Get ready for increased reports on financial frauds now

I have been waiting for this type of news to come. With crisis this deep and huge financial flows pre-crisis, financial frauds is something natural to expect. The events of financial fraud have begun to roll now.

Portfolio points 3 cases of frauds have been reported:

First, we witnessed the New York lawyer Marc Dreier being arrested after impersonating another lawyerin what has to be one of the most bizarre and fascinatingfraud cases in recent history. Charged with swindling hedge funds out of hundreds of millions of dollars, Dreier was denied bail on Thursday after prosecutors called him “an enormous risk of flight.”

Then we had Chicago. Oh, Chicago, your corrupt politicians never cease to captivate the country! Governor Rod Blagojevich was chargedwith brazenly soliciting bribes in his quest to fill the Senate seat vacated by President-elect Barack Obama.

And now, we have Bernie Madoff. The president of Bernard L. Madoff Investment Securities, the 70-year-old Wall Street trader was arrested by the F.B.I. and charged with securities fraud late Thursday. The fraud allegedly totaled over $20 billion.

Here is the Dreir story from NYT which is slightly more complex with issuance of fake promissory notes. What was SEC doing?

Madoff was a classic case of ponzy scheme which is reporetd to have swindled about USD 50 billion from investors. For details see NYT , WSJ, Marketwatch. I liked this from portfolio.com:

Mr. Madoff, 70 years old, allegedly told employees he had a couple of hundred million dollars left and wanted to distribute it before turning himself in to authorities, this person said.You read that right. When the boss comes in and says “Take your bonus now before the Feds get it instead,” you know something is amiss. 

What amazes me is that both Madoff and Dreir managed to swindle not just ignorant public (which is expected to be financially literate) but suave hedge fund investors (Madoff in particular) and managers (Dreir in particular).  In Madoff’s case:

Most Ponzischemes collapse relatively quickly, but there is fragmentary evidence that Mr. Madoff’s scheme may have lasted for years or even decades. A Boston whistle-blower has claimed that he tried to alert the S.E.C. to the scheme as early as 1999, and the weekly newspaper Barron’s raised questions about Mr. Madoff’s returns and strategy in 2001, although it did not accuse him of wrongdoing.

Investors may have been duped because Mr. Madoff  sent detailed brokerage statements to investors whose money he managed, sometimes reporting hundreds of individual stock trades per month. Investors who asked for their money back could have it returned within days. And while typical Ponzi schemes promise very high returns, Mr. Madoff’s promised returns were relatively realistic — about 10 percent a year — though they were unrealistically steady.

This reminds of the classic paper by Dean Foster and Peyton Young who show how difficult it is to differentiate between a genuine fund manager and a con one. They also show how easily a con fund manager can show him to be a genuine one. The paper looks at more sophisticated strategies that con managers can use, Madoff shows it is a lot easier.  

5 Responses to “Get ready for increased reports on financial frauds now”

  1. » Get ready for increased reports on financial frauds now Says:

    […] ø MeetTheFirms.com ø Official Meet the Firms Site! wrote an interesting post today onHere’s a quick excerptI have been waiting for this type of news to come. With crisis this deep and huge financial flows pre-crisis, financial frauds is something natural to expect. The events of financial fraud have begun to roll now. Portfolio points 3 cases of frauds have been reported: First, we witnessed the New York lawyer Marc Dreier being arrested after impersonating another lawyerin what has to be one of the most bizarre and fascinatingfraud cases in recent history. Charged with swindling hedge funds out of h […]

  2. AcK Says:

    >>What amazes me is that both Madoff and Dreir managed to swindle not just ignorant public (which is expected to be financially literate) but suave hedge fund investors (Madoff in particular) and managers (Dreir in particular).

    What is this supposed to mean exactly. I have seen this statement bandied about almost anytime something unexpected happens in the market. Finance is a people business and unless you have an eye (or a nose) for trouble, this could happen to you as well as any other person. I agree that this consistent returns in case of Madoff should have rung some alarm bells.

    However, this brings us to the other (and frankly deeper) problem in this industry. How many contrarions are celebrated in general (or for that matter, how many bears). I am not talking about one Meredith Whitney but how many people are willing to go with a contrarions given (1) he has a nose for trouble and (2) you are willing to bet on his calls not working for some time. The pressure on an analyst to confirm to what is the general trend in the industry exists. In my view, having been a part of an i-banking team for a long time, this is not even much of direct pressure. However, if you give a contra call and it does not work for two months (yes, 2 frigging months), your own sales team will stop pitching your ideas. The tolerance level (and time period over which your investment view should be) is too small. Thus the herd mentality. I know of an insurance investment manager (should ideally take at least 3-5 yr view, in my opinion), who is reviewed on a monthly basis. This is not only stupid, but a lot more prevalent and harmful than one freak ponzy scheme.

    • Amol Agrawal Says:

      Hi AcK,

      Well the purpose behind the statement was to point that hedge fund business isn’t as great as it is made out to be. It is pretty difficult to distinguish a good fund mananger from a con fund manager.

      Well, I agree with you on the points you make about contrarians etc. This isn’t anymore a people’s industry (though ws supposed to be one) but has become a cosy club – You don’t question me, I don’t question you. Another example is the no of sell reports one gets to see from equity analysts- 1 in 1000 may be….YOu talk to any equity analysts and question him on this..most get offensive and say if we do, there won’t be any buisiness….

  3. o8justiceforall Says:

    What is this obsession with what we are in is called? Does it matter when you pay your bills? When the government is planning on and has already bailed out those who are not only operating a business by making bad decisions but they are doing things that are against the law. When Maddoff has been stealing for over a decade tally is currently at over 50 Billion, when Dreier has been involved in identity theft and stealing and his firm can file for bankruptcy, when Bank of America who has the top two ranking for identity theft is given bailout money? The bailout money is not free, it is paid for by you and I. The tax payers of this country need to stop this now. We should say no more. What are your thoughts?

    http://o8justiceforall.wordpress.com/

  4. Satyam does an Enron! « Mostly Economics Says:

    […] does an Enron! By Amol Agrawal When I had posted earlier that be ready for more financial frauds, it was least expected that it would come from Indian […]

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