The Corporate Observer Blog : Consumer Protection, Corporate Abuse : Class Action Lawyer & Attorney : Steven Berk Law Firm

The defense will claim—get this—that the SEC's freeze of his assets led to the downfall of Stanford’s empire.

It’s finally showtime for one of the greatest grifters, flim-flam artists and con men of the century.  Yep.  Allen “who wants to play cricket with me” Stanford began his trial yesterday.  After a curious and all-too-convenient case of depression-induced amnesia, this cowboy finally stands trial for running a $7 billion Ponzi scheme.

So, who is to blame for the some 20,000 people who were robbed of their money?  What will be the theory of his defense?  Well, the regulators, of course!  Postponing his trial gave his defense team plenty of time to cook up a doozy of a strategy.  They must have taken a poll or something.  It’s the old claim, it’s all about those evildoers at the Securities Exchange Commission.  You see, after determining Stanford was a fraud (all those jets and private Caribbean Islands were a good clue), the SEC froze Stanford’s assets in 2009 and charged him with fraud.  The defense will claim—get this—that this freeze led to the downfall of Stanford’s empire.

Mr. Stanford, sorry to be the one to break it to you, but you cannot blame the regulators.  In fact, only one group really can—those who lost their money in what they believed were safe investments in certificates of deposit.  They have every right to blame the SEC and other financial regulators for letting you get away with this.  These regulators failed to act promptly and in the face of mounting evidence, turned a blind eye to the activities of Stanford’s firm until it was too late for many investors.

Well sit back and get comfortable, this is not going to be over any time soon.  P.T. Barnum—er, Allen Stanford—may just pull a rabbit out of his hat...

Assisted by Setareh Ebrahimian

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Yesterday, regulatory heads from the SEC, Federal Reserve, FDIC, and CFTC addressed two congressional subcommittees regarding the Volcker Rule.  They showed spine, commitment and solidarity towards the Rule, which should give heart to Main Street.  It’s about time.

Detractors argue that the Rule, which forces banks to return to their role as basic depositor and lender, limits the banks’ ability to “make markets,” politician-speak for “bet the farm.”  This will negatively impact liquidity, making it harder for investment capital to reach those that seek it, they argue.  Blah blah blah.  And needless to say they find “friends” in Congress (read: recipients of donations) to beat the drum.  Well this time, the administration is not budging. Can you say, “Election year”?

Here’s the bottom line.  Banks have served two distinct functions this millennium, one as deposit holders and lenders, and one as investors.  The deposit-holding and lending function (the actual banking) serves Main Street.  The risky investments—or “market-making” if you listen to bank lobbyists—serve the bank executives at the risk of depositors.  The Volcker Rule allows banks to hedge risk but make no other investments.

Investing—for example, in incomprehensible derivatives that include AAA-rated, subprime mortgages not worth the ink in which they’re written—is not the role of a bank.  It is the role of separate institutions, which will certainly step up to fill the void.  And when they step in, they won’t be risking the deposits of unwitting taxpayers.

Dodd-Frank gives banks two years to comply with the Volcker Rule, and they’d better get changes underway.  The regulators are—knock on wood—finally serious and unified in their efforts.  Bankers beware.  Main Street, rejoice.

Assisted by David T. Martin

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I guess he got sick of eating lunch alone.  I can see it now, he walks into the SEC’s cafeteria (actually I don’t think they have a cafeteria) and says,”You guys mind if I join you?”

“Sure,” says Head of Enforcement Robert Khuzami, hoping not to offend the respected yet independent-minded and powerful Inspector General, H. David Kotz.  “But actually we were—hmmmm—just leaving.”  And so it goes, another lunch alone.

Next time, he figures, he’ll just work through lunch.  Since 2007, Kotz has produced some stinging and thoughtful reports on the failure of his agency to do its job.  He will be best known for his thoughtful, take-no-prisoners critique of the Commission’s failure to ferret out the Madoff and Stanford schemes earlier.  He also highlighted problems at Bear Stearns before its collapse and drew attention to insider trading and conflicts of interest among SEC employees.

We should all commend his tireless service.  The role of the Inspector General is a unique one.  The French Army had an IG as early as the mid-17th Century, assigned to report to King Philip (or was it Louis?) regarding the state of the army.  The United States adopted the position during the Revolutionary War: An Army Inspector General was assigned to training the Continental Army (which was really just an assembly of militias) and ensuring uniformity of tactics.  In the three-plus centuries since, the role has expanded in the United States to just about every major governmental department.  Mr. Kotz filled the role admirably at the SEC, and at a difficult time.  We wish him well.

We now look forward to seeing Chair Mary Schapiro’s obvious choice for his replacement.  “Drum roll please...”

Harry Markopolos.

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The press recently reported (click here for the WSJ story) that DOJ is joining the investigation of S&P for its shady practices of rating the very folks who pay its bills. Below is what I imagine to have transpired in an initial conversation between investigators and S&P officials.  

S&P Vice President for Compliance: Come in guys.  Sorry the coffee is cold and the pastries are a bit stale.  We’ve been expecting you for, well, the last few years.  Were the directions we gave you a little tough to follow?  Should have used Google maps?

DOJ Prosecutor: No. It’s all good.  Frankly, we were going to give you a pass (wink nod).  Just too complicated.  We like easier cases.  But then you went ahead and downgraded US Treasury Bonds.  That did not play well at the home office. 

S&P Vice President: Yeah, I guess it was not the time to get righteous.  So how long will your team need to be around?

DOJ Prosecutor: I guess that depends. Now that the press is on to the investigation, we have to make a show of it.  And look, from what we know, you guys made over $2 billion (with a b) dollars rating these CDO; that’s a little too much to ignore.

S&P Vice President: And how bout the SEC?  What about their investigation?

DOJ Investigator: Oh, those guys? Ha! Trust me, they need all the help they can get.

S&P Vice President: Do you think anyone is going to jail?

DOJ Investigator: Nahhhh.  We get it.  You guys bend over backwards for the Wall Street firms so that your friends over there are happy and well fed – and in return when your kids near college you move over to take a lucrative seat on the other side of the table.  And so it goes.  (The old you scratch my back, I’ll scratch yours).  If we were going to prosecute folks for that kind of behavior, Wall Street would be empty.  We’d have to let out all the drug dealers and addicts to make room in the prisons.

S&P Vice President: Hey thanks, we’ll bring in some fresh coffee … and if your daughter needs a summer a job, make sure to use my name.

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Come on fellas, you gotta be kidding.  Here’s the big change we’ve all been waiting for from the protector of the nation’s securities markets:

For those who plead guilty to fraud and other criminal offenses, the option of settling civil charges brought by the SEC will not be able to proceed with a mere “neither admit or deny liability” settlement.  Nope, the new “get tough” sheriff in town (the SEC) says no more “denying liability.”  Convicted criminals can instead remain silent and will not be forced to admit liability; that’s it.

For civil settlements: no change.

For a complete explanation of the SEC’s new policy see David Hilzenrath’s article in the Washington Post.

Okay, let’s see if I get this right.  In 90% of cases (that is, civil cases)—no change.  In the approximately 10% of criminal cases—a defendant need not admit civil liability.  This is “less than meaningless” because to be convicted of a crime, prosecutors must establish guilt at a higher standard (beyond a reasonable doubt) where in a civil case the evidence must only be established by “a preponderance of evidence.”  So if someone has already accepted (or been found guilty) beyond a reasonable doubt—what does it matter?—they have for all intents and purposes admitted civil liability (the lower standard).

Got it?  I sure don’t.  I respect the SEC.  I know they have a cadre of hardworking, smart people.  So what beyond window dressing is this latest effort?  Surely Judge Rakoff, the provocateur in this effort will not be satisfied.

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 This blog is belongs in the category of: “You can’t make this stuff up.”

Life Partners Holdings’ business plan is simple: pay people a small sum up front in exchange for that person’s life insurance policy.  Life Partners then sells shares in those life insurance policies as securities to average independent investors.  Essentially, Life Partners and its investors make money by betting that people will die sooner rather than later.  The sooner the death, the quicker (and larger) the payout on the life insurance policy.  Yuck.  Isn’t there a better way to make a living; say build a house, clean the streets, heck, run for President?

To boot, Life Partners is not alone.  There are plenty of players in this “bet on death” space.  Life Partners is different though; they are financed by average investors as opposed to institutional investors.

What happens if the policyholders outlive their insurance policies?  Well, in that case, Life Partners and its investors take a hit.  You must be thinking, “Wow, they better have some good actuaries over there to minimize risk.”  Nope.  Turns out Life Partners Holdings hired an unqualified doctor to make unreasonable and incorrect estimates on life expectancy.  Why?  Hard to say, but it suggests that all along the business might have been about making money for the owners and to heck with the investors.  According to the SEC, the doctor estimated on average that policy holders would live 4.6 years, but, in actuality, sound actuarial practices would’ve revealed an average life expectancy of 9 more years – 13.6 in total.  Thus, investors were tricked into thinking securities were far more valuable than they actually were.

Can you say snake oil!

Life Partners was recklessly selling securities whose value was far below the advertised price, leaving little chance for positive return for investors.

The SEC, undeterred by the slap down it received from Judge Rakoff, has filed charges alleging disclosure and accounting fraud as well as insider trading by the company’s CEO, Brian Pardo and General Counsel, R. Scott Pelden who each sold millions of dollars of stock based on insider knowledge of Life Partners’ weak financial state.

As if the business of betting on death wasn’t already sleazy enough, the folks over at Life Partners have taken it to a whole new level.  “Have you no shame, Mr. Pardo and Mr. Pelden?”  It's one thing to be in the business of profiting on the early death of others but to do that and cheat is just beyond reprehensible.  I can’t see this pair being invited to the elementary school on “what my father does for a living day.”

Assisted by Zachary A. Kady

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Mr. Rajaratnam, enjoy your last weekend at home. Watch some football, enjoy your favorite foods and make sure to hug your kids. Because come Monday it's federal prison in Massachusetts – ouchhh.

Despite the arguments of your eloquent and powerful attorney, Patricia Millett, the trial judge and a panel of judges from the second circuit court of appeals feared you would opt for your native Sri Lanka (presumably fleeing surreptitiously in the baggage hold of someone’s private jet – since surely your passport has been seized) instead of lovely western Massachusetts.

But fear not Raj fans, I would not be shocked if on appeal his conviction is overturned. As I’ve written before, the prosecution team obtained its evidence using tactics that were aggressive and arguably crossed the line. Raj and his team argue that prosecutors conveniently failed to disclose key facts from prior SEC investigations when applying for wiretap warrants.  Judge Howell was surely troubled but decided it was prudent to allow the case to proceed to the jury.

