Odd Lots - Episode 17: How One Analyst Uncovered a $7 Billion Fraud

Episode Date: February 29, 2016

In late 2008, as markets tanked thanks the the global financial crisis, two massive Ponzi schemes unraveled. One was the $17.5 billion fraud engineered by Bernie Madoff. The other was the smaller but no less interesting one run by R. Allen Stanford, a flamboyant Texan who lived in the small Caribbean island of Antigua and operated a bevy of companies under the Stanford brand. Best known for his involvement in the sport of cricket, Stanford soon found himself under a much less flattering spotlight -- all thanks to the work of one independent financial analyst, Alex Dalmady. This is the story of how Dalmady did a favor for a friend and then ended up uncovering a $7 billion investment fraud. Seven years after Dalmady's work set in motion the events that culminated in Stanford's downfall, we discuss the research note that spawned an international investigation and whether we can expect more such schemes to emerge in the wake of recent market upheaval.See omnystudio.com/listener for privacy information.

Thanks for listening to Oddlots. Follow the show on Amazon Music for more future episodes or just ask Alexa play the podcast OddLots on Amazon Music. Welcome to Oddlots. It's Monday, February 29th. I'm Tracy Alloway. And I'm Joe Wisenth. So, Joe, I am really excited about this week's episode. It's a great story that involves a humbled billionaire, some brilliant research by an independent analyst, and a big, big win for digital journalism. And I think at least two of those things are, you know, kind of close to our hearts, right? Yeah, and it involves like some huge financial crime, right? So in addition to just being a humbled billionaire, there's a dramatic element, right? Oh, for sure. But let's start with the billionaire.

Okay, we'll back up a little bit. It's a guy called Alan Stanford. I remember him. Yeah. I think a lot of people probably do. He was CEO of the Stanford Financial Group of Companies, which included all sorts of things, like a real estate. company investment firm and a bank based in Antiqua, which is this tiny little island in the Caribbean. I remember Stanford. I remember he was in the news a lot around the same time as Bernie Madoff.

I don't remember a lot of the details. So I'm really excited about talking about this story. Yeah. I mean, if you were living in the UK any time before 2009, you would have heard of Stanford because he was this kind of eccentric larger-than-life character, this fifth-generation Texan, as he described himself, who decided to come in and support the sport of cricket and transform it. Right. I remember this, that he became this huge backer of cricket, which seemed really weird for a Texas billionaire, and it almost seemed impossible to believe that he was, in fact, a Texan. Yeah, I want to kind of nail the eccentricities here, because he used to helicopter into the Lord's cricket tournament. He was caught on camera flirting with these cricketers' wives. He really

made a name for himself in sports and political circles as well. So I could go on and on, but why don't we just let Alan Stanford kind of speak for himself? This is an interview from CNBC with Stanford back in late 2008. You managed to avoid the subprime debacle almost entirely, didn't you? A hundred percent. We avoided the subprime debacle. How did you do that? What made you, and I'm sure you had the opportunity to raise some of that risk? What told you it was not a wise move? Well, it was very simple because we never understood what the risk was. You know, securitized debt's been around for over three decades now.

And when you start packaging something, a lot of assets that are all mixed up, and you can't get your arms around what the real asset is, therefore what the risk is, we decided that whatever perceived profits there might be, we decided not to take that risk. we didn't know what the risk really was, and the perceived profits really became irrelevant. Kind of makes you wonder whether or not the banks what they were thinking. I think we're going to see a lot of problems surfaced during the first quarter of 2009. Before we let you go, is it fun being a billionaire?

Well, yes. Yes, yes. I have to say it is fun being a billionaire. I think it's hard word. But it's hard work. That was great. I love the idea that he said it was great to be a billionaire because so many people will say otherwise or they'll say something humble or they'll say something about how it lets them do good for the world or philanthropy. And he just straight up talked about how great it was to be rich. That's right. Sir Alan Stanford. No red flags there or anything. No, indeed. And I loved also that he said he thought there were going to be a lot of problems for banks in early 2009 because as it turned out, that was the time when his own bank, Stanford International,

came under a lot of scrutiny. Well, at least he was right about banks in general. Okay, that's one way of putting it. All right, but think back to the headlines in 2009. Suddenly, Alan Stanford is accused of a $7 billion Ponzi scheme and this widespread on-growing fraud. So how did he defend himself when we first started hearing about these allegations? All right, we have another clip.

