Peregrine – Twenty Years of Fraudulent Cash Balances
INTRODUCTION
“It’s crazy that he duped us with a P.O. box and Photoshop.” Commissioner Bart Chilton
of the Commodity Futures Trading Commission (Phillips et al. 2012).
Nine days after his surprise Las Vegas wedding, Russell Wasendorf Sr., Chief
Executive Officer of Peregrine Financial Group (PFG), was found unconscious in his car
with a tube running from the exhaust pipe into the vehicle. Wasendorf was widely known
in the futures industry as “Russ Senior,” since his son Russell Wasendorf Jr. served as
the president of PFG. Three years earlier, Wasendorf had moved Peregrine from
Chicago to the edge of the university town of Cedar Falls, Iowa. He quickly became an
active and respected community leader, donating millions to the local university and
several charities. Along with a suicide note, police found a statement in which the CEO
admitted he had committed fraud for over 20 years. The note stated, “I have been able
to embezzle millions of dollars from customer accounts at Peregrine Financial Group.
Using a combination of Photoshop, Excel, scanners, and both laser and ink jet printers,
I was able to make convincing forgeries of nearly every document that came from the
bank” (Phillips et al. 2012). With this equipment, Wasendorf allegedly fooled regulators
through an elaborate scheme that included forged bank statements, faked e-mails, and
a bogus bank account at a post office box.
The fraud was exposed when the National Futures Association (NFA) sent an
audit team to review Peregrine’s books and pressure Peregrine into participating in a
new electronic confirmation system for verifying accounts. Wasendorf fooled the NFA a
year earlier after the regulator received an email from a bank employee on a Friday
indicating that Peregrine’s account for customer balances had less than $8 million. The
following Monday, the NFA received an email fax purportedly from the same bank
employee with a hand-written note that the account balance was now $218.6 million
(Phillips 2012). Apparently, the NFA auditors accepted this correction and did not follow
up on how the bank could have made such a large error. A later investigation revealed
that the fax was sent by Wasendorf (Huffstutter et al. 2012b). Included among the
missing assets were 304 silver coins sporting the image of TV cartoon character
SpongeBob SquarePants. When the FBI searched the firm’s Cedar Falls headquarters,
they seized SpongeBob coins worth about $375,000, based on the retail price per
set of $259. The SpongeBob coins were the brainchild of a Peregrine unit called PFG
Precious Metals Inc. and an Auckland, New Zealand-based minting firm, which began
manufacturing the novelty items for the Peregrine unit in 2011 to sell to customers. PFG
Precious Metals also sold gold and platinum coins (Saphir 2012a).
WASENDORF’S BACKGROUND AND
PEREGRINE FINANCIAL GROUP’S HISTORY
Now known as the ‘Midwest Madoff’ (Epstein 2012), Wasendorf grew up in eastern
Iowa. He was raised by a single mother following his father’s sudden death when
Wasendorf was in kindergarten. He studied at the University of Northern Iowa, which he
left to pursue a career as a documentary filmmaker. He was introduced to the futures
industry in the 1970s through a trading program aimed at farmers. Wasendorf launched
a financial advisory boutique in 1980 in the backroom of a barber shop (Huffstutter et al.
2012a). A correct bet ahead of the Black Monday market crash of 1987 provided the
capital for the launch of Peregrine Financial Group three years later. Wasendorf said, “I
named the company Peregrine because there is an expression in our business that you
are ‘either predator or prey.’” The firm moved from Iowa to Chicago in 1994 just as the
futures industry boomed with the advent of electronic trading.
