Sarbox, Frank-Dodd Don't Stop MF Global, Corzine

Jeff  Carter
Posted: Nov 05, 2011 12:01 AM

I thought that Sarbox was supposed to head off all this accounting fraud at the pass. Apparently MF CEO Corzine didn’t understand the law. Today it comes out that MF was hiding their losses for two years.

The junky thing about accounting is that the numbers you see on financial statements are all subject to human judgement. It’s not a scientific process, although via the Financial Accounting Standards Board (FASB) and Generally Accepted Accounting Principles (GAAP), there are guidelines for the production of those numbers.

However, just like a legal opinion, accounting rules can be bent-until they can’t.

Eventually, when you paper over losses they tend to come out. You can’t carry them forward forever. World governments are finding this out in their own income statements and balance sheets.

The economic meltdown has forced their omissions and errors to be brought to the surface, not to mention changing demographics. MF Global, like Enron and others before it couldn’t keep their fraud under wraps forever.

Through the grapevine, I heard that MF conspired to hide things from independent exchange auditors. As soon as the exchange auditors were done, MF started moving the money back around. They must have done the same thing with PriceWaterhouseCoopers. PwC had given them a clean bill of health.

Enron brought down Arthur Anderson. But, it seems that it’s not the fault of the auditors when fraud happens and it goes undetected. Crafty financiers within a company that is hell bent on committing fraud are going to do it no matter what the law is, or what the accounting standards are.

Rules and laws are written to be broken. That’s the lesson that we should be learning. No amount of bureaucratic regulation, legislation or public outcry is going to prevent fraud from happening. It’s going to happen from time to time.

Sarbanes Oxley, Dodd-Frank, the CFTC, and all the rest of the regulators were not going to stop MF from misbehaving. They can’t be all knowing, and they certainly can’t forecast fraud before it happens. That’s why it was ludicrous for people to say Dodd-Frank could prevent concentrated risk from building up in any one entity. Even with all the data in front of them, it’s probably a judgement call.

The only time they know something happened is with 20/20 hindsight in the mirror. Government and it’s regulators cannot be proactive.

The best antidote to fraud is transparency, and the market destroying the company once the fraud is found out. The only way to be anticipatory is to set up transparent market structures that force companies to shed sunlight on their activities. The market is the greatest truth detector there is. It’s like Santa Claus, it always knows whos naughty and nice.

Individual lessons that should be learned are these. Take a basic accounting course so that you at least can read and understand the cash flows through the business you are working for. It’s worker beware. Secondly, don’t put all your eggs in the basket of the company you work for. You are investing your human capital in that company. Invest your money, risk capital, other places in the market. Ideally in a no load mutual fund that replicates the S&P.

Third, when you are a trader and holding large amounts of capital in your account, you need to know who you are in bed with. Capital is the life blood of your business and without it you cannot operate. Thousands of traders have been dislocated by the MF debacle, and many have lost good businesses that will be hard to rebuild after the dust settles.

It seems the more we try to do, the more this sort of thing happens.