Category: Fraud

The Stanford Fraud

stanford logo

Yesterday, the SEC filed a complaint against R. Allen Stanford and three of his companies: Antiguan-based Stanford International Bank, Houston-based broker-dealer and investment adviser Stanford Group Company, and investment adviser Stanford Capital Management.

Tuesday morning, the Wall Street Journal reported on Stanford Depositors head to Antigua or Redemptions. Word had gotten out that the authorities were investigating the Stanford International Bank and depositors were nervous.

They should have been nervous when they first made the investments. According to item 31 in the SEC complaint, SIB was offering very high rates of return on CDs. On November 28, 2008 SIB was offering a 5.375% rate on a 3 year CD, while other US banks were offering rates under 3.2%. At the same time, SIB was saying the investments were safe and invested in very liquid assets. [Investing 101. The greater the risk the greater the rate of return you should expect.]

Unfortunately it looks like the problem has been in place for years. According to the SEC complaint [item 4] , SIB had identical returns in 1995 and 1996.

Bruce Carton points out that one of Stanford’s own lawyers has emerged as a key figure in the matter: Attorney for Stanford’s “Disaffirmation” of Prior Statements Was Red Flag for SEC. Bruce cites a Bloomberg report that Thomas Sjoblom, a partner at law firm Proskauer Rose doing work for Stanford’s company’s Antigua affiliate, told authorities that he “disaffirmed” everything he had told them to date.

Felix Salmon, of Portfolio.com, first pointed the problems with Stanford International Bank on February 10: What’s Going On at Stanford International Bank? Felix noted that Stanford had very consistent returns that seemed to not be impacted by any of the gyrations of the market over the last few years. Feliz also dug up a report by Alex Dalmady that highlighted the problems.

I see many similarities to the Madoff scheme. The principal was well respected. (Antigua even bestowed knighthood on him.) Investors were promised safety. Investors were shown reasonable, consistent returns. The investment technique was obscure.

Unlike Mr. Madoff, it looks like Mr. Stanford took off in one of his private jets and authorities are still looking for him.

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Why Don’t Sanctions Deter Fraud?

Meric Craig Bloch theorizes that punishing people who are caught committing fraud is not an effective way to deter fraud. The reasons behind his theory:

  • Employees who commit fraud don’t anticipate getting caught. The threat of sanctions does not deter them because they don’t expect to face them. To deter them, you have to raise the “perception of detection” – people who believe they will be caught committing fraud are less likely to commit it.
  • Employees who commit fraud rationalize their conduct so that it seems legal or justified. They do not see their actions as wrong.
  • Because employees who commit fraud are primarily motivated by status, the greatest threat they face is that their crime will be detected.
  • Sanctions are reactive – you are punishing someone after the damage to the company has been done.

Is Your Organization Adequately Prepared to Fight Today’s Workplace Fraud?

EthicsPoint published this webinar focusing on proper and efficient investigations.

The presenter was Meric Craig Bloch, VP Compliance and Corporate Investigations of Adecco Group North America.

Meric predicted more fraud coming into the workplace as part of this down economy. Managers are focused on making their numbers and it is harder to do.

Profile of a fraudster:

  • Likely acts alone
  • Likely a male over 40
  • Has worked at the company for a number of years
  • Some college (and probably more) education
  • no criminal record
  • no history of job discipline

It is obvious from this that fraud risk is less on the person and more on the internal situation and pressures. The fraud triangle is a combination of:

  • opportunity – compliance programs are in place to remove opportunities
  • rationalization – when dissonance happens and gets justified as not stealing (for instance –  entitlement, revenge, minimal damage, everyone else is doing it)
  • pressure – how and when fraud happens when the pressure to commit fraud is greater than the pressure to not

In this down economy the pressure is increased. So we need to remove the opportunities.

What is the ideal opportunity for a fraudster:

  • weak internal controls or ability to override
  • Pressure to be dishonest
  • perceived reward is relatively high
  • perception of detection is low
  • potential penalty is low

What is the best way to respond

  • good internal controls
  • raise the perception of detection
  • manage pressures and incentives (this includes treated employees during layoffs and not setting difficult targets)
  • focus on identified risks
  • zero tolerance for fraud

Meric calls for doing a fraud risk assessment. Learn about the potential fraud risks inside your company and the impact on the external view of your company. You need to determine your own tolerance for fraud risk. You need assess both the likelihood and impact of the fraud. Then you can evaluate your internal controls to see if they are designed effectively and are they operating effectively. Then you need to address the residual risks that are not mitigated by existing controls or anti-fraud programs.

Meric points out that you need to take steps to detect fraud. One tool is a whistleblower hotline. But hotlines are passive. You need someone sufficiently motivated to pickup the phone and make the call. You should make fraud reporting a mandatory requirement.

