Madoff

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Madoff timeline

The Ponzi scheme orchestrated by Bernard L. Madoff was the largest fraud by anyone in American history, involving $65 billion and damaging the finances of thousands. Victims were mainly individuals and charities, and included many people prominent in the Jewish community.

Madoff auditor consents to judgement

SECURITIES AND EXCHANGE COMMISSION V. DAVID G. FRIEHLING, C.P.A AND FRIEHLING & HOROWITZ, CPA'S, P.C. (S.D.N.Y. Civ. 09 CV 2467)

MADOFF AUDITORS CONSENT TO PARTIAL JUDGMENT IMPOSING PERMANENT INJUNCTIONS

The Securities and Exchange Commission today announced that Bernard Madoff's auditors have agreed not to contest the SEC's charges that they enabled Madoff's fraud by falsely stating they audited the convicted fraudster's financial statements in accordance with the relevant accounting and auditing standards.

On November 3, 2009, the SEC submitted to the Honorable Judge Louis L. Stanton, a federal judge in the Southern District of New York, the consents of David G. Friehling and Friehling & Horowitz, CPA'S, P.C. ("F&H") to a proposed partial judgment imposing permanent injunctions against them. Friehling and F&H consented to the partial judgment without admitting or denying the allegations of the SEC's complaint, filed on March 19, 2009. If the partial judgment is entered by the Court, the permanent injunction will restrain Friehling and F&H from violating certain antifraud provisions of the federal securities laws.

The proposed partial judgment would leave the issues of the amount of disgorgement, prejudgment interest and civil penalty to be imposed against Friehling and F&H to be decided at a later time. For purposes of determining Friehling's and F&H's obligations to pay disgorgement, prejudgment interest and/or a civil penalty, the proposed partial judgment precludes Friehling and F&H from arguing that they did not violate the federal securities laws as alleged in the Complaint.

In its complaint, the SEC alleges that Friehling and F&H enabled Madoff's Ponzi scheme by falsely stating, in annual audit reports, that F&H audited Bernard L. Madoff Investment Securities LLC's ("BMIS") financial statements pursuant to Generally Accepted Auditing Standards (GAAS). F&H also made representations that BMIS' financial statements were presented in conformity with Generally Accepted Accounting Principles (GAAP) and that Friehling reviewed internal controls at BMIS. The complaint alleges that all of these statements were materially false because Friehling and F&H did not perform a meaningful audit of BMIS and therefore had no basis to form an opinion about the firm's financial condition or internal controls.

Post-Madoff Reforms

On June 29, 2009, Bernard L. Madoff was sentenced to 150 years in prison after pleading guilty in federal district court in New York to perpetrating a massive Ponzi scheme since the early 1990s that victimized thousands of investors. Mr. Madoff pleaded guilty to 11 criminal counts including securities fraud, investment adviser fraud, and providing false documents and testimony to the Securities and Exchange Commission.

In the wake of the Madoff fraud, the SEC’s Office of the Inspector General launched an internal investigation in December 2008 to determine why the agency did not detect the scheme. While awaiting the report, the SEC has been taking decisive and comprehensive steps to reduce the chances that such frauds will occur or be undetected in the future.

