Madoff, money laundering, and cooked books

money laundering

Daniel Finnegan, a former fraud investigator, left a comment to our post about Madoff not having made trades. He has a wealth in information to share, so I’m reposting it here.

As a former fraud investigator with over 25 years of experience in financial fraud, I thought some readers might be interested in my reactions to this story.

The evidence shows Bernie Madoff did not act alone, that key perpetrators include other Madoff family members, that these family members are likely to now control off-shore accounts containing substantial stolen funds.

The Madoff fraud was, without a doubt, a group effort. Bernie Madoff could not have done it all himself. At a minimum he needed three types of support:

1. Computer Systems; unless Bernie hand typed customer statements each and every month, he had computer systems support. Systems support was necessary to track customer accounts, produce false trade reports, and the myriad of other tasks necessary to create the impression among clients of a real hedge fund.

Indeed. As a database programmer with twenty years experience, I can safely say that creating software that prints out legitimate looking statements from fraudulent data would require a seriously skilled team and major commitments of time and money. So, who wrote the code? Discover that, and you discover much, I think.

2. Accounting; two sets of books are more than twice as hard to maintain as a single set. Real accounting systems benefit from automated importing of data from bank and stock trading accounts. In a fraud scheme all this data must be manufactured. Off-the-shelf accounting systems send up many red flags when data is not consistent. Fraudulent accounting creates an impression of such consistency where none exists. This is a major task.

And it needs to be smart enough to fool sophisticated investors and regulatory agencies. Again, hardly a trivial task.

3. Tax and Government Reporting: although Madoff went to great lengths to escape government regulation, nonetheless the scheme was bound to standard income and tax reporting requirements. The usual sources for such reporting did not exist—actual income and taxes paid—therefore fake data needed to be manufactured and reported by individuals expert in these isssues.

Bogus statements, two sets of books, fraudulent tax statements. We are talking major resources and money to do this, as well as multiple skill sets.

Therefore, it is certain Bernie Madoff did not act alone and, at a minimum, had knowledgeable coconspirators in computer systems, accounting and tax and government reporting. It is highly likely that the conspiracy involved a much larger group.

It is also highly likely that fraud scheme was a family enterprise. Like the Mafia, the family is the basic unit of most organized fraud schemes. The reason is simple—outsiders create a substantial risk of defection or blackmail. There is no honor among thieves. Bernie Madoff’s business was a family enterprise family members heading up all major functions including, computer systems, accounting and tax and government reporting.

Yet his sons appear to have spent most their time fishing. While it seems likely they were involved, many others, non-family members, had to be involved too.

In his warning to the SEC Harry Markopolos listed 29 red flags that the Madoff hedge fund was a Ponzi scheme. All of these flags were visible to family members working in the firm every day. They had to have known a great deal more including the fact that all the trades Bernie Madoff claimed to be making never occurred. Close-up views of every fraud scheme I have ever investigated made it clear the emperor has no clothes. The most that can plausibly be claimed is that family members knew what was happening and did nothing.

Bernie’s story is that at the last minute he informed his wife, his brother, and his sons that all was not well and that acting alone he had for seventeen years perpetrated the largest Ponzi scheme in history. Being shocked, shocked that fraud was going on the sons went to the authorities the very next day. None of this is in anyway believable. That the sons participated in this charade is evidence of long-term involvement

Third it is likely that a significant portion of the lost billions are in hidden accounts or bonds controlled by family members. Money laundering is not difficult given time and financial sophistication. The Madoff scheme had a great deal of both.

All Ponzi schemes come to an end sooner or later. Therefore, the perpetrators inevitably develop exist strategies. I cannot believe the Madoff perpetrators did not do the same. New alternative identities are almost as easy to create as money is to launder.

Given these facts, I suspect that prosecutors will concentrate Madoff family members as the most promising method of recovering stolen funds. Without perpetrator cooperation laundered funds are seldom found. Bernie Madoff will be spending the rest of his life in jail, therefore there is no plea bargain possible to gain cooperation. The fate of other family members creates much greater leverage. In return of full recovery and accounting of all Madoff Ponzi scheme funds, the prosecutors are likely to trade leniency for some family members.

In the absence of such a full accounting and recovery I predict that, in a few years, when things a quieted down, one or more Madoff family members will quietly disappear and then a new mega-yacht will appear in St Tropez owned by Americans with vague backgrounds.

The feds can seize assets and will almost certainly watch Madoff family members financial transactions for years to come. Given their spectacular incompetence here, one hopes they are up to the task.

Of course, incompetence is often used as a cover for criminality and collusion.