FraudBytes

Doping in Cycling: Some News that Caught My Eye

noreply@blogger.com (MZ) — Mon, 23 Jan 2012 17:06:00 +0000

Today has two strange stories about cyclists who have been linked to doping that I just couldn't resist commenting on...
The first one is a story about a 19 year old Cat 3 amateur who rides for a feeder team in France. It's a sad story to hear this young guy is risking his future health as a Cat 3. If he can't become a Cat 2 racer without taking 12 doping substances he might want to look for other career options, assuming he has some. A friend suggested that cycling races ought to be categorized by IQ and let this guy race against the likes of Riccardo Ricco and other brilliant dopers...

The second story is about the infamous steak eater, Alberto Contador. As you know Contador was found with a banned substance in his blood during the Tour de France and he is blaming a tainted steak on this violation. Clenbuterol is known for helping produce lean muscle mass. Today's article says Contador has gained over 16 lbs. since last-year's Tour de France. That's a massive amount for any cyclist, let alone a climber who wins by being light and strong. I expect Contador to hold another press conference to explain that when you quit eating steak accidentally tainted with clenbuterol, extra weight goes on quickly...

Another Link Dump

noreply@blogger.com (Aaron) — Fri, 20 Jan 2012 19:25:00 +0000

Here are a few more links to keep you up to date on the latest fraud-related news:

Trial Set for Financier Accused in Decades-Long Ponzi Scheme--Despite continuing excuses from his lawyers, Allen Stanford's trial is set to begin next week. Amazingly, it has taken three years to get to this point.

Panel Clears Accounting Firms in Olympus Fraud--An unofficial panel of experts has declared KPMG and E&Y free from responsibility for the Olympus Fraud. The firms aren't yet in the clear, as Japan's Financial Services Agency is conducting a separate investigation and the firm may be subject to sanctions by Japanese regulators. However, investigations that absolve auditors of responsibility in a financial statement fraud seem to be extremely rare, so maybe this is a positive sign (or maybe the panel has some incentive to give audit firms a clean bill of health so Olympus can retain an audit firm and avoid delisted from the Tokyo Stock Exchange).

Mets Owners Can Look Forward to Trial During Spring Training--The case against the Mets owners continues to march toward trial and a settlement looks increasingly unlikely. Looks like we'll be revisiting the issue in March, when we will likely see a jury scrutinize the Mets owners' dealings with Bernie Madoff.

Mozilo Tied to Loan to Top Lawmaker--The lack of investigations into improprieties related to the housing crisis has been surprising, to say the least. Angelo Mozilo already agreed to a $67.5 million settlement with the SEC related to civil fraud and insider trading charges. This latest report suggests that lawmakers may have received preferential treatment from Mozilo when obtaining loans from Countrywide.

Contador Investigation: Expect Alberto to be found Innocent

noreply@blogger.com (MZ) — Thu, 12 Jan 2012 01:22:00 +0000

VeloNews is reporting that WADA lawyers have threatened to walk out of the Alberto Contador hearing which is supposed to rule this week whether the Spaniard will be found to have violated doping rules. Contador has a lot riding on this ruling (no pun intended) since the rule states that any clenbuterol found in his system is a violation that will cause him to lose his Tour de France title and ban him for up to two years. As we've covered on Fraudbytes previously, Contador claims he got the steroid from eating tainted beef during the tour.

The VeloNews article is short and highlights several claims by an anonymous source that Contador has biased the arbitration process in his favor. If you're interested in why WADA is so frustrated by this hearing, I'd recommend reading the article.

Lance Armstrong Investigation: LiveStrong Brought to Light

noreply@blogger.com (MZ) — Mon, 09 Jan 2012 16:59:00 +0000

Outdoor Magazine published an extensive article on Lance Armstrong's LiveStrong Foundation today. I know they have been working on this for a while since the author, Bill Gifford, first contacted me in May 2011. Interestingly, I received several phone calls from investigative reporters around the same time--undoubtedly because they found these posts of interest.

As far as I can tell, Gifford's article is the first one to hit the press. His article notes why this may be the case by saying:

At least two other major publications have done serious reporting on Livestrong—that is, they started to. In both cases, Livestrong lawyers succeeded in shutting down the stories before they were published. They applied the same pressures to Outside, blitzing my editors with pissed-off e-mails, phone calls, and, eventually, a five-page letter from general counsel Mona Patel complaining about “Mr. Gifford’s conduct, professionalism, and method of reporting.” One of my crimes was a failed attempt to get a source to talk off the record, an ordinary journalistic practice. All of which now makes me wonder if I missed something.

I recommend reading the article if you're interested in LiveStrong and Lance. For those who want to get a flavor of the article, here are a few highlights that summarize the main conclusions:
The header summarizes it well as follows:

If Lance Armstrong went to jail and Livestrong went away, that would be a huge setback in our war against cancer, right? Not exactly, because the famous nonprofit donates almost nothing to scientific research. Bill Gifford looks at where the money goes and finds a mix of fine ideas, millions of dollars aimed at “awareness,” and a few very blurry lines.

Gifford begins by describing an angry, threatening phone call he got from Lance and, as Gifford notes, LiveStrong's "$320,000-a-year" CEO, Doug Ulman. Apparently, Lance and Ulman called to berate his work because Gifford tweeted about Lance in a way that they found offensive. (I have yet to receive any of these calls and some reporters who have called me have been surprised. I'll let you know if I do!) After reviewing the 60 Minutes expose' on Three Cups of Tea, Gifford turns to the crux of the issue with LiveStrong:

Others noticed an annoying tendency: whenever questions about doping arose, Armstrong and his supporters changed the subject to his cancer work, a tactic that the bicycling website NY Velocity called “raising the cancer shield.” After the 60 Minutes segment on Armstrong aired in May—complete with damning claims from ex-teammate Tyler Hamilton that Armstrong had cheated—Armstrong’s lawyers denied the allegations and quickly invoked Livestrong in his defense. In their one legal brief to date, they blasted the feds over alleged leaks to 60 Minutes that, they said, were intended to legitimize “the government’s investigation of a national hero, best known for his role in the fight against cancer.”

But what did that fight amount to? Did Livestrong actually do much to eradicate cancer, or did it exist largely to promote Lance? If and when any indictments came down, would his good deeds help him escape conviction or jail time? It seemed likely that this theme could come up. Barry Bonds’s lawyers recently asked for probation instead of prison time as punishment for the baseball star’s 2011 Balco conviction, citing his “significant history of charitable, civic, and prior good works.”

Gifford ultimately admits that after visiting LiveStrong he could not find any hard evidence of serious wrongdoing. As noted earlier, he also wonders if he missed something because of the way he was threatened by Lance's forces. Even so, this paragraph summarizes his search for the possibility that Lance was using LiveStrong as a personal piggy bank:

The financial records appear to back up Armstrong’s assertion, and if there’s a more nefarious reality behind the curtain, it may take someone with subpoena power to bring it to light. In addition to Novitzky’s investigation, the IRS examined the foundation’s 2006 returns, although Livestrong officials say it was a routine review.

As alluded to in the summary quoted above, Gifford does find, however, that LiveStrong doesn't provide funding for cancer research. He notes that the erroneous belief that LiveStrong does support research is perpetuated by Lance and others. He provides many examples to support his claim that "Armstrong and his supporters help perpetuate the notion that they are, in fact, helping battle cancer in the lab." While it once did provide some, limited, research funding, it has now evolved into what Giffords calls a "hip marketing agency" when he says:

I found a curiously fuzzy mix of cancer-war goals like “survivorship” and “global awareness,” labels that seem to entail plastering the yellow Livestrong logo on everything from T-shirts to medical conferences to soccer stadiums. Much of the foundation’s work ends up buffing the image of one Lance Edward Armstrong, which seems fair—after all, Livestrong wouldn’t exist without him. But Livestrong spends massively on advertising, PR, and “branding,” all of which helps preserve Armstrong’s marketability at a time when he’s under fire. Meanwhile, Armstrong has used the goodwill of his foundation to cut business deals that have enriched him personally, an ethically questionable move.

“It’s a win-win,” says Daniel Borochoff, head of the American Institute of Philanthropy, a watchdog group. “He builds up the foundation, and they build up him.”

...(Lance's) comeback (in 2007) also saw Livestrong’s final evolution from a research nonprofit into something that looks more like a hip marketing agency. Rather than funding test-tube projects, it was deploying buzzwords like leverage, partnering, and message.

