Securities and Exchange Commission

Can Fraud Be Immunized by Giving the Defrauder Certain Governmental Powers Over the Victims?

by Hans Bader on October 26, 2011 · 1 comment

in Economy, Legal, Personal Liberty, Property Rights

Can a private organization that has been delegated some government regulatory powers claim absolute government immunity against lawsuits when it engages in fraud against those it regulates — even when the fraud is at most distantly related to its regulatory functions? Amazingly enough, an appeals court said yes — a ruling that conflicted with another appeals court’s ruling — and the Supreme Court is now being asked to reverse that decision.

The Competitive Enterprise Institute joined Cato Institute in filing an amicus brief asking the Supreme Court to review that disturbing ruling shielding wrongdoing. The brief, which cites constitutional safeguards and separation-of-powers principles, can be found here. The case is Standard Investment Chartered v. National Association of Securities Dealers (NASD). NASD converted into an entity called FINRA after deceiving regulated members about the terms of the conversion. (FINRA’s CEO was shortly thereafter appointed by President Obama to head the federal Securities and Exchange Commission.)  Cato Institute’s Ilya Shapiro describes the significance of the case here.

Forbes has an interesting article on the case by Edward Siedle. As he puts it:

Should FINRA, the brokerage industry’s self- regulatory organization, have absolute immunity from lawsuits—even when FINRA issues a false and misleading proxy statement to its membership? As a former SEC attorney and owner of a FINRA-member brokerage for more than 20 years, in 2008 I thought the answer to this question was pretty simple. Almost four years later, I’m still waiting to learn whether FINRA is accountable to anyone.

Back in 2008 I was well aware that the degree of control FINRA had over the investing public was both remarkable and disturbing. . . .self-regulation of the brokerage industry involves an inherent and insurmountable conflict of interest. . . Investors pay a heavy price for conflict ridden self-regulation. . .[NASD boasted that] “The NASD has successfully resisted many proposals inimical to the best interests of . . . its members.” Very revealing—no pretense of concern for the nation’s investors in that boastful line.

Despite this unique history of largely unchecked power over investors, as a former securities regulator I figured there were limits to how far this maniacal monster could go. I was confident that if FINRA, an organization responsible under the law with regulating the truth and adequacy of statements by members of the brokerage industry, lied about the terms of a financial transaction, FINRA, like anyone else, would be held liable.

In 2008, my brokerage firm, Benchmark Financial Services, Inc. filed a class action lawsuit against FINRA on behalf of all FINRA-member firms alleging that FINRA had issued a false and misleading proxy statement to its members in connection with the merger of the NASD and NYSE. Also named as a defendant in the suit was its then Chairman and CEO, Mary Schapiro—the current Chairperson of the Securities and Exchange Commission. . .. The lawsuit focuses chiefly on the truth of statements made about a $35,000 payment that was made by the NASD to induce its members – firms such as Benchmark – to vote in favor of the merger of the NASD and NYSE. The merger closed in July 2007 leading to the creation of FINRA. . .. [NASD falsely] stated in the proxy statement that the tax code and the Internal Revenue Service had imposed a $35,000 ceiling on the payment to NASD members in connection with the merger. Through the course of the litigation, I learned that a much higher payment to NASD member firms was not only possible but feasible. In actuality, the NASD did not even receive an IRS ruling with respect to the payment until months after the proxy statement was issued to NASD members. Documents that the NASD subsequently filed with the SEC made it clear that the NASD’s mantra that the tax code imposed a $35,000 limit on the payments to NASD members was simply untrue. The IRS did not issue a private letter ruling to the NASD concerning the payment to members until March 13, 2007, nearly four months after the proxy was issued and nearly two months after the voting had closed. OK—so NASD fabricated the claim that the IRS limited the payment to a maximum of $35,000 . . .. Here’s the killer: The IRS private letter ruling . . . did not provide any specific limitation on the payment to NASD members. Instead it provided a range of permissible payments that would not affect the self-regulatory organization’s tax exempt status.

[click to continue…]

Federal Register Hits 40,000 Pages

by Ryan Young on July 19, 2010

in Politics as Usual, Regulation

I’m a bit late getting to this, but an SEC “Order Approving Proposed Rule Change Relating to the Restated Certificate of Incorporation of Financial Industry Regulatory Authority, Inc.” pushed the 2010 Federal Register to the 40,000 page mark on Tuesday.

