FROM: FEDERAL DEPOSIT INSURANCE CORPORATION
Remarks by Thomas M. Hoenig, Director, Federal Deposit Insurance Corporation - Financial Oversight: It’s Time to Improve Outcomes to the AICPA/SIFMA FSA National Conference; New York, NY
November 30, 2012
Introduction
Many remain skeptical of claims that the financial system has been reformed and that taxpayer bailouts are relics of the past. Such skepticism is understandable. For nearly a century, the public has been told repeatedly that stronger regulations and supervision, greater market discipline, and enforced resolution will ensure that financial crises will be less likely, and, should they occur, will be handled effectively.
Despite these assurances, the public remains at risk of having to pick up the pieces when the next financial setback occurs. The safety net continues to expand to cover activities and enterprises it was not intended to protect, resulting in subsidized risk taking by the largest financial firms and fueling their leverage. At the same time, the tolerance for leverage remains essentially unchanged, leaving us in a situation that is little different than before the recent crisis. We can be confident that as time passes, this leverage again will be a problem and the public again will be left holding the bag.
To change this outcome, we must change the framework and related incentives.
Defining the Problem
The structure of the system, the rules of the game, and the methods of accountability are all keys to the success or failure of any market system. They determine incentives and, of course, performance outcomes. As you would expect following this most recent crisis, various commissions attempted to sort out what went wrong and offered remedies to prevent such a crisis from recurring.
But for all this effort, incentives around risk remain mostly unchanged and leave the industry vulnerable to excesses. While there are no perfect solutions, there are actions that, taken together, can more effectively improve outcomes.
First, we must change the structure of the industry to ensure that the coverage of the safety net is narrowed to where it is needed, and stop the extension of its subsidy to an ever-greater number of firms and activities.
Second, we must simplify and strengthen capital standards to contain the impulse for excessive leverage and to provide a more useful backstop to absorb unexpected losses.
Third, we must reestablish a more rigorous examination program for the largest banks and bank holding companies to best understand the risk profile of both individual firms and financial markets.
Narrowing the Safety Net
Commercial banking in the United States has been protected for decades by a public safety net of central bank lending, deposit insurance and, more recently, direct government support. This has been done because commercial banks are thought essential to a well-functioning economy. Their operations involve providing payment services, taking short-term deposits, and making loans. In other words, conducting activities that intermediate the flow of credit from savers to borrowers, transforming short-term deposits into longer-term loans. This funding arrangement requires that the public and business have confidence that they can access their money on demand. The safety net helps provide that assurance.
The intended purpose of this government support is well understood. However, less understood is its unintended consequence: providing banks a subsidy in raising funds. As a result, they are less subject to economic or market forces, and their funding costs are less than that of firms outside the safety net. This subsidy, in turn, creates incentives to leverage their balance sheets and take on greater asset risk.
In the United States, this financial subsidy was greatly expanded in 1999 with the enactment of the Gramm-Leach-Bliley Act (GLB), which eliminated prohibitions that kept banks from affiliating with broker-dealer and securities firms. By allowing such cross ownership, the safety net and, therefore, its subsidy was expanded to more and ever-larger financial firms, conducting ever more complex and risk-oriented activities. Subsidies are valuable, and once given are hard to take away and once expanded are hard to restrict.
Despite repeated assurances following GLB that no firm would be too big to fail, the actions of governments have only confirmed that some firms -- the largest or most complex -- are simply too systemically important to be allowed to fail. Under such circumstances, market discipline breaks down since creditors are confident that they will be bailed out regardless of what the bank does. The deposit subsidy and the lack of market discipline from the consequences of failure create an incentive to take on excessive risk.
Narrowing the safety net, limiting its coverage, and realigning incentives, therefore, must be among the highest priorities following this recent crisis. Governments would be wise to limit commercial banking activities to primarily those for which the safety net’s protection was intended: stabilizing the payments system and the intermediation process between short-term lenders and long-term borrowers. That is, it should be confined to protecting our economic infrastructure.1
Trading activities do not intermediate credit. They reallocate assets and existing securities and derivatives among market participants. When they are placed within the safety net, they create incentives toward greater risk-taking and cause enormous financial distortions. Protected and subsidized by the safety net, complex firms can cover their trading positions by using insured deposits or central bank credit that comes with the commercial bank charter. Non-commercial bank trading firms have no such access and no such staying power. The safety net provides the complex organizations an enormously unfair competitive advantage. Thus, while such activities are important to the success of an economy, there is no legitimate reason to subsidize them with access to the safety net.
The mixing of commercial banking and trading activities also changes incentives and behavior within the firm. Commercial banking works within a culture of win-win, where the interests and incentives of banks and their customers are aligned. If a customer is successful, the payoff to the bank means success as well. In contrast, trading is an adversarial win-lose proposition because the trader’s gains are the counterparty’s losses -- and oftentimes the counterparty is the customer. Trading focuses on the short-term, not on longer-term relationship banking. Culture matters, and as we have seen in recent years, the mixing of banking and trading tends to drive organizations to make short-term return choices.
It is sometimes suggested that had broker-dealer and trading activity been separated from commercial banking, the recent financial crisis would have been just as severe. Lehman Brothers was not a commercial bank, and yet it brought the world to its knees. However, following GLB, just as commercial banks enjoyed the special benefit of the safety-net subsidy, firms like Lehman enjoyed the benefits from the special treatment given to money market funds and overnight repos to fund their activities. They were essentially operating as commercial banks and enjoying an implied subsidy very similar to that of commercial banks. Thus, a fundamental change needed to encourage greater accountability and stability is to correct the rules giving special treatment to money market funds and repos, thereby ending their treatment as deposits.
Market discipline works best when stockholders and creditors understand they are at risk and when the safety net is narrowly applied to the infrastructure for which it was intended.
