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WASHINGTON — Bernard L. Madoff haunts these corridors like the He-Who-Must-Not-Be-Named of Wall Street.

David Goldman for The New York Times

A member of a new Securities and Exchange Commission enforcement team, Bruce Karpati in New York.

In the headquarters of the Securities and Exchange Commission, Mr. Madoff’s name is rarely spoken. More than seven months after he was sentenced to prison for orchestrating a global Ponzi scheme, shaken S.E.C. employees are still struggling to come to grips with how they failed to catch him before it was too late.

Many here refer to the scandal — a $65 billion fraud that, despite several red flags, went undetected by the S.E.C. for more than two decades — as “the event” or “the incident.”

It is the job of Robert S. Khuzami, the S.E.C. head of enforcement, to unmask the next Madoff — and, equally daunting, to convince skeptics that the commission can reassert itself and adequately police Wall Street.

Since arriving at the S.E.C. a year ago this month, just as the Madoff scandal was grabbing headlines, Mr. Khuzami has cut red tape, created specialized teams to plumb hedge funds and other worrisome areas and tried to make the S.E.C. quicker and more nimble.

Unlike some at the commission, Mr. Khuzami, 53, talks openly about the Madoff fiasco. “For a group of people committed to investor protection and prevention, the tragedy of investors’ losses are not lost on anyone,” he said in an interview in his bright, corner office in Washington.

While Mary L. Schapiro, the chairwoman, is the public face of the commission, Mr. Khuzami and his lieutenants are the officers on the beat. Their first challenge is to shake off the psychic blow of the Madoff affair. Not since the 1950s, when budget cuts and deregulation defanged the commission, have its stature and influence sunk so low. Mr. Khuzami, a straight-talking former federal prosecutor and Wall Street executive, says he wants to infuse the S.E.C. with the ethos of a start-up company, making it faster, more proactive and even a bit entrepreneurial.

The practical challenges are formidable. Wall Street vastly outdoes the S.E.C. in terms of people, money and, many in the financial industry argue, talent. The administration has requested a budget of $1.3 billion for the S.E.C. for 2011. Hedge fund stars can make that in a year. Big banks usually pull in the equivalent in revenue in a single week.

On Monday, what S.E.C. officials had hoped might be a quick victory in a prominent case instead turned into another potential headache. Mr. Khuzami and a squadron of S.E.C. lawyers filed into a New York courtroom where the commission was trying to end its long investigation into the takeover of Merrill Lynch by Bank of America. But District Judge Jed S. Rakoff — who last September rejected as too low an earlier $33 million settlement that the S.E.C. had reached with Bank of America — again raised questions about the commission’s handling of the case. If he rules against the second settlement, for $150 million, the case is set to go to trial on March 1.

At the heart of Mr. Khuzami’s effort is the commission’s new Office of Market Intelligence, a clearing house for the tips and referrals that stream into the S.E.C. The head of that unit is Thomas A. Sporkin, son of Stanley Sporkin, the outspoken retired federal judge who earned national recognition in the 1970s for his investigations of corporate malfeasance as director of enforcement at the commission.

The S.E.C. also has established five investigative units, hoping to transform some of its many generalists into specialists. One of those units focuses on so-called structured products and securitization, which spawned some of the most dangerous instruments of the financial collapse. The others focus on the market in municipal securities, cases stemming from the Foreign Corrupt Practices Act, market abuses like insider trading, and asset management, including hedge funds.

The S.E.C. has been criticized for meting out relatively light punishments in some recent cases. The commission also has not satisfied critics on Capitol Hill — and many ordinary Americans — who had hoped to see charges leveled at banking executives after the financial collapse.

Mr. Khuzami recognizes that the cases the S.E.C. brings, or does not bring, will define his tenure and, possibly, the future of the commission. “It’s all about the cases in the end,” he said.

It may surprise many just how difficult it has been for the S.E.C. to act. Under Ms. Schapiro’s predecessor, Christopher Cox, investigators had to get approval from the five S.E.C. commissioners to negotiate financial penalties against corporations. She lifted that restriction. Enforcement lawyers had always had to get permission from the commission to open an investigation involving subpoenas. She has authorized the enforcement division to do that on its own.

Team Khuzami hardly comes across as the Untouchables, but members say they are energized and up to the job.

Kenneth Lench, a lawyer who heads the structured products group, is trying to become an expert in an arcane corner of Wall Street. He totes heavy textbooks on securitization law and says he now reads trade publications like Derivatives Week, the bible of the market in financial derivatives. He also attended an industry conference last month with 10 other S.E.C. lawyers.

It is a real challenge to keep up with the street in developing these products,” Mr. Lench said. He said he hoped to recruit people from Wall Street, and to acquire technology that would put the S.E.C. on a more equal footing with the industry.

