Avoiding More Madoffs: The IRS Model May Be the Key

NERA Senior Vice President Marcia Kramer Mayer Suggests that the SEC Borrow
Ideas from the IRS to Protect Investors from Ponzi Schemes
NEW YORK--(Business Wire)--
Proven systems already in use by the US Internal Revenue Service (IRS) should be
adopted by the Securities and Exchange Commission (SEC) to deter and detect
Ponzi schemes of the sort perpetrated by Bernard Madoff, according to a new
white paper by NERA Senior Vice President Marcia Kramer Mayer.

"While the reforms proposed by the Obama administration are an excellent start,
they don`t go far enough in ensuring that we won`t see another Madoff-type fraud
in the future," said Dr. Mayer, a financial economist. "A common feature of
Ponzi schemes is that investment advisers overstate the account assets that they
report to clients. The IRS`s simple, proven approach of routinely cross-checking
reported data would be ideal for the SEC to adopt in its regulation of
investment advisers, and such a system could be implemented at no cost to
taxpayers."

Dr. Mayer`s paper, Ponzi Scheme Detection: How the SEC Can Catch the Next Thief,
notes that the IRS does not simply accept at face value the income amounts
submitted to it by taxpayers. Instead, Dr. Mayer writes, it systematically
compares those items to submissions by income payers (employers, financial
institutions, the Social Security Administration, trustees, etc.) to identify
discrepancies. Dr. Mayer proposes a similar multiple-source reporting and
cross-checking system for the SEC in its regulation of investment advisers,
whereby:

* Advisers would be required to report quarter-end assets under management by
account. They would also be required to use an independent custodian.
* Custodians would be required to report quarter-end assets under management by
position for each investment adviser client.
* The IRS would be required to report the number of Forms 1099 filed by an
adviser and their year-end combined assets. The Form would be revised to include
account assets as a required reporting item.
* Investors would be invited - but not required - to report their quarter-end
assets under management, by adviser and account.

Under Dr. Mayers`s proposal, the asset data would feed into computers programmed
to routinely perform comparisons and report disparities; if any disparities were
large, numerous, or persistent for a particular adviser, an SEC inquiry would
result.

"The involvement of individual investors is the linchpin of this plan, and even
a modest level of participation would be effective," according to Dr. Mayer.
Requiring advisers to use an independent custodian is the single most important
step the SEC could take to thwart Ponzi schemes, but additional measures are
needed because custodians could be deceived or complicit. "A scheming adviser
would risk exposure from random clients reporting their presumed account assets
to the SEC. Unless the adviser had reported the same account-level assets and
the custodian corroborated the total, any one investor report could trip him
up," said Dr. Mayer.

"The massive and sustained over-reporting of client assets by Madoff and others
of his ilk demands better detection systems on the part of regulators," said Dr.
Mayer. "Instead of taking half-way measures, the Obama administration and the
SEC should look to the tried and true approach to data verification that the IRS
has been successfully using for decades."

The views expressed by Dr. Mayer in this release and in her paper Ponzi Scheme
Detection: How the SEC Can Catch the Next Thief are her own opinions and do not
necessarily represent the views of NERA Economic Consulting or any other NERA
consultant. To view the full paper, please visit www.nera.com.

About NERA

NERA Economic Consulting (www.nera.com) is a global firm of experts dedicated to
applying economic, finance, and quantitative principles to complex business and
legal challenges. For nearly half a century, NERA`s economists have been
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NERA Economic Consulting
Benjamin Seggerson, +1 202-466-9232
Public Relations Manager
ben.seggerson@nera.com

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