Now on appeal, Raj has put his fate in Patricia Millett, a rising star in the rarified world of Supreme Court Attorneys. As an attorney in the Solicitor General’s Office she argued 25 times before the Supreme Court. She is known as a persuasive oral advocate and strong writer. Unlike Raj’s trial counsel (John Dowd), she is in the prime of her career.    Overturning this conviction would catapult her to the highest level of appellate lawyers and who knows, the Attorney General’s Office or maybe even a black robe, driver and a key to the Supreme Court’s basketball court. You can be sure she is motivated to do well in this very high profile matter.

Prosecutors cannot breathe a sigh of relief just yet.   They will have their work cut out defending this conviction.

Raj, you won’t be home for Christmas, but maybe next year.

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As a former SEC attorney myself, I know how difficult it can be to work with limited staff, time, and money to reign in the fraud and deceit that seems to run rampant in Gotham…  Excuse me, I meant Wall Street.  But resources aside, some cases demand a full court press.

The bloggers are a blogging and twitter is atwitter with talk of Judge Rakoff’s refusal to approve a proposed settlement between the SEC and Citigroup for “alleged” fraud.  Specifically, Citigroup is accused of selling junk securities to investors only so it could turn around and short, or bet against, its own customers when the securities tanked.  According to the New York Times, investors lost $700 million while Citigroup made $160 million from the deal.  This is not just aggressive business-as-usual but the kind of fraud you’d expect from some boiler room shop manned by ex-cons.  It’s surely not something you’d expect from one of our nation’s largest banks.  (Who, by the way, survived only after receiving $30 billion from you and me – taxpayers, that is.)

Rakoff’s decision is hailed by some as a triumph of reason over “business as usual,” but derided by others as capricious overreaching by a judge who should defer to an agency’s discretion to settle such matters.  I’m firmly with Judge Rakoff on these facts.  It was the right case to make a statement.

Business as usual has to change.  Companies like Citigroup should not be allowed to simply sweep improper conduct under the rug with no admission of guilt and a penalty that Judge Rakoff appropriately described as pocket change.  As I pointed out in this interview, somebody must be held responsible.  Somewhere on Wall Street sit a couple of bankers who decided it would be a smart idea to bet against their customers and worse, to sabotage their customers’ investments.  Those people must be held accountable and the company they work for should admit wrongdoing.  Who are they?  In this case, taxpayers are entitled to know.

On the other hand, agencies like the SEC do not have unlimited resources.  As a former SEC attorney myself, I know how difficult it can be to work with limited staff, time, and money to reign in the fraud and deceit that seems to run rampant in Gotham…  Excuse me, I meant Wall Street.  But resources aside, some cases demand a full court press.  This is one that shocks the conscience.

Judge Rakoff was correct that Citigroup is a recidivist and repeat offender and I look forward to watching the effects of this potential “new era” trickle out to the rest of Wall Street.  There is a new sheriff in town and his name is Jed Rakoff.  Will he enlist others?

Assisted by Zachary A. Kady

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Barney Frank, a unique politician and extraordinary American, announced his “early” retirement yesterday.  He took on the mightiest among us with aplomb and good humor.  As they say in New England, he was “wicked smaht.”  Thank you, Barney, for never shying away from protecting consumers.

A member of Congress since 1981, Frank has a long list of accomplishments.  In 2008 Frank supported the passage of the American Housing Rescue & Foreclosure Prevention Act, which sought to protect thousands of homeowners from foreclosure.   He contended that underregulation of markets led to the subprime situation.   Frank also drew admiration from consumer advocates for his instrumental role in the passage of the Credit Cardholders’ Bill of Rights Act of 2008, which establishes fair and transparent practices relating to the extension of credit.  A champion of equal rights, Frank is known particularly for his LGBT platform, “the right to marry the individual of our choice; the right to serve in the military to defend our country; and the right to a job based solely on our own qualifications.”

The Corporate Observer has applauded Barney Frank in the past for his efforts to build confidence in American companies and limit fraudulent schemes before they metastasize.   The whistleblower provision of the Dodd-Frank financial reform bill encourages individuals to stand up against corporate, securities, or government misconduct by offering protection and monetary incentive.  As mentioned in previous posts, the whistleblower incentives will help solve an immense problem plaguing our economy today: unchecked, gambling financial executives that helped bring our economy to the brink of collapse.  Today, consumers are paying the price for corporate America’s greed.  Tomorrow, the SEC, side-by-side with Dodd-Frank whistleblowers, will ensure that we do not make the same mistake twice.

Barney Frank leaves us at a time when Washington needs him more than ever; but power partisan politics finally got the best of him.  He's run an ultra-marathon for consumers and it is time to take a victory lap.  We will miss his quick wit, outspoken courage, unconventional speaking style, and most importantly, his legacy for speaking from the heart—something we don't get enough of in our nation's capitol.

Assisted by Arezu Hadjialiloo

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The SEC’s recent settlement with Citigroup wouldn’t even brush back Alex Rodriguez, so it’s certainly not scaring the world’s fourth-biggest bank into compliance.  If the banks’ reaction to recent regulation is any indication, Citigroup will just levy more fees on its unsuspecting customers to pay off the $285 million legal tab in a few days.

Ho hum…  Citigroup to pay hundreds of millions in a settlement related to subprime mortgage instruments.  The SEC crackdown is finally underway!

Yeah right.  Though $285 million is a big number on Main Street, in the executive suite of mighty Citigroup it is a rounding error, less than 8% of the bank’s $3.8 billion profit from Q3 alone.  Heck, Citigroup has probably paid CEO Vikram Pandit alone close to that amount over the years.

The lawsuit and settlement relates to Citigroup’s sleazy effort to take advantage of the market conditions resulting from the subprime financial crisis.  In a sentence, the banks loaded investment portfolios with risky-at-best instruments, neglected to inform their customers of the risk as they sank billions into the portfolios, then surreptitiously bet against the instruments themselves.  The more their investors lost, the more the banks won.

The outrageousness of this plan can be illustrated with an analogy to our favorite sport, baseball.  Consider Cardinals skipper Tony La Russa convincing thousands of fans to bet on his team in the World Series, not too difficult.  Once he’s holding the cash, he benches sluggers Albert Pujols and Matt Holliday and sneaks to Vegas, placing millions on the Rangers.  Got it so far?  Here’s the rub.  When Major League Baseball finds out, he’s fined a mere $75,000.  It's that blatant folks.

Banks like Citigroup have proven time and again that a slap on the wrist like this won’t change the trend towards greed and unimpeded profit-mongering above sound banking principles and just plain ethical conduct.  The SEC’s recent settlement with Citigroup wouldn’t even brush back Alex Rodriguez, so it’s certainly not scaring the world’s fourth-biggest bank into compliance.  If the banks’ reaction to recent regulation is any indication, Citigroup will just levy more fees on its unsuspecting customers to pay off the $285 million legal tab in a few days.  $1.00 to walk in the door of your local branch, $2.00 to use the restroom.  Oh, you planned to wash your hands?  Please insert an extra quarter.

More concerning than the mere slap on the wrist is that no regulation has been effectively passed and enacted since the crisis to prevent future transgressions.  Dodd-Frank has met the immovable object known as partisan obstinacy.  Moreover, the Volcker Rule, which would require banks to get back to doing what they do best—perhaps the only thing they can do effectively—which is loan money, is being watered down, bludgeoned and otherwise made an ineffective mess by Gucci-loafered lobbysts from the financial industry.  It's time to stand up to these shenanigans.  Mr. President, where are you?

Assisted by David Martin

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Judge Richard H. Howell sentenced Raj to 11 years in prison this morning following his August conviction for securities fraud and conspiracy.  According to the New York Times, the 11 year sentence is the longest ever for insider trading, surpassing the 10 year sentence of Zvi Goffer, also a former Galleon trader (and just short of my prediction of a 15 year sentence back in August).

Deterrence matters. As a former Federal Prosecutor, I’ve seen the power that a stiff sentence and a prominent presence on the front pages can have on lowering crime rates.  Haynes & Boone white collar defense attorney, David Siegal expressed a similar sentiment: “One legacy of this case that Wall Street will be more careful about what they say on telephones than they used to be.”  Good.  We should hope that vigilance on the phone will spill over into vigilance when walking the line between aggressive fact gathering and insider trading.

The SEC can celebrate a job well done, but not for too long.  We need these investigators – who, for the first time in history, placed wiretaps on suspected insider traders – back out there catching bad guys.  Stay on the hunt. Stay on the front pages.  Rajaratnam made profits of more than $60M from insider trading…who is making $70M, $100M?

Insider trading affords the well-connected on Wall Street an unfair advantage over the average yet diligent investor on Main Street.  That, my friends, is unacceptable.  The regulatory agencies must remain on the watch, making sure the game remains fair – for everyone.

Assisted by Zachary Kady

Update (10/14/2011): Please enjoy the Newsy video coverage below.

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When Standard & Poor’s downgraded U.S. credit, I wrote in these pages that it had done a disservice to the American economy and consumers.  Far from providing a true barometer of the risk associated with U.S. debt, S&P was “paying back” for missing the most flagrant foul of the century: Providing Triple A ratings for sub-prime mortgage securities.

Fast forward four years to today and S&P misguided effort to get it “right” by downgrading US debt.  S&P was alone and wrong to do so.  Its sudden lurch to “overprotective, overcautious rating agency” was a cue followed by no one; yet it led to the worst single-day Dow Jones drop since 2008.  (And trust me, with an election year nearly upon us, we haven’t heard the last of this historic downgrade.)

Now comes the SEC, with its whistle and a big yellow flag flying. “Penalty, S&P.  Frivolous granting of a AAA rating to a basket of questionable mortgage backed securities issued in 2007.  Fifteen yards and an automatic first down.”

Given the timing of the SEC action (on the heels of S&P's decision to downgrade US debt) its motivation may be suspect, but the Commission is surely moving in the right direction.  The Credit Rating Agencies must be subject to greater regulation.  While the SEC is looking into S&P actions leading up to the financial crisis, they must continue to prosecute where they can and with rigor and purpose.

We can only hope this current probe into S&P will lead to a wider investigation, in which the entire structure and dependence on CRAs is evaluated.  Major repair is needed in any system in which an agency is paid by the very company it is rating to issue an “unbiased opinion”.  But first the SEC must add some bite to its bark by imposing real penalties on S&P’s. We’ll see.

Consider me among the skeptics. 

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What is the Inspector General of the SEC thinking?  Recommending David Becker be investigated by the DOJ for fraud?

