For Ross Mandell and Sky Capital, a Long Trip Indeed…Too Long

Most major media outlets reported this morning that Ross Mandell and several of his colleagues were arrested for a $140 million investment fraud scheme.  Mr. Mandell is the founder of Sky Capital and its former CEO.  The government alleges that Sky Capital was nothing more than a boiler room.

Mr. Mandell and his background on Wall Street is a case study for why there has to be regulatory reform.  What most media outlets didn’t report is that Mr. Mandell is historically one of the most penalized brokers in history.  He was the subject of a 5,649-word story in the Wall Street Journal which disclosed that as of March of 1996 (which is when the story was published) customers had filed 14 known complaints and he had switched jobs at least 13 times during a twelve year career, having been terminated four times for “alleged misconduct.”

There’s no question this guy should have been banned from the industry right then and there.  Either the SEC or the so-called self-regulatory agencies, including the NASD and NYSE (which were later combined to form FINRA), were powerless or too lazy to do it - neither of which is an adequate explanation.

Back to Mr. Mandell…

He blamed his woes on an addiction to cocaine and alcoholism and in 1990 entered rehab.  Nevertheless a year later despite being sober the NYSE investigated him for unauthorized trading in customer accounts and he faced multiple customer complaints thereafter.  Many states wouldn’t license him to trade stocks but through his various employers’ connection with industry regulators he always found a way to continue working on Wall Street.  In 1995 he served a six-month suspension for “churning,” which is the act excessive buying and selling of securities in customer accounts for the purpose of generating commissions.

Mr. Mandell again made headlines in 2002 when he launched Sky Capital, a full service brokerage firm which he described as “a more traditional, more personalized alternative to the major financial institutions.”  The NASD was apparently powerless to stop him.  He told reporters that he had turned over a new leaf and with predictable audacity criticized tech-bubble analysts and CEO’s of being “irresponsible.”  He then took Sky Capital public on the London Stock Exchange (LSE).

Sky Capital’s office was later raided in 2006 by the FBI allegedly because customer funds were being used to finance operations after a client filed a related $130,000 arbitration claim.  Sky Capital’s answer to that problem was to sue the NASD for $300 million, a lawsuit that was later dismissed by the SEC.  The LSE later suspended trading of Sky Capital.

This latest arrest appears to be his last as he faces a potential 20-year sentence.  According to the 1996 Wall Street Journal story, Mr. Mandell’s high school yearbook quote was from the Grateful Dead: “Lately it occurs to me what a long, strange trip it’s been,” is what he inserted.  Way too long actually; he should have been banned years ago.  Now its up to tax payers to clean up this mess.

The story of Ross Mandell is an embarrassment of riches for anyone seeking support to an important clause found on page 72 of President Obama’s plan to reform financial regulation.  The clause would “support the SEC in pursuing authority to impose collateral bars against regulated persons across all aspects of the industry rather than in a specific segment of the industry.”

I guess this can be filed into the “better late than never” drawer.

Hedge Fund Regulation: It’s going to take an act of Congress

Recent events have made it clear that hedge funds pose systemic risk to the financial industry, individual investors and the general public.  A rash of hedge fund blow-ups and frauds show that self-regulatory and market-discipline principles aren’t effective.  Left unchecked, hedge funds will continue to damage the markets.  In January 2009 Senators Levin and Grassley introduced The Hedge Fund Transparency Act which would close a loophole left open by the Investment Company Act of 1940 that allowed hedge funds to evade the definition of an “investment company”. Congress should adopt this bill or something very similar. Otherwise, hedge funds will continue to abuse the shortfalls of our regulatory system.

This is why I’m looking forward to tomorrow’s Senate Banking Committee Hearing entitled “Investor Protection and the Regulation of Securities Markets.”  Hedge fund regulation ought to take center stage.

Hedge funds, by far, have more capital in the equities market then any other asset class. Their transactions are often so large that the impact in the broader markets can be and is quite impactful. Therefore the risks they take are not only their own. That’s why reform needs to start with registration. Under former SEC Chairman Christopher Cox, the SEC’s attempt at hedge fund registration requirements was thwarted by the aforementioned loophole.  Naturally, Mr. Cox chose to drop the issue altogether rather then lobby Congress for change.

