Individuals Causing the 2008 Housing Crisis Receive No More Than a Slap on the Wrist

Following the 2008 housing crisis, several of the banks involved paid large settlement fines. JPMorgan Chase was one of those banks. The Justice Department used evidence from an anonymous whistleblower in the prosecution, but until recently the whistleblower remained anonymous. Matt Taibbi recently released an article in Rolling Stone describing why the whistleblower, Alayne Fleischmann, has gone public with what she knows. Ironically, the Justice Department wasn’t committed to bringing “justice” to those individuals who contributed to the fall of the economy through fraudulent activities. In fact, Attorney General Eric Holder said the following:

“I am concerned that the size of some of these institutions becomes so large that it does become difficult for us to prosecute them when we are hit with indications that if you do prosecute, if you do bring a criminal charge, it will have a negative impact on the national economy, perhaps even the world economy, and I think that is a function of the fact that some of these institutions have become too large.”

What is the Justice Department doing if they aren’t bringing justice to those responsible for major crimes? When Fleischmann realized that much of what she reported to the SEC and the Justice Department was not being fully pursued, she decided she had to go public with what she knew.

Whistleblowing is Paying Off

The WSJ reported this week that the SEC has handed out it's second ever Dodd-Frank award for whistleblowing. the article says that the SEC expects more awards in the future. Here's a quote...

City Governments Committing Financial Statement Fraud

The Wall Street Journal reported recently that city governments in Pennsylvania, Florida, California, New Jersey and Illinois are increasingly being charged with financial statement fraud in their bond offerings. In the case of Harrisburg, Pennsylvania, the SEC stated that:

...this is the first time the (SEC) has "charged a municipality for misleading statements made outside of its securities disclosure documents."

According to "Anthony Figliola, a vice president at Empire Government Strategies, a Long Island-based consulting firm to local governments. 'Harrisburg is the tip of the iceberg.'"

SEC to Focus more on Financial Reporting Fraud

According to the Wall Street Journal, the SEC is ready to get back to work looking for financial reporting fraud. After the mortgage meltdown, the article states that the SEC turned its attention to cases related to the financial crisis and took its eye off of fraudulent financial reporting. Interestingly, the article identifies one new tool that the SEC plans to use to identify fraudulent financial statements...

JOBS Act Leads to First Fraud Case

In March of this year we blogged about the, then proposed, JOBS Act and how this act would eliminate important disclosures meant to protect investors from fraud. The Act lowers the regulatory hurdles for companies who are defined as emerging growth companies. The NY Times reported this week that a company named Caribbean Pacific Marketing is the first company that got its start under the JOBS Act and is being prosecuted for fraud. Here are a few bytes from the NY Times:

Revisiting Allen Stanford's Ponzi Scheme

While Bernie Madoff has claimed the bulk of the spotlight in fraud related news over the past few years, Allan Stanford's fraud isn't just another Ponzi scheme, as highlighted in this interesting article by DailyFinance.  Here are some of the highlights:

Lehman Brothers and the U.S. Department of InJustice

60 Minutes aired what is likely to be the last segment on the global mortgage meltdown and how the U.S. Department of Justice has essentially given the key players a "Get out of Jail Free" card. The latest segment focuses on the Lehman bankruptcy and the fraud involved in that case. Steve Kroft of 60 Minutes says that he has given up hope that the Department of Justice or the SEC will bring any charges against the key players. He says that he is "astounded" that the government has failed to bring cases against the key individuals. In the main video...

Wall Street Justice II: More Insanity on the Way

As if the government's hands-off approach to prosecuting Wall Street firms wasn't enough, Congress is in process of passing laws to lessen regulation for firms trying to go public so they can raise money without the usual disclosures. Guess what industry is licking their lips right now hoping this bill passes--the investment banking industry. The following is from yesterday's Washington Post:

The SEC's Record with Large Ponzi Schemes: Not So Hot

I've been listening to Harry Markopolos's book, "No One Would Listen: A True Financial Thriller" (I recommend it by the way) and have been surprised at how much of the book is devoted to criticizing the SEC. From Harry's account, the SEC totally dropped the ball and was incompetent, corrupt or both in how it handled the Madoff case. I personally think he has a pretty good argument and that the SEC has managed to avoid serious consequences even though the Madoff case was a tragedy that they could have prevented.

Well, now that the Stanford Ponzi scheme is being tried, we are learning that the SEC also dropped the ball with Sir Charles. It may be that the SEC really doesn't understand Ponzi schemes or that they are underfunded, undereducated, understaffed and under-incentivized. All we know for sure is that they appear to be underperforming. Reuters has an article that talks about how Sir Charles was able to keep the SEC at bay for so many years while he built his Ponzi empire, complete with retail offices in the U.S. I recommend it for further insight.