The Federal Register’s page growth has been accelerating as the year has progressed. It is currently on pace for 76,536 pages. That’s about 2,000 pages more than the Bush administration’s average. In January, the projected page count was only 63,187 pages.

Earlier in the year, an average day’s volume contained 278 pages. Now it’s up to 306 pages per day. As new rules hit the books as required by the health care bill, the financial regulation bill, and other legislation, the pace could pick up further. And if Democrats lose control of Congress, we can expect a very busy lame duck session.

The Code of Federal Regulations already weighs in at 157,000 pages. It will probably be pushing 160,000 before too long.

Goldman Sachs Endorses Trojan-Horse Financial “Reform” Bill; Bill Has Payoffs for Special Interests

by Hans Bader on April 28, 2010

in Bailout Watch, Economy, Legal, Politics as Usual, Precaution & Risk, Regulation, Sanctimony, Zeitgeist

The CEO of Goldman Sachs, the Wall Street firm accused of fraud by the SEC, has endorsed the so-called financial “reform” bill backed by President Obama and congressional leaders.

The bill would enrich Goldman Sachs at the expense of taxpayers and smaller competitors.  While the bill contains lots of red tape and fees that will harm insurance policyholders and Main Street, it contains selective “carve-outs” from consumer-protection laws for cronies of Senator Chris Dodd.  Dodd recently attracted criticism for financial and ethical lapses, such as his receiving “a sweetheart deal on an Irish “cottage” from a crooked stock-trader” and “two preferential discount mortgage interest deals from the now-bankrupt Countrywide.”  Goldman Sachs is the fourth-largest donor to Democratic campaigns, ranking just below public-employee unions and trial lawyers in its massive support for liberal politicians.

The financial bill contains goodies for Big Labor and “too big to fail” banks and financial institutions, at the expense of taxpayers and competing firms.

As journalist Matt Welch notes, Obama “is lying his face off about financial reform.”

Obama has collected millions from Wall Street special interests, his administration contains many Wall Street lobbyists, and he supported the unnecessary $700 billion bank bailout.  But now, he’s pushing a deceptive financial regulation bill with phony rhetoric about “reform,” claiming it is “not legitimate” to point out that the bill could lead to yet more bailouts and government takeovers.

Obama’s legislation would do nothing to rein in the worst offenders behind the mortgage crisis, the government-subsidized mortgage giants Fannie Mae and Freddie Mac, while enriching left-wing lobbying groups and community organizers, and giving the government the permanent ability to bail out and take over Wall Street firms.

Obama’s proposed financial rules overhaul does absolutely nothing about Fannie Mae and Freddie Mac, admits Obama’s Treasury Secretary, tax cheat Timothy Geithner, even though he admits that “Fannie and Freddie were a core part of what went wrong in our system.” Worse, the Obama administration lifted the $400 billion limit on bailouts for Fannie and Freddie, so that they could continue to buy up junky mortgages at taxpayer expense, and showered their executives with $42 million in compensation.  The Obama administration is now expanding the bailouts of these mortgage giants so that they can lavish pay on their CEOs and reduce the payments of deadbeat mortgage borrowers.  (At the direction of the Obama administration, Freddie Mac is now running up $30 billion in losses to bail out mortgage borrowers, some of whom have high incomes.  Federal regulators sought to make Freddie Mac hide the resulting losses from the SEC and the public.)

Fannie and Freddie helped spawn the mortgage crisis by acting as loan toilets, buying up risky mortgages and thus creating an artificial market for junk.  “From the time Fannie and Freddie began buying risky loans as early as 1993, they routinely misrepresented the mortgages they were acquiring, reporting them as prime when they had characteristics that made them clearly subprime.”

Why did they buy these risky loans?  They put up with Clinton-era affordable-housing regulations that required them to buy up lots of risky loans, in order to curry favor on Capitol Hill and thus retain their annual $10 billion in tax and other special privileges (which they possessed owing to their status as “Government-Sponsored Enterprises” or GSEs). They paid their CEOs millions in the process, and engaged in massive accounting fraud — $6.3 billion at Fannie Mae alone — to increase the size of their managers’ bonuses.  As GSEs, they were exempt from the capital requirements that apply to private banks, so they did not have enough reserves to cover their losses when their mortgages started defaulting.

