The Questionable Activities of For-Profit Schools

Federal prosecutors in Manhattan and Georgia last week scored a major Medicare fraud bust with the indictments of 44 members of an Armenian-American crime syndicate who billed Medicare for more than $100 million of treatments that were never performed or received. The group reportedly succeeded in stealing $35 million in Medicare reimbursements, making it the largest Medicare fraud operation conducted by a single group to result in criminal fraud charges.

“With 118 phantom clinics and over $100 million in bogus billings, this group of international gangsters allegedly ran a veritable fraud franchise,” Preet Bharara, the United States attorney in Manhattan, said in a statement announcing the charges. “As charged, they stole taxpayer dollars earmarked for the elderly and infirm and got away with it, until now.”

If Bharara and his federal colleagues are genuinely concerned about misuse of taxpayer money, it is my sincere hope that they are taking a close look at the GAO’s allegations that many of the nation’s leading for-profit schools engaged in equally deceptive practices involving taxpayer dollars.

As someone who has investigated Wall Street for more than three decades, I’ve seen an incredible amount of wrongdoing. However, the activities of for-profit education schools appears to take the cake. Most Wall Street wrongdoing involves firms or brokers simply ripping off their customers; there is considerable evidence suggesting that for-profit education companies may have systematically defrauded the Department of Education, ruined, possibly forever, the finances of already hard-pressed low-income students, and deceived investors about the true condition of their business. The extent and the magnitude of the wrongdoing could possibly rival the sub-prime mortgage debacle.

The GAO reported in August that undercover tests at 15 for-profit colleges found that all made “deceptive or otherwise questionable statements” to the agency’s undercover applicants. One admissions representative told an applicant to fraudulently remove $250,000 in savings on a financial aid form. A student interested in a massage therapy certificate costing $14,000 at a for-profit college was told that the program was a good value, but the GAO said the same certificate from a local community college cost $520. Recruiters at these schools also frequently engaged in aggressive marketing tactics to pressure these students, who had few options and limited financial flexibility, into enrolling. To review the extent of the alleged wrongdoing, here’s a link to the GAO report. Warning: the accompanying video will make your blood boil.

My firm represents investors who bought for-education stocks that were aggressively touted by their brokers. The clients were told that for-education stocks would prosper in the wake of the downturn because millions of people would seek vocational retraining. The investors, of course, were never told that for-education companies were boosting their financials using questionable sales and marketing practices. The stocks of these companies have plummeted.

President Obama has repeatedly been bashing Wall Street for its greed and unscrupulous practices but so far his rhetoric rings hollow. The SEC remains as ineffective as ever under his administration, merely meting out wrist slaps to alleged fraudsters like Goldman Sachs and Angelo Mozilo. I say alleged because despite agreeing to pay fines of $550 million and $67.5 million respectively, they weren’t required to admit any wrongdoing.

If President Obama truly cared about curbing Wall Street’s reckless and ruinous behavior, he’d be at the forefront calling for a public investigation of for-profit companies and criminal prosecutions for defrauding any government program, not just Medicare.

Is Education the New Subprime?

Stop me if you’ve heard this one before: Publicly traded corporations accused of wrongdoing countering critics by saying they are helping low-income Americans achieve the American dream.

No, this isn’t the subprime loan debacle all over again.  It’s the for-profit higher education industry, which is currently reeling from plummeting stock prices and shareholder unrest due to a government investigation that found potentially fraudulent practices and a need for new regulations.

Indeed, on August 3, 2010, the U.S. Government Accountability Office (GAO) issued a report which concluded that for-profit educational institutions had “encouraged fraudulent practices” designed to recruit students. The GAO investigated for-profit colleges in Arizona, California, Florida, Illinois, Pennsylvania, Texas and Washington, D.C. Recruiters at all 15 colleges studied by the GAO were found to have, “made some type of deceptive or otherwise questionable statement to undercover applicants, such as misrepresenting the applicant’s likely salary after graduation and not providing clear information about the college’s graduation rate. Other times our undercover applicants were provided accurate or helpful information by campus admissions and financial aid representatives.”

