Two years ago, I wrote a long post about the Stanford International Bank Fraud. I recently thought about the story and realized I never followed up to see what happened. After a quick Google search, I was pleased to see that Allen Stanford was convicted and sentenced to 110 years in prison.
The most amazing part is even after his conviction Stanford still claims he wasn’t running a Ponzi scheme and the government is responsible for his victims’ losses. Incredible.
There is an interesting alleged accounting fraud unfolding in China. Sino-Forest Corporation, a Chinese company in the business of selling timber, has been accused by short sellers of being a massive Ponzi scheme.
Like Enron, they seem to be running their business through a complex system of subsidiaries in order to obfuscate transactions.
One of the funnier quotes from the short sellers’ report is below:
Despite TRE’s opacity on the revenue side, we have overwhelming evidence that the $231.1 million in Yunnan province timber TRE claimed to sell is largely fabricated. Such amount exceeds TRE’s real timber holdings in Yunnan province. It exceeds the applicable harvesting quotas by six times. Transporting the harvested logs would have required over 50,000 trucks driving on two-lane roads winding through the mountains from this remote region, which is far beyond belief (and likely road capacity).
In other words, the amount of timber they claimed to sell in this one transaction not only exceeded their holdings, but the provinces’ road capacity. Oops. They should have sandbagged a little.
Sino-Forest is fighting back today against the allegations. It will interesting to watch this story unfold. Thanks to @bargles for the tweet that piqued my interest.
My wife tells me my blog is boring because it doesn’t have enough pictures…and also it’s about accounting. So, with that in mind, I am prepared to blow your mind with this post, pictures and all.
Benford’s Law. Who’s heard of it? Anybody. Anybody. Bueller….
This is Benford’s Law.
What, equations don’t do it for you? Well then, let’s dive in.
Benford’s Law is one of those things that can be proven mathematically, but flies in the face of common sense. People have tried to explain the mechanics, but to me it’s like gravity. Nobody really understands it. We just know it works.
It states that in large, non-standard, real life tables of numbers (i.e. water bills, death rates, bank amounts), there is a pattern. Sounds very ominous doesn’t it? For any given dataset, 1 is the first digit around 30% of the time. Subsequent leading digits appear in descending probability, with 9 occurring as the first digit less than 5% of the time. Here’s a picture (for you honey).
This has all sorts of implications in the real world. It means that if you take a large enough dataset and compare the leading digits to Benford’s Law, there should be a close match. If not, it is likely that human tampering of the data has occurred.
This is one of the tests that gives auditors the warm-fuzzies. Fraudsters, when they tamper with data, tend to use the same leading digit or a random assortment of leading digits. For example, say you have an evil staff accountant who makes a large number of small dollar revenue entries that, when aggregated, inflate revenue by a material amount. Normal substantive tests may not catch this fraud because each entry by itself is immaterial. However, because people tend to reuse leading digits in repetitive tasks, the clerk’s entries likely would cause the data not to conform to Benford’s law, thus allowing the auditor to identify the fraud.
Well, that’s all I’ve got for tonight. I’m glad we could have this talk.
While Bernie Madoff was busy having his face shown all over the news last year, a smaller but equally devastating Ponzi scheme was discovered by federal authorities: Standford International Bank (“SIB”). Because of the dollars involved in Madoff’s scam ($65 billion), the Stanford fraud ($7.2 billion) didn’t get much press coverage. However, for the victims of this fraud, the outcome may be worse.
Stanford International Bank was started in 1986 by Allen Stanford. Based out of Antigua in the Carribean, the bank primarily sold CDs and offered better than average rates of return on their products. In February 2009, federal agents raided the headquarters in Texas with a court order to place the company in the hands of a receiver. Assets were frozen and records seized. In the interim receiver’s report dated July 1, 2010, SIB had $7.2 billion in outstanding CDs and only $46 million in cash. The rest, the SEC alleges, was used to pay previous investor distributions and line the pockets of Allen Stanford and other employees.
The protections provided for victims of fraud in the United States are overseen by two agencies: 1) Federal Deposit Insurance Corporation (“FDIC”) and 2) Securities Investor Protection Corporation (“SIPC”). However, for victims of the Stanford fraud, it appears that neither of these agencies will be able to assist. FDIC is charged with regulating US banks and providing insurance for depositors in the case of fraud or insolvency. However, since SIB was headquartered in Antigua, this falls outside FDIC’s jurisdiction.
SIPC is a lesser known organization that is charged with protecting investors from harm if a securities dealer fails. It was created in 1970, and is operated as a nonprofit funded by its members. This is the organization that is helping to make whole a good deal of Bernie Madoff’s victims. Stanford’s parent company was headquartered in Texas, so at first it looked as if there might be some coverage. However, this was proven not to be the case due to a crucial distinction in the coverage SIPC provides. This is from the same report referenced above.
Question 2. I understand that the U.S. Securities Investor Protection Corporation (“SIPC”)
provides protection for securities in customer accounts when a brokerage firm is closed due to
financial difficulties. Is SIPC protection available to cover the losses on my SIB CDs?First, SIPC coverage is very different from FDIC coverage. SIPC protects only the custodial
function of an insolvent member firm. Thus, SIPC only provides protection for securities and
cash that are missing from a customer’s account at a SIPC member firm. That is, SIPC only
ensures that securities and cash that are contained in a customer account at a SIPC member firm
remain in the customer’s account. SIPC does not insure or otherwise provide protection for a
loss in the value of the securities that are in the customer’s account, whether the loss in value
occurs because of changed business conditions, fraud on the part of the issuer, or any other
reasons.In this case, the securities themselves — the certificates of deposit — are not missing. The
problem instead is that they are not backed by cash or other assets sufficient to repay any
significant portion of the amount owed. Although there has been a substantial loss in the value
of the SIB CDs, SIPC provides no protection for such a loss in value.
So, in summary, because the securities (SIB CDs) were not missing from customers’ accounts, SIPC disclaims any obligation to offer assistance. While I understand the distinction, this feels like a loophole. In addition to the $80.5 million in cash on hand as of June 24, 2010, the receiver lists $847.3 million in potential assets, so at best victims are looking at 10%-12% recovery. At worst, nothing.
The lesson of the wave of 2008/2009 Ponzi schemes is that no matter how well run they are, in a down market, the frauds will be uncovered. So, by all means, if you feel like spending your golden years in prison, give it a shot. Skilling, Ebbers, Madoff, Kozlowski, and others will be there to keep you company.
Posted in Fraud
I recently finished a book on the Enron scandal entitled, “The Smartest Guys in the Room.” It was a fantastic book and, for the accounting geeks, had good descriptions of the related party transactions that Enron used to prop up their earnings during the late 90s. The SPEs had really fun names like Chewco and Jedi and Whitewing. Inside, I think Fastow must have been a Star Wars fanboy.
Amidst all the accounting and structured finance shenanigans, there was a paragraph from an employee that summarized the entire meltdown.
Here’s how another former employee describes the process: ‘Say you have a dog, but you need to create a duck on the financial statements. Fortunately, there are specific accounting rules for what constitutes a duck: yellow feet, white covering, orange beak. So you take the dog and paint its feet yellow and its fur white and you paste an orange plastic beak on its nose, and then you say to your accountants, ‘This is a duck! Don’t you agree that it is a duck?’ And the accountants say, ‘Yes, according to the rules, this is a duck.’ Everybody knows that it’s a dog, not a duck, but that doesn’t matter, because you’ve met the rules for calling it a duck.’ And there was the ultimate problem.
Principles based accounting, anyone?