  • Safeguarding Investors’ Assets: The SEC in May proposed two rules that would better protect clients of investment advisers from theft and abuse. The rules would provide assurance to these clients that their accounts contain the funds that their investment adviser and account statements say they contain. Among other things, the rules would encourage investment advisers to place their clients’ assets in the custody of an independent firm.
  • Surprise Exams: One proposal would require all investment advisers who control or have custody of their clients’ assets to hire an independent public accountant to conduct an annual “surprise exam” to verify those assets actually exist. This surprise examination would provide another set of eyes on the clients’ assets, thereby offering additional protection against the theft or misuse of funds.
  • Third Party Reviews: A second proposal would apply to investment advisers who do not use independent firms to maintain their clients’ assets. Such advisers would be required to obtain a third party written report assessing the safeguards that protect the clients’ assets. The report — prepared by an accountant registered and inspected by the Public Company Accounting Oversight Board — would, among other things, describe the controls that are in place to protect the assets, the tests performed on the controls, and the results of those tests. Existing rules make no distinction between an investment adviser whose affiliate holds its clients’ funds and an investment adviser that uses a truly independent custodian.
  • Revitalizing the Enforcement Division: Under the leadership of a new Enforcement Director, the SEC is restructuring the division to better ensure that it focuses on significant cases that will have a meaningful impact. The restructuring will reduce bureaucracy and speed up the enforcement process by removing a layer of management in the 1,100 person division. The newly structured division will include specialized units that will enable staff in those units to concentrate their expertise in focused areas and help detect patterns, links, trends and motives. In addition, the Division is streamlining internal processes to make investigative procedures more efficient.
  • Revamping the Handling of Complaints and Tips: In order to improve the handling of hundreds of thousands of complaints, tips, and referrals it receives each year, the SEC has contracted with Mitre, a federally funded research and development center, to help the agency revamp its processes across the agency. After reviewing and analyzing its intake procedures, the SEC is now beginning to improve upon its processes for collecting, recording, investigating, referring and tracking this information. Among other things, the agency is creating a centralized system for handling this information. Once the information and processes are centralized, the agency will apply risk analytics to better enable it to reveal links, trends, statistical deviations and patterns that might not be observable when each complaint is examined one at a time.
  • Advocating for a Whistleblower Program: The SEC has advocated for expanded authority from Congress to reward whistleblowers who bring forward substantial evidence to the agency about significant federal securities violations. In proposed legislation that the Chairman sent to Congress, a fund would be established to pay whistleblowers using money collected from wrongdoers that is not otherwise distributed to investors.
  • Conducting Risk-Based Examinations of Financial Firms: The SEC has dispatched its examiners to conduct a “sweep” of firms that present certain risk characteristics to ensure, among other things, that the clients’ assets in fact exist. Such risks include advisers whose clients’ assets are held with an affiliate, as opposed to an independent entity; hedge funds that seem to have “smooth” or outlier returns; firms that use an unknown auditor or no auditor at all; firms with a disciplinary history; and broker-dealers that sell an affiliate’s hedge fund or limited partnership.
  • Increasing Focus on Agency-Wide Risk Assessment: The SEC is assessing and improving the use of risk assessment techniques, agency-wide, to more proactively identify areas of risk to investors. The agency is increasing collaboration with third parties and other government agencies to identify firms or products that may pose risk to investors or markets. The agency is also improving our ability to monitor the industry — by identifying the data and information that financial firms would submit to the SEC — to allow it to better identify those particular firms that warrant a closer look by examiners and enforcement staff.
  • Improving Fraud Detection Techniques for Examiners: The SEC instituted measures to improve the ability of examiners to detect fraud and other types of violations. The measures include more rigorous reviews of firms before the examiners enter the premises, and a more complete exam guide that focuses not only on obvious signs of fraud but also more subtle signals that deserve closer inspection, such as a firm using an unknown accountant. The measures also include increased checks on outside entities to verify that assets actually exist there and expanded use of exams of an entire entity when firms have joint or dual registrants such as affiliated broker-dealers and investment advisers.
  • Recruiting Staff with Specialized Experience: The SEC is working to bring in new staff with diverse skill sets to expand its knowledge base and improve its ability to assess risk, conduct examinations, detect and investigate wrongdoing, and focus our priorities. Some initial examples included:
  • Senior Specialized Examiners: The agency is hiring new staffers to the examination unit who have specialized experience in areas such as trading, operations, portfolio management, options, compliance, valuation, new instruments and portfolio strategies, and forensic accounting.
  • Industry and Market Fellows Program: The agency is hiring new staffers who are highly-seasoned financial experts to keep pace with the practices of Wall Street and protect investors. These experts would provide other staffers with new information and perspectives to help them identify emerging issues and understand the ways the industry is changing.
  • Expanding and Targeting Training: The SEC is providing its staff with targeted training related to hedge funds and specialized products, derivatives and options, complex trading, and investigations of regulated entities. Additionally, the SEC is conducting programs to train hundreds of staffers to become Certified Fraud Examiners, and expanding the availability of programs for staffers to become Certified Financial Analysts.
  • Seeking More Resources: The SEC has been seeking additional funding to hire more examiners who can go into more financial firms to see whether they are in compliance with the law, as well as for more enforcement staff who can bring more enforcement cases when fraud and other violations of the law are found. In recent years, the SEC has not had adequate resources to oversee the securities industry. For example, the SEC has just over 450 people in its exam program to examine the more than 11,000 regulated investment advisers and 8,000 mutual funds.
  • Integrating Broker-Dealer and Investment Adviser Examinations: The New York Regional Office has adopted a protocol that will integrate examination teams to make sure people with the right skill sets are assigned to examinations. Under the new protocol, a single team of examiners, drawn from the broker-dealer and investment managements units, will jointly examine selected firms to ensure that the examination team includes those most expert in the subject of the exam. In addition, this initiative includes greater cross-training and coordination between broker-dealer and investment management staff on their examination plans.
  • Enhancing Licensing, Education and Oversight Regime for “Back-Office” Personnel: Working with senior SEC staff, FINRA has committed to establish a new system to enhance the oversight and professional requirements of personnel performing back-office functions at broker-dealer firms. “Back-office” personnel typically perform critical custody, accounting, transfer agency and account maintenance functions. They have an important role that must be performed with skill and integrity. Under the new regime, certain back-office personnel would be subject to licensing and education requirements as well as enhanced oversight. The new regime will further promote the qualifications and professionalism of those performing back-office functions so that client accounts are better protected.

