SEC:
Taking on Big Firms is 'Tempting,' But We Prefer Picking on Little
Guys
26
April, 2012
If
you want to see a perfect example of how completely broken our
regulatory system is, look no further than a speech that Daniel
Gallagher, one of the S.E.C.’s commissioners, recently gave in
Denver, Colorado.
It’s
a speech whose full lunacy is hard to grasp without some background.
It’s
by now been well-established that the S.E.C.’s performance in
policing Wall Street before, after, and during the crash has been
comically inept. It would be putting it generously to say that the
top cop on the financial services beat has demonstrated particular
incompetence with regard to investigations of high-profile targets at
powerhouse banks and financial companies. A less generous
interpretation would be that the agency is simply too afraid, too
unwilling, or too corrupt to take on the really dangerous animals in
this particular jungle.
The
S.E.C.’s failure to make even one case against a high-ranking
executive involved in the mass frauds leading to the 2008 crash –
compare this to the comparatively much smaller and less serious S&L
crisis twenty years earlier, when the government made 1,100 criminal
cases and sent 800 bank officials to jail – became so conspicuous
that by the end of last year, the “No
prosecutions of top figures”
idea became an accepted meme in mainstream
news media coverage
of the economic crisis.
The
S.E.C. in recent years has failed in almost every possible way a
regulator can fail to police powerful criminals. Failure #1 was that
it repeatedly fell down on the job even when alerted to problems at
big companies well ahead of time by insiders. Six months before
Lehman Brothers collapsed, setting off a chain reaction of losses
that crippled the world economy, one of Lehman’s attorneys, Oliver
Budde, contacted the S.E.C. to warn them that the firm had
understated CEO Dick Fuld's income by more than $200 million; the
agency blew
him off.
There were similar brush-offs of insiders with compelling information
in cases involving Moody’s,
Chase,
and both
of
the major Ponzi scheme scandals, i.e. the Bernie
Madoff
and Allen
Stanford
cases.
The
S.E.C.’s attitude toward whistleblowers at powerhouse companies has
not just been aloof or indifferent, it’s been downright hostile at
times. Whistleblowers commonly report being treated as though they're
the
criminal. The most notorious example probably involved Peter Sivere,
a compliance officer at Chase who years ago went to the S.E.C. to
complain that Chase was withholding an incriminating email from the
agency, which was investigating an illegal trading practice. When
Sivere contacted the S.E.C. with the documents, he asked if he would
be eligible for an award; they told him no, and he gave them the
documents anyway. Subsequently, Sivere was fired
by Chase
because, in the words of Chase’s attorneys, Sivere had "sought
payment from the SEC to provide documents and information to them.”
Sivere
had to scratch his head and wonder how his bosses knew about the
award request , until it dawned on him: the S.E.C. had ratted him out
to Chase! It subsequently came out that the S.E.C. official who’d
narked on Sivere was George Demos, who more recently was seen running
for Congress
in New York.
Since
the S.E.C. couldn’t make cases even when insiders handed them to
them, it followed that the agency fared even worse when asked to
deduce problems by mere analysis and review, which brings us to
failure #2: the agency was spectacularly inept at detecting
marketplace problems that should have been obvious to anyone with
access to a federal regulator’s investigatory tools. It came out
after the crash, for instance, that the SEC repeatedly ignored
warnings of excessive risk-taking at companies like Bear Stearns;
they even censored
an IG report
to conceal, among other things, their history of non-action.
More
notoriously, the SEC stood by and did nothing even after the FBI
publicly warned
that the incidence of so-called “liar’s loans” – mortgage
applications in which income levels and other information were not
verified – was “epidemic” and could cause an “economic
crisis.” The SEC could have walked into any major mortgage lender’s
office anytime in the five years prior to the 2008 crash and in one
afternoon’s worth of interviews learned that fraud in the mortgage
markets was out of control, but instead they allowed companies like
Countrywide and Long Beach to proliferate and pump the economy full
of millions of bad loans, nearly destroying the economy.
Failure
#3 is that even after the fact, they have so far failed to make cases
against even the most obvious targets, from the Deutsche Bank
executives who knowingly sold billions in risky mortgages they
knew were “pigs,”
to the Lehman bankers who hid
liabilities
and cooked the books in the infamous “Repo 105” case, to the
creeps at Barclays who, in what one Wall Street attorney I spoke to
described as “the biggest bank robbery in the history of the
world,” siphoned off billions of dollars from the rotting hulk of
Lehman Brothers just before that company’s collapse. In that deal,
executives at Lehman and Barclays essentially sold Lehman assets and
operations to Barclays at fractions of their real cost – and some
of the Lehman executives involved went to work for Barclays right
after Lehman collapsed. Lehman’s creditors unsuccessfully
tried to get Barclays to pay back
over $11 billion.
Failure
#4: one company after another was allowed to settle serious criminal
charges without
having to admit wrongdoing.
Failure #5: in those settlements, the S.E.C.continually allowed
companies to avoid having to disclose the exact nature of their
crimes, which not only shielded those firms from litigation, but kept
the general public, which might otherwise have been warned away from
doing business with those firms, in the dark about crucial
information. “Truth is confined to secretive, fearful whispers,”
federal judge Jed Rakoff complained,
talking about the settlements.