Not only is the recommendation absurd under the publicly disclosed facts, but it sends a deep chilling effect across Washington and among those who might consider pursuing a position in public service.  I don't know David Becker well, but I have friends who have worked closely with him.  I understand him to be a person of the highest integrity.  In this particular situation he seems to have acted in a manner that is exemplary, hardly meriting investigation and the expenditure of limited government resources.

The facts.  David’s parents were Madoff investors, earning $1.5 million.  They were not fund managers or insiders, they made money as unwittingly as the scheme’s victims lost it; there is no allegation they had any idea they were invested in a multi-billion dollar Ponzi scheme.  They did not recruit others to the scheme.  When they recently died, David and his brother stood to inherit the funds.  But as General Counsel to the SEC he was right smack in the middle of the Madoff inquiry.  Immediately aware of the potential conflict and an appearance of impropriety, he did the right thing.  David alerted not one, not five, but seven officials at the SEC, including Chairwoman Shapiro.  They cleared him to continue his work for the Commission, where he worked for no more than 10% of what he received in his work in private practice.

Notwithstanding his decision to immediately come clean, David is being investigated and it will cost him thousands to defend himself, not to mention the significant aggravation he and his family must endure.  Can't Inspector General Kotz find something better to do?  The role of the Inspector General is to ensure compliance and ferret out impropriety, but here something is missing.  Someone is abusing the process.  My concern is not just for David Becker but for the thousands of high quality professionals who may pass on public service because it just ain't worth it.

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Yes, this is America and everyone is entitled to make a living.  But pushing risky bonds on five Wisconsin school districts while failing to disclose the risk crosses the line.  Even the often silent (and slow to react) SEC agrees and has filed a civil complaint against Mr. Noack and his firm.

That famous phrase (“Have you no sense of decency?*”) was delivered to the infamous Wisconsin Senator Joseph McCarthy by Army General Counsel Joseph Welch, as McCarthy tried to accuse yet another patriotic American of being a Communist.  Historians say the uttering of that phrase and the disdain in Mr. Welch’s demeanor sparked the downfall of the Senator.  He had simply gone too far.

And so too has David Noack and Stifel Financial gone too far.  Yes, this is America and everyone is entitled to make a living.  But pushing risky bonds on five Wisconsin school districts while failing to disclose the risk crosses the line.  Even the often silent (and slow to react) SEC agrees and has filed a civil complaint against Mr. Noack and his firm claiming they committed fraud.  Yes, fraud; directed no less at schools in need of every dollar.

How low can we go Mr. Noack?  Although the schools (and the children they serve) lost tens of millions on the bonds, Mr. Noack and his employer netted commissions totaling a cool $1.6 million.  Let’s say Mr. Noack personally received 15% of that commission, or approximately $250,000.  That’s a lot of money in Wisconsin (or anywhere) but is it enough to justify depriving students and teachers of badly needed resources?

Gretchen Mortensen highlighted this case, where Noack convinced a risk-averse, inexperienced school district to invest $200 million in AA- rated notes.  He did so by assuring them that they were sure-thing investments.  According to the SEC's Complaint he promised that "15 Enrons" would have to occur to put the investment at risk; that, or a default level worse than that during the Great Depression.  Of course, neither occurred, but Mr. Noack collected his commission while the school district's investment collapsed and millions in public funds went with it.

While Noack is no Joseph McCarthy, he is sadly indicative of a generation of bankers that place profits above ethics and ahead of their clients’ interests.  When will see a change in ethics?  It may be a while, and in the interim, Michelle Bachmann, Rick Perry and Sarah Palin be damned, we need more regulation and more regulators to ensure that the Noacks and Stifels of the world at least have some deterrence in place to temper what seems like an insatiable appetite for profit.  And let’s hope long term that those Wisconsin kids whose schools were robbed learn ethics and are mindful of the need to put what is right before what is profitable.  Otherwise my children may be writing this same blog post one day.

*This post originally read, "Have you no shame," misquoting the historic line from Mr. Welch.  It has been corrected with the correct quote.  TCO apologizes for the error.

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The New York Times’ Gretchen Morgenson has done it again.  Her article, “Findings That May Get Lost in Arbitration,” doesn’t just expose James G. Kelsoe Jr. and the Morgan Keegan Fund for misleading investors (she already did that in 2007).

Morgenson’s reporting also highlights the failure of both the SEC and the FINRA arbitration process.

The SEC enforcement action came almost four years (what in heaven’s name were they doing for four years?) after a settlement between Morgan Keegan and the Indiana Children’s Wish Fund.  Kelsoe, the Keegan Fund manager, pushed a bad investment — essentially making up the price — on the non-profit foundation, causing it to lose $48,000 and leaving nine terminally ill children with unfulfilled wishes.  Nice guy.  Stealing from a charity.

This belated enforcement action finally punished Morgan Keegan’s blatant misrepresentation of investments which cost investors more than $1 billion.  A leading firm in what they call Wall Street South (same level of greed, just add Southern accents), Morgan Keegan must pay a substantial fine and Mr. Kelsoe has thankfully agreed to a lifetime ban from the securities industry.  Let’s hope, like Pete Rose, the baseball ball player who bet against his own team, Mr. Kelsoe is never reinstated.

End of story?   Happy ending?  Well… not exactly.  Individual defrauded investors must seek a judgment against Morgan Keegan and damages in a FINRA arbitration process to be made whole.  Morgan Keegan attorneys blithely say they will try to block use of the SEC enforcement action as evidence in these individual proceedings.  How do those guys sleep at night?  (“Hi honey, how was your day at work?”  “Awesome, I spent my day beating up on investors who in some cases have lost their entire life savings.  Yep, I argued evidence of fraud by the very same firm, in the very same case should not be used against them.”  “That’s so nice dear, I’m proud of you, now wash up for dinner.”).

First, in those four years, when the SEC was taking its bureaucratic sweet time and dotting every I… crossing every T, they should have required as part of the “settlement” that Morgan Keegan be forbidden from arguing in the context of individual lawsuits against the admissibility of the SEC enforcement action.  Slam that door shut.

Second, any arbitrator worth his or her $600-800 hourly wage should act decisively and allow all credible evidence into the record.  They are perfectly capable of weighing its importance.  Unlike a jury, they are trained and paid handsomely to do just that.  We wish each of these investors well and remind them to send Gretchen Morgenson a nice thank you card.


Assisted by Natasha Duarte

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All those billions in profits, particularly when it comes during a downturn, certainly raises suspicion and, in the case of Goldman Sachs, the indisputable leader on Wall Street, government scrutiny as well. First the threat of regulatory scrutiny came from the SEC. But, as is too often the case, the SEC’s appetite for enforcement can be sated with a mouthful of low hanging fruit. After just a few weeks of brinksmanship, the SEC was satisfied with a fine/judgment of $550 million. Playing the victim, Goldman bemoaned the size of the settlement, but more than likely behind closed doors they were thrilled with the result and happy to pay what is, for a firm of Goldman’s size and profitability, chump change.

But now comes the “Main Event”. The Department of Justice and criminal subpoenas. Ouch. Nothing like the threat of jail to get you focused. The Wall Street Journal reports that DOJ will likely issue subpoenas to Goldman executives in an effort to learn more about the firm’s mortgage-related business.

All of this following a cruel April for Goldman Sachs where The Senate Permanent Subcommittee on Investigations issued a 639-page report that accuses the powerhouse firm of making bets against the housing market, misleading investors, and (here’s the shocker) putting its own interests ahead of those of its clients. The Law Blog reports that Senator Carl Levin has called for the criminal investigation of Goldman Sachs - A refreshing reminder to MainStreet that there are still those willing to hunt the cause of ruin. Expect DOJ to be tougher than the SEC, especially with the power of criminal charges in its arsenal.

A DOJ investigation is a sobering experience for all involved. Lanny Breuer, head of the Criminal Division, and his team are no pushovers. They will not be intimidated by Goldman or its phalanx of white-collar specialists; but I wouldn’t hold my breath for any indictments, Raj Rajaratnam-style. As far as I know, DOJ has no wiretap recordings of Goldman partners scheming illegally and blatantly. These guys are just too damn smart. And the last time I checked, smart, savvy -- and throw in greedy for good measure -- are not crimes.
 

Assisted by Zachary Kady

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Pull a Madoff -- in that the Commission will miss the shenanigans that are right underneath their noses, just as they did with Bernie years ago.

Yesterday the SEC announced a proposed set of regulations that would curb some of the abuses of the rating agencies (Moody's Corp. (MCO), Standard & Poor's, a McGraw-Hill Cos. (MHP) subsidiary, and Fitch Ratings).

First, let’s talk about the basic problem.  The issuer of debt pays for the rating.  It’s a naked conflict of interest.  Here’s an oversimplified example.  Bank of America has a bunch of sub-prime mortgages it securitizes in a bond offering it wants to offer for sale to pension funds, university endowments, charitable trusts and the like.  They need an Aaa rating or something close to it; it is called investment grade, since many institutions cannot invest in anything lower.

They go to Moody’s where they’ve had some luck before (wink, nod).  Moody’s, being a bit “moody” after all the bad publicity post-2008 disaster, says: “You know BofA there is a lot of risk in these underlying bonds (“really”).  Sorry, best we can do is Ba1.”

Bank of America, undaunted, and knowing how to play the game, comes back with: “Come on guys, how ‘bout if we sweeten the deal a little and increase your fee... and we’ll throw in some Legend Seats at Yankee stadium.”

“Against the Red Sox?”

“Fine, against the Red Sox.”

“You know those bonds are looking more Aaa every day,” says the Moody analyst, as he pulls his favorite Red Sox cap off the shelf.  It’s a conflict of interest at its simplest.  And guess what, if a BofA bondholder wants to sue the rating agencies after the bonds default, good luck.  The rating agencies have a “get out of jail card” at the ready.  “We were merely exercising our First Amendment right to render an opinion.”  Wins every time in court.

Second major problem: the Revolving Door.  That same Moody’s analyst who loves the Red Sox and will see them up close on BofA’s dime has already sent her resume to Bank of America and hopes to enjoy a 100% salary increase when she takes a job as a newly minted Vice President in the debt securities division.

Dodd-Frank provides the SEC with new authority to fix these conflicts.  What is the Commission doing?  A little window-dressing is all, nothing more.  For instance, the SEC has suggested rules that would have rating agencies clearly define and disclose the meaning of any symbols used by the rating agency.  The proposed rules attempt to directly address conflict of interest issues, but half of the section is devoted to exemptions and exceptions.  It is also seeking to set up qualification standards for credit analysts, to make sure they meet new training and experience standards.  Ho hum.  And indeed, the rating agencies are fighting even these minor reforms.