Daniel Rosenbaum for The New York Times
Elaine C. Greenberg in Washington.

Daniel M. Hawke, head of the market abuse unit, is also looking for outside talent. He said he recently received an e-mail message that read: “I know where the bodies are buried. I’ve been on the Street for 20 years.”

Still, Mr. Hawke is particularly excited about the prospect of applying the expertise gained in one case to others. For instance, he recalled a case stemming from a tip about unusual stock trading before a merger of two drug companies.

After poring over thousands of trading records, S.E.C. investigators found a pattern of rapid buying and selling a brokerage firm in Estonia. Then they mined trading data from the firm and discovered that two traders had hacked into Business Wire, letting them see news releases involving a wide range of companies before they were released. With enough evidence to charge the traders with securities fraud, the S.E.C. quickly froze more than $32 million in 200 accounts at the Estonian brokerage firm.

“We need to sustain what we learned from that case,” Mr. Hawke said.

It is too soon to know whether the announcements will lead to the revitalization of an institution viewed for a long time as captive to the industry it regulated.

Joel Seligman, an S.E.C. historian, said it needs two things to turn itself around: a sustained period of serious enforcement and several structural repairs, the most important of which is becoming self-financed through some form of fees or penalties so it is no longer hostage to Congressional budget masters.

The S.E.C. has hired some talent from Wall Street. Norm Champ, the former general counsel of Chilton Investment Company, a multibillion-dollar hedge fund, was named last year as an associate director in the examinations group in New York. Richard Bookstaber, a former Wall Street risk manger, joined the new division of risk, strategy and financial innovation.

But a relatively tight budget and antiquated technology still pose major challenges for the S.E.C., outsiders say.

The S.E.C. plans to propose a rule this spring to require the self-regulatory agencies like NYSE Euronext, which operates the New York Stock Exchange, to give the commission the same data they receive. But it is unclear who would pay for such a measure and what systems the S.E.C. would need to handle that much data.

Despite the S.E.C.’s recent travails, the elder Mr. Sporkin is optimistic. “Khuzami is really shaking things up,” he said. “We have a new chef in the kitchen, and now we get to try his cooking.”

Louise Story contributed reporting from New York.

Mr. Gorman's videos




SEC REMEDIES: TIME FOR A REASSESSMENT

THIS WEEK IN SECURITIES LITIGATION (February 5, 2010)
A PRELIMINARY INJUNCTION IN ANOTHER PONZI SCHEME CASE »
SEC REMEDIES: TIME FOR A REASSESSMENT

Commissioner Louis Aguilar, in remarks at SEC Speaks last Friday, called for a revamping of the Commission’s 2006 Statement on Corporate Penalties, discussed here. While Commissioner Aguilar makes a good point, any reassessment should begin with a careful undertaking in the broader context of evaluating all of the SEC’s remedies as part of a comprehensive program, not just corporate penalties. See Remarks of Commissioner Luis Aguilar, SEC Speaks, Washington, D.C., February 5, 2010.

Commissioner Aguilar focused only on corporate penalties. Penalties are changing the complexion of SEC enforcement from remedial to punitive. The Commission has had the authority to impose penalties since 1990 with the passage of the Remedies Act. Reliance on huge penalties, however, really began with the WorldCom settlement. Since then, there has been an increasing use of large corporate penalties.

Penalties are punitive and seek to assure future compliance through deterrence. The idea is that imposing a huge fine punishes the wrong doer. Others will be deterred from engaging in wrongful conduct by seeing the huge penalty. The validity of this rationale is difficult to assess at best. It does, no doubt, give SEC enforcement a harsh edge which seems more in tune with criminal enforcement. Interestingly, despite the increasing use of large penalties in recent years, respect for SEC enforcement has declined.

Prior to the Remedies Act of 1990, the SEC relied on equitable remedies. The injunction and related ancillary relief were the only remedies available. Those remedies sought to ensure future compliance, but not through a hard edge punitive approach. Rather, the Commission took a forward-looking, creative approach, crafting mechanisms which would help bring a new ethics to the marketplace. New compliance procedures, monitors and other devices were employed not to punish, but to effectively give the Commission a continuing presence inside the company in a kind of on-going monitoring program. While some may have questioned the effectiveness of this approach, there is little doubt that SEC enforcement was highly respected and effective during those years.

The Remedies Act, with the authority to impose penalties, was viewed by Congress in 1990 as a supplement to the Commission’s arsenal. Penalties were not intended as a substitute for existing remedies, but only as a supplement to be used in certain situations. The idea was to add authority to an existing, highly effective program, not replace it.

By 2006, there was an increasing reliance on corporate penalties by the Commission. Under that statement issued that year, the use of corporate penalties was largely a function of two factors: 1) whether there is a direct benefit to the corporation as a result of the violation; and 2) if the penalty will recompense or further harm the injured shareholders.