Fraud generally continues until detected. Half of fraud schemes are discovered by accident.

Fraud allegations can come from many sources, so you should have a consistent protocol for investigating fraud. Your organization should have a best practice for investigations. You need to make sure the investigations are run consistently and are well-documented.

The investigator is not the police. As the investigator you need to think about the business needs. Your investigation should lead to process improvements and better internal controls.

One of the questions was how to prove ROI. Of course, compliance is all about preventing fraud and loss. So it is hard to show savings for events that did not happen.

Madoff in Limerick Form

freakonomicsFreakonomics ran a contest for the best definition for Bernie Madoff in limerick form.

They had special guest judge Chris J. Strolin, founder and editor-in-chief of The Omnificent English Dictionary In Limerick Form announce The Winning Definition of “Madoff,” in Limerick Form.

The best of the best was #98 by sqlman:

His investments’ ascent: like a rocket.
His method: his hand in your pocket.
His scheming: detested.
His freedom: arrested.
His future: a day on the docket.

With rhyme and meter perfect throughout, this limerick encapsulates a complex story in just five lines, giving the details very well and in an interesting format. This one shimmers!

Second place goes to #104 by The Tortoise:

The Madoff scam: what’s it about?
Paying Paul (and thus fending off doubt)
By robbing poor Peter;
And what could be neater?
But it palled when the funds petered out

Presenting a strong summing up of the situation, this limerick ends with double wordplay in the fifth line so elegant that I can overlook the lack of an ending period.

And lastly, the title of Miss Congeniality (a.k.a. third place) goes to #78 by Robin:

With Bernie’s cachet as the lure,
Even smart folks invested, quite sure
That with Madoff, funds grow
And sweet dividends flow.
Now they find themselves swindled … and poor.

More perfect rhyme and meter throughout and an accurate telling of the history of this event, but with an interesting pause for dramatic effect at the end — very nice touch!

U.S. Senate Hears About Madoff

On Tuesday, the U.S. Senate Committee on Banking, Housing, and Urban Affairs held a hearing on the background and implications of the Madoff scandal: Madoff Investment Securities Fraud: Regulatory and Oversight Concerns and the Need for Reform.

Video Archive

Member Statements

Witness Testimony

Madoff Liquidation and Suits Filed Against Madoff

On January 2, 2009, the trustee charged with liquidating Bernard Madoff Investment Securities, LLC issued a notice outlining the requirements for filing SIPC claims. Notice of Commencement of Liquidation Proceeding for Madoff Investment Securities

Anyone having a claim or potential claim against BMIS should read that notice. It provides that customers of BMIS must file their claims with the trustee on or prior to March 3, 2009 to receive the maximum protection.

It further provides that a first meeting of BMIS’s customers and creditors will be held on February 20, 2009, at 10:00 a.m., at the Auditorium at the United States Bankruptcy Court, Southern District of New York, One Bowling Green, New York, New York 10004.

The trustee also has established an official website [http://www.madofftrustee.com] to provide public information about the bankruptcy court proceeding.

Typical lawsuits that one might expect to see in a situation such as this one are those filed by investors against Madoff and his entities. The most notable of such actions filed to date include class actions Kellner v. Madoff [No. 08CV05026 (E.D.N.Y. filed Dec. 12, 2008)] and Chaleff v. Madoff ( No. 08CV08260 [C.D. Cal. filed Dec. 15, 2008)] and individual action Sciremammano v. Madoff [No. 08CV11332 (S.D.N.Y. filed Dec. 30, 2008)].

  • The Kellner case asserts a class action on behalf of all persons and entities who invested with Madoff, BMIS, or other selling agents affiliated with Madoff or BMIS, from as early as the formation of BMIS in the 1960s. The complaint alleges violations of the securities laws and related federal laws, including the Racketeer Influenced and Corrupt Organizations Act  and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, violations of New York General Business Law provisions concerning deceptive acts and practices, fraud, negligent misrepresentation, breach of fiduciary duty, conversion, and unjust enrichment.
  • In the Chaleff case, a class action was brought against Madoff, BMIS, Brighton Company and its general manager, Stanley Chais, alleging securities law violations on behalf of all persons or entities that invested through or in Chais or Brighton, had capital invested with Madoff or BMIS on December 12, 2008.
  • The plaintiffs in the Sciremammano case are individuals who began investing with Madoff in 1995. They seek injunctive relief to stop the alleged fraud and preserve assets, disgorgement of gains with interest, and civil monetary penalties. The alleged violations include fraud under the federal securities laws, fraudulent practices under New York state law, violations of the Investment Advisers Act of 1940, and breach of fiduciary duty.

Madoff Litigation: Can the Lost Billions be Recovered? How?