What the SEC must put on the front burner instead is the organization of a government-mandated clearinghouse intermediary through which credit raters would be assigned blindly to work on various bond offerings.  (No more Legend Seats.)  This intermediary was called for in Dodd-Frank and is being pushed for by Senator Franken.  Alas, in the way of Washington, the SEC will study the issue and issue a report, next—yes next—summer.

I can see the headlines a year in advance: SEC Misses Trillion Dollar Losses Caused by Continued Rating Agency Conflicts.

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If the Rottweiler guarding your property is anything like the SEC, I hope you set your house alarm.

As the WSJ Law Blog pointed out today, the SEC’s deadline to finalize Dodd-Frank Whistleblower rules has come and gone without a peep from the Commission.  So much for its bite being worse than its bark.  If the Rottweiler guarding your property is anything like the SEC, I hope you set your house alarm.

The SEC’s website has subtly shifted its schedule to allow an extra three months for rulemaking—and there is no reason to trust that adjustment either.  Commission defenders will point to the extensive rulemaking required and the tight government budget; I would point to the nine months originally allotted and immense importance of the rule finalization.

The Journal quotes SEC spokesman John Nester, who defends the Commission’s desire to emphasize “getting the rules right.” Thanks, John. “Right” entails “on time”; otherwise even more doubt as to the Commission’s commitment to the rules will arise.  Main Street has seen decades of supposed third-party regulators bow at the feet of well-paid lobbyists and executives.  The SEC was supposed to champion a major step forward this week; instead, they have amplified the doubt many have in their ability to effectively regulate and enforce.

I may be the only one, but I believe the SEC will get things together soon and finalize a robust and clear set of rules for Dodd-Frank’s whistleblower provisions.  However, delays like this undermine the bill and allow the Wall Street-centric status quo to continue.  As each day passes, Americans forget the reasons for the economic catastrophe—some of which were corporate corruption and lack of business oversight.  Dodd-Frank’s whistleblowers have a chance to cheaply and efficiently remedy this problem from the inside.

As is true of too many government regulations, the conclusion is yet to be written on this one. Let’s just hope the humid DC summer doesn’t pass without seeing these rules finalized.

Assisted by David Martin

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The government has rested.  The jury has heard scores of taped conversations and a mountain of documents and other materials have been presented to the jury and introduced into evidence.  Unlike most cases involving fraud and financial misconduct, where juries must piece together varying degrees of circumstantial evidence gleaned from documents alone, here the jury has direct evidence.  Raj’s voice: kidding, cajoling, prodding, and insisting on obtaining inside information from his “friends” on the inside.  All told according to the FBI agent who was the last witness to testify for the government, Raj earned over $60 million from trading on inside information.  That’s a big number.   It doesn’t look good for this … well … corpulent and rather cuddly bad guy.

What does he do?

On Monday, it’s the defense’s turn.  Mr. Dowd, Raj’s lead counsel, can stand and with as much righteous indignation as he can muster, state in a loud clear voice, “the defense calls NO witnesses”.  That’s what Barry Bond’s high-priced team has chosen.  The bet underlying that tactic is that the jury is skeptical of the government’s case, and the defense argues that under the Constitution, yes that Constitution, a citizen ACCUSED of a crime need not prove their innocence.  All they must do is demonstrate that the government failed to meet its burden of proving its case beyond a reasonable doubt. 

Hmmmm.  From what I’ve seen, that’s a non-starter here. The government’s case is just too strong.  “What’s the best strategy then, Mr. Former Federal Prosecutor?”

I’d say you have to put Raj on the stand.  First, he’s hardly a threatening presence.  He’s a big teddy bear.  He is smooth and persuasive.  It only takes one juror to be seduced by his charm to keep him from what will more than likely be a long stay for him at a federal penitentiary.   Second, remember he is the “tippee” not the “tipper”.  What?   Yes.  The tipper is the “insider”.  In this case there were many.  Most notably was the Director of Goldman Sachs who literally called Raj from outside the Board Room with inside information on proposed mergers.  Raj can try to argue that all these “tippers” are the real guilty parties and they are merely trying to save their skin by implicating Mr. Rajaratnam.

Will that work?  Probably not.  And as I’ve written before his best shot is going to be to appeal the court’s decision allowing the taped conversations into evidence despite rather sloppy, if not worse, conduct on behalf of the government in seeking the warrants necessary to wiretap conversations. 

 We’ll know come Monday. 

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Although talking tough, in the end the rant by the Court is just that: a rant.

Last year it was Judge Rakoff's refusal to accept a proposed settlement between Merrill Lynch, soon to be Bank of America and the SEC.  He almost made the parties go to trial but in the end accepted some modest changes to the settlement and let the parties move forward with a deal that was dubious at best and arguably contrary to the best interests of shareholders.  The Judge was hardly throwing real punches, just shadow boxing.  Well he's at it again.

He's in the ring once again with the SEC.  And yet again, he is being asked to approve a settlement between the Commission and this time, three executives of a semiconductor company, who according to the SEC had been cooking the books of the company for "a decade".  Although spiced with cutting rhetoric aimed at the Commission's practice of allowing bad guys to get off the hook "without admitting or denying wrongdoing," he approves the settlement.

The Judge's feigned opprobrium is merely dicta.  Every lawyer learns the concept in the first days of law school.  It's Latin, generally meaning a discussion or language in a judicial opinion that may hint at the court's reasoning, but in the end is unrelated to the court's holding or decision.  Judge Rakoff's pronouncements in the case are just that—dicta.  Eloquent to be sure, worldly and learned, you bet.  Check this sentence out:

"The result is a stew of confusion and hypocrisy unworthy of such a proud agency as the S.E.C."

But in the end, all those words don't amount to a "hill of beans" because the "holding" in the case—the headline—is, "Federal Judge Approves Settlement" despite the Commission allowing the bad guys to get away without admitting any wrongful conduct.  Although talking tough, in the end the rant by the Court is just that: a rant.

Could it be argued that the next settlement brought before the Judge by the SEC using the language "without admitting or denying wrongdoing" will be rejected?  Perhaps, but don't count on it.

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Memories are short in Washington and even shorter on Wall Street.  Temporary becomes permanent, and the petulance and arrogance of the rating agencies is soon forgotten.

I was disturbed to read this weekend in another fine piece by Gretchen Morgenson how yet again the rating agencies (Standard and Poor's and Moody's and the like) had obtained another “Get Out of Jail Free Card.”  For decades they avoided liability from their negligence (or worse: stark conflicts of interest with issuing banks), by cleverly claiming their grades given to investment securities (AAA and on down) were opinions to be afforded First Amendment—as in the United States Constitution—protection.  Well, they got away with it until the financial crisis of 2008, when hundreds of billions in mortgage-backed securities with investment-grade ratings were determined to be just about worthless.

Congress responded to this historic immunity nonsense in Dodd-Frank by explicitly requiring that the ratings agencies be subject to expert liability, opening up for the first time liability from investor lawsuits.  How did the ratings agencies respond?  Like a petulant child by refusing to rate asset-backed securities.

Rescuing the rating agencies from the “time out” they deserved, the SEC gave them a free pass.  First temporary, now permanent; a “no action letter” was granted providing agencies with an absolute defense to investor lawsuits.  Last week, Martha Coakely, the Massachusetts Attorney General, in a letter to Mary Shapiro, Chairman of the SEC, wants to know, “Why?”

The party-line, spewed by co-author of the legislation, Barney Frank: this is merely a short-term strategy to wean the markets from reliance altogether from the influence of ratings agencies, we’re just not there yet.

Sadly, this won’t work.  Memories are short in Washington and even shorter on Wall Street.  Temporary becomes permanent, and the petulance and arrogance of the rating agencies is soon forgotten.  I hope General Coakley fights hard for answers and doesn’t back down—this no action response of the SEC is unacceptable.

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The confluence of budget cuts to regulators like the SEC and CFTC, which were no Batman and Robin even at full strength, coupled with a likely skeleton staff at the new consumer finance protection agency spells disaster sooner rather than later.

Sadly Mr. Ferguson's prediction, made during an interview with Andrew Ross Sorkin of the New York Times, that another financial meltdown is ten years away is overly optimistic.  I fear the confluence of budget cuts to regulators like the SEC and CFTC, which were no Batman and Robin even at full strength, coupled with a likely skeleton staff at the new consumer finance protection agency -- thanks to the tea party's misguided efforts to demand budget cuts no matter the harm to Main Street -- spells disaster sooner rather than later.

Moreover, on Wall Street the beat goes on, with new "synthetic derivatives" being created on a daily basis.  These instruments merely line the pockets of lawyers and bankers and traders -- while substantively increasing one thing and one thing only: volatility and risk.

Finally, world events will no doubt add to market turbulence.  Even if every government in the Middle East miraculously survives this latest wave of popular uprising, tensions will remain high.  All that is needed is a nuclear scare in Iran or Pakistan and US markets could be thrown into a another tailspin.

With all due respect to Mr. Ferguson, my prediction is 3-5 years.

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And if you think that the SEC can be influenced by a $1.5 million dollar investment, you might want to check your backyard for Martian tracks.

Mr. Picard’s latest effort at headline grabbing is a lawsuit against David Becker, the SEC’s General Counsel (yes that SEC) for “profits” Mr. Becker’s parents made in connection with investments from Madoff funds.  According to various news reports, Mr. Becker made approximately $1.5 million as an executor of his parents' estate with his brother.  First, it is hokum, complete nonsense, to believe the SEC was somehow diverted from the Madoff trail because Mr. Becker influenced the process to protect his family’s investments.  Mr. Becker is a longstanding public servant who has served his country with great distinction and honesty.  And if you think that the SEC can be influenced by a $1.5 million dollar investment, you might want to check your backyard for Martian tracks.

Second, the importance of this story is Mr. Picard’s continued assault on what I would characterize as innocent investors.  These are folks who were not in the Madoff inner circle and had no basis to believe there was a fraud.  In my humble opinion they should be able to keep their money.  To claw back funds years later, Mr. Picard must show some level of fraudulent conduct or knowledge.  I applaud Mr. Picard’s suit against JPMorgan Chase because if he is right, they “knew” of the fraud and drove the getaway car; or in this case, a fleet of armored cars.  A predicate to every suit brought by the trustee must be knowledge and fraudulent intent.

Indeed, if we adopt Mr. Picard’s definition of profit (taking out more than you put in), we might as well try to clawback his firm’s fee, which now stands at a cool $128 million.  Hasn’t he “profited” from the Madoff fraud?  You bet; maybe its time for Mr. Picard to look in the mirror.

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A light-hearted, but pertinent clip to start this latest entry:

The New York Times reported  earlier this week that scores of high level executives on Wall Street are once again circumventing the spirit of the law in search of a quick buck.

