FROM: U.S. DEPARTMENT OF JUSTICE
Tuesday, February 5, 2013
Department of Justice Sues Standard & Poor’s for Fraud in Rating Mortgage-Backed Securities in the Years Leading Up to the Financial Crisis
Complaint Alleges that S&P Lied About its Objectivity and Independence And Issued Inflated Ratings for Certain Structured Debt Securities.
Attorney General Eric Holder announced today that the Department of Justice has filed a civil lawsuit against the credit rating agency Standard & Poor’s Ratings Services alleging that S&P engaged in a scheme to defraud investors in structured financial products known as Residential Mortgage-Backed Securities (RMBS) and Collateralized Debt Obligations (CDOs). The lawsuit alleges that investors, many of them federally insured financial institutions, lost billions of dollars on CDOs for which S&P issued inflated ratings that misrepresented the securities’ true credit risks. The complaint also alleges that S&P falsely represented that its ratings were objective, independent, and uninfluenced by S&P’s relationships with investment banks when, in actuality, S&P’s desire for increased revenue and market share led it to favor the interests of these banks over investors.
"Put simply, this alleged conduct is egregious – and it goes to the very heart of the recent financial crisis," said Attorney General Holder. "Today’s action is an important step forward in our ongoing efforts to investigate – and – punish the conduct that is believed to have contributed to the worst economic crisis in recent history. It is just the latest example of the critical work that the President’s Financial Fraud Enforcement Task Force is making possible."
Attorney General Eric Holder was joined in announcing the filing of the civil complaint by Acting Associate Attorney General Tony West, Principal Deputy Assistant Attorney General for the Civil Division Stuart F. Delery, and U.S. Attorney for the Central District of California André Birotte Jr. Also joining the Department of Justice in making this announcement were the attorneys general from California, Connecticut, Delaware, the District of Columbia, Illinois, Iowa and Mississippi, who have filed or will file civil fraud lawsuits against S&P alleging similar misconduct in the rating of structured financial products. Additional state attorneys general are expected to make similar filings today.
"Many investors, financial analysts and the general public expected S&P to be a fair and impartial umpire in issuing credit ratings, but the evidence we have uncovered tells a different story," said Acting Associate Attorney General West. "Our investigation revealed that, despite their representations to the contrary, S&P’s concerns about market share, revenues and profits drove them to issue inflated ratings, thereby misleading the public and defrauding investors. In so doing, we believe that S&P played an important role in helping to bring our economy to the brink of collapse."
Today’s action was filed in the Central District of California, home to the now defunct Western Federal Corporate Credit Union (WesCorp), which was the largest corporate credit union in the country. Following the 2008 financial crisis, WesCorp collapsed after suffering massive losses on RMBS and CDOs rated by S&P.
"Significant harm was caused by S&P’s alleged conduct in the Central District of California," said U.S. Attorney for the Central District of California Birotte. "Across the seven counties in my district, we had huge numbers of homeowners who took out subprime mortgage loans, many of which were made by some of the country’s most aggressive lenders only because they later could be securitized into debt instruments that were given flawed ‘AAA’ ratings by S&P. This led to an untold number of foreclosures in my district. In addition, institutional investors located in my district, such as WesCorp, suffered massive losses after putting billions of dollars into RMBS and CDOs that received flawed and inflated ratings from S&P."
The complaint, which names McGraw-Hill Companies, Inc. and its subsidiary, Standard & Poor’s Financial Services LLC (collectively S&P) as defendants, seeks civil penalties under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) based on three forms of alleged fraud by S&P: (1) mail fraud affecting federally insured financial institutions in violation of 18 U.S.C. § 1341; (2) wire fraud affecting federally insured financial institutions in violation of 18 U.S.C. § 1343; and (3) financial institution fraud in violation of 18 U.S.C. § 1344. FIRREA authorizes the Attorney General to seek civil penalties up to the amount of the losses suffered as a result of the alleged violations. To date, the government has identified more than $5 billion in losses suffered by federally insured financial institutions in connection with the failure of CDOs rated by S&P from March to October 2007.
"The fraud underpinning the crisis took many different forms, and for that reason, so must our response," said Stuart F. Delery, Principal Deputy Assistant Attorney General for the Department’s Civil Division. "As today’s filing demonstrates, the Department of Justice is committed to using every available legal tool to bring to justice those responsible for the financial crisis."