This is still a bit vague so you're probably wondering "if LiveStrong isn't using money to fund research, what exactly is it using the funds for?" Gifford goes on to analyze how LiveStrong funds have been spent in recent years. Here are some good quotes:

(T)he foundation’s financial reports from 2009 and 2010 show that Livestrong’s resources pay for a very large amount of marketing and PR. During those years, the foundation raised $84 million and spent just over $60 million. (The rest went into a reserve of cash and assets that now tops $100 million.)

A surprising $4.2 million of that went straight to advertising, including large expenditures for banner ads and optimal search-engine placement. Outsourcing is the order of the day: $14 million of total spending, or more than 20 percent, went to outside consultants and professionals. That figure includes $2 million for construction, but much of the money went to independent organizations that actually run Livestrong programs. For example, Livestrong paid $1 million to a Boston–based public-health consulting firm to manage its campaigns in Mexico and South Africa against cancer stigma—the perception that cancer is contagious or invariably fatal.

Livestrong touts its stigma programs, but it spent more than triple that, $3.5 million in 2010 alone, for merchandise giveaways and order fulfillment. Curiously, on Livestrong’s tax return most of those merchandise costs were categorized as “program” expenses. CFO Greg Lee says donating the wristbands counts as a program because “it raises awareness.”

This kind of spending dwarfs Livestrong’s outlays for its direct services and patient-focused programs like Livestrong at the YMCA, an exercise routine tailored to cancer survivors available at YMCAs nationwide.

Gifford then describes other major expenditures such as legal fees and marketing costs.

Livestrong spends as much on legal bills as on these two programs combined: $1.8 million in 2009–10, mainly to protect its trademarks. In one memorable case, its lawyers shut down a man in Oklahoma who was selling Barkstrong dog collars. Meanwhile, “benefits to donors” (also merchandise, as well as travel expenses for Livestrong Challenge fundraisers) accounted for another $1.4 million in spending in 2010.

There’s still a research department, but now it focuses on things like quality-of-life surveys of cancer survivors. During my visit, I was plied with glossy reports and brochures, which are cranked out by the truckload. The foundation’s 2010 copying-and-printing bill came to almost $1.5 million.

But Livestrong’s largest single project in 2009—indeed, the main focus of Armstrong’s comeback—was the Livestrong Global Cancer Summit, held in Dublin in August. The summit ate up close to 20 percent of the foundation’s $30 million in program spending that year.

To kick things off, Livestrong hired Ogilvy, the famous advertising firm, to create a global cancer-awareness campaign leading up to the summit. Cost: $3.8 million. It spent another $1.2 million to hire a New York City production company to stage the three-day event. Then it paid more than $1 million to fly 600 cancer survivors and advocates to Dublin from all over the world—the U.S., Russia, Bangladesh, and 60 other countries. The former president of Nigeria even showed up.

I think this quote summarizes what many people might be wondering when they read this:

“You wonder,” AIP’s Borochoff says. “If they just gave the money to cancer research, would it generate as much great publicity for Lance Armstrong?”

Gifford also explores Lance's claim that when he returned to cycling it was for cancer funding, not for personal gain. He notes:

Although Armstrong had told Vanity Fair he would be racing for free, he actually pocketed appearance fees in the high six figures from the organizers of both the Tour Down Under and the Giro d’Italia. An Australian government official told reporters that the money was a charitable donation, but Lance himself admitted to The New York Times that he was treating it as personal income.

Gifford discusses Lance's many business deals with Nike, Radio Shack and others and notes the role LiveStrong plays in those deals. He says:

In a sense, Livestrong and Lance are like conjoined twins, each depending on the other for survival. Separating them—or even figuring out where one ends and the other begins—is no small task. The foundation is a major reason why sponsors are attracted to Armstrong; as his agent Bill Stapleton put it in 2001, his survivor story “broadened and deepened the brand … and then everybody wanted him.” But the reverse is also true: Without Lance, Livestrong would be just another cancer charity scrapping for funds.

In one particular case involving the Haiti earthquake victims, Gifford found the following disturbing account:

Not all the money goes where Livestrong says it goes, however. In January 2010, after the devastating earthquake in Haiti, Armstrong made a personal video statement: to help earthquake victims, Livestrong would give $125,000 each to the charitable organizations Doctors Without Borders and Partners in Health, which it subsequently did. RadioShack also hopped on board, soliciting $538,000 in customer donations for the Haitian cause. According to Livestrong, it gave $413,000 of the RadioShack money to Partners in Health. And the foundation’s 2010 tax form shows a $458,000 donation to the group. But $333,000 of that had been previously allocated to a separate hospital project in Haiti that “had nothing to do with the earthquake,” says a spokesperson for Partners in Health. That means Livestrong used the RadioShack earthquake donations to cover its prior hospital pledge.

Another questionable action by Lance and Livestrong includes his sale of the Livestrong website. Gifford notes:

Most people are unaware that there are two Livestrong websites. Livestrong.org is the site for the nonprofit Lance Armstrong Foundation, while Livestrong.com is a somewhat similar-looking page that features the same Livestrong logo and design but is actually a for-profit content farm owned by Demand Media.

We've discussed this before at this link so I won't review it again here. I will say that I believe it potentially reveals Lance's moral compass and how he views Livestrong. Donors should ask if the foundation is a way to build power and wealth or a way to fight cancer.

In the end, I think the following quote sums up what many unbiased and informed donors to Livestrong ought to be thinking about Livestrong:

“It’s going to have a huge impact,” says Michael Birdsong, a former Livestrong supporter, now disillusioned, who estimates that he has given $50,000 to Livestrong over the years. “Who wants to support a foundation that was founded by a cheater? Not only a cheater, but a person who lied about it.”

Unfortunately, fraud leaves a wake of pain and suffering, even when the fraud perpetrator tries to do something good so as to either salve his conscience or to hide his true character.

Happy New Year and A Few Links

noreply@blogger.com (Aaron) — Tue, 03 Jan 2012 23:39:00 +0000

Happy New Year! While I've never really been one for New Year's resolutions, I do intend to post more often over the next year. In the meantime, I've been collecting links to write about on FraudBytes and I've fallen a bit behind. In an effort to purge my queue, here are a few articles worth reading:

The Lasting Shadow of Bernie Madoff--Three years later, many are still hurting from the fallout of the collapse of Madoff's Ponzi scheme.

Former Madoff Employee to Admit to Guilt--Madoff's former controller admits to, "falsifying the company's records and making phony submissions to government regulators."

S.E.C. Files Suit to Recoup Losses in Stanford Case--The SEC has sued the SIPC in an effort to get the SIPC to reimburse losses of investors in Allen Stanford's Ponzi scheme.

Financier in Fraud Case Is Declared Fit for Trial--Allen Stanford appears to have tried to fake or exaggerate amnesia in order to avoid trial. A federal judge has declared Stanford fit for trial. When your best legal defense is essentially, "I got hit on the head and forgot," I would say things aren't looking too hot for Stanford.

Authorities Seize Documents in Raid on Olympus in Tokyo--Japanese officials are getting more involved in investigating the alleged fraud at Olympus. Meanwhile, Olympus appears to be attempting to take actions that will minimize reform.

Pyongyang Myth-Builders Step It Up--North Korean officials have quite the task on their hands in turning Kim Jong Eun into a quasi-deity in the minds of the North Korean people. If the legends of Kim Jong il are any indicator of what we can expect, we will probably be hearing soon about Kim Jong Eun's amazing sporting feats, among other incredible ventures.

Doping in Cycling and the Mafia

noreply@blogger.com (MZ) — Thu, 01 Dec 2011 22:44:00 +0000

The head of the World Anti Doping Association (WADA), David Howman, gave an interview in New York City that gives some insights into the difficulty of battling doping in cycling and other sports. Here are some of the meatier quotes from an article on CyclingNews, along with my comments:

"We, WADA, were set up because every sport and every government had a different rule. I think things have improved considerably because now there is one set of rules covering everything, and I think that the gaps to the cheaters has narrowed quite considerably," he told Cyclingnews. "On the other hand, the cheaters that are really clever are now cleverer, or they're getting more help, and that's a challenge."
That 'help', Howman made clear, is coming from mafia-style criminal rings who have moved from selling hard drugs such as heroin, into the markets of steroids and performance enhancing drugs, where higher mark-ups and minimal police intervention means that the financial rewards can be far greater.