Failure
#6: companies have been allowed to settle cheap on the promise that
they would never commit the same crimes again, only to do exactly
that – and be allowed by the S.E.C. to get off with the same
promise! The Times
made
a list
of firms that got the “Just promise you’ll never do it again,
again” treatment:
They
read like a Wall Street who’s who: American International Group,
Ameriprise, Bank of America, Bear Stearns, Columbia Management,
Deutsche Asset Management, Credit Suisse, Goldman Sachs, JPMorgan
Chase, Merrill Lynch, Morgan Stanley, Putnam Investments, Raymond
James, RBC Dain Rauscher, UBS and Wells Fargo/Wachovia.
All
of this is important background for the speech
given in Denver on April 13 by S.E.C. commissioner Gallagher.
The commissioner was trying to explain the S.E.C.’s thought process
in how it decides to allocate its relatively meager resources. The
key thing, Gallagher explained, was to make sure that when you send
Enforcement staff on a case, you should make sure there’s actually
crime there to fight:
It
is critically important that our enforcement program be extremely
efficient… Recognizing that it is unrealistic to imagine we will
ever achieve a one-to-one correspondence between incidents of
misfeasance and SEC Enforcement staff, we’d better plan to do
everything we can to increase our hit-rate per investigation opened,
and should commit our staff resources carefully, which is to say,
consciously.
Sounds
reasonable, although this does also sound a little odd; how is
securing a good "hit rate" in finding crime a problem in an
era where even an $11 billion robbery isn’t high enough in the
in-box to warrant a criminal investigation? For most of the last ten
years, you could walk into any major bank in America and find whole
departments committed to the practice of writing false, robosigned
affidavits. We’re not talking about crime that is hidden in a line
item, or has to be deduced by checking and re-checking the numbers of
dozens of accounts: we’re talking about groups of flesh-and-blood
human beings, sitting there in plain view with huge stacks of folders
on their desks, openly committing fraud and perjury. Walk in any
direction in lower Manhattan with a badge, you're going to hit a
fraud case whether you want to or not.
But
fine, Gallagher’s point is taken: when you commit resources, you
want to make sure you get hits. So what’s the solution? He goes on,
cheerfully employing a jockish metaphor:
Experience
teaches us, for example, that fraud tends to proliferate in smaller
entities that may lack highly developed compliance programs. It also
means thinking carefully about what we might, borrowing again from
the world of sports, call “shot selection.”
It can be tempting to tangle with prominent institutions. But chasing
headlines and solving problems are two different things.
The question is what will do most good – where our focus should be.
And the record seems to suggest that we can do most to protect
smaller, unsophisticated investors by focusing more attention on
smaller entities...
Just
so we’re clear about what we’re talking about here: the S.E.C.,
rather than go after serial violators like Bank of America and Chase,
proposes that the best place to find crime is in small-cap companies,
because that’s where fraud “proliferates.”
In
the last year or so I’ve heard from several attorneys who represent
smaller clients who tell me they’re flabbergasted, watching the
S.E.C. give the Chases, Goldmans, and Citigroups free ride after free
ride while their pockmarked little clients at fledgling public
companies get served the whole regulatory meal for minor disclosure
violations – even cases that simply involve bad paperwork, where
money isn’t even stolen. If you’re a little tech startup and
there’s a $100,000 problem in your books, you can expect the full
Princess
Bride torture
machine treatment, with multiple agents assigned to your case,
serious criminal penalties, asset seizures, etc.
Want
an example of the S.E.C.’s idea of “shot selection”? Every
year, a parade of itty-bitty failed public companies lets their
paperwork lapse. Dead little companies sitting in the bureaucratic
atmosphere doing nothing at all are a major threat to national
security, of course, so the S.E.C. flies in to the rescue and
feverishly revokes their registrations.
These
actions are called “12(j) registration revocations,” and the
beauty of them, from the S.E.C.’s point of view, is that it can
list each one of those revocations as a separate enforcement action,
when it goes before Congress at the end of every year to brag about
all the good work it’s done.
Therefore
toward the end of every calendar year, you’ll see a rush of these
12(j) revocations. In 2011, about one out of every six S.E.C.
enforcement actions – 121
out of 735
– involved these delinquent filings. In the stats they submit to
Congress, they list these cases right next to things like market
manipulation, insider trading, and financial fraud. “The S.E.C.
Enforcement staff takes 10 minutes and shoots a zombie company in the
head and then has the guts to call it enforcement,” is how one
attorney put it to me.
Just
days after 60
Minutes ran
its piece
last year about the epidemic of unprosecuted fraud on Wall Street,
the S.E.C. charged into action. Take a look at the dates on these two
documents.
While Chase’s "London
Whale"
was preparing to play billion-dollar faro with federally-insured
money and MF Global was still struggling to find its "misplaced"
$1.6 billion in customer money, the S.E.C. was gallantly taking on
the likes of A.J. Ross Logistics, Inc., Status Game Corp., and
Fightersoft Multimedia Corporation. And bragging to Congress about
its conquests. It's as clear a case of juking the stats as you'll
ever see.
Apparently,
this is a better use of the S.E.C.’s time than giving in to the
"temptation" of taking on prominent institutions. Anyway,
if you want insight into why nothing’s been done to clean up Wall
Street, look no further. Why tangle with Goldman and Chase, when you
can take on a dead video game startup?
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