Capital and Bank Safety
Capital is fundamental to any industry’s success, both as a source of funding and as a cushion against unforeseen events. This is especially the case for financial firms, as they are, by design, highly leveraged. But what is the right amount of capital, and how should it be measured and enforced to assure a more stable financial environment?
Basel standards have for more than two decades been the focal point of discussion in defining adequate capital for the financial industry. A new version of Basel standards is out for comment as supervisors struggle to find a system that properly defines capital, appropriately allocates it against risk, and results in a more stable financial system. However, the Basel proposal remains extremely complex and opaque as it attempts to anticipate every contingency and to assign risk weights to every conceivable asset that an institution might place on or off its balance sheet. The unfortunate consequence is ineffective capital regulation due to confusion, uncertainty about the quality of the balance sheet, and added costs imposed on a firm’s capital program.
Past attempts at defining the correct amount and distribution of capital have uniformly failed. For example, in 2007 as the financial crisis was just emerging, Basel’s measure of total capital to risk-weighted assets for the10 largest U.S. financial firms was approximately 11 percent -- a very impressive level of capital. But the ratio, using the more conservative tangible-equity-to-tangible-assets measure, was a mere 2.8 percent2. Had this been the primary capital measure in 2007, it is likely that far more questions would have been asked about the soundness of the industry, resulting in a less severe banking crisis and recession.
Today, this same tangible-equity measure for the largest U.S. banks, while double the 2.8 percent number, remains far below what history tells us is an acceptable market-determined capital level. We should learn from past experience and turn our attention from using a capital rule that gives what in the end is a false sense of security to one that is effective because of its simplicity, clarity, and enforceability. Before the safety net was in place in the United States, the market demanded that banks on average hold between 13 and 16 percent tangible equity to tangible assets -- a far cry from the 2.8 percent held by these largest firms in 2007 or the 6 percent they hold today.
Therefore, as an alternative to the unmanageably complex Basel risk-weighted standards, the emphasis should be shifted to a tangible-equity-to-tangible-asset ratio, of say 10 percent. With this simple but stronger capital base, bank management could then allocate resources in a manner that balances the drive for return on equity with the discipline of greater amounts of tangible equity. Moreover, global supervisors would have a clear benchmark to test against and enforce a minimum level. Behind this tangible measure we could use a simplified risk-weighted measure as a check against excessive off-balance sheet assets or other factors that might influence firms’ safety.
Some argue that a high minimum would be too much capital, and would impede credit growth and eventually economic growth. However, this level of capital remains well below what the market would most likely require without the safety net and its subsidy. Recall that because so little tangible capital was available to absorb loss when the last crisis emerged, the industry had to resort to a violent shedding of assets and downsizing of balance sheets as it grasped to maintain even modest capital ratios. The effect of too little capital was far more harmful in the end than the effect of a strong capital framework.
Finally, it should be noted that except for the very largest U.S. commercial banks, most banks are currently near this minimum level for tangible equity. For example, while the tangible equity capital to tangible assets for the 10 largest bank holding companies in the U.S. is 6.1 percent, for the top 10 regional banks with less than $100 billion in assets, it is 9 percent. This ratio for the 10 largest banks with less than $50 billion in assets is 9.4 percent, and for the top 10 community banks with less than $1 billion in assets it is 8.3 percent.
Only the largest, most complex banks are too big to fail as evidenced by the capital numbers presented here. When the public and the market are at risk, they demand more -- not less -- capital.
Bank Examinations and Financial Stability
Relying on a single tangible measure as a minimum capital standard begs the question of whether it will assure an adequate capital level for the industry. In other words, under a straight leverage ratio, would banks load their balance sheet with the most risky assets because all assets are weighted equally?
First, such a question fails to recognize that a system that underweights high-risk assets and overweights low-risk assets is even more dangerous. This has been the experience with the Basel system going back almost to its start. Also, a minimum tangible-equity-to-tangible-asset ratio, of 10 percent for example, would bring more tangible capital to the balance sheet than current Basel III calculations.
Second, we need to remember that Basel has three pillars: capital, market discipline, and an effective bank supervision program. Effective bank supervision requires that authorities systematically examine a bank and assess its asset quality, liquidity, operations, and risk controls, judging its risk profile and whether it is well managed. Done properly, therefore, the best way to judge a firm’s risk profile is through the audit and examination process.
If, following an exam, a bank is judged to carry a higher risk profile, then the minimum capital, it should be judged inadequate for the risk and capital required. Moreover, in this instance the bank’s dividend and capital redemption programs would be curtailed until the adjusted minimum is achieved. For example, a 10 percent minimum tangible capital ratio would be adequate for a 1-rated bank, while a bank whose risk profile is 2 rated might require a higher ratio, say 11 percent, and similarly a 3 rating might require say 13 percent. A bank rated more poorly would be under a specific supervisory action.
Such an approach would most affect the largest banks where full-scope examinations have been de-emphasized in favor of targeted reviews, financial statement monitoring, model validations, and, more recently, the use of stress tests. These activities can be useful, but they are limited in scope and have been adopted because the largest firms are judged simply too large and complex for full scope examinations. However, full exams are doable. Statisticians, for example, have long been designing sampling methodologies for auditing and examining large bank asset portfolios and other operations, providing reliable estimates of their condition, and at an affordable cost.
And finally, commissioned examiners as a rule are highly skilled professionals, able to effectively assess bank risk and to do so in a more thorough manner than a static risk-weighted program. Their success, however, is tied not only to their skills but, as always, to the leadership of the supervisory agency. The examination process, effectively conducted and effectively led, holds the best potential to identify firm-specific risks and adjust capital levels as needed. In the end, an industry with strong individual firms is a strong industry.