Mafia-style criminal rings are now helping athletes cheat by selling steroids, EPO, HGH, etc! According to this interview, the mob can make more money selling EPO than they can selling heroin.

How long such activity has been going on is unclear but Howman estimates that there have been at least five years in which the problem has escalated. In the last 12 months WADA has launched into collaboration with Interpol, sharing information – a bold move considering that the anti-doping agency's budget was frozen for 2012 and that their further investigations and hard work has lead to greater knowledge of sport's murky underworld.

Interestingly, the last 12 months or so includes the time frame when Jeffrey Novitzky's team has been working on its investigation into Lance Armstrong's doping allegations.

Last month Howman bluntly told a conference in Paris that only the 'dopey dopers' were being caught, pointing out that the number of suppliers and doctors who have been caught remains low.

Only dopey dopers get caught is a sad comment that explains how the peloton can be using these products and nobody gets caught until someone does something stupid like leaving a bunch of syringes in the hotel trash can.

"I think you've got to address the major issue, and sport has to look at this. Is organised crime moving into sport or not? Sport would like to say surely it's not but we now know that through match fixing and everything that goes on with betting that that's what goes on in the underworld. We know that the mafia-organised crime is making more money from pushing steroids than it is through pushing heroin."

Is he saying the Mafia is supplying drugs to athletes and betting on their customers?! Imagine if they decide to throw a big event by supplying tainted drugs. Let's say the 2012 Tour de France. Assume Contador is up by 5 minutes going into the final week of the Tour and the Schleck brothers are in 2nd and 3rd, about one minute between each other and another five minutes to the fourth place rider, Levi Leipheimer.

The odds in Vegas are that Contador will walk away the winner. If you want to bet on Levi you can get great odds (50:1). The mafia decides to bet on Levi and fix the game on the last week by giving Contador's team and Andy Schleck's team some EPO mixed with a virus that takes 7 - 10 days to go away. Levi, who was ten minutes down at the beginning of the final week, ends up running away with the race as Contador and both Schleck brothers abandon with this wicked virus. It would make for some drama but I think pro sports of all types just got a lot less interesting to me...

Regarding how long Contador's case is taking, Howman said:

"I'll feel more comfortable talking about that when it comes to a conclusion but what I'll say is that no case should take this long," Howman admitted.
"But when you've got cases where you've got lawyers who want to make sure that every piece of evidence is put through a court and you've got a court that allows that, then instead of having a case where it's 30 pages long you've got one that's 3,030 pages long."

"The appeal was based on the fact that the federation got it wrong in exonerating him, simple as that. He had the banned substance in his system, with no excuse and that was why we appealed. I'm hopeful that CAS will make the correct decision."

Well, I'm pretty sure we know what's going to happen with this case. Contador sure doesn't seem worried about it as he's been talking about competing in the Olympics this week. I might be wrong but if I was a betting man (which I'm not), I wouldn't be putting much money against Contador winning this case...

By the way, if you think Jeffrey Novitzky's investigation to pursue Lance Armstrong is a waste of money, you might consider whether you want organized crime to be involved in supplying doping products to both pro and amateur athletes. I think the progress they appear to be making in the past year in identifying who the parties are that are involved probably wouldn't have happened without Novitzky's team investigating what some pro cyclists have referred to as the "cycling mafia" along with the "boss" of the peloton...

Madoff and Watergate

noreply@blogger.com (MZ) — Thu, 24 Nov 2011 03:58:00 +0000

No, Bernie Madoff didn't play a role in the Watergate scandal (at least as far as we know) but it turns out that his Ponzi scheme may have been going way back then. If so, it will go down in history as not only the largest Ponzi scheme we know of but also the longest running scheme too (by far!). This new revelation is according to the guilty plea of 66 year old David L. Kugel who was apparently associated with Madoff even back when Richard Nixon was in the Whitehouse. Here are a few quotes:

This from Bloomberg:

David Kugel, a former trader at Bernard Madoff’s investment firm, pleaded guilty in federal court in New York to creating fake, backdated trades in a fraud scheme that began more than 30 years ago.
During his plea hearing today, Kugel, a former supervisory trader in the proprietary trading operation of Bernard L. Madoff Investment Securities LLC (aka BLMIS).. implicated two other former Madoff employees, Joann Crupi and Annette Bongiorno.
Kugel, 66, said he provided the two with historical price information that allowed them to create fictitious, backdated arbitrage trades during the decades that Madoff’s Ponzi scheme was under way. ...
“I provided history trading information to other BLMIS employees used to create backdated trades,” Kugel told U.S. District Judge Laura Taylor Swain in Manhattan. “Specifically, by the early 1970s until the collapse of BLMIS in December, 2008, I helped create backdated trades,” Kugel said.
Kugel, who is cooperating with prosecutors, pleaded guilty to six criminal counts, including falsifying trading and business records, and securities and bank fraud...
Bongiorno, who recruited investors and helped run Madoff’s investment advisory office, and Crupi, a keypunch operator, have denied the charges against them and are awaiting trial.
Kugel faces as long as 85 years in prison and fines of $11.75 million, said Swain, who agreed to release Kugel on a $3 million bond secured by $900,000 in cash and properties. ...

Separately, the Securities and Exchange Commission sued Kugel today over backdated trades in his own account at BLMIS. He allegedly withdrew almost $10 million in phony profits over the years. Kugel has agreed to settle the case and forfeit any gains from the scheme, the SEC said in a statement.
Today in court, Moore said Kugel also agreed to sell homes in Boca Raton, Florida and Sands Point, New York, as well as luxury vehicles and other assets purchased with funds from his Madoff accounts.

The Guardian had this to say about Kugel:

Kugel's cooperation and his claim that the fraud goes back to the 1970s will add further pressure on Peter Madoff, Bernard's younger brother and the subject of a separate inquiry. Peter Madoff had worked with his brother since at least 1970, when he left law school.

Picard is seeking to recover at least $226.4m from several Madoff family members including Peter, Bernard Madoff's son Andrew and the estate of Madoff's late son Mark.

Kugel would be the fifth former Madoff executive, including Madoff, to plead guilty to participating in the fraud. Five other former Madoff employees, include Daniel Bonventre, the firm's former chief of operations, have denied charges that they were co-conspirators and are awaiting trial.

I'm glad Mr. Kugel is cooperating and I don't feel bad that he has to sell some of his many homes and luxury cars. Unfortunately for him, he is very likely to receive a death sentence given his age and the likelihood that he will spend a decade or two in prison.

The Guardian comment about Peter Madoff reminded me few people are implicated in this case. It will be interesting to me to see if Bernie was clever enough to either keep his family out of his scheme or hide any trail to them. Time will tell...

Free Markets, Families and Regulating Fraud

noreply@blogger.com (MZ) — Sat, 19 Nov 2011 17:45:00 +0000

I’ve been reading several calls for prosecution of fraud on Wall Street lately. No, these aren’t coming from the Occupy Wall Street crowd. Instead, top economic and business commentators and scholars are noting the dearth of prosecution and the role this is playing in our economic challenges. This is a fascinating debate and I only have time to capture enough to spark your interest in hopes that you will check out some of the sources I post. For starters,

I’ve been interested for some time in the notion that many seem to ascribe to that if we want a free market then we don’t want regulation. This post by Barry Ritholz (who has been noted as one of the top 15 economic journalists) captures some great thoughts by leading free market economists on the role of regulation and prosecution of fraud. Here are a few quotes:

There is a widespread myth that free market supporters are against regulation or prosecuting fraud. In fact, Adam Smith – the father of free market capitalism – was for regulation of banks, and believed that trust is vital for a healthy economy. Because strong enforcement of laws against fraud is a basic prerequisite for trust, Smith would be disgusted by the lack of prosecution of Wall Street fraudsters today. Smith railed against monopolies and their corrupting influence. And Smith was pro-regulation, so long as the regulation benefited the little guy, as opposed to the wealthiest:

In addition to Adam Smith, Ritholz also notes that more contemporary free market economists are also for regulation and prosecution of fraud as a means to keep the free market working properly. Incuding Richard Posner, Alan Greenspan, Ludwig von Mises and even Friederich Hayek.

