Year: 2010

The New Face of Evil?

The New Face of Evil?

His crime was simple: collect money from investors, fake the returns, pocket the money, and repeat. His crime was the biggest: $20 billion in cash plus $45 billion of fake returns.

Should Bernie Madoff be the new name for evil? Christine Hurt of University of Illinois College of Law contrasts Madoff with the original Ponzi schemer, Charles Ponzi himself.

Judge Chin at the Madoff sentencing cast him with the label of evil:

Here, the message must be sent that Mr. Madoff’s crimes were extraordinarily evil, and that this kind of irresponsible manipulation of the system is not merely a bloodless financial crime that takes place just on paper, but that it is instead, as we have heard, one that takes a staggering human toll

His 150 year sentence is a staggering sentence for a non-violent crime. Financial fraud sentences are rapidly increasing in length and severity.

Perhaps, as Hurt point out, this increase in penalty is a reflection of the American society. We are now more afraid of outliving our retirement savings than of home invasion. (But not of people taking pictures of planes.)

Unlike the complexity of the WorldCom and Enron financial misdeeds, Madoff’s were much more straight-forward. It’s an easier story to tell the judge. It’s easier to lay the blame. Bernie kept his mouth shut and did not implicate anyone else.

We are already seeing the “Madoff” label being applied to other fraud schemes. Kenneth Starr’s fraud is being labeled “Madoff-Like.” other frauds are being called “Mini-Madoff.”

Maybe the Madoff label will stick.

Sources:

Michael Lewis, Greece, and Corruption

Michael Lewis has moved from Wall Street, to baseball, the left tackle, Iceland, the credit collapse and on to Greece. He takes a look at Greece’s financial crisis in the October issue of Vanity Fair: Beware of Greeks Bearing Bonds.

One issue is the debt hangover. Greece has about $400 billion in outstanding government debt and $800 billion in pension obligations. That $1.2 trillion is about a quarter-million for each working adult.

Another is the generous wages paid to government works. The average government worker makes three times the wage of the average private-sector job. The national railroad has annual revenues of €100 million, but has an annual wage bill of €400 million and another €300 million in other expenses.

Then there is the corruption. “It’s simply assumed, for instance, that anyone who is working for the government is meant to be bribed.”

The government is notorious for pulling tax collectors off the streets during election years. An estimated 2/3 of Greek doctors report incomes of less than €12,000. Self-employment means self reporting of income. Only those salaried employees who have taxes taken from their paycheck get stuck paying taxes. Greece is a poor country full of rich people.

Just to prove the point, he didn’t get a receipt for his coffee with a whistle-blowing tax collector. Even the fancy hotel was not paying the sales tax it owed.

“Everyone is pretty sure everyone is cheating on his taxes, or bribing politicians, or taking bribes, or lying about the value of his real estate. And this total absence of faith in one another is self-reinforcing. The epidemic of lying and cheating and stealing makes any sort of civic life impossible; the collapse of civic life only encourages more lying, cheating, and stealing. “

Greece was desperate to become part of the European Union. That meant they needed to get their deficit under control and prove a stable economy. It seems like they did it by “cooking their books” instead of economic policy. They simply moved expenses and obligations off their balance sheet to earn their 2001 entrance to the EU, swapping the drachma for the euro.

What went wrong?

Prime Minister Costas Karamanlis was involved in a scandal, leading to his ouster and the ouster of his government. The new finance minister took the more honest approach and began finding all of the financial skeletons.

[He] found so much less money in the government’s coffers than it had expected that it decided there was no choice but to come clean. The prime minister announced that Greece’s budget deficits had been badly understated—and that it was going to take some time to nail down the numbers. Pension funds and global bond funds and other sorts who buy Greek bonds, having seen several big American and British banks go belly-up, and knowing the fragile state of a lot of European banks, panicked. The new, higher interest rates Greece was forced to pay left the country—which needed to borrow vast sums to fund its operations—more or less bankrupt. In came the I.M.F. to examine the Greek books more closely; out went whatever tiny shred of credibility the Greeks had left. “How in the hell is it possible for a member of the euro area to say the deficit was 3 percent of G.D.P. when it was really 15 percent?” a senior I.M.F. official asks. “How could you possibly do something like that?”

