Er, people don't cheat on live with their modded Xbox. You know why? Because they can't get onto live with a modded xbox.
People who cheat on live use the 'magic button' trick, also know as unplugging your router or connection to xbox live for a slit second. This allows them to see everyone as staying still (to appear as if they were lagging) and kill them where they stand OR run to cover and be simply invisible. There are also glitches which are apparent when doing this in certain games, such as changing guns during the process or living after getting shot - etc.
I hope MS kicks people whos connections are interruptedduring a game. If they detect a wire being unplugged and so forth, then they should be automatically booted from the server and forced to log back in manually.