OPS Risk: Tsunami of Fraud...

Just when you think you have avoided the major risk of the credit crisis, HSBC may have been one of many banks exposed to the Bernard Madoff "tsunami of fraud".

Banks and investment funds across the world lined up on Monday to admit investing billions of dollars in the companies of Bernard Madoff, whom U.S. authorities accused of masterminding a massive fraud.

HSBC Holdings was the latest bank to join the growing list, saying it had exposure of around $1 billion (663 million pounds), making it one of the biggest victims of the alleged $50 billion fraud.

Royal Bank of Scotland and Man Group, Japan's Nomura and France's Natixis also said they were hit by the worldwide scandal.

Financial companies, reeling after a year of enormous writedowns on bad credit assets, have so far tallied up more than $10 billion in direct and indirect exposure to the possible fraud by Madoff, the 70-year old trader who was arrested on Thursday.

Last year, HSBC sold it's 42 story headquarters tower for $1.1B. to Metrovacesa in a smart strategy that has now been extinguished by the likes of a simple and yet enourmous ponzi scheme. A Ponzi is an investment fraud in which profits are promised to investors from fictitious sources. Sounds like a hedge fund. Early investors are paid off with funds raised from later ones. Is there any conservative institution that will be spared from the corporate malfeasance and corruption that has permeated our global systems of finance?

The SEC has issued the temporary restraining order for Madoff and his companies while this is drowning out the recent fraud allegations against Marc Dreier:

Dreier was arrested in Canada this month and charged with impersonating a lawyer for the Ontario Teachers Pension Plan. He was released on bail and arrested by U.S. authorities on his return to New York.

Dreier on Dec. 11 was ordered held in custody pending his trial after prosecutors told a federal magistrate that victims of a fraud that started in 2006 have lost $380 million.

If convicted of the securities fraud and wire fraud charges against him, Dreier faces as many as 20 years in prison on each count.

The U.S. Securities and Exchange Commission filed a civil suit against Dreier claiming he stole $38 million from an escrow account set up to hold money for the unsecured creditors of 360networks (USA) Inc., which the firm represented in bankruptcy court.

The movie moguls in Hollywood must be looking at these latest cases to determine if a screenplay might be a worth while endeavor. The hundreds of lawyers and other workers impacted by these two incidents alone, will no doubt bring out a few who were close enough to the two crooks to be able to provide technical consulting on the projects. The setting in the Hampton's or the Palm Beach Country club could even bring some real well known people into the movie picture itself.

Back in May 2008 this blog touched upon the legal ecosystem and the survival of the fittest. Fraud, like other crimes of opportunity, have three common attributes:

1. A growing supply of motivated offenders
2. The availability of prospective or ideal targets
3. The lack of consistent oversight mechanisms—control systems or someone to monitor the business

Beyond the typical motivations for initiating deceptive practices and fraud are the underlying mind sets. "Neutralization" creates the road map for nullifying internal moral objections. The type of fraud is not the issue here as much as that offenders seek to justify or rationalize their actions and methods. The next trend line we will see is the up tick in court filings and the litigation wars for the next few years to come. One fact remains obvious. Organizations large and small will be drawn into these Operational Risk Management challenges without the proper policies, practices and behavior to prevail. In any "legal ecosystem" we know about the phrase "Survival of the Fittest" comes to mind and this one, will be no different.

operational risk