Finra panel reviews regulator's policing procedures

Board yet to decide whether to release a public report, sparked by Bernard Madoff and R. Allen Stanford cases

An internal committee of the Financial Industry Regulatory Authority Inc. has submitted a draft report analyzing the regulator's processes for scrutinizing securities firms in the wake of the high-profile investment scandals involving Bernard Madoff and R. Allen Stanford. Whether or not the report is to be made public is unclear.

“Earlier this year, the Finra board of governors formed a special committee to conduct a review of its examination program in light of the Madoff and Stanford cases,” said Finra spokeswoman Nancy Condon.

Assisted by outside legal counsel, the special committee is headed by Finra board member Charles Bowsher, a former U.S. comptroller general, she added.

A draft report of the special committee's findings has already been submitted to the board, but the report is not final, she added.

The board has not announced whether it will release the report.

“I cannot speak for the board,” Ms. Condon said “They will review it and determine what they will do.”

Mr. Stanford, a Texas financier, was charged in February with allegedly running a $7 billion fraudulent investment scheme. In June, Mr. Madoff was sentenced to 150 years in prison for conducting a $65 billion Ponzi scheme.

Mr. Bowsher was not immediately available for comment.

Trustee seeks billions for Madoff investors

"Jeffry M. Picower, a longtime investor in Bernard L. Madoff’s fraud scheme who died in his Palm Beach swimming pool last month, left an estate with assets far in excess of $1 billion — and that could be a spot of good news for Mr. Madoff’s victims.

Although Mr. Picower’s wil, which is expected to be filed on Tuesday, leaves the bulk of the estate to charity, that amount depends on how much his family pays to settle legal claims brought by the trustee gathering assets for Mr. Madoff’s victims.

But the estate is clearly large enough to add at least several billion dollars to the $1.4 billion that the trustee has gathered so far. The trustee, Irving H. Picard, estimates that the cash losses in the enormous Ponzi scheme total at least $21 billion.

Mr. Picard has demanded the return of $7 billion he says Mr. Picower and his wife withdrew from their Madoff accounts over several decades. Lawyers for the Picowers say they withdrew $2.4 billion during the six-year recovery period allowed for the trustee’s claims under New York State law and contend that should be the limit of Mr. Picard’s claim.

