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Forensic Accounting

Forensic Accounting











Forensic Accounting




 1. Introduction


Forensic accounting is the process of accounting, which involves integration of accounting, investigating and auditing skills. The forensic accounting process ensures that financial data are analyzed with respect to laws associated with finance and the process of this forensic investigation is done with both internal and external audit by working on operational examination of the books of accounts. The requirement of forensic accounting arises in the applicability of accounting techniques to unearth frauds done in accounting process and have given rise to embezzled fund, fraudulent financial schemes and any wrong –doing or wrong representing in the books of accounts. Detection and lawful analysis of financial manipulation are major objectives of forensic accounting. It usually deals in analysing financial figures of P/L and balance sheet to ensure that there is no misappropriation of fund. Forensic accounting ensures that the stakeholders’ interests are protected.

Bernard Madoff is a former American stockbroker who was convicted in a Ponzi scheme and is currently serving sentence in federal prison. He is guilty of the largest financial fraud in U.S history. He was running a legitimate stock broking business alongside a fraudulent investment company. The investment securities fund business was a Ponzi scheme. He collected money from scattered   individual investors, promising them a low risk and high return policy. He founded his investment business Bernard L. Madoff investment Securities in the year 1960, as a penny stock company with an initial investment of $ 5000. Later due to intense competition in the brokerage industry he created, his investment firm which was the start of the Ponzi Scheme.



2. Background


The fraud that came into existence is by nature a Ponzi scheme. The concept of a Ponzi was named after Charles Ponzi, who started this pattern of Fraud in the 1920s. A Ponzi is a fraudulent investment scheme, which attracts funds from new investors by promising very high rates of returns and secretively pays off the dues of earlier investors from the money thus collected.  In this way, they do not allow in damage to goodwill in the market thus attracting more and more unsuspecting victims. It successfully maintains a illusion of sustainable business, thus generating newer funds continuously. Bernard Madoff was a pioneer of electronic trading in NASDAQ and he was extremely respected in the industry. This is a case of money laundering, Ponzi as well as securities fraud. There is a dispute regarding when the scheme actually started, however during investigation he claimed that it was initiated in 1991, but his other account employees gave witness that it was almost running from 1975. The money that he collected he deposited in the Chase Manhattan Bank, which later became J. P Morgan & Chase (Lewis, 2013).   The deposits earned interests, which were used to pay-off any investor who wanted to withdraw his money. Sometimes money was paid from receipts of newer investors. Madoff maintained a front of respectability thus wooing more investors. Bernard was a well-respected active member of the financial industry, which in turn helped him to stay afloat even after multiple reports of suspicious activities from Securities Exchange Commission. It is known that the scheme was of the scale $65 billion. In 2008, Mad off’s son told authorities that their father had confessed regarding the scheme and this led to the investigation of the largest fraud of Ponzi. The Madoff investment scandal defrauded thousands of investors of billion dollars of hard-earned money. He was charged with 11 federal felonies and was sentenced to a150- year sentence.

3. How the Fraud Scheme was perpetrated


The Madoff Ponzi scandal was a massive deception scheme, which led to huge money loss for the people. Five long-term employees of Madoff were also prosecuted. This entire process was perpetrated by habitual doctoring of books and records in a periodical systematic way. There was maintenance of phantom records and huge window dressing of financial statements. The entire scheme could be committed because the false sustainable image of the investment scheme of Madoff had a very good image in the market. He was a veteran in the industry and his image as a successful man who was constantly beating the markets actually ensured success for the firm (Forbes.com. 2018). Bernie Madoff did not have to borrow funds to invest as he already had the money from the unsuspecting investors, which he kept rolling.  Madoff owned a legitimate broking business and he used his booming brokerage business to shield his fraudulent activities. He collected money from his own clients initially and then from references, deposited them in his own bank account. His bank account balance grew which he used as collateral in his broking business. Whenever an investor would request a payout, he facilitated it by paying out of the deposits received from new investors. This cyclical activity along with his image of a brilliant fund manager, he pulled off the fraud. The strategy involved by Madoff was that he paid high returns in a flat market. He doubly paid the hedge fund managers on both purchase, delivery points of the fund transaction, and this was done clandestinely, without mentioning his name. The illegal advisory Ponzi scheme was conducted in seventeenth floor of his mid – Manhattan office. In 2003 and 2004 the SEC started getting complaints alleging that Mad off’s schemes were showing signs of Ponzi nature.  Earlier there was a major red flag issued against Bernie’s company by Markopolos, who claimed that either Mad off’s firm was into insider trading or it was running a Ponzi scheme. When the SEC decided to start investigation, Bernie objected and reminded that he had been chairperson of NASDAQ for three years. But on further investigation the contradictory statements and irrational fund size of the Bernie fund ensured that gradual fraudulent activity information was coming to light(Dcollins.faculty.edgewood.edu, 2018). 