As Mr. Deeds so pointedly asked, “When you were kids, did you dream about becoming a savvy investor one day; who would think with his wallet instead of his heart?”  A central tenet of the financial reform of the past few years was to put executives’ interests closer in line with investor interests to encourage a profitable, but safe, investment climate.

Hedging is a common and financially wise move when betting on the fluctuation of the markets. However, Goldman executives, as reported in the Times, have been hedging against their own company, placing bets on the stock’s stagnation, limiting risk associated with plunges in stock value, and even betting against quick growth.  While this is a wise move for these executives’ personal portfolios, it does not instill confidence in the investor who would like to think those working at an investment bank trust in that bank’s ability to succeed.

For heaven’s sake, Pete Rose received a  lifetime ban for betting for his own team, shouldn’t there be some repercussions for some of the most influential investors in the world betting against – or at least only extremely cautiously for – their own firm?

We call on the SEC today to tighten up these rules.  Close up the loophole allowing financial executives to hedge their deferred compensation.  No doubt they will find another way – but government must stand vigilant in its effort to protect the general investing public and that means proceed by all deliberate measures to ferret out and cease efforts that challenge both the spirit and letter of the law.

Assisted by Zachary Kady

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For the smartest kid on the playground, it has been a tough few months.  First news swirled of Goldman’s clever idea to essentially bet against both the market it created and the investors it had enlisted.  All in the name of bringing “liquidity” to the market (so they said) and mega profits to the Street’s richest firm for yet another “financial innovation”.  However, the new, “we’re tougher than ever” SEC would have none of it and a settlement was reached costing Goldman $550 million (nothing that will rock this giant, but a half a billion dollars is still a lot of money).  On the heels of the settlement, ACA, a private Wall Street insurer, initiated a lawsuit over the same issue.

Perhaps related, perhaps not, Goldman made serious concessions to its critics by divulging the source of some of its revenue.  Specifically, Goldman has implemented new procedures to: (1) disclose the source of its profits; (2) increase transparency; (3) separate and clearly define the responsibilities of traders and investment bankers; and (4) publish a simplified balance sheet in addition to the balance sheet required under minimum accounting standards.  As part of the change Goldman will distinguish profits it earns investing on its own behalf from those earned for investors on investor accounts.  The hope is that this will dispel theories that the firm is making improper trades (or less gently “betting against it’s own customers”).

While the smart kid who seemed to run the schoolyard took a punch on the nose, he may have just learned his lesson.  The extent to which Goldman truly works towards transparency remains to be seen, but this initial good faith offering is a step in the right direction.  We can only hope that in addition to being a market leader in profits, they also want to be a market leader in the area of reform.  If so, others firms on the playground, large and small might just follow.

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First and foremost, happy new year to our Corporate Observer readers.  Here’s to a great 2011.  We have some quick links to kick off the year.

Elizabeth Warren has apparently begun the hunt for a head of the Consumer Financial Protection Bureau.  While it is unfortunate that Ms. Warren herself will apparently not lead the CFPB, hopefully she will find someone that shares her vision and eagerness.  She has conferred with “business and consumer groups,” but ultimately the decision must be hers.

The Washington Post reported on a disturbing wave of public sector employees heading to greener pastures in the private sector.  The White House, the SEC, and Federal Reserve Board Members, to name a few, have seen employees flee to financial and legal firms; there they can expect higher pay and benefit from contacts in the public sector.  This is a concerning trend for a government that has recently emphasized regulation and consumer protection – if they lose their best employees, how to they expect to live up to the high standards set for the coming years?

Lastly, we have updated our current cases at Berk Law, and if you feel inclined to take a look you can see them here.

Assisted by David Martin

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In 2010, we had plenty of opportunities to come to the keyboard in hopes of shining a light on hypocrisy, pleading for fairness, particularly on behalf of consumers and investors and just plain venting about our corporate culture that has too often lost its way. As 2011 nears, we thought a wish list for the coming year would be fun.

1.       Elizabeth Warren Officially Named Head of the CFPB

There’s no hiding it, we have a crush on Elizabeth Warren (click here and here for past blogs). Her leadership and influence were essential to the creation of what we hope will be an engaged and powerful consumer finance protection agency. While we were delighted when President Obama chose Professor Warren to lead the formation of this new agency, we hope in 2011 he shows the courage to name her the Director. Will there be a battle in the Senate over her nomination? You bet. But we say bring it on; she is uniquely qualified for the post. Professor Warren has the knowledge, intelligence, creativity and passion to get the job done. That scares corporate America. But a tough fight, played out on the evening news and on You Tube will be good for the nation.

2.       The SEC Gets the Money it Was Promised and Opens Its Whistleblower Office

The passage of the Dodd-Frank bill was merely the strategy for restoring confidence in the American financial system. Implementation requires funding. Hard working, honest citizens have the right and deserve an opportunity to report corporate fraud without fear of retaliation. To be meaningful, this right must be backed up by resources ready to investigate and provide a response up or down. Unfortunately, congress’ recently imposed budget freeze has temporarily stalled funding for a new, independent whistleblower office at the SEC. For now, whistleblower claims will be handled by the enforcement division, the same division that missed Madoff. That same enforcement staff is unlikely to effectively handle the many complaints the office is likely to receive. (click here) Hopefully in 2011, congress and the SEC can work together to give whistleblowers an effective means to spot, prosecute, and curtail corporate fraud.

3.       A Stronger, More Active CFTC Enforcement Division

Dodd-Frank greatly expanded the powers of the CFTC enforcement division. The change turned what was once a poor man’s SEC, into a regulatory power house. Several trillion dollars are under management and supervision of this agency. As a threshold matter they must write thousand of rules and regulations. We hope that process steams along at a good pace. We also hope that the hiring of David Meister as new head of the enforcement division (click here) will help continue this trend through 2011.

4.       Banks like JP Morgan Chase and Bank of America are Held Accountable for their Roles in Massive Ponzi Schemes and Other Fraud

We’ve mentioned it time and again, some of the largest banks have played surprisingly important roles in support of massive Ponzi schemes. Investors lost billions. (Click here,  here, here for our blogs). Our firm, Berk Law (www.berklawdc.com) is currently litigating four cases against both Bank of America and JP Morgan Chase for their roles in fraudulent investment schemes across the country. (Click here, here, here, and here for blogs on JP Morgan Chase) We hope 2011 will bring justice for thousands of investors who have lost much of their life’s savings.

5.       A Favorable Ruling for Consumers in AT&T v. Concepcion

Just a few weeks ago, the Supreme Court heard oral arguments to determine the enforceability of mandatory arbitration clauses, which ban class actions completely (“whether brought in court or before the arbitrator”). This ban is not only unfair to a consumer holding a valid claim but it also a fast one on consumers. We hope for a ruling upholding the California court’s decision invalidating such contracts under the doctrine of unconscionability. Click here for our blog on the case and here for the scotusblog entry.

6.       Wall Street Makes Billions of Dollars

Seriously. Prosperity on Wall Street should be encouraged. What should be discouraged are the risky, unfair, and myopic practices of the past decade. Investing in sound businesses and long-term plans will help lift the American economy, stabilize the investment world, and restore confidence to investors who will invest more comfortably in sustainable portfolios. Click here for a blog about responsible investing.

7.       An Active SEC Enforcement Unit to Stomp Out Fraud Before It Hurts Investors

The SEC must bring more cases. While the new whistleblower office (if it ever gets funding) will be critical, a hungry first rate staff must be priority one.

     8.       The Risks of Indoor Tanning Get the Attention They Deserve

Enough is enough. Teens, mostly girls, should not continue to tan and essentially fry themselves with reckless abandon. They dramatically increase their risk of cancer. Tanning, like cigarettes and alcohol, is a personal choice, but at present the risks are largely ignored or downplayed by the industry. We’ve said it before and we’ll say it again, indoor tanning causes cancer (click here and here). In moderation, maybe, but we ask simply that the risks are published so that consumers can make an informed decision. Click here for our series on indoor tanning.

9.       Foreclosure Proceedings Gain an Air of Legitimacy and Homeowners are Treated Fairly

The gap between risk and lending simply grew too large. In many cases it just didn’t exist.   What incentive did a bank have to ensure the reliability of its loan if it was simply going to sell the loan the next day as part of a massive securitization? Click here. The still-ongoing mortgage crisis is a microcosm of the irresponsibility, greed, disorganization, and shoddy oversight pervasive in the banking world. Hopefully 2011 will put back the link between risk and lending. (because if we don’t, I fear more bad paper and a huge risk.)

    10.   A Political Climate that Puts the True Needs of Main Street First

With a decidedly angry republican opposition taking power in the House in January, the potential for political stagnation is as high as ever. Sure, deliberation and substantive arguments are what the founders intended for Congress. We simply hope that the interests of Main Street don’t take a backseat to partisan rivalries and that we can continue to move towards respectable reform.

11.   Last, But Certainly Not Least, a Washington Capitals Stanley Cup Victory 

Hey, we’ve got to have some local pride. Life’s good inside the beltway, unless of course you’re a sports fan. McNabb and the ‘skins just didn’t pan out, John Wall’s not going to win a title alone, and it’s not looking like anyone in the NL East has a shot besides Philly. So, put on your Ovechkin jersey because DC’s going to have to be a hockey town. We’re in first place as of today – let’s keep it that way. Maybe you’ll catch me downtown at the Verizon center for a game. I’ll be the guy making sure the refs, the owners, and the league play by the rules – after all, this is The Corporate Observer.

Assisted by Zachary Kady

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The only way to end the cycle is to bite the bullet and fund the necessary office at the SEC.  Until we break the cycle, tens of thousands and the integrity of the markets remain at risk to predatory schemes like the one Mr. Madoff ran for years and years, right under the Commission’s nose.

The Dodd-Frank financial reform bill has taken its share of hits over the past few months.  This week’s might be the biggest.  The Wall Street Journal reported Friday that a lack of funding will force the SEC to delay opening an independent whistleblower office.  In the meantime, the SEC’s enforcement division will handle the anticipated 30,000 whistleblower claims per year.  Surely you’re not serious; the same SEC that missed Madoff and scores of smaller ponzi schemes?

This delay, just a month after the SEC released its proposed rule governing whistleblowers for public comment.  The bill required that the SEC finalize and adopt the rules by April 12, 2011, but what good are rules without a department to enforce them?  The incentives provided to whistleblowers under Dodd-Frank are an enormous step forward for investor protection in post-economic-crisis America.  Informed citizens alerting the government of fraud and corporate has a proven track record. 