Banking expert Peter J. Wallison, who prophetically warned against the risky practices of Fannie Mae and Freddie Mac for years, says that Obama’s proposals will lead to “bailouts forever” and give big, politically-connected banks that are “too big to fail” the ability to drive smaller rivals out of business at the expense of consumers and taxpayers.  His colleague Alex Pollock notes that Obama has not lived up his administration’s claims that it would back reform of Fannie Mae and Freddie Mac.

Obama claims that it will not lead to more bailouts, but even congressional Democrats admit that it will.  As Congressman Brad Sherman (D-Calif.) admitted, the “bill has unlimited executive bailout authority. . .The bill contains permanent, unlimited bailout authority.”

Government pressure on banks to make loans in economically-depressed neighborhoods was another key reason for the mortgage meltdown and the financial crisis.  If Obama has his way, that pressure will increase.  The House earlier approved Obama’s proposal to create a politically-correct entity called the Consumer Financial Protection Agency. “The agency would be in charge of enforcing the Community Reinvestment Act, a law that prods banks to make loans in low-income communities.”  It would do so without regard for banks’ financial safety and soundness, even though the Community Reinvestment Act was a key contributor to the financial crisis.

Obama’s proposed financial regulations would also harm retail banking operations used by middle-class people and small businesses.

Porn More Interesting to Media Than Flaws of Financial ‘Reform’ Bill; Obama Is “Lying His Face Off”

by Hans Bader on April 26, 2010

in Bailout Watch, Economy, Insurance, Legal, Politics as Usual, Regulation, Sanctimony

There are plenty of problems with the financial “reform” bill, but the media aren’t interested in that.  They’re much more interested in revelations that senior enforcement staff at the federal Securities and Exchange Commission, which would gain new powers under the bill, spent many hours looking at porn on their office computers.

The porn issue certainly deserves some attention, given just how much time some SEC staff wasted looking at porn at taxpayers’ expense: “A senior attorney at the SEC’s Washington headquarters spent up to eight hours a day looking at and downloading pornography. When he ran out of hard drive space, he burned the files to CDs or DVDs, which he kept in boxes around his office.”  You have to wonder if this kind of inattention to its duties led the SEC to ignore the $50 billion fraud by Bernard Madoff, which was repeatedly brought to its attention to no avail, and the multi-billion dollar Ponzi scheme committed by Robert Allen Stanford.  But it probably didn’t.

While the media, including the New York Times, has reported on the porn, it has largely ignored substantive criticism of the financial “reform” bill, which is a Trojan horse that would reinforce risky practices that led to the housing bubble, while ignoring needed reforms, harming insurance policyholders, and giving executive branch officials arbitrary power to bail out or take over banks and financial institutions.

As journalist Matt Welch notes, Obama “is lying his face off about financial reform.”

President Obama has collected millions from Wall Street special interests, his administration contains many Wall Street lobbyists, and he supported the unnecessary $700 billion bank bailout.  But now, he’s pushing a deceptive financial regulation bill with phony rhetoric about “reform,” claiming it is “not legitimate” to point out that the bill could lead to yet more bailouts and government takeovers (as economists and banking experts like Peter Wallison have demonstrated).

Obama’s legislation would do nothing to rein in the worst offenders behind the mortgage crisis, the government-subsidized mortgage giants Fannie Mae and Freddie Mac, even as it would enrich the politically-connected liberal Wall Street firm Goldman Sachs (recently accused of fraud), enrich left-wing lobbying groups and community organizers, and give the government the permanent ability to bail out and take over Wall Street firms.

Obama’s proposed financial rules overhaul does absolutely nothing about Fannie Mae and Freddie Mac, admits Obama’s Treasury Secretary, tax cheat Timothy Geithner, even though he admits that “Fannie and Freddie were a core part of what went wrong in our system.” Worse, the Obama administration lifted the $400 billion limit on bailouts for Fannie and Freddie, so that they could continue to buy up junky mortgages at taxpayer expense, and showered their executives with $42 million in compensation.  The Obama administration is now expanding the bailouts of these mortgage giants so that they can lavish pay on their CEOs and reduce the payments of deadbeat mortgage borrowers.  (At the direction of the Obama administration, Freddie Mac is now running up $30 billion in lossesto bail out mortgage borrowers, some of whom have high incomes.  Federal regulators sought to make Freddie Mac hide the resulting losses from the SEC and the public.)