Here is a quote Ritholz attributes to Hayek:

There remains, however, one other kind of harmful action that is generally thought desirable to prevent and which at first might seem distinct. This is fraud and deception. Yet, though it would be straining the meaning of words to call them ‘coercion,’ on examination it appears that the reasons why we want to prevent them are the same as those applying to coercion. Deception, like coercion, is a form of manipulating the data on which a person counts, in order to make him do what deceiver wants him to do. Where it is successful, the deceived becomes in the same manner the unwilling tool, serving another man’s ends without advancing his own. Though we have no single word to cover both, all we have said of coercion applies equally to fraud and deception. … Liberty not only means that the individual has both the opportunity and the burden of choice; it also means that he must bear the consequences of his actions…. Liberty and responsibility are inseparable.

Another quote from Ritholz attributed to Mises:

Government ought to protect the individuals within the country against the violent and fraudulent attacks of gangsters, and it should defend the country against foreign enemies.

Interestingly, Ritholz notes that it is fraud combined with poor monetary policy that leads to bubbles in the economy such as we’ve experienced with the dot.com and real estate bubbles in the past decade or so. Ritholz then notes that the current administration has a terrible record for prosecuting fraud. He says:

Obama has prosecuted fewer financial crimes than any president in decades – less than Ronald Reagan, less than George H.W. Bush, less than Bill Clinton, and less than George W. Bush. The economy is worse than it has been since the Great Depression, if not before. See the connection?

Now to be fair, this connection is not necessarily a clear one. However, Ritholz is not alone in saying that the economy is being held back because fraud is not being prosecuted. He continues on his blog to discuss the differences between good and bad regulation and asserts that good regulation is critical to the operation of the free market. I tend to agree but only to a point.

Instead of a focus on regulation, I would say that trust must exist for the operation of a free market and trust can be obtained either by a good regulator/enforcer who prevents and punishes fraud or it can be obtained by self regulation. The best way to have trust is to have self-regulation by an ethical populace. Self-regulation has been described as “obedience to the unenforceable.” For example, Harvard's famous Professor Clayton M. Christensen refers to self-regulation and notes an essay written by the “Lord John Fletcher Moulton, the great English jurist, who wrote that the probability that democracy and free markets will flourish in a nation is proportional to ‘The extent of obedience to the unenforceable.’”

In other words, when the populace regulates their behavior based on ethical and religious beliefs, trust can exist without much government regulation. Imagine an economy where everyone lives the golden rule and words and handshakes are always honored. A lot of occupations, including auditors, lawyers, fraud examiners, virus software developers, policeman, military, security guards, etc., etc. would be in much lower demand or eliminated altogether. Instead, economic efforts would be focused on productive pursuits and we would have a high standard of living with much less effort since we wouldn’t need to support all these regulatory mechanisms. However, as the family and society fails to produce a populace who are obedient to the unenforceable, a need for government regulation arises to punish fraudsters. As this need gets too big in a given economy then the opportunity arises for a more ethical society to step in and take over the economic opportunities because they can do so at a much lower cost.

This topic of trust in the economy and prosecuting fraud is the subject of another blog post by Ritholz. He quotes numerous economists and scholars and notes that our economy won’t recover until trust is restored and trust won’t be restored unless the government prosecutes and punishes the executives on Wall Street and in the financial industry who were involved in the mortgage meltdown.

This brings me to my last reference. If you are really interested in learning more about the role of fraud in the mortgage meltdown, I highly recommend listening to this excellent interview about how the banks committed fraud in the mortgage industry. You can download the MP3 file and listen to it, like I did, while exercising. It’s worth the time. I’ve read a few books on the mortgage meltdown and found this to be informative in addition.

In my opinion, (as I've mentioned on this blog before) the bottom line is that the American family is failing to produce a populace that is obedient to the unenforceable. As a result, there is a bigger need for other mechanisms to prevent, detect and prosecute fraud and other forms of economic corruption. Many are observing that the government seems to be headed in the other direction and allowing top executives to get away with their corrupt activity. This is a recipe for more hard times to come and potentially for a more righteous society to gain economic advantage. What is to be done? Strengthen families in the long run and build stronger mechanisms to prosecute and regulate fraud in the short run.

Update on Olympus: Potential Ties to Organized Crime

noreply@blogger.com (Aaron) — Fri, 18 Nov 2011 22:57:00 +0000

Not only is Olympus being accused of a massive financial statement fraud, the latest revelations suggest that the financial statement fraud involved companies with links to organized fraud. According to the NYT:

Japanese officials say that at least $4.9 billion is unaccounted for in a financial scandal at Olympus and are investigating whether much of that money went to companies with links to organized crime.

In a memo prepared by investigators and circulated at a recent meeting of officials from Japan’s Securities and Exchange Surveillance Commission, the Tokyo prosecutor’s office and the Tokyo Metropolitan Police Department, officials say they are trying to determine whether Olympus worked with organized crime syndicates to obscure billions of dollars in past investment losses and then paid them exorbitant sums for their services.

The article also contains some additional details about the nature of the alleged fraud:

At the heart of Olympus’s action is a once-common technique to hide losses called tobashi, which Japanese financial regulators tolerated before clamping down on the practice in the late 1990s.

Tobashi, translated loosely as “to blow away,” enables companies to hide losses on bad assets by selling those assets to other companies, only to buy them back later through payments, often disguised as advisory fees or other transactions, when market conditions or earnings improve.

The Japanese investigators’ memo chronicles Olympus’s efforts to pay off its previous losses through payments camouflaged as acquisitions and supposedly related advisory fees to buy companies that seemed to have little relation to its main business.

With the knowledge that this fraud may have been aided by organized crime, I wonder how far the link may have gone. In the Crazy Eddie fraud, the Antar family went to great lengths to perpetrate their fraud, including infiltrating the audit firm that was signing off on Crazy Eddie's financial statements. I'm wondering if we might learn of something of that nature with Olympus. If organized crime was involved, it doesn't seem like too much of a stretch to think that individuals within Olympus's audit firm, within Olympus itself, and within other organizations with ties to Olympus may have been influenced to ignore the shady dealings going on within Olympus.

Olympus is Accused of Massive Financial Statement Fraud

noreply@blogger.com (MZ) — Tue, 08 Nov 2011 22:05:00 +0000

The camera and electronics company, Olympus, is being reported to have engaged in a massive financial statement fraud. Reports are pretty ambiguous right now but this could be one of the largest financial reporting frauds we've seen in a long time. Here are some excerpts from the NY Times article today:

Olympus said Tuesday that more than $1 billion in merger payouts were used to hide years of losses on investments, an acknowledgment that is an abrupt about-face for the company, which had denied any wrongdoing in the wake of a widening scandal.
That revelation alone could make this one of the biggest accounting fraud cases in corporate history.
But in an extraordinary statement issued Tuesday, the company said the panel found that the money for mergers had in fact been used to mask heavy losses on investments racked up since about 1990.
The panel found that Olympus channeled money through several investment funds to “eliminate latent losses,” the company said in the statement, without elaborating...
The payouts in question involve $687 million in fees Olympus paid to an obscure financial adviser over its acquisition of the British medical equipment maker Gyrus in 2008. That fee amounted to roughly a third of the $2 billion acquisition price, a fee amount more than 30 times the norm.
The Federal Bureau of Investigation and the Securities and Exchange Commission in the United States are also investigating the Gyrus deal, according to people familiar with the matter.
Olympus also acquired three small companies in Japan for a total of $773 million, only to write down most of their value within the same fiscal year. Those companies ... had little in common with Olympus’s main line of business of producing cameras and other electronics.
At a news conference, the company’s new president, Shuichi Takayama, bowed deeply in apology. “It is true that there were inappropriate dealings,” he said. “Our previous statements were in error.” But he stopped short of acknowledging fraud at the company, and said that no money had flowed out of the company. He said Olympus was still investigating the case and was still unprepared to reveal the scale of past losses.

Like I said, things are a bit vague right now. I'm wondering if this involved misusing merger reserve accounting back in the 1990's. We'll be following this in the future to see what becomes of it. In many large fraud cases, the initial report of the magnitude turns out to be only a fraction of the total fraud. For example, I think WorldCom started at $3 billion being reported and grew to $11 billion. Time will tell with this case...