Zamansky & Associates has been investigating a number of these publicly held corporations purporting to offer accredited higher education including: The Apollo Group (APOL), Corinthian College (COCO), ITT Education Services Inc. (ESI), among more than a dozen others.  A full list of corporations our investigation is focusing on can be viewed here.  These corporations’ recruitment practices call into question whether they engaged in false and/or misleading statements and failed to disclose information to investors such as their accurate growth prospects and true financial results.

The actions of these companies has been detrimental to shareholders, but, like the subprime scandal before it, there is a human toll as well.  On June 24, 2010 Yasmine Issa, a 25 year-old single mother of 3 year-old twins, testified at a Senate hearing that she paid $32,000 to learn to become an ultrasound technician, believing she would receive marketable skills and job placement services.  Instead, after exhausting her savings, and taking on $20,000 of debt, she couldn’t find a job, and the so called placement services were of no help.  Unfortunately, this sad story is a common one.

Supposedly, lawmakers are going to step-in and change the laws that govern how for-profit education corporations operate.  The Department of Education, for example, plans to enact a “gainful employment” rule that threatens to cut off federal student loan money to schools that allowed their students, after having lost their jobs during the recession,  to take on more debt than they could afford.

Just like lending institutions such as Countrywide Financial, who argued they were helping low-income families achieve the American Dream when in reality the company was bleeding them dry, for-profit education companies are on the offensive.  They have reportedly hired expensive lobbyists and consultants to sway government rule makers, while also taking out full-page ads at their shareholders’ expense.  Corinthian Colleges, Inc.’s “1,000,000 students don’t count?” campaign and its website www.mycareercounts.com is a prime example.

Wall Street made a fortune selling loans to people who couldn’t pay them back.  For-profit education companies similarly paid their executives millions, while making empty promises to students looking to better themselves.  And while there are many similarities between the two scandals, the for-profit education industry differs in one very important way: it’s not too late for regulators to act.

Mirror, Mirror On the Wall… Who’s the Culprit For My Financial Fall?

As an investor advocate, I’m always on the lookout for easy-to-understand materials that can readily explain why investors should be wary of stockbrokers, insurance salesmen, and other peddlers of financial products that are supposedly a “sure thing” or “totally risk free.”  One of the best legal documents on this subject is the fraud complaint Massachusetts’ securities head William Galvin filed against Merrill Lynch in connection with the sale of auction rate securities.  The document is rich in detail about how Merrill Lynch always put its interests ahead of its customers.

Neil Weinberg, a senior editor at Forbes and one of the most knowledgeable personal finance journalists in the business, earlier this month published a feature that decidedly is one of the most insightful articles I’ve read about Wall Street in recent memory. Weinberg candidly warns his readers that the markets are a “rigged game” and provides a litany of evidence showing how investors are constantly being duped and deceived.  Among his examples: Nearly three quarters of the tax-deferred annuities sold in the first quarter were placed in IRA and other retirement accounts.  Annuities are great products for insurance brokers because they carry whopping commissions; but for investors, they are pricey and “dim-witted” (Weinberg’s words) for a retirement account.

Weinberg also quite possibly is the only mainstream financial journalist to appreciate the significance as to why Wall Street and the insurance industry fought so aggressively — and ultimately successfully — to eliminate a passage in the recent financial reform bill that would have held brokers and insurance salesmen as fiduciaries. Under this standard, brokers and insurance salesmen could be held liable for selling products that were not in the best financial interests of their clients. The upshot: bye, bye, 8 percent commissions for dubious annuities products. But Congress once again opted to put Wall Street’s interests ahead of investors.

Fortunately, there are signs that individual investors are getting wise to Wall Street’s shenanigans.  Merrill, Morgan Stanley, and Smith Barney last year controlled 25 percent of the industry assets under management in 2009, down from 32 percent in 2007, according to Cerulli Associates statistics cited in Bloomberg Businessweek.  Independent advisers and regional broker-dealers have increased their percentage of assets to 32 percent from 28 percent in 2007. That’s a comforting trend.

