by Jim Marasco , CPA,CIA, CFE

Rochester Business Journal, April 2009

It seems that with every economic downturn (or recession, if you will), Americans are introduced to a different type of fraudulent activity. It has been estimated that nearly 20% of the failed Savings and Loans during that late 80’s and early 90’s can be attributed to fraud and/or insider transaction abuses. The bursting of the technology bubble in the early 2000’s displayed how corporate greed had reached new heights through income smoothing, accounting irregularities and fraudulent reporting of Enron, MCI/WorldCom, Adelphia and others. Perhaps befitting its status as the most significant recession in the past 75 years, the recent economic downturn has provided a variety of fraudulent activities, highlighted by perhaps one of the oldest and simplest schemes in the book, the Ponzi scheme.

Recent Developments

Clearly the history books will be re-written to include the name Bernard Madoff. While the notorious $50 billion figure may be inflated to include fictitious gains, the fact remains that this currently owns the top position as the most brazen fraud perpetrated by a “single individual.” However, the ink used to print the Bernie Madoff stories had barely dried when we learned that the SEC was investigating (and subsequently charging) R. Allen Stanford with an $8 billion fraud centered around the sale of certificates of deposit. It has been suggested that the Stanford case has the potential to eke out Bernie as Stanford manages approximately $51 billion. These two are not alone: In addition to the Ponzi schemes noted, the country has been exposed to fraud involving real estate at an unprecedented level. It has been reasoned that the current recession has been precipitated by the decline in the value of real estate due to the rampant speculative practices employed over the past decade. However, it would be foolish to think malfeasance and fraud aren’t at least partly to blame. We have witnessed fraud in the mortgage origination market, as appraisers, mortgage brokers and even lending institutions colluded to improperly finance the sales of homes to people unable (or never intending) to pay the underlying mortgage. Not to be outdone, the fraudulent activity noted in the secondary mortgage-backed security markets include the manipulation of payment schedules of the underlying mortgages in a securitized package, as well as misrepresentation of the riskiness of the underlying mortgages. This is just a taste of what has been happening around the country. In the past six months, it seems a multi-million dollar scheme has been exposed in nearly every state. The losses to investors are startling, and it seems to lead to a chicken and the egg question: Is there more fraud in a recession or does a recession cause these schemes to fail and be flushed out?

How did we get here?

It has been said that hindsight is twenty-twenty. After reviewing Madoff’s reporting, investment philosophy, and incredibly consistent returns, it seems obvious this scheme was fraudulent. In fact, brilliant Wall Street financial advisors and the SEC rubber-stamped these investments and failed to scrutinize his performance and/or actions. As we’ve seen, the “toxic” mortgage-backed securities have brought Wall Street titans AIG, Citigroup and Lehman Bros. to their knees. With respect to Ponzi schemes, one could cite investor ignorance and a sorry lack of due diligence. Any investment opportunity that promises above-average investor returns, seemingly countering the overall performance of the stock market, should be heavily scrutinized. Also at fault could be greed. It can be easy for an investor, even an experienced one, to become seduced by the promise of exceptional returns, particularly when it is promised by a “reputable” manager like Bernie Madoff or R. Allen Stanford. In addition, neither Madoff nor Stanford employed the services of an auditing firm qualified to adequately render the services needed. Greed and ignorance are not the only reasons. With respect to the mortgage-backed securities market, there is little to no regulation currently in place. This was acknowledged by SEC Chairman Christopher Cox in September when he stated that, “significant opportunities exist for manipulation” and cited that the secondary market was, “completely lacking in transparency and completely unregulated.” As the Madoff scandal has unfolded, it has been discovered that the SEC received multiple complaints regarding his investment practices. It seemed to be a well-known secret around Wall Street that Mr. Madoff’s activities were questionable and many investment firms advised clients and other insiders against becoming involved with him. However, during the time that these two were perpetrating their massive frauds, the SEC found the time to sentence Martha Stewart to five months in prison for selling approximately $230,000 in ImClone stock on an insider tip and to interview Howard Stern several times concerning his move to Sirius Satellite Radio.

The Mindset of the Individual

I had the unique opportunity of investigating a multi-million dollar Ponzi scheme ten years ago. As I searched the desk of the perpetrator, I found a cartoon he kept close to him. People were featured sitting around a board table with the chairman at the head of the table telling everyone, “Remember, you can fool some of the people all of the time. Those are the people we need to concentrate on.” This speaks volumes about the individuals who perpetrate these crimes. Unfortunately, frauds will always endure. The schemes and the perpetrators may change, but someone will always be lurking – waiting to take advantage of trusting individuals.

• Andres Pimstein in Miami, FL, perpetrated an iPod reselling Ponzi scheme which netted over $50 million.
• Joseph Forte of Broomall, PA, solicited over $50 million, claiming he could bet on the direction of the S&P 500 index.
• Carolina Development conned more than 1,000 investors and $50 million in a California Ponzi scheme involving fraudulent real estate projects.
• Paul Greenwood and Stephen Walsh were implicated in a $553 million fraud in North Salem, NY where he was also the Town’s Supervisor.
• Joel Steinger, founder of Mutual Benefits, his brother and two Florida attorneys were indicted on $1 billion Ponzi scheme involving the sale of shares in life insurance policies on the terminally ill and elderly, known as viatical settlements.

James I. Marasco, CPA/CFF, CFE, CIA Jim is a partner at EFPR Group. He brings more than 18 years of public accounting and auditing experience. He is a full-time management consultant and travels extensively throughout the country while leading StoneBridge Business Partners (an EFPR Group affiliate company). Article republished with the permission of the Rochester Business Journal .