Conclusion
The remarks and suggestions outlined here are not new. We have long been aware of the destabilizing effects of broadening the coverage of the financial safety net to an ever-expanding list of activities. There is a long history of the danger of confusing strong capital with complex capital rules, and of confusing strong supervision with monitoring instead of full examinations.
We would be wise to think beyond added rules to fundamental change. We must narrow the safety net and confine it to the payments system, deposit taking, and the related intermediation of deposits to loans. We must simplify and strengthen the capital standards and then subject all banks to the same standard of measurement and performance. And finally, we must reintroduce meaningful examination programs for the largest firms. These steps, taken together, would do much to assure greater stability for our financial system.
FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C., Nov. 20, 2012 — The Securities and Exchange Commission sanctioned two investment advisory firms for impeding examinations conducted by SEC staff.
An SEC investigation found that Evens Barthelemy and his New York-based firm Barthelemy Group LLC misled SEC examiners by inflating the firm’s claimed assets under management (AUM) ten-fold in an apparent attempt to show that the firm was eligible for SEC registration. Another SEC investigation found that Seth Richard Freeman and his San Francisco-area firm EM Capital delayed nearly 18 months in producing books and records related to the firm’s mutual fund advisory business.
Both firms agreed to settle the SEC’s charges against them.
"Barthelemy was not truthful and Freeman was not responsive during their respective interactions with SEC examiners," said Bruce Karpati, Chief of the SEC Enforcement Division’s Asset Management Unit. "We will continue to pursue enforcement actions against firms that obstruct or delay the SEC’s critical work in overseeing investment advisers."
Carlo di Florio, Director of the SEC’s Office of Compliance Inspections and Examinations, added, "Examinations of SEC-registered firms play a vital role in protecting markets and investors, and we expect their candor and prompt cooperation as SEC staff works to promote compliance, monitor risk, and prevent fraud."
According to the SEC’s order against Barthelemy and his firm, when examiners asked for a list of client assets, Barthelemy misrepresented his firm’s AUM as $26.28 million instead of the actual $2.628 million. He downloaded client account balances from the firm’s online custodial platform onto a spreadsheet, and then manually moved the decimal points for each client one place to the right before providing it to the SEC staff. From July 2009 to early 2011, Barthelemy improperly registered Barthelemy Group with the SEC on the basis of the aspirational AUM that was 10 times higher than reality. Barthelemy Group, through Barthelemy’s actions as chief compliance officer, also failed to adopt reasonable compliance policies and procedures or to maintain required books and records concerning codes of ethics and providing the firm’s disclosure brochure to clients.
Barthelemy agreed to be barred from the securities industry and from associating with an investment company, with the right to reapply after two years. Without admitting or denying the allegations, Barthelemy and his firm consented to cease-and-desist orders, and the firm was censured. Barthelemy and his firm also will provide a copy of the proceeding to their clients and appropriate state securities regulators, will post a copy on the firm’s website, and will disclose the proceeding in an amended SEC Form ADV filing.
According to the SEC’s order issued today against Freeman and his firm, they failed to immediately furnish the required books and records upon request by SEC staff in December 2010. EM Capital and Freeman repeatedly promised to provide the records including financial statements, e-mails, and documents related to their management of a mutual fund. However, they did not fully comply until September 2012, months after learning that SEC staff was considering enforcement action against them.
Freeman and EM Capital agreed to pay a combined $20,000 penalty. Without admitting or denying the SEC’s findings, Freeman and EM Capital also agreed to censures and cease-and-desist orders.
The SEC’s investigation of Barthelemy Group was conducted by David Neuman and Scott Weisman of the SEC’s Asset Management Unit. The examination of Barthelemy Group was conducted by Dawn Blankenship, Kristine Geissler, Arjuman Sultana, Margaret Pottanat, and Anthony Fiduccia of the New York Regional Office’s investment adviser/investment company examination program. The SEC’s investigation of EM Capital was conducted by Sahil W. Desai and Erin E. Schneider of the San Francisco Regional Office, who are members of the SEC’s Asset Management Unit. The examination of EM Capital was conducted by Tom Dutton, Ada Chee, and Ed Haddad of the San Francisco Regional Office’s investment adviser/investment company examination program.
FROM: U.S. COMMODITY FUTURES TRADING COMMISSION
CFTC Charges North Carolina Resident Michael Anthony Jenkins and his Company, Harbor Light Asset Management, LLC, with Solicitation Fraud, Misappropriation, and Embezzlement in Ponzi Scheme
Defendants charged with fraudulently soliciting and accepting at least $1.79 million from approximately 377 persons
In a related criminal action, Jenkins was indicted for securities fraud and is in custody awaiting trial
Washington, DC – The U.S. Commodity Futures Trading Commission (CFTC) today announced the filing of a federal civil enforcement action in the U.S. District Court for the Eastern District of North Carolina, charging Michael Anthony Jenkins of Raleigh, N.C., and his company, Harbor Light Asset Management, LLC (HLAM), with operating a Ponzi scheme for the purpose of trading E-mini S&P 500 futures contracts (E-mini futures). From at least January 2011 through January 2012, the defendants fraudulently solicited at least $1.79 million from approximately 377 persons, primarily located in Raleigh, N.C., in connection with the scheme, according to the complaint.
The CFTC complaint also charges Jenkins, the owner and President of HLAM, with embezzlement and failure to register with the CFTC as a futures commission merchant. Furthermore, Jenkins allegedly misappropriated $748,827 of investors’ funds to trade gold and oil futures, stock index futures, and E-mini futures in his personal accounts. Jenkins also used misappropriated funds to pay for charges at department and discount stores and gasoline stations, and for cellular phone bills and airline tickets, according to the complaint.