One claim by Markopolos is that the SEC staff are all basically looking for a job in industry to make more money. As such, when they go to investigate a firm, they also ask for a job application. The Reuters article seems to add a second witness to this claim as it describes a former SEC investigator by the name of Barasch and his role in helping Stanford stay out of the SEC's crosshairs:

Barasch was told at the time by an SEC ethics officer that he was legally precluded from representing Stanford. Barasch went to work for Stanford anyway. In a later investigation of the failure to catch Stanford earlier, the SEC Inspector General asked Barasch why he did so. His reply, according to the Inspector General's report: "Every lawyer in Texas and beyond is going to get rich over this case. Okay? And I hated being on the sidelines." 

FBI agents and prosecutors also uncovered evidence that on at least two occasions Barasch sought confidential information regarding the SEC's probe of Stanford during his brief representation of the banker, Justice Department officials said in court records and a press release. 

In agreeing to pay the fine, Barasch denied any misconduct, settling the matter "to avoid the expense and uncertainty of protracted litigation," his attorney, Paul Coggins said.

Another claim by Markopolos is that the SEC seemed to avoid taking on the Madoff case because it was too large and complex. Instead, they went after cases that Harry describes as fleas while the elephant (Madoff) was running free. This Reuters article also seems to bear this out in the following quote:

In 1997, 1998, 2002, 2004, and 2005, according to internal agency records seen by Reuters, examiners for the SEC recommended that the agency investigate Stanford. In three of those instances, Barasch, at the time an SEC official in Ft. Worth, personally overruled the examiners' recommendations, according to those records. Those decisions helped the Ponzi scheme to continue unabated for several additional years, costing investors additional billions of dollars, according to a report by the SEC's Inspector General. 

Barasch told the SEC Inspector General that he made those decisions because he was not sure the SEC had the statutory authority or jurisdiction to investigate. He blamed his superiors and a broader culture within the SEC for pressuring the staff not to pursue complex and difficult cases, according to the Inspector General report. 

Apparently, Barasch was able to help Stanford both while he worked for the SEC and after he went to work for Sir Allen (i.e. Stanford) himself. Sounds like a bad case of a corrupted fraud investigator. I have a feeling I will be reading another book in the future about how the SEC dropped the ball in the Stanford Ponzi scheme too, costing thousands of people billions of dollars.

Madoff and the SEC: Serious Conflicts Existed

The NY Times recently discussed the results of a report on the SEC showing that a lawyer with heavy involvement in the Madoff case had serious conflicts of interest. Here are a few key quotes from the article:

Doping in Cycling: McQuaid Wants Former Dopers Out of Management

VeloNation is reporting that Pat McQuaid, President of the UCI, has proposed that any rider who has been caught doping should be banned from later taking a position managing a cycling team.  The rationale for McQuaids proposal is based on the following premise:

Ponzi Schemes and Sophisticated Investors

So when you read about a small, $50 million dollar, Ponzi scheme coming to light, you almost always read about some gullible investors who had no idea they couldn't make 50% returns in a legitimate business deal. The list of victims was recruited from friends or family in an affinity fraud and almost always includes a bunch of doctors and dentists who have too much money and think they need a bunch more but don't understand risk and return. It is very rare that the so-called sophisticated investors who understand risk and return get duped. The following story was sent to me by a former student, Robert Madsen, who pointed out that this is what makes this story incredible...

WikiLeaks versus the SEC

No, (to my knowledge) Wikileaks hasn't released detailing corruption in the SEC.  Instead, Sherron Watkins, the primary whistleblower in the Enron fraud, weighed in on the SEC's new incentives for whistleblowers.  In a panel discussion about whistleblowers held by the New York State Society of Public Accountants, Watkins said the following (via the PaperTrail):

$67.5 Million Settlement for Former Countrywide CEO

The economic crises resulted in many fraud allegations--now we are seeing some of the fallout of those allegations.  Angelo Mozilo has agreed to a $67.5 million settlement with the SEC over allegations of civil fraud and insider trading charges.  Mozilo did not admit to any wrongdoing in the settlement.  Via NYT:

Dodd-Frank and Whistle-blowing to the SEC

I just read an interesting post in the NY Times about how the new Dodd-Frank financial regulations bill will provide an incentive for whistle-blowers to give information about various frauds to the SEC. Apparently, deep in the bowels of the 2,500 page Dodd-Frank bill that overhauls our financial regulatory system is a provision that requires the SEC to award whistle-blowers 10-30% of monetary sanctions collected by the SEC that exceed $1 million.