According to the complaint, S&P publicly represented that its ratings of RMBS and CDOs were objective, independent and uninfluenced by the potential conflict of interest posed by S&P being selected to rate securities by the investment banks that sold those securities. Contrary to these representations, from 2004 to 2007, the government alleges, S&P was so concerned with the possibility of losing market share and profits that it limited, adjusted and delayed updates to the ratings criteria and analytical models it used to assess the credit risks posed by RMBS and CDOs. According to the complaint, S&P weakened those criteria and models from what S&P’s own analysts believed was necessary to make them more accurate. The complaint also alleges that, from at least March to October 2007, and because of this same desire to increase market share and profits, S&P issued inflated ratings on hundreds of billions of dollars’ worth of CDOs. At the time, according to the allegations in the complaint, S&P knew that the quality of non-prime RMBS was severely impaired, and that the ratings on those mortgage bonds would not hold. The government alleges that S&P failed to account for this impairment in the CDO ratings it was assigning on a daily basis. As a result, nearly every CDO rated by S&P during this time period failed, causing investors to lose billions of dollars.
The underlying federal investigation, code-named "Alchemy," that led to the filing of this complaint was initiated in November 2009 in connection with the President’s Financial Fraud Enforcement Task Force.
FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
Yitzchak Zigdon Settles SEC Fraud Charges
On January 23, 2013, the U.S. District Court for the Southern District of Florida entered a final judgment by consent against Yitzchak Zigdon in the SEC's enforcement action against seven defendants concerning the common stock of CO2 Tech Ltd. The final judgment enjoins Zigdon from future violations of Sections 5(a), 5(c) and 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The Court also ordered Zigdon to pay disgorgement of $260,000, prejudgment interest of $74,516 and a civil penalty in the amount of $130,000 for a total of $464,516 in monetary sanctions. In addition, the Court barred Zigdon from participating in an offering of penny stock. Zigdon consented to the entry of the final judgment without admitting or denying any of the allegations of the Commission's Complaint.
According to the Commission's complaint filed in February of 2011, the defendants' coordinated misconduct enabled them to sell CO2 Tech stock at artificially inflated prices, resulting in profits of over $7 million. In the complaint, the Commission alleged that CO2 Tech Ltd. was a sham company without significant assets or operations whose stock prices were quoted in the Pink Sheets. According to the complaint, among other things, Zigdon provided the paper work necessary to establish the account that was used to dump the shares of CO2 Tech on to the market. The complaint also stated that he caused materially false and misleading information about CO2 Tech to be disseminated in press releases and on its website. In particular, the complaint alleged that CO2 Tech falsely touted business relationships that the company had not formed, including a relationship with the Boeing Company when, in fact, there had been no communications, correspondence or understandings between CO2 Tech and Boeing.
FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C., Jan 29, 2013 — The Securities and Exchange Commission today charged a day trader in Sugar Land, Texas, with defrauding investors in his supposed high-frequency trading program and providing them falsified brokerage records that drastically overstated assets and hid his massive trading losses.
The SEC alleges that Firas Hamdan particularly targeted fellow members of the Houston-area Lebanese and Druze communities, raising more than $6 million during a five-year period from at least 33 investors. Hamdan told prospective investors that he would pool their investments with his own money and conduct high-frequency trading using a supposed proprietary trading algorithm. Hamdan promised annual returns of 30 percent and assured investors that his program was safe and proven when in reality it was a dismal failure, generating $1.5 million in losses. As he failed to deliver the promised profits, Hamdan told investors that his funds were tied up in the Greek debt crisis and the MF Global bankruptcy among other phony excuses.
The SEC is seeking an emergency court order to halt the scheme and freeze Hamdan’s assets and those of his firm, FAH Capital Partners.
"Hamdan’s affinity scam preyed upon people’s tendency to trust those who share common backgrounds and beliefs," said David R. Woodcock, Director of the SEC’s Fort Worth Regional Office. "Hamdan raised money by creating the aura of a successful day trader among friends and family in his community, and he continued to mislead them and hide the truth while trading losses mounted."
According to the SEC’s complaint filed in federal court in Houston, Hamdan is well-known in the Lebanese and Druze communities in the Houston area and is a former treasurer of the Houston branch of the American Druze Society. Hamdan found investors for his trading program by talking with his friends and family in these communities. As word spread about his purported trading success, he asked existing investors to solicit their friends for investments.
