Category: Fraud

Lance Armstrong – A Lying Liar Just Like Madoff

sad lance armstrong

It’s tough to see a hero fall. I didn’t consider Lance Armstrong to be a hero for riding. But what he did for cancer survivors was remarkable.

Until recently, cycling was filthy with doping. Take a look at the podium finishers for the Tour de France. Only two of the podium finishers in the Tour de France from 1996 through 2005 have not been directly tied to likely doping through admission, sanctions, public investigation or exceeding the UCI hematocrit threshold. The sole exceptions are Bobby Julich – third place in 1998 and Fernando Escartin – third place in 1999.

I could forgive Armstrong for doping. It seems clear that everyone was doping. It leaves open the question of whether Armstrong was one of the greatest cyclists or merely one of the greatest dopers. We have no way of knowing whether his regime of doping merely leveled the playing field or elevated him above the level of his also doping competitors. Were his competitors lesser cyclists or merely less capable at doping?

What caught my attention about the Armstrong interview was the window into the mind of a pathological liar. Armstrong had been telling the lie over and over and over. He lied to the public. He lied to the press. He lied to cancer survivors. He lied under oath.

Beyond that, he attacked those who accused him of doping. He ruined the careers of journalists who dared accuse him of doping. He ruined the careers of riders who accused him of doping.

I put Mr. Armstrong in the same group as Bernie Madoff. Two men who lived their lies for decades. They both seem to regret that they got caught, not that they were lying and stealing money. Granted Mr. Armstrong’s theft was a bit more indirect.

I don’t believe most of what Mr. Armstrong told Oprah in the interview. He’s been lying too long to think that he is now telling the whole truth. But there may be bits of truth mixed in his interview. He did clearly admit to doping.

As with most pathological liars, Mr. Armstrong expressed more remorse that he was caught, than for the harm he caused. He found justification for his bad acts.

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Another Real Estate Ponzi Scheme

The Securities and Exchange Commission is claiming that Wayne L. Palmer and his firm, National Note of Utah, were operating a real estate-based Ponzi scheme that bilked $100 million from investors. U.S. District Judge Bruce Jenkins issued a temporary restraining order, froze the assets of National Note, and appointed attorney Wayne Klein as a receiver to take over the company’s operations.

So far, the statements in the SEC complaint have not been proven and Mr. Palmer is contesting the charges. As I have with other cases, I look at lessons from the filings, assuming they are true, to highlight issues that should be warning.

A first warning is the use of bank account names.

National Note investors initially deposit their funds into an account at JP Morgan Chase Bank titled “investor trust account.” National Note immediately wires nearly all these investor funds to an account at Wells Fargo titled “investor interest account.” National Note’s internal accounting classifies the investor funds as income upon transfer to the Wells Fargo investor interest account. From the Wells Fargo investor interest account, the funds are used to pay returns to other investors.

Why the need to fund interest payments? According to the SEC complaint, the Palmer companies only generated $300,000 in revenue and was obligated to pay $1 million in interest to not holders. Palmer was selling notes that paid a 12% interest rate.

Another warning sign is that the notes were marketed as guaranteed, with a complete safety of principal. The safest investment is US treasuries and it pays less than 2%. You can’t expect a 12% return to not have significant risk.

Another is his use of EMS  and CCFMB after his name. They are impressive acronyms, but I can’t figure out what they stand for. EMS typically stands for Emergency Medical Services, but that doesn’t sound right for a real estate professional. I searched LinkedIn for CCFMB and Mr. Palmer was the only person who came back.

Another warning is where the money from the sale of notes is being deployed. The claim is that it purchases real estate notes and real estate equity that generates returns of 15% to 20 annually. According to the complaint all of the capital is being deployed into related entities controlled by Palmer.

It looks like Palmer’s scheme unraveled in October 2011 when it failed to make interest payments. The complaint does not point out when Palmer’s business went from legitimate to Ponzi. The SEC goes as far back at 2009 when the scheme raised $18.6 million while paying back $14 million in investors.  Palmer has been in the real estate business for many years. So I’m skeptical that his operation has been a fraud from the outset. I would guess that he ran into trouble in 2008, just like everyone else on the planet. Rather than be honest and open about losses, he tried to cover them up and hope things would recover fast enough to dig him out of his hole.

Scott Frost, Paul Feindt, Matthew Himes and Alison Okinaka of the SEC’s Salt Lake Regional Office conducted the investigation; Thomas Melton will lead the litigation.

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Mortgage Fraud Rises in 2011

The Financial Crimes Enforcement Network released its full year 2011 update (.pdf) of mortgage loan fraud reported suspicious activity reports. It  reveals a 31% increase in submission.It also shows some of the trends that lead to the 2008 financial crisis.

