Perspective is a funny thing. The full taxpayer cost of the
S&L bailout came to an enormous, inflation-adjusted tab of
around $255-billion; and yet, in the shadow of the latest spate of
bank bailout checks written by Congress, that doesn’t seem
like much. Similarly, the $60-billion Madoff fiasco tends to make
the many Ponzi scheme busts that followed seem quaint by
comparison, including the $7-billion scam allegedly carried out by
Robert Allen Stanford’s firm.
Just to make sure everybody agrees that $7-billion is a lot of
money – keep in mind it exceeds the GNP of 40% of the nations
on earth. Imagine putting a match to all the goods and services
produced in one year by the people of Laos or Mongolia. Stanford is
accused of doing that, and more. But because it’s just a
tenth of the wealth destroyed by Madoff, Stanford may forever be
regarded a Ponzi also-ran.
But dig a little deeper and you’ll find the Stanford case
is the bigger outrage by far, not so much for the scam itself, but
for the shocking behavior of the regulators tasked with preventing
it. Where Madoff was enabled by SEC bureaucratic incompetence,
Stanford was empowered by overt SEC indifference.
That’s right – indifference. Unlike Meghan
Cheung, the former head of enforcement at the SEC’s New York
branch, who didn’t know how to determine whether Madoff was
running a Ponzi scheme, her counterpart in Fort Worth spent
years swimming in evidence of Stanford’s scam, but simply
preferred not to do anything about it.
The evidence, if you can stomach it, is oozing out of the
report
recently submitted by SEC Inspector General extraordinaire David
Kotz. In it, we learn that SEC examiners spotted the red flags
as early as 1997, and spent eight years lobbying then-chief of Fort
Worth’s enforcement division, Spencer Barasch, to
investigate. Barasch repeatedly declined, even as evidence of the
Stanford scam – together with the size of the scam itself
– grew exponentially.
The first referral by SEC examiners was sent to Barasch in 1998.
According to the testimony of Julie Preuitt, who helped author the
request, Barasch declined to investigate after discussing the
matter with Stanford’s legal counsel at the time, former SEC
Fort Worth Distinct Administrator Wayne Secore.
According to the report:
Barasch told Preuitt “he asked Wayne Secore if there was a
case there and Wayne Secore said that there wasn’t. So he was
satisfied with that and decided not to pursue it
further.”
Obviously, Barasch denies this, and such a claim would be
difficult to believe were it not for the well-documented facts that
follow.
Barasch finally left the SEC for a spot as partner in the law
firm of Andrews Kurth in 2005, shortly after putting the kibosh on
a third attempt by SEC examiners to investigate Stanford.
Barasch’s replacement accepted a similar recommendation later
that year, but the resulting inquiry was mismanaged and did not
produce an enforcement case until February 2009, after the
Commission’s hand was forced by Madoff’s admission two
months earlier.
But it was what happened after Barasch’s departure from
the SEC that casts his earlier actions in a much harsher light. As
the investigation discovered:
[Barasch], who played a significant role in multiple decisions
over the years to quash investigations of Stanford, sought to
represent Stanford on three separate occasions after he left the
Commission, and in fact represented Stanford briefly in 2006 before
he was informed by the SEC Ethics Office that it was improper to do
so.
The final of Barasch’s three attempts to represent
Stanford was by far the most brazen, not to mention instructive. It
happened in February 2009, immediately after the SEC filed suit
against Stanford. Like the two before it, the third was also
denied. When asked to justify the renewed request, Barasch
replied,
“Every lawyer in Texas and beyond is going to get rich
over this case. Okay? And I hated being on the
sidelines.”
In email, veritas.
Not only was Barasch apparently numb to the definition of
“ethical conflict,” he seems to have used it as a
business development tool, at least that’s the impression
left by an email not included in the Kotz report but acquired by
the Dallas Morning News. According to the email, after Mark
Cuban was sued by the SEC’s Fort Worth office for insider
trading in 2008, Barasch told an associate of Cuban’s,
“I am friends with and helped promote two of the guys who
signed the Complaint against Mark. Someone should tell Mark to look
at my profile on my firm website, my SEC press releases, and advise
Mark to add me to his defense team.”