Merrill, now part of Bank of America, and Wells Fargo, the third-largest full-service U.S. brokerage, apparently are racking up some nice profits cross-selling banking services.  It might behoove investors to be wary of this cross-selling as big banks can no longer claim they adhere to a higher moral standard than brokerage firms.  A District Judge recently accused Wells Fargo of “gouging and profiteering” for changing its policies to process checks, debit card transactions and bill payments from the highest dollar amount to the lowest, rather than in the order the transactions took place. This, in turn, caused customer accounts to be overdrawn, thereby allowing Wells Fargo to pocket additional overdraft fees.  California also charged Wells Fargo with fraud for its aggressive sale of auction rate securities.

The warnings signs are as clear as day. As Weinberg pointedly tells readers: “Wall Street gets rich while you eke by. If you are looking for a culprit, look in the mirror.”

More Half-Baked Justice from the SEC

Last year, Judge Jed Rakoff of the United States Southern District of New York struck a blow on behalf of all investors when he ordered the SEC and Bank of America back to the negotiating table. He deemed the settlement agreement the SEC submitted for Bank of America’s alleged failure to disclose billions of dollars of losses at Merrill Lynch as inadequate and poorly constructed. When the SEC and Bank of America went back to the drawing board and agreed to somewhat stricter terms, still without admission of guilt, Judge Rakoff reluctantly approved. But not without a last salvo.

Judge Rakoff proclaimed that the revised settlement represented “very modest punitive, compensatory, and remedial measures that are neither directed at the specific individuals responsible for the nondisclosures nor appear likely to have more than a very modest impact on corporate practices or victim compensation…While better than nothing, this is half-baked justice at best.”

The same “half-baked justice” Judge Rakoff described last year was evident in the SEC’s recent settlement with Citigroup. The SEC alleged Citigroup executives hid $40 billion in toxic mortgage industry assets from its shareholders. Citigroup paid a $75 million fine for what might be one of the biggest accounting scandals on record and managed to avoid using the word “fraud” to describe its actions. Carefully crafted by Citigroup’s attorneys, the terms of the settlement were clearly designed to protect executives from liability and undermine shareholder’s seeking to recover their losses.

Goldman Sachs executives similarly managed to escape blame stemming from the SEC’s accusation that the firm inappropriately constructed the ABACUS CDO transaction. To recall, Goldman created ABACUS so that its clients would unknowingly invest in securities design to fail. To avoid admitting fraud and spare the reputations of senior-level executives, Goldman paid a fine of over $500 million. The settlement was so favorable to Goldman Sachs that its stock price rose 5% percent.

The SEC’s lackluster enforcement record during the financial crisis stands in stark contrast to the country’s state regulators. Attorneys General and securities regulators from many states have done all the heavy lifting, and have extracted meaningful settlements along the way. Most notable is Massachusetts Secretary of State William Galvin. Among Mr. Galvin’s accomplishments is ordering Bear Stearns to pay back 100 percent of any losses suffered by Massachusetts residents who invested in the firm’s infamous, sub-prime laden, hedge funds that spectacularly collapsed in 2007. He also was among the earliest regulators to take action against Wall Street for misleading investors about auction rate securities and he has ordered the Madoff feeder-fund Fairfield Greenwich to pay its investors every penny they lost.

Another active state enforcement official is Mark Connolly, Director of Securities Regulation for New Hampshire, who has accused UBS of fraud for its sales practices related to Principal Protected Notes issued by Lehman Brothers. His case is especially notable because unlike the SEC, he isn’t afraid to use the word “fraud” to describe “misleading investors.”

I could write for hours about all of the significant cases filed by state regulators, but there is a common theme: state securities regulators help investors recover losses from fraudulent schemes and seek to deter it from happening again within their borders.

Unfortunately the same cannot be said of the SEC.