A New Madoff Interview

noreply@blogger.com (MZ) — Tue, 08 Nov 2011 01:11:00 +0000

60 Minutes Overtime aired a video recently of an interview with Ruth and Andrew Madoff discussing such things as the decision and process of turning Bernie in to the authorities, etc. Andrew and his mother also talk about Bernie and Ruth's failed effort to commit suicide. Crazy stuff for sure...Check it out here.

A Potentially Costly Combination: Deloitte, Taylor Bean and the PCAOB

noreply@blogger.com (MZ) — Thu, 20 Oct 2011 20:43:00 +0000

If you follow news affecting auditors, you may have noticed that the PCAOB made a very rare disclosure yesterday about one of the big four firms, Deloitte. The PCAOB said that Deloitte was previously sanctioned for not being skeptical enough to challenge statements made by management and that they still have problems with this.

Normally, the PCAOB tells the big audit firms what they did wrong and gives them a year to fix it with the threat that they will disclose their failures after a year if the firm doesn't fix it. Well, they decided Deloitte was still dropping this ball so they disclosed it publicly. Importantly, the timing of this ball dropping may have been very detrimental to Deloitte. Here is why...
Recently, we blogged about Deloitte being sued for over $7 billion for it's audits of Taylor Bean, a firm that was heavily involved in the mortgage meltdown. The lawsuit claims that Deloitte was both negligent and turned a willful blind eye. Unfortunately for Deloitte, this recent PCAOB disclosure seems to provide some fuel to ignite that claim.

But this isn't all. As it turns out, at least one of the audits that the PCAOB references in their disclosure sounds like it may have either been Taylor Bean or someone very much like them. Here are some quotes from a Washington Post article that probably make the attorneys at Deloitte very uncomfortable:

“The firm’s apparent failure to appropriately challenge management’s representations occurred in numerous areas,” the report by (the PCAOB) said.

Though Deloitte was alerted to the problems in spring 2008, a year later it had failed to fix them, according to the oversight board. It’s unclear whether the failings were subsequently addressed because the board’s more-recent findings remain confidential.

The audits at issue date from a period when the United States was sliding toward a financial crisis, and at least one was of a company involved in mortgage investments.

At that company, identified only as “Issuer E,” the oversight board accused Deloitte of failing to properly assess such matters as the value of mortgage-backed securities, the accounting for delinquent loans and the treatment of financial instruments known as swaps, a form of derivative.

This sounds like it very well could have been Taylor Bean and, even if it wasn't, I'm betting that the attorneys suing Deloitte are going to be drawing the parallel...

Widow of Mark Madoff Talks

noreply@blogger.com (MZ) — Thu, 20 Oct 2011 02:08:00 +0000

ABC News has an article about Mark Madoff's widow, Stephanie Madoff Mack, and her view of what Bernie did to her. Here are a few quotes I found interesting:

"He (Bernie) stood there in the corner at my wedding watching everyone dance, and he knew that everyone in that room was going to get screwed," said Mack.
Madoff Mack told Cuomo that if she saw her father-in-law today, she’d tell him “that I hold him fully responsible for killing my husband, and I’d spit in his face.”
Determined to make Madoff suffer even more for what he had done to his son, Mack wrote a letter to him describing the life he would forever be missing with his two grandchildren.
Instead of showing remorse, Madoff wrote back bragging about his new life in prison, telling Stephanie that he was treated as a celebrity.

All I can say is that Bernie Madoff is one very sick and sad excuse for a human being...It appears that he is totally oblivious to the immense pain he has caused to others, even those closest to him such as his son. What a pitiful life he lived.

Fraud in Amateur Sports

noreply@blogger.com (MZ) — Sat, 15 Oct 2011 14:48:00 +0000

Photo taken from KTLA.com

So, I was appalled to read about a marathon runner who caught a bus over the last six miles of the race and then waited until the 1st and 2nd place racers passed him before taking 3rd place with a personal record! I can just see this guy bragging about his PR to his friends at work! In my book, he's a bigger loser than the last place finisher who followed the rules. It gives a whole new meaning to the phrase "The biggest loser!"

This story reminded me of the pro and amateur cyclists who are out there doping even though they know it's against the rules (see this link for links to a few articles). I personally can understand the pros getting caught up in it more than I can the amateurs. A pro has all sorts of pressure to keep his contract and win and others are trying to take his job from him by doping better than he does.

Amateurs on the other hand, are supposed to be doing something they love and that keeps them fit. If they are racing to prove their self worth, something is really missing in that soul's life...Yet, we can read that it happens and some people believe more doping is happening among amateurs than among the pros.

I hear people speculate all the time about amateurs who are doping. For example, sometimes masters cyclists are known to race all over the region and dominate the races but then they skip Masters Nationals. Why would they do that? The speculation is that it's because at Masters Nationals, they test for doping. When you sign up for the event it notifies you that they test. I believe that this fact pattern and speculation paints a pretty dark cloud over these amateurs. Clean racers can't help but wonder why someone who travels all over the region and wins will then skip the one, most prestigious race of the year, which also happens to be likely to test the winner for doping. It leaves a bad aura on all the races and leads to questioning of anyone who is riding strong. Not a healthy situation in my book...

So what can be done? I've recommended an amendment to the Utah Cycling Association's (UCA's) rules to institute drug testing at some of the UCA races this year. I doubt these changes will take place but I would love to see them. Here is my recommendation:

Require every UCA category winner (e.g., Pro 12, Cat 3, Masters 35+, etc.) to submit a urine sample which may or may not be tested for doping. Also, require every UCA race to drug test some number (e.g., 5) of the category winners.

The goal of this proposal would be to help deter the doping among pro and amateur cyclists that we can read about in the news. I've heard that the cost to analyze a urine sample for doping is not that high (e.g., $200). Whatever it is, I would be willing to pay a higher entry fee to institute drug testing in more amateur races.

There undoubtedly are some who don't race because they don't want to compete against those who cheat. On the other hand, some racers may quit coming if they know they will be tested. I personally think this will improve the amateur races and help send the message that cheating is not tolerated.

Just as business and the economy is ruined by greedy fraudsters, sports and competition are ruined by cheaters of all types!

Avoiding Consumer Fraud [Guest Post]

noreply@blogger.com (Aaron) — Mon, 10 Oct 2011 20:51:00 +0000

“You’ve just won $10,000! Act now! This opportunity won’t last long!” Every day, millions of consumers run into ploys like this one, and some of these people fall victim to the scam. Americans lose hundreds of billions of dollars to consumer fraud every year.

Victims of mass market fraud could potentially lose their life savings and/or have the need to file for bankruptcy. Con artists can find these innocent people through the internet, by telephone, email, and even post mail. People easily get tricked into trusting these scams and give out money or their very valuable personal information.

What is Consumer Fraud?

Consumer fraud occurs when a seller knowingly misleads a consumer by misrepresenting or failing to reveal an important fact. This may seem very straight forward, but it is quite difficult to prove fraudulent acts at times. To prove that fraud has occurred, a person much show all of the following: false representation, knowledge of untrue facts and statements by the defendant, intention of deception, true belief of those statements by the victim, and real damages as the result of the false representation.

Identify Consumer Fraud

While proving consumer fraud can be difficult, it can be quite easy to avoid the fraudulent act in the first place. With the right information, identifying potential consumer fraud can be simple. There are four types of fraud you should be aware of to avoid falling victim to their scams.

Mail – Americans over 65 account for 26% of all mail fraud victims. This percentage is greater when the fraud offers prizes or sweepstakes (60%). These types of scams work most often when victim is ignorant of fraudulent acts through mail until after they have already sent in money or personal information.
Telemarketing – So called “boiler room” sellers use high pressure sales techniques over the phone on unsuspecting consumers. Typically, these scams will use mystery phone charges, request money for a nonexistent charity, or use some other lie to gain the trust of the victim and unknowingly commit the fraudulent act.
Door-to-Door – Phony home repair companies, magazine subscription salesmen, or students raising money for a nonexistent school project could come to the victim’s door asking for a hand out. Not only could these solicitors ask for money, but they could also request access to the victim’s home to commit other crimes like theft.
Internet – This is the easiest way for scammers to solicit money and/or information from victims because there is easy access to a greater number of people when compared to the other options. Deceptive internet sales or companies, emails from what may seem like an official website asking for personal information and hackers working their way into your computer are just a few ways these people can try to take money and information.

Avoid Consumer Fraud

If you get an email, phone call, or other notification for a prize or lottery, the following tips can help you detect possible fraudulent acts. If the offer has one or more of the following characteristics, you should probably not respond.