This post contains my notes from the webinar: Madoff Litigation: Can the Lost Billions be Recovered? How? The Webinar was sponsored by NERA Economic Consulting and produced by The Securities Docket. The slides are available on Securities Docket.com: Materials from Madoff Litigation Webcast.

Brad divides the world into those invested direftly through a Madoff account and those that invested through a feed fund or a fund of funds. The two groups of investors have different causes of actions and different approachs. Brad is representing both but focused his piece on direct investors.

The direct investors are in the worst position. Their biggest hope of recovery is from the SIPC. The limit is $500,000 for securities. The SIPC may also take the position that the limit is $100,000 (the cash limit) since Madoff apparently never invested in securities. Recovery is also limited to the dollars put in less the cash returned over time. Of course the direct investors will also have claims against the Madoff bankruptcy estate and should file a claim.

In an audience vote, 70% though Madoff should not be free on bail.

Gerald focuses on the issues arising from indirect Madoff investors.  The feeder funds offer a deep pocket for recovery. In the case of a limited partnership structure, they will need to prove gross negligence or willful misconduct. Recovery will be governed by the partnership agreement and related documents. The other problem is that the general partner may be able to use the assets of the limited partnership to defend and indemnify themselves.  You end up suing yourself.

Fred pointed out that there are lots of “losses”, but also lots of  “damages” and probably very little “recovery.” Among the factors are (1) choice of law, (2) allocation among the parties based on conduct and causation and (3) time at which damages are estimated. The starting point for damages is going to be the differences between the reported value on the account statement and the actual value of the securities in the account.

Losses Due to Fraudulent Reported Value = Loss on Subscriptions – Gain on Redemptions (similar to 10b-5 damage valuations)

Fred cites the case of Goldstein v. SEC (DC Cir. 2006):

If the investors are owed a fiduciary duty and the entityis also owed a fiduciary duty, then the adviser will inevitablyface conflicts of interest. Consider an investment adviser to ahedge fund that is about to go bankrupt. His advice to the fundwill likely include any and all measures to remain solvent. Hisadvice to an investor in the fund, however, would likely be tosell. …It simply cannot be the case that investment advisers are theservants of two masters in this way.

It was a great panel. Thanks to the panelists, sponsors and publishers of the webcast.

Irrational Exuberance

In an essay in the Wall Street Journal, Stephen Greenspan explains some of the psychology behind the success of Ponzi schemes: Why We Keep Falling For Financial Scams.

The basic mechanism explaining the success of Ponzi schemes is the tendency of humans to model their actions — especially when dealing with matters they don’t fully understand — on the behavior of other humans. This mechanism has been termed “irrational exuberance,” a phrase often attributed to former Federal Reserve chairman Alan Greenspan (no relation), but actually coined by another economist, Robert J. Shiller, who later wrote a book with that title. Mr. Shiller employs a social psychological explanation that he terms the “feedback loop theory of investor bubbles.” Simply stated, the fact that so many people seem to be making big profits on the investment, and telling others about their good fortune, makes the investment seem safe and too good to pass up.

In Mr. Shiller’s view, all investment crazes, even ones that are not fraudulent, can be explained by this theory. Two modern examples of that phenomenon are the Japanese real-estate bubble of the 1980s and the American dot-com bubble of the 1990s. Two 18th-century predecessors were the Mississippi Mania in France and the South Sea Bubble in England (so much for the idea of human progress).

Mr. Greenspan has model of four explanatory factors for “foolish action.”

  • situation – a social challenge you need to solve
  • cognition – a deficiency in knowledge and/or clear thinking
  • personality – trust and niceness
  • emotion – greed or the desire to not lose

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ponzi

Gullibility

NPR’s Science Friday has an interesting broadcast on Gullibility. Ira Flatow interview Stephen Greenspan, author of Annals of Gullibility: Why We Get Duped and How to Avoid It.

Can science explain why some swindles are so successful? Why are some people more likely to try to buy the Brooklyn Bridge or send money to the heir of a deposed Nigerian prince online? In this segment of Science Friday, we’ll talk about gullibility and the psychological principles at work in scams, from the $15 ‘genuine Rolex’ watch to the Bernard Madoff Ponzi scheme.

Mr. Greenspan was also the author of an essay in the Wall Street Journal: Why We Keep Falling for Financial Scams.

One memorable quote was his take on the Madoff scheme.  Mr. Greenspan point out that the scheme was not focused on greed. Madoff was not offering the high returns of typical Ponzi schemes. Instead, Madoff was offering a steady return. Madoff was offering safety. Mr. Greenspan points out that gullibility can be driven by the fear of losing money as much as it can be driven by the greed for money.

Professor Frankel Testifies In Congress

Boston University School of Law professor Tamar Frankel testified before the Committee on Financial Services of the U.S. House of Representatives discussing Ponzi schemes, the importance of trust in the securities markets and the need for regulatory reform in light of the Madoff scandal.

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