The SEC alleges that Hamdan misrepresented to investors that he generated positive returns in 59 of 60 months between 2007 and 2012. He showed them phony documentation to support his false claims. For instance, a purported brokerage statement he provided investors for the first quarter of 2010 showed an opening balance of more than $2.3 million with quarterly trading gains of $2.7 million for a closing balance above $5.1 million. An actual brokerage statement obtained by SEC investigators for Hamdan’s account during that same period shows the opening balance at just $27,970.76 and the closing balance at $148,210.02, with quarterly trading losses of $7,452.80.
According to the SEC’s complaint, Hamdan made several other false claims to potential investors. For instance, he lied about the existence of a cash reserve account that secured their investments. Hamdan falsely stated that investments were further secured by a $5 million "key-man" insurance policy. He also falsely claimed that a well-known hedge fund manager in the Dallas area made a million-dollar investment with him and promised to invest more based on Hamdan’s continuing success.
The SEC’s complaint alleges that Hamdan violated the antifraud provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934. The complaint seeks various relief including a temporary restraining order, preliminary and permanent injunctions, disgorgement of ill-gotten gains with prejudgment interest, and financial penalties.
The SEC’s investigation was conducted by Jonathan Scott, Timothy Evans, and Mark Pittman of the Fort Worth Regional Office. Bret Helmer will lead the SEC’s litigation.
FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C., Jan. 30, 2013 — The Securities and Exchange Commission today charged five former real estate executives who defrauded investors into believing they were funding the development of five-star destination resorts in Florida and Las Vegas when they were actually buying into a Ponzi scheme.
The SEC alleges that Cay Clubs Resorts and Marinas raised more than $300 million from nearly 1,400 investors nationwide through a network of hundreds of sales agents, marketing seminars, and podcasts that touted the profitability of purchasing units at Cay Clubs resort locations. Investors were promised immediate income from a guaranteed 15 percent return and a future income stream through a rental program that Cay Clubs managed. But instead of using investor funds to develop resort properties and units, the Cay Clubs executives used new investor deposits to pay leaseback returns to earlier investors. Meanwhile they paid themselves exorbitant salaries and commissions totaling more than $30 million, and investor funds also were misused to buy airplanes and boats. While still advertising itself as a profitable venture, Cay Clubs eventually abandoned its operations. Many investors’ properties went into foreclosure.
"These Cay Clubs executives lined their pockets with millions of dollars that they told investors would be used to develop five-star resort properties," said Eric I. Bustillo, Director of the SEC’s Miami Regional Office. "They continued to defraud investors as Cay Clubs collapsed."
The SEC’s complaint filed in U.S. District Court for the Southern District of Florida charges the following former Cay Clubs executives:
Fred Davis Clark, Jr. – president and CEO
David W. Schwarz – chief accounting officer
Cristal R. Coleman – manager and sales agent
Barry J. Graham – sales director
Ricky Lynn Stokes – sales director
According to the SEC’s complaint, the scheme began in 2004. Clark, Coleman, Graham, and Stokes solicited investors with promises of guaranteed income, instant equity in undervalued properties, historic appreciation, and at least $30,000 in upgrades to the units they purchased at Cay Clubs resort locations in Florida and Las Vegas. The representations about investors’ profitability and instant equity were false because the purported triple-digit returns resulted from undisclosed insider transactions with Cay Clubs by Coleman, Graham, and Stokes. Their actions made it appear that Cay Clubs units had enormous rates of appreciation over a short period of time when in fact the transactions were merely part of an insider flipping scheme. Further, Stokes wrote letters directly to potential investors claiming that the leaseback payments and profits were "guaranteed" and that Cay Clubs was a "very stable financially healthy company worth BILLIONS."
The SEC alleges that Cay Clubs continued to solicit new investors despite the fact that the company’s financial condition had deteriorated so significantly that it did not have sufficient funds to make the "guaranteed" leaseback or rental payments to investors. Clark, Coleman, and Schwarz misappropriated millions of dollars in investor funds using the multitude of bank accounts they controlled. Besides purchasing airplanes and boats, they misused investor money for unrelated business ventures including investments in precious metals and a liquor distillery that produced Pirate’s Choice Rum. After Cay Clubs abandoned its operations in 2008, Clark and Coleman (who are now husband and wife) moved to the Cayman Islands and continued to dissipate assets and funnel at least $2 million to offshore accounts.
