the commission needs only if the commission needs an emotionally unstable idiot savant...You cannot be serious." Come on Professor Coffee, tell us what you really think!!!

Lehman and EY: Maybe I spoke too soon...

In my Fraud Examination yesterday we talked about how the audit profession appears to have learned from the last economic crisis when it was heavily criticized for inadequate audit work in the frauds that came to light around the turn of the millennium. My comment was that so far, it appears that the fingers of blame for the fiascoes leading to the "Great Recession" were not pointing much toward the audit profession. Some potential exceptions include the Madoff feeder fund audits and the New Century/KPMG situation but I concluded that the auditor finger pointing is not nearly as serious this time as it was at the turn of the millennium.

Today I'm wondering if I should have waited a few hours to make such a comment since a new report was issued about the time I was in class yesterday. This report details the Lehman Brothers collapse and is very critical of EY's audits.

(You can read the 2,200 page report online; I've search for Ernst and found the examiner is very critical of the EY's audits. Also, there are numerous articles about the report and EY's role in the collapse including the WSJ and Huffington Post.)

Suffice it to say that this report says EY failed to meet professional auditing responsibilities. The issue revolves around inappropriate repurchase transactions, known as Repo 105 transactions, used to make Lehman look like it was in better condition than it really was. The report says that Lehman used these Repo 105

... transactions to temporarily remove $50 billion of assets from its balance sheet at first and second quarter ends in 2008 so that it could report significantly lower net leverage numbers than reality.

Lehman did so despite its understanding that none of its peers used similar accounting at that time to arrive at their leverage numbers, to which Lehman would be compared...

The examiner alleges that EY was told about concerns that these transactions were inappropriate but they failed to report the concerns to the Board or to adequately investigate the propriety of the transactions.

One of many damaging quotes from the report is:

There are colorable claims against Lehman's external auditor Ernst & Young for, among other things, its failure to question and challenge improper or inadequate disclosures in those financial statements.

The report explains:

In May 2008, a Lehman Senior Vice President, Matthew Lee, wrote a letter to management alleging accounting improprieties; in the course of investigating the allegations, Ernst & Young was advised by Lee on June 12, 2008 that Lehman used $50 billion of Repo 105 transactions to temporarily move assets off balance sheet and quarter end.

The next day ‐- on June 13, 2008 ‐- Ernst & Young met with the Lehman Board Audit Committee but did not advise it about Lee's assertions, despite an express direction from the Committee to advise on all allegations raised by Lee.

Ernst & Young took virtually no action to investigate the Repo 105 allegations. Ernst & Young took no steps to question or challenge the non‐disclosure by Lehman of its use of $50 billion of temporary, off‐balance sheet transactions.

Colorable claims exist that Ernst & Young did not meet professional standards, both in investigating Lee's allegations and in connection with its audit and review of Lehman's financial statements.

My guess is that now that the report has been out for more than half a day now, 25 or more class action lawsuits have been filed against EY. A report this critical is an invitation to file such lawsuits.

I was hoping that since these particular transactions were not part of last annual audit opinion (since Lehman imploded before the 2008 financial statements were issued), that EY's role may be limited. However, it appears that the transactions date back to the 4th quarter of 2007 and affected the amounts that were audited by EY (see chart at this link). In addition, quarterly 2008 filings that were reviewed by EY were involved. As such, the question to be resolved is what should EY have done when told about these transactions? Apparently, the examiner felt they didn't do their job.

This report is definitely unsettling and the ultimate responsibility of EY in the Lehman situation will likely take months, or even years, to determine. In the meantime, I'll be more careful with my comments about the audit profession's role when the next round of economic turmoil comes to light.

Madoff victims beware...

I can't believe the nerve of some fraudsters out there! A recent WSJ article reported that a fake SIPC (Securities Investor Protection Corp) website is defrauding victims of the Madoff fraud. They are contacting Madoff victims and telling them that they are the real SIPC and need their information to process claims. They then steal the victims' identities and inflict pain on these individuals who just lost a good chunk or all of their life savings! Another sad testament that wherever there is money there are greedy lifeforms that are trying to get it!

Psychics beware: The SEC has your number!

A recent NY Times article gives some details of a lawsuit by the SEC against a psychic who claimed he could predict the stock market by looking into the future. The suit says that Sean David Morton took more than $6 million from investors with promises of “piles of money,” and spiritual happiness. The article says Morton "calls himself 'America’s Prophet' and says he was "trained by Nepalese monks in the art of time travel."

Morton is quoted as saying:

“I have called ALL the highs and lows of the market giving EXACT DATES for rises and crashes over the last 14 years,”

I wonder if Morton knew this lawsuit was coming?!

Winners and Losers in the Madoff Scam...

The WSJ reported yesterday that the courts are deciding whether investors in Madoff's Ponzi scheme who took out more money than they put in should be able to collect recovered funds. The trustee is arguing that any recovered funds should be given to those who took out less than they put in since their funds were already given to the net winners. The article points out that if net winners are also given a share of the recovered funds then this means less funds will go to the net losers. Since, no net loser will ever break even after it's all said and done, the net winners will be better off than the net losers even if they had to forfeit any amounts they received above their investment. The amazing thing is that this has to be debated in court! I think the real net winners are the attorneys who are fueling the arguments!

Could Skilling be set free?

Today's WSJ reported that the U.S. Supreme Court has agreed to hear arguments that Jeffrey Skilling's trial for fraud at Enron was not fair since it took place in Houston. The juror selection process appears to have been weak. I guess we'll have to see if Skilling will be set free by the Supreme Court.

Was Harry paranoid?

Fortune magazine has excerpts from an interesting interview with Harry Markopolos, the guy who tried to blow the whistle on Bernie Madoff. Harry is definitely an interesting personality. He talks about having to be undercover these days since he's now famous. He also talks about looking under his car for bombs because he feared Madoff may try to kill him. At one point the interviewer asks him if he was being overly paranoid. He explains that his wife was expecting twin boys and he wanted to make sure they had a father. Well, nobody said being a fraud examiner and a whistleblower was easy or without risks!