Financial institutions submitted 92,028 MLF SARs in 2011, compared to 70,472 submitted in 2010. Financial institutions submitted 17,050 MLF SARs in the 2011 fourth quarter, a 9 percent decrease in filings over the same period in 2010 when financial institutions filed 18,759 MLF SARs. While too soon to call a trend, the fourth quarter of 2011 was the first time since the fourth quarter of 2010 when filings of MLF SARs had fallen from the previous year.

Since 2001, the number of mortgage loan fraud SARs has grown each year.

The report pins the sharp increase in 2011 on mortgage repurchase demands. Those demands prompted a review of mortgage loan origination files where filers discovered fraud. In 2011 a majority of the SAR filings related to fraud that was more than 4 years old. So this is the fraud leading up to the bubble now being detected.

Simply redo the chart by focusing on the year of the fraudulent activity instead of the date of filing.

You can see the rise in fraud tracking the heights of the real estate bubble in 2005 through 2008.

Going back to the 2011 reports:

  • 21% involved occupancy fraud, when borrowers claim a property is their primary residence instead of a second home or investment property
  • 18% involved income fraud, either overstating income to qualify for a larger mortgage or understating to qualify for hardship concessions.
  • 12% involved employment fraud

The up and coming frauds are related to the repercussions of the housing bubble.

Short sales are a source of fraud. SAR filers noted red flags in short sale contracts, such as language indicating that the property could be resold promptly, or “common flip verbiage” in the sales contract, or discovered that the “buyer’s
agent” was not a licensed realtor.

Several SAR filers described borrowers who “stripped” or removed valuable items from their foreclosed homes before vacating the premises. In one SAR, borrowers removed $33,000 worth of fixtures from the home, including major appliances and fixtures.

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Battling Back Against Spammers

The SEC posted a warning on Bogus E-Mail Purporting to be from SEC Office of the Whistleblower. The SEC’s Office of the Whistleblower is real; the e-mail is a hoax.

Earlier this week I received an angry email complaining about spam sent by me. That left me a bit confused because I don’t send out spam. It turns out a scumbag was sending around a fake message from the SEC’s Whistleblower Office:

Dear customer, Securities and Exchange Commission Whistleblower office has received complaint about alleged misconduct at your company, including Material misstatement or omission in a company’s public filings or financial statements, or a failure to file Municipal securities transactions or public pension plans, involving such financial products as private equity funds.

Failure to provide a response to this complaint within 21 day timeframe will result in Securities and Exchange Commission investigation against your company. You can have access to the complaint details in U.S. Securities and Exchange Commission Tips, Complaints, and Referrals portal under the following link …

It turns out the email was using a hotlink to a copy of the SEC logo I store on this website. So the email displays the SEC logo by pulling the image from Compliance Building.

My first action was to delete the image file. I don’t want to help the spammers. This left a little red “x” in the email indicating a missing image.

Then I noticed that the email was running rampant. My site stats tools did not pickup hotlinked image files. My webhost pointed me to the visitors log. That showed thousands of instances of that image file being accessed every hour.

I decided to change course and fight back. Since I know just enough html to get myself in trouble, I decided to change the image, but keep the same image file name and file path. I inserted the simple image you see at the top of this story.  Email recipients of the spam will see that image instead of the SEC logo. Hopefully that will make email much less effective.

In case you couldn’t follow, the spam email originally looked like this:

By changing the image file on my site, the spam email now looks like this:

I’m just sorry that I didn’t see the usage sooner. I also contacted the site that supposedly hosted the complaint details. They removed the offending file, hopefully putting an end to the mischief. The spam email seems to still be in wide circulation since I see that image file getting accessed so often.

Paperwork Dotted with Legal-Sounding Gibberish

Whenever you hear about a “prime bank” investment opportunity, walk away. A prime bank opportunity generally is described by the sponsor as an international investing program involving complex financial instruments that are too technical and complicated for non-experts to understand. If it’s too technical for you to invest why would you? – Astronomical returns are promised in exchange for secrecy about this lucrative international banking platform.

The SEC’s case against Frank L. Pavlico and his firm, The Milan Group, was just another prime bank scheme. It caught my eye because the SEC also brought charges against a lawyer involved in the scheme, Brynee K. Baylor.

What kept my attention was this quote from Stephen L. Cohen, Associate Director of the SEC’s Division of Enforcement:

“Pavlico and Baylor produced paperwork dotted with legal-sounding gibberish designed to deceive investors into believing this is a highly-sophisticated investment opportunity.”

And in the complaint:

“These documents were legal-sounding gibberish dotted with meaningless legal and financial terms that were designed to deceive investors into believing they were participants in a legitimate investment.”

A complaint by one of the deceived investors (.pdf) lays out what the scheme was offering. if the investor would deposit $325,000 into Baylor’s trust account Milan would provide a leased instrument with a value of $10 million. This would then be monetized and the resulting funds would be used to acquire a larger instrument.