4. How the Fraud scheme detected


Initially, the fraud was detected by an accountant named Harry Markopolos, who tracked Mad off’s revenue stream. He is famous as the whistleblower in the Bernie Madoff Ponzi case. He filed complaints with the SEC, but was not entertained. However, the scheme was finally exposed when the market was severely hit by the crash of the housing financial crisis in 2008. The sub-prime crisis exposed the Ponzi felony. When the market crashed, several investors lost money and this led then to claim their amounts from Bernard Madoff’s firm. This is when he was faced with no other way than to plead guilty of running a Ponzi, because he had a liquidity crisis and could not pay off all the investors. If the markets had not been affected by the sub- prime crisis, he would have gone undetected. The SEC had conducted an investigation and had failed to detect any anomalies, the liquidity crunch of the sub-prime crisis forced Madoff to plead guilty. This failure of SEC to detect the fraud, led to further investigations by Inspector General David Kotz, into the failure. The report clearly indicated that the examiners were aware of Mad off’s stature in the financial market leading to be less aggressive. The involvement in fund rolling with clients of the big four audit houses had also played a heavy deterrent in the investigative procedure (Sec.gov, 2018). 


5. The Investigation and the Aftermath


The financial juggernaut Lehman Brothers had filed for bankruptcy leading to market crash and  liquidity crunch for Bernie Madoff‘s Ponzi scheme due to huge one time claims by investors. He confessed to his sons that, the decade long business was a Ponzi. He pleads guilty in the court of law and his firm was liquidated.  The BLMIS was liquidated recovering around $ 9 million only. Irving Picard was appointed trustee who conducted the liquidation process and wound up the company eventually distributing to the victims in a proportionate basis. However, Picard could only settle 2500 claims and had to deny 13000 claims (Forbes.com, 2018). The recovery efforts though aggressive were only successful to a very small extent. The aftermath of the investigation led to the criminal investigation, though Madoff claimed that he had acted alone, yet the authorities brought criminal charges against 15 individuals of his company’s innermost circle. The accountant who was the longest serving Frank DiPascali received a long sentence. The major changes that took place were that, there were many reforms that, the Securities and Exchange Commission (SEC) formulated. Enforcements of rules have now become a priority.

6. The Impact and the Fallout


The massive impact of the largest Ponzi scheme in the history of the markets was that it led to a wide spread liquidity crunch. The shadow of this crisis is hanging heavily on the Wall Street.  As a part of the deferred in prosecution, JP Morgan Chase also had to pay$1.7 billion in penalties for its alleged role in the Madoff case. The bank had failed to report fraudulent activities on suspicion. The court had mentioned that a red flag should have been put forward by the banker. JP Morgan had to pay $350 million to the office of the Comptroller of Currency (Forbes.com.2018). 