Ethical Showdown: Goldman vs. Bear

Goldman Sachs has long reigned supreme on Wall Street because of the widespread perception and belief that they employed the smartest guys in the business.  But the SEC’s fraud charges against the firm have exposed another possible reason for the firm’s stratospheric success: The firm is more ethically challenged than some of its rivals.

We will let the courts decide the legal merits of the fraud charges the SEC filed against Goldman last week, but let’s consider the moral propriety of the firm selling its clients mortgage securities that hedge fund powerhouse John Paulson had determined were most likely to fail.  Goldman steadfastly maintains that it had no legal obligation to disclose that Paulson was the designer of the CDOs, but at least one competitor reportedly couldn’t stomach concocting such an arrangement.

In his book, “The Greatest Trade Ever,” Wall Street Journal reporter Greg Zuckerman discloses that Paulson first approached Bear Stearns trader Scott Eichel to structure  a package of highly toxic securities with a high likelihood of failure, but Eichel and his colleagues apparently wouldn’t do the deal.  According to Zuckerman:

Mr. Eichel said he felt it would look improper for his firm. “On the one hand, we’d be selling the deals to investors, without telling them that a bearish hedge fund was the impetus for the transaction, Mr. Eichel told a colleague; on the other hand, Bear Stearns would be helping Mr. Paulson wager against the deals.”

Zuckerman says that Deutsche Bank and other unnamed banks also worked with Paulson to structure CDOs that he could short, which, if true, raises the question as to why the SEC has singled out only Goldman for fraud.  Bears Stearns was hardly the paragon of ethical propriety (it marketed hedge funds filled with dubious subprime mortgage securities to unsuspecting retail investors), but its impressive that they chose to turn down a lucrative fee arrangement rather than engage in a transaction they perceived as morally wrong. Goldman and Deutsche Bank apparently had no such ethical compunctions.

Ironically, Eichel now reportedly works for Royal Bank of Scotland, which acquired a business unit of ABN AMRO that was on the losing side of the Paulson designed instruments.  Goldman maintains that it also lost $90 million on the deal, but I’m skeptical about the validity of the claim; the firm has long bragged about its risk management and its ability to hedge its trades. So while perhaps Goldman did indeed lose $90 million on one side of the transaction, it’s more than likely that they made it up on another.

Double Dealing: How UBS Profited From Lehman’s Accounting Duplicity

One of the recurring themes of my blog posts is that it’s nearly impossible to orchestrate financial wrongdoing of significant magnitude without the complicity of major financial institutions. Banks and brokerage firms almost invariably put their financial interests ahead of their clients, and any investor who believes otherwise should take the time to read this complaint by Massachusetts Secretary William Galvin alleging fraud in connection with Merrill Lynch’s sale of auction rate securities.  While Galvin’s complaint relates to Merrill, the countless allegations about how that firm failed its customers are pretty typical of how Wall Street treats its clients.

The Lehman bankruptcy examiner’s report made public last week further documents how Wall Street firms are quick to aid and abet wrongdoing.  To dress up its balance sheet, Lehman engaged in a myriad of “Repo 105″ transactions, a financial legerdemain that allowed the company to raise cash by parking assets at rival overseas firms and booking the sham swaps as “sales.”   This accounting hocus pocus, while not permissible under U.S. rules, was deemed kosher in the UK providing that Lehman orchestrated repo transactions through its London-based subsidiary and with non-U.S. banks. The examiner’s report makes clear that the foreign banks that facilitated Lehman’s sham sales were very much aware of the firm’s “desperation” to create the illusion that it had significantly shed assets and reduced its leverage.  For those not well versed in accounting, allow me to explain in simpler but cruder terms about what transpired: About a half dozen foreign banks played an active role in helping Lehman put some heavy duty lipstick on a pig.