The SEC’s complaint seeks financial penalties from Clark, Coleman, and Stokes and the disgorgement of ill-gotten gains plus prejudgment interest by all five executives. The complaint also seeks injunctive relief to enjoin them from future violations of the federal securities laws as well as an accounting and an order to repatriate investor assets.
The SEC’s investigation was conducted in the Miami Regional Office by Senior Counsel Linda S. Schmidt and Senior Regional Accountant Fernando Torres under the supervision of Assistant Regional Director Jason R. Berkowitz. Senior Trial Counsel Amie R. Berlin will lead the SEC’s litigation.
FROM: U.S. COMMODITY FUTURES TRADING COMMISSION
Chairman Gary Gensler’s Opening Remarks at CFTC Roundtable
January 31, 2013
Welcome to the Commodity Futures Trading Commission (CFTC). Thank you, Rick, and thanks to the team for putting together this roundtable. This is the CFTC’s 21st public roundtable since the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). Next week, we'll be holding the 22nd roundtable, the third focused on customer protection.
Today’s roundtable is occurring at an historic time in the markets. The marketplace is increasingly shifting to implementation of common-sense rules of the road for the swaps market.
For the first time, the public will benefit from the greater access to the markets and the risk reduction that comes with central clearing. Required clearing of interest rate and credit index swaps between financial entities begins in March.
For the first time, the public is benefiting from seeing the price and volume of each swap transaction. This post-trade transparency builds upon what has worked for decades in the futures and securities markets. The new swaps market information is available free of charge on a website, like a modern-day ticker tape.
For the first time, the public will benefit from specific oversight of registered swap dealers. As of the end of this week, there will be 71 provisionally registered swap dealers. They are subject to standards for sales practices, recordkeeping and business conduct to help lower risk to the economy and protect the public from fraud and manipulation.
An earlier crisis led to similar common-sense rules of the road for the futures and securities markets. I believe these critical reforms of the 1930s have been at the foundation of our strong capital markets and many decades of economic growth.
In the 1980s, the swaps market emerged. Until now, though, it lacked the benefit of such rules to promote transparency, lower risk and protect investors. What followed was the 2008 financial crisis. Eight million American jobs were lost. In contrast, the futures market, supported by earlier reforms, weathered the financial crisis.
President Obama and Congress responded and crafted the swaps provisions of Dodd-Frank by borrowing from what has worked best in the futures market for decades: clearing, transparency and oversight of intermediaries.
Given that we have largely completed swaps market rulewriting, with 80 percent behind us, today is a good opportunity to hear from market participants on where we are and where we ought to go from here. As we have asked throughout this process, we'd like to hear from market participants today on what provisions for swaps should mirror those for futures and when is it appropriate for there to be differences. I would note that Congress included a number of provisions in Dodd-Frank recognizing appropriate differences. For instance, it is critical that farmers, ranchers, merchants and other end users continue to benefit from using customized swaps that are not cleared.
Now that the entire derivatives marketplace -- both futures and swaps – has comprehensive oversight, it's the natural order of things for some realignment to take place.
The notional open interest of the futures market ranges around $30 trillion. There are various estimates for the notional size of the U.S. swaps market, but it ranges around $250 trillion. Though the futures market trades more actively, just one-ninth or so of the combined open interest in the derivatives marketplace is futures. Approximately eight-ninths of the combined derivatives marketplace is swaps, which until recently were unregulated.
This roundtable also provides an opportunity to hear from market participants on the recent actions of the two largest exchanges. Last fall, IntercontinentalExchange converted power and natural gas-related swaps into futures contracts. In addition, the CME Group's ClearPort products, which were cleared as futures, including those that were executed bilaterally as swaps, are now being offered for trading on Globex or on the trading floor. CME also adopted new block trading rules for its ClearPort energy contracts, as well as began trading a futures contract where the underlying product is an interest rate swaps contract.
It’s important to note that whether one calls a product a standardized swap or a future, both markets now benefit from central clearing. Since the late 19th century, central clearing in the futures market has lowered risk for the public. It also has fostered access for farmers, ranchers, merchants, and other participants and allowed them to benefit from greater competition in the markets. In March, swap dealers and the largest hedge funds will be required, for the first time, to clear certain interest rate swaps and credit index swaps. Compliance will be phased in for other market participants throughout this year.