7. Lessons Learned


The lessons learned from the Bernie Madoff case are immense.  The risk management system was seen in a new light. Market based funds were subjected to newer methods of risk profiling. There was zero exposure of equity in the fund and this is a potential danger. The Madoff fund performance on further analysis showed lack of stability, the risk profile was not divergent, leading to higher danger (Douady, Abdulali, & Adlerberg, 2013). There is a strong adherence to due diligence and there is a need to understand the difference between windfall profits and viable profits. There was a constant reiteration, on, transparency and declarations that are more open, to the public (Vonnegut, 2017). Other lessons learnt were the stress on diversification and not putting entire money on one basket. Madoff Acquired his major clients from recommendations this showed that blind faith can be extremely hazardous. Hence, the need to dig deeper before investing and to check out promoter’s background was a hard lesson learnt. There is another major lesson learnt is that the investor should try to understand and analyze the investment strategy that is yielding such high returns.  If one had only investigated into Madoff’s “split- strike”, then this, strategy to involve such jargons of “call and put options” and confuse would have been checked out and people would have been aware (Washington Post, 2018)


8. Recommendations to Prevent Future Occurrences


The recommendation after this historic case has been manifold. The SEC gave these recommendations:

·         Strengthened its whistleblower policy and

·         Started to give, stress on recruitments of people with specialized knowledge.

·         Advocated improvement of risk management assessment

·         Revitalized the enforcement division strongly ( Sec.gov, 2018). 

·         More transparency was recommended in the market, funds and hedge funds had to undergo specific declarations.

·         The authorities like SEC and financial bodies like the bank had to be much more vigilant.

The practice of due diligence was of pivotal importance. Another important recommendation in this case is that there should be ways by which declaration had to be made so that collusion between big firms and financial institutions do not occur. The victims in Madoff’s case were individuals, charities, employee’s vendors and communities; hence, a very important recommendation is to strengthen the law to make the financial markets more easily monitored.  Heeding red flags was another strong recommendation. If the first whistleblower was heeded then nine years of fraud could have been prevented.





Reference List


Forbes.com. (2018)., Inside the Mind of Madoff: When Did Scam Really Begin? Retrieved 28 September 2018, from https://www.forbes.com/sites/johnwasik/2012/10/03/inside-the-mind-of-madoff-when-did-scam-really-begin/#592d593c4ec8

Lewis, L. S. (2013). The confidence game: of others and of Bernard Madoff. Society50(3), 283-292.

Dcollins.faculty.edgewood.edu.( 2018).  Bernie Madoff’s Ponzi Scheme: Reliable Returns from a Trustworthy Financial Adviser Retrieved 28 September 2018, from http://dcollins.faculty.edgewood.edu/pdfdocuments/Madoff%20Case.pdf

Larsen, J., & Hinton, P. (2009). SEC settlements in Ponzi scheme cases: putting Madoff and Stanford in context. The fourth annual institute on securities fraud.

Sec.gov.( 2018).  Investigation of Failure of the SEC to Uncover Bernard Madoff’s Ponzi Scheme - Public Version Retrieved 28 September 2018, from https://www.sec.gov/news/studies/2009/oig-509.pdf

Forbes.com. (2018). Madoff Ponzi Scheme, Five Years LaterRetrieved 28 September 2018, from https://www.forbes.com/sites/jordanmaglich/2013/12/09/madoff-ponzi-scheme-five-years-later/#1c054ace1b76

Douady, R., Abdulali, A., & Adlerberg, I. (2013). The Madoff case: Quantitative bests qualitative.

Forbes.com.( 2018).  Madoff Fallout Hits Wall Street (Again!) Retrieved 28 September 2018, from


Vonnegut, N. (2017). Three Lessons from the Bernie Madoff ScandalCFA Institute Enterprising Investor. Retrieved 28 September 2018, from https://blogs.cfainstitute.org/investor/2017/07/26/three-lessons-from-the-bernie-madoff-scandal/

Washington Post. (2018). The lessons we should have learned from Madoff Retrieved 28 September 2018, from https://www.washingtonpost.com/business/economy/the-lessons-we-should-have-learned-from-madoff/2013/12/10/31fe2c38-61d4-11e3-8beb-3f9a9942850f_story.html?noredirect=on&utm_term=.45529b7da8bf

Sec.gov. (2018).  The Securities and Exchange Commission Post-Madoff Reforms. Retrieved 28 September 2018, from https://www.sec.gov/spotlight/secpostmadoffreforms.htm











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