Instead, there is a bit of a vicious cycle: poor whistleblower system helps cause crisis, which helps cause budget shortfall, which results in underfunding the SEC, which leads to poor whistleblower intake, and so on.  But the only way to end the cycle is to bite the bullet and fund the necessary office at the SEC.  Until we break the cycle, tens of thousands and the integrity of the markets remain at risk to predatory schemes like the one Mr. Madoff ran for years and years, right under the Commission’s nose.

Assisted by Zach Kady and David Martin

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Two years after Bernie Madoff’s arrest, the United States Attorney for the Southern District of New York announced the indictment of two key back-office employees.  The first question is, “What took them so long?”  (A question for another day.)  More interesting to me is who these people are and how the largest Ponzi scheme in recorded history operated for so long undetected?

I should say at the outset, I was surprised by the backgrounds of the indicted employees.  In my representation of Madoff victims, I have seen the elaborate and very detailed statements sent out each month by Madoff’s crew of thieves to thousands of investors, including many “sophisticated” fund managers.  These statements were written under the name Bernard L. Madoff Securities of Wall Street and London.  They identified specific securities owned and explained a complex trading methodology that, like magic, paid returns exceeding 10% every year.

I would have thought this grand multi-billion dollar ruse was the work of some computer programming genius.  Think Mark Zuckerberg of Facebook or his friend Sean Parker, the inventor of Napster.  Or perhaps some super nerdy, M.I.T. Ph.D. student who hacks into the Department of Defense’s operational control system for weekend fun.

Nope, it was two Italian grandmothers from New Jersey (I’m actually guessing they are grandmothers – but they could be): Jo Ann Crupi and Annette Borgiorno.  Both from working class backgrounds hired by Madoff back in the 1980s as key punch operators.  

The indictment explains that to fool regulators, they merely set up a phony (second) set of books.  (How clever!)  Continuing on the low-tech theme, Madoff's crew kept records of investments on handwritten note cards – I’m guessing those three by five cards we used in grade school for our class speeches.

If true, what does this say about the SEC and other regulators – fooled by the oldest trick in the book – two sets of books?  Maybe down the road we’ll find that Madoff had a super-computer and the world’s greatest programmers money (a lot of money) could buy.  But for now, these latest indictments merely throw more mud in the eye of those who should have dug deeper.  Not only the regulators, but those “sophisticated” investors (fund managers) who looked the other way while taking their huge monthly fees.

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At long last, the SEC has taken measures to electronically streamline the tips and complaints it receives.  Information, no matter how it is received by the SEC, will now enter a searchable and cross-referenced database that is to be ready for use by the end of the year.  Sadly, this constitutes a major change from standard operating procedure.  Notably, the SEC received multiple tips regarding Bernard Madoff’s scheme.  The commission launched two different investigations at separate SEC offices which were mutually unaware of each others’ efforts—the NEXT Madoff will not be so lucky.

Enforcement director Robert Khuzami has taken his title seriously, although as with every bureaucratic process it has taken some time.  Streamlining the SEC complaint process and the Dodd-Frank Bill’s whistleblower incentives allow for effective self-policing, which is essential in a field where (as previous experience shows) the SEC can’t possibly oversee every company and transaction effectively.

This shift in focus to efficiency and incentivizing self-regulation are a major step forward.  But the Commission must continue to vigilently maintain its commitment to a more practical, nimble and effective form of regulation.

Assisted by David Martin

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What is Goldman up to nowadays?  Oh, just raising compensation by 3.5% despite a projected 13.5% decrease in revenue.  Do they call that a lack-of-performance-based raise?

For years the public mostly turned a blind eye to Wall Street’s corporate practices, including the lucrative (and ludicrous) bonuses and salaries paid to top executives, largely for speculative trading.  Wall Street produces no products.  But so long as their companies made enough to pay out such exorbitant amounts, we rationalized, what was the problem?  The financial collapse should have served as ice water poured on our snoozing faces.  Incentivized by a pay structure that valued risk, we were all led to the brink of disaster.  It was only the infusion of $450 billion in taxpayer money that saved us from The Great Depression, Part II.  So why on earth are Wall Street’s top companies set to pay a record $144 billion in compensation this year?

I feel like a broken record.  Yes, the majority of TARP loans have been repaid and we are on the slow road to recovery, but we cannot become complacent.  The next step must change the paradigm.  It must tighten regulation and oversight of corporate compensation.  And that applies to all companies—even the unassailable Goldman Sachs, which was saved by the rescue of AIG, its principal insurer.  What is Goldman up to nowadays?  Oh, just raising compensation by 3.5% despite a projected 13.5% decrease in revenue.  Do they call that a lack-of-performance-based raise?

This is why we need regulations sooner rather than later.  SEC Chair Mary Schapiro (no stranger to compensation issues) at last has detailed a timeline for the regulations that will soon govern the entire industry.

Most of the Commission’s timeline occurs before the New Year, but that is not soon enough.  We propose a more immediate solution to the compensation problem: redirect any salary or bonus that is based on purely speculative trading towards public infrastructure.  Instead of paying millions of dollars to each executive that nearly ran our economy into the ground, let’s use the excess to modernize transportation systems, fix bridges and pay teachers.

It won’t happen but it should.  Let’s hope the SEC gets in gear and moves quickly to enact effective rules to protect the public from another crisis.

Assisted by David Martin

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Nice work FINRA.  On the one hand you pay yourselves like captains of industry, but when the going gets tough you hide behind immunity reserved for lunch bucket civil servants making less than $80,000 per year.  And yes there is more.

If we could all be so lucky.

The Financial Industry Regulatory Authority released a report on its own internal investigation into excessive compensation for Mary Schapiro during her time as CEO of the Authority.  To be kind, the report was a joke and a self-serving cover up that demands further scrutiny.

As a threshold matter, let’s make something clear: FINRA is a government regulator.  It is the largest so-called “independent” securities regulator, overseeing almost 5,000 brokerage firms, and is designated overseer of the NYSE and the NASDAQ.  Yet as investors across the board were losing a nice chunk of their nest eggs in the financial markets (earned the hard way and put aside for college tuition and retirement), Mary Schapiro was raking in a base salary of $2.5 million and earning million-dollar-plus bonuses.  Try to challenge that salary.  You can’t.  FINRA will assert governmental immunities to thwart any challenges to its decision making or salary structure and they will win – trust me I tried.

Nice work FINRA.  On the one hand you pay yourselves like captains of industry, but when the going gets tough you hide behind immunity reserved for lunch bucket civil servants making less than $80,000 per year.  And yes there is more.  When Ms. Schapiro left FINRA, she received a parting payment of $9 million.  Yes $9 million.  As in, “Thanks Mary you did a great job.”  A great job?

During her tenure, the markets nearly imploded and investors lost trillions.  I don’t know Mary Schapiro.  When I was at the SEC, I would see her now and again in the hallways.  I have nothing against her personally, but the payments she received as President of FINRA are nothing short of an outrage.  A true public outrage.  But the internal report and investigation, paid for by FINRA after a feisty California securities broker-dealer called Amerivet demanded an explanation, was far from expressing outrage.  Indeed, it defended every aspect of Ms. Schapiro’s pay and her performance.  Relying on studies of executive salaries at leading investment firms, Ms. Schapiro was being—well if anything—underpaid.

And where did lucky Mary go?  To the chairmanship of the Securities and Exchange Commission, where else?  We commend Amerivet for its courage.  They are fighting an uphill battle to be sure.  But they are on to something and they should not let go.  These enormous salaries and benefits can only lead to abuse.

As to FINRA: are you fish or fowl?  If you are a private actor, accepting private sector dollars without any of the risks, don’t wrap yourselves around governmental immunity when the going gets tough.  And if you truly are a government regulator, stop taking enormous private sector salaries.  You can’t have it both ways.

Assisted by David Martin

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Uncharacteristically, FINRA plans to propose a rule that makes it easier and fairer for securities disputes to be decided.  Arbitration, currently presided over by a group least one member of the securities industry, would shift to a committee of only members of the public.

The SEC continues to crack down on phone investment scams that target innocent investors.  For a complete list of press releases regarding their cases, see the Commission’s press releases.

Some large banks have fully repaid their TARP loans, but we must not forget the billions loaned out to smaller banks, many of which are struggling to repay.  Less than 20% of the banks that accepted loans have repaid fully, and over $60 billion was still due to the Treasury as of August, Reuters reports.

Assisted by David Martin

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But it’s a fool’s errand to sue the SEC, a federal agency rightly immune from private lawsuits.  What’s next, suing President Johnson posthumously for not ending the war in Vietnam sooner?  Or how about Alan Greenspan for looking the other way (or tacitly supporting) the explosion of sub-prime debt in the 1990s?  Where would it end?

The Litwin Foundation recently sued the SEC for negligence in failing to detect Bernie Madoff’s Ponzi scheme earlier than it did.  The Foundation, which supports important medical research into Crohn’s disease and Alzheimer’s, alleges the negligence cost it $19 million.  Unfortunately, this is not the first time that investors in Madoff’s scheme have seen fit to sue the SEC for lack of oversight.  But if they really want to know who to blame, these groups need only look in the mirror.  In the first instance, it was their lack of diligence, not the SEC’s, which allowed years of Ponzi fraud to occur.

The blame-the-other-guy-in-the-room attitude will only lead us down the very same road we are trying to escape, especially if the “other guy in the room” is the government agency in charge of oversight.  Should the SEC have done a better job?  Absolutely.  Could Madoff have been caught earlier, saving investors millions of dollars that they will never recover?  Likely.  But it’s a fool’s errand to sue the SEC, a federal agency rightly immune from private lawsuits.  What’s next, suing President Johnson posthumously for not ending the war in Vietnam sooner?  Or how about Alan Greenspan for looking the other way (or tacitly supporting) the explosion of sub-prime debt in the 1990s?  Where would it end?

If the Litwin Foundation is spending charitable assets in the form of attorney’s fees they should be investigated by their State Attorney General and fined.  Filing frivolous lawsuits is not a proper use of charitable funds.  Enhanced diligence must come from us as individuals and from groups like the Litwin Foundation that are supposed to invest money wisely so it has more to provide to its noble causes.

The lesson from Madoff’s scheme should be twofold.

Lesson One: Investors need to realize that a substantial amount of individual diligence must go into every decision.  Just like free lunches, there is no such thing as a “risk-free investment.”  It is the duty of every investor to investigate her own financial opportunities and if necessary, bring any suspect behavior to the attention of the authorities.

Lesson Two: The SEC and other financial regulators cannot operate successfully under the system and attitudes that we had five years ago.  Elizabeth Warren’s Consumer Financial Protection Bureau is a major step forward, but we must continue to empower overseers and encourage enforcement from outside Wall Street and from those working within.

