The SEC Needs a Win Against Mozilo

As a New York Times story suggested earlier this week, Federal Judges are no longer rubber stamping the SEC’s settlements with Wall Street. This has put the SEC in an almost impossible situation: drive harder bargains and risk facing off in court against Wall Street’s limitless legal resources or bow to their wishes and risk more rejected settlements.

It all started with Judge Jed S. Rakoff’s denouncement of the SEC’s settlement with Bank of America for allegedly misleading shareholders about losses pending at Merrill Lynch, which at the time was in the process of being acquired. Judge Ellen Segal Huvelle then refused to accept a settlement with Citigroup, which also was accused of misleading shareholders about tens of billions of dollars in potential losses.

Judges are frustrated that the SEC’s settlement patterns harm shareholders who actually bear the brunt of the fines. They also want the SEC to negotiate stiffer penalties holding executives personally liable for fraudulent acts.

There are many reasons why large Wall Street firms are able to negotiate such generous terms with the SEC. One reason is the so-called “revolving door,” where former SEC officials representing Wall Street sit across from their past colleagues who themselves might be eying lucrative Wall Street jobs. But another is that Wall Street knows that the SEC is at a disadvantage if push comes to shove and a trial is scheduled.

The SEC rarely argues cases in a courtroom and even more rarely prevails against large Wall Street banks. With a track record like that, Wall Street’s legal representatives have the leverage they need to protect senior management and continue practices that exploit investors.

But that could all change in October when the trial against former Countrywide Financial CEO Angelo Mozilo is scheduled to begin.

A settlement agreement has yet to be struck between the SEC and senior executives of mortgage giant Countrywide Financial, including Mr. Mozilo. The SEC has accused them of misleading investors about their lending standards. It’s conceivable that an agreement may prevent a trial or that a judge could dismiss the charges, but considering the judicial scrutiny of late, the terms of a settlement would not be favorable to Mr. Mozilo and his former colleagues. Thus, it certainly looks like a civil fraud trial will get started this October.

The symbolic importance of the trial has been noted by several experts including former SEC chairman Harvey Pitt, who said that the case is “significant because it is a reflection of the SEC’s commitment to go after people who have been involved in the financial meltdown.”

I agree with Chairman Pitt, and I’d take it a step further: a win for the SEC would provide its enforcement team with the leverage they need to negotiate stiffer terms for settlements. Future settlements could and should include admissions of liability, as well as personal financial liability of the wrongdoer and his or her manager if applicable.

For the SEC, this is a “bet the farm” lawsuit and one that could lay the groundwork for the future of enforcement on Wall Street.

UBS Clients Flee: The Rest of the Story

Since 2008, UBS has shed $220 billion in client assets and has suffered from a mass broker exodus from its Wealth Management unit.  In an attempt to halt investor outflows and calm its battered and bruised clients, UBS’ CEO has taken to the road and is headlining events for the bank’s high net worth clients hoping his charm can stem the tide of resentment.

According to a recent Wall Street Journal report, UBS’ illegal tax shelters are largely to blame for client defections.  But that’s only part of the reason for UBS’ problems: UBS also widely peddled dubious investments that blew up its clients’ portfolios and destroyed its brokers’ reputations.

The firm was one of the largest marketers of auction rate securities (ARS).  And after the ARS market collapsed, regulators forced UBS to re-purchase $22 billion worth of the stuff back from clients due to misleading sales practices.

Then there’s the firm’s regrettable involvement with Lehman Brothers its “principal protected notes” (PPN).  UBS was the chief seller of PPN’s issued by Lehman, having sold as much as $1 billion worth.  UBS’ sales practices are currently under investigation by regulators and scores of investors have filed arbitration cases after finding out, much to their surprise, that their “principal investments” weren’t so protected after all.

UBS’ brokers were also caught off guard.  They knew little about principal protected notes and their exposure to Lehman.  Feeling misled, many brokers have joined competitors or have exited the business entirely.

UBS has lost every PPN case that has gone to arbitration.  Full disclosure: I took the first case to trial and have dozens more.

Recently, UBS’ CEO Oswald Grubel summed it up pretty well when he told reporters, “We shouldn’t underestimate the reputational damage we engineered for ourselves.”

I couldn’t have said it better myself.

The Farcical Prosecution of “Fab” Tourre

Admittedly, it takes all the charity in one’s heart to feel any sympathy for Fabrice Tourre, the Goldman Sachs bond trader who gleefully sold securities he knew to be toxic to institutional clients he played as suckers.  “Fabulous Fab,” his email nom de plume when corresponding with his girlfriend, underscores Tourre’s unabashed arrogance and his prescience about the inevitable collapse of the securities he was peddling, and leaves no doubt that he knew exactly what he was doing.  Nevertheless, the SEC’s decision to charge the 31-year-old trader while letting Goldman off the hook is akin to prosecuting someone for securing a get-a-way car for an armed bank robber while letting the bank robber walk free.

As Tourre makes clear in his court filing, bigwigs in Goldman’s legal, compliance, and sales and trading areas knew full well what he was up to.  There hasn’t even been a scintilla of evidence introduced suggesting that Tourre was a rogue employee — if he was, you can rest assured Goldman wouldn’t keep him on a paid leave of absence and continue paying his legal bills.

In allowing Goldman to settle for a measly $550 million without admitting any wrongdoing, the SEC wanted a sacrificial lamb to tar and feather and garner some prosecution batting practice. Goldman’s lawyers were no doubt steadfast against offering up CEO Lloyd Blankein or any other person in a position of meaningful authority, so instead young Tourre got the nod.

Though it’s probably of little comfort to “Fab,” he is part of a fast growing ignominious group of hapless mid and junior level employees who have taken the fall for their powerful Wall Street bosses.  Forbes a few years back chronicled how Bear Stearns sold out some mid-level employees to save its hide in the market timing scandal, and former New York Attorney General Eliot Spitzer only chose to prosecute a mid-level broker named Ted Sihpol for Bank of America’s market timing scandal.

Such is the rule of justice on Wall Street.  The most senior executives — the ones ultimately responsible for sanctioning the industry’s widespread fraud and wrongdoing — are never held legally accountable.  Goldman’s $550 million fine will sting a tad for a quarter, but it won’t cause Blankfein to get religion and ensure no further wrongdoing occurs under his watch.

In prosecuting “Fab”, perhaps the SEC is sending a signal that it will get tough on any employee involved in unethical or questionable activities.  But if the SEC truly wants to curb wrongdoing on Wall Street, they should start at the top.