If investment advisors are required to register, hedge fund managers should be as well, no matter how many “official” clients they have. Regulators can and should periodically audit firms to ensure risk isn’t out of control.  Risk disclosures must be more transparent. Enough is enough with the creative micro-text found at the end of an offering memorandum. 

Once hedge funds fall under regulatory authority, enforcement of the law is paramount. Unfortunately, the SEC has fallen short of enforcing Wall Street effectively even though those institutions fall under their regulatory authority. This must change for Wall Street and hedge funds alike. The punishment must fit the crime and investors should have a clear and fair process to challenge any perceived wrongdoing.

Thus, investors and employees of hedge funds should be able to file arbitration claims against hedge funds. Arbitration claims, though not perfect, are more cost efficient than litigation and are heard in a much shorter period of time.   

Hedge fund regulation is clearly vital to any future functioning financial system in this country but it can’t end there. There also must be more scrutiny given to the esoteric derivatives market like credit default swaps. Look no further than AIG to see the problems this largely unregulated market has created. Just this week, Chairman Ben Bernanke called AIG “a hedge fund basically” that “exploited a huge gap in the regulatory system”.

If AIG, a public, “regulated” company can operate “like a hedge fund” due to regulatory gaps, then reform is clearly way past due. I trust that Congress will do the right thing and enact legislation that will close regulatory loop holes, protect investors and strengthen our financial system in the process.

Joseph Forte: Bernie’s got Company

Just as Bernie Madoff proved, and others before him, the Ponzi scheme did not end with Charles Ponzi and it appears it won’t end with Bernie Madoff either. The Pennsylvania fund manager, Joseph Forte, seems to be the latest alleged fraudster.

According to the SEC, Forte began Joseph Forte LP in 1995 and obtained $50 million from roughly 80 investors. He lured his investors by giving them a limited partnership in his firm and employed an investment strategy that traded S&P. 500 stock futures in addition to foreign currency futures and other futures contracts. He promised unbelievably generous returns between 19% and 38% annually, according to the SEC. Amazingly, these returns would make Forte’s fund, however fraudulent, appear to be an even better investment than Madoff Securities.

Ironically, it may have been Madoff’s downfall that led Forte’s investors to reveal his alleged fraud. As an aside, the SEC might try to take credit for bringing down Forte but I’m skeptical. According to the Philadelphia Inquirer, an investor sent Forte an email asking that he confirm assets in the supposedly inflated $150 million fund. It’s suspected that many investors filed suit and Forte realized then his alleged fraud would become exposed. According to the Commodities Futures Trading Commission (C.F.T.C), Forte then promptly turned himself in.

As I’ve said before, fraudsters usually get exposed eventually. But the trick is not to get caught up in one of these schemes in the first place. The most important take away for any investor is that they should take exceptional care when choosing where to invest their money. They should understand their money manager’s investment strategy and should expect realistic returns on their investment. This may all seem very obvious to some but too often smart investors are taken advantage of by a seemingly safe investment or are blinded by lavish returns. One lesson I hope will last is that investors should not allow someone who they consider to be a friend, manage their money. This can only lead to clouded judgment. .

Like Madoff and Forte or before them, Peter Dawson in Long Island, NY and Joseph Shereshevsky of WexTrust, perpetrators of financial fraud don’t only strike the ultra-high net worth individuals or institutional investors. They also hit mom and pop investors, religious communities, public institutions and non-profit organizations. I’ve been an investor advocate for a long time and while I’ve seen it all, I still cringe when I hear about these cases.

Hopefully, a small silver lining will be that the people who deceive investors’ confidence for their own benefit will be slowly exposed and eliminated. And while I’m certain that is of no solace to investors who lost their money with Forte, there still might be options on the table for investors to recoup some of their lost funds.

Motion To Dismiss In Arbitration? Not So Fast

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