Academic

A Proposal to Better Detect Ponzi Schemes

By Gordon Smith, Christine, Hurt, Vic Fleischer, Fred Tung, Lisa Fairfax, David Zaring

Yesterday I moderated a broadcast by the SEC Historical Society, which highlighted top presentations from NERA Economic Consulting's seminar on finance, law and securities litigation.  The presentations focused on topics ranging from SEC settlement actions and policy changes related to such actions and misunderstandings about mark-to-market, to proposals for regulating credit default swaps and other over-the-counter derivatives as well as a proposal to facilitate the SEC?s detection of Ponzi schemes.  Although the topics were diverse, each presentation explored issues central to the financial crisis, while seeking to assess how new or proposed reforms would impact those issues.  One particularly intriguing presentation was from Marcia Kramer Mayer who proposed that the SEC adopt a multiple-source reporting system in order to better detect Ponzi schemes, such as the one committed by Bernard Madoff.   The proposed multiple-source reporting system, which draws its inspiration from the one employed by the IRS, would require investment advisers, independent custodians and the IRS to provide certain periodic data to the SEC about managed assets, while also inviting (but not requiring) investors to provide certain data about their assets.  The data would feed into computers programmed to routinely and automatically cross-check such data for disparities.  Mayer noted that one problem with the current system is that the SEC has no ready way to confirm information reported to it.  Reflective of this problem, Madoff not only submitted fraudulent reports to the SEC, but he also submitted different reports to the SEC and investors.  An advantage of the multiple-source reporting system is that it could catch such discrepancies, while providing an incentive for more honest reporting from advisers who would be aware of the SEC?s ability to receive information from different sources.   By Friday, a fuller exposition of the proposal will be available here, which will certainly do more justice to explaining the proposal than I could do.   Nevertheless, her proposal reflects an interesting way to think about how best to resolve the potential fraud and other problems that arise because of the simple fact that most often the SEC receives its routine information from the most self-interested party.

Full post as published by Conglomerate on July 29, 2009 (boomark / email).