William D. Zabel, a lawyer for the family, declined to comment Monday night on the settlement talks, except to note that the figures under discussion obviously range from $2.4 billion to $7 billion. Any settlement in that range would at least double the amount available to Mr. Picard to cover victim losses.

Mr. Zabel said “a fair and generous settlement with the Madoff trustee” should still leave “hundreds of millions of dollars” to establish a new charitable foundation envisioned in the will and to pay more than $240 million in cash bequests.

Trustee's motion denying customer claims

Memorandum of law in support of Trustee's motion for an order upholding Trustee's determination denying "customer" claims for amounts listed on last customer statement, affirming Trustee's determination of net equity, and expunging those objections with respect to the determination relating to net equity.

SIPA lacks sufficient funds to repay Madoff investors

The Securities Investor Protection Corp. said in a letter to a congressional subcommittee that claims by victims of Bernard Madoff’s Ponzi scheme far exceed the funds available to the agency to reimburse them.

As of Aug. 1, the SIPC had a total fund of $1.2 billion and access to as much as an additional $2.5 billion in loans from the U.S. Securities and Exchange Commission, SIPC President Stephen Harbeck said in a Sept. 7 letter to the House Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises.

Claims by Madoff victims total $57.2 billion based on false account statements issued by Madoff’s firm in November 2008, the month before his arrest, according to the SIPC letter. Victims lost $17.3 billion when calculated as the difference between money invested and money withdrawn from Madoff’s firm.

The SIPC, which is required to pay victims a maximum of $500,000 for most claims, has allocated $888 million to pay claims based on lost principal. If forced to pay based on the account statements, the SIPC would have to pay an additional $1.1 billion, it said in the letter.

The letter, which was produced in connection with a subcommittee hearing on Sept. 23, responds to questions contained in an Aug. 20 letter by the Democratic chairman and ranking Republican on the subcommittee.

According to the letter, Madoff made 90,000 payouts to investors, totaling $18.5 billion, that were in excess of the money they invested. Irving Picard, a trustee appointed to oversee the bankruptcy of Madoff’s firm, has filed 19 claims in U.S. bankruptcy court seeking to recover $15 billion from clients who got overpayments, according to the SIPC letter.

Madoff Victims

Madoff victims have tried, unsuccessfully so far, to force the SIPC to pay based on their fictitious account balances. The SIPC, supported by trustee Picard and U.S. Bankruptcy Judge Burton Lifland in Manhattan, has said it’s required only to pay based on cash invested minus withdrawals.

Representatives Paul Kanjorski and Scott Garrett, a Pennsylvania Democrat and New Jersey Republican, respectively, have pushed the SIPC to consider other methods of repaying investor claims. The two, who serve as the top members of the House Financial Services Subcommittee on Capital Markets, held a hearing Sept. 23 on the “limitations of the Securities Investor Protection Act” that established SIPC.

“While SIPC’s actions may follow the letter of the law, many would argue that SIPC has ignored the spirit of the law,” Kanjroski said at the Washington hearing. He added that lawmakers need to “consider the best way to change the tone at SIPC and refocus this body on maintaining confidence in the financial system and promoting investor protection.”

Litwin Lawsuit

Yesterday, the Litwin Foundation, a Madoff investor, sued the SEC for “negligence” in failing to uncover the Ponzi scheme. The New Hyde Park, New York-based foundation seeks to recover at least $19 million and other unspecified damages against the agency for failing to prevent losses at Madoff’s investment firm.

The government’s “sovereign immunity” from lawsuits should be waived under a law that allows cases to be brought against the U.S. if its workers were negligent, the foundation said in the complaint. The organization was established in 1989 and contributes to nonprofits that include Lincoln Center for the Performing Arts and the Brooklyn Botanical Garden.

The SEC “had countless opportunities to stop the Ponzi scheme Madoff operated over 16 years and botched all of them,” the foundation said in the complaint.