Commissioner Aguilar termed the 2006 guidelines approach “misguided” and called for it to be revamped. Since the purpose of a penalty is to punish and deter, the key question in determining whether there should be a penalty is the conduct, not the factors in the 2006 release. The current guidelines do not focus on the conduct and, accordingly, should be revamped, according to Commissioner Aguilar. The Commissioner did not outline specific proposals for revamping the guidelines.

While Commissioner Aguilar raises an important point, any revamping of SEC remedies requires a broader focus. A broader inquiry should be undertaken to determine not just the standards for corporate penalties, but the overall purpose of SEC remedies and how they are to be used. While punishment and deterrence through large penalties may be appropriate in some instances, clearly there are others where the traditional remedial approach may be more effective. Focusing on only one option such as penalties misses the broader context and runs the risk of over emphasizing one remedy at the expense of others. Accordingly, when there is a reassessment of corporate penalties it should be done in the context of analyzing all of the remedial options available to SEC Enforcement to ensure that the most effective approach is used going forward.

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THE IMPACT OF COOPERATION
July 27, 2010

Cooperation can have a significant impact on the outcome of an enforcement action for the company and its executives. TheSeaboard Release in 2001, regarding corporate charging and cooperation principles, for example offers the prospect of no charges or reduced sanctions in exchange for cooperation. Last January, the Commission expanded its efforts to secure cooperation to individuals while also broadening its proposals to business organizations as discussed here.

For the company or individual considering the question of cooperation, the potential impact of cooperation can be difficult to assess. A recent study and a case last week shed some light on the question.

In a forthcoming paper tiled “SEC Enforcement: Does Forthright Disclosure and Cooperation Really Matter?” (available here), Professor Rebecca Files finds “that cooperation increases the likelihood of being sanctioned, perhaps because it improves the SEC’s ability to build a successful case against the firm. However, both cooperation and forthright disclosures are rewarded by the SEC through lower monetary penalties.” The paper is based on an analysis of 1,249 companies which restated their financial statements between 1997 and 2005. The study reports that as a reward for cooperation, the SEC reduces firm penalties on average by $37.4 million when the company initiates its own investigation into the law violation. In addition, penalties are reduced on average by $609,000 for each week earlier that the restatement is announced to the public.

A concrete illustration of cooperation can be seen in the recently filed settled enforcement action against the owner and two executives of Sunrise Living, Inc. SEC v. Sunrise Senior Living, Inc., Civil Action No. 1:10-CV-01247 (D.D.C. Filed July 23, 2010). This accounting fraud action was brought against the company and two of its former senior officers, Larry Hulse, former CFO, and Kenneth Abode, former Treasurer.

The Commission’s complaint alleges an earnings management scheme that began in the second half of 2003 and continued for 2005. It spawned two false annual reports, six incorrect quarterly reports, a false registration statement which incorporated the flawed financial statements and incorrect SOX CFO certifications. The scheme ended with a March 2008 restatement.

The complaint, built on allegations of intentional conduct primarily by Mr. Hulse, centers on improper accounting in the corporate bonus accrual account and the health and dental reserve to make earnings forecasts. For example, guidance for the fourth quarter of 2003 informed investors that earnings would be between $2.63 to $2.65 per share for fiscal year 2003 and between $0.66 and $0.68 per share for the quarter. About two weeks before the fiscal year end internal projections showed that EPS for the fourth quarter would be $0.57. According to the complaint, the day after this projection was made Mr. Hulse, who was aware of it, directed his accounting staff to eliminate the balance in the 2003 bonus accrual account for the company. Yet, before the earnings release for the quarter was issued, senior management, including Mr. Hulse, agreed to pay the bonuses. The company, however, did not have a reserve since it had been released.

In subsequent quarters, similar actions were taken. In each instance, the action was taken to meet guidance. In each instance, the adjustments made to the reserve were improper and, in the end, were restated.

In resolving the case, the Commission gave Sunrise credit for what it termed “its substantial assistance in the investigation.” As is typical, there is no delineation of the steps which constitute that assistance. It does however appear to be reflected in the settlement.

• The company settled by consenting to the entry of a permanent injunction prohibiting future violations of Exchange Act Sections 13(a) and 13(b)(2)(A) and (B). No penalty was imposed.

• Mr. Hulse consented to the entry of a permanent injunction prohibiting future violations of Securities Act Sections 17(a)(2) and (3) and Exchange Act Sections 13(a), 12(b)(2)(A) and (B) and 13(b)(5). He also agreed to pay disgorgement of $83,333 and prejudgment interest and a civil penalty of $50,000. In a related administrative proceeding, Mr. Hulse consented to the entry of an order under Rule 102(e) suspending him from appearing or practicing before the Commission as an accountant, with a right to reapply after three years.