The CFTC complaint, filed on November 20, 2012, alleges that HLAM’s Investment Agreement falsely represented to investors that their investment was solely for investing in E-mini futures and that investors’ funds would be immediately wired to a specific trading account. However, according to the complaint, most of investors’ funds were misappropriated by HLAM and Jenkins. To conceal and continue the fraud, Jenkins allegedly sent trading spreadsheets and statements to investors that falsely reported trades and profits earned and inflated the value of investments. The defendants’ fraudulent conduct resulted in a loss of approximately $1.3 million in investor funds, consisting of $1.16 million in misappropriated and embezzled funds and $140,000 in trading losses, according to the complaint.
In its continuing litigation, the CFTC seeks restitution, return by Jenkins and HLAM of all ill-gotten gains received, civil monetary penalties, trading and registration bans, and permanent injunctions against further violations of the Commodity Exchange Act, as charged.
In a related criminal action by the Securities Division of the North Carolina, Department of the Secretary of State, Jenkins was indicted on August 20, 2012 on three counts of securities fraud in The General Court of Justice, State of North Carolina, Wake County, and is in custody awaiting trial.
The CFTC appreciates the assistance of the Securities Division of the North Carolina Department of the Secretary of State.
CFTC Division of Enforcement staff members responsible for this action are Xavier Romeu-Matta, Nathan B. Ploener, Christopher Giglio, Manal Sultan, Lenel Hickson, Stephen J. Obie, and Vincent A. McGonagle.
FROM: U.S. DEPARTMENT OF JUSTICE
Tuesday, November 20, 2012
Former Executive at Florida-Based Lender Processing Services Inc. Admits Role in Mortgage-Related Document Fraud Scheme
Over 1 Million Documents Prepared and Filed with Forged and False Signatures, Fraudulent Notarizations
WASHINGTON – A former executive of Lender Processing Services Inc. (LPS) – a publicly traded company based in Jacksonville, Fla. – pleaded guilty today, admitting her participation in a six-year scheme to prepare and file more than 1 million fraudulently signed and notarized mortgage-related documents with property recorders’ offices throughout the United States.
The guilty plea of Lorraine Brown, 56, of Alpharetta, Ga., was announced by Assistant Attorney General Lanny A. Breuer of the Justice Department’s Criminal Division; U.S. Attorney for the Middle District of Florida Robert E. O’Neill; and Michael Steinbach, Special Agent in Charge of the FBI’s Jacksonville Field Office.
The plea, to conspiracy to commit mail and wire fraud, was entered before U.S. Magistrate Judge Monte C. Richardson in Jacksonville federal court. Brown faces a maximum potential penalty of five years in prison and a $250,000 fine, or twice the gross gain or loss from the crime. The date for sentencing has not yet been set.
"Lorraine Brown participated in a scheme to fabricate mortgage-related documents at the height of the financial crisis," said Assistant Attorney General Breuer. "She was responsible for more than a million fraudulent documents entering the system, directing company employees to forge and falsify documents relied on by property recorders, title insurers and others. Appropriately, she now faces the prospect of prison time."
"Homeownership is a huge step for American citizens," said U.S. Attorney O’Neill. "The process itself is often intimidating and lengthy. Consumers rely heavily on the integrity and due diligence of those serving as representatives throughout this process to secure their investments. When the integrity of this process is compromised, illegally, public confidence is eroded. We must work to assure the public that their investments are sound, worthy, and protected."
Special Agent in Charge Steinbach stated, "Our country is increasingly faced with more pervasive and sophisticated fraud schemes that have the potential to disrupt entire markets and the economy as a whole. The FBI, with our partners, is committed to addressing these schemes. As these schemes continue to evolve and become more sophisticated, so too will we."
Brown was the chief executive of DocX LLC, which was involved in the preparation and recordation of mortgage-related documents throughout the country since the 1990s. DocX was acquired by an LPS predecessor company, and was part of LPS’s business when LPS was formed as a stand-alone company in 2008. At that time, DocX was rebranded as "LPS Document Solutions, a Division of LPS." Brown was the president and senior managing director of LPS Document Solutions, which constituted DocX’s operations.
DocX’s main clients were residential mortgage servicers, which typically undertake certain actions for the owners of mortgage-backed promissory notes. Servicers hired DocX to, among other things, assist in creating and executing mortgage-related documents filed with recorders’ offices. Only specific personnel at DocX were authorized by the clients to sign the documents.
According to plea documents filed today, employees of DocX, at the direction of Brown and others, began forging and falsifying signatures on the mortgage-related documents that they had been hired to prepare and file with property recorders’ offices. Unbeknownst to the clients, Brown directed the authorized signers to allow other DocX employees, who were not authorized signers, to sign the mortgage-related documents and have them notarized as if actually executed by the authorized DocX employee.
Also according to plea documents, Brown implemented these signing practices at DocX to enable DocX and Brown to generate greater profit. Specifically, DocX was able to create, execute and file larger volumes of documents using these signing and notarization practices. To further increase profits, DocX also hired temporary workers to sign as authorized signers. These temporary employees worked for much lower costs and without the quality control represented by Brown to DocX’s clients. Some of these temporary workers were able to sign thousands of mortgage-related instruments a day. Between 2003 and 2009, DocX generated approximately $60 million in gross revenue.
After these documents were falsely signed and fraudulently notarized, Brown authorized DocX employees to file and record them with local county property records offices across the country. Many of these documents – particularly mortgage assignments, lost note affidavits and lost assignment affidavits – were later relied upon in court proceedings, including property foreclosures and federal bankruptcy actions. Brown admitted she understood that property recorders, courts, title insurers and homeowners relied upon the documents as genuine.