Until we complete the alteration to our rules and our attitudes, the blame game will continue while investors pay the price.

Assisted by David Martin

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Yesterday SEC Inspector General David Kotz called the timing of the SEC’s recent lawsuit against the infamous Goldman Sachs “suspicious,” but this statement should be viewed in context (see WSJ story).  Yes, it coincided with the release of Kotz’s “scathing” report about the Commission’s handling of the Stanford Ponzi scheme.  And yes, I have been critical of my former colleagues at the Commission in the past. From my recent experience they can be plodding and overstaff even the smallest of matters (it’s not hard to see how they missed Madoff and Stanford).  But this most recent claim of “suspicion” is really rather petty and belies the facts.

First, the case against Goldman was bold and creative.  Perhaps it was akin to a makeup call by a sports referee.  (Missing Goldman’s more flagrant fouls over years, they frustratingly called a foul for a rather convoluted deal that touched on Goldman’s often duplicitous conduct that has made it the most powerful player on Wall Street).  But the result was swift and decisive.  Goldman quickly agreed to pay $550 million.  Over a half a billion dollars – even by Goldman standards that is nothing to sneeze at.  So I say: so what that the case was brought on the eve of another “scathing” report by Mr. Kotz?

Second, the new enforcement chief, Robert Khuzami, is a tough former federal prosecutor who needs more time to assemble his team and begin changing the culture of the enforcement staff.

Third, and most importantly, the SEC alone cannot both police and set the ethical tone for the entire financial sector.  Let’s not forget the role of the banks (who provided safe havens and substantial assistance for Ponzi schemes), accountants (signing off on the value of worthless assets to the tune of many, many billions), and the rating agencies (AAA ratings for Subprime Debt – how wrong were they?).

So Mr. Jonathan Kotz, Inspector General, let’s not issue reports merely to conclude conduct was “suspicious,” which simply undermines the progress of the Commission.  If you have something bring it on, otherwise let your colleagues focus on the hard work ahead.

Assisted by David Martin

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The SEC’s insider trading case against Mark Cuban has been reversed in Federal Appeals Court after originally being dismissed. The SEC’s perseverance against such a high-profile character shows their renewed commitment to stemming corporate fraud.

Driven under by new-age companies like Netflix, news is that Blockbuster is preparing to file for bankruptcy later this week. Barring a turnaround, the trend looks to continue as booksellers Barnes and Noble and Borders find themselves in technology-caused dire straits as well.

“Flash Cookies” – similar to the html cookies stored on your web browser – are tracking your actions when you watch video online. A major privacy issue has arisen because flash cookies are difficult to block and unknown to most web users.

Assisted by David Martin

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I am debuting a new feature at The Corporate Observer: articles and blog posts that may be of interest to readers.  I hope you enjoy.

• Elizabeth Warren wrote a short piece at the White House Blog saying that she’s ready to “pull up [her] socks and get to work.”  Consumers should be as enthusiastic about her appointment as she seems to be.
• Speaking of Ms. Warren, here is an article that she wrote back in 2007 declaring the need for what she termed a “Financial Product Safety Commission.”  This manifest of sorts was a driving force in her selection for her role with the Consumer Financial Protection Bureau.
• The SEC set up a website for comments regarding the regulations they will soon establish with regard to the Dodd-Frank Bill.  Chime in and take advantage of the opportunity to voice any concerns or suggestions you may have with new provisions and their enforcement mechanism.

Assisted by David Martin

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An important securities law story went underreported last week: The SEC ordered the State of New Jersey to cease and desist fraudulent activities related to the funding of its state pension plans. This marked the first time the SEC had initiated a securities-fraud case against a state.   The New York Times reported that from 2001 to 2007 New Jersey claimed in filings with the SEC to have set aside funds in a “benefit enhancement fund” in order to pay for new benefits for teachers and general state employees.

 In reality, the fund was a simple accounting trick – there was no money and no fund. The SEC did not impose monetary damages or penalties on the New Jersey government or any of the officials associated with the fraud.   Moreover, the SEC failed to act at all against the investment bankers who underwrote and managed the fund.   Hmmmmm?  While the SEC’s effort to protect the pension funds of state employees is surely admirable, why give the underwriters and bankers a free pass?  Enforcement efforts must have some teeth to them.  Name names and impose penalties that will hurt.  If not, pension assets will remain at risk.

Assisted by Zach Kady

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Today, consumers are paying the price for corporate America’s greed. Tomorrow, with some help from the SEC, whistleblowers will ensure that we do not make the same mistake twice.

On Wednesday I detailed for our readers what you need to know about the Dodd-Frank Wall Street Reform and Consumer Protection Act. An important question has arisen regarding the effectiveness of the whistleblower provisions within the Bill. Sources like Daily Finance are concerned that the Bill will generate little more than unsubstantiated claims from people grasping at straws in an attempt to take advantage of the enhanced benefits afforded to whistleblowers.

To supporters of the bill: these concerns cannot be dismissed out of hand. For example, employees with a poor performance record may abuse the whistleblower provision by wrapping themselves around the protections afforded legitimate whistleblowers by filing a frivolous claim. Once that claim is filed they have, at a minimum, made it more difficult to be fired based on their poor employment record.  Similarly, people seeing dollar signs will inevitably submit unsupported or frivolous allegations of fraud in an attempt to collect on the enhanced whistleblower’s reward. 

Despite this potential for mischief and abuse, my support for the whistleblower provisions remains unchecked:

First: I firmly believe that 99.9% of Americans are honest people who will not exploit this Bill. 

Second: The SEC must step in and create rules for those bringing baseless claims under the whistleblower statute. This will weed out the dishonest whistleblowers but allow those with legitimate information to rightfully benefit from the Dodd-Frank Bill’s provisions.

Third, and most importantly: On balance, the whistleblower incentives will help solve a far bigger problem than they will create. Unchecked, gambling financial executives helped bring our economy to the brink of collapse.  As former Treasury Secretary Hank Paulson re-tells in his recent memoir On the Brink, this titan of the financial world vomited under the stress of the crisis after addressing the press and Congress.  And what better watchdogs to dissuade corporate corruption than the employees that work with the executives on a daily basis?

The Sarbanes Oxley Act of 2002 was the initial attempt at protecting and promoting whistleblowers; the toothless Act has yielded hundreds of fruitless complaints from whistleblowers. One after another they have been withdrawn or dismissed. Dodd-Frank enhances Sarbanes-Oxley in the following key ways:

•           Extending whistleblower protection to employees of privately owned companies; 
•           Steepening fines for non-compliant companies;
•           Offering contingent cash rewards; and
•           Allowing complaints to be immediately filed in court.

In sum, the Bill rewards those who are diligent and more importantly, serves as a real deterrent to would-be-transgressors. This is the ultimate goal of any regulation—not to punish those who are out of line but to prevent future wrongdoing.

The categorical condemnation of the Bill’s whistleblower provisions is the equivalent of emptying out a bottle of wine to retrieve the broken cork. The Bill is not a flawless solution, but it will drastically diminish the unchecked corporate malfeasance that brought our economy to the brink of collapse; with a little regulation it can do this at a minimal public cost. Today, consumers are paying the price for corporate America’s greed. Tomorrow, with some help from the SEC, whistleblowers will ensure that we do not make the same mistake twice.

If you have suggestions for how the SEC should effectively regulate the whistleblower provisions, or if you oppose the regulation entirely, we are interested in carrying potential rules to the SEC as well as hearing other solutions.

Assisted by David Martin

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The American economy will be strengthened by the new whistleblower provision in the Dodd-Frank financial reform bill. Reporting securities violations and other corporate misconduct will both strengthen the world’s confidence in American companies and limit fraudulent schemes before they metastasize. Whistleblowers – ranging from high-powered executives to entry level employees to average citizens can be among our most useful tools in combating fraud. For this reason, The Corporate Observer applauds the Dodd-Frank bill.

Under the new bill, whistleblowers will be eligible to receive:

(1)                           10% to 30% of any monetary penalty in excess of $1 million imposed as a direct result of their assistance, cooperation, and knowledge; and

(2)                           Statutory protection from employment discrimination.

Who are whistleblowers?

Conscientious and ethical citizens who become aware of corporate misconduct; and have the courage to stick their necks out to report that conduct to the appropriate governmental authority. A Whistleblower is not a snitch or a tattle tale. Rather they are vigilant citizens who speak up to protect others from becoming victims of corporate misconduct and securities fraud.

What is a whistleblower claim?

A whistleblower claim is a formal notice to the government, in this case the SEC, of wrongdoing. For example, if you become aware of illegal conduct such as:

(1)   Maintaining improper accounting practices;

(2)   Systematically misappropriating investor monies; or

(3)   Violating any other securities law;

you should consider submitting a whistleblower claim. Claims will be reviewed by the SEC and delegated to the appropriate regulatory department. From this point, the SEC will investigate the validity of the claim, the value in pursuing the accused party, and the proper penalty to assess.

To be clear, the Dodd-Frank Financial Reform bill allows whistleblowers to report any violation of securities laws to the SEC. Specific rules will be issued by the SEC in approximately 250 days.

Why file a whistleblower claim?

Individuals across America and across the globe invest in American businesses based on their reliability and integrity. Specifically, foreign governments purchase U.S. treasury bonds because they believe in the soundness of the American system. Violators of securities laws threaten the credibility and reliability of the American economy.

Those who invest in securities deserve your vigilance. Most securities are not held by wealthy individuals, but rather by average American investors who have 401K retirement accounts, college savings funds, and pension assets in stocks of public companies. Millions of American investors – thousands of people’s futures – depend on the credibility of the securities market for financial planning.

Acting as a whistleblower for securities fraud violations is every citizen’s opportunity to right corporate wrongs and protect consumers by limiting fraud.

How?

The Dodd-Frank Financial Reform Bill allows the SEC up to 270 days from July 21, 2010 to formulate rules and regulations for submitting a whistleblower claim to the SEC. Until these rules are finalized, the SEC has requested that complaints be submitted through its online forum (http://www.sec.gov/complaint.shtml) or by mail to the SEC’s complaint center at

SEC Complaint Center.

100 F Street NE

Washington, DC

20549-0213

Check back here for updates to the SEC’s claim submission guidelines and policies.

Legal Representation

Whistleblowers submitting claims anonymously are required to retain legal representation before submitting a claim. All other whistleblowers have the option to retain an attorney, but are not required to do so. At Berk Law we are experienced in whistleblower actions. Steven Berk has served in the General Counsel’s Office of the SEC and as an Assistant United States Attorney. If you’re interested in filing, or have any questions about a whistleblower claim please contact us at info@berklawdc.com   or visit our website, www.berklawdc.com for more information.