Let's fast forward to 2010. This was not a Ponzi scheme. never in my life have I ever set out to defraud a person never never have we done anything that I'm not proud of never have we done anything to the best of my knowledge

that was illegal or wrong and if there are things that were done that outside of my direct control you know I don't know what to say he sounds it a bit different there than his clip from the end of 2008.

Yeah, the tone is slightly different, right? All right. So when we started, I mentioned that in addition to the humbled billionaire, part of the story was independent analysis and digital journalism. That's because the investigation around Alan Stanford and his eventual conviction for fraud was sparked by one research note, a single research note that was written by this guy down in Florida and subsequently picked up by five. financial blogs around the world.

Right. Remember when Madoff collapsed, it turned out that there had been a whistleblower who had written a note about him, but no one picked it up. It was not public. No one saw it. It was ignored. This was different because someone actually did write a public note and say, hey, there's something going on here. Yes, he did. And his name is Alex Dalmody. We're going to have him on the show today to talk about the research note and how it came to be and what happened afterwards. And I'm really excited about talking about this now because, you know, it's not a coincidence that Madoff and Stanford were both discovered during the collapse of 2008, 2009, because it's only when the tide is receding people are losing money that these frauds can no longer go on. And so we're in another period of volatility. And I'm not saying we're going to see another made off.

But the business models that thrive during the boom years and the shady companies, many of them are likely to be exposed in a market downturn. Yeah, I think that's exactly right. There's that famous Warren Buffett quote about the tide going out, right? We get to see everyone who's been swimming naked. Guys like Madoff and Stanford, it turns out, were definitely in the nude. And of course, you're fond of a Galbraith's idea of the Bezzle and what we learn about that during a downturn. All right, let's bring on Dalmadi. Alex Dalmadi, welcome to the show. Hi, Tracy. How are you doing?

I'm good, thanks. Thanks for joining us. It's my pleasure. All right, so tell us what you were doing back in sort of early 2009. Who are you and what was keeping you busy back then? Okay, well, actually the story starts a little bit earlier in 2008 when I was just doing my thing, which is an investment advice. so I was looking at the chaos in the markets.

And a friend called me, asked me to do some due diligence on Stanford in the National Bank, where he had a substantial part of his assets. So I did that. And then going over the numbers and the notes of financial statements, it pretty much became clear to me that they couldn't be true, that was a lie. There was no way that they could be reporting the kind of performance they were reporting because it was through the bank. And instead of giving out loans, it was playing the stock market and the financial markets. And supposedly making very consistent in high returns every single year, something that if you're an investment advisor, you know, it's very, very, very hard to do.

So you looked at this bank, your friend brought you this bank. He had put his money into a CD, essentially, that offered this eye-popping return. No, not even that eye-popping. I think he was, at the time, he was maybe 5% maybe on the CDs, which if you go back to them, that's maybe a couple of points over what you would get on a shirt. Yeah, I guess now in 2016, 5% seems like an eye-popping return, but maybe it wasn't that bit. So tell us what you saw. You're looking at Stanford's numbers as a favor to your friend to send a person.

What were the big warning signs that you picked out? Well, the business model itself, which was they state, we do not, we don't give loans. We invest in stocks, bonds, hedge funds, and, you know, gold or whatever. So let's just saying they have an investment portfolio, which is fine if you have a low cost, very low cost of funds. You know, you can't, as a bank, you can't invest in something as volatile as markets like these, and at the same time, expect to be able to return stable amounts to your depositors. It was just an impossible business model because you can't expect to make the kind of returns that they need it to make to pay their expenses and their depositors every year.

calculating that it came up to like 13% is what they had to be great keep it and they were claimed even in 2008 they claimed to have made a profit even in a year in which literally nobody who was long stock long private equity or long gold was making anything right they were claiming to at that point we had half year results and they were still claiming to make money and I went back over the results and they were claiming they were making 13 14, 50% every year. So no, it's just not possible. So I just want to, before we move on, I just want to sort of get the summary right for listeners. So like a typical bank, you'd put in a deposit. If it was a CD, you'd get some tiny return. And the bank would then generate a profit

via a typical loan portfolio. On the flip side, you have investment institutions that'll invest your money in risky things like stocks and private equity, but those don't ever, typically pay a high fixed return. So the investor could lose money. In this case, it was this combination of both the promise security and safety of a bank with the returns of an investment company, and that's what you found implausible. Exactly. You said it a lot better than I could. So the investor money supposedly is not at risk, and so the whole risk has been transferred to bank's equity, and it's leveraged pretty much 20 to 1. And the other thing is the cost of funds is ridiculously high,

because not so much because the CD's rates were that high is because they didn't have any other sort of deposit. There was no demand accounts or demand deposits, checking accounts, or any of that. It was basically all CDs. So if all your funding is, is accruing interest. It just makes your costs not much higher.