Brown also admitted that she and others also took various steps to conceal their actions from clients, LPS corporate headquarters, law enforcement authorities and others. These actions included testing new employees to ensure they could mimic signatures, lying to LPS internal audit personnel during reviews of the operation in 2009, making false exculpatory statements after being confronted by LPS corporate officials about the acts and lying to the FBI during its investigation. LPS closed DocX in early 2010.
This case is being prosecuted by Trial Attorney Ryan Rohlfsen and Assistant Chief Glenn S. Leon of the Criminal Division’s Fraud Section and Assistant U.S. Attorney Mark B. Devereaux of the U.S. Attorney’s Office for the Middle District of Florida. This case is being investigated by the FBI, with assistance from the state of Florida’s Department of Financial Services.
FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C., Nov. 14, 2012 — Building on last year’s record results, the Securities and Exchange Commission today announced that it filed 734 enforcement actions in the fiscal year that ended Sept. 30, 2012, one shy of last year’s record of 735. Most significantly, that number included an increasing number of cases involving highly complex products, transactions, and practices, including those related to the financial crisis, trading platforms and market structure, and insider trading by market professionals. Twenty percent of the actions were filed in investigations designated as National Priority Cases, representing the Division’s most important and complex matters.
The SEC also announced that it obtained orders in fiscal year 2012 requiring the payment of more than $3 billion in penalties and disgorgement for the benefit of harmed investors. It represents an 11 percent increase over the amount ordered last year. In the past two years, the SEC has obtained orders for $5.9 billion in penalties and disgorgement.
"The record of performance is a testament to the professionalism and perseverance of the staff and the innovative reforms put in place over the past few years," said SEC Chairman Mary L. Schapiro. "We’ve now brought more enforcement actions in each of the last two years than ever before including some of the most complex cases we’ve ever seen."
Robert Khuzami, Director of the SEC’s Division of Enforcement, added, "It’s not simply numbers, but the increasing complexity and diversity of the cases we file that shows how successful we’ve been. The intelligence, dedication, and deep experience of our enforcement staff are, more than any other factors, responsible for the Division’s success."
The sustained high-level performance comes two years after the Division underwent its most significant reorganization since it was established in the early 1970s. The results in 2012 were aided by many of the reforms and innovations put in place in the past two years, such as increased expertise in complex and emerging financial markets, products, and transactions, including through enhanced training, the hiring of industry experts, and the creation of specialized enforcement units focused on high-priority misconduct; a flatter management structure; streamlined and centralized processes and the improved utilization of information technology; and a vastly enhanced ability to collect, process, and analyze tips and complaints.
Financial Crisis-Related Cases
Among the cases filed by the SEC in FY 2012 were 29 separate actions naming 38 individuals, including 24 CEOs, CFOs and other senior corporate officers, regarding wrongdoing related to the financial crisis.
These cases included enforcement actions involving:
The former senior officers of Fannie Mae and Freddie Mac for misleading statements regarding the extent of each company’s holdings of higher-risk mortgage loans.
Former investment bankers at Credit Suisse for fraudulently overstating the prices of $3 billion in subprime bonds.
Several bank and mortgage executives including those at United Commercial Bank, TierOne Bank, Franklin Bank, and Thornburg Mortgage for misleading investors about mounting loan losses and the deteriorating financial condition of their institutions.
The U.S. investment banking subsidiary of Japan-based Mizuho Financial Group for misleading investors in a CDO by using "dummy assets" to inflate the deal’s credit ratings.
During the last 2½ years, the agency has filed actions related to the financial crisis against 117 defendants – nearly half of whom were CEOs, CFOs and other senior corporate executives, resulting in approximately $ 2.2 billion in disgorgement, penalties, and other monetary relief obtained or agreed to. The SEC brought enforcement actions against Goldman Sachs, J.P Morgan Securities, and Morgan Keegan as well as senior executives from Countrywide, New Century, and American Home Mortgage.
Insider Trading Cases
Insider trading cases also are on the upswing with 58 actions filed in FY 2012 by the SEC, an increase over last year’s total of 57 actions. The 168 total insider trading actions filed since October 2009 have been the most in SEC history for any three-year period.
In these actions, the SEC has charged approximately 400 individuals and entities for illegal trading totaling approximately $600 million in illicit profits. Among those charged in SEC insider trading cases in 2012 were:
Former McKinsey & Co. global head Rajat Gupta for illegally tipping convicted hedge fund manager Raj Rajaratnam.
Hedge funds Diamondback Capital and Level Global Investors and affiliated traders and analysts.
Hedge fund manager Douglas Whitman.
John Kinnucan and his expert network consulting firm Broadband Research Corporation.
A second round of charges in an insider trading case involving former professional baseball players and the former top executive at Advanced Medical Optics.
Other Enforcement Matters
In order to ensure fair trading and equal access to information in the securities markets, the SEC brought several actions involving compliance failures and rules violations relating to stock exchanges, alternative trading platforms, and other market structure participants.
These cases included:
First-of-its-kind charges against the New York Stock Exchange for compliance failures that gave certain customers an improper head start on trading information.
The first-ever action against a "dark pool" trading platform (Pipeline Trading Systems) for failing to disclose to its customers that the vast amount of orders were filled by an affiliated trading operation.
An action against Direct Edge Holdings LLC for violations at two of its electronic stock exchanges and a broker-dealer arising out of weak controls that resulted in millions of dollars in trading losses and a systems outage.
In the NYSE matter, the exchange and its parent company NYSE Euronext agreed to pay a $5 million penalty, marking the first-ever SEC financial penalty against an exchange.
Investment Advisers: The SEC filed numerous actions resulting from several risk-based, proactive measures that identify threats at an early stage so that early action to halt the misconduct can be initiated and investor harm minimized. In 2012, several actions resulted from the Division’s investment adviser compliance initiative, which looks for registered investment advisers who lack effective compliance programs designed to prevent securities laws violations.