The name of the company is listed online as a scam.
The organization doesn’t have a website and cannot be found through a search engine.
The offer (email, telemarketer, etc.) requests bank account information, credit card numbers, driver’s license or passport numbers, your mother’s maiden name or other personal information.
The offer says that you have won a prize, but you did not enter a competition represented by the same company.
An email says you have won a lottery. There are no legal lottery organizations that notify winners by email.
The return address for the email is from yahoo, Hotmail, or other free email account.
The prize promoters require a fee paid in advance. Any administration, processing, taxes, or other fees are deducted from the winnings in legitimate lotteries.
The company requires you to travel at your own expense to receive your prize.
The offer sounds too good to be true. Don't trick yourself into thinking that you are the exception to the old mantra: if it sounds too good to be true, it probably is.

Avoiding fraud can be a lot easier if you know what you are looking for. There are many trustworthy companies out there that will do great things with the money you give them, but there are also many others who will do just the opposite. Whenever a stranger comes to your door or you get a piece of junk mail, just make sure you keep these warning signs in mind.

Amy Young is an author of finance articles published to help inform readers about credit resources available online.

Madoff and the SEC: Serious Conflicts Existed

noreply@blogger.com (MZ) — Wed, 28 Sep 2011 23:20:00 +0000

The NY Times recently discussed the results of a report on the SEC showing that a lawyer with heavy involvement in the Madoff case had serious conflicts of interest. Here are a few key quotes from the article:

"David M. Becker, the S.E.C.’s general counsel, who went on to recommend how the scheme’s victims would be compensated, despite his family’s $2 million inheritance from a Madoff account."

"Mr. Becker’s tie to the Madoff situation came from a Madoff account held by his mother, who died in 2004. Her three sons inherited the account and closed it shortly thereafter, with a $1.5 million profit, based on Mr. Madoff’s fraud."

"Mr. Becker’s lawyer, William R. Baker III, said in a statement that the report confirmed that Mr. Becker had notified seven senior S.E.C. officials about his late mother’s Madoff account, including Ms. Schapiro and the agency’s designated ethics officer."

"Among the actions taken by Mr. Becker that were cited in the report were his efforts to influence the deliberations concerning how Madoff victims would be compensated, which could have had a direct impact on his financial standing. The report cited testimony from a witness who said that by early 2009, Ms. Schapiro indicated that most of the S.E.C. commissioners had agreed on a method that would give investors a claim to only the money they had put into their Madoff accounts. This might have meant the Beckers would be able to keep only around $500,000 of the $2 million withdrawn when the account was closed, Mr. Kotz’s report said."

"But after Mr. Becker rejoined the S.E.C. in February 2009 after an earlier stint, he argued for a reversal of this decision, the report says, at first pushing for victims to be compensated in part based on the final balance listed in their account. That position was supported by Annette Nazareth, a former S.E.C. commissioner who is representing some Madoff victims, according to the report."

"However, Mr. Becker told the inspector general that ultimately he determined that legally 'it’s not legitimate to say that we believe we have entitlement to assets that have never existed and that are just a figment of someone’s imagination.'”

"In the end, Mr. Becker supported a compromise that victims should be able to keep some of the gains their investments had generated, since the investment might have grown over time even in a low-interest account."

"The Becker family stood to benefit from this approach by $138,500, according to Mr. Kotz’s calculations. The S.E.C. approved that compensation plan backed by Mr. Becker in the fall of 2009, though final payouts and clawbacks from those who gained in the scheme are being determined in the court system."

"But none of the commissioners except Ms. Schapiro knew of Mr. Becker’s ties to the Madoff account, the report said. As a result, Mr. Kotz has recommended that the commission take another vote on the Madoff compensation matter “in a process free from any possible bias or taint.” One commissioner, Luis A. Aguilar, told the inspector general that it was “incredibly surprising and incredibly disappointing” that the conflict had not been shared with the commissioners."

I think the key issues that look bad in this case are that he originally lobbied for compensating victims based on ending balances which he later admitted were based on a figment of Madoff's imagination! Then he lobbied for paying based on principal plus some reasonable return all while nobody knew he had money involved. Finally, he was the boss of the ethics officer who approved his involvement.

The SEC is supposed to be protecting us from frauds in corporations but they don't seem to understand the conflicts that lead even good people to commit fraud.

Lance Armstrong Investigation: Money Trails and Ferraris

noreply@blogger.com (MZ) — Tue, 27 Sep 2011 04:36:00 +0000

I apologize for being so slow to comment on this news but last week I was taken out of commission by a long-boarder who ran into me while riding my bike. I ended up with a broken arm, broken rib and broken bike frame, not to mention a lot of road rash and a concussion. I was unconscious for about ten minutes, or so they say. But, enough of the excuses. What do I make of this news about Lance and Michele Ferrari? Here is my take:
Here is a summary of what I've seen in the news on this:

Michele Ferrari has been shown to have a company in Switzerland called "Health and Performance" which received a lot of money from cyclists over the years. (see this link)
Several top cyclists (20-30), including Lance Armstrong, Denis Menchov, Michele Scarponi, Vladimir Gusev and Vladimir Karpets and others have allegedly been linked to Ferrari's operation through large sums of cash paid to this company even as recently as the final year Lance raced in the Tour de France. (see this link)
An Italian news outlet is saying that Lance has been linked to Ferrari's company and that phone taps have also been used to collect evidence. (see this link)
Money laundering is being alleged as part of the potential illegal acts involving Ferrari and cyclists such as Armstrong and Menchov. (see this link)
Lance once said he cut off all interaction with Ferrari around 2006. Then, when it was shown they had interactions more recently including 2010, Lance said it was because they were friends. Now, Ferrari explains the interaction he has had with Lance by saying that his son is providing training advice to cyclists. Ferrari has said that Lance did send money to his son to get "coaching" from him. (see this link)
Some people, such as Betsy Andreu, are wondering how stupid Lance thinks we are. (see this link)
I am wondering if much of the world even cares if Lance thinks they are stupid.

My overall takeaway is that it sounds like the authorities in the U.S. and overseas are coming up with some hard evidence that will be hard for Lance to fight. I have said all along that if they can trace the cash going to doping products or money laundering, Lance will be in big trouble.

Assuming Lance is guilty of even a few of the many frauds he is being accused of such as his involvement in a cycling mafia, the money trail undoubtedly exists; the question is whether the investigators will work hard enough to find it. It sounds like Jeffrey Novitzky and those he is working with are making progress. This case will be slow to come to fruition. These things take time to get to the bottom of them. In the end, I won't be surprised if someday we hear about some compelling evidence that has been accumulated.

Deloitte and Taylor Bean: Real Money is on the Line

noreply@blogger.com (MZ) — Tue, 27 Sep 2011 03:48:00 +0000

Another of the Big 4 is being sued regarding their audit of a firm that was allegedly committing serious fraud during the mortgage meltdown, Taylor Bean. Here is an excerpt from an article on Bloomberg which describes the lawsuit involving Deloitte:

Deloitte, which audited Taylor Bean’s financial statements from 2002 to August 2009, ignored red flags in the company’s books, allowing the lender’s former chairman, Lee Farkas, to orchestrate a fraud that toppled the company, according to the complaints filed today in state court in Miami. Taylor Bean’s bankruptcy trustee, Neil Luria, and its Ocala Funding unit are seeking more than $7.6 billion in damages.

“Deloitte’s negligence, and willful blind eye, was the fuel without which the looters’ fraud would have sputtered out long before it resulted in the multibillion-dollar debt under which TBW collapsed,” according to Luria’s complaint.

The claims are “utterly without merit,” Jonathan Gandal, a spokesman for New York-based Deloitte, said in an e-mail. Taylor Bean and Ocala were wholly owned private companies through which “convicted felon Lee Farkas and his co- conspirators committed their crimes,” Gandal said.

Unfortunately, these massive cases are potentially very painful for the auditor. Because the potential damages are so huge (large enough to put any of the Big 4 out of business), Deloitte will not want this to go to court where the whim of a jury will determine their fate.

In this sense, this suit is similar to the Ernst and Young lawsuit over the collapse of Lehman. Even so, the Lehman case is potentially several times larger than even this.

Both accounting firms will fight vigorously to get the court to dismiss the case. This can take years. If it looks like the case may go to trial the auditors will likely then settle. If they can't settle for some reasonable amount, they will be required to fight it in court.