Fannie and Freddie helped spawn the mortgage crisis by acting as loan toilets, buying up risky mortgages and thus creating an artificial market for junk.  “From the time Fannie and Freddie began buying risky loans as early as 1993, they routinely misrepresented the mortgages they were acquiring, reporting them as prime when they had characteristics that made them clearly subprime.”

Why did they buy these risky loans?  They put up with Clinton-era affordable-housing regulations that required them to buy up lots of risky loans, in order to curry favor on Capitol Hill and thus retain their annual $10 billion in tax and other special privileges (which they possessed owing to their status as “Government-Sponsored Enterprises” or GSEs). They paid their CEOs millions in the process, and engaged in massive accounting fraud — $6.3 billion at Fannie Mae alone — to increase the size of their managers’ bonuses.  As GSEs, they were exempt from the capital requirements that apply to private banks, so they did not have enough reserves to cover their losses when their mortgages started defaulting.

Banking expert Peter J. Wallison, who prophetically warned against the risky practices of Fannie Mae and Freddie Mac for years, says that Obama’s proposals will lead to “bailouts forever” and give big, politically-connected banks that are “too big to fail” the ability to drive smaller rivals out of business at the expense of consumers and taxpayers.  His colleague Alex Pollock notes that Obama has not lived up his Administration’s claims that it would back reform of Fannie Mae and Freddie Mac.

Obama claims that it will not lead to more bailouts, but even congressional Democrats admit that it will.  As Congressman Brad Sherman (D-Calif.) admitted, the “bill has unlimited executive bailout authority. . .The bill contains permanent, unlimited bailout authority.”

Government pressure on banks to make loans in economically-depressed neighborhoods was another key reason for the mortgage meltdown and the financial crisis.  If Obama has his way, that pressure will increase.  The House earlier approved Obama’s proposal to create a politically-correct entity called the Consumer Financial Protection Agency. “The agency would be in charge of enforcing the Community Reinvestment Act, a law that prods banks to make loans in low-income communities.”  It would do so without regard for banks’ financial safety and soundness, even though the Community Reinvestment Act was a key contributor to the financial crisis.

Obama’s proposed financial regulations would also harm retail banking operations used by middle-class people and small businesses.

Trojan Horse Financial “Reform” Bill Enriches Goldman Sachs, Rips Off Taxpayers

by Hans Bader on April 19, 2010

in Bailout Watch, Economy, Legal, Politics as Usual, Precaution & Risk, Regulation

The Obama administration and Congressional leaders are pushing a trojan-horse financial “reform” bill that would enrich the wealthy and powerful investment bank Goldman Sachs, which was recently cited for massive fraud by the Securities and Exchange Commission (SEC).  That’s the discovery of John Berlau, who won the National Press Club’s Sandy Hume Memorial Award for exposing the conflicts of interest of a former IRS Commissioner.

Earlier, the administration used the AIG bailout to give billions in legally unnecessary payments to Goldman Sachs, which is so rich that it has admitted it didn’t even need the money.  Goldman Sachs, one of the Democratic Party’s biggest donors, is using its political connections to reap record profits.

Moreover, Obama’s legislation would do nothing to rein in the worst offenders behind the mortgage crisis, the government-subsidized mortgage giants Fannie Mae and Freddie Mac, even as it would give the government the permanent ability to bail out Wall Street firms.

Obama’s proposed financial rules overhaul does absolutely nothing about Fannie Mae and Freddie Mac, admits Obama’s Treasury Secretary Timothy Geithner, even though he admits that “Fannie and Freddie were a core part of what went wrong in our system.” Worse, the Obama administration lifted the $400-billion limit on bailouts for Fannie and Freddie, so that they could continue to buy up junky mortgages at taxpayer expense, and showered their executives with $42 million in compensation.

The administration is now expanding the bailouts of these mortgage giants, which are now giving lavish pay to their CEOs and reducing the payments of deadbeat mortgage borrowers.  (At the direction of the Obama administration, Freddie Mac is now running up $30 billion in losses to bail out mortgage borrowers, some of whom have high incomes.  Federal regulators sought to make Freddie Mac hide the resulting losses from the SEC and the public).