In addition, transparency has been a longstanding hallmark of the futures market –both pre-trade and post-trade. Now, for the first time, the swaps market is benefitting from post-trade transparency. On December 31, registered swap dealers began real-time reporting for interest rate and credit index swap transactions. Building on this, swap dealers will begin reporting swap transactions in equity, foreign exchange and other commodity asset classes on February 28. Other market participants will begin reporting April 10. The time delays for reporting currently range from 30 minutes to longer, but will generally be reduced to 15 minutes this October for interest rate and credit index swaps. For other asset classes, the time delay will be reduced next January. After the CFTC completes the block rule for swaps, trades smaller than a block will be reported as soon as technologically practicable.
Oversight of intermediaries and the protection of customer funds have long been integral parts of futures market regulation. Futures commission merchants, introducing brokers and commodity pool operators have been CFTC-registered intermediaries. Dodd-Frank extended oversight of these intermediaries to include their swaps activity, and to promote market integrity and lower risk to taxpayers, brought oversight to another category of intermediaries called swap dealers. The initial group of provisionally registered swap dealers includes the largest domestic and international financial institutions dealing in swaps with U.S. persons. It includes the 16 institutions commonly referred to as the G16 dealers. Reforms the CFTC has finalized to enhance the protection of customer funds, as well as proposed enhancements, consistently cover both futures and swaps.
Looking ahead, to further enhance liquidity and price competition, the CFTC must finish the pre-trade transparency rules for swap execution facilities, as well as the block rules for swaps. It is also critical that we preserve the pre-trade transparency that has been at the core of the futures market. In that context, I am looking forward to hearing from panelists today about recent actions by exchanges to lower their minimum block sizes for certain energy futures.
Thank you again for coming, and we look forward to your input.
FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
SEC Charges Jonathan C. Gilchrist with the Unregistered Offer and Sale of Securities and Stock Manipulation
The Securities and Exchange Commission today filed a civil injunctive action in the U.S. District Court for the Southern District of Texas against Jonathan C. Gilchrist, alleging that he effected the unregistered offer and sale of shares of The Alternative Energy Technology Center, Inc. and engaged in a stock manipulation scheme in violation of the registration and antifraud provisions of the federal securities laws.
The Commission’s complaint alleges that in December 2007, Gilchrist, acting as the president and chairman of Mortgage Xpress, Inc. (subsequently renamed The Alternative Energy Technology Center, Inc.), authorized the unregistered offer and sale of six million company shares at a deep discount to himself and two entities he controlled, improperly maintaining that the offer and sale were exempt from registration under Rule 504 of Regulation D of the Securities Act of 1933. The complaint alleges that the company could not claim a Rule 504 exemption from registration because it was a development stage company which, at the time, planned to merge with another entity. The complaint further alleges that the shares issued to the two entities controlled by Gilchrist should have been subject to restriction on resale based on Gilchrist being an affiliate of the company, but were not. As a result, according to the complaint, the share issuance improperly gave Gilchrist control over at least 94% of the public float.
The complaint further alleges that from January through March 2008, Gilchrist effected 25 wash trades in company securities through brokerage accounts he controlled and, in March 2008, arranged for promoters to tout the company. Gilchrist allegedly thereby drove the per share price from $1.00 per share immediately after the reverse stock split on January 18, 2008 to $3.75 per share on April 1, 2008, the day before the Commission suspended trading in the stock. During this time period, Gilchrist made unregistered sales of 229,661 shares, resulting in illicit proceeds of $692,146.38.
Based on the facts alleged, the Commission charged Gilchrist with violating Sections 5(a), 5(c), 17(a)(1) and 17(a)(3) of the Securities Act, and Section 10(b) of the Securities Exchange Act of 1934 and Rules 10b-5(a) and (c) thereunder. The Commission is seeking to have Gilchrist permanently enjoined, ordered to pay disgorgement and a civil money penalty, barred from participating in any penny stock offering, and prohibited from serving as an officer or director.
The SEC thanks the Financial Industry Regulatory Authority's (FINRA) Office of Fraud Detection and Market Intelligence for its assistance in this matter
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