The SEC also filed actions charging three advisory firms and six individuals as part of the Aberrational Performance Inquiry into abnormal performance returns by hedge funds. Other actions against investment advisers included cases against UBS Financial Services of Puerto Rico and two executives for misleading disclosures relating to certain proprietary closed-end mutual funds, Morgan Stanley Investment Management for an improper fee arrangement, and OppenheimerFunds for misleading investors in two funds suffering significant losses during the financial crisis. UBS paid more than $26 million to settle the SEC’s charges while OppenheimerFunds paid more than $35 million for its violations.
The SEC filed 147 enforcement actions in 2012 against investment advisers and investment companies, one more than the previous year’s record number.
Issuer Disclosures:
The SEC brought 79 actions in FY 2012 for financial fraud and issuer disclosure violations. Those cases included actions against Life Partners Holdings and senior executives for fraudulent disclosures related to life settlements; two executives at China-based Puda Coal for defrauding investors about the nature of the company’s assets; and an enforcement action against Shanghai-based Deloitte Touche Tohmatsu for its refusal to provide the SEC with audit work papers related to a China-based company under investigation for potential accounting fraud against U.S. investors.
Broker-Dealers:
The agency filed 134 enforcement actions related to broker-dealers, a 19 percent increase over the previous year. Broker-dealer actions included charges against a Latvian trader and electronic trading firms for their roles in an online account intrusion scheme that manipulated the prices of more than 100 NYSE and Nasdaq securities as well as charges against New York-based brokerage firm Hold Brothers On-Line Investment Services and three of its executives for their roles in allowing overseas traders to access the markets and conduct manipulative trading through accounts the firm controlled. The defendants in the Hold Brothers action paid a total of $4 million to settle the SEC’s charges.
FCPA:
The SEC filed 15 actions in FY 2012 for violations of the Foreign Corrupt Practices Act. FCPA actions were filed against former Siemens executives, Magyar Telekom, Biomet, Smith & Nephew, Pfizer, Tyco International, and a former executive at Morgan Stanley’s real estate investment and fund advisory business.
Municipal Securities:
The SEC filed 17 enforcement actions related to municipal securities, more than double the number filed in 2011. Among those charged in SEC municipal securities actions were the former mayor and city treasurer of Detroit in a pay-to-play scheme involving investments of the city’s pension funds, and Goldman Sachs for violations of various municipal securities rules resulting from undisclosed "in-kind" non-cash contributions that one of its investment bankers made to a Massachusetts gubernatorial candidate.
FROM: U.S. DEPARTMENT OF JUSTICE
Monday, November 19, 2012
Former Executives of Stanford Financial Group Entities Convicted for Roles in Fraud Scheme
WASHINGTON – A Houston federal jury has convicted Gilbert T. Lopez Jr., the former chief accounting officer of Stanford Financial Group Company, and Mark J. Kuhrt, the former global controller of Stanford Financial Group Global Management, for their roles in helping Robert Allen Stanford perpetrate a fraud scheme involving Stanford International Bank (SIB).
The guilty verdict was announced by Assistant Attorney General Lanny A. Breuer of the Justice Department’s Criminal Division; U.S. Attorney Kenneth Magidson of the Southern District of Texas; FBI Assistant Director Kevin Perkins of the Criminal Investigative Division; Assistant Secretary of Labor for the Employee Benefits Security Administration Phyllis C. Borzi; Chief Postal Inspector Guy J. Cottrell; and Special Agent in Charge Lucy Cruz of IRS-Criminal Investigation.
Stanford, who was convicted in a separate trial held earlier this year, illegally used billions of dollars of SIB’s assets to fund his personal business ventures, to live a lavish lifestyle, and for other improper purposes.
The evidence presented at the trial of Lopez and Kuhrt established that they were aware of and tracked Stanford’s misuse of SIB’s assets, kept the misuse hidden from the public and from almost all of Stanford’s other employees, and worked behind the scenes to prevent the misuse from being discovered.
The trial against Lopez and Kuhrt spanned five weeks. After approximately three days of deliberations, the jury found both Lopez, 70, and Kuhrt, 40, both of Houston, guilty of 10 of 11 counts in the indictment. Each defendant was convicted of one count of conspiracy to commit wire fraud and nine counts of wire fraud. Each was found not guilty on one wire fraud count.
Both defendants were immediately remanded into custody.
U.S. District Judge David Hittner, who presided over the trial, has set sentencing for Feb. 14, 2013. At sentencing, Lopez and Kuhrt will each face a maximum of 20 years in prison on each count of conviction.
The investigation was conducted by the FBI, U.S. Postal Inspection Service, IRS-CI and the U.S. Department of Labor, Employee Benefits Security Administration. The case was prosecuted by Deputy Chief Jeffrey Goldberg and Trial Attorney Andrew Warren of the Criminal Division’s Fraud Section, and by Assistant U.S. Attorney Jason Varnado of the Southern District of Texas.
FROM: U.S. SECURITES AND EXCHANGE COMMISSION
Washington, D.C., Nov. 16, 2012 — In coordination with the federal-state Residential Mortgage-Backed Securities Working Group, the Securities and Exchange Commission today charged J.P. Morgan Securities LLC and Credit Suisse Securities (USA) with misleading investors in offerings of residential mortgage-backed securities (RMBS). The firms agreed to settlements in which they will pay more than $400 million combined, and the SEC plans to distribute the money to harmed investors.
The SEC alleges that J.P. Morgan misstated information about the delinquency status of mortgage loans that provided collateral for an RMBS offering in which it was the underwriter. J.P. Morgan received fees of more than $2.7 million, and investors sustained losses of at least $37 million on undisclosed delinquent loans. J.P. Morgan also is charged for Bear Stearns' failure to disclose its practice of obtaining and keeping cash settlements from mortgage loan originators on problem loans that Bear Stearns had sold into RMBS trusts. The proceeds from this bulk settlement practice were at least $137.8 million.