Fannie and Freddie helped spawn the mortgage crisis by acting as loan toilets, buying up risky mortgages and thus creating an artificial market for junk.  “From the time Fannie and Freddie began buying risky loans as early as 1993, they routinely misrepresented the mortgages they were acquiring, reporting them as prime when they had characteristics that made them clearly subprime.”

Why did they buy these risky loans?  They put up with Clinton-era affordable-housing regulations that required them to buy up lots of risky loans, in order to curry favor on Capitol Hill and thus retain their annual $10 billion in tax and other special privileges (which they possessed owing to their status as “Government-Sponsored Enterprises” or GSEs). They paid their CEOs millions in the process, and engaged in massive accounting fraud — $6.3 billion at Fannie Mae alone — to increase the size of their managers’ bonuses.  As GSEs, they were exempt from the capital requirements that apply to private banks, so they did not have enough reserves to cover their losses when their mortgages started defaulting.

Banking expert Peter J. Wallison, who prophetically warned against the risky practices of Fannie Mae and Freddie Mac for years, says that Obama’s proposals will lead to “bailouts forever” and give big, politically connected banks that are “too big to fail” the ability to drive smaller rivals out of business at the expense of consumers and taxpayers.  His colleague Alex Pollock notes that Obama has not lived up his administration’s claims that it would back reform of Fannie Mae and Freddie Mac.

Government pressure on banks to make loans in economically-depressed neighborhoods was another key reason for the mortgage meltdown and the financial crisis.  If Obama has his way, that pressure will increase.  The House earlier approved Obama’s proposal to create a Consumer Financial Protection Agency. “The agency would be in charge of enforcing the Community Reinvestment Act, a law that prods banks to make loans in low-income communities.”  It would do so without regard for banks’ financial safety and soundness, even though the Community Reinvestment Act was a key contributor to the financial crisis.

False Claims by Government in Supreme Court Case: PCAOB Agency Is More Powerful and Independent Than Government Claims

by Hans Bader on December 6, 2009 · 3 comments

in Legal, Politics as Usual, Regulation

The members of the Public Company Accounting Oversight Board (PCAOB), an agency being challenged in the Supreme Court on December 7, aren’t appointed by the president, nor can he remove them. The General Accounting Office describes the PCAOB as “an independent board with sweeping powers and authority;” its rules and red tape cost the economy billions of dollars every year (with an long-term cost of perhaps $1 trillion).

Yet the government suggests in its brief that the president has “fully effective control” over the PCAOB (see pg. 46 of that brief). That’s not the only peculiar claim made in the PCAOB’s defense.

The case raises the issue of whether members of an agency — the PCAOB — picked by the members of yet another independent agency — the five Commissioners of the Securities and Exchange Commission (SEC) acting as a group — are, in light of their broad policy making role, actually “principal officers” who thus should have been picked instead by the president under the Constitution’s Appointments Clause. Alternatively, assuming that PCAOB members are mere “inferior” officers, the case raises the issue of whether they should have been picked, as the Appointments Clause requires for inferior officers, by the “Head” of a “Department,” rather than the SEC Commissioners acting collectively (the SEC has a Chairman who manages it and supervises its staff).

Government lawyers argue that the PCAOB is so controlled by the SEC that its members are mere inferior officers, and claim that the SEC is headed by all its Commissioners, not its Chairman. But as Jonathan Moore has noted, a long-time SEC commissioner debunked these claims on December 3. Former SEC Commissioner Paul Atkins took the exact opposite view, in a panel discussion at the American Enterprise Institute, which one can view and listen to here (Atkins was the fifth speaker; I also spoke at the event, and Jonathan Moore, who was in the audience, questioned the panel).

Atkins spoke at length about the PCAOB and how difficult it was for the SEC to influence the PCAOB. He noted that the PCAOB had enough autonomy to frustrate the SEC’s attempts at oversight. When the SEC sought a business plan from the PCAOB, the PCAOB Chairman said that “the statute was his business plan” and more or less failed to comply. It took five years to get something akin to a business plan from the PCAOB. Atkins said that PCAOB’s “Audit Standard 2” “has a very checkered history” and illustrated the “limits” of SEC oversight. The 400 pages of requirements from Auditing Standard No. 2 made compliance with Sarbanes-Oxley “very difficult” and “very costly.”