So that was basically the whole thing. The business model itself was impossible, and therefore the numbers themselves couldn't be true. There were some other red flags, though, as well, right? You have this bank based in Antiqua, which isn't necessarily a well-known capital of governance. Yeah. It's not Switzerland.

Right. And you also had the fact that Stanford was using this totally unknown auditor, which seemed to be run by a single guy. Like I said, it was a small auditing firm. He had been auditing forever. They had never changed auditors. That was another red flag. And then you had, there was a number of things. Just the language of the statements was not typical of what you will find in an audited statement.

It made subjective qualifications. Like, for example, just an example, it said that the bank had a balanced portfolio. That's something that no audit is ever final. The numbers didn't make it. The language wasn't right. So I just told my friend, you know what, get out as soon as you can. When did you actually make the decision to synthesize all of these points into a public analysis?

Yeah. Now, this is something I haven't told a lot of people afterwards. What happened in December of 2008, the made-off scandal came out. I'm sitting there, and I'm looking at the TV, and my friend again, he calls me. And it turns out that not only he was invested in Stanford, he had his. invested in Madoff. Oh, geez. So that was

unfortunately not a large amount because he kind of lost that. This totally just and I told him, you know what? I'm going to write something about Stanford. We're going to blow that open. And he had already gotten his money out. He said, well, go ahead.

You know, nail it. So this decision of yours to go public with your findings, you wrote a note, It was called Ducktails, the reference being if it walks like a duck and quacks like a duck, it is a duck. If it looks and acts like a Ponzi, it is a Ponzi. There's an important parallel with Madoff, which is that there was a whistleblower, Harry Markopoulos, who had tried to warn the world about Madoff a long time earlier, but he never really went public with his findings. It wasn't something that journalists could have picked up on. Regulators ignored him. So when you decided to go public, people actually discovered it.

You did it in a way that allowed people to actually find and promote your work. So tell us about exactly where you published the material and then how you got the attention for it. Yeah. Initially, I was going to publish it in a Venezuelan newspaper. But in the end, they turned me down. So I went to Venezuela and the Economic Review newspaper. Alex, I was going to ask, were you scared publishing this?

Because, you know, let me set the scene. We're talking about this larger-than-life character. He's kind of famous for giving lots of money to sporting events. He has a knighthood from Antiqua. He's donated millions of dollars to U.S. politicians. You must have been a little nervous, right? I was terrified. I thought I was going to be sued.

and I thought my, especially the editor and I, were going to be, get our pants suit off. And on the other hand, I figured, well, it's pretty much certain that this is, this is a fraud. So if they come out and sue, you know, that will just make the whole thing much more public. So even though there was the obvious fear of calling this large organization and rich guy a fraudster, because you were just so rock-solid in your analysis, you ultimately determined you just had nothing to really be afraid of. I was 99.9% sure, because for their numbers to be correct, he had to be the outlier of the outliers. You published this note, and it gets picked up by initially, I think, all these sort of financial bloggers, right? Yes. And the Financial Times picked it up pretty early, too.

And that was a big thing. Mostly it was the bloggers who picked it up and put it in the cyber domains, you know, because I had published on paper initially. So once it got into the Internet, the thing that happened, although there was lots of people looking at him at Stanford, the same way I had been looking at. Matthew Goldstein from Businessweek had been preparing an article. He was one of the first to call me.

And the folks at Bloomberg were also onto the stories. And once it started going through getting into the more mainstream blogs and articles, then it just exploded. My article went out at the end of January, and two weeks later, we're raiding the Houston offices and shutting them down. So, Alex, when I listen to the story, the overriding question I have on my mind is, how did regulators miss this guy? You know, you took a look at the financial numbers and with 99.9% certainty said this was a Ponzi. How come no one else did the same?

