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Law360 (April 21, 2020, 5:13 PM EDT )
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| Sean Dowd |
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| Meaghan Schmidt |
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| Vineet Sehgal |
Once you have addressed the critical matters of safeguarding your family and your people, you must turn to the health and safety of your business. Looking at precedent market downturns, fraudulent activity was exposed shortly after the stock market's low points.
With COVID-19 wreaking havoc on the economy and the market, combined with several years of a soft regulatory environment, it seems inevitable that we will see new fraud schemes as investors seek liquidity.
Corporate Scandals, Ponzi Schemes, Insider Trading and Investment Fraud
In the early 2000s, the burst of the internet bubble, followed by the terrorist attacks of Sept. 11, 2001, drove a stock market downturn. From March 2000 to October 2002, the Dow Jones Industrial Average was down 27% and the S&P 500 Index was down 43%.
Five years later, the financial crisis of 2008 ignited, and the stock market fell approximately 777 points on its worst day. From October 2007 to March 2009, the Dow Jones Industrial Average lost 54% of its value, and the S&P 500 lost 57%.
Fast-forward 12 years to the global spread of the novel coronavirus, and the stock market has dropped approximately 30% below its February 2020 all-time high. This global pandemic hastened the end of an 11-year bull market.
Taking a deeper look at Ponzi schemes, approximately 157 collapsed during the financial crisis of 2008-2009 when investor redemptions soared, revealing that none of their money had been in the stock market, and there was nothing to draw upon.
Sixty alleged Ponzi schemes were uncovered by state and federal authorities in 2019, representing $3.25 billion — the largest amount since 2010.[1]
Now with COVID-19 wreaking havoc on the stock market, combined with several years of a soft regulatory environment, it seems inevitable that the current state of the stock market will potentially expose new fraud schemes as investors seek liquidity.
2002 was dubbed the Year of the Scandal by CNN, and 2009 was named the Year of the Ponzi Scheme by The Associated Press.
As shown in the chart above, the early 2000s were peppered with accounting scandals, including most notably Enron Corp., the U.S. energy company, which resulted in the firm's filing for bankruptcy and spurred the fall of its auditor, accounting firm Arthur Andersen LLP.
Enron's fraud was uncovered in October 2000, not long after burst of the dot-com bubble and subsequent market crash, which was accelerated in 2001 by the Sept. 11 terrorist attacks. As the U.S. market and economy reeled from these events, in 2002 there was a parade of accounting scandals including telecom companies Qwest Communications International Inc., WorldCom Inc., Global Crossing and Tyco International, among others.
The global financial crisis of 2008 brought with it severe market crashes and recession around the world, revealing instances of fraud at Bernard L. Madoff Investment Securities LLC and Stanford Financial Group, for example.
Regardless of the time period or situation, how a business addresses fraud can have a significant impact on the outcome. We recommend:
- Move quickly: Take immediate action to understand the financial impact, the source and details of the fraud.
- Preserve value: Safeguard assets. Secure information technology systems. Obtain documents. Information is key to investigations and disputes. Preserved assets help compensate victims.
- Understand dynamics: Financial fraud and Ponzi schemes have far-reaching implications that require seamless and efficient analysis of financial data, instituting claims processes, and supporting litigation and asset recovery.
- Communicate: Investors are looking for information. Develop channels to quickly share details as information is learned and understood.
Although it's far too early to tell what 2020 will reveal, if history repeats itself as it often does, businesses should be extra vigilant for warning signs of fraud and ensuring your company's financial controls and monitoring systems are effective. Now is the time to investigate, identify and remediate — before your company becomes a 2020 data point.
Sean Dowd, Meaghan Schmidt and Vineet Sehgal are managing directors at AlixPartners LLP.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
[1] Maglich, Jordan, Ponzitracker.com, accessed March 20, 2020, https://www.ponzitracker.com/.
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