J.P. Morgan has agreed to pay $296.9 million to settle the SEC's charges.
According to the SEC's order against Credit Suisse, the firm similarly failed to accurately disclose its practice of retaining cash for itself from the settlement of claims against mortgage loan originators for problems with loans that Credit Suisse had sold into RMBS trusts and no longer owned. Credit Suisse also made misstatements in SEC filings about when it would repurchase mortgage loans from trusts if borrowers missed the first payment due. The firm made $55.7 million in profits and losses avoided from its bulk settlement practice, and its investors lost more than $10 million due to Credit Suisse's practices concerning first payment defaults.
Credit Suisse has agreed to pay $120 million to settle the SEC's charges.
"In many ways, mortgage products such as RMBS were ground zero in the financial crisis," said Robert Khuzami, Director of the SEC's Division of Enforcement. "Misrepresentations in connection with the creation and sale of mortgage securities contributed greatly to the tremendous losses suffered by investors once the U.S. housing market collapsed. Today's actions involving RMBS securities are a continuation of the SEC's strong efforts to pursue wrongdoing committed in connection with the financial crisis."
Mr. Khuzami is a co-chair of the RMBS Working Group, which brings together federal and state agencies to investigate those responsible for misconduct that contributed to the financial crisis through the pooling and sale of RMBS.
RMBS Working Group Co-Chair and U.S. Attorney for the District of Colorado John Walsh said, "Today's filings represent significant steps towards the accomplishment of the Working Group's mission - to investigate and confront the abuses in the residential mortgage-backed securities market that significantly contributed to the Financial Crisis. The Working Group model allows the Department of Justice to lend a hand to other enforcement partners around the country who, in turn, have their own unique resources, talents, and legal tools to contribute to the effort. And the Justice Department's efforts in this area have benefited from SEC's work on its own cases."
RMBS Working Group Co-Chair and New York State Attorney General Eric Schneiderman said, "Today's actions are another step forward in the process of bringing accountability for the misconduct that led to the collapse of the housing market. We will continue to work together on behalf of consumers and investors to ensure that it never happens again."
According to the SEC's complaint against J.P. Morgan filed in federal court in Washington D.C., federal regulations under the securities laws require the disclosure of delinquency information related to assets that provide collateral for an asset-backed securities offering. Information about the delinquency status of mortgage loans in an RMBS transaction is important to investors because those loans are the primary source of funds by which investors can earn interest and obtain repayment of their principal.
The SEC alleges that in the prospectus supplement for the $1.8 billion RMBS offering that occurred in December 2006, J.P. Morgan made materially false and misleading statements about the loans that provided collateral for the transaction. The firm represented that only four loans (.04 percent of the total loans collateralizing the transaction) were delinquent by 30 to 59 days, and that those four were the only loans that had had an instance of delinquency of 30 or more days in the 12 months prior to the "cut-off date" for the transaction. However, at the time J.P. Morgan made these representations, the firm actually had information showing that more than 620 loans (above 7 percent of the total loans collateralizing the transaction) were, and had been, 30 to 59 days delinquent, and the four loans represented as being 30 to 59 days delinquent were in fact 60 to 89 days delinquent.
The SEC's complaint also alleges that Bear Stearns' bulk settlements covered loans collateralizing 156 different RMBS transactions issued from 2005 to 2007. Loan originators were usually required by contract to buy back loans that suffered early payment defaults or had other defects. However, Bear Stearns frequently negotiated discounted cash settlements with these loan originators in lieu of a buy-back on loans that were owned by the RMBS trusts. The firm - both before and after the merger with J.P. Morgan - then kept most of the bulk settlement proceeds. The firm failed to disclose the practice to investors who owned the loans. Bear Stearns repurchased only about 13 percent of these defective bulk settlement loans from the trusts, compared to a nearly 100 percent repurchase rate when loan originators agreed to buy back the defective loans. For most loans covered by bulk settlements, the firm collected money from originators without paying anything to the trusts.
J.P. Morgan settled the SEC's charges by consenting to pay $50.5 million in disgorgement and prejudgment interest and a $24 million penalty for the delinquency misstatements, which the SEC will seek to distribute to harmed investors in the transaction through a Fair Fund. J.P. Morgan agreed to pay $162,065,536 in disgorgement and prejudgment interest and a $60.35 million penalty for the bulk settlement practice misconduct, and the SEC will seek to distribute these funds to harmed investors through a separate Fair Fund. J.P. Morgan consented, without admitting or denying the allegations, to the entry of a final judgment permanently enjoining them from violating Section 17(a)(2) and (3) of the Securities Act of 1933. The settlement is subject to court approval.
According to the SEC's order instituting a settled administrative proceeding against Credit Suisse, the firm and its affiliated entities misled investors in 75 different RMBS transactions through the bulk settlement practice. From 2005 to 2010, Credit Suisse frequently negotiated bulk settlements with loan originators in lieu of a buy-back of loans that were owned by the RMBS trusts. Credit Suisse kept the bulk settlement proceeds for itself and failed to disclose the practice to investors who owned the loans. In nine of the 75 RMBS trusts, Credit Suisse failed to comply with offering document provisions that required it to repurchase certain early defaulting loans. Credit Suisse also applied different quality review procedures for loans that it sought to put back to originators, instituted a practice of not repurchasing such loans from trusts unless the originators had agreed to repurchase them, and failed to disclose the bulk settlement practice when answering investor questions about early payment defaults.