All the Big 4 firms have a few huge lawsuits hanging over their heads at any given point in time. It makes me wonder if one will eventually rear its ugly head and consume one of them. We shall see...

The Cost of Loss [Guest Post]

noreply@blogger.com (Aaron) — Mon, 26 Sep 2011 19:00:00 +0000

Fraud affects everyone. According to a recent survey, US businesses lose an estimated $400 billion due to fraud each year. The Association of Certified Fraud Examiners found that one in four employees commits fraud at some point in their careers, and a quarter of those employees worked for their employer for more than ten years! Every industry feels the loss associated with fraud, and the public often foots the bill. Despite the best efforts of auditors and accountants to detect fraud, the losses remain steady from year to year. As a question of forensic psychology, what motivates loyal and otherwise trustworthy people to take dishonest advantage of employers? Regardless of individual circumstances, we find surprisingly similar motives and means.

The many reasons for fraud can be distilled down to two main motivators: greed or need. When employees don't feel their needs are being completely addressed, they overwhelmingly turn to fraudulent actions. These often takes the form of employees stealing to “compensate” for inadequate pay raises or benefits, or an overarching sense of entitlement when employees feel “worth” more than what they're paid. This dissatisfaction with circumstances makes fraud or embezzlement especially appealing.

Employees motivated by need frequently rationalize their misdeeds because of greater personal losses: the company cut pay or benefits and the employee deserves to make up the difference, needs to pay for an expensive medical procedure, or struggles with massive personal debt. In each situation, money motivates fraud. For most employees there is little value in attempting to steal material goods, and in most corporate positions it's easier to conceal the flow of money than missing physical possessions. Additionally, stealing goods requires the embezzler to “fence” the stolen goods at a fraction of their face value.

With an understanding of the primary motivations for fraud, we need to consider the factors that enable fraudulent behavior. Of the many studies conducted on fraud in all its forms, researchers found three factors that must be present to create an environment conducive to fraud: pressure, opportunity, and rationalization. The pressures to commit fraud (greed or need) mentioned earlier explain the motivation for committing fraud, but for fraud to occur the right opportunity must exist.

Members of corporate accounting departments pull off many fraudulent acts because they have the greatest opportunities to divert funds and mask their transfer. These employees possess an in-depth understanding of how their business systems work and how to exploit any weaknesses for personal gain. In the vast majority of cases, fraud occurs because employees lack adequate oversight. Most cases escape detection until a customer returns an errant check, a fraudulent transaction fails to go through, or an external audit discovers an inconsistency. In companies that employ routine external audits and a process of double-checking employees’ work, the incidence of fraud is a fraction of that in companies without such safeguards.

The final factor of fraud is rationalization. When interviewed by forensic accountants and law enforcement officials, most perpetrators of fraud exhibit a high degree of cynicism stemming from their underlying belief that one must lie or cheat to get ahead. In a 2009 Josephson Institute of Ethics study, 51 percent of young people under 18 felt that lying and cheating are necessary to succeed. As adults, these people are far more likely to commit insurance fraud, falsify tax returns, or inflate an expense report. In each case, adults are able to rationalize their behavior because it was “part of the game.” As an expected behavior, perpetrators of fraud justify their needs being worth it. Whether it's an instance of an investor losing his seed money or a Bernie Madoff-style Ponzi scheme, the defrauders in each case view their behavior as necessary and appropriate, even as they acknowledge their wrongdoing.

Based on all we’ve discussed, fraudulent behavior seems inevitable. The good news is that people's character still plays a large role in whether they commit fraud. Our workforce is largely composed of honest, hard-working individuals who seek to do their best each day. This core work ethic along with a strong external program of checks and balances can work to limit the effects of fraud. Above all, prevention is the key. Companies must use appropriate safeguards and work to reduce employee need as a motivation in order to combat this problem.

---

Allison Gamble has been a curious student of psychology since high school. She brings her understanding of the mind to work in the weird world of internet marketing. Check out more of her work at forensicpsychology.net.

Rouge Traders and Double Standards

noreply@blogger.com (Aaron) — Mon, 26 Sep 2011 17:30:00 +0000

You may have seen the recent news of a rouge trader at UBS whose trading activity led to a $2 billion loss for the company. In a recent blog post, the WSJ highlights what may be a double standard in unauthorized trades:

Trading on Wall Street, of course, is a thinly controlled game of dice. Traders put their firm’s capital at risk, but must do so with authorization. As this latest scandal shows, authorization is either easy to come by or circumvent. And as nearly every “rogue” has said in their defense, there were winners making unauthorized trades, too. The difference: they were winners.

We've discussed some of the cultural aspects of Wall Street that can lead to questionable behavior on a broad scale. If the double standard described by the WSJ blog really exists, should we really be surprised to see major losses like this? The post continues:

So, why is trading beyond internal limits allowed? Because of the winners. Enter Philipp Meyer, a former UBS derivatives trader who left the business a few years ago and wrote about the excess of the business for The Independent. To be clear, Meyer never said he made unauthorized trades, but he did offer this observation about trading. ” It was pretty clear what The Market didn’t like. It didn’t like being closely watched. It didn’t like rules that governed its behavior.”

Then there is Jerome Kerviel, the ultimate rogue trader who lost $7 billion at Societe Generale in 2008. Kerviel claims he exceeded his credit limits regularly and that when he made money for the bank in 2007, he received a $416,000 bonus for $60 million in profits for SocGen.

Ultimately, the difference between trading floor rogues and royalty is how their bets pay off, not whether they take extreme risks. As Leeson said, there’s no excuse for not catching rogue trading today or even 18 years ago: “a very simple check would have exposed it.”

So basically the relevant internal controls are only relevant if violators aren't making money for the bank... That doesn't sound like much of a control to me. Banks with this kind of implicit control environment are inviting control violations and leaving the door wide open to huge losses. Boards of directors and top executives are responsible for establishing the right tone at the top. Are they any less responsible for these major losses than the traders who seem to be passively encouraged to engage in unauthorized trading?

I am interested in seeing how this case will unfold. In particular, I am curious to see whether this case leads to any repercussions for E&Y, UBS's auditor. E&Y signed off on internal controls as of December 31, 2010. If these control violations were taking place during the period under consideration by E&Y, the firm could face civil suits seeking to recover damages.

Ernst & Young and Lehman Case is Still Cooking

noreply@blogger.com (MZ) — Wed, 14 Sep 2011 15:46:00 +0000

Fox News published a short article about litigation involving Lehman and its executives and mentioned that the lawsuit against EY is still progressing. The article says that testimony may be recorded in the near future about the motivation for Lehman's extensive use of Repo 105 transactions. Here are a few quotes:

The New York Attorney General’s office is ramping up its investigation of the Lehman Brothers September 2008 bankruptcy, according to people with direct knowledge of the matter. These people say the office is preparing to take testimony from witnesses about how top executives managed the firm’s finances, including their use of a controversial accounting technique known as Repo 105 in the months prior to the bankruptcy filing...

Much of the New York AG’s suit involves Ernst & Young’s approval of Lehman’s use of Repo 105, which according to the civil complaint, helped disguise serious financial problems at the firm from investors in the months preceding the bankruptcy...

(A)ttorneys for witnesses who have already given testimony to the state AG’s office in the Ernst and Young case say their clients are being called back to provide more information, and the focus of the state AG has shifted more toward what senior Lehman executives did during those months leading up to the firm’s collapse, says one person with direct knowledge of the matter.

At least one witness slated to give testimony in the coming weeks expects to be asked about what motives senior Lehman executives had for using Repo 105, according to a person with direct knowledge of the matter.

News about this lawsuit has been quiet from what I can tell. If anyone knows more about what's happening, feel free to shoot us an email.

Madoff Claims He's Teaching at Harvard

noreply@blogger.com (MZ) — Mon, 05 Sep 2011 20:53:00 +0000

It sounds like Bernie Madoff is telling stories again. According to this short article on Fox, Bernie said:

“I have been approached by (a) number of other business schools but have only committed to Harvard,” he wrote me in mid July adding: “I have an interview that is ahead with the Harvard Business School. I will keep you posted. Some strange turn of events, HUH!”