• Mr. Abode was only named as a defendant in count two, which alleges violations of Exchange Act Section 13(a), and count three, alleging violations of Exchange Act Sections 13(b)(2)(A) and (B) and Section 13(b)(5). According to the Commission’sLitigation Release No. 21600 (July 23, 2010), Mr. Abode consented to pay a civil penalty of $25,000 (his settlement papers are not available at this date). In a related administrative proceeding, he consented to the entry of a cease and desist order from causing any violations of Section 13(b)(5) of the Exchange Act and related rules. He also agreed to the entry of an order denying him the privilege of appearing or practicing before the Commission as an accountant with a right to reapply after one year.



THE SEC IG EXPANDS ITS INQUIRY ON GOLDMAN: TO MUCH OF A GOOD THING?
July 26, 2010

When the SEC filed its enforcement action against Goldman Sachs, it sparked a wave of criticism. Politicians on Capitol Hill argued there were news leaks and the suit was timed to suit the Administration which was seeking to pass what is now Dodd-Frank Act. The SEC’s Inspector General opened an investigation focused on the claims in response to a letter from Republican congressman Darrell E. Issa. Now the IG is expanding his inquiry to include more allegations from Capitol Hill. Now the question is whether the settlement was politically timed. While there is no doubt that Inspector Generals serve a laudable purpose, can there be too much of a good thing?

The SEC’s Office of Inspector General, like those at other agencies, is an independent office. Its purpose is to audit the programs and operations of the Commission to ensure proper operations. According to the Inspector General’s posting on the SEC’s website, the “mission of OIG is to detect fraud, waste and abuse and promote integrity, economy, efficiency and effectiveness in the Commission’s programs and operations.” These are commendable goals which in many ways mirror the SEC’s mission to bring a new ethics to the marketplace.

When the SEC’s Inspector General conducts an inquiry, it is essential that the investigation be focused to achieve the goals of its office. In part, this means that, while seeking to promote the integrity and effectiveness of the SEC, the IG should avoid impeding or otherwise interfering with the Commission’s essential law enforcement functions. It is also means that the IG should not become a political tool of Capitol Hill, something which would inject politics into the SEC’s processes rather that serve as a safeguard against such an occurrence.

The inquiry being conducted by the SEC’s IG raises critical questions about compliance with its mission. The investigation began immediately after the Commission filed what is undoubtedly its most high profile enforcement action in years. As with many high profile cases, it generated controversy. Yet, in response to Capitol Hill, the IG almost immediately stepped into the spotlight, announcing the opening of an investigation into the filing of Goldman.

Investigating an open enforcement action has, at a minimum, the prospect of interfering with a critical SEC function. There can be little doubt that the IG’s inquiry has been a distraction for the Commission staff tasked with litigating a very difficult case against a significant opponent. Equally clear is the fact that the IG inquiry undercut the Commission’s credibility in the marketplace thereby detracting from the merits of the Goldman case. Since the questions being investigated by the IG had nothing to do with the merits of the action, there is no reason the inquiry could not have been conducted later. At a minimum, it should have remained non-public and confidential.

Perhaps more importantly the IG’s inquiry has the potential to undermine the Commission’s processes and of its office. The inquiry is supposed to focus on whether the case against Goldman is tinged with partisan politics. Yet, it was opened and expanded as a direct result of clamor from Capitol Hill and thus risks injecting partisan politics into the process in the name of ensuring against such a prospect. Such needless risk does not promote the integrity of the SEC’s processes and it is inconsistent with the goals of the IG’s office. While there is no doubt that the IG does a commendable job, timing is often crucial and sometimes there can be too much of a good thing. This is one of those times.



THIS WEEK IN SECURITIES LITIGATION (July 23, 2010)
July 23, 2010

The Dodd-Frank bill, now signed into law, contains a number of provisions enhancing SEC Enforcement. SEC Chairman Mary Schapiro estimates that the Commission will be required to hire an additional 800 people to implement the Act. The CFTC, however, is moving quickly to implement its new authority, publishing a list of rule making initiatives regarding derivatives.

SEC enforcement filed a settled action against computer giant Dell Inc, its founders and several officers. The company agreed to pay a large fine, consented to a fraud and books and records injunction and remedial procedures. Mr. Dell and others agreed to a Securities Act Section 17(a)(2)&(3) negligence based injunctions and other relief. Criminal prosecutors continued bringing investment fund fraud cases, while the FSA resolved a father and son insider trading action.