The other focus of the Lewis’ story is the Vatopedi Monastery that was part of the Karamanlis scandal. The monastery had title to a lake in northern Greece. They convinced the Greek government to trade for the ownership of the lake with government owned property. This included the gymnastics center from the 2004 Olympics. The lake was worth roughly €55 million and the government property they received is probably worth many time that amount. It’s even more valuable now that the monastery has convinced the government to re-zone big chunks of the property for commercial purposes.

It seems the monks just want to use the money to rebuild their monastery. Nobody is claiming the leadership of the monastery is pocketing the money.  The same is not true on the other side of the transaction.

Sources:

Image of the Parthenon is by Simon Tong.

How About Working for SEC Enforcement?

The Dodd-Frank Act has created some new positions and some long occupied seats have opened up at the Securities and Exchange Commission. Maybe you have the skills to help the SEC?

Yes, the SEC dropped in the rankings of best federal workplace, slipping from 3rd in 2007 to 24th in 2010. I suspect that reflects the turmoil from the Great Panic and Madoff frauds.

The SEC has new mandates and new leadership. The Enforcement Division has some high level openings and are actively look for talented people to apply. The pay looks good (for a government job).

Chief Counsel

This position has not been available for 17 years. Joan McKown left the SEC to join law firm Jones Day as a partner in its Washington, D.C. office. She had held the Chief Counsel position since 1993. The Chief Counsel plays a key role in establishing enforcement policies at the SEC and in reviewing proposed enforcement actions before they are recommended to the Commission for approval.

“The Chief Counsel of the Division of Enforcement serves as principal advisor and consultant to the Director, and other high ranking officials of the Division, on a wide range of matters including technical, and/or precedent-setting, aspects of the federal securities laws.”

Job Posting for Chief Counsel

Associate Director – Office of Whistleblower Coordinator

This is a new position created by Dodd-Frank who will report to the Chief of the Office of Market Intelligence and to the Office of the Director of Enforcement for purposes of whistleblower advocacy.

Job Posting for Associate Director – Office of Whistleblower Coordinator

Associate Director

Chris Conte vacated the position of Associate Director in the enforcement unit to take a position with Steptoe & Johnson LLP after almost 18 years with the SEC. he had just finished an investigation of Dell’s accounting violations and obtained a $100 million penalty.

Job Listing for Associate Director

Compliance Bits and Pieces for September 10

It’s back-to-school week for me (well … my kids). That means summer is over and time to re-focus on good compliance and ethics. Here are some stories on those topics that popped up recently:

Boards of directors: Clueless, but not criminal, mostly by Matt Kranz in USA Today

Directors are rarely charged with fraud. The SEC doesn’t maintain a count of outside directors accused of fraud. But since 1996, the SEC has brought only about nine significant actions against outside directors, the agency says.

Unintended Consequences by Bill Piwonka in Integrity at Work

[A]s governments worldwide enact legislation to decrease the incidents and impacts of unethical behavior, there is a greater chance the various laws will be inconsistent across boundaries. For instance, Sarbanes-Oxley requires publicly held US companies or those listed on US exchanges to offer a way for employees to anonymously report financial misconduct, yet Portugal and Spain have outlawed anonymity. The FCPA allows for facilitation payments in certain circumstances, but the UK Bribery Act forbids them entirely. And so on.

The SEC Departs from an Important Safeguard by Wayne Carin in The Harvard Law School Forum on Corporate Governance and Financial Regulation

Recently, the SEC made permanent the delegation of its statutory formal order investigation authority to the Director of the Division of Enforcement. This delegation, which the Enforcement Director has sub-delegated to senior enforcement staff, essentially transfers the SEC’s broad authority to invoke its subpoena power to numerous of its enforcement staff without any apparent oversight.

My Two Cents On The FCPA’s Affirmative Defenses by Mike Koehler in FCPA Professor

For starters, I respectfully disagree with Sheahen’s statement that “business and businessmen accused of giving bribes to foreign officials have fared poorly in federal courts” as well as the implication that this somehow supports his thesis. The three FCPA trials cited from 2009 – Frederick Bourke, William Jefferson, and Gerald and Patricia Greene were a mixed bag for the DOJ, not slam-dunk successes.

