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  • Success! The SEC Caved


    On November 28, Federal Judge Jed Rakoff rejected the SEC’s settlement with Citigroup, a serial offender of the fraud statutes. He lambasted the agency for using their boilerplate language of “neither admit nor deny” instead of asking for a guilty plea in the settlement.  
    Rakoff’s cri de coeur inspired many of us to take up the cause of ending neither admit nor deny. The huge public outcry has forced the SEC to modify their settlement policy. Robert Khuzami, the SEC’s enforcement chief  announced that the regulator will no longer accept “neither admit nor deny” when the defendant has already plead guilty in a parallel Department of Justice (DOJ) case.

    Professor Cornelius Hurley, director of Boston University’s Center for Finance, Law, & Policy, underscored the hypocrisy of the SEC’s settlement policy in the recent proposed settlement of the Wachovia fraud case. The DOJ demanded a guilty plea on the record while the SEC initially used their boilerplate language of “neither admit nor deny” for the settlement of the same charges.

    Hurley, who hopes more judges pull a “rakoff” and challenge the SEC, argues, “It defies logic that the two agencies can produce such different settlements. With a guilty plea already on the record in the Wachovia fraud case, the SEC couldn’t continue to justify their decision to not insist on a confession by arguing that a guilty plea would open up the defendant to civil suits.”

    Former NY Governor Eliot Spitzer, known as the “Sheriff of Wall Street” during his tenure as NY State Attorney General, applauds the SEC decision, but does not think it goes far enough. “The days of the neither admits nor denies must be over. We need more judges like Jed Rakoff that do not rubberstamp the SEC’s deals,” said Spitzer.

    Posted by Laura Goldman on 01/08/12
  • 12/13/11
  • Spitzer and BU's Hurley Discuss SEC Reform




    With President Obama and SEC Chairman Mary Schapiro called for increased penalties for violators of securities laws; it seemed prudent to check if this would actually protect the investing public. Professor Cornelius Hurley, director of Boston University’s Center for Finance, Law & Policy, supports the escalation in fines. “Companies will think twice about committing fraud if they can’t settle for chump change,” he said.

    Hurley’s preferred reform would be to combine the SEC and CFTC. Combining the two agencies would save money by eliminating the duplication of oversight and allow for a more efficient deployment of a staff and other resources. “The collapse of MF Global suggests that we are paying a price for not combining the CFTC and SEC, which was suggested in a white paper about financial reform developed by the Treasury Department soon after Obama arrived in town,” he said. “Anyone can see that an organizational chart where two regulators are regulating the same space is absurd.”

    Unfortunately, the greed of members of Congress killed the unification efforts. “The House and Senate Financial Services Committees oversee the SEC while the Agriculture Committee administers the CFTC.  Members of the agricultural committee did not want to lose the tremendous contributions to their campaigns from the commodities firms,” explained Hurley. He marvels at the hypocrisy of the Republican Party for championing the free market discipline, yet be against any efforts to increase transparency.

    Former NY Governor Eliot Spitzer emphasized a different solution.  “The days of the neither admits nor denies must be over.” Neither admits nor denies is the controversial, decade’s long SEC practice of not extracting a confession from guilty parties in a settlement so that they can encourage settlements and avoid lengthy and costly trials against well-funded defendants.

    Spitzer, known as the “Sheriff of Wall Street” during his tenure as NY State Attorney General, lauded Federal Judge Jed Rakoff for rejecting a proposed SEC settlement of Citigroup’s securities fraud charges partially over the lack of an admission of guilt on the part of repeat offender Citigroup. “We need more judges like Jed Rakoff that do not rubberstamp the SEC’s deals,” he said.

    Hurley hopes the New Jersey federal judge overseeing the settlement of securities fraud by Wachovia, now Wells Fargo, considers the Rakoff decision when making her own decision. Although the Department of Justice insisted on an admission of guilt for the Wachovia settlement, the SEC inexplicably still used their boiler plate language of “neither admits nor denies.” Hurley said, “It defies logic that the two agencies can produce such different settlements. “

    The one problem with the elimination of “neither admits nor denies” is that it is difficult to sanction corporations that provide jobs for thousands of people. Spitzer conceded, “One of the Occupy Wall Street signs made the point – “Until the State of Texas executes a corporation, corporations are not people”.  You cannot just kill Citibank.”

    Under the current system, it is the shareholders, not the corporate executives that committed the wrongdoing, that bear much of the financial pain of a corporation’s malfeasance. Spitzer wants to change that. “There must be individual responsibility. “Right now, the SEC now uses restitution as a proxy,” said Spitzer. “Executives of corporations must be held accountable for the corporation’s bad behavior.”

    Besides no allocution of guilty behavior, the SEC settlement required Citigroup to only pay $285 million -$160 million for disgorgement of profits and $125 million in fines. Goldman Sachs for a similar offense paid $535 million in penalties. Spitzer and many others were shocked at this light punishment for repeat offender Citigroup.

