Investor Fraud and Ponzi schemes
by Criminal Analyst from Pennsyvlania
Indictments for Ponzi schemes and investor fraud have been increasing everyday. While pundits, congress and financial experts pinpoint problems with regulatory agencies such as the SEC, the real problem centers on what I call the “Due Diligence Mess,” the way in which this process is handled within the legal and financial community.
After the recent sentencing of Bernard Madoff one of his victims made this statement to USA Today, “My due diligence was the SEC. What greater due diligence can you have than the SEC? They failed us.”
While I agree that the SEC and the SIPC failed to uncover the crimes of Madoff and his affiliates, the initial decision to invest with Madoff was made by the investors and it was their responsibility to make an informed decision. That decision must not be based solely on government information.
Anyone who seeks to invest in a business or financial product knows that there is risk, and that risk is primarily based on the ethics and competency of the people running the operation. While the U.S. economy nose-dived, some geographic areas did not have the same economic problems as the rest of the country. Most notable was South Dakota and Indiana.
When banking and financial executives were asked the reason for this in a recent NPR interview their answer was simple: “We did not get involved in the sub-prime phenomenon and we stayed with the conservative financial model that we have always used.” Ethical, cautious, professional people and organizations provide safe havens for investment. Those qualities are best discovered through forensic psychology and criminal investigation models.
Just as forensic accounting is a powerful tool in vetting the numbers of an organization, forensic criminal investigation models are just as powerful in vetting the quality and ethics of people leading an organization. The following is a list of three reasons why I believe the financial crimes of the past year will continue to occur unless radical changes are made in the due diligence process.
1. The Problem with Databases With the aggressive rise of the Internet in the mid 1990′s the use of online databases has become a mainstay in the daily processes of many law firms and accounting firms.
The problem with these databases is their dependence on local, state and federal agencies to provide accurate and updated information. Our legal services division investigators have found that 40 to 45% of the information that comes through these databases is inaccurate or outdated even information from the “premier’ providers.
Our investigators also discovered that much of the remaining information cannot be verified, which begs the question: “Why are legal and accounting professionals still depending on these inadequate systems?” The answer is simple they are inexpensive and convenient.
There is nothing inexpensive or convenient about due diligence. In my experience it requires time and professional manpower to collect accurate data, confirm those data and assess the information. “Easy” does not enter into the process of accurate due diligence.
The other problem with databases is that the information must be assessed using criminal forensics. What may seem unimportant to the untrained eye can be a critical element to an investigation. Knowing what to look for and knowing how that information plays into a psychological assessment of a fund manager, business executive or broker comes only from forensic psychology which has the distinct ability to look behind the professional facade of people.
Bottom line: due diligence is as much a criminal investigation as it is a financial and legal process.
2. Forensic Accountants but not Forensic Investigators?
Over the past 10 years, the use of forensics accountants has become increasingly commonplace in civil and divorce legal cases. Their value as a tool for uncovering financial crimes has become a legal necessity.
However, the use of forensic investigators in due diligence is a legal rarity. This contradiction is troubling. In most cases cost is the primary factor – “my client doesn’t want to spend the money!” How ironic this is since the client will be investing a significant amount of money in a business enterprise or handing over the significant amount of money to an investment firm.
Rather than explain the value of a proper investigation some professionals will attempt to do the work “in house.” This is done through their favorite private investigator.
Contrary to popular belief most private investigators do not have criminal forensics training. Their training consists of “experience” which can be inconsistent and unreliable. Even many federal agents are not trained in this process. Inexperienced investigators without proper forensics training set the stage for a legal and financial disaster.
3. Data Without Context Data without context are useless. Because many professionals lack criminal forensics training, they do not understand how to accurately assess human data. Because of this limitation, many professionals miss key information that would have saved their clients great pain.
A perfect example is the correlation between trespassing, breaking and entering, and sex crimes. I have seen this fact missed many times in background checks and criminal investigations.
What seems like unimportant data can be an indicator of narcissistic activities, embezzlement or other negative behaviors on the part of the people running an organization. Bottom line: either data are accurately assessed or people will suffer.
The current state of due diligence is woefully inadequate in determining risk. The current focus of such efforts is mistakenly solely placed on the company being purchased or the organization that will handle the client’s money and not on the people operating these entities.
Professionals and investors alike must understand the need for forensics within this process. Due diligence is about assessing the people and people assessment has and always will be the domain of forensic psychology
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