SEC Investigations

The plaintiffs said that during a period of 16 years, the SEC investigated Madoff on multiple occasions and failed to expose the fraud.

John Heine, a spokesman for the SEC, declined to comment on the lawsuit.

Several pieces of legislation have been introduced in the U.S. Congress aimed at relieving losses to Madoff’s investors. Representative Bill Pascrell, a New Jersey Democrat, has introduced a bill that would allow Madoff investors to recoup some of the losses through the U.S. tax system. Senator Charles E. Schumer, a New York Democrat, has introduced similar legislation in the Senate.

“It would seem to me that one major and fundamental reform would be for them, through the actions of the trustee that has been appointed, to see themselves as an advocate rather than an adversary against innocent defrauded investors,” said Garrett, who is co-sponsoring the Pascrell bill. Investors, Garrett added, need to “feel as though they are being assisted by the SIPC process, rather than hunted down and accused of some kind of wrongdoing.”

Madoff Liquidation

Madoff, 72, is serving a 150-year prison term after pleading guilty last year to masterminding the largest Ponzi scheme in history. The liquidation of New York-based Bernard L. Madoff Investment Securities LLC is the biggest such case undertaken by SIPC, according to court records.

The bankruptcy case is: Securities Investor Protection Corp. v. Bernard L. Madoff Investment Securities LLC, 08-01789, U.S. Bankruptcy Court, Southern District of New York (Manhattan). The Litwin case is The Litwin Foundation v. United States of America, 10-CV-7367, U.S. District Court, Southern District of New York (Manhattan).

Bank should have detected Madoff fraud

"Bernard Madoff had two primary bank accounts set up for him in New York. One account was with the Bank of New York Mellon, account number 866-1126-621 (referred to as BONY 621). This account was supposed to be the primary cash account for the legitimate broker-dealer business he and his brother Peter had in the late 1960s. Madoff also had an account at JPMorgan Chase, account number 140081703 (referred to as JPM 703), which investors used when wiring money or sending cheques to what would turn out to be a fake advisory business – a hedge fund, they thought at the time.

This was also the account investors used when clients withdrew money from the fund. Many were able to withdraw funds within days, and Madoff always had the money ready, no matter how large the amount. It was one of his biggest selling points.

After his arrest, Madoff would claim in court that the legitimate brokerage firm and the criminal hedge fund were completely separate. However, in 2001 money began to slosh back and forth between the two bank accounts regularly. Money was transferred from both the Bank of New York and the JPMorgan Chase accounts to Madoff’s London office; Madoff personally wired roughly $500m over to London and then back again between 2001 and 2008, according to copies of the documents filed by the Madoff trustee, Irving Picard. Over those seven years Madoff also withdrew cash from the broker-dealer’s account with Bank of New York, sometimes as much as $2m in a single day.

It was this sort of cross-over that got some people on Wall Street wondering about the legitimacy of Madoff’s operations as early as September 2008.

Madoff was close friends and business associates with a long-time over-the-counter trader named Aldo Parcesepe, a senior managing director and head of Nasdaq market making at the investment bank Bear Stearns. Parcesepe regularly traded with Madoff’s broker-dealer firm, and between 2005 and 2008, he served on the board of the National Stock Exchange (NSX), an electronic exchange for equities and options that the Madoffs had subsidised in the late 1970s.

Madoff owned 10 per cent of the NSX, and Bear Stearns regularly traded through the exchange. Brokers who traded at Bear Stearns used the firm’s automated equity order system to buy and sell stocks. A broker would enter the stock symbol and the number of shares he or she wanted to trade. The system was supposed to do the rest: work to find the best counterparty to trade with from among the many market makers that traded with Bear Stearns.

But for Nasdaq stocks, Bear Stearns had an unwritten code: the system automatically defaulted to trade with Madoff. Madoff reportedly paid Bear Stearns substantial fees for this default setting on their equity order system, and he may have paid other customers to do the same. Between 2000 and 2008, Bear Stearns’ 400 or so brokers all used this system, and all their Nasdaq trades defaulted to Madoff. It was a big source of revenue for Madoff and vaulted Bear Stearns to the largest counterparty trading with Madoff.

