The SEC has Failed Us: What now?

The alleged Ponzi scheme perpetrated by Bernie Madoff should be the death-knell for the SEC. The SEC ignored numerous red flags waved by investors going back ten years. It was a not-so-well-kept secret across Wall Street that Mr. Madoff’s reported returns were fictitious and in 2001, Barron’s published a story entitled, “Don’t Ask, Don’t Tell; Bernie Madoff is so secretive, he even asks investors to keep mum.”

The signs were there. Period. And the SEC decided to lazily ignore the problem and is continuing to claim jurisdictional road blocks. It argued that Mr. Madoff didn’t register as an investment advisor, but that is not true. He was registered in 2006 and the SEC was required to examinie his operation then, and every five years thereafter.

In light of its recent performance, to make excuses at this point this is nothing less than insulting to investors.

Our financial regulatory system has failed. Therefore, steps must be taken to correct the problem now. If the United States wishes to remain the financial capital of the world, we must take a leadership role immediately.

Many factors such as securitization, leverage, asset bubbles, conflicts and outright fraud contributed to the economy’s downfall. But in general, I believe that it is self-regulation and inadequate oversight that provided the essential glue for the confluence of issues that have led to the economy’s collapse. One needs to not look any further than the fact that Bernie Madoff himself presided over the NASDAQ, which at the time served as one of the key financial regulators overseeing him and those of his ilk. Moreover, he was able to perpetrate his alleged schemes knowing the SEC was asleep at the wheel.

Nearly at every turn there are examples of Wall Street’s influence over regulation:

For example, in 2002 Wall Street successfully lobbied the SEC to adopt directives that would be “equivalent” to proposed European Union (E.U.) regulation that would have put the big five U.S. investment banks under the umbrella of E.U. regulatory authority. In response, the SEC, perhaps unwittingly, created as a result the Consolidated Supervised Entity (”CSE”), which relaxed net capital requirements and green-lighted unlimited debt/equity ratio leverage. This action permitted firms like Merrill Lynch and Bear Stearns to leverage their assets up to 40:1 with cataclysmic results for the financial system.

Another long-term and distressing trend is that the SEC Chairman and its top regulatory executives moved freely between the financial services industry and government positions. This resulted in a failure to manage conflicts. For example, in a scathing report issued by the Commission’s inspector general’s office, it was determined that the SEC’s Miami office found Bear Stearns improperly priced its collateralized debt obligations in 2005. An SEC official who later joined a major securities law firm gleefully informed Bear Stearns that the SEC would squash the investigation saying, “Christmas came early.”

The report went on to disclose numerous situations where conflicts clearly affected the SEC’s judgment including that an employee improperly used her position with regard to a family member’s dispute with a broker, potential insider trading and even one instance where one of the SEC’s own attorneys had not maintained his bar status in 14 years. The well documented case of the SEC’s handling of the Pequot insider trading allegations is another black eye.

Most of these scandals occurred under the watch of Chairman Christopher Cox, who prior to serving in the U.S. House of Representatives was a partner a Lanthan & Watkins, a go-to securities law firm for much of Wall Street. Chairman Cox’s laissez-faire oversight of the securities market makes Harvey Pitt’s famous “kindler, gentler” SEC look downright forceful. Plainly put, if Chairman Cox were the coach of a professional sports team, he would have been fired a few weeks into his first season.

Regulatory reform does not stop with the SEC. The current Secretary of the Treasury is easily the poster child of Wall Street’s “regulation domination.” In 2006, Secretary Paulson established the “Committee on Capital Markets Regulation,” a.k.a. “The Paulson Committee”, which set out to reduce the regulatory burden on the financial services industry. The Committee consisted exclusively of representatives of investment banks, auditors and corporate issuers. There were no representatives of either institutional or individual investors. Their targets were:

Ø Sarbanes-Oxley Act - particularly reforms designed to improve internal controls and the ability for Attorney Generals to prosecute corporate malfeasance

Ø Reducing litigation liability for auditors

Ø Making it harder to “prove” securities fraud

The proposals would have basically left securities and corporate fraud unchecked, which is exactly what Wall Street wanted. Though Wall Street’s meltdown has tempered Secretary Paulson appetite for additional deregulation, his oversight of the TARP funds appears to be engineered by the industry as well. Wall Street banks were provided billions in direct funding without any questions asked. And instead of using the funds to break the credit log jam, Wall Street is hoarding the money for its own purposes.