    “The issue of corporations’ recidivism must be addressed,” he said. “When I was an assistant district attorney, I worked in the career criminals unit. Those that had committed more than two felonies were punished more severely. They were sent away for a long time.  For corporations that repeatedly offend, we need to increase exponentially the financial penalties and insist on structural changes such as compensation.” He urges the SEC to drop standard practice and use creativity to tackle recidivism.

    None of the experts contacted thinks that there needs to be additional laws or new agencies to regulate the financial industry. Barbara Roper, director of investor protection at the Consumer Federation of America, just wishes that Congress would increase the budget of the SEC.

    Spitzer urges the SEC to be more aggressive. “If Congress does not like it, take your case to the public,” suggests Spitzer. “They have enough power. They just need the will to use it.”

    Hurley pointed out that the collapse of MF Global violated long existing securities laws about customer account segregation not newer regulations like Dodd Frank. “Regulation is about individuals, culture.  Former Federal Reserve Chairman Alan Greenspan could have protected the mortgage borrower with powers given to him in the Home Owners Equity Protection Act had he been a different person – not a free market champion and devotee of Ayn Rand,” he said.

    He was reserved in his praise for the current group of regulators. He was happy to see that Shapiro is changing the SEC culture by hiring more financial professionals to investigate fraud. Yet, there was no reason that she did Wall Street's bidding by lobbying successfully to exclude brokerage firms from the oversight of the Consumer Financial Protection Bureau. Hurley wonders how CFTC Chairman Gary Gensler, a former Goldman Sachs colleague of former MF Global chairman Jon Corzine, “could have seen no conflict of interest while regulating MF Global but now that the CFTC is investigating wrongdoing he suddenly has a conflict of interest.”

    Spitzer may have the best insight into the problems with the SEC, “Whenever I was down there, I could not wait to get out of there.”

    Posted by Laura Goldman on 12/13/11
  • 11/6/11
  • MF Global Bankruptcy Proves Need For Privatization of Financial Regulation



    Here we go again. After all of the public outcry to rein in Wall Street, the eighth largest commodities trading firm in the United States has declared bankruptcy, three short years after the Lehman Bankruptcy.  This bankruptcy comes with a twist - $593 million of customer money is missing. The FBI, as well as the securities regulators, is now camped out the firm's headquarters. Will we ever learn?


    I have been arguing for privatization of financial regulation for some time. This bankruptcy proves that we need to find a new paradigm for regulation. The regulations and regulators that we have now in place are not working. After the last financial crisis, it seems incredible that there were no rules in place to limit the leverage and concentration of trades done with firm's money. Once again, a trader could make huge bets without any clawback of his earnings. 



    My new paradigm for securities regulations is to empower outside lawyers, with a vote by the commissioners, with the ability to investigate securities and commodities firm, prosecute violators and pocket the fines imposed. I am working on this with the community reporting news site, Spot. us. More details here. 



    Regulators are always Johnny Come Lately if they arrive at all. The CTFC did not detect the lack of controls   over the segregation of client money. Exactly when MF Global clients desperately need his insight and wisdom, the head of the CFTC, Gary Gensler, has withdrawn from any involvement in the case due to his close relationship with the firm's former CEO Jon Corzine, his former boss at Goldman Sachs.  Funny, that close relationship never seemed to be a problem when Corzine was lobbying for what he wanted.


    MF Global clients may lose as much as 40% of the capital in their personal accounts. Some of these losses could have prevented if regulators were paying attention,  Many institutional investors, having their ear to the ground, rushed to withdraw their money last week. A money manager in Chicago told the New York Times that his firm, hearing the rumors, pulled out $5 million last week. The CTFC gave sophisticated investors an advantage by not blocking last week's hastily arranged withdrawals. Maybe, the withdrawals can be clawed back like they are in a Ponzi scheme.


    Corzine was using the commodities firm, which was also a registered broker-dealer, as his own private casino. He was making huge bets, leveraged 40 to 1, on European sovereign debt with the firm's money.  If he won, he would become richer. If he lost, he would walk away as he has done.


    The Financial Industry Regulatory Authority, a private organization, first raised the alarm about MF Global's risky bet. Then the panic spread. MF Global tried to sell itself to Interactive Brokers but the missing client money precluded a deal. The firm may not have been properly segregating customer money.; It  may have been using the money to shore up their under the water positions.


    We might be able to write this off this speculative use of firm firm as a one time incident except that Corzine and the CEOs of other commodity firms were lobbying the CTFC  to even further relax the rules surrounding commodity firms' uses of customers' money. Gensler wanted to tighten the rules, but apparently was unable to stand up to the bulldozer that is Corzine. The Republican commissioners were also against more regulation. Gensler isn't perfect. When he served in the Clinton White House, he was against more regulation of derivatives. 