Peregrine moved back to Iowa in 2009, where Wasendorf was known for his
restaurants and environmental and philanthropic work (Huffstutter et al. 2012a). The
fraud shocked the small town of Cedar Falls where Peregrine was located, as well as
the Chicago financial community. A closed sign now hangs on his high-end Italian
restaurant my Verona. Wasendorf built a building in a wooded area outside of town
designed specifically for the operations of the financial firm, with technology accessible
throughout the building. A gym, day-care and cafeteria were available at no charge to all
staff. The first person he hired for the project was a biologist to ensure that endangered
species or woodlands would not be harmed. Now the building sits empty. “That property
could be vacant for five years” says Jim Benda, a broker at a commercial realtor in
Cedar Falls. “It’s going to be a difficult sale” (Louis 2012).
ECHOES OF EARLIER SCANDALS
Major frauds tend to imitate those of the past. First Securities Company of
Chicago is one of the early significant auditor legal liability cases brought under the
1934 Securities Act. The perpetrator of the fraud, Leston Nay, received funds from
friends to invest in an “escrow syndicate.” In fact, however, the syndicate did not exist
and all of the funds were lost. To prevent detection, Nay instituted a “mail rule” and
insisted that only he could open mail addressed to him. The fraud, which lasted about
30 years, ended in tragedy in 1968. Unable to make payments when a trustee of an
estate attempted to redeem funds held by First Securities, Nay killed his wife and then
himself. The Peregrine case is similar. To prevent other Peregrine employees from
learning about the real bank balances, Wasendorf insisted that only he could open mail
from the bank for 20 years.
The largest of the financial frauds that were revealed in the aftermath of the 2008
financial crisis involved Bernie Madoff. Like Wasendorf, Madoff apparently could not
stop once he started the fraud. Madoff’s fraud began in the 1990s, though some believe
that it started in the 1980s (Frank et al. 2009). Madoff was audited by a two-person CPA
firm with only one practicing CPA. Similarly, Peregrine was audited by Veraja-Snellnig &
Co., a one-person CPA firm. However, no one raised questions about why a financial
services firm with hundreds of millions under management would employ such a small
audit firm.
CONFIRMATION OF CASH BALANCES
Cash is perhaps the most basic audit area, and the audit work is typically
performed by new staff auditors. One professor recalls hearing in new staff audit
training – “cash is cash – you either have it or you don’t.” Faking cash balances does
not seem plausible, and cash is rarely central to most major frauds. It is far easier to
create fictitious inventory, receivables, or understate accounts payable. However, the
fraud at Parmalat, which was revealed in 2003, highlighted the ability of companies to
fraudulently overstate significant cash balances.
American Institute of Certified Public Accountants (AICPA) auditing standards
(AU-C 500) define an external confirmation as “audit evidence obtained as a direct
written response to the auditor from a third party (the confirming party), either in paper
form or by electronic or other medium (for example, through the auditor’s direct access
to information held by a third party)” (AICPA 2009, 2011). Janvrin et al. (2010) identify
several problems involving confirmation, including the need to evaluate the reliability of
the response. Fictitious responses indicate a need to authenticate responses for
balances involving significant risks, while responses involving collusion between the
client and customer indicate a need for additional collaborative evidence in addition to
confirmations.
Confirmation of cash balances is a typical audit procedure performed by many
auditors, and the AICPA provides a standard bank confirmation form (see Exhibit 1).
The practice is so common that most auditors are surprised to learn that confirmation of
cash is not currently required by auditing standards, although the PCAOB is considering
requiring confirmation of cash balances (PCAOB 2009). Auditors typically confirm cash
balances directly with the bank. In the Parmalat case, executives sent a forged
confirmation to the auditors confirming 3.95 billion euros in a Cayman Island account.
Potential fictitious bank balances and confirmations have recently arisen as a problem
area in audits of Chinese companies (Rapaport 2011), but has not been a common
problem in audits of U.S. companies.