The key to a new Obama regulatory regime is expanded rules of play and stronger leadership. New regulation must be written on the basis of transparency, full disclosure and an end to conflicts of interest all together. Among the key focal points, I recommend:

Ø There has to be a complete overhaul of all the “grey” areas that continue to slip through the cracks. Indeed, it’s unclear whether the SEC should have had oversight of Mr. Madoff’s investment business because it was structured separately from his broker-dealer operation.

Ø There needs to entirely be more transparency for investment advisors, the credit default swaps market and hedge funds. Hedge fund regulation must go further than the so-called “Goldstein Rule,” which was a feeble attempt by the SEC to require fund managers simply to “register.” It’s notable that when the SEC was told it couldn’t require hedge funds to register as a matter of law, the agency choose to “punt” and not pursue such powers with Congress. To rein-in the damage they can cause, hedge funds, broker-dealers, market makers and investment advisors alike should be subject to periodic audits for systemic risk and “style drift.” Such an audit would expose Ponzi schemes, ala Mr. Madoff.

Ø And if there are breaches of regulations, the penalty must fit the crime. Gone should be the days when thirteen of the largest investment banks are fined a paltry $15 million collectively for violations, as was the case when the SEC found evidence of wrongdoing related to auction rate securities (ARS) years before the market froze. Paltry fines have been the cost of doing business for too long. Enforcement action should be discouraging enough to prevent violations.

Ø Finally, let investor arbitration be a stronger check for industry wrongdoing. FINRA must eliminate the requirement of one industry arbitrator sitting on each three member panel. This will make arbitration hearings fairer for investors - creating a more level playing field because the industry arbitrator is inherently partial.

What is going to give the Madoff scandal major impact is that very influential people have been profoundly affected including Senator Frank Lautenberg, real estate magnate and Daily News editor Mort Zuckerman, movie director Stephen Spielberg, among others. While there are countless individual investors that learned long ago of the SEC’s dormant ways, the agency’s negligence in the Madoff case has dramatically raised awareness of the agency’s ineffectiveness. I’m hopefully that the investor protection I’ve long been calling for is finally implemented.

Madoff’s Indirect Investors May Recover Some Money, Lawyer Says

Madoff Revelations Set off Legal Stampede

Lehman Brothers Stock Loss

Zamansky & Associates is currently investigating claims on behalf of investors in several securities tied to Lehman Brothers. These investors bought Lehman Brothers’ “principal protected notes,” also known as “structured notes” as well as the firm’s preferred and common stock. Many of the investors we are hearing from were inappropriately placed into these securities by their brokers and are seeking to recoup their losses. It is likely that claims like these with regard to bank stocks, will be the next “Dot.com” and thousands of investors will file for arbitration.

Lehman Brothers Structured Notes

Lehman structured notes are financial instruments that were pitched to investors looking for safe, conservative places to invest their money. Brokerages pitched these ostensibly risk free products to their most risk-adverse clients, namely retirees or near retirement investors. In many cases, they were sold just months or weeks before the firm declared bankruptcy.

Many of these investors can seek recovery for their lost investments.

Generally speaking, Lehman Brothers structured notes consist of “derivatives,” a complex security that is masked with fixed income-like qualities. Lehman Brothers structured notes were supposed to provide an investor with the safety of a bond and the rate of return of an equity investment. However many investors were unaware that these securities were tied to other risky assets. And what is now known is that Lehman Brothers and other brokerages were using the revenue generated from these obscure products to make up for underperformance in other areas of their business related to the subprime mortgage crisis. Indeed, major brokerages such as UBS, Wachovia, Merrill Lynch, Citigroup, and many others sold Lehman structured notes for the same reason.

Another major selling point was that Lehman Brothers guaranteed the structured notes with “100 percent principal protection” and claimed buyers had “uncapped appreciation potential” in a brochure sent to investors in July. The brochure even made the audacious assertion that the buyer would at the very least get back their 1,000 per note investment in three years. Since Lehman Brothers is now out of business, the guarantee is basically worthless.

If your brokerage firm pitched you Lehman Brothers structured notes, contact Zamansky & Associates.

Lehman Brothers Preferred and Common Stock

We would also like to hear from investors who were sold Lehman Brothers preferred or common stock. Depending on when and how brokers pitched the preferred or common stock, losses could be recovered through FINRA arbitration.