It’s safe to say that Barasch plays the heavy in the
IG’s report, but read it carefully, and you’ll find
that he’s not the real villain. Instead, that role is played
subtly but consistently by the broader SEC Enforcement
Division’s flawed culture.
As the report stated,
We found that the Fort Worth Enforcement program’s
decisions not to undertake a full and thorough investigation of
Stanford were due, at least in part, to Enforcement’s
perception that the Stanford case was difficult, novel and not the
type favored by the Commission. The former head of the Fort Worth
office told the OIG that regional offices were “heavily
judged” by the number of cases they brought and that it was
very important for the Fort Worth office to bring a high number of
cases…The former head of the Examination program in Fort
Worth testified that Enforcement leadership in Fort Worth
“was pretty upfront” with the Enforcement staff about
the pressure to produce numbers and communicated to the Enforcement
staff, “I want numbers. I want these things done
quick.” He also testified that this pressure for numbers
incentivized the Enforcement staff to focus on “easier
cases” – “quick hits.”
And these instructions were predictably manifest in the handling
of the Stanford case, as evidenced by the reaction to an anonymous
Stanford insider’s letter, first sent to the NASD, denouncing
Stanford as a Ponzi scheme. The letter was forwarded to the SEC
where Barasch saw and ignored it, saying,
“Rather than spend a lot of resources on something that
could end up being something that we could not bring, the decision
was made to not go forward at that time, or at least to not spend
the significant resources and wait and see if something else would
come up.”
The report also cites a former Fort Worth office administrator
who says Barasch and others in his group had been subjected
to criticism from high-level SEC staff in Washington DC for
“bringing too many Temporary Restraining Order, Ponzi, and
prime bank cases.”
Accordingly, Fort Worth was admonished to avoid investigating
“mainstream” cases in favor of simple accounting
fraud.
Now, let’s take a step back to see what insights into the
SEC’s enforcement paradigm might be gleaned from what
we’ve learned so far.
- Given his actions both prior to and after leaving the
Commission, I suspect Spencer Barasch’s approach to
regulating Stanford – and presumably other entities –
was heavily influenced by a desire to maximize his eventual private
sector opportunities. This is further evidence that the
significance of regulatory capture and the revolving
door ethic in the minds of SEC enforcement officials cannot be
overstated.
- Whereas “Ponzi and prime bank cases” most often
apply to investing institutions, while accounting fraud charges are
most often leveled against public companies, I suspect the
high-level mandate to prefer the latter over the former to be the
root of the SEC’s long-suspected
anti-issuer/pro-institutional investor bias – or at the very
least, further evidence of it.
- This apparent anti-issuer bias, paired with the report’s
well-documented evidence of the SEC’s preference of case
quantity over quality, offers additional support for the
widely-held belief that cases against public companies are seen as
low-hanging (and career-protecting) fruit in the eyes of
Enforcement Division staffers.
If my conclusions are correct, then the Stanford outrage is not
really about Spencer Barasch, but the SEC’s flawed
enforcement culture, from Washington DC on down. I further suspect
this culture to be a key factor in explaining the SEC’s role
as enabler of the stock manipulation schemes extensively documented
here on Deep Capture.
But don’t take my word for it. Instead, consider the words
of then-Director of the SEC’s Division of Enforcement, Linda
Chatman Thomsen, responding to a question posed by a member of the
audience following her keynote address at the US Chamber of
Commerce’s 2008 Capital Markets Summit.
Audience member: “You spent a lot of time
talking about insider trading and penny stock fraud, but you failed
to mention an issue that’s of great concern to the Chamber,
and that is naked short selling and the unsettled trades that can
result from that. How can the Commission claim that it is serious
about enforcement when millions of trades fail to settle every day
and companies remain on Reg SHO Threshold Lists for years and
years?”