According to Madoff, he is working on an entrepreneur course for Harvard. However, the spokesman for Harvard responded to this claim by saying: “There are no official discussions of any kind about developing a course with him,”

After reading the article on Fox, it sounds like a Professor at Harvard has been in contact with Bernie for research purposes. Who knows where Bernie got the idea that he might be teaching an entrepreneur course.

It sounds to me that he's delusional...I can't imagine Harvard or any business school hiring Bernie to teach a class. Maybe they could use him as some sort of guest speaker on fraud but even that is doubtful in my mind. I certainly wouldn't work with him!

The Latest on Bernie Madoff's Victims

noreply@blogger.com (Aaron) — Tue, 02 Aug 2011 15:50:00 +0000

An excellent NYT editorial discusses the latest in the Bernie Madoff saga. For those of you who may not be following the story very closely, last Thursday the judge overseeing the civil suits brought against alleged beneficiaries and enablers of the Madoff fraud threw out a suit against HSBC, dealing a pretty substantial blow to the efforts to recover funds for Madoff's victims. The entire editorial is worth reading, but here are a few tidbits that stood out to me:

And so it was on Thursday: in throwing out Picard’s suit against HSBC — and strongly implying that every other bank the trustee has sued is also likely off the hook — Rakoff may have used sharp language, but he was really just interpreting the law as most judges would. You can’t read his opinion without being impressed with his legal logic — and the difficulty of mounting a successful appeal. You also can’t read it without shaking your head in dismay: Even as innocent Madoff victims are being sued to pay back other innocent Madoff victims, the enabling banks get to walk away. Sounds familiar, doesn’t it?

Talk about what appears to be a legal double standard! Especially in light of some of the evidence of complicity:

During the course of a lengthy investigation, Sheehan became horrified by the evidence of bank complicity. HSBC, for instance, funneled enormous sums of money into Madoff. It served as the custodian to a number of Madoff feeder funds. Yet whenever the bank did due diligence into Madoff’s hedge fund, it ignored numerous red flags suggesting that Madoff was operating a fraud. Various HSBC due-diligence reports actually described Madoff’s returns as “too good to be true.”

JPMorgan Chase, which is also being sued by the trustee — and has also argued that the case should be thrown out of court — was Madoff’s bank. Its bankers saw money coming into the Madoff account and going out again, without ever being invested in the market. They saw evidence of money-laundering. Yet they never uttered a peep. Madoff’s business was too important.

This definitely seems like something that should be addressed by lawmakers. Banks and other enablers should not get off free and clear when they overlook evidence of wrongdoing, especially when they are enabling that wrongdoing. While any change in the law would need to be carefully crafted to avoid imposing an extreme level of liability on banks and other intermediaries, I do think some change is needed.

Finally, a note regarding the relationship between Madoff's "net winners" and trustee Irving Picard:

There’s one other aspect of Thursday’s decision that I couldn’t help noticing. The net winners, many of them, were nearly giddy over the fact that Picard got his comeuppance so publicly — even though Rakoff’s decision will surely hurt them. Of the $100 billion Picard has sought, at least three-quarters came from lawsuits like the one Rakoff just threw out. Had Picard won those suits, he would likely have had enough to compensate not just the net losers but the net winners. The fact that he lost means that he will continue to press hard for clawback money.

It is easy to understand the net winners’ anger at the trustee. To wake up one day and learn that you’ve been victimized by a financial fraud is painful enough. But to then realize that you are expected to return money that you thought was yours is infuriating. As their fury has grown, however, they have forgotten who the real bad guy is.

It’s not Irving Picard. It’s Bernie Madoff.

I couldn't agree more.

An Update on Lehman and EY

noreply@blogger.com (MZ) — Thu, 28 Jul 2011 20:51:00 +0000

According to an article in the Wall Street Journal:

A lawsuit contending that Lehman Brothers Holdings Inc.'s former officials, underwriters and auditors are responsible for investor losses should go forward for the most part, a federal judge ruled Wednesday.

According to the article, the judge ruled that:
"(I)nvestors who filed the lawsuit have "adequately alleged" that the former Lehman executives...and other defendants misled them about Lehman's financial health, leverage, risk management and exposure to dicey mortgage and real-estate assets."

The article goes on to clarify that the investors "contend (that) Lehman's use of "Repo 105" transactions—repurchase agreements that allowed Lehman to lower its leverage temporarily—falsely allowed the bank to present itself as financially stronger than it really was."

As for the impact of this ruling on EY, the article states that:

(The judge) rejected the defendants' attempt to dismiss the entire case, but he threw out some claims, particularly some of those against Ernst & Young LLP, Lehman's independent auditor. The judge did allow a claim to continue alleging that E&Y made misstatements in July 2008 about Lehman's compliance with accounting rules when in fact E&Y was aware of the bank's use of Repo 105s, which "cast into doubt" whether its balance sheet was consistent with generally accepted accounting principles.

So is this good news or bad news for EY? It sounds like it's both but I believe that the good news is fairly minor and the bad news overshadows any good news. On a good note, it helps that many of the claims against EY have been dismissed. With that said, I'm not even sure what those claims were.

As for bad news, EY still appears to have a big monkey hanging over them in the Repo 105 transactions. In my opinion, those transaction have always been at the heart of EY's risk. In other words, EY's audit of Lehman's use of Repo 105 transactions are still something that a jury could latch onto and rule that EY allowed Lehman to mislead investors. If they did, and that's a big if, the amount of a ruling against EY could be huge since the Lehman bankruptcy was astronomical.

The article provided some quotes that also suggest that EY made some minor headway but is by no means out of the woods yet. For example, an attorney representing the plaintiffs said "(H)e was pleased with the ruling. The 'vast majority' of the case will go forward, he said, including the core allegations, and all of the defendants remain in the case."

Even so, EY made a statement that it was "pleased that Judge Kaplan's ruling dismisses most of the claims against us in this matter, and we strongly believe that we will ultimately prevail on the remaining claim."

Unfortunately for EY, as the plaintiff's attorney said, the "core allegation" still remains. As I've said before, even if the Repo 105 transactions were technically in compliance with the letter of the accounting rules, convincing a jury that it's okay for an auditor to let their client mislead investors through their accounting will be a tough sell.

More on the Cheating Scandals in Public Schools

noreply@blogger.com (MZ) — Wed, 20 Jul 2011 14:16:00 +0000

Imagine if the response to Enron and WorldCom was to say that business leaders are set up to commit fraud because the market is too interested in accounting information so we should have businesses report less economic data about their performance. According to an article in The New Republic, that is essentially the reaction by some in education to the recently reported cheating scandals in Atlanta and elsewhere. Here are a few quotes:

When asked about Atlanta, noted school reform apostate Diane Ravitch pointed the finger at the federal No Child Left Behind law, saying that, when high-stakes incentives are attached to test scores, we are “virtually inviting” teachers to cheat. At the Daily Kos, readers were told that “the tests, and the stakes attached to them, are the issue. No rational person can look at cheating this widespread and decide its existence is about the individuals, however blameworthy their behavior may be.” One Atlanta-area teacher put it this way: “Anybody whose job is tied to performance, it is a setup.”

I agree that pressure to perform leads to fraud. Afterall, it's one part of the fraud triangle. The other two parts are being ignored here though: rationalization or character and opportunity. What these writers are apparently assuming is that opportunity will always exist and that teachers do not have enough integrity to resist rationalizing. If that is the case, our educational system is doomed for failure.

The New Republic also made the following observation:

Corruption, educational or otherwise, should be fought with strong law enforcement, the election of public officials with integrity, and the vigilance of citizen’s groups and a watchful press. The Securities and Exchange Commission exists because lawmakers correctly assume that the pressures and temptations of making money are so great that companies and financial actors can’t be trusted. Other than lunatic objectivists and Wall Street water-carriers, nobody reacted to Madoff, Enron, or WorldCom by calling for less enforcement and public reporting of information. Instead, they rightly called for more.

If there is a role for performance measurement, as there is in business, then there will be pressure to commit fraud. This leads to the need for systems to reduce opportunity for fraud such as internal controls, auditing, etc. and for means of improving integrity or reducing rationalization. Tone at the top goes a long way toward helping build integrity. In the case of the Atlanta school scandal, the tone was corrupt at the top and it filtered throughout the school district.

I'm not sure what is being done to reduce opportunity for cheating on educational performance but it doesn't sound like anything was done in Atlanta. This sounds like an area that is ripe for new assurance services to me...