David Kotz will present his session, "Bernie Madoff and the Case that Changed How We View Fraud" at Accountex USA on November 17 at 8:15. Click Here to register or learn more.
Bernie Madoff actually was surprised. After years of convincing thousands of trusting investors
to hand over their savings, he sat down with investigators with a stone cold poker face. And why wouldn’t he? As of Nov. 30, 2008, when the Securities and Exchange Commission (SEC) finally amassed enough evidence to end his run, Madoff had managed to bilk 4,800 clients out of $64.8 billion.
Madoff used a Ponzi scheme, named after Charles Ponzi, to lure his unsuspecting prey into practically handing over their money to him with the promise of high returns. Ponzi schemes are the perfect con. A central operator, in this case, Madoff, uses the money from new, incoming investors to pay off the promised returns to older ones.
To avoid having too many investors reclaim their profits, Ponzi schemes encourage them to stay in the game and earn more money through vague or secretive investing strategies, which schemers use to protect their businesses. Simply tell your clients periodically how much they are making, and the scheme continues.
But that’s not what really surprised H. David Kotz, the former Inspector General (IG) of the Securities and Exchange Commission (SEC) who was tasked with conducting the landmark investigation into why the SEC failed to see any of this. What surprised him was how Madoff acted when they sat down for his first interview.
“It was a very interesting interview,” Kotz recalls. “It took several hours, and he was very open, answering all the questions I had. I thought he would be a little bit more reticent to answer certain ones. He answered some in a way that I absolutely knew was a lie, and yet, he answered them with a straight face. There were a couple of times when I thought to myself, ‘He knows that I know he confessed.’ There were certain things he said that were so obviously and patently false it was ridiculous. Yet, he proceeded on.”
In his upcoming presentation at Accountex USA www.accountexusa.com, “The Truth Behind the Madoff Scandal and Lessons We Can All Learn from the Largest Fraud in History,” Kotz will provide an introspective look at the investigation, as well as the scores of other high profile and complex investigations he conducted as IG, including the collapse of Bear Stearns and the financial crisis. The conference, which attracts key industry experts and thought leaders from across the world, as well as a slate of innovative vendors, takes place Nov. 15-18, 2016, at the Mirage in Las Vegas. To register for the show, click here.
There was another thing that stood out to Kotz during their interview. For example, Madoff had admitted to being nervous and anguished every time he met with the SEC, not because he might be caught, but because he didn’t want to have to go through the whole process of admission.
“I wasn't very sympathetic,” Kotz says. “He was living in a very fancy penthouse and living a very fancy life. He admitted that it was almost a relief when he finally confessed, because there were so many times when he was sure he was going to get caught. Yes, to be sure, he was shocked, maybe more than anybody, that it took so long.”
In the end, the Madoff Ponzi scheme deteriorated after clients requested a total of $7 billion back in returns, of which Madoff only had $200 million to $300 million left to give. He confessed in December 2008, and was charged with 11 counts of fraud, money laundering, perjury and theft. The punishment was 150 years in prison.
The Madoff case wasn’t Kotz’s first dance with regulatory improprieties. One of his first big projects as IG in late 2007 was the audit of Bear Stearns. Kotz was asked by Congress to find the reason for its collapse – a very public report he knew would be scathingly negative. “Because I came in with a relatively negative report, I really made a great effort to demonstrate that my role was really constructive, and not just to issue negative reports that would be portrayed in the media as negative toward the SEC,” he says.
The Art of Regulatory Oversight
In his years as IG, Kotz had a front row seat to the challenges companies face when it comes to regulatory oversight. During his Accountex presentation, Kotz will share the four lessons he learned conducting internal investigations and how you apply them. The lessons include avoiding a lack of aggressive oversight, lack of skills and competence, lack of accountability and greater than achievable mandates.
Lesson No. 1 – Lack of Aggressive Oversight
This was a factor in the SEC's failure in the Madoff case, and others. Basically, Kotz says the SEC conducted oversight, but they weren't aggressive enough with respect to that oversight. “That's one thing that companies and auditors can look at in terms of not just pointing out things, but really being aggressive and digging once you see potential red flags about where it would lead you to,” he says.
Lesson No. 2 – Lack of Skills and Competence
At the end of the day, SEC investigators and examiners really were no match for Bernie Madoff. Kotz admits Madoff was more prepared than them and, simply outsmarted them at every step. “You have to have skills and competence,” he says. “That involves training and bringing in the right people. Potentially, you may need forensic experts, etc., to uncover fraud. It's very hard to keep up with fraudsters. You really need technical expertise and competence to do that.”
Lesson No. 3 – Lack of Accountability
Ask Kotz how many SEC employees were fired because of their colossal failure to uncover the Madoff Ponzi scheme, and the answer may surprise you. Zero. “One of the things I suggest companies should not learn from the SEC is a lack of accountability,” he says. “When you have a fraud incident, you have to hold people accountable. If you don't, the lesson that people around the company will learn is there are no consequences.”
Lesson No. 4 – Greater than Achievable Mandates
This is where Kotz looks at the SEC in a more positive light by giving a reason for its failures. “One of the biggest problems you have in government sometimes is too many responsibilities and not enough resources,” he says. “There was a timeframe when the SEC would be given more and more responsibilities, but they either couldn't or didn't increase their budget. I generally found when I conducted investigations and SEC audits that there were many times where the SEC simply did not have the resources to conduct meaningful oversight.”
The takeaway Kotz wants you to get from his presentation is that there are ways to combat fraud and to identify red flags. “If you have the right skills, resources and training, auditors can identify potential issues of fraud and can conduct appropriate investigations to ensure that fraud incidents don't occur again,” he says. “Don't lose faith just because there have been so many high profile frauds. The Bernie Madoff Ponzi scheme went on for so long because of incompetence on the part of the SEC, rather than because it was not possible to uncover it. If you adopt the right lessons from the reviews of these frauds, there are ways to win.”
Protecting Yourself from Fraud
In his book, “Why Ponzi Schemes Work and How To Protect Yourself From Being Defrauded,” former Inspector General H. David Kotz provides a step-by-step guide to how you can protect yourself from fraud and identify potential Ponzi schemes. The takeaway: If you are diligent and aggressive in how you do your work, it can be done. To order a copy of the book, click here.