Atkins noted that “All five commissioners” were in favor of “radical” changes to it, yet it took years for them to obtain merely “some” changes to that audit standard, owing to the need for consensus and PCAOB foot dragging. He recounted how the PCAOB adopts “staff-driven” rules through “informal rulemaking” that apply without being approved by the SEC, regardless of Sarbanes-Oxley’s formal approval process for rules. Atkins says, for example, that its guidance regarding “stock options” was “not subject to any rule at all,” despite functioning in practice as a rule. While the SEC has to approve formal rules, the PCAOB functions heavily through informal rules never approved by the SEC. He said that “Peekaboo does have real power,” “investigative power,” and “prosecutorial power.” Although the SEC theoretically reviews the PCAOB’s budget, Atkins noted that “staff at Peekaboo were not telling the truth” about the PCAOB’s budget system to the SEC, making evaluation of its budget and spending difficult. He noted that on the SEC’s website, there is video footage of his concerns over this at the last budget meeting. He noted that because of the PCAOB’s separate status and the SEC’s lack of control over PCAOB staff, the “SEC found it didn’t really have the authority” to control the PCAOB’s budget that it supposedly did.

Atkins noted that the SEC’s “power is not plenary” over the PCAOB, that it was difficult to get a group consensus focused on oversight over the PCAOB, and that oversight of the PCAOB was “like pushing on a string.” He said that the current set-up under Sarbanes-Oxley is a “very difficult way for the SEC to oversee a separate board.” He cited “flawed implementation of [SOX Section] 404” from 2002 to 2006 as an example, and noted the “incredible amount of attention diverted” to accounting issues that were not important as a result of the PCAOB’s internal-controls rules.

He addressed the question of whether the SEC’s chairman is its head for appointments clause purposes. He said that the Founders realized the “committee structure” or the “committee system was not a very effective decision making type of body” for things like appointments, and cited the 1950 Reorganization Plan 10 that vested “authority over the budget” and “HR decisions” in the SEC’s chairman. Although he noted that “consensus” is desired for key posts like the General Counsel, when push comes to shove, “in reality, he [the Chairman] can still appoint who he wants.” He said that the idea that PCAOB members – or even SEC members – were really accountable to the president was silly, and that the SEC’s own history “illustrates how difficult it is for the President to assert authority” over the SEC, much less the PCAOB.

Atkins’ observations debunk the government’s suggestion that the president has “fully effective control” over the SEC – and the lower court ruling upholding the PCAOB, which claimed that the SEC was not headed by its Chairman, but by SEC Commissioners as a group – a claim based on that court’s inconsistent reasoning. Law professor Donna Nagy similarly debunks claims that the PCAOB is “heavily controlled” by the SEC in a forthcoming article in the Pittsburgh Law Review, noting that PCAOB members are “principal officers” “acting with significant discretion and autonomy outside the SEC’s control” who constitutionally must be appointed by the president — not, as is currently the case, by the SEC Commissioners as a group.

Also available online is the text of SEC Commissioner Paul Atkins’s earlier 2006 speech noting the SEC’s limited ability to control the PCAOB (such as the PCAOB’s unapproved guidance on subjects like “options grants” and the PCAOB chair’s view that the PCAOB is more like the SEC’s “cousin” than its subordinate).

Courts sometimes take judicial notice of such statements. See Nebraska v. EPA, 331 F.3d 995, 998 n.3 (D.C. Cir. 2003) (taking judicial notice of statements on web site); Cf. Parents Involved in Community Schools v. Seattle School District No. 1, 551 U.S. 701, 780 n. 30 (2006) (Thomas, J., concurring) (quoting from web site); id. at 730, n.14 (plurality) (citing news articles about website’s earlier content).

SEC penalty policy change could harm innocent investors

by John Berlau on February 6, 2009 · 2 comments

in Bailout Watch, Politics as Usual, Precaution & Risk, Sanctimony, Zeitgeist

In one of her first actions as SEC chairman, Mary Schapiro announced today that she was getting rid of a policy that required SEC officials to get approval from the commissioners before negotiating corporate penalties. According to the Associated Press, “Schapiro said that practice ‘just sends the wrong message.’”

But Schapiro should perhaps focus a little less on message and a little more on an action’s consequences for investors the SEC is supposed to protect. Because unfortunately, this change will have the effect of further harm to shareholder victims of corporate fraud.