Image of a Thomas Saf-T-Liner HDX school bus is by Joedamadman.

We Have Video of Barney Frank Arguing With a Dining Room Table

After pushing through the Dodd-Frank Wall Street Reform and Consumer Protection Act, Barney Frank now needs to run for re-election. He is not running unopposed in the Democrat primary, but the opposition is … “interesting.”

Barney is the congressman for my district, so I have voted for him in the past and plan to vote for him again. I would have hard time voting or his primary opponent. He will also have to face a Republican candidate in November, either former Marine Sean Bielat or businessman Earl Sholley.

Last year at a town hall meeting, a woman named Rachel Brown, a Lyndon LaRouche follower who accuses President Obama of acting like Adolph Hitler, challenged Financial Services Committee Chairman Barney Frank with a question. He responded that talking to Ms. Brown “would be like trying to argue with a dining room table.” The Congressman does not usually argue with furniture.

Unfortunately, Brown was so incensed that she decided to run against him for his Congressional seat. For some unknown reason, Frank actually agreed to a televised debate with her.

She decided to compare Obama to Roman Emperor Nero instead of Hitler at the beginning of the debate. She also thinks we should be piping water in from Canada to invigorate the American economy.

Sources:

Ethics Upgrade at Oracle?

I’m not sure what to make of Mark Hurd, Hewlett-Packard, Larry Ellison, and Oracle.

HP threw Hurd out on the street for some stupid behavior. By throwing out on the street, I mean let him keep most of his compensation package.

Larry Ellison immediately came to his defense. He even went a step further and hired him as co-president of Oracle. Not only that, they are giving him a seat on their Board of Directors.

That angered H-P so much they filed a lawsuit to stop him from taking the job. They want him on the street, not with a competitor.

I keep scratching my head over the behavior of H-P’s board. They fired him, but let him keep a compensation package. If they thought it was a serious ethical lapse, then they should have made it for cause and kept the compensation. The definition of “for cause” was probably set too high for Hurd’s stupid actions. But the H-P Board didn’t even try.

Oracle’s stock jumped on the news of Hurd’s hiring. H-P’s Stock took a tumble when they announced his firing.

It makes a compliance and ethics guy like me scratch his head and wonder: does compliance and ethics really matter? To answer that, we need to look at the original incident and decide if Hurd’s behavior so unethical that he should have been fired.

Sources:

Credit Rating Agency Investigated for Fraud

The SEC brought an action against LACE Financial for issues with its independence. We also learned that the SEC had investigated whether rating agency Moody’s Investors Service, Inc. violated the registration provisions or the antifraud provisions of the federal securities laws.

Moody’s was working on a rating for some new European securities. They ended up giving the security an Aaa rating. They later discovered a problem with their model and found a coding error. After finding the error, a Moody’s rating committee met and discussed the problem.

They made no change to the outstanding credit rating. The SEC found smoking gun emails that showed rating committee members were concerned about the impact on Moody’s reputation if it revealed an error in the rating model.

“In this particular case we seem to face an important reputation risk issue. To be fully honest this latter issue is so important that I would feel inclined at this stage to minimize ratings impact and accept unstressed parameters that are within possible ranges rather than even allow for the possibility of a hint that the model has a bug.”

That does not sound like the company was living up to the principle of the Rating Agency Act to “improve ratings quality for the protection of investors and in the public interest by fostering accountability, transparency, and competition in the credit rating agency industry.”

The SEC declined to bring an enforcement action “of uncertainty regarding a jurisdictional nexus to the United States in this matter.” The rating committee responsible for the credit ratings of the rated securities met in France and the United Kingdom. The rated securities were arranged by European banks and marketed in Europe.

The Commission notes that, in recently enacted legislation, Congress has provided expressly that federal district courts have jurisdiction over Commission enforcement actions alleging violations of the antifraud provisions of the Securities Act of 1933 or the Exchange Act involving “conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors” or “conduct occurring outside the United States that has a foreseeable substantial effect within the United States.” Dodd-Frank Wall Street Reform and Consumer Protection (Dodd-Frank) Act, Pub. L. No 111-203, § 929P(b)(1), (2) (2010) (to be codified at 15 U.S.C. §§ 77v(c), 78aa(b)). NRSROs should expect that the Commission, where appropriate, will pursue antifraud enforcement actions, including pursuant to such jurisdiction.