Assisted by Zach Kady

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For too long, Wall Street insiders have made fortunes based on who they know. Perhaps that’s just the way business works, but it is critical for financial markets to be better...Expand this investigation. Push it to the limit.

Federal prosecutors accused hedge fund manager Raj Rajaratnam and five others of using insider information to accumulate more than $20 million in profits. 

Sadly, this latest news comes as no surprise. For too long, Wall Street insiders have made fortunes based on who they know. Perhaps that’s just the way business works, but it is critical for financial markets to be better. To increase stability and fund growth, they must operate with the utmost integrity. The arrest of Raj Rajaratnam, particularly with his A list of confederates (from Intel, McKenzie and former Bear Stearns employees) make us question that integrity. Indeed, many on Wall Street have had a few sleepless nights since Mr. Rajaratnam’s arrest. And that’s a good thing.

Our financial markets to a large degree operate on faith and trust. Without that trust, Main Street investors (and worse yet, the Chinese) would likely flee for the exits. Why would you want to put your money in a market rigged to profit the rich and connected at the expense of the average investor? The US markets are still the safest in the world and they must stay that way. Everyone needs to play by the same rules. Surely we are not naïve. Insiders of one kind or another will always have an advantage—but that advantage must be constantly challenged.

Let’s applaud the SEC and law enforcement officials. But their hard work must continue. Expand this investigation, push it to the limit. Federal prosecution and the potential threat of jail time make for powerful deterrents. If the SEC and other government officials can keep up the pressure, Main Street should sleep easier.

Assisted by Jess Begen

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We have become dependent on the accuracy of the ratings, and yet the agencies that issue them are unregulated and are far from objective… Clearly we cannot continue at status quo.

 

Three cheers: to James Surowiecki of the New Yorker

In protecting Main Street, it is rare that I give banks and regulators a break. However, given the lack of attention to another guilty branch of the financial sector, they are going to get a brief (if undeserved) reprieve from me. The other blameworthy party that I speak of is the credit ratings agencies. Let me explain.

Credit rating agencies assess and label the riskiness of financial instruments (AAA being the best). As this recent New Yorker piece by James Surowiecki details, a problem arises because the rating agencies are privately owned and yet the S.E.C. anointed three of them as official ratings agencies—thus instilling a special trust in them by investors. And that was forty years ago. Today everything—from rules and regulations on financial instruments to interest rates—depends on these ratings.

So what happens when these agencies drastically overestimate the soundness of mortgage-backed securities? In part, that is what caused our current economic situation. The article explains the problem: we have become dependent on the accuracy of the ratings, and yet the agencies that issue them are unregulated and are far from objective. I must commend Mr. Surowiecki for this insight. When the agencies gave mortgage-backed securities a rating of AAA, investment flooded to them, creating the all-too-famous housing bubble. When, in light of the housing crash, the agencies harshly downgraded the securities, it drastically accelerated the bursting of the bubble.

Clearly we cannot continue at status quo. As in other under-regulated fields, Main Street became the victim of overzealous and unchecked standards. What can we do about these agencies? The New Yorker suggests scrapping the ratings agencies altogether, reasoning that no faith is better than false faith. I don’t know if that is the answer—it would be preferable to merely disconnect the ratings agencies from governmental endorsement—but clearly Main Street must be spoken for here as well. Hopefully my voice on this issue will couple with the Mr. Surowiecki of the New Yorker to be the first of many to advocate sweeping reform.

Assisted by David Martin.

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Frustrated by Bank of America’s failure to come clean, Rakoff issued a bitter ruling condemning the bank for its dishonesty and immorality. “It is not fair, first and foremost because it does not comport with the most elementary notions of justice and morality…”

Today we applaud the Honorable Jed Rakoff – our former “Person of the Week” – once again, for standing up against both Wall Street greed and immorality and one of the nation’s most important regulators. Not a bad day’s work.

On Monday, Rakoff stridently refused to approve a $33 million settlement deal between the Securities and Exchange Commission (SEC) and the Bank of America.

Rakoff’s decision protects the rights of Main Street and fulfills the judiciary’s historic role as the conscience of America. As Alexander Hamilton writes in Federalist Paper No. 78,

“The judiciary…has no influence over either the sword or the purse; no direction either of the strength or of the wealth of the society; and can take no active resolution whatever. It may truly be said to have neither FORCE nor WILL, but merely judgment.” Jed Rakoff’s actions demonstrate great judgment in the face of force and will.

The $33 million penalty—which would ultimately be borne by shareholders on Main Street—would have settled an SEC lawsuit filed against Bank of America, following its merger with Merrill Lynch & Co. The lawsuit accused Bank of America of lying to its Main Street shareholders, publicly promising that Merrill executives would not be rewarded year-end bonuses, while privately allotting upwards of $5.8 billion for bonus compensation.

Frustrated by Bank of America’s failure to come clean, Rakoff issued a bitter ruling condemning the bank for its dishonesty and immorality. He argued that the settlement was not only inadequate—$33 million from shareholders for a $5.8 billion lie?—but also unjust and absurd in that it doubly punishes Main Street victims, who would ultimately pay the costs of the $33 million penalty. “It is not fair, first and foremost,” wrote Rakoff, “because it does not comport with the most elementary notions of justice and morality, in that it proposes that the shareholders who were the victims of the Bank’s alleged misconduct now pay the penalty for that misconduct.”

Rakoff’s harsh language surely expresses the frustration shared by many Americans and perhaps suggests that business as usual on Wall Street will no longer be tolerated, at least by Jed Rakoff. And for that, we salute him as Main Street’s Player of the Month.

Stay tuned: Rakoff has scheduled the case for trial on February 1, 2010.

Assisted by Jessica Begen.

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The SEC is getting aggressive on Ponzi and Prime Bank schemes.

Here we go again.  The SEC has shut down another Ponzi scheme.  When will it end?  It will only end when big banks stop sponsoring, assisting, and ignoring schemes that are operating within their banks.

From October 2006 until the summer of 2009, William Graulich IV of Henryville, PA was operating a fraudulent “Prime Bank” scheme under the nose of the SEC and through JP Morgan Chase bank accounts.  Graulich and his firm, iVest Inc., allegedly convinced at least 5 investors to deposit more than 13 million dollars into his accounts, mostly with JP Morgan Chase.  Graulich promised weekly returns from 22%-140%.  Graulich never made any of the investments that he had claimed, and was brazen enough to use a substantial portion of the funds for personal expenses, payment of back taxes, repayment of creditors, and other miscellaneous expenses.

Schemes like Graulich’s, which promise exorbitant returns with little or no risk to the investor, are exactly what we need to be watching for in today’s financial market.  The SEC refers to these schemes as “Prime Bank” schemes, or “High Yield Investment Schemes”.  The SEC warns that these programs often promise high returns with no risk, purport trading in sound financial instruments such as standby letters of credit and medium term bank notes, and murky language to disguise the source of financial gain.

It is nice to see that the SEC is getting aggressive and proactive in fulfilling its duties.  We hope this aggressive behavior continues, but for now ask a lot of questions.  To read the full SEC complaint, click here.

Assisted by: Zach Kady

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"A novel in quarterly installments"

I recently had the opportunity to review one of the quarterly statements Madoff sent regularly to victims of his odious crime.  They are rather chilling: 

• You begin from the top with those addresses: very legitimate.  Just off Wall Street and London’s exclusive Mayfair neighborhood; but as you go down the page it gets even more interesting.
• Exact stocks are listed, good blue chip companies: Coca Cola, Hewlett Packard, ExxonMobil (household names) with precise shares and values.
• You then see those Treasury Bills and a purported transfer (transfer numbers included) between long and short positions in stocks to bonds. Truing up at the end of the month in some elegant cosmic unified theory (he touted as a “split strike or conversion strategy used no less to “reduce risk”).
• No penny stocks, middle market unknowns, or exotic derivatives or futures on Manchurian sawdust.
• All the numbers add up – or so they seem.

But it was all a fiction, “a novel in quarterly installments." According to the court-appointed receiver, Madoff hadn’t purchased a security since 1992. These statements were written, devised and distributed to deceive. They did so masterfully; month after month, year after year.  In many cases they were sent to sophisticated investors.  But when you are winning it's only natural to congratulate yourself and not look too hard for problems (“I’m invested with Madoff and I’m making money”). It’s like a poker player who wins three or four hands in a row; it’s not luck or someone feeding him the cards – no it's skill, experience and pure gravitas.

My first reaction to seeing these statements was this could hardly be the work of one man. Surely not a 70 year old man without computer training who likely couldn’t program his cell phone; maybe a computer geek-extraordinaire (think Napster in Italian Job), but that’s only possible in the movies (poor Steven Spielberg, prominent Madoff investor).

No it had to have taken the work of a small – very loyal – cadre of confederates at many levels (heck Danny Ocean needed 11 to steal $150 million). These detailed quarterly statements, tell me it was the work of an IT department and many more generating these lies of a comfortable retirement and money enough for generations. You’d think years ago someone would have cracked and spilled the beans.

But my overriding reaction to seeing those statements (besides empathy for my client) was how true – how accurate – is my own brokerage or IRA statement? Do the stocks listed really exist somewhere and what if I need the cash one day – that day. In fact, how many statements are true?

You’d think the SEC, with its expertise and subpoena power could have asked to see a few of those “transfers” or verify all those purchases detailed in Madoff’s quarterly novellas. And what about the third party custodians controlling at least 1000 IRA accounts invested with Madoff? They surely never checked the basics: custody.  Where were these t-bills and stock certificates listed on those statements? Who had custody? One simple audit would have unraveled this house of cards.

We have long been in an electronic age with trillions of securities transactions daily. Investment houses and banks don’t have to have stock certificates in a big old vault (like the one visited by Harry Potter before heading off to Hogwarts) – but we have the technology to check, to verify, to audit, to ask the right questions, to design the right software to ferret out fraud. We need to use it.

Why not use some of those stimulus dollars to improve technology, coupled with stricter compliance regulations at the state and federal level. Private rights of action that hold banks, custodians and anyone allowed who is entrusted with someone else’s assets accountable are also key. Finally, courts must judge these entities as fiduciaries – requiring them to exercise the highest duty recognized by law.

Creating those protections will not eliminate the next Madoff, but it might just reduce the number and size of future schemes. We will always have swindlers but we must do everything possible to reduce the sheer volume of these schemes, making less likely the enormity of pain and ruined lives Madoff and his confederates left in their wake.

Finally, more protection for all investors will create a higher level of confidence: critical to getting Main Street back into the markets and the financial system back on its feet.        

* Steven Berk is currently co-lead counsel against FiServ and other entities that served as the exclusive third party IRA custodian for Madoff Securities.

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