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Preventing Fraud Rather than Being Ready to Contain It

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Written by Ryan Gill

Edited by Sarah Mejia

Five years after his hedge fund collapsed, five previous employees of Bernard Madoff are being brought to court. These men are accused of several crimes including securities fraud and creating false books and records. So far, nine people have been jailed because of this multi-billion dollar Ponzi scheme. Madoff, now 75, is serving a 150-year term in prison. He remains adamant that he perpetrated this crime alone leaving his employees in the dark, however the evidence is stacked up against the men on trial. Frank DiPascali, who could face up to 125 years in prison after his conviction in 2009, will most likely be called as a prosecution witness to testify that his former co-workers did, in fact, perpetrate the fraud.

The SEC responded very quickly to the Madoff scandal by releasing their post Madoff reforms. In 1999, Harry Markopolos, a financial expert revealed that it was mathematically impossible for Madoff to have paid the returns that he reported. His analysis was largely ignored. Because of this, much of the SEC’s effort was put towards protecting whistle blowers and incentivizing them to speak out.

I believe more effort should be put into preventing another scam from happening than trying to contain one. The SEC’s current plan allots a percentage of the money returned to be awarded to the person who reported it. Unfortunately, this strategy encourages whistleblowers to act as bounty hunters and wait for a fraud to become more costly so they receive more benefits.

There are two main reforms that I believe need to be enforced: highly transparent records and mandatory affirmative disclosure to investors. Sarbanes-Oxely mandates that a team of internal signing officers must certify that all documents and accounting files are accurate. Auditors from an external company must then release their opinion statement regarding the degree of effectiveness the firm holds in maintaining internal controls. If all of the accounting records were transparent and released to the stockholders, a firm could never get away with a large-scale scam. It is still fairly reasonable to assume that an outside accounting auditor and a group of internal controllers could be coerced or bribed into committing fraud. The shroud of secrecy surrounding the origins of Madoff’s profits allowed him to get away with his crime for 30 years. Relating to the current news, it will be very difficult to prove one way or another whether the defendants did have knowledge of the fraud as it was being committed. However, should the records have been out in the open, it would also be impossible for his employees to plead ignorance as they are now doing in court.

Mandatory affirmative disclosure should be done to protect the investors. Madoff went out of his way to make sure that investors did not know the risks of their investment or how toxic the system was. He called his system a “black box model,” stating that he could not disclose the secret to his success. To scare people out of investigating from where the profit streams came, he barred a few clients who were questioning his methods from investing. Since his investing firm was exclusive, people chose to accept the returns and ignore the uncertainty he perpetuated.

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**Due to technical difficulties, we recently had to switch domains and transfer all of our website content.  Please keep in mind that while we have been publishing articles for two years, the published dates shown may not reflect the initial publish date.

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“Con of the Centure.” The Economist. The Economist: Print Edition, 18 Dec. 2008. Web. 9 Nov. 2013.

Lenzner, Robert. “Bernie Madoff’s $50 Billion Ponzi Scheme.” Forbes. Forbes Magazine, 12 Dec. 2008. Web. 09 Nov. 2013.

Matthews, Christopher M. “Madoff Employees Lied, Prosecutor Says at Trial.” Wall Street Journal. N.p., 16 Oct. 2013. Web. 15 Nov. 2013.

“The Securities and Exchange Commission Post-Madoff Reforms.” U.S. Securities and Exchange Commission. N.p., 2 Apr. 2012. Web. 09 Nov. 2013.

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