How To Prevent Another Madoff Scandal
For those of us that did not lose money, it is fun to dish about Bernard Madoff, but plenty of people and charities were hurt. We, as a capitalist nation, need to find a way to prevent this from happening again or, at the very least, make it harder.
In some ways, the entire past year was the financial world’s equivalent of 9/11. We need to react in a similar fashion. After 9/11, the Bush administration moved quickly to establish the new Department of Homeland Security with its infamous color-coded warnings.
The Obama administration needs to create a Financial Consumer Safety Agency for all financial products including investment along the lines of the Food and Drug Administration (FDA) or the Consumer Safety Products Commission. The mission of the agency would be to protect and educate the consumer about a wide range of financial products, not to punish the transgressor.
This agency should be staffed with savvy market professionals, not just lawyers. It should monitor investment products, credit cards, and mortgages. Currently, the regulation of consumer financial products is assigned to the agency that regulated the issuing institution instead of by the consumer that uses the product. No financial regulatory agency in Washington is focused on the consumer.
Many may question why I am advocating for the establishment of a yet another potentially useless bureaucracy instead of calling for the revamping of the Securities and Exchange Commission (SEC). In my opinion, the SEC is so broken that it can not be fixed. Incredibly, in these financially turbulent times, the SEC has reduced staff by 10%.
The SEC likes to think of itself as Wall Street’s cops. The beat cop in my neighborhood once derided this description and I agree with him. They are not cops. They are tasseled-loafer wearing lawyers who prefer to sit behind a desk rather than burning the shoe leather necessary to solve and prevent crimes.
The numbers bear me out. The New York Times reported that “U.S. government officials are on pace this year to bring the fewest prosecutions for securities fraud since at least 1991.” For the first 11 months of this year, there were 133 prosecutions. This is down from a high of 513 prosecutions in 2002. This is a 75% decline in prosecutions in a time period when the discovery of fraud has multiplied exponentially.
I am 300% sure that simple enforcement of existing legislation would stop this scum in first year of operation. New, more restrictive legislation will damage more 10 000 law abiding businesses, rather than stop some fraudsters who spit on the law with decades of impunity from authorities. Naked shorting, anyone?
The proposal to establish a government investor safety commission sounds an awful lot like proposals to regulate guns. That is, honest investment vehicles will have all sorts of complicated, onerous, expensive stumbling blocks placed in front of them, while shady groups will slither through loopholes and blind spots in the government regulatory scheme. The result will be that plenty of shady operators will find ways to get onto the market, while honest investment vehicles will be hobbled.
Does the writer of this proposal actually think new laws will will sanitize the human tendency to finagle finances? Who will the author put in charge of her scheme? Charles Rangel?
Laura:
My reason for commenting on this is quite simple. I have noticed a lack of clarity as to why — or more importantly — how it could have happened.
We do not need the SEC to unearth a scheme like this one. There is a simple rule that investors can follow and I believe they will avoid these schemes and that is, have an independent custodian for your assets.
This investment fraud was made possible chiefly because investors with Madoff did not have an independent custodian for the assets entrusted to his firm. If there had been an independent custodian, I think the scheme would never have been possible. For example, it appears that Madoff did not make the trades in clients accounts that he claimed to have made. If those clients had an independent custodian, they would have seen their account holdings and transactions on the statement. If Madoff claimed to have made a given trade, but it never hit the client’s acount, a serious red flag would have been raised. Also, the returns he claimed were exaggerated. If clients were receiving accurate statements from the custodian, they would have known his performance claims were false.
The tools of enforcement are there but you will never overcome the temptation of greed, of both criminals and “victims”.
The SEC has been hobbled by Bush. Under Obama, heads will roll, improvements will be made, and prosecutions will increase. No need for additional bureaucracy – we just need to use the one we have.
DS
I agree with the importance of an independent custodian and administratior. That is why I did not invest in Madoff in the first place.
Maybe, the SEC should mandate that, but I do not think it ever will.
My whole point is that the SEC needs to be set on fire and be rebuilt from the ground up. It needs to be staffed with market professionals not lawyers.
Put Jim Cramer or Larry Kudlow in charge of the SEC if you want reform.
“Under Obama, heads will roll, improvements will be made, and prosecutions will increase.”
Clearly satire or the author has not been paying attention, PEBO nominated an SEC lifer to be the chairman. She will do nothing different than what has been done before. That is why she was nominated.
The staff cuts are because the SEC’s cheif source of fees — IPO prospectuses and merger proxies are way off and they don’t need the people who spent their time reviewing such documents.
Madoff did not perform this huge fraud over decades without help from lots of people-employees, family members, auditors, et al. Why didn’t any of them turn him in? The fact is, no one likes a whistleblower. If the SEC offered lucrative rewards, bounties and prosecutorial immunity in exchange for hard evidence on fraudulent activities, Madoff would have been exposed years ago.
Madoff has become the picture boy of fraud for this year. There are many like Madoff working overtime as we speak.
Laws, regulations out the whazoo! This will not stop the scoundrels. The only way to protect society is to eliminate them. String ‘em up! Quickly and publicly. Imagine, the jerk sits in his penthouse under “house arrest” while the lawyers fix the game for him. As a former chief of police in LA said once, “you don’t kill a rabid dog to teach other dogs not to go rabid, you do it to protect society.” I know for sure that if you or I stole even $1,000. we would be in jail. He should be also. Oh sure #5, blame it all on Bush. Where was Queen Frank, Dodd, et al, while all this was going down?
I agree with Mark Cuban, and for this matter, SEC’s own chairman Christopher Cox, that the cure to our ailings is more transparency. And transparency, or at least a significant step towards transparency, can be achieved through the use of well defined and open-source standards, like XRBL, that would allow for instant checks and balances, detailed statistical analysis and comparisons, for the sake of audit efficiency and accuracy. Anomalies would be much easier to spot, as would the use of cooked-up software like the one Madoff probably used. What’s more, XRBL could allow unprecedented public scrutiny over government spending.
I’m basically parotting Cuban here, so for the real deal:
http://blogmaverick.com/2008/12/16/the-sec-madoff-and-xbrl/
I believe that the Peoples Republic of China has the death penalty for fraud. Surely there must be some Chinese bank or investor that was robbed by Madoff. If that is the case, he can be extradited to China for trial and execution. I understand they sell body parts of executed criminals. Perhaps the Chinese can sell his body parts on Ebay to help recover money for compensation of victims. I bet Madoff’s gall would fetch a real good price:)
C’mon Burke! Do you really think the use of XBRL would have caught Madoff? His two man (very small for a large hedge fund) audit firm deliberatly helped Madoff maintain the fraud. Any junion auditor, still wet behind the ears, could of figured this out. Bernie’s auditors will be going to jail with him.
Jim,
I don’t think XRBL is a miracle solution, but I sure think it would have made it so much more difficult for him to cook his books and last that long. Of course, I know no other hedge fund had been able to retroactively replicate his results, which in itself was a good reason to investigate him. And as we know, the SEC has declined investigating his operations multiple times. But the use of an open-source standard like XRBL, and possibly the introduction of legislation warranting mandatory online statements for all financial products, would allow for better client vigilance, and the development of very sophisticated analysis tools. Of course, any client willingly participating in a very secretive and shady operation, is only begging to be defrauded, or for their money to be used for unlawful purposes. Transparency is a two-way street…
That said, I agree his audit firm should join him in jail, as should the software programmers who provided technical support for his scam, and other complicit employees. I’m still baffled that it was his sons who finally denounced him. No whistleblower at Madoff’s…