This is because brokers have a fiduciary responsibility only to recommend investments that are in line with their client’s risk tolerance. It seems brokers who pushed their clients into preferred or common stock of Lehman Brothers in the last 16 months may have done so for their own personal gains or were simply incompetent. In either case, investors are assured they can file for protection through FINRA arbitration. In addition, those investors that bought preferred shares through the Lehman preferred stock offering in March, 2008 could potentially file claims.

Investors who were over-weighted in Lehman Brothers preferred and common stock, as well as investments tied to other financial institutions, may also seek recovery. Brokers should have diversified their clients early on in the credit crisis.

Lehman Brothers’ Improper Disclosure Allegations

It is alleged that Lehman Brothers failed to make proper disclosures in its preferred stock offering’s prospectuses relating to the problems the firm faced as a result of the sub-prime crisis. Financial experts have alleged that the problems it faced back in March 2008 ultimately led to its bankruptcy filing on September 15, 2008. Investors should have been alerted of these grave troubles.

We have been contacted by several investors who have incurred losses relating to Lehman securities. We offer free consultations and ensure confidentiality. If you suffered losses stemming from Lehman Brothers’, contact Zamansky & Associates.

Fannie Mae and Freddie Mac Stock Losses

The credit crisis and collapse of the sub-prime mortgage market has led to the collapse of both Fannie Mae and Freddie Mac, two of the largest issuers of preferred stock over the past decade.  In turn, Wall Street has underwritten much of this debt and unloaded it on unsuspecting investors looking for income-generating investments that are consistent with their risk profile.

Zamansky & Associates is representing investors including retirees and institutional investors such as endowments that purchased shares of Fannie Mae and Freddie Mac based on fraudulent information provided to them by their stock brokers.

Investors were led to believe these stocks were “conservative” and would provide steady income through above-average dividends.  Moreover, investors were told that the Federal Government would assure that their investments were safe.

Millions of investors have seen their portfolios and retirement accounts devastated by the collapse of Fannie Mae and Freddie Mac, which should have been prevented.  Brokers have a fiduciary responsibility to only recommend investments that are in line with a client’s risk tolerance and they should never over expose a client to single investment.

At a minimum, brokers should have convinced clients to diversify out of their Fannie Mae and Freddie Mac holdings as it became clear that the subprime mortgage crisis would have material effects on these two companies.  Brokers that failed to protect their clients may have put their own commissions on stock purchases ahead of their client’s interests or were incompetent or negligent.  On both accounts, brokers are likely to be held accountable for their actions through FINRA arbitration.

Zamansky & Associates has already filed several claims on behalf of investors that lost money due to the collapse of Fannie Mae and Freddie Mac.  We offer free consultations and ensure confidentiality.

Stunned Investors Spur Bull Market in Complaints

SocGen Slapped With Class-Action Subprime Suit

New Exchanges to the Rescue? No Way, Say Skeptics of Secondary Market for Auction-Rate Securities

JP Morgan Buys Bears Stearns: Assets Less “Liabilities”

The shocking news that JP Morgan is buying Bear Stearns for the price of $2 per share has many people scratching their heads. Currently Bear Stearns stock isn’t even trading that low. However if you examine the amount of litigation costs and arbitration claims that JP Morgan inherits, it seems a little more reasonable. JP Morgan has announced it had to set aside $6 billion “pretax for litigation, losses on sales of Bear assets and back-office and other consolidation expenses.”

In my mind, Bear Stearns’ spectacular fall underscores the firm’s reluctance to cooperate with other Wall Street brokerages and its unreasonable treatment of investors. Bear Stearns famously neglected to cooperate with the bail out of Long Term Capital Management (LTCM). And more recently, after the firm’s two now collapsed hedge funds were discovered to be on the brink last summer, Bear Stearns stonewalled all attempts by its lenders to inject liquidity into the spiraling funds.

Ironically, it was J.P. Morgan Chase that encouraged Bear Stearns to act, according to a meeting recounted by a Wall Street Journal story from last June:

An hour and a half into the meeting, John Hogan, head of risk management for J.P. Morgan’s investment bank, raised his hand. “With all due respect, I think you’re underestimating the severity of the situation,” he said to Mr. Cioffi and his boss, Bear Stearns Asset Management Chief Executive Richard Marin, according to people who were there. The funds “needed to figure out” how to meet their margin calls, he said, and if that meant bringing in funding from the parent company, “we recommend you do that.”