One of Lehman’s most active beauticians was UBS.  UBS reportedly transacted approximately $10 billion in Repo 105 deals with Lehman, likely garnering the firm tens of millions of dollars in interest payments relating to the sham sales.  But UBS had another reason to help Lehman deceive investors about its flailing financial health. During the period Lehman was orchestrating its “Repo 105″ transactions, UBS’s retail brokers were aggressively peddling to their customers a product deceptively known as Lehman Brothers “100 Percent Principal Protected Notes.”  Although UBS marketed these notes to investors as being “risk free,” they were in fact extremely risky unsecured IOUs whose repayment was entirely dependent on Lehman’s financial solvency.  UBS paid its brokers high commissions to sell the risky Lehman notes to unsuspecting investors, which explains why the sales force successfully unloaded more than $1 billion of the paper. When Lehman collapsed, its notes instantly became nearly worthless.

UBS’s sale of the Lehman notes was questionable even before the bankruptcy examiner’s disclosure.  New Hampshire’s securities regulator charged in a filing last June that UBS engaged in “dishonest and unethical” practices selling the Lehman notes, causing New Hampshire investors to lose $2.5 million. The North American Securities Administrators Association (NAASA) has said it was considering convening a task force on the Lehman notes, and it’s my understanding the SEC is also looking into the matter.  I recently won a significant arbitration award on behalf of a client in South Carolina who bought Lehman notes from a UBS broker; it was the first arbitration decision relating to UBS’s sale of Lehman notes, and my office has more than a dozen pending.

Rest assured, UBS is going to have to account for why it continued to aggressively market Lehman notes to retail customers as highly conservative investments while on the institutional side facilitating transactions that were designed to mask Lehman’s troubled financial condition.  Ernst & Young, Lehman’s auditor, also has some “accounting” to do; that firm, as it happens, also is UBS’s auditor.  It will be interesting to learn how UBS booked the assets that Lehman “sold” the firm.

Individual investors owe Lehman bankruptcy examiner Anton Valukas a tremendous debt of gratitude. His report lays out in painstaking detail Wall Street’s fundamentally dishonest ways and makes clear the industry cannot be trusted to regulate itself.  Individual investors also should note that in early 2007, the year Lehman began its financial shenanigans, Charles Schumer and Michael Bloomberg, respectively New York’s senior senator and Mayor, issued this report by McKinsey & Company saying that the U.S. markets were fast losing ground to the UK because they were overly regulated.  As Lehman’s “Repo 105″ transactions were only permissible in the UK and not the US, we obviously shouldn’t be looking to that country for a regulatory model worth emulating.

Ironically, a significant number of investors who bought Lehman notes from UBS reside in the UK.  Fortunately for them, they can file arbitration claims in the US to seek redress.

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.

Bank of America: “Bank of Opportunity for Convicted Fellons” Part 2

We’ve discovered that it’s no accident that Bank of America is the “Bank of Opportunity” for convicted felons. The bank’s modus operandi  is to “See No Evil, Hear No Evil, Speak No Evil.”

As outlined in the class action suit we filed last month, Bank of America (NYSE:BAC), the nation’s largest bank, substantially assisted Nicholas Cosmo’s $400 Ponzi scheme and played a major role in the loss of investor funds. The evidence is substantial that Bank of America knew, or should have known, that Cosmo was committing fraud. Cosmo was indicted earlier this week for mail and wire fraud. 

Our investigation has progressed and in the amended complaint we filed yesterday, we allege that Bank of America not only opened the proverbial barn door to Cosmo’s victims, the bank personally guided them through the barn.

Cosmo is a convicted felon who after completing a nearly two year stint in federal prison founded Agape World, Inc., a Long Island company specializing in making short-term “bridge” construction loans carrying high interest rates. Through a network of about a dozen brokers, Cosmo gathered some $400 million from investors who wanted to realize the attractive rates of returns. Unbenounced to the investors, Cosmo re-sold the same interests hundreds, if not thousands, of times. 

Although Bank of America ostensibly has “know your customer” rules and procedures, our complaint alleges that employees were routinely pressured to ignore obvious red flags such as a customer whose rap sheet includes securities fraud. 

Once upon a time BoA had a special unit based in Boston dubbed the “High Risk Group” whose mandate was to ferret out fraudsters like Nick Cosmo.  But we’ve learned that in 2006 Bank of America summarily shut the unit down because conscientious employees were resisting pressure to circumvent the bank’s purported “know your customer” rules.

