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Forensic Accounting and Scott Rothstein's Ponzi Scheme
Jeff Chesen, NCSTL Research Attorney

According the United States Securities and Exchange Commission (SEC), a Ponzi scheme is an investment fraud where the organizers promise returns to existing investors that come from funds paid by new investors.1 Frequently Ponzi scheme organizers promise high returns on investments with little or no risk. The scheme often falls apart when the organizer flees with the invested funds or when a sufficient number of investors cannot be found to continue paying dividends to prior investors.

Forensic accountants hired to search through records can often determine where Ponzi scheme money was hidden and where it was distributed. Utilizing accounting and auditing skills, forensic accountants perform investigative accounting work prior to prosecution and litigation. They identify evidence of financial irregularities and locate electronic clues to locate additional evidence. Forensic accounting requires familiarity with both criminal and civil law and tax codes to locate and uncover fraudulent financial transactions.

Florida lawyer Scott Rothstein is being charged with organizing a Ponzi scheme through his now-bankrupt law firm. Bankruptcy attorneys estimate that Rothstein's fraud brought in $1.4 billion to $1.6 billion.2 But the investigation into the losses was made easier because Rothstein did not keep a second set of false books and he had fewer than 50 bank accounts rather than hundreds.3 The task was complicated by the chaotic condition of the law firm's records.

Forensic accountants perform cash flow analysis by searching through bank records, invoices, falsified books, brokerage statements, faxes and e-mails; their search can include both an electronic and a paper trail.4 They reconstruct the scheme by obtaining relevant banking records. The bank deposits make an investment a transaction that can be traced, frequently following a pattern where funds move from the investor to the organizer, then to the organizer's bank, then to earlier investors, and in some cases into the organizer's accounts. A forensic accountant can create a cash flow statement from the investigation charting the movement of funds received and disbursed from the organizer's bank accounts. The results of the forensic cash flow analysis can be used as evidence in the criminal investigation. Forensic accountants can be called as expert witnesses and the cash flow analysis can be used in court to illustrate how the scheme operated and how the organizer spent the investors' funds.

In Rothstein's case, accountants have identified $24 million in loans to Rothstein's former employees, business associates and friends, $1.1 million to Kim Rothstein, Scott Rothstein's wife, for shopping purchases made on a law firm credit card, and at least $43 million repaid to investors before the law firm trust account went dry.5 A forensic accountant researching the law firm's records testified in bankruptcy court that Rothstein had approximately 600 separate investment deals involving 127,000 bank transactions.6 He also testified that the firm used accounting software that was more appropriate for a small business than a large law firm.

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Sources

1 "Ponzi Schemes—Frequently Asked Questions," U.S. Securities and Exchange Commission website, found at www.sec.gov/answers/ponzi.htm (last checked on Apr. 21, 2010).
2 Peter Franceschina, Following the Money Trail: Accountants Closing in on Where the Millions in Rothstein's Scheme Went, S. FLA. SUN-SENT., Apr. 4, 2010, at 1A.
3 Id.
4 4 Ron Scherer, Accounting Sleuths on the Trail of Madoff Money, CHRISTIAN SCI. MONITOR, Dec. 22, 2008, at 1.
5 See also note 2.
6 Peter Franceschina, Judge Freezes $33 Million Paid to Financial Adviser in Rothstein Case, S. FLA. SUN-SENT., Apr. 16, 2010, at 1B.