Market reform

SEC enforcement: The Dodd-Frank Wall Street Reform and Consumer Protection Act, signed into law, has a number of provisions which enhance the authority of SEC Enforcement as discussed here. They include provisions: (1) enhancing the antifraud provisions under Exchange Act Sections 9, 10(1) and 15; (2) on extraterritorial jurisdiction, effectively overruling the Supreme Court’s decision in Morrison and extending the jurisdiction in this area of the government and SEC; (3) extending aiding and abetting authority for the SEC under the Securities Act, the Investment Company Act and the Investment Advisers Act; (4) clarifying the SEC’s authority over formerly associated persons of regulated entities; (5) imposing joint and several liability on control persons in SEC actions; (6) authorizing the nationwide service of subpoenas in SEC district court enforcement actions; (7) authorizing the SEC to impose collateral bars; and ( expanding the SEC’s authority to impose penalties to all cease and desist proceedings. The Act also imposes certain time limits on investigations and inspections.

CFTC rule making:

The CFTC published a list of its rule making relating to over-the-counter derivatives under Dodd-Frank. The list includes: (1) the comprehensive regulation of swaps dealers and major swap participants; (2) clearing; (3) trading; (4) particular products; (5) enforcement; (6) position limits; and (7) other titles.

SEC enforcement action

Financial fraud: SEC v Dell Inc., Civil Action No. 1:10-cv-01245 (D.D.C. Filed July 22, 2010) is a settled action alleging violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 13(a), 12(b)(2)(A) and (B). The defendants are Chairman and CEO Michael Dell, former CEO Kevin Rollins, former CFO James Schneider, former Assistant Controller Leslie Jackson and former regional Vice President of Finance Nicholas Dunning. The complaint alleges that Intel Corporation made exclusivity payments to Dell so that the company would not use CPUs manufactured by its rival Advance Micro Devices, Inc. The payments grew from 10% of operating income in fiscal 2003 to 38% in fiscal 2006 to 76 % in the first quarter of fiscal 2007. When Dell announced in the second quarter of fiscal 2007 that it would begin using ADM CPUs, Intel sharply cut the payments resulting in the equivalent of a 75% decline in Dell’s operating income. The defendants never disclosed that the company was able to meet its earnings targets as a result of the Intel payments. At a second quarter 2007 earnings call, investors were not told that the sharp drop in operating results was caused by Intel’s action. Rather, the drop was attributed to other causes. The company also maintained a cookie jar reserve from the third quarter of fiscal 2003 through the first quarter of fiscal 2005.

To settle the action the company consented to the entry of a permanent injunction prohibiting each of the sections cited in the complaint, agreed to enhance its Disclosure Review Committee and disclosure processes and to retain an independent consultant to make recommendations. The company also agreed to pay a $100 million civil penalty.

Messrs. Dell and Rollins consented to the entry of a permanent injunction prohibiting future violations of Securities Act Sections 17(a)(2) & (3) and aiding and abetting violations of Exchange Act Sections 13(a). Each executive agreed to pay a civil penalty of $4 million. Mr. Schneider consented to the entry of an injunction prohibiting future violations of Securities Act Section 17(a)(2) &(3), Exchange Act Section 13(b)(5) and aiding and abetting violations of 13(a) and 13(b)(2)(A) & (B). He also agreed to pay disgorgement of $83,096 along with prejudgment interest. Messrs. Dunning and Jackson consented to the entry of permanent injunctions prohibiting future violations of Exchange Act Section 13(b)(5) and from aiding and abetting violations of Sections 13(a) and 13(b)(2)(A)&(B). Mr. Dunning also agreed to pay a civil penalty of $50,000. Messrs. Schneider, Dunning and Jackson also consented to the entry of an order under Rule 102(e) suspending each from appearing or practicing as an accountant before the Commission with a right to reapply after five years for Mr. Schneider and three years for Messrs. Dunning and Jackson.
See also Litig. Rel. 21599 (July 22, 2010).

Kickbacks: SEC v. Langford, Case No. CV-08-0761 (N.D. Ala. Filed April 30, 2008) is the first enforcement action involving security based swap agreement, discussed here. It centers on a kickback scheme involving Larry Langford, the mayor of Birmingham, Alabama, William Blount, the co-owner and chairman of Blount Parris, a municipal securities broker and Albert LaPierre, a lobbyist and former executive director of the Alabama Democratic Party. Mr. Blount, his brokerage firm, and Mr. LaPierre settled with the Commission, consenting to the entry of permanent injunctions prohibiting future violations of Securities Act Section 17(a), Exchange Act Sections 10(b) and 15B(c)(1) and certain rules of the Municipal Securities Rulemaking Board. The SEC’s claims for disgorgement and civil penalties were dismissed. See also Litig. Rel. 21595 (July 20, 2010). Previously, the defendants in the Commission’s case were indicted on criminal charges based on the same scheme as discussed here. Mr. Blount also consented in a related administrative proceeding to the entry of an order barring him from associating with any broker, dealer or municipal securities dealer. In the Matter of William B. Blount, Adm. Proc. File No. 3-13974 (July 22, 2010).