Many attendees were puzzled by Bear’s apparent unwillingness to bail out the struggling fund, according to people who were there. After the meeting, these people say, there was sympathetic talk about Mr. Cioffi, a loyalist to the firm who seemed to be getting no help in return, and grumbling over memories of the Long-Term Capital Management crisis.

That afternoon Steve Black, J.P. Morgan’s co-chief of investment banking, put in calls to Bear co-presidents and chief operating officers, Mr. Spector and Alan Schwartz. “Is Bear going to stand behind your asset-management company?” he asked Mr. Schwartz, according to people who were briefed on the conversation. Mr. Schwartz said he’d get back to Mr. Black.

An hour later, he called and said that on the advice of Bear’s lawyers, the firm wasn’t going to get involved, these people said. A spokeswoman said Mr. Schwartz couldn’t be reached for comment.

Given its historically self-interested approach to investor crises, this deal could be a positive for individuals with arbitration claims against Bear Stearns such as Zamansky & Associate’s clients. At the least the buyout avoids a Bear Stearns bankruptcy.

Perhaps at most, J.P. Morgan may not have the same motivation to impede investors from recovering losses due to the unscrupulous management of the hedge funds that we now look back at as the beginning of the end for Bear Stearns.

The Subjective Nature of Wall Street Write-Downs

Fourteen billion. That’s the apparent magic number for Merrill Lynch and its new CEO John Thain as formally they announced a write down of $14 billion for the fourth quarter of last year. An equally staggering number was announced by Citigroup and its new CEO Vikram Pandit, which wrote-down $18 billion for the fourth quarter. Together their losses amount to more than the Ecuadorian GDP! It is of course strategically logical for Mr. Thain and Mr. Pandit to write-down such massive losses. As incoming CEOs the losses weren’t under their watch and they can ride gains to the upside. No where to go but up from here!

But what is more troubling about Merrill’s and Citi’s write downs is how it exemplifies the subjective nature of Wall Street’s accounting methods. Just one quarter ago the write-down was $8 billion for Merrill and $11 billion for Citi. Both of those write downs occurred during the tenures of the now “retired” CEOs Stan O’Neil and Charles Prince, respectively.

I have a few questions: If the previous CEOs were still in place would the fourth quarter numbers have been the same? Did Mr. O’Neil and Mr. Prince choose to take smaller write downs in an attempt to save their jobs or is Mr. Thain and Mr. Pandit taking a bigger write down than necessary to ensure they receive the full extent of the upward bell curve? Or are you going to believe “uncertain market conditions” are to be blamed?

The point is, strategy shouldn’t influence when and how much to write down losses. What Wall Street’s earnings environment shows us is that a CEO may have a greater influence on balance sheet than, well… the balance sheet.

In an ideal world we would count on an independent accounting firm to honestly audit Wall Street’s books. But accounting firms are anything but independent as noted by Francine McKenna, whose blog re: The Auditors covers the “Big Four” accountancies. In a recent post, she disclosed the lucrative relationship between PricewaterhouseCoopers (PwC) and Goldman Sachs. PwC has been Goldman’s sole auditor since the firm went public in 1999, but they deliver a myriad of other professional services to the firm.

Writes Ms. McKenna, “This past year, total audit fees were $43.4 million, audit related fees were an additional 3.3 million and tax fees were 2.6 million. In addition, [PwC] made $19.2 million more by providing services to merchant banking and other funds managed by Goldman Sachs subsidiaries. All of these fees were for audit and tax services. By comparison to prior years’ numbers, we can see that over the years, and like other large, complex, global companies, audit and related fees have grown substantially due to Sarbanes-Oxley. But the services to the Goldman Sachs funds have also been part of the package since almost the beginning and add a significant amount to PwC’s overall compensation.”

What Ms. McKenna delicately touched upon I will say outright: with money like that at stake an accounting firm is not incentivized to interpret accounting rules strictly and universally. More plainly, either Mr. Thain or Mr. O’Neil has some explaining to do because investors should not accept that Merrill Lynch couldn’t have written down any of the $14 billion before now.

The game is clearly rigged in Wall Street’s favor if a CEO has billions of dollars of leeway when it comes time to pay the piper. With such grey accounting standards, the write-downs are largely meaningless. And therein lies the lesson. When investing in Wall Street, you’re on a wing and a prayer.