Bank of America’s shuttering of its “High Risk Group” might also explain how in 2008 Florida fraudster Andy Bowdoin managed to use Bank of America as a conduit for his Ponzi scheme.   At Bank of America revenues apparently supersede all other obligations and considerations.

Our amended lawsuit also alleges that Bank of America apparently provided Cosmo access to information about the cash balances of Agape investors who had accounts with Bank of America.  Agape investors routinely received aggressive solicitations from Cosmo when their balances swelled.  So much for client confidentiality. 

Bank of America’s privacy problems are particularly alarming because back in July of 2007, the bank settled a lawsuit with the Utility Consumers Action Network, who alleged Bank of America disclosed consumers’ personal, private, confidential information to third parties without consumers’ consent. As part of the multi-million dollar settlement Bank of America made changes to its various privacy policies, it’s Web site and its procedures

Generating revenues to the detriment of customers is quite common on Wall Street. One of the best documented examples is the Commonwealth of Massachusetts’ complaint against Merrill Lynch regarding that firm’s peddling of auction rate securities.   ”Time after time, when confronted with conflicts of interest, Merrill Lynch was consistent in that it placed its own interests ahead of its investor clients,” the administrative complaint charged.

Bank of America acquired Merrill Lynch earlier this year.  When it comes to customer exploitation, it’s a marriage made in heaven.

Congress’ Task: An Honest Debate over ‘Stoneridge’

When a murder for hire crime is committed, two trials usually proceed.  The prosecutor’s office brings a criminal case and the victim’s family usually sues the defendant’s in civil court for monetary damages.  Unfortunately, it doesn’t work like that in the corporate world due to a Supreme Court ruling labeled, “The Stoneridge Decision,” which declared that “third-party liability” is limited to those that directly influenced investment decisions.  In other words, even though lawyers, investment bankers and auditors may have aided a corporate fraud, because a corporation interacts directly with shareholders, service providers don’t have any liability. I think there is something fundamentally wrong with this picture.

Lest anyone say the comparison I’ve just described is overly dramatic, I’ve excerpted below Federal Judge Gerald Lynch’s opinion regarding a fraud case he was forced to dismiss because of the crippling Supreme Court Stoneridge snub:

There are accomplices and there are accomplices: after all, in the criminal context when the Godfather orders a hit, he is only an accomplice to murder - one who ‘counsels, commands, induces or procures’  but he is nonetheless liable as a principal for the commission of crime. Likewise, some civil accomplices are deeply and indispensably implicated in the wrongful conduct.

 The fraud case Judge Lynch is referring to involves Mayer Brown, a large law firm, which was one of the law firms that has been alleged to have helped Refco, a now defunct brokerage giant, hide over $1 billion in losses from shareholders.

In addition to shareholders, the Stoneridge Decision has a huge impact for investors that have fallen victim to Ponzi Schemes and fraudulent hedge funds.  In almost all these cases there is nothing left of the funds leaving penniless victims without any recourse, even if the individuals responsible for ripping them off had help from outside sources?

Unfortunately a law on the books as influential as the Stonebridge Decision doesn’t gain the attention it deserves compared with the A.I.G. bonuses, for instance, but this law’s implications are greatly felt on Main Street U.S.A.

In related news, Bernard Madoff’s accountant was arrested earlier this week and charged with aiding and abetting investment adviser fraud and four counts of filing false audit reports. He faces up to 105 years in prison if convicted.  Reportedly, the accountant received $186,000 a year in fees for audit work, bookkeeping and tax services.

These fees and other assets owned by the allegedly crooked accountant are likely out of the reach for investors who took his audits at face value.  Indeed, while the accountant is likely to be sitting in a warm jail cell, the victims are left out in the cold.

The next session of Congress is likely going to be focused on reforming regulation of the financial services industry.  An honest discussion over the consequence of the Stoneridge Decision needs to be at the forefront of the agenda. I urge Congress to take meaningful steps to addressing this immensely important issue.

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.