Criminal cases

Investment fund fraud: U.S. v. Brown (S.D.N.Y. Unsealed July 22, 2010) is a criminal complaint charging securities fraud, wire fraud and money laundering against CPA Laurence Brown. According to the court papers, beginning in 2008 Mr. Brown, a principal in an accounting firm, raised about $2 million from investors who were solicited to purchase shares in Infinity Reserves-Tennessee, Inc. The funds were to be used to upgrade a natural gas pipeline in Tennessee. In fact, the shares were fictitious and most of the money was diverted to the defendant’s personal use. The Commission filed a parallel proceeding against Mr. Brown and his partner Ronald Mangini, SEC v. Brown, Civil Action No. 10-CV-5564 (S.D.N.Y. Filed July 22, 2010). Both cases are in litigation.

FINRA

SunTrust Investment Services, Inc., and two of its brokers, David Bredenburg and another broker, from 2004 through November 2006 engaged in a pattern of unsuitable short term UIT, CEF and mutual fund transactions in the accounts of seventeen customers, most of whom were elderly and/or disabled. In addition, FINRA concluded that the two brokers recommended to ten of those customers unsuitable purchases and sales of securities on margin. The firm settled the action by agreeing to pay $1.44 million. About $900,000 of that amount is a fine while nearly $224,000 constitutes disgorgement. The remaining $540,000 is restitution to the customers. Mr. Bredenburg was permanently barred from the industry in a prior proceeding. The supervisor of the two brokers, Donald Mattran, was suspended for six months from acting in any principal capacity and fined $10,000.

Court of appeals

Fiduciary duties: U.S. v. Lay, No. 08-3893 (6th Cir. July 14, 2010) is, as discussed here, an appeal by an investment adviser from his conviction on violations of the Advisers Act and other charges. Defendant Mark Lay is an investment adviser. His client is Ohio Bureau of Workers’ Compensation. Mr. Lay’s company, Capital Management, Inc. started managing the Bureau’s investment in a long-term bond fund, the Long Fund. Subsequently, in 1998 Mr. Lay started a hedge fund, the Active Duration Fund. The Bureau moved $100 million of its investment from the Long Fund to the Active Duration Fund. The agreement set a non-binding 150% leveraging guidelines which Mr. Lay exceeded. As losses grew at the hedge fund the Bureau transferred additional funds to it but the losses continued and most of the investment was lost. The losses resulted in large part from excessive leverage far beyond the guidelines. The jury was instructed on the elements of Adviser Section 80b-6-(1) or 80b-2(2) or 80b-6(4). The court also instructed the jury that it could find as a matter of fact that Mr. Lay had a fiduciary duty to the Bureau with regards to its investment in the hedge fund. The jury returned verdicts of guilty which the Sixth Circuit affirmed. Mr. Lay did not dispute the fact that he had an investment adviser-client relationship with respect to the Long Fund. He did dispute this claim with regard to the hedge fund, arguing that the fund and not the Bureau was the client. The court rejected this claim.

FSA

Jeremy Burley, the Managing Director of BMS Minerals, a Ugandan company, and his father Jeffery Burley, were fined by the FSA for engaging in market abuse or insider trading in June 2009. According to the FSA Jeremy Burley learned around June 11, 2009 that Tower Resources, a company for which BMS Minerals furnished equipment, was unlikely to find oil in the first well it was drilling and that exploration regarding a second was unlikely to proceed. Before the public announcement of these events Jeremy Burley passed the information to his father and another with instructions to his father to sell his holdings in the company. The father followed the instructions and avoided a loss of over $30,000. The FSA fined Jeremy Burley over $200,000 and his father over $50,000. The fine as to Jeremy Burley reflected his lack of cooperation.



FOR SEC ENFORCEMENT, WHAT IS THE ENCORE?

July 22, 2010

The commentary, speculation and second guessing about the SEC’s settlement in Goldman may be drawing to a close, or at least diminishing. There is no doubt that Goldman is the most significant market crisis case to come from the numerous investigations the Commission has been conducting. Indeed, simply bringing the case was a significant step in view of the bank’s stature on Wall Street and the fact that the claims took the SEC into uncharted and very difficult waters. At the same time, it is beyond dispute that one big case does not create an enforcement program. So what does the SEC Enforcement Division do for an encore?

One might look for clues in the testimony of SEC Chairman Mary Schapiro before the House Financial Services Committee on Tuesday. The remarks were titled “Evaluating Present Reforms and Future Challenges,” available here. The Chairman’s testimony recounts recent efforts of the Enforcement Division, with the promise of a look at future challenges.