Corporate penalties take money not from individual executives guilty of fraud, but from the corporate treasury that ultimately belong to the ordinary investors in the company. Frequently, these penalties have the effect of harming shareholder victims of corporate fraud twice: once when the corporate executives misuse a company’s money, and a second time when when the corporate penalty further reduces the company’s assets that belong to all shareholders. That’s why it is more just and more effective for the SEC to levy penalties against individual wrongdoers rather than the corporation as a whole.

The 2006 policy Schapiro wants to reverse was prompted by concerns expressed for former Commissioner Paul Atkins and others that the interests of innocent shareholders weren’t being given enough weight in negotiation of corporate penalties. The rule was a sensible change that didn’t outlaw corporate penalties, but ensured that their use was carefully considered by SEC commissioners before enforcement staff could levy an arbitrary fine that could harm shareholder interests.

Moreover, the policy only applied to penalties on corporations, not individuals accused of wrongdoing or private broker-dealers such as the firm of Bernard Madoff.

Schapiro, whom I have praised previously for her regulatory prudence, is correct in wanting the agency go after corporate wrongdoers with full force. But she should seriously rethink instituting this policy change that would have the unintended but predictable effect of punishing innocent shareholders twice.

Madoff: Hiding in Plain Sight, Thanks to SEC

by John Berlau on December 28, 2008 · 18 comments

in Bailout Watch, Features, Nanny State, Personal Liberty, Politics as Usual, Precaution & Risk, Regulation, Zeitgeist

When news broke of Bernard Madoff’s alleged $50 billion worldwide Ponzi scheme, news accounts first protrayed him as a shadowy hedge fund manager outside the scope of regulation by the Securities and Exchange Commission. But as the sheer magnitude of the fraud became clearer, so did the picture of Madoff’s place in the Wall Street-Washington world.

Madoff’s businesses were actually subject to a variety of financial regulations, something Madoff would actually use as a selling point to investors. Last year in a speech, Madoff said, “In today’s regulatory environment, it’s virtually impossible to violate rules.” He registered as an investment adviser in 2006, and had been under the SEC’s extensive regulatory framework for securities broker-dealers since he founded his firm almost 50 years ago.

And far from being a shadowy figure, Madoff was a pillar of the financial establishment. He showered campaign contributions on politicians, mostly Democrats. He was also quite chummy with many of the financial regulators charged with overseeing him.

For instance, Clinton administration SEC Chairman Arthur Levitt, who has championed onerous mandates like the burdensome Sarbanes-Oxley accounting mandates to preserve “market intergrity,” appointed Madoff during his SEC tenure to what the New York Times describes as “a large advisory commission … that explored the rapidly changing structure of the financial markets.”

An even closer connection was SEC assistant inspections director Eric Swanson who, according to CNBC reporter Charles Gasparino, “was part of the team that examined Madoff’s brokerage firm” in 1999 and again in 2004. “During those exams, the SEC team said it found almost nothing wrong,” Gasparino writes in The Daily Beast. In 2007, after leaving the SEC, Swanson married Madoff’s niece Shana, who is the regulatory compliance attorney at her uncle’s firm

While there is no evidence of wrongdoing with regard to Madoff by either Levitt or Swanson, SEC officials, for whatever reason, looked the other way, despite numerous allegations and “red flags,” some received as early as 1992. And since 1999, rival investment manager Harry Markopolos had sent the agency detailed analysis of why he though Madoff consistent postive returns were mathematically impossible without running a Ponzi scheme or insider trading. In a 2005 submission he made to the SEC that was recently made public by the Wall Street Journal, Markopolos charged that it was “highly likely” that “Madoff Securities is the world’s largest Ponzi scheme.”

But despite the SEC’s incompetence in heeding these warnings, many are still arguing that to prevent future Madoff-type frauds, we need more regulations that give more power to the SEC. But it’s hard to see how any additional powers could have made a difference in this case, given that the SEC almost seemed determined to look the other way for violations of the most basic rules against securities fraud that had long been in place.

Since hedge funds were among Madoff’s clients (and biggest victims, as this WSJ editorial points out), calls are again being intensified for further hedge fund regulation to bring them under the cumbersome registration process for investment advisers. (The SEC already has full authority to investigate hedge funds and other unregistered investment entitities if there are suspicions of fraud.) This is what the agency tried to do a few years ago, only to have a three-judge federal appeals court panel throw out the rule in 2006 in a unanimous finding that the agency had stretched the law.