Wasendorf supplied the auditor with the address for a post office box that he
controlled for the mailing of the confirmations. It was not just the external auditors that
he fooled. Peregrine was audited by the National Futures Association (NFA) in February
2010 and May 2011. As noted in the opening quote, Commodity Futures Trading
Commission (CFTC) Commissioner Bart Chilton noted, “It’s crazy that he duped us with
a P.O. box and Photoshop.” Further, NFA President Daniel Roth stated on July 25,
2012 that, "The sheer volume of forged documents that were produced as part of this
scheme is staggering, and had to occur on a daily basis." However, the use of
Photoshop to create forged documents may not be so crazy, as suggested by Caster
and Verardo (2007), who found that some forms of technology, such as scanners and
printers, may weaken traditional audit procedures and actually serve as an enabler to a
fraudster.
ELECTRONIC CONFIRMATIONS
The process of confirming written bank balance confirmations had largely been
unchanged for decades until the Parmalat fraud. The forged confirmation in the
Parmalat fraud involved an alleged account at Bank of America. Following the fraud,
Bank of America announced that it would only process confirmations sent electronically
through a third-party intermediary, Capital Confirmation. Capital Confirmation, similar to
other electronic confirmation providers, uses a secure web-based approach (e.g.,
Confirmation.com) to assist auditors with electronic confirmation. Electronic
confirmations provide verification through authentication of all parties involved in the
confirmation process (audit firm, client, and financial institution), improving audit
efficiency and effectiveness (Aldhizer and Cashell 2006).
The NFA began using Confirmation.com in the wake of the October 2011
collapse of MF Global Holdings, a company led by former New Jersey governor Jon
Corzine. The NFA began to demand that futures brokerages submit to its e-confirmation
services in summer 2012. After significant pressure, Wasendorf agreed to authorize the
NFA to electronically confirm Peregrine’s cash balances the day before he attempted to
kill himself.
EPILOGUE
Wasendorf recently entered into a plea agreement regarding this case (Harris
and Witosky 2012). Details of the plea agreement remain secret. However, news
reports of the missing assets recovery investigation provide little hope that investors will
receive a significant portion of the $220 million in missing funds stolen over the past 20
years. Thus far, investigators have learned that most of Wasendorf’s assets, including
his luxury Iowa home, downtown Chicago apartment, and private plane, were highly
mortgaged. Further, officials are investigating a $50,000 deposit made by Wasendorf to
his new wife’s daughter the morning of his suicide attempt, missing gold valued at
$60,000, and 304 missing silver SpongeBob SquarePants coins valued at $20,000
(Saphir 2012a). Peregrine filed for bankruptcy within a week of Wasendorf’s suicide
attempt and over 300 employees are now laid off and 17,000 futures customers and
7,000 trading clients were forced to find alternative trading services (Saphir 2012b).
CASE REQUIREMENTS
1. What are the requirements for confirmation of cash balances under U.S. auditing
standards? Do you believe confirmations of cash balances should be required by U.S.
auditing standards? Why or why not?
2. Another account many auditors confirm is accounts receivable. U.S. auditing
standards currently require confirmation of accounts receivable in most situations.
However, international auditing standards do not require confirmation of accounts
receivable, citing cultural differences between countries as one reason why requiring
receivable confirmation would not be appropriate. For example, in some countries, a
request to confirm an account balance would be viewed as insulting. Do you believe
confirmations of cash and accounts receivable balances should be required by
international auditing standards? Why or why not?
3. Peregrine was audited by a one-person CPA firm? Do you believe this played a role
in the failure to detect the fraud?
4. The fraud was revealed when regulators moved to electronic confirmation of bank
balances. What are the advantages of electronic confirmations?
5. What are the risks associated with electronic confirmations? How can an auditor gain
confidence in the reliability of responses received electronically?
6. Should electronic confirmation of cash balances be required? Could standard written
bank confirmations have been effective in detecting the fraud at Peregrine?
7. Given the relatively small number of electronic confirmation providers, what happens
if:
a. an electronic confirmation provider’s server goes down for an extended time or if
the server is compromised by hackers?
b. an electronic confirmation provider experiences financial problems or goes out of
business?