 The NY Times post also said that while the amount of the award must range from 10-30% of the sanctions, the exact amount awarded is up to the discretion of the SEC. Also, the whistle-blower must meet certain conditions in order to collect under Dodd-Frank.  Here is what the post said about the requirements:

Credit Agencies and Auditors

There has been a lot of press lately about the three credit rating agencies, Moodys, Standard and Poors, and Fitch, and their role in the credit crisis. In particular, some have pointed to the fact that companies hire these credit rating agencies to rate their securities and this creates a conflict of interest that leads to higher ratings. The same criticism has been lobbed at financial statement auditors for decades--especially when there have been some highly publicized audit failures involving undetected fraud. Interestingly, Congress is doing something about this conflict for the credit rating agencies as described in a recent Bloomberg article that says:

Psychics beware: The SEC has your number!

A recent NY Times article gives some details of a lawsuit by the SEC against a psychic who claimed he could predict the stock market by looking into the future. The suit says that Sean David Morton took more than $6 million from investors with promises of “piles of money,” and spiritual happiness. The article says Morton "calls himself 'America’s Prophet' and says he was "trained by Nepalese monks in the art of time travel."

Morton is quoted as saying:

“I have called ALL the highs and lows of the market giving EXACT DATES for rises and crashes over the last 14 years,”

I wonder if Morton knew this lawsuit was coming?!

SEC to require disclosures on global warming risks

Yes, that's right, the SEC has announced that it wants public companies to try to estimate the risk that global warming poses for their assets or operations! No, I didn't get this off The Onion News Network either! Just do a Google Search and you will see articles in The NY Times and elsewhere.

So what does this mean? I suppose, for example, if the company believes it is too close to the rising oceans and could be under water sometime in the next millennium then it needs to disclose that risk! Also, if a company believes legislation on global warming could negatively impact future earnings then the company needs to disclose that risk.

I personally think that the effects of global warming are so hard to predict that companies could comply with this requirement in one sentence: "The effects of global warming or legislation related to global warming on the Company's assets or operations are not estimable in any reliable way." Seems like some wasted ink to me. Maybe the SEC wants companies to say something like: "The impact on the environment from the extra paper necessary to disclose the possible effects of global warming will not lead to any serious litigation since the company is required by the SEC to go through this silly exercise!"

We can only assume that the SEC will be spending time and money reviewing these disclosures to determine if companies are sufficiently complying. Never mind that they had their hands full and failed to regulate some huge Ponzi schemes such as those operated by Bernie Madoff and R. Allen Stanford before investors lost tens of billions in these schemes! Is this really a priority?!

It seems that investors have serious risks of fraud in this world. Scammers such as Madoff, Pang, Stanford, and companies such as Enron, Worldcom and Satyam need to be regulated and shut down. The SEC needs adequate resources to do these jobs and it has appeared to lack the necessary funding for decades. However, if this is their focus in the future then I question whether voters will sympathize with their calls for additional funding!

EY settles with the SEC

This week, the NY Times reported that the SEC reached a settlement with EY for its audits of Bally Total Fitness. The article reports that "Six current and former Ernst partners, including Randy G. Fletchall, the partner in charge of the firm’s national office, were ... sanctioned by the commission in one of its most sweeping actions against auditors involved in a failed audit." The SEC's $8.5 million settlement is reported as "one of the highest ever paid by an accounting firm.”
Here are a few quotes:

“It is deeply disconcerting that partners, even at the highest levels of E. & Y., failed to fulfill their basic obligations to the investing public by not conducting proper audits.”

“This case is a sharp reminder to outside auditors that they must carry out their duties with due diligence."

"Mr. Fletchall, who remains with Ernst, was in charge of resolving technical accounting issues in the United States ... was censured by the commission."
"A veteran S.E.C. official ... said he knew of no previous enforcement cases in which a partner of a major firm was cited for his actions as head of a national office."
"Ernst was reacting in 2002 to a growing number of accounting scandals, including Enron, and decided to get tough with clients who had previously been allowed to take aggressive accounting positions. The firm forced Bally to stop recording revenue in an improper manner that allowed it to claim earnings earlier than was allowed by accounting rule. But in doing that, the firm allowed Bally to not admit to having violated the rules in the past, an action that would have forced it to restate its accounts and admit that losses in previous years had been much larger."
"The case could provide support for reformers who have said companies should be forced to periodically change accounting firms, a change that Congress considered but rejected in passing the Sarbanes-Oxley law in 2002."

Tell us what you really think Harry...

Here's a juicy quote from Harry Markopolos regarding the SEC's ability to find fraud:

Harry Markopolos, the fraud investigator who brought his allegations to the S.E.C. about improprieties in Mr. Madoff’s business starting in 2000, testified that the agency’s staff “was not capable of finding ice cream in a Dairy Queen.”

I wonder what he thinks about the ability of independent auditors to detect fraud...I'm not trying to defend the SEC or disparage auditors but it might be interesting to evaluate the number of frauds detected as a function of resources devoted to auditing or detecting material fraud between these two institutions who are both charged with responsibilities for fraud detection: the SEC and independent auditors. Anyone have a guess as to which mechanism would have the best track record?