The SEC's order also found that Credit Suisse made misleading statements about a key investor protection known as the First Payment Default (FPD) provision in two RMBS offerings. The FPD provision required the mortgage loan originator to repurchase or substitute loans that missed payments shortly before or after they were securitized. Credit Suisse misled investors by falsely claiming that "all First Payment Default Risk" was removed from its RMBS, and at the same time limiting the number of FPD loans that were put back to the originator.
Credit Suisse settled the SEC's charges by consenting to pay $68,747,769 in disgorgement and prejudgment interest and a $33 million penalty, which the SEC will seek to distribute through a Fair Fund to harmed investors in the 75 RMBS transactions affected by the bulk settlement practice. Credit Suisse agreed to pay $12,256,651 in disgorgement and prejudgment interest and a $6 million penalty, which the SEC will seek to distribute through a separate Fair Fund to harmed investors in the two transactions affected by the FPD misstatements. Credit Suisse agreed to an order, without admitting or denying the allegations, requiring them to cease and desist from violations of Section 17(a)(2) and (3) of the Securities Act and Section 15(d) of the Securities Exchange Act of 1934.
These investigations were conducted by members of the SEC Enforcement Division's Structured and New Products Unit in both the Denver and Washington, D.C. offices, including Zachary Carlyle, Mark Cave, Sarra Cho, Allison Herren Lee, Laura Metcalfe, Colin Rand, Thomas Silverstein, John Smith, Andrew Sporkin, Amy Sumner, and Jeffrey Weiss. The trial unit members assigned to this matter were Dugan Bliss, Kyle DeYoung, Jan Folena, and Christian Schultz. The Enforcement Division was assisted by Eugene Canjels and Vance Anthony in the Division of Risk, Strategy and Financial Innovation. The SEC thanks the other agencies who are members of the RMBS Working Group for their assistance and cooperation regarding these enforcement actions.
"These actions demonstrate that we intend to hold accountable those who misled investors through poor disclosures in the sale of RMBS and other financial products commonly marketed and sold during the financial crisis. Our efforts in that regard continue," said Kenneth Lench, Chief of the SEC Enforcement Division's Structured and New Products Unit.
FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
November 20, 2012
The Securities and Exchange Commission today charged Stamford, Conn.-based hedge fund advisory firm CR Intrinsic Investors LLC and its former portfolio manager along with a medical consultant for an expert network firm for their roles in a $276 million insider trading scheme involving a clinical trial for an Alzheimer's drug being jointly developed by two pharmaceutical companies. The illicit gains generated in this scheme make it the largest insider trading case ever charged by the SEC.
The SEC alleges that Mathew Martoma illegally obtained confidential details about the clinical trial from Dr. Sidney Gilman, who served as chairman of the safety monitoring committee overseeing the trial. Dr. Gilman was selected by Elan Corporation and Wyeth to present the final drug trial results to the public. In phone calls that were arranged by a New York-based expert network firm for which he moonlighted as a medical consultant, Dr. Gilman tipped Martoma with safety data and eventually details about negative results in the trial about two weeks before they were made public in July 2008. Martoma then caused several hedge funds to sell more than $960 million in Elan and Wyeth securities in just over a week.
Dr. Gilman, who lives in Ann Arbor, Mich., where he works as a medical school professor, has agreed to settle the SEC's charges and cooperate in this action and related SEC investigations. In a parallel action, the U.S. Attorney's Office for the Southern District of New York today announced criminal charges against Martoma and a non-prosecution agreement with Dr. Gilman. Martoma lives in Boca Raton, Fla.
According to the SEC's complaint filed in federal court in Manhattan, Martoma first met Dr. Gilman through paid consultations arranged by the expert network firm. Dr. Gilman provided Martoma with material nonpublic information concerning the Phase II trial of the potential Alzheimer's drug called bapineuzumab (bapi). They coordinated their expert network consultations around scheduled safety monitoring committee meetings, and during their phone calls they discussed PowerPoint presentations made during the meetings and Dr. Gilman provided Martoma with his perspective on the results. Dr. Gilman developed a personal relationship with Martoma, eventually coming to view Martoma as a friend and pupil.
The SEC alleges that Martoma caused hedge funds managed by CR Intrinsic as well as hedge funds managed by an affiliated investment adviser to trade on the negative inside information he received from Dr. Gilman. Although Elan and Wyeth's shares rose on June 17, 2008, on the public release of top-line results of the Phase II trial, market participants were disappointed by the detailed final results issued on July 29, 2008. Double-digit declines in Elan and Wyeth shares ensued. After Martoma was tipped, the hedge funds not only liquidated their combined long position in Elan and Wyeth of more than $700 million, but went on to hold substantial short positions in both securities. This massive repositioning allowed CR Intrinsic and the affiliated advisory firm to reap approximately $82 million in profits and $194 million in avoided losses for a total of more than $276 million in illicit gains.
According to the SEC's complaint, Martoma received a $9.3 million bonus at the end of 2008 - a significant portion of which was attributable to the illegal profits that the hedge funds managed by CR Intrinsic and the other investment advisory firm had generated in this scheme. Dr. Gilman, who was generally paid $1,000 per hour as a consultant for the expert network firm, received more than $100,000 for his consultations with Martoma and others at the hedge fund advisory firms. Dr. Gilman also received approximately $79,000 from Elan for his consultations concerning bapi in 2007 and 2008.
The SEC's complaint charges each of the defendants with violating Section 17(a) of the Securities Act of 1933, and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, and seeks a final judgment ordering them to disgorge their ill-gotten gains plus prejudgment interest, ordering them to pay financial penalties, and permanently enjoining them from future violations of these provisions of the federal securities laws.
Dr. Gilman has agreed to pay more than $234,000 in disgorgement and prejudgment interest. He also agreed to a permanent injunction against further violations of the federal securities laws. The proposed settlement is subject to approval by the court, which also will determine at a later date whether any additional financial penalty is appropriate.
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