    The coziness of Gensler and Corzine may be unseemly but probably had very little effect on the final result. When I was at Wharton, Gensler and his twin brother were the most intelligent and best prepared students in every class I attended. If Gensler was blindsided by Corzine's actions, then probably no one could have seen it. When traders leave Wall Street and become Washington regulators, something appears to happen to them. It must be the brand of cool aid they serve in Washington. 


    While many treat Elizabeth Warren as a hero for dreaming up the Consumer Financial Protection Bureau, this bureau also would not have prevented the MF Global disaster.  More regulations and regulators are not the answer. Smart people in the private sector must be given tools by which they can protect the consumer. Regulators are not up to the job. 


    There may be one good thing to come out of the MF Global bankruptcy. While it is a commodity firm and not a bank, the bankruptcy should shore up support for the Volcker Rule, which is meant to curtail speculative investments by the banks. 

    Posted by Laura Goldman on 11/06/11
  • 10/1/11
  • A Case Study of the SEC at Work


    With the SEC admitting defeat and announcing a change strategy to target negligence instead of  the harder to prove fraud, I thought it was a good time to discuss my idea of saving the SEC by outsourcing its work. I am developing  my idea with the help of the community reporting site,

    Private lawyers would be allowed to present a SEC staffed tribunal with customer complaints or credible allegations of violations of securities law. The tribunal would then put it to a vote to decide if the investigation by the private lawyers should proceed.. Once the investigation is authorized, the lawyers would be armed with full investigative powers of the government including subpoena. Upon the finding of wrong doing,  the staff tribunal would impose punishment. The lawyers would be paid from the fines imposed.
    Everyone knows about the failure of the SEC to detect the Madoff fraud. More recently, SEC attorney Darcy Flynn blew the whistle and revealed that the SEC has hindered investigations and broken National Archive rules by destroying documents that are required to be kept for 25 years.

     My personal experience of  trying to inform the SEC about a potential fraud might be more illustrative of the reasons that government oversight of the securities markets is not enough. When I discovered several years that serial con man Glenn Manterfield of England had registered the hedge fund Lydia Capital that he co-founded with Evan Andersen with the SEC, I immediately contacted and alerted them that he had stolen money from me and clients of mine.

    I also informed them that he lied about his criminal history on the SEC  form ADV. The form asks about the applicant's criminal history and requires registrants to update the SEC about any developments. He had checked that he had no criminal history and had not informed him of his latest arrest, which occurred after his registration. The SEC indictment later said he lied about his extensive criminal record.

    Although we regularly throw around the term international financial markets, the SEC has not adjusted to the globalization,. The SEC can only access American fingerprint databases so there was no way to discover Manterfield's British criminal history. A SEC lawyer told me that they had to get special permission to make a transatlantic call so they have no regular ability to check on international applicants for registration. It is negligent to register international applicants if you can’t run the proper background checks.

    Requiring hedge funds to register was one of the knee jerk responses of Congress to the Wall Street bailouts, but it is not the right answer. No one contemplated the pitfalls of registration. Manterfield's bone chilling retort to why he registered shows the downfall of this lack of foresight - "We were just two guys with an idea. The SEC registration gave us credibility."

    When the SEC did not proceed with an investigation, I contacted the office of William Galvin, the Secretary of the Commonwealth of Massachusetts. After Galvin's office started the prosecution, a light finally went on at the SEC and they took over the prosecution. They later apologized to me for ignoring my tip.

    The SEC closed Lydia and appointed a receiver to recover assets. They imposed a lifetime ban and a $2.91 million fine on Manterfield for defrauding 60 investors of $34 million. 

    Unfortunately, this was not the end of the story. Even though I warned the SEC that Manterfield could be running multiple cons at once, they didn't check. I complained again to Galvin's office. They issued a cease and desist order for his second entity, Osiris FX.  The US Attorney of Massachusetts, which rarely prosecutes securities violations, declined to prosecute even though they had the cooperation of the British police.

    Without my intervention and a little luck, Lydia Capital could have defrauded investors for years. Lydia Capital happened to be headquartered in Boston. Massachusetts' Galvin is one of the few state law enforcement officials aggressive about prosecuting securities crimes. Anywhere else in the country, my warnings would have also been ignored by the state authorities.

    Galvin stepping in might have saved the day for Lydia's investors but it is not a permanent solution. We need cops patrolling the securities beat. From my varied interactions with the SEC, I do not think that they are up to the job. They also do not seem to have any incentive to look for fraud. 

    Outside lawyers need to step in and supplement the investigative staff of the SEC.  We already outsource some aspects of law enforcement such as bounty hunting.  Private SEC investigations would be the next logical step.

    Posted by Laura Goldman on 10/01/11
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