Thomsen: “As to naked short selling, and
more generally market manipulation generally, it is an area we are
focused on. We have seen fewer cases in that arena because, often
times, this is not necessarily with respect to naked shorts, but
shorting or market manipulation more generally, because often the
components of something that might look to be manipulative are all
legal trades as you point out. So it’s a hard case to bring,
which is not to say that it isn’t something that we
don’t investigate, because we do. So I hear and understand
the frustration of many on the subject of short selling generally.
When we hear complaints about short selling—and, frankly, it
is both short and naked short, it is a combination of both—we
routinely hear from companies who’ve come in, who worry that
they’re being shorted in an illegal way. We routinely take
all that information in and look into it.
“And often times, as I think many defense counsel would be
happy to tell you, when we dig in, what we find is that some of the
information that has caused people to be shorting is actually true
as to the company, and we may very well be confronted with two
issues, one on the company and its disclosure side as well as on
the trading side. But they’re very difficult cases, which is
not to say that we aren’t focused on them and interested in
them and indeed this new focus that we have on some smaller
companies and smaller issuers will wrap some of those concerns into
their focus as well.”
Thomsen’s answer needs to be examined from two angles:
what she said and what she (meaning, her division) actually
did.
What Thomsen said, was that when it comes to
illegal, manipulative naked short selling, “it’s a hard
case to bring,” and that it often it turns out the targeted
company deserved to have its stock manipulated. But
don’t worry…the SEC Division of Enforcement cares and
regularly investigates complaints of illegal, manipulative short
selling.
What Thomsen’s division actually did was
quite different. We know this thanks to another
outstanding report by SEC Inspector General David Kotz relating
to the Commission’s handling of complaints of illegal,
manipulative naked short selling between January 2007 and June
2008. What Kotz discovered was that of the more than 5,000
complaints received by the Division of Enforcement during that
time, not one resulted in an investigation.
Kotz further found that while robust methods exist for dealing
with complaints relating to “spam driven manipulations,
unregistered online offerings and insider trading” (again,
infractions typically committed by issuers), no written policies
existed for dealing with complaints of illegal naked short selling.
This “[has] the effect of naked short selling complaints
being treated differently than other types of
complaints.”
And in this case, “differently” meant “not at
all.” This attitude closely mirrors that of the SEC’s
Division of Enforcement as described in the Stanford report.
In my opinion, the best thing to happen to the SEC in many years
is the arrival of Inspector General David Kotz. The second best
thing is the February 2009 departure of Linda Thomsen. In the
months following the arrival of Thomsen’s successor, Robert
Khuzami, many encouraging developments have been observed,
including two enforcement cases brought against manipulative naked
short sellers, the permanent adoption of regulations greatly
reducing instances of such manipulation, and the recent case
brought against Goldman Sachs (NYSE:GS). Each of these represents
an important departure from the SEC’s long-standing
anti-issuer/pro-bank approach to regulation.
These positive developments notwithstanding, the dysfunctional
culture at the SEC’s Division of Enforcement was undoubtedly
a long time in the making. As a result, it will require a long time
to root out. Unfortunately, we don’t have a long time.
Investor confidence in the fundamental fairness of our capital
markets must be restored now, not as long as it takes the old
guard’s institutional memory to fade away. Having read the
Stanford report, the only practical solution I see is a new
beginning. Congress needs to sunset the SEC on an immovable —
and ideally not too distant – date certain and instruct
the Department of Justice to have a replacement ready to begin work
the next day.
The next best solution would be to disband the SEC entirely, and
send big, red warning letters to all potential market participants,
giving them fair warning that they’re on their own.
These may seem like desperate measures, but I suspect
you’ll agree these are becoming increasingly desperate
times.
Judd Bagley is a reporter
for Deep
Capture