The arrangement was in place when Bear Stearns went under in early 2008, and it continued under JPMorgan Chase, which took over Bear Stearns’ operations in the spring of 2008. It may have seemed an unfair system for Bear Stearns customers, but such agreements are common and legal."

Internal review of SEC oversight of Madoff

"It might be bank failure Friday, but it’s also “closer look at how the SEC utterly embarrassed itself r.e. Bernard Madoff” day.

The SEC has released a detailed archive of exhibits compiled in support of the recently published report on the regulator’s failure to uncover Bernard Madoff’s epic Ponzi scheme.

There are 536 such exhibits, which include emails, letters and telephone records. Here’s are some (randomly selected) samples, any emphasis ours.

Exhibit 15:

“And, you know, over the last five-plus years, I’ve met a lot of people in this businesss, you know, running hedge funds of funds or doing due diligcence, and in my opinion, are just clueless. Over those years I’ve met plenty of people who, you know, claim to have investments with Madoff and was always reluctant, in a sense that they’re my competitors, to tell them it was a fraud but I just couldn’t help myself.”

“So whenever someone mentioned Madoff, I kind of went out of my way to outline why I thought Madoff was a fraud, and it appeared that very few people listened.” …

“So you know, no, we couldn’t find anyone on the street who claimed to do trading with him, which was just another red flag because, you know, frankly, people, you know, people talk, especially back in the ’90s and, you know, early 2000. If a large trade went up in the options market, you can make one phone call and figure out, you know, within two minutes who did the trade.”

“And, you know, at the time, there was always the possibility that, you know, I would call Goldman Sachs and the guy, you know, wouldn’t say he’d done business with Bernie, you know, because they’re not supposed to anyway.”

“But, you know, I’m just being totally truthful with you, like, during those times, if a large trade went up, you know, you can make a couple phone calls and pretty much figure out who did it or someone would tell you.”

“So I mean, Harry and I just literally went to the Wall Street Journal, you know, went to the options page, looked at the open interest, and basically figured out, like, it was impossible. He would have been more than the entire open interest.”

(Editor’s note: the most interesting aspect of Exhibit 15 is the suggestion the SEC didn’t catch Madoff because they simply did not understand how options trading actually worked. See also Exhibit 18, below)

Exhibit 18:

…And then that’s when I brought Harry [Markopolos] in to see Grant Ward, unfortunately, If he’d seen — I know if he had seen Jim Adelman, the results would have been different.”

Q: Why do you say that?

A: When we walked out of the meeting, Harry and I, with Grant Ward, we looked at each other we both said, He didn’t understand a damn thing we said.

Exhibit 22, testimony on the culture of competitiveness among the SEC’s regional offices:

I sometimes sensed at the SEC that there was a bit of eat what you kill kind of — a bit of competitiveness between the offices. I’m sure we were that way and I know some of the regional offices were that way.

Exhibit 39: “I didn’t see anything the resembles the kind of formal work papers, audit work papers that would comply with generally accepted audit standards. So there was almost nothing that indicated that any audit work had been done.”

Exhibit 23:

“At some point there were press articles that suggested that the firm’s returns in its investment advisory business were, perhaps, too good to be true. And there was — there were allegations that the rationale for that was the investment advisory firm was front-running its market-making orders in order to generate those returns.”

Exhibit 02:

“It is difficult, you don’t want to disparage former co-workers but the SEC is a large organization” [Editor’s note: he goes on to comprehensively disparage former co-workers]

Exhibit 19:

“My assessments were that [Harry Markopolos] was factually knowledgeable but I was concerned about the — I came to understand that he’d become a bounty hunter, and I was concerned about the bias that would bring to anybody who came to us with information.” … I’m always watchful to make sure that it isn’t the shorts that are talking to the publications because then I reduce the credibility of it.


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