Regulators, high probability isn't any good, is improved for them. Because they are more than account insurance or financial analysts, they're lawyers. What they need is a smoking gun. They want somebody, an insider to tell them that's Ponzi. They want a customer to complain that it's a Ponzi. They want something more than high probability of it not being as it's told. You can't really act on it's probable. I understand.

I understand their position, not totally, I mean, but to a point. because your regulators, they're bound by certain company has to produce. They have to produce financial statements. They have to do this, that. And if you check those all off the list, well, they're good. So, Alex, what are you doing nowadays? I'm doing the same thing I've always been doing. I'm an investment advisor.

I'm a financial analyst. People ask me what to do with their money, and I'll give my ideas. and do you keep an eye out for the next like do you know for the next one like do you sort of probe and look at things that seem suspicious no I don't but somehow some of these things actually seem to find me no I was a couple of years back I actually found um there was a case called final forest oh yeah yeah I found myself on the other side of that had some some uh clients invested, had bonds of this company. And fortunately, of course, since I had been in the whistleblower shoes, you know, I got out quickly. Joe and I were talking earlier about the idea

that when the easy money kind of dries up and when bull markets come to an end, a lot of these Ponzi's emerge. We've seen a lot of market volatility recently. Do you think we're in a sort of same time period now? Could we see some of these things come out of the woodwork? Well, very possibly, but then again, I think regulators have tightened up a bit too also. So the easy Ponzi's were also discovered back in 2008, 2009, 2010. You see the activity in that sense, I think it's gone down a bit, hopefully. But there's a lot of things that continue to be problematic. I mean, hedge funds are just not transparent enough, and they're prone to being fraudulent.

And then you have all these off-the-market products, you know, the unlisted and unregulated reits and things like that, but you're never sure. So do you have, real quick, one or two rules that everybody should abide by if they want to avoid getting, scammed. Say, you know, the best thing is to try to understand missions and the and the why somebody is selling this to you. You know, if it's so good,

you know, why isn't this person, why are they selling, why are they offering it to meet? Why am I so special that they're offering this huge opportunity to me? So that's one thing I would look out. for. And the other thing is, if you can, if you really know somebody who is, who can look at it for you and it doesn't have a vested interest in it, get them to look at it, just like my friend

did. He, you know, he called me out of the blue after someone, I don't know, I haven't seen him for years. And, and, and that turned out really well for him. And it turned out well for me, too. I mean, it was an interesting part of my life, I guess. Interesting, indeed. Alex, thank you so much for your time. Thank you. That was great. There's so many good things about that story,

and I think for both of us, a story like this, has a special place in our hearts for multiple reasons. One, both of us, we're very active in digital media during the crisis. We both covered this story. It's a little guy versus a big guy's story. It has everything. Yeah, and I feel like I should mention that Alex is actually writing a book on this very topic. So it should be out this year.

It's going to be called If It Walks Like a Duck. And if you want to hear more about this kind of crazy tale, you should definitely pick it up. One thing that I just want to go back to and you hit on this because it is kind of the craziest thing is just the guts that it takes to publish something like this. Even if you're totally sure, this is a big financial institution, this is a billionaire. and there was no equivocating in his original essay on it. It wasn't like, I have concerns. It said, this is a fraud. And I just find that to be extraordinarily brave to do, even with all the evidence on your side.

I think that's absolutely right. And if anything, it really demonstrates the importance of independent financial analysis. And the reason, you know, his explanation for why regulators aren't equipped to catch these things, they're not really so much looking at the financial stuff. They're more wanting tips and stuff like that. It's also another fascinating angle. And I actually, he gave me a little more sympathy for the people who miss these frauds. You think so? A little bit. I'm kind of more angry about it because here I see this little guy who was 99.9% certain just by looking at numbers and coming up with his own thought process. And then you have regulators whose job is to do the same thing and they won't act without 100% certainty. Yeah, no, that's true. I guess I'm just thinking in terms of filtering out, you know, you look at, you try to, you see these financial institutions and I could see how you end up just checking off the box. Like they filed this, they had this auditor do this and say, okay. And so look at how regulators might go about trying to find these frauds. It sounds like there's structural things that might need to be changed with that. All right. We're going to leave it there for this week. I'm Tracy Allaway. You can follow me on Twitter at Tracy Allaway.

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