But the SEC can’t argue that this would have helped them prevent Madoff’s fraud, because, as noted above, Madoff had registered as an investment adviser in 2006, and was registered as a broker-dealer for decades.

This broker-dealer registration gave the SEC full power to investigate all affiliated businesses. As MarketWatch commentator David Weidner pointed out (in a column with a curious headline about “lack of regulation” that is the exact opposite of the author’s point — often columnists, unlike bloggers, don’t wite their own headlines), “Broker-dealers are supposed to be the most scrutinized of the investment community. If Madoff was running separate businesses, the SEC and FINRA should have been looking at all of them as a whole.”

In fact, the fact that Madoff was under such heavy regulation probably helped him in constructing the alleged facade. As business reporters Binyamin Appelbaum and David S. Hilzenrath wrote in their perceptive Washington Post article, “the fraud Madoff allegedly constructed was successful in part because it avoided the appearance of risk.” The article quoted an expert as saying that SEC regulators “had to make judgments, and they decided to look at derivatives, short sales, insider trading, all the things that Madoff never had.”

So The SEC was too busy hounding unregistered hedge funds, short-sellers, and entrepreneurial companies for trivial minutiae from Sarbanes-Oxley and other mandates to notice the fraud right in front of them. The regulators didn’t just “drop the ball,” as President-Elect Barack Obama recently asserted. They lost focus on where the most important “ball” was.

Getting that “ball” back by paying attention to warning signs about where the real fraud is, and rolling back the mounds of red tape on honest investors and entrepreneurs that also wastes the time the agency has to go after the real problems, must be the number one priority of newly designated SEC chairman Mary Schapiro.

Too Bad Daschle Isn’t at SEC — Backed Sarbanes-Oxley Relief

by John Berlau on November 20, 2008

in Bailout Watch, Economy, Healthcare, Insurance, Legal, Politics as Usual, Precaution & Risk

President-Elect Barack Obama just nominated former Senate Democratic Leader Tom to be his Secretary of Health and Human Services. Much is being written about Daschle being a Washington insider, which he certainly is, but after leaving the Senate after his defeat in 2004, Daschle has commendably taken on the Beltway conventional wisdom on an important issue: The Sarbanes-Oxley accounting mandates.

In late 2005, Daschle became one of the first Democrats to criticize the 2002 law, rushed through Congress in the wake of the Enron and WorldCom falures, for its unintended consequences on entrepreneurs. In doing so he helped make the cause of Sarbox relief and reform biparisan. In a Wall Street Journal op-ed Daschle co-wrote with former Senate Republican Leader Bob Dole, the authors told readers of “small and mid-sized capitalization companies who say that their access to capital from publicly-traded stock markets has been made prohibitively expensive.” They pointed out that “studies have shown that the additional cost per company for compliance averages $1.4 million to $4.4 million,” and explained that “although increased auditing fees amount to a small burden for Fortune 500 companies as a percentage of revenue, the doubling or tripling of auditor bills, accompanied by additional accounting and legal fees, can be the difference between a profit and a loss for emerging businesses.”

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CDS’s House of Cards

by Julie Walsh on October 1, 2008

in Bailout Watch, Economy

It’s been called a ticking time bomb by Investor’s Business Daily. CNNMoney asks if this will be the next disaster. Yet the Feds are delaying one key in bringing stability to our financial markets.

As a $62 trillion dollar over the counter market, CDSs need an exchange or central clearinghouse to provide transparency and collateral requirements. CME (formed from the Chicago Board of Trade and the Chicago Mercantile Exchange) and the Clearing Corp (formed from 17 financial players including UBS and Goldman Sachs) have stepped up to the plate. Clearing Corp could have had a clearinghouse up and running within a week or so; however, the Fed has pushed Clearinghouse to obtain a banking license which will probably delay its opening until next year. But with each bank that is removed from this house of cards the threat of meltdown is increased. The banks are falling one after another internationally, and with the CDSs so intertwined, its only a matter of time until when you take away one more card and they all fall.

According to Bloomberg, “Barclays analysts estimated in February that if a financial institution that had $2 trillion in credit-default swap trades outstanding were to fail, it might trigger between $36 billion and $47 billion in losses for those that traded with the firm. That doesn’t include the market-value losses investors face as the cost to protect companies against a default widens.”

Perhaps it would be a good idea for the Feds to speed their approval process?

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