These are just allegations, nothing has been proven and the defendants have not settled the charges.

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But the Computer Did It!

The Securities and Exchange Commission brought charges of securities fraud for concealing a significant error in the computer code of the quantitative investment model. I found this case to be interesting because it was not flawed human decisions, but flawed computer decisions. However, we still live in the age where computers do what we tell them to do. So, if the computer is doing something wrong, then a person is behind it.

Barr M. Rosenberg developed complex automated models and an “optimization” process to create and manage client portfolios. Barr Rosenberg Research Center LLC was the registered investment adviser. In April 2007, BRRC put into production a new version of the Risk Model, one component of its quantitative trading program. Two programmers linked the Risk Model to the Optimizer, a second component of the quantitative trading program. However, they made an error in the Optimizer’s computer code.

In June 2009, an employee noticed some unexpected results when comparing the new Risk Model to the existing one that was rolled out in April 2007. Some Risk Model components sent information to the Optimizer in decimals while other components reported information in percentages. That meant the Optimizer had to convert the decimal information to percentages in order to effectively consider all the information. That screwed up the inputs and the outputs resulting in the Optimizer not giving the intended weight to common factor risks.

As with most mistakes that lead to SEC action, the error caused the portfolios to underperform. The error impacted more than 600 client portfolios and caused approximately $217 million in losses. Obviously, this is a bad result.

The problems came, as they usually do, when someone tried to hide the problem. Mr. Rosenberg concealed the error and told his employees not to disclose the error to the investment officers or managers of the firm. That meant the firm was making material misrepresentations and omissions concerning the error to their clients, including:

(i) omitting to disclose the error and its impact on client performance,
(ii) attributing the Model’s underperformance to market volatility rather than the error, and
(iii) misrepresenting the Model’s ability to control risks.

The SEC charged Rosenberg with willful violations of  Sections 206(1) and 206(2) of the Investment Advisers Act. Section 206(1) prohibits any investment adviser from, directly or indirectly, “employing any device, scheme, or artifice to defraud any client or prospective client.” Section 206(2) prohibits any investment adviser from engaging in any “transaction, practice or course of business which operates as a fraud or deceit upon any client or prospective client.”

Rosenberg was aware of the problems, but did not disclose the error and directed others not to disclose. As a result, the firm misrepresented that the underperformance was attributable to factors other than the error and inaccurately stated that the model was functioning when in fact it was not. In addition, Rosenberg’s caused a delay in fixing the error leaving it uncorrected for several additional months. Rosenberg caused his clients to continue sustaining losses from an error that could have been promptly fixed.

Rosenberg has to pay the $2.5 million penalty fine and he received the ban from the SEC. He is barred from association with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization and prohibits him from serving as an officer, director or employee of a mutual fund.

Lesson learned. If the computer is broken, fix it right away. And don’t lie about it.

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Was Full Tilt Poker a Ponzi Scheme?

The United States Government forced online poker sites to the fringes of the financial system. The U.S. government has long argued that online poker gambling is illegal under the Wire Act, a 1961 law that explicitly prohibits sports betting conducted over electronic communication. In 2006, Congress made it illegal for financial institutions to process funds for online gambling.

It should be no surprise that an online poker site would run into legal problems. The complaint against Full TItle Poker caught my eye because

“By March 31, 2011, Full Tilt Poker owed approximately $390 million to players around the world, including approximately $150 million to United States players. However, the company had only approximately $60 million in its bank accounts.”

Many Ponzi schemes started off as legitimate enterprises. When funding shortfalls or an unexpected loss hits, the managers try to hide the bad news. This creates a spiraling downfall leading from poor management to criminal behavior. In this case, Full Tilt was having trouble moving the cash around the financial system to collect wagers from players and make payments to the winners. It sounds like Full Tilt was funding winnings without withdrawing initial bets from the player accounts.

But was it a Ponzi scheme? While there is no official definition of a Ponzi scheme, these are what I think are the elements:

(1) A promise of financial reward.

(2) Current contributions to the scheme are not invested, but are spent to make good on returns promised to earlier contributors.

(3) The manager of the scheme maintains his ability to pay the returns only by getting other contributors.

(4) The contributors think the manager is investing their contributions to make the return (not necessarily in a fully legal way).

(5) If future contributors do not arrive in sufficient numbers, the Ponzi scheme will have too little money to pay current returns/redemption.

Full Tilt was not an investment scheme. Sure you can argue about whether poker success is based on skill or luck, with luck being a key element of gambling. (I think it’s a combination of both.) But it’s not an investment and you are not buying a security. The contributors did not think the manager was doing anything with the money other than keeping it safe. They were winning or losing based on the hands the contributors played.

It does seem that current winnings were being paid from new contributions. According to the complaint, the mangers were taking more cash out than the business could support. The company had a funding shortfall because it was having trouble moving the wagers and winnings through the financial system.