The Enforcement program “is a key element to fair and effective markets,” the Chairman told the Committee. She then rehashed the now familiar reforms such as the delegation of authority to issue a formal order of investigation, as well as the initiatives to encourage cooperation. The new Financial Fraud Enforcement Task Force and the structural changes Enforcement Director Khuzami has implemented, creating new specialty units and hiring new personnel were reviewed. All of these reforms were, as usual, tied to themes of speed and efficiency.

The results of these and other efforts, the Chairman noted, are reflected in part by the statistics. In testimony reminiscent of remarks by Mr. Khuzami in a recent speech, discussed here, the Chairman noted that in 2009 the Commission secured orders for disgorgement and civil penalties in amounts that exceeded those for fiscal year 2009 by, respectively, 46% and 101%. The SEC also sought more than twice as many temporary restraining orders while issuing more than twice as many formal orders of investigation.

Cases brought by the Division bolster the statistics, according to the Chairman. Key examples include the action against American Home Mortgage, the cases naming the officers of Countrywide Financial Corp and New Century as defendants, and the actions against Brookstreet Securities and Morgan Keegan. Interestingly, only after citing these cases did the Chairman mention the high profile settlement in Goldman, discussed here. Ms. Schapiro went on to tell the Committee about other significant cases such as ICP Asset Management, the action against the former chairman of Taylor, Bean and the case against State Street Bank.

Overall the Chairman’s remarks recount where the program has been recently. But where is it going? What is happening with all the market crisis investigations Commissioner Walter and others previously mentioned?

While the SEC press release and litigation release for Goldman each contain the identical statement that the settlement does not apply to “any other past, current or future SEC investigations against the firm,” suggesting there may be other investigations, it seems clear the inquiry is over. Goldman’s 8-K states that it “understands that the SEC staff also has completed a review of a number of other Goldman mortgage-related CDO transactions and does not anticipate recommending any claims against Goldman or any of its employees.” Undoubtedly that language was reviewed in the settlement discussions.

So the Goldman investigation is over. Ms. Schapiro’s testimony, despite its title referencing “Future Challenges,” gives no clue about the future direction of any pending enforcement investigations. The question persists: Is Goldman the beginning of a bold new enforcement program that is about to unravel the roots of the market crisis or the end of the significant cases emanating from all the market crisis investigations? What is the encore?
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But Senators Dodd and Frank included this one in that exempts the SEC from accountability.

SEC Says New Financial Regulation Law Exempts it From Public Disclosure
Written by CAA Politics on July 29, 2010, 01:42 AM
DUNSTAN PRIAL

So much for transparency.

Under a little-noticed provision of the recently passed financial-reform legislation, the Securities and Exchange Commission no longer has to comply with virtually all requests for information releases from the public, including those filed under the Freedom of Information Act.

The law, signed last week by President Obama, exempts the SEC from disclosing records or information derived from "surveillance, risk assessments, or other regulatory and oversight activities." Given that the SEC is a regulatory body, the provision covers almost every action by the agency, lawyers say. Congress and federal agencies can request information, but the public cannot.

That argument comes despite the President saying that one of the cornerstones of the sweeping new legislation was more transparent financial markets. Indeed, in touting the new law, Obama specifically said it would “increase transparency in financial dealings."

The SEC cited the new law Tuesday in a FOIA action brought by FOX Business Network. Steven Mintz, founding partner of law firm Mintz & Gold LLC in New York, lamented what he described as “the backroom deal that was cut between Congress and the SEC to keep the SEC’s failures secret. The only losers here are the American public.”

If the SEC’s interpretation stands, Mintz, who represents FOX Business Network, predicted “the next time there is a Bernie Madoff failure the American public will not be able to obtain the SEC documents that describe the failure,” referring to the shamed broker whose Ponzi scheme cost investors billions.

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"The new provision applies to information obtained through examinations or derived from that information," said SEC spokesman John Nester. "We are expanding our examination program's surveillance and risk assessment efforts in order to provide more sophisticated and effective Wall Street oversight. The success of these efforts depends on our ability to obtain documents and other information from brokers, investment advisers and other registrants. The new legislation makes certain that we can obtain documents from registrants for risk assessment and surveillance under similar conditions that already exist by law for our examinations. Because registrants insist on confidential treatment of their documents, this new provision also removes an opportunity for brokers, investment advisers and other registrants to refuse to cooperate with our examination document requests."

Criticism of the provision has been swift. “It allows the SEC to block the public’s access to virtually all SEC records,” said Gary Aguirre, a former SEC staff attorney-turned-whistleblower who had accused the agency of thwarting an investigation into hedge fund Pequot Asset Management in 2005. “It permits the SEC to promulgate its own rules and regulations regarding the disclosure of records without getting the approval of the Office of Management and Budget, which typically applies to all federal agencies.”

Aguirre used FOIA requests in his own lawsuit against the SEC, which the SEC settled this year by paying him $755,000. Aguirre, who was fired in September 2005, argued that supervisors at the SEC stymied an investigation of Pequot – a charge that prompted an investigation by the Senate Judiciary and Finance committees.