It sure sounds like the SEC is looking hard at rating agencies and their culpability for the Great Panic of 2008.

Sources:

Credit Rating Agencies and Conflicts of Interest

Personally, I place a big chunk of blame on the Credit Rating Agencies for the Great Panic of 2008. They were throwing AAA ratings at piles of garbage. There is an inherent conflict in the rater being paid by the security issuer instead of the security purchaser. They are beholden to the customer and the customer wants a great rating for its security.

Exchange Act Rule 17g-5(c)(1) prohibits a Nationally Recognized Statistical Rating Agency from issuing or maintaining a credit rating solicited by a person that, in the most recently ended fiscal year, provided the NRSRO with net revenue equaling or exceeding 10 percent of the total net revenue of the NRSRO for the fiscal year.

“The Commission’s rules were designed to further the goals of the Rating Agency Act to “improve ratings quality for the protection of investors and in the public interest by fostering accountability, transparency, and competition in the credit rating agency industry.” To meet these goals, it is critical that firms provide accurate information to the Commission and the public in their Form NRSROs and financial reports, that they do not have prohibited conflicts, and that they establish, maintain, and enforce policies and procedures to address conflicts of interest.”

LACE Financial submitted an application to register as an NRSRO on October 31, 2007. LACE also requested an exemption from the 10 percent rule, which the SEC granted. LACE requested the exemption because LACE’s largest client (“Firm A”) provided LACE with more than ten percent of LACE’s total revenue during fiscal year 2007. Firm A managed Collateralized Debt Obligation (“CDO”) and hired LACE to prepare regular reports that Firm A distributed to investors in these CDOs.

According to the SEC Release, in an attempt to keep the 2007 revenue from Firm A as close as possible to ten percent of its total revenues for the year, LACE postponed billing Firm A for reports completed during December 2007 until January 2008. In its exemption request letter, LACE stated that its estimated annual revenues from Firm A for 2007 would be $119,000 when calculated on a cash basis and $179,000 when calculated on an accrual basis. “The total value of work performed for Firm A by LACE during 2007 was in fact $233,268.28, approximately 28 percent of LACE’s revenues for the year when properly calculated on an accrual basis as required by GAAP.”

LACE got slapped with a civil money penalty in the amount of $20,000 and an injunction not to break the law again. They also charged Damyon Mouzon, the president of LACE, blaming him for trying to shift revenue and deliberately hide the conflict of interest.

It seems clear to me that the rating agencies were not trying to protect investors. They were trying to generate revenue. That means keeping their clients, the securities issuers happy.

Sources:

Compliance Bits and Pieces for September 3

You are either getting your kids back to school, enjoying a vacation, or enjoying everyone else being out of the office on vacation.

Me? I’m out of the office.

There was still some interesting compliance news this past week:

SEC employees win battle to dress casual By Zachary Goldfarb for Market Cop

Some of the Securities and Exchange Commission’s rank-and-file employees have won a quiet battle with top officials: They no longer have to wear formal business attire when out on the job.

Trust Me – I’m from HR/ IT/ Legal/ Finance ! by Charles H. Green in Trust Matters

These internal staff have exactly the same challenge that their outside brethren have—to successfully persuade and influence others, over whom they have exactly zero direct authority. But it’s worse for internals: first, because they eat in the same lunchroom as their clients and are known by their first names, they tend to not get the same respect that outside experts do.

The Impact of Dodd-Frank – And a Warning to Rating Agencies by Thomas O. Gorman in SEC Actions

The Moody’s Investors Services, Inc. Section 21(a) report released on August 31, 2010 gives an indication of the potential impact of Dodd-Frank. It is based on an existing limitation of the enforcement program, but reflects the removal of that impediment by the legislation. Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: Moody’s Investors Services, Inc., Exchange Act Release No. 62802 (Aug. 31, 2010).

Image is Lone Tree. Footpath from Tealby Thorpe to Willingham Woods. The tree is a relic of a lost hedgerow.
By Kate Nicol