You would hope that a leading federal prosecutor would know the difference between different types of fraud. Full Tilt was not a Ponzi scheme. As good as you may be at poker, your wagers are not investments.

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Is Madoff a Sociopath?

The New York magazine interview with Bernie Madoff has finally been published.  Steve Fishman spoke with Madoff on the phone (collect calls from Madoff’s prison) for several hours.

And so, sitting alone with his therapist, in the prison khakis he irons himself, he seeks reassurance. “Everybody on the outside kept claiming I was a sociopath,” Madoff told her one day. “I asked her, ‘Am I a sociopath?’ ” He waited expectantly, his eyelids squeezing open and shut, that famous tic. “She said, ‘You’re absolutely not a sociopath. You have morals. You have remorse.’ ” Madoff paused as he related this. His voice settled. He said to me, “I am a good person.”

There aren’t many who would agree.

According the the interview, Madoff was already a wealthy man before he starting stealing from his clients and lying about their investments.

In the early days, Madoff mostly employed technical and fairly low-risk arbitrage techniques built around his market-making business. “I always had a good feel for the direction of the market because of the order flow I was seeing,” he said. In the eighties, he said, he produced consistent returns of 15 to 20 percent, and he insists he did it legally.

To me it sounds a bit like he was taking advantage of his trading business to help out his investment advisory business. Madoff had long been suspected of front-running trades to make money for his advisory business.

In the interview, he claims that the fraud started after the crash of 1987. Clients pulled out capital and he was forced to unwind long-term hedges on unfavorable terms. Then his trading scheme was no longer working because the market lacked the volatility needed for his arbitrage. And because trading spreads were narrowing because of the rise of electronic exchanges.

In the interview, Madoff displays some of the classic criminological behaviors of a fraudster.

He blames his victims: “Madoff says that he waved red flags, issued caveats that should have been obvious to even an unsophisticated investor.”

He denies his victims: “Everyone was greedy,” he continues. “I just went along. It’s not an excuse.” “Look, none of my clients, even if they lost every penny they put in there, can plead poverty.” In the tapes he claims that very few of the early investors will have lost their invested capital.

He condemns his condemners: “The whole new regulatory reform is a joke. The whole government is a Ponzi scheme.”

He claims everyone else is doing it: “It’s unbelievable, Goldman … no one has any criminal convictions.”

I think Madoff’s prison therapist told him the wrong answer. Or Madoff lied to Fishman about the therapist response.

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The Amish Madoff

The Securities and Exchange Commission filed charges against Monroe L. Beachy, a 77-year-old Amish man from Sugarcreek, Ohio. They found the Bernie Madoff of the Amish.

Beachy targeted his fellow Amish in his alleged fraud. He raised more than $33 million from as early as 1986. Beachy enticed investors by promising interest rates that were greater than banks were offering at the time. Beachy told his investors that their money would be used to purchase risk-free U.S. government securities. Many of Beachy’s investors treated their investment accounts with Beachy like money market accounts, from which they could withdraw their money at any time. In reality, Beachy used the money to make speculative investments in junk bonds, mutual funds, and stocks.

By the time Mr. Beachy filed for bankruptcy in June 2010, less than $18 million of the original $33 million of investor money remained.

I would guess that Beachy started off doing the right thing, but made a bad investment along the way. Rather than be honest with his investors, he took greater risks to try and make back the earlier loss, missing again and again.

Like Madoff, it sounds like he was offering a modest rate of return. That would allow this Ponzi scheme to go on longer and longer.

Like Madoff, the fraud continued for decades. Because of the length of Mr. Beachy’s alleged scheme, generations of families were affected. Older generations of Amish investors would referred their children to Beachy.

Unlike Madoff, Beachy had actually invested the money. Just not in the safe investments he promised to his investors.

UPDATED: The Washington Post has a great story with some background on the fraud: In an Amish village, the SEC alleges a Madoff-like fraud by David S. Hilzenrath.

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Amish Buggy Sign is by Daniel Schwen

It Has a Name: Operation Broken Trust

Apparently, many of the recent financial fraud actions in the news have been part of a nationwide operation organized by the Financial Fraud Enforcement Task Force to target investment fraud: Operation Broken Trust.

“To date, the operation has involved enforcement actions against 343 criminal defendants and 189 civil defendants for fraud schemes that harmed more than 120,000 victims throughout the country. The operation’s criminal cases involved more than $8.3 billion in estimated losses and the civil cases involved estimated losses of more than $2.1 billion. … Starting on Aug. 16, 2010, within a three-and-a-half month period, Operation Broken Trust involved 231 criminal cases and 60 civil enforcement actions. Eighty-seven defendants have been sentenced to prison, including several sentences of more than 20 years in prison.”