The SEC closed the case in 2006, but would re-open it three years later. This year, Pequot and its founder, Arthur Samberg, were forced to pay $28 million to settle insider-trading charges related to shares of Microsoft (MSFT: 25.95 ,0.00 ,0.00%). The settlement with Aguirre came shortly later.

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“From November 2008 through January 2009, I relied heavily on records obtained from the SEC through FOIA in communications to the FBI, Senate investigators, and the SEC in arguing the SEC had botched its initial investigation of Pequot’s trading in Microsoft securities and thus the SEC should reopen it, which it did,” Aguirre said. “The new legislation closes access to such records, even when the investigation is closed.

“It is hard to imagine how the bill could be more counterproductive,” Aguirre added.

FOX Business Network sued the SEC in March 2009 over its failure to produce documents related to its failed investigations into alleged investment frauds being perpetrated by Madoff and R. Allen Stanford. Following the Madoff and Stanford arrests it, was revealed that the SEC conducted investigations into both men prior to their arrests but failed to uncover their alleged frauds.


Blog Comments
Name:
djphoenix
Comment:
We will see what the Courts say! People need to stop being silent about these issues. We are not sheeple - WE THE PEOPLE are the ones running this show. I wonder what they are hiding (or are attempting to hide) this time.

Name:
Sabrejock
Comment:
Did you feel it?Turn your head and cough again. Now? did you feel it that time? BO and his minions are at it again. Say one thing and do somethng else while they "give it to you" The only thing transparent is there arrogance.

http://conservativeactionalerts.com/blog_post/show/737
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Market reform

Dodd-Frank: H.R. 5970 was introduced this week to amend Section 9291 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Generally, that Section of the Act protects from disclosure any internal compliance or audit records obtained by the Commission under the Section. Some commentators claim the provision will permit the Commission to withhold a broad array of materials from FOIA requests. The new bill, titled the SEC Transparency Act of 2010, would repeal the provision.
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Still a work in progress

DODD – FRANK: CREDIT RATING AGENCIES, PART I
August 23, 2010

Credit rating agencies, and in particular, nationally recognized statistical rating organizations (“NRSRO”), have been thought by many to be at the center of much of what went on with the market crisis, particularly in the area of structured products. The agencies have come under significant criticism for their methodologies, lack of procedures and conflicts of interest.

Dodd-Frank seeks to address these concerns in a series of provisions dealing with oversight and structure which will be discussed in this series. Other provisions significantly impact liability. The Act also requires the SEC to write a number of rules in this area and directs that several studies be prepared, all of which promise further legislation in this area in the future. These provisions will be discussed subsequently. Prior segments of this series have dealt with portions of the legislation concerning SEC ruling making (here), SEC Enforcement (here), executive compensation (here) and corporate governance (here).

Dodd-Frank creates the new SEC Office of Credit Ratings. This Office is charged with administering SEC rules with respect to NRSRO practices in determining ratings. The Office is also required to conduct an annual examination of each NRSRO and issue a public report. The report must summarize the essential findings of the examination, identify material deficiencies, state if previous SEC recommendations have been resolved and record any response by the examined agency. The SEC is also required to establish fines and penalties for any NRSRO violations.

A key part of the new provisions deals with the structure of the rating agencies. This begins with the board of directors and its accountability for critical functions. Each NRSRO is required to have a board of directors, at least half of whom are independent. The board is charged with overseeing the implementation of internal controls regarding policies and procedures for determining ratings, as well as compensation and promotions within the organization. It is also responsible for overseeing the management of conflicts of interest through the implementation of appropriate policies and procedures.

The organization is required under the Act to maintain a documented, effective system of internal controls for determining ratings. The Commission is charged with requiring that each NRSRO prepare an annual report regarding its controls. The report must include an attestation by the CEO that describes the responsibility of management for establishing and maintaining the system.

Each NRSRO is also required to designate a compliance officer. That officer cannot perform credit ratings or participate in marketing or sales activities. Likewise, the compensation of the officer can not be tied to the financial performance of the organization. Rather, it must be arranged to assure independence.

The compliance office is charged with preparing an annual report addressing changes in the internal compliance procedures and code of ethics of the organization. The report must also examine compliance with the securities laws and the organization’s policies and procedures. The SEC is required to review the code of ethics and the conflict of interest policy of the organization annually and when there are material changes.

The Act also addresses the “revolving door” issue between NRSROs and their clients. In this regard, Dodd-Frank requires that each NRSRO report to the SEC employment of certain senior officers associated with the rating agency in the prior five years where the agency has issued a rating for an instrument during the twelve month period prior to the employment of that person. The SEC is to make this information available to the public.

Next: Commission rules

http://www.secactions.com/

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