Financial crimes are extraordinarily complex, both from a mathematical and human perspective, and the bright minds in forensic accounting jobs need to combine both their specialist financial and legal knowledge with the analytical and investigative skills of a detective.
The story that highlights this dual purpose of forensic accountants the most is the biggest fraud in the history of Wall Street, which took the form of a two-decade Ponzi scheme involving not only financial irregularities but a man at the centre with so much influence he was the chairman of the NASDAQ
The only possible factor that could take Bernie Madoff down was the truth, and the work of a few brilliant mathematicians, forensic accountants and investigators, as well as exceptionally turbulent circumstances, would take him down.
The Impossible Strategy
The first suspicions that Madoff Investment Securities was not being entirely honest with its investment practices came in 1991, around the time when Bernie Madoff would later admit he had stopped making legitimate investments.
Edward O Thorp, a mathematics professor who proved the effectiveness of card counting in blackjack and developed similar hedge fund strategies to make reliable financial gains via the use of probability theory, knew the stock market well enough to sense a potential fraud.
He found irregularities in the claims Mr Madoff had made surrounding investment activities, meaning that was either exaggerating or outright lying, the most egregious of which being a claim to have purchased 103 more call options for Proctor & Gamble than had been traded in total that day.
Similarly, Rob Picard, then working for the Royal Bank of Canada, found that Madoff became evasive whenever he was pressed on his strategy, which led to the conclusion that he either didn’t understand his own strategy or was lying. RBC would cut all contact with Mr Madoff and feeder fund Tremont Group in 1997.
The most major investigation, however, and the one that would ultimately expose the entire fraud came from Harry Markopolos, a forensic accountant working for Rampart Investment Management, who was asked to replicate Madoff’s returns using a strategy Rampart’s trading partner Access International Advisors had been provided by Madoff.
After four hours of attempts at different strategies, Mr Markopolis concluded that the returns were mathematically impossible using the strategies he claimed to use, which meant either front running (a form of insider trading and illegal even in 2000) or the entire operation was a Ponzi scheme.
Named after the infamous mail coupon scam run by Charles Ponzi, a Ponzi scheme is a financial scam where the fund from new investors are paid to old investors as profit, with the scam relying on a supply of new investors coming in ad infinitum.
Mr Markopolis reported this to the Securities and Exchange Commission and would later write a 17-page memo detailing the scheme which he approached The Wall Street Journal to publish in 2005.
The constant rate of returns with only seven losing months in 14 years was described as being as suspicious as a baseball player having a batting average of “.966” when even the best players average around “.300”.
As early as 2005, Mr Madoff was on the brink of insolvency, taking out loans and accepting leveraged funds until 2008, when the start of the global financial crisis exposed the